This discussion should be read in conjunction with our unaudited interim condensed consolidated financial statements and the notes thereto. CRITICAL ACCOUNTING ESTIMATES The policies and estimates that the Company considers the most critical in terms of complexity and subjectivity of assessment are those related to environmental liabilities, pensions, income taxes, goodwill and property, plant and equipment and other intangible assets (net of depreciation and amortization). These policies have been discussed in the Company's 2019 Form 10-K. Impact of COVID-19 Pandemic and Current Economic Environment In the first quarter of 2020, we did not experience a significant impact on our business resulting from government restrictions on the movement of people, goods, and services. While there was some slowdown of operations in our Fuel Specialties business, we experienced limited impact to our operations and financial position during the quarter. We are expecting to see our operations for the remainder of the year impacted by the current economic environment. We are experiencing what we believe will be a short-term decrease in demand for fuel additives due to the reduced demand for fuel. Our Oilfield Services business is experiencing a significant decline in the demand for our goods and services as customer activity has declined sharply due to the fall in oil price. In Performance Chemicals demand is currently holding up well which is a reflection of the integral role our products play in meeting the daily health, hygiene and cleaning needs of consumers around the world. We do not know how long this downturn will last and the rate of recovery will depend heavily on the rate and extent to which the government restrictions on movement are lifted. Our manufacturing facilities have continued to operate with only some minor interruption, and we expect them to continue to do so. We have implemented flexible working, including working from home for our employees where possible, in line with advice and rules in each of the jurisdictions in which we operate. Raw material sourcing has not been significantly impacted and we do not expect that to change over the remainder of the year. Logistics are operating with some delays but our products are currently being delivered to our customers. Our financial position remains strong. We have sufficient access to capital if needed, including our$250 million revolving credit facility we entered into inSeptember 2019 and do not anticipate any issues with meeting the covenants for our debt agreements. Our major capital projects are continuing to progress as planned. As we operate in the chemical industry, we continue to be focused on protecting the health and safety of our employees and have procedures in place at each of our operating facilities to help ensure their well-being. We do not know how long the current economic environment will continue and while we have made estimates as to potential impacts on our financial position and operations, the ultimate impact on our business will depend on many factors which are very difficult to predict with certainty and substantially beyond our control. 21
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Table of Contents RESULTS OF OPERATIONS The Company reports its financial performance based on the following four reportable segments: Fuel Specialties, Performance Chemicals, Oilfield Services and Octane Additives. The following table provides operating income by reporting segment: Three Months Ended March 31 (in millions) 2020 2019 Net sales: Fuel Specialties$ 147.0 $ 156.0 Performance Chemicals 113.1 118.1 Oilfield Services 112.2 114.2$ 372.3 $ 388.3 Gross profit/(loss): Fuel Specialties$ 51.2 $ 55.7 Performance Chemicals 27.6 26.6 Oilfield Services 36.2 37.7 Octane Additives (1.1 ) (2.2 )$ 113.9 $ 117.8 Operating income/(loss): Fuel Specialties$ 32.1 $ 32.9 Performance Chemicals 15.6 13.5 Oilfield Services 7.2 7.8 Octane Additives (1.2 ) (2.8 ) Corporate costs (12.8 ) (15.2 ) Total operating income$ 40.9 $ 36.2 22
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Table of Contents Three Months EndedMarch 31, 2020 The following table shows the change in components of operating income by reporting segment for the three months endedMarch 31, 2020 and the three months endedMarch 31, 2019 : Three Months Ended March 31 (in millions, except ratios) 2020 2019 Change Net sales: Fuel Specialties$ 147.0 $ 156.0 $ (9.0 ) -6 % Performance Chemicals 113.1 118.1 (5.0 ) -4 % Oilfield Services 112.2 114.2 (2.0 ) -2 %$ 372.3 $ 388.3 $ (16.0 ) -4 % Gross profit/(loss): Fuel Specialties$ 51.2 $ 55.7 $ (4.5 ) -8 % Performance Chemicals 27.6 26.6 1.0 +4 % Oilfield Services 36.2 37.7 (1.5 ) -4 % Octane Additives (1.1 ) (2.2 ) 1.1 +50 %$ 113.9 $ 117.8 $ (3.9 ) -3 % Gross margin (%): Fuel Specialties 34.8 35.7 -0.9 Performance Chemicals 24.4 22.5 +1.9 Oilfield Services 32.3 33.0 -0.7 Octane Additives n/a n/a n/a Aggregate 30.6 30.3 +0.3 Operating expenses: Fuel Specialties$ (19.1 ) $ (22.8 ) $ 3.7 -16 % Performance Chemicals (12.0 ) (13.1 ) 1.1 -8 % Oilfield Services (29.0 ) (29.9 ) 0.9 -3 % Octane Additives (0.1 ) (0.6 ) 0.5 -83 % Corporate costs (12.8 ) (15.2 ) 2.4 -16 %$ (73.0 ) $ (81.6 ) $ 8.6 -11 % 23
