INNOSPEC INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) This discussion should be read in conjunction with our consolidated financial statements and the notes thereto.

EXECUTIVE OVERVIEW Our business performance in 2012 was against a background of continued weakness in European demand due to the on-going economic difficulties, especially in Southern European countries. Demand in other developed markets continued to show slow growth, while enhanced demand for fuel and personal care products in emerging markets boosted prospects in South America and Asia-Pacific. Although global fuel demand was relatively weak, the major weakness was in gasoline demand in the developed markets of Europe and North America, driven mainly by a significant improvement in vehicle fuel economy. Diesel demand, however, was stronger, supported by global commercial fleet demand, and passenger car demand in Europe. There was limited new legislation in the developed markets, with a slow roll out of sulfur and biofuel legislation in other markets. Strong demand from the oil and gas sector, notably in North America, provided a positive environment for our nascent Oilfield Specialties business, while consumer demand for contaminant-free and natural/renewable cosmetic ingredients provides a driver for new technology in personal care. Economic difficulties in the European markets have driven softer demand for our Polymers business.

We have managed our investments in capital equipment, working capital and recruitment of additional skilled personnel in line with these market factors.

Our capital program and expenses during 2012 included investment in a new information system platform, which we expect to add value to our business in 2014. During 2012, we completed the acquisition of Strata Control Services, Inc.

("Strata") to help build-out our presence in Oilfield Specialties, and we continue to seek further opportunities for this area in 2013. We also made a non-binding offer for the TPC Group, and later withdrew this offer as we felt that we could not derive sufficient shareholder value from the deal. This aborted transaction resulted in a $2.1 million charge for acquisition-related costs in the fourth quarter. We also instituted a one-time special dividend of $2.00 per share, which was paid on December 21, 2012 to shareholders of record on December 14, 2012.

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.

Contingencies We are subject to legal, regulatory and other proceedings and claims. The Company discloses information concerning contingent liabilities in respect of these claims and proceedings for which an unfavorable outcome is more than remote and the potential loss could materially 26-------------------------------------------------------------------------------- Table of Contents impact our results of operations, financial position and cash flows. We recognize within selling, general and administrative expenses liabilities for these claims and proceedings when it is probable that the Company has incurred a loss based on an unfavorable outcome and the amount of the loss can be reasonably estimated and we endeavor to fairly present, in conjunction with the disclosures of these matters in our consolidated financial statements, management's view of our exposure. We review outstanding claims and proceedings with external counsel as appropriate to assess probability and estimates of loss. When the reasonable estimate is a range, the recognized liability will be the best estimate within the range. If no amount in the range is a better estimate than any other amount then the minimum amount of the range will be recognized.

We re-evaluate our assessments each quarter or as new and significant information becomes available. The actual cost of ultimately resolving a claim or proceeding may be significantly different from the amount of the recognized liability. In addition, because it is not permissible to recognize a liability until the loss is both probable and estimable, in some cases there may be insufficient time to recognize a liability prior to the actual incurrence of the loss (upon verdict and judgment at trial, for example, or in the case of a quickly negotiated settlement).

Environmental Liabilities Remediation provisions at December 31, 2012 amounted to $29.3 million and relate principally to our Ellesmere Port site in the United Kingdom. We recognize environmental liabilities when they are probable and costs can be reasonably estimated, and asset retirement obligations when there is a legal obligation and 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. The Company views the costs of vacating our Ellesmere Port site as contingent upon if and when it vacates the site because there is no present intention to do so. The Company has further determined that, due to the uncertain product life of TEL particularly in the market for aviation gasoline and other products being manufactured on site, there are uncertainties as to the probability and timing of the expected costs. Such uncertainties have been considered in estimating the provision.

Pensions The Company maintains a defined benefit pension plan covering a number of its current and former employees in the United Kingdom. The Company also has other much smaller pension arrangements in the U.S. and overseas, but the obligations under those plans are not material. The United Kingdom plan is closed to future service accrual, but has a large number of deferred and current pensioners.

Movements in the underlying plan asset value and Projected Benefit Obligation ("PBO") are dependent on actual return on investments as well as our assumptions in respect of the discount rate, annual member mortality rates, future return on assets and future inflation. A 27-------------------------------------------------------------------------------- Table of Contents 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 by approximately $26 million and the net pension charge for 2013 by approximately $0.8 million. A 0.25% change in the level of price inflation assumption would change the PBO by approximately $23 million and the net pension charge for 2013 by approximately $2.1 million.

