INNOSPEC INC. (IOSP) FY 2022 MD&A

Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion should be read in conjunction with our Consolidated Financial Statements and the Notes thereto.

EXECUTIVE OVERVIEW

In 2022 Innospec delivered double-digit sales and operating income growth with expanded margins, and each of our businesses contributed meaningfully to our results. We benefited from our balanced end-market exposure in late 2022 as the negative impact of year-end customer destocking in Performance Chemicals was offset by continued growth in Oilfield Services and Fuel Specialties.

In Performance Chemicals, despite aggressive customer destocking which drove lower volumes and margins in the fourth quarter, full-year operating income increased by 34 percent, and operating margin improved for the fifth consecutive year. Our industry-leading personal care technologies drove the majority of operating income growth in 2022.

Fuel Specialties delivered double-digit operating income growth for the full year. Gross margins remained below our expected range, but improvement continues to be a key focus and opportunity for our business in 2023. We believe there is potential for gross margin expansion once inflation normalizes and demand for our higher margin jet fuel additives recovers.

Oilfield Services achieved significant sales and operating income growth over the prior year. In 2023, we anticipate that a portion of our sales will moderate versus the extremely strong third and fourth quarters of 2022. However, we expect potential for further improvement in the other markets within our oilfield business.

CRITICAL ACCOUNTING ESTIMATES

Note 2 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of the consolidated financial statements.

Plant Closure Provisions

We are subject to environmental laws in the countries in which we conduct business. Ellesmere Port in the United Kingdom is our principal site giving rise to asset retirement obligations, associated with the production of TEL. There are also asset retirement obligations and environmental remediation liabilities on a much smaller scale in respect of other manufacturing sites. At Ellesmere Port there is a continuing asset retirement program related to certain manufacturing units that have been closed.

Plant closure provisions at December 31, 2022 amounted to $57.2 million and relate principally to our Ellesmere Port site in the United Kingdom. We recognize environmental

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remediation liabilities when they are probable and costs can be reasonably estimated, and asset retirement obligations when there is a legal requirement, including those arising from a Company promise, and the costs can be reasonably estimated. The Company has to anticipate the program of work required and the associated future expected costs, and comply with environmental legislation in the countries in which it operates or has operated in. We develop these assumptions utilizing the latest information available together with recent costs. While we believe our assumptions for plant closure provisions are reasonable, they are subjective estimates and it is possible that variations in any of the assumptions will result in materially different calculations to the liabilities we have reported.

Income Taxes

We are subject to income and other taxes in the U.S., the U.K., and a number of other jurisdictions. Tax laws are dynamic and subject to change as new laws are passed and new interpretations of the law are issued or applied.

The calculation of our tax liabilities involves evaluating uncertainties in the application of accounting principles and complex tax regulations. We recognize liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes will be required. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary.

We also recognize tax benefits to the extent that it is more likely than not that our positions will be sustained, based on technical merits of the position, when challenged by the taxing authorities. To the extent that we prevail in matters for which liabilities have been established or are required to pay amounts in excess of the liabilities recorded in our financial statements, our effective tax rate in a given period may be materially affected. An unfavorable tax settlement may require cash payments and result in an increase in our effective tax rate in the year of resolution. We report interest and penalties related to uncertain tax positions as income taxes. For additional information regarding uncertain income tax positions, see Note 11 of the Notes to the Consolidated Financial Statements.

Pensions

The Company maintains a defined benefit pension plan covering certain current and former employees in the United Kingdom (“UK Plan”). The UK Plan is closed to future service accrual but has a large number of deferred and current pensioners. The Company also has other smaller pension arrangements in the U.S. and overseas.