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Table of Contents Fuel Specialties Net sales: the table below details the components which comprise the year over year change in net sales spread across the markets in which we operate: Three Months Ended March 31, 2020 Change (%) Americas EMEA ASPAC AvTel Total Volume -7 -11 -12 +88 -5 Price and product mix +5 +2 +1 -42 +1 Exchange rates 0 -3 0 0 -2 -2 -12 -11 +46 -6 Volumes in theAmericas were lower, in part due to the continuation of a specific issue from the latter part of 2019 related to disruption from one supplier.Innospec now have alternative sources of supply which minimises the future impact. Volumes in all our regions suffered from the adverse impact of the global COVID-19 pandemic towards the end of the quarter which reduced demand for fuel additive products. Although the future market demand for fuel additive products is uncertain due to the COVID-19 pandemic, we believe that customer demand will continue to be adversely impacted in the second quarter. Price and product mix in all our regions was favorable due to a richer sales mix. AvTel volumes were higher than the prior year due to variations in the demand from customers, partly offset by an adverse price and product mix. EMEA was negatively impacted by exchange rate movements year over year, driven by a weakening of theEuropean Union euro against theU.S. dollar. Gross margin : the year over year decrease of 0.9 percentage points was in comparison to a strong product mix for the prior year comparative. Operating expenses: the year over year decrease of$3.7 million was driven by lower personnel related performance-based remuneration due to a decrease in the share-based compensation accruals linked to theInnospec share price which declined in the quarter. Performance Chemicals Net sales: the table below details the components which comprise the year over year change in net sales spread across the markets in which we operate: Three Months Ended March 31, 2020 Change (%) Americas EMEA ASPAC Total Volume +13 -1 +60 +7 Price and product mix -11 -8 -6 -9 Exchange rates 0 -3 -2 -2 +2 -12 +52 -4 Higher volumes in theAmericas and ASPAC were driven by increased demand for our Personal Care products. Volumes were slightly reduced in EMEA due to lower demand in Personal Care and Home Care products. All our regions suffered an adverse price and product mix, including the adverse impact of lower raw material prices driving lower selling prices for certain products. EMEA and ASPAC were negatively impacted by exchange rate movements year over year, due to a weakening of theEuropean Union euro against theU.S. dollar during the quarter. Gross margin: the year over year increase of 1.9 percentage points was driven by a richer sales mix and the continued focus on margin improvement projects. 24
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Table of Contents Operating expenses: the year over year decrease of$1.1 million was driven by lower personnel related performance-based remuneration due to a decrease in the share-based compensation accruals linked to theInnospec share price which declined in the quarter. Oilfield Services Net sales: the year over year decrease of$2.0 million , or 2 percent, was due to reduced customer activity in completions as a result of the decline in the price of crude oil, which was partly offset by increases in revenue from production chemicals, drag reducing agents and sales to a new customer intoSaudi Arabia . The Company expects the adverse impact from the decline in the price of crude oil to continue into the second quarter. Gross margin: the year over year decrease of 0.7 percentage points was due to lower sales of higher margin products in the completions market. Operating expenses: the year over year decrease of$0.9 million was driven by lower personnel related performance-based remuneration due to a decrease in the share-based compensation accruals linked to theInnospec share price which declined in the quarter. Octane Additives Net sales: were nil in the current quarter and the prior year, which is in line with our expectations as the one remaining customer is nearing the completion of their transition to unleaded fuel. Gross loss : was$1.1 million in the current year compared to$2.2 million in the prior year. The reduction in losses was a result of the halt in production, in line with the expectation of nil demand for the quarter. The cost primarily relates to the accretion charge on the plant closure provision. Operating expenses: the year over year decrease of$0.5 million was a result of management plans to maintain efficient operational activity in line with the lower production volumes. Other Income Statement Captions Corporate costs: the year over year decrease of$2.4 million was driven by lower personnel related performance-based remuneration, primarily due to a decrease in the share-based compensation accruals linked to theInnospec share price, which declined in the quarter. The reduction in costs was partly offset by higher spending on information technology following the network security incident in the second quarter of 2019. Other net income: for the first quarter of 2020 and 2019, included the following: (in millions) 2020 2019 Change . United Kingdom pension credit$ 1.7 $ 1.9 $ (0.2 ) German pension charge (0.2 ) (0.2 ) 0.0