Further information is provided in Note 9 of the Notes to the Consolidated Financial Statements.

Deferred Tax and Uncertain Income Tax Positions At December 31, 2012, no valuation allowance is required against our foreign tax credit carry forwards within deferred tax as management believes that all the foreign tax credit carry forwards can be utilized in future periods prior to their expiration.

No deferred taxes have been provided for the unremitted earnings of our overseas subsidiaries as any tax basis differences relating to investments in these overseas subsidiaries are considered to be permanent in duration. We have no current intention to repatriate past or future earnings of our overseas subsidiaries and consider that these earnings have been reinvested overseas. If circumstances were to change that would cause these earnings to be repatriated an additional U.S. tax liability could be incurred, and we continue to monitor this position.

The calculation of our tax liabilities involves evaluating uncertainties in the application of 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, 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 our liabilities, 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. A favorable tax settlement may be recognized as a reduction in our effective tax rate in the year of resolution. We report interest and penalties related to uncertain income tax positions as income taxes. For additional information regarding uncertain income tax positions see Note 10 of the Notes to the Consolidated Financial Statements.

Goodwill The Company's reporting units, the level at which goodwill is tested for impairment, are consistent with the reportable segments: Fuel Specialties, Performance Chemicals and Octane Additives. The components in each segment (including products, markets and competitors) 28-------------------------------------------------------------------------------- Table of Contents 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. The Company tests goodwill annually for impairment, or between years if events occur or circumstances change which suggest that an impairment may have occurred.

The Company performs its annual goodwill tests in respect of Fuel Specialties and Performance Chemicals as at December 31 each year. In reviewing for any impairment charge the fair values of the reporting segments are estimated using an after-tax cash flow methodology based on management's best available estimates at that time. The key assumptions underpinning these calculations include future revenue growth, gross margins and the Company's weighted average cost of capital. At December 31, 2012 we had $117.6 million and $30.1 million of goodwill relating to our Fuel Specialties and Performance Chemicals segments, respectively. Our annual impairment tests as of such date indicated no impairment because the estimated fair values of those reporting segments substantially exceeded the carrying values.

In light of the continuing decline in the Octane Additives market globally, as the Company makes sales of Octane Additives in each quarter, future remaining sales and corresponding cash flows that can be derived from the Octane Additives segment are being reduced, and accordingly the fair value of the Octane Additives segment is also reduced. As a result, the Company determined that quarterly impairment tests should be performed from January 1, 2004 and any impairment charge arising be recognized in the relevant quarter. As a result of the Octane Additives impairment tests performed during 2012, 2011 and 2010 impairment charges of $1.2 million, $2.0 million and $2.2 million, respectively, have been recognized. These charges are non-cash in nature and have no impact on taxation. In 2012 some of the assumptions and estimates relating to the Octane Additives segment discounted cash flows were revised as part of our planning processes (although the overall methodology was unchanged). These revisions had no material impact on the reporting of goodwill. There was $1.3 million of goodwill remaining at December 31, 2012 which relates to the Octane Additives segment and equates to the fair value of the goodwill at that date. Given the amount and predictability of the remaining future cash flows from the Octane Additives segment the Company expects goodwill impairment charges to be recognized in the income statement on an approximate straight-line basis to December 31, 2013. However, since the remaining sales of the Octane Additives segment are concentrated around a relatively small number of customers, there is a risk that they could dramatically decline resulting in an accelerated impairment of the Octane Additives segment goodwill as the forecast discounted cash flows from that segment would be reduced.

While we believe our assumptions for impairment tests are reasonable, they are subjective judgments, and it is possible that variations in any of the assumptions may result in materially different calculations of impairment charges, if any.

29 -------------------------------------------------------------------------------- Table of Contents Other Intangible Assets (Net of Amortization) and Property, Plant and Equipment At December 31, 2012 we had $68.6 million of other intangible assets (net of amortization), and $49.8 million of property, plant and equipment, that are discussed in Notes 7 and 5 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 13 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.