In May 2022, the Trustees of the UK Plan entered into an agreement with Legal and General Assurance Society Limited to acquire an insurance policy that operates as an investment asset, with the intent of matching the remaining uninsured part of the UK Plan’s future cash outflow arising from the accrued pension liabilities of members. Such an arrangement is commonly termed as a “buy-in”. The benefit obligation was not transferred to the insurer, and the Company remains responsible for paying pension benefits. The initial value of the asset associated with this contract was equal to the premium paid to secure the contract and is

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adjusted each reporting period to reflect the estimated fair value of the premium that would be paid for such a contract at that time. The buy-in reduces the UK Plan’s value at risk in relation to key risks associated with improved longevity, inflation and interest rate movements while improving the security to the UK Plan and its members. The Company consequently benefits from the buy-in as it reduces the UK Plan’s potential reliance on the Company for future cash funding requirements.

Movements in the UK Plan’s Projected Benefit Obligation (“PBO”) are dependent on our assumptions in respect of the discount rate, annual member mortality rates, future return on assets and future inflation. A change in any one of these assumptions could impact the plan asset value, PBO and pension charge recognized in the income statement. Such changes could adversely impact our results of operations and financial position. For example, a 0.25% change in the discount rate assumption would change the PBO at December 31, 2022 by approximately $10.3 million and the net pension credit for 2023 would change by approximately $0.1 million. A 0.25% change in the level of price inflation assumption would change the PBO at December 31, 2022 by approximately $6.5 million and the net pension credit for 2022 by approximately $0.6 million.

Further information is provided in Note 10 of the Notes to the Consolidated Financial Statements.

Goodwill

The Company’s reporting units, the level at which goodwill is assessed for potential impairment, are consistent with the reportable segments. The components in each segment (including products, markets and competitors) have similar economic characteristics and the segments, therefore, reflect the lowest level at which operations and cash flows can be sufficiently distinguished, operationally and for financial reporting purposes, from the rest of the Company.

To test for impairment the Company performs a qualitative step zero assessment to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a segment is less than the carrying amount prior to performing the quantitative goodwill impairment test. Factors utilized in the qualitative assessment process include macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; and Company specific events.

If a quantitative test is required, we assess the fair value based on projected post-tax cash flows discounted at the Company’s weighted average cost of capital. These fair value techniques require management judgment and estimates including revenue growth rates, projected operating margins, changes in working capital and discount rates. We would develop these assumptions by considering recent financial performance and trends and industry growth estimates. While we believe our assumptions for impairment assessments are reasonable, they are subjective judgments, and it is possible that variations in any of the assumptions will result in materially different calculations of any potential impairment charges.

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At December 31, 2022 we had $358.8 million of goodwill relating to our Performance Chemicals, Fuel Specialties and Oilfield Services segments. Our step zero impairment review at December 31, 2022 indicated the fair value of each segment is, more likely than not, higher than the carrying value, meaning no step one impairment review was required to be performed.

Property, Plant and Equipment and Other Intangible Assets (Net of Depreciation and Amortization, respectively)

As at December 31, 2022 we had $220.9 million of property, plant and equipment and $45.0 million of other intangible assets (net of depreciation and amortization, respectively), that are discussed in Notes 6 and 9 of the Notes to the Consolidated Financial Statements, respectively. These long-lived assets relate to all of our reporting segments and are being amortized or depreciated straight-line over periods of up to 17 years in respect of the other intangible assets and up to 25 years in respect of the property, plant and equipment.

We continually assess the markets and products related to these long-lived assets, as well as their specific carrying values, and have concluded that these carrying values, and amortization and depreciation periods, remain appropriate.

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RESULTS OF OPERATIONS

The following table provides sales, gross profit and operating income by reporting segment:

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Results of Operations – Fiscal 2022 compared to Fiscal 2021:

Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.

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:

Higher sales volumes for the Americas and ASPAC were primarily driven by increased demand for our personal care products. Lower sales volumes for EMEA were due to

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reductions in demand for our home care products when compared to strong sales volumes in the prior year. All our regions benefited from a favorable price and product mix due to increased sales of higher priced products together with the impact of increased raw materials pricing being passed on through higher selling prices. EMEA and ASPAC were adversely impacted by exchange rate movements year over year, due to a strengthening of the U.S. dollar against the British pound sterling and the European Union euro.