Foreign exchange gains on translation 0.5 2.2 (1.7 ) Foreign currency forward contracts gains 1.9 0.2 1.7
$ 3.9 $ 4.1 $ (0.2 ) 25
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Table of Contents Interest expense, net: was$0.6 million for 2020 compared to$1.5 million in the prior year, driven by lower average net debt as the business generated cash inflows. Income taxes: the effective tax rate was 25.1% and 26.0% in the first quarter of 2020 and 2019, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 25.1% in 2020 compared with 26.8% in 2019. The 1.7% decrease in the adjusted effective rate was primarily due to the fact that a higher proportion of the Company's profits are being generated in lower tax jurisdictions. The Company believes that this adjusted effective tax rate, a non-GAAP financial measure, provides useful information to investors and may assist them in evaluating the Company's underlying performance and identifying operating trends. In addition, management uses this non-GAAP financial measure internally to evaluate the performance of the Company's operations and for planning and forecasting in subsequent periods. The following table shows a reconciliation of the GAAP effective tax rate to the adjusted effective tax rate: Three Months Ended March 31 (in millions) 2020 2019 Income before income taxes$ 44.2 $ 38.8
Indemnification asset regarding tax audit 0.2 0.0 Adjustment for stock compensation
1.4 1.5$ 45.8 $ 40.3 Income taxes$ 11.1 $ 10.1 Tax on stock compensation 0.4 0.9 Adjustment of income tax provision (0.0 ) (0.2 )$ 11.5 $ 10.8 GAAP effective tax rate 25.1 % 26.0 % Adjusted effective tax rate 25.1 % 26.8 % 26
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Table of Contents LIQUIDITY AND FINANCIAL CONDITION Working Capital In the first quarter of 2020 our working capital increased by$33.8 million , while our adjusted working capital increased by$42.3 million . The difference is primarily due to a reduction in our cash and cash equivalents. The Company believes that adjusted working capital, a non-GAAP financial measure, (defined by the Company as trade and other accounts receivable, inventories, prepaid expenses, accounts payable and accrued liabilities rather than total current assets less total current liabilities) provides useful information to investors in evaluating the Company's underlying performance and identifying operating trends. Management uses this non-GAAP financial measure internally to allocate resources and evaluate the performance of the Company's operations. Items excluded from working capital in the adjusted working capital calculation are listed in the table below and represent factors which do not fluctuate in line with the day to day working capital needs of the business. March 31, December 31, (in millions) 2020 2019 Total current assets$ 626.7 $ 630.3 Total current liabilities (266.1 ) (303.5 ) Working capital 360.6 326.8 Less cash and cash equivalents (68.1 ) (75.7 ) Less prepaid income taxes (4.7 ) (2.5 ) Less other current assets 0.0 (0.8 ) Add back current portion of accrued income taxes 12.3 10.3 Add back current portion of finance leases 0.8 1.0 Add back current portion of plant closure provisions 5.6 5.6 Add back current portion of operating lease liabilities 11.1 10.6 Adjusted working capital$ 317.6 $ 275.3
We had a
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Table of Contents Operating Cash Flows We generated cash from operating activities of$2.4 million in the first three months of 2020 compared to cash inflows of$13.2 million in the first three months of 2019. The reduction in cash generated from operating activities was primarily related to additional payments for inventory and the timing of payments for income taxes. Cash AtMarch 31, 2020 andDecember 31, 2019 , we had cash and cash equivalents of$68.1 million and$75.7 million , respectively, of which$54.4 million and$57.9 million , respectively, were held by non-U.S. subsidiaries principally in theUnited Kingdom . The decrease in cash and cash equivalents in 2020 of$7.6 million was primarily related to the Company's investment in property, plant and equipment. Debt AtMarch 31, 2020 , we had$60.0 million of debt outstanding under our revolving credit facility and$1.2 million of obligations under finance leases relating to certain fixed assets within our Fuel Specialties and Oilfield Services segments. AtDecember 31, 2019 , we had$60.0 million of debt outstanding under the revolving credit facility and$1.5 million of obligations under finance leases relating to certain fixed assets within our Fuel Specialties and Oilfield Services segment. 28
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