We also test these long-lived assets for any potential impairment when events occur or circumstances change which suggest that an impairment may have occurred. These types of events or changes in circumstances could include, but are not limited to: • introduction of new products with enhanced features by our competitors; • loss of, material reduction in purchases by, or non-renewal of a contract by, a significant customer; • prolonged decline in business or consumer spending; • sharp and unexpected rise in raw material, chemical or energy costs; and • new laws or regulations inhibiting the development, manufacture, distribution or sale of our products.

In order to facilitate this testing the Company groups together assets at the lowest possible level for which cash flow information is available. Undiscounted future cash flows expected to result from the asset groups are compared with the carrying value of the assets and, if such cash flows are lower, an impairment loss may be recognized. The amount of the impairment loss is the difference between the fair value and the carrying value of the assets. Fair values are determined using post-tax cash flows discounted at the Company's weighted average cost of capital. If events occur or circumstances change it may cause a reduction in periods over which these long-lived assets are amortized or depreciated, or result in a non-cash impairment of a portion of their carrying value. A reduction in amortization or depreciation periods would have no effect on cash flows.

We are continuing with the implementation of a new, company-wide, information system platform. The platform provider is well established in the market. The implementation will be a phased, risk-managed, site deployment and follow a multistage user acceptance program with the existing platform providing a fallback position. Internally developed software and other costs capitalized at December 31, 2012 were $10.1 million (2011 - $3.1 million). No amortization was recognized in 2012 (2011 - $0.0 million).

30-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following table provides operating income by reporting segment: (in millions) 2012 2011 2010 Net sales: Fuel Specialties $ 527.2 $ 521.2 $ 458.1 Performance Chemicals 179.6 177.0 152.7 Octane Additives 69.6 76.2 72.4 $ 776.4 $ 774.4 $ 683.2 Gross profit: Fuel Specialties $ 158.7 $ 149.3 $ 145.9 Performance Chemicals 43.8 40.6 33.3 Octane Additives 33.9 36.5 34.9 $ 236.4 $ 226.4 $ 214.1 Operating income: Fuel Specialties $ 87.6 $ 81.7 $ 77.6 Performance Chemicals 24.3 22.6 16.7 Octane Additives 26.0 (22.4 ) 25.8 Pension credit/(charge) 0.3 (0.5 ) (10.8 ) Corporate costs (38.5 ) (29.2 ) (26.3 ) Restructuring charge (0.2 ) (0.6 ) (8.7 ) Impairment of Octane Additives segment goodwill (1.2 ) (2.0 ) (2.2 ) Profit on disposal, net 0.1 0.0 0.1 Total operating income $ 98.4 $ 49.6 $ 72.2 31 -------------------------------------------------------------------------------- Table of Contents Results of Operations - Fiscal 2012 compared to Fiscal 2011: (in millions, except ratios) 2012 2011 Change Net sales: Fuel Specialties $ 527.2 $ 521.2 $ 6.0 +1 % Performance Chemicals 179.6 177.0 2.6 +1 % Octane Additives 69.6 76.2 (6.6 ) -9 % $ 776.4 $ 774.4 $ 2.0 0 % Gross profit: Fuel Specialties $ 158.7 $ 149.3 $ 9.4 +6 % Performance Chemicals 43.8 40.6 3.2 +8 % Octane Additives 33.9 36.5 (2.6 ) -7 % $ 236.4 $ 226.4 $ 10.0 +4 % Gross margin (%): Fuel Specialties 30.1 28.6 +1.5 Performance Chemicals 24.4 22.9 +1.5 Octane Additives 48.7 47.9 +0.8 Aggregate 30.4 29.2 +1.2 Operating expenses: Fuel Specialties $ (71.1 ) $ (67.6 ) $ (3.5 ) +5 % Performance Chemicals (19.5 ) (18.0 ) (1.5 ) +8 % Octane Additives (7.9 ) (58.9 ) 51.0 -87 % Pension credit/(charge) 0.3 (0.5 ) 0.8 n/a Corporate costs (38.5 ) (29.2 ) (9.3 ) +32 % $ (136.7 ) $ (174.2 ) $ 37.5 -22 % 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: Change (%) Americas EMEA ASPAC Avtel Total Volume -4 +3 -5 -24 -3 Price and product mix +7 +6 +12 +6 +7 Exchange rates 0 -8 -1 0 -3 +3 +1 +6 -18 +1 Sales volumes in both the Americas and ASPAC declined for the second year running primarily due to lower sales of high volume but low margin products, offset by higher sales of more added value products, resulting in an improved price and product mix in both these markets. Sales volumes, and price and product mix, in EMEA continued to benefit in 2012 from new contracts and contract amendments entered into in 2011, partially offset by a 32-------------------------------------------------------------------------------- Table of Contents weakening of the European Union euro and British pound sterling against the U.S.