Gross margin: the year over year decrease of 0.4 percentage points was primarily due to adverse manufacturing variances and higher raw materials costs in the fourth quarter of 2022, being partly offset by a favorable sales mix from increased sales of higher margin products.

Operating expenses: the year over year increase of $0.4 million was due to higher selling expenses to support our increased sales and higher personnel-related expenses, including higher share-based compensation accruals and higher performance-related remuneration accruals; being partly offset by lower provisions for doubtful debts.

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:

The Americas and ASPAC sales volumes have increased year over year as the global demand for refined fuel products has increased. EMEA sales volumes were lower year over year primarily due to a reduction for the sales of higher volume lower margin products. Price and product mix was favorable in all our regions due to a favorable sales mix with an increased proportion of sales of higher margin products, together with the impact of increased raw materials pricing being passed on through higher selling prices. AvGas volumes were higher than the prior year due to variations in the demand from customers, being offset by an adverse price and product mix with a higher proportion of sales being made to lower margin customers. EMEA and ASPAC were adversely impacted by exchange rate movements year over year, due to a strengthening of the U.S. dollar against the British pound sterling and the European Union euro.

Gross margin: the year over year decrease of 0.8 percentage points was due to the impact of the time lag for passing higher raw material costs through to selling prices.

Operating expenses: the year over year increase of $11.6 million was due to higher personnel-related expenses, including higher share-based compensation accruals, higher travel expenses, increased sales promotions and increased provisions for doubtful debts.

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Oilfield Services

Net sales: have increased year over year by $254.0 million, or 75 percent, with the majority of our customer activity being concentrated in the Americas region. Customer demand has increased through each quarter in 2022, which we believe represents a positive sign for further sales growth going into 2023.

Gross margin: the year over year increase of 1.9 percentage points was due to a favorable sales mix, while management are continuing to maintain prices in a competitive market.

Operating expenses: the year over year increase of $67.0 million was driven by higher customer service costs which are necessary to support the increase in demand, together with higher personnel-related expenses, including higher share-based compensation accruals and higher performance-related remuneration accruals, and increased provisions for doubtful debts.

Other Income Statement Captions

Corporate costs: the year over year increase of $15.8 million was driven by higher personnel-related expenses, including higher share-based compensation accruals and higher performance-related remuneration accruals, together with increased maintenance expenditure for our information technology infrastructure.

Profit on disposal: in the prior year there was a profit on disposal of $1.8 million, which principally related to the sale of land within our oilfield services business in the U.S..

Other net income/(expense): for 2022 and 2021, includes the following:

Interest expense, net: was $1.1 million in 2022 compared to $1.5 million in 2021. Interest expense includes a commitment fee to retain the Company’s revolving credit facility for the term of the agreement.

Income taxes: The effective tax rate was 28.0% and 30.7% in 2022 and 2021, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 27.0% in 2022 compared with 22.7% in 2021. 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.

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The GAAP effective tax rate and adjusted effective tax rate in 2022 have been negatively impacted by foreign income inclusions, net of foreign tax credits, which arise each year from certain types of income earned overseas being taxable under U.S. tax regulations.

As a consequence of the Company having operations outside of the U.S., it is exposed to foreign currency fluctuations. These have also had a negative impact on the GAAP effective tax rate and adjusted effective tax rate in 2022.

The adjusted effective tax rate is lower than the GAAP effective tax rate, primarily due to elimination of stock compensation activity to better reflect the Company’s underlying business performance.

The most significant factor impacting our adjusted effective tax rate in 2021 is the elimination of the impact of the increase in the U.K. statutory income tax rate.