dollar. Avtel volumes declined 24% in 2012, compared to a 13% increase in 2011, due to the timing of shipments to customers as opposed to any change in the long-term outlook for that market. This Avtel sales volume decline was partially offset by an improved customer mix.

Gross margin: the year on year increase of 1.5 percentage points primarily reflected a lower proportion of sales of lower margin products, specifically in the Americas and ASPAC markets, and the continued benefit in 2012 of the new contracts and contract amendments entered into in 2011. Many of the raw materials that we use are derived from petrochemical-based feedstocks and their costs were less volatile due to the stable crude oil prices experienced in 2012.

Operating expenses: the year on year increase of 5%, or $3.5 million, was primarily due to the release of a $3.7 million accrual in respect of an old customer claim in the first quarter of 2011 which did not recur in 2012. This increase was partially offset by the $0.5 million favorable impact of foreign currency exchange rates on our European cost base denominated in European Union euro and British pound sterling.

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: Change (%) Americas EMEA ASPAC Total Volume +19 -8 +1 +4 Price and product mix +1 +1 +5 +1 Exchange rates -1 -6 -2 -4 +19 -13 +4 +1 Overall sales volumes increased in this segment despite the competitive pressures faced in all the markets we serve. Improved sales volumes within the Personal Care market focused in the Americas and the global Fragrance Ingredients market, were partially offset by lower volumes due to weaker demand in our Polymers market which is focused in EMEA. Price and product mix was substantially unchanged in our larger Americas and EMEA markets, and benefitted in ASPAC due to the higher proportion of more added value products sold in 2012.

Sales in all our markets, but notably EMEA, suffered from a weakening of the European Union euro and British pound sterling against the U.S. dollar.

Gross margin: the year on year increase of 1.5 percentage points reflected the continued improvement in demand across the markets despite the competitive pressures on margins, with the exception of our Polymers market. Weaker demand in our Polymers market resulted in lower sales volumes and sales prices with a consequential adverse impact on gross margin. Many of the raw materials that we use are derived from petrochemical-based feedstocks and we benefitted from the fact that their costs were less volatile due to the stable crude oil prices experienced in 2012.

33 -------------------------------------------------------------------------------- Table of Contents Operating expenses: the year on year increase of 8%, or $1.5 million, was primarily in respect of $1.2 million higher personnel-related compensation costs, partially offset by the $0.5 million favorable impact of foreign currency exchange rates on our European cost base denominated in European Union euro and British pound sterling.

Octane Additives Net sales: decreased by 9% entirely in respect of lower volumes since sales mix and revenue from our environmental remediation business were unchanged. In both 2012 and 2011, sales were focused in the Middle East and Northern Africa.

Gross margin: increased marginally by 0.8 percentage points from 47.9% to 48.7%.

Operating expenses: decreased by $51.0 million primarily due to the fact that the impact of the $45.0 million NewMarket Corporation civil complaint settlement and associated $5.5 million legal and other professional expenses in 2011 did not recur in 2012.

Other Income Statement Captions Pension credit/(charge): is non-cash, and was a $0.3 million credit and a $0.5 million charge in 2012 and 2011, respectively.

Corporate costs: the year on year increase of 32%, or $9.3 million, primarily reflected $4.7 million higher accruals for share based compensation expense, driven by the year on year rise in our stock price, including a $3.9 million higher charge in respect of the long-term incentive plan. The remainder of the increase was due to $2.7 million higher legal and other professional expenses and $2.1 million higher information technology service platform costs.

Acquisition-related costs were $2.8 million and $3.0 million in 2012 and 2011, respectively.

Restructuring charge: comprised the following: (in millions) 2012 2011 Reduction in EMEA headcount $ 0.2 $ 0.7 Release of an accrual in respect of the relocation of a U.S.

sales and administration facility 0.0 (0.1 ) $ 0.2 $ 0.6 Impairment of Octane Additives segment goodwill: was $1.2 million and $2.0 million in 2012 and 2011, respectively. Effective October 1, 2011, we updated the estimates used in the detailed forecast model to calculate impairment charges to reflect the Company's extended estimate for the future life of our Octane Additives segment from December 31, 2012 to December 31, 2013, resulting in a lower charge. We expect the impairment of Octane Additives segment goodwill charge for the year ending December 31, 2013 to be approximately $1.3 million.

34 -------------------------------------------------------------------------------- Table of Contents Profit on disposal, net: in 2012 the Company recognized $0.1 million profit following the disposal of surplus real estate.

Other net income/(expense): other net expense of $2.0 million primarily related to losses on translation of net assets denominated in non-functional currencies in our European businesses offset by net foreign exchange gains on foreign currency forward exchange contracts. In 2011, other net income of $6.3 million was comprised of $6.5 million of net foreign currency exchange gains and gains on translation of net assets denominated in non-functional currencies in our European businesses, and $0.2 million sundry other expenses.

Interest expense, net: decreased from $3.3 million to $1.2 million due to the lower average level of debt in 2012 and losses on interest rate swaps in 2011.

Income taxes: the effective tax rate was 28.3% and 7.0% in 2012 and 2011, respectively. The effective tax rate, once adjusted for the NewMarket Corporation civil complaint settlement, adjustment of income tax provisions and for the tax impact of acquisition-related funding, was 20.3% in 2012 compared with 15.8% in 2011. 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.

(in millions, except ratios) 2012 2011 Income before income taxes $ 95.2 $ 52.6 Add back NewMarket Corporation civil complaint settlement 0.0 45.0 $ 95.2 $ 97.6 Income taxes $26.9 $ 3.7 Add back tax on NewMarket Corporation civil complaint settlement 0.0 15.7 Add back adjustment of income tax provisions (0.2 ) (4.0 ) Add back tax impact of acquisition-related funding (7.4 ) 0.0 $ 19.3 $ 15.4 GAAP effective tax rate 28.3 % 7.0 % Adjusted effective tax rate 20.3 % 15.8 % In addition to those mentioned above, the following factors had a significant impact on the Company's effective tax rate as compared to the U.S. federal income tax rate of 35%: (in millions) 2012 2011 Foreign tax rate differential $ (15.6 ) $ (9.9 ) Foreign income inclusions 46.5 10.7 Foreign tax credits (36.5 ) (13.5 ) Deferred tax credit from United Kingdom income tax rate reduction $ (0.5 ) $ (2.5 ) 35 -------------------------------------------------------------------------------- Table of Contents The impact on the effective tax rate from profits earned in foreign jurisdictions with lower tax rates varies as the geographical mix of the Company's profits changes year on year. In 2012, the Company's income tax expense benefited from a greater proportion of its overall profits arising in Switzerland than in 2011. This resulted in a $12.0 million benefit in Switzerland (2011 - $8.9 million). In addition, there was a $3.3 million benefit in relation to the United Kingdom (2011 - $0.1 million) and a $0.7 million benefit in relation to Germany (2011 - $0.9 million).

Foreign income inclusions arise each year from certain types of income earned overseas being taxable under U.S. tax regulations. These types of income include Subpart F income, principally from foreign based company sales in the United Kingdom, including the associated Section 78 tax gross up, and also from the income earned by certain overseas subsidiaries taxable under the U.S. tax regime. In 2012, the amount of Subpart F income and the associated Section 78 gross up amounted to $4.3 million (2011 - $3.0 million). The income earned by certain overseas subsidiaries taxable under the U.S. tax regime increased to $2.5 million from $2.0 million in 2011. In addition, a dividend from an overseas subsidiary, remitted to the U.S., increased foreign income inclusions by $39.0 million during 2012 (2011 - $5.5 million).