For additional information regarding the GAAP effective tax rate in 2022, see Note 11 of the Notes to the Consolidated Financial Statements.

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Results of Operations – Fiscal 2021 compared to Fiscal 2020:

Financial information with respect to our domestic and foreign operations is contained in Note 3 of the Notes to the Consolidated Financial Statements.

Performance Chemicals

Net sales: the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:

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Higher volumes for the Americas were driven by increased demand for our personal care products. Volumes in EMEA were favorable including the continued recovery of demand across several markets which have been adversely impacted by the pandemic. Lower volumes in ASPAC were primarily driven by a reduction in demand for our personal care products. All our regions benefited from a favorable price and product mix due to increased sales of higher priced products and increased raw materials pricing being passed on through higher selling prices. EMEA and ASPAC benefited from favorable exchange rate movements year over year, due to a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.

Gross margin: the year over year decrease of 0.6 percentage points was due to adverse manufacturing variances as activity slowed over the holiday season in the fourth quarter, together with some one-off provisions.

Operating expenses: the year over year increase of $5.3 million was due to increased spending on research and development, an increase in the allowance for doubtful debts and higher personnel-related expenses including higher share-based compensation accruals and higher performance related remuneration accruals.

Fuel Specialties

Net sales: the table below details the components which comprise the year on year change in net sales spread across the markets in which we operate:

Volumes in all our regions have increased year over year, as the global demand for refined fuel products has returned to near the pre-pandemic levels. Price and product mix was favorable in all our regions due to increased sales of higher margin products and increased raw materials pricing being passed on through higher selling prices. AvGas volumes were lower than the prior year due to variations in the demand from customers, being offset by a favorable price and product mix with a higher proportion of sales to higher margin customers. EMEA and ASPAC benefited from favorable exchange rate movements year over year, due to a strengthening of the British pound sterling and the European Union euro against the U.S. dollar.

Gross margin: the year over year decrease of 0.1 percentage points was impacted by the time lag for passing higher raw material costs through to selling prices in the second half of the year.

Operating expenses: the year over year increase of $12.8 million was due to higher selling expenses to support the increased sales, together with higher research and development costs

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and higher personnel-related expenses including higher share-based compensation accruals and higher performance related remuneration accruals.

Oilfield Services

Net sales: have increased year over year by $84.8 million, or 33 percent, with the majority of our customer activity continuing to be in the Americas region. Customer demand has increased throughout the year as the pandemic recovery has continued. We expect to see continued growth in customer demand into 2022.

Gross margin: the year over year increase of 2.6 percentage points was due to a favorable sales mix compared to a prior year comparative which was adversely impacted by the pandemic, while management have successfully maintained prices in a competitive market.

Operating expenses: the year over year increase of $15.8 million was driven by our continuing customer service flexibility which allows us to support the increase in demand as the pandemic recovery has continued, together with higher personnel-related expenses including higher share-based compensation accruals and higher performance related remuneration accruals.

Octane Additives

The Octane Additives business ceased trading and is no longer a reporting segment from July 1, 2020 as the production of TEL for use in motor gasoline has finished. Legacy costs related to these operations have now been recorded as operating expenses within corporate costs.

Prior to the business ceasing trade there were no sales in 2020, together with a gross loss of $2.2 million and operating expenses of $0.6 million.

Other Income Statement Captions

Corporate costs: the year over year increase of $3.4 million was driven by higher personnel-related expenses including higher share-based compensation accruals and higher performance related remuneration accruals, together with the adverse impact of the foreign currency translation of our costs at Ellesmere Port in the United Kingdom due to a strengthening of the British pound sterling against the U.S. dollar.

Profit on disposal: there has been a profit on disposal of assets for $1.8 million in 2021, which principally relates to the sale of land within our oilfield services business in the U.S..