Foreign tax credits can fully or partially offset these incremental U.S. taxes from foreign income inclusions. The utilization of foreign tax credits varies year on year as this is dependent on a number of variable factors which are difficult to predict and may in certain years prevent any offset of foreign tax credits. During 2012, an overseas dividend was remitted to the U.S. to provide funding for the Company's acquisition program. In total, $42.8 million of foreign tax credits were utilized during 2012 to partially offset the incremental U.S. taxes arising from foreign income inclusions in the year. Of this balance, $14.2 million of foreign tax credit carry forwards from earlier years was utilized. This resulted in a decrease in the recognition of foreign tax credit carry forwards of $6.6 million during the year (2011 - a $9.4 million increase). The total tax cost of funding the Company's acquisition program was $7.4 million.

Following the United Kingdom's 2% reduction in the corporation tax rate from 25% to 23% in April 2013, enacted in July 2012, the Company benefitted from a net deferred tax credit of $0.5 million (2011 - $2.5 million) in the third quarter of 2012 primarily in relation to the deferred tax position of the United Kingdom defined benefit pension plan.

Further details are given in Note 10 of the Notes to the Consolidated Financial Statements.

36 -------------------------------------------------------------------------------- Table of Contents Results of Operations - Fiscal 2011 compared to Fiscal 2010: (in millions, except ratios) 2011 2010 Change Net sales: Fuel Specialties $ 521.2 $ 458.1 $ 63.1 +14 % Performance Chemicals 177.0 152.7 24.3 +16 % Octane Additives 76.2 72.4 3.8 +5 % $ 774.4 $ 683.2 $ 91.2 +13 % Gross profit: Fuel Specialties $ 149.3 $ 145.9 $ 3.4 +2 % Performance Chemicals 40.6 33.3 7.3 +22 % Octane Additives 36.5 34.9 1.6 +5 % $ 226.4 $ 214.1 $ 12.3 +6 % Gross margin (%): Fuel Specialties 28.6 31.8 -3.2 Performance Chemicals 22.9 21.8 +1.1 Octane Additives 47.9 48.2 -0.3 Aggregate 29.2 31.3 -2.1 Operating expenses: Fuel Specialties $ (67.6 ) $ (68.3 ) $ 0.7 -1 % Performance Chemicals (18.0 ) (16.6 ) (1.4 ) +8 % Octane Additives (58.9 ) (9.1 ) (49.8 ) n/a Pension credit/(charge) (0.5 ) (10.8 ) 10.3 -95 % Corporate costs (29.2 ) (26.3 ) (2.9 ) +11 % $ (174.2 ) $ (131.1 ) $ (43.1 ) +33 % 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: Change (%) Americas EMEA ASPAC Avtel Total Volume -2 +7 -9 +13 +1 Price and product mix +11 +9 +13 +8 +11 Exchange rates 0 +5 +1 0 +2 +9 +21 +5 +21 +14 Sales volumes in both the Americas and ASPAC declined primarily due to lower sales of high volume but low margin products, offset by higher sales of more added value products, resulting in an improved price and product mix in both these markets. Sales volumes, and price and product mix, in EMEA benefitted from new contracts and contract amendments 37-------------------------------------------------------------------------------- Table of Contents entered into in 2011, and a strengthening of the European Union euro and British pound sterling against the U.S. dollar. Avtel volumes improved due to the timing of shipments to customers as opposed to any change in the long-term outlook for that market.

Gross margin: the year on year decrease of 3.2 percentage points primarily reflected a higher proportion of sales of lower margin products, specifically in the EMEA market, and the competitive pressure on margins resulting from increased raw material costs despite the benefit of the new contracts and contract amendments. Many of the raw materials that we use are derived from petrochemical-based feedstocks and increases in their cost were driven by the general increase in crude oil prices experienced in 2011. In periods when raw material costs are rising there is generally a time lag before we are in a position, contractually or otherwise, to raise our prices to customers with a consequential adverse impact on margins during that lag.

Operating expenses: the year on year decrease of 1%, or $0.7 million, was primarily due to the release of a $3.7 million accrual in respect of an old customer claim in the first quarter of 2011. The release offsets increases in operating expenses due to $0.8 million higher licensing costs and the $1.8 million adverse impact of foreign currency exchange rates on our European cost base denominated in European Union euro and British pound sterling.

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: Change (%) Americas EMEA ASPAC Total Volume -7 -2 +12 -2 Price and product mix +14 +15 +13 +14 Exchange rates +1 +6 +3 +4 +8 +19 +28 +16 Overall sales volumes declined in this segment reflecting the competitive pressures faced in all the markets we serve but especially within the Fragrance Ingredients market, offset by improved sales volumes within the Personal Care market. Price and product mix was substantially improved primarily in respect of our Polymers business which benefited from high demand. Sales in all our markets, but notably EMEA, benefitted from a strengthening of the European Union euro and British pound sterling against the U.S. dollar.