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Other net income/(expense): for 2021 and 2020, includes the following:

Interest expense, net: was $1.5 million in 2021 compared to $1.8 million in 2020, driven by the repayment in full of our revolving credit facility in the second half of 2020. Interest expense includes a commitment fee to retain the Company’s revolving credit facility for the term of the agreement.

Income taxes: The effective tax rate was 30.7% and 27.7% in 2021 and 2020, respectively. The adjusted effective tax rate, once adjusted for the items set out in the following table, was 22.7% in 2021 compared with 23.5% in 2020. 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.

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The most significant factor impacting our adjusted effective tax rate in 2021 is the elimination of the impact of the increase in the statutory income tax rate in the U.K..

The most significant factors impacting our adjusted effective tax rate in 2020 are the restructuring charge relating to the cessation of production and sales of TEL for use in motor gasoline, the impairment of acquired intangible assets in our Oilfield Services segment, and the elimination of the impact of the increase in the statutory income tax rate in the U.K..

LIQUIDITY AND FINANCIAL CONDITION

Working Capital

In 2022 our working capital increased by $75.3 million, while our adjusted working capital increased by $88.7 million. The difference is primarily due to the exclusion of the increase in our cash and cash equivalents, together with the movements for income taxes.

The Company believes that adjusted working capital, a non-GAAP financial measure, 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 the adjusted working capital calculation are listed in the table below and

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represent factors which do not fluctuate in line with the day to day working capital needs of the business.

The movements in our adjusted working capital are explained as follows:

We had a $50.1 million increase in trade and other accounts receivable primarily driven by increased trading activity across our reporting segments. Days’ sales outstanding in our Performance Chemicals segment decreased from 64 days to 60 days; increased in our Fuel Specialties segment from 53 days to 54 days; and increased from 52 days to 54 days in our Oilfield Services segment.

We had a $95.5 million increase in inventories, net of a $1.7 million increase in allowances, as we managed inventory levels to support future demand, with the intention of mitigating the risk of potential supply chain disruption for certain key raw materials. Days’ sales in inventory in our Performance Chemicals segment increased from 59 days to 78 days; increased in our Fuel Specialties segment from 108 days to 138 days; and decreased from 76 days to 58 days in our Oilfield Services segment.

Prepaid expenses decreased $3.9 million, from $18.0 million to $14.1 million principally due to the reduction in prepaid customer marketing arrangements.

We had a $53.0 million increase in accounts payable and accrued liabilities primarily due to increased activity across all our reporting segments. Creditor days (including goods received not invoiced) decreased in our Performance Chemicals segment from 47 days to 42 days; decreased in our Fuel Specialties segment from 50 days to 45 days; and increased from 48 days to 54 days in our Oilfield Services segment.

Operating Cash Flows

We generated cash from operating activities of $81.7 million in 2022 compared to cash inflows of $93.2 million in 2021. The reduction in cash generated from operating activities

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was primarily related to the increases for our working capital being partly offset by the improvements in our earnings before depreciation and amortization.

Cash

At December 31, 2022 and 2021, we had cash and cash equivalents of $147.1 million and $141.8 million, respectively, of which $76.4 million and $55.1 million, respectively, were held by non-U.S. subsidiaries principally in the United Kingdom.

The $5.3 million increase in cash and cash equivalents in 2022 was driven by the cash inflows from operating activities, while being partly offset by increased working capital levels, continued investments in capital projects and the payment of our semi-annual dividends.

Debt

As at December 31, 2022 and December 31, 2021 the Company had repaid all of its borrowings under the revolving credit facility and as a result, the related deferred finance costs of $0.6 million (December 31, 2021 – $1.0 million) are now included within other current and non-current assets at the balance sheet date.

On September 16, 2020, Innospec and certain of its subsidiaries agreed to extend the term of its revolving credit facility, as described below, until September 25, 2024. The costs of $0.3 million for extending the term have been capitalized on the balance sheet, which are being amortized over the expected life of the facility.

On September 30, 2019 the Company repaid its pre-existing term loan and revolving credit facility that had been amended and restated on December 14, 2016, and replaced this borrowing with the new credit facility. As a result, refinancing costs of $1.5 million were capitalized which are being amortized over the expected life of the facility.

On September 26, 2019, Innospec and certain of its subsidiaries entered into a new agreement for a $250.0 million revolving credit facility until September 25, 2023 with an option to request an extension to the facility for a further year. The facility also contains an accordion feature whereby the Company may elect to increase the total available borrowings by an aggregate amount of up to $125.0 million.

The revolving credit facility contains terms which, if breached, would result in it becoming repayable on demand. It requires, among other matters, compliance with the following financial covenant ratios measured on a quarterly basis: (1) our ratio of net debt to EBITDA must not be greater than 3.0:1.0 and (2) our ratio of EBITDA to net interest must not be less than 4.0:1.0 Management has determined that the Company has not breached these covenants and does not expect to breach these covenants for the next 12 months.

The revolving credit facility contains restrictions which may limit our activities as well as operational and financial flexibility. We may not be able to borrow if an event of default is outstanding, which includes a material adverse change to our assets, operations or financial

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condition. The credit facility contains a number of restrictions that limit our ability, among other things, and subject to certain limited exceptions, to incur additional indebtedness, pledge our assets as security, guarantee obligations of third parties, make investments, effect a merger or consolidation, dispose of assets, or materially change our line of business.

At December 31, 2022, we had no debt outstanding under the revolving credit facility and no obligations under finance leases.

Contractual Commitments

The following represents contractual commitments at December 31, 2022 and the effect of those obligations on future cash flows:

Operating activities

Operating lease commitments relate primarily to right-of-use assets at third party manufacturing facilities, office space, motor vehicles and various items of computer and office equipment which are expected to be renewed and replaced in the normal course of business.

The estimated payments on debt are the commitment fees for our $250.0 million revolving credit facility. Any interest income has been excluded.

Due to the uncertainty regarding the nature of tax audits, particularly those which are not currently underway, it is not meaningful to predict the outcome of obligations related to unrecognized tax benefits. Further disclosure is provided in Note 11 of the Notes to the Consolidated Financial Statements.

Investing activities

Capital commitments relate to certain capital projects that the Company has committed to undertake.

Internally developed software relates to the planned completion costs for the implementation of our new Enterprise Resource Planning system for EMEA and ASPAC, including the acquisition costs for the software as well as the external and internal costs of the development.

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Outlook

Despite the general recessionary outlook for 2023, we continue to anticipate technology-based organic growth opportunities across all our businesses. Over the medium to long-term, we do not expect any change in our customers’ drive towards cleaner formulations, lower carbon footprint and operational efficiency. We plan to continue our investment in R&D to improve our products and technology. Our innovative chemistries and highly-responsive technical service directly support our customers’ priorities.

Our strong balance sheet gives us the flexibility to move in parallel on all of our capital allocation priorities. In 2023, we expect to substantially complete our $70 million Performance Chemicals expansion while continuing dividend growth and, based on our assessment of market conditions, share repurchases. In parallel, we intend to continue to pursue potential acquisitions that complement and expand our geographic, technology and end-market footprint.

Environmental Matters and Plant Closures

Under certain environmental laws the Company is responsible for the environmental remediation of hazardous substances or wastes at currently or formerly owned or operated properties.

As most of our manufacturing operations have been conducted outside the U.S., we expect that liability pertaining to the investigation and environmental remediation of contaminated properties is likely to be determined under non-U.S. law.

We evaluate costs for environmental remediation, decontamination and demolition projects on a regular basis. Full provision is made for those costs amounting to $57.2 million at December 31, 2022. See Note 13 of the Notes to the Consolidated Financial Statements for further details. Expenditure utilizing these provisions was $4.2 million, $5.3 million and $4.1 million in the years 2022, 2021 and 2020, respectively.

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