Gross margin: the year on year increase of 1.1 percentage points reflected the continued improvement in demand across the markets, especially our Polymers business, despite the competitive pressures on margins resulting from increased raw material costs. Many of the raw materials that we use are derived from petrochemical-based feedstocks and increases in their cost were driven by the general increase in crude oil prices experienced in 2011. In periods when raw material costs are rising there is generally a time lag before we are in a position, contractually or otherwise, to raise our prices to customers with a consequential adverse impact on margins during that lag.

38-------------------------------------------------------------------------------- Table of Contents Operating expenses: the year on year increase of 8%, or $1.4 million, was less than the 16% growth in sales as we continued to leverage the infrastructure of this segment. The increase in operating expenses primarily related to $0.7 million higher personnel-related compensation costs, a $0.5 million adverse impact of foreign currency exchange rates on our European cost base denominated in European Union euro and British pound sterling, and $0.2 million higher REACH costs.

Octane Additives Net sales: increased by 5% with increased volumes (up 4 percentage points) and an improved sales mix (up 3 percentage points) offset by reduced revenue from our environmental remediation business (down 2 percentage points). In both 2011 and 2010, sales were focused in the Middle East and Northern Africa.

Gross margin: decreased marginally by 0.3 percentage points from 48.2% to 47.9%.

Operating expenses: increased by $49.8 million due to the $45.0 million NewMarket Corporation civil complaint settlement and $1.3 million higher associated legal and other professional expenses in 2011, and the $3.0 million adjustment to the settlement accrual related to OFFP and FCPA investigations resulting in a release to the income statement in 2010.

Other Income Statement Captions Pension credit/(charge): this non-cash charge decreased by $10.3 million to $0.5 million reflecting the reduction in the pension liability and the near elimination of the service cost since the Company closed the United Kingdom defined benefit pension plan to future service accrual with effect from March 31, 2010.

Corporate costs: were $29.2 million, compared with $26.3 million a year ago. The year on year increase of $2.9 million primarily reflected $2.8 million higher accruals for share based compensation expense, driven by the substantial year on year rise in our stock price, including a $0.8 million higher charge in respect of the long-term incentive plan; and acquisition-related costs of $3.0 million.

A $3.9 million charge for the probable cost of the Company's external compliance monitor was recognized in 2010.

Restructuring charge: comprised the following: (in millions) 2011 2010 Reduction in EMEA headcount $ 0.7 $ 0.5 Release of an accrual in respect of the relocation of a U.S.

sales and administration facility (0.1 ) 0.0 Pension curtailment 0.0 8.2 $ 0.6 $ 8.7 39 -------------------------------------------------------------------------------- Table of Contents The Company closed its United Kingdom defined benefit pension plan to future service accrual with effect from March 31, 2010 and accordingly we recorded a non-cash curtailment loss of $8.2 million in the first quarter of 2010.

Impairment of Octane Additives segment goodwill: was $2.0 million and $2.2 million in 2011 and 2010, respectively. Effective October 1, 2011, we updated the estimates used in the detailed forecast model to calculate impairment charges to reflect the Company's extended estimate for the future life of our Octane Additives segment from December 31, 2012 to December 31, 2013, resulting in a lower charge.

Profit on disposal, net: in 2010 the Company recognized $0.1 million profit following the disposal of surplus real estate.

Other net income/(expense): of $6.3 million was comprised of $6.5 million of net foreign currency exchange gains and gains on translation of net assets denominated in non-functional currencies in our European businesses, and $0.2 million sundry other expenses. In 2010, other net income of $3.1 million related to net foreign currency exchange gains.

Interest expense, net: the net interest expense, including amortization of deferred finance costs, decreased from $4.6 million to $3.3 million due to the lower level of debt in 2011 and the deferred finance costs becoming fully amortized in the third quarter of 2011.

Income taxes: the effective tax rate was 7.0% and (4.2)% in 2011 and 2010, respectively. The effective tax rate, once adjusted for non-recurring items relating to the NewMarket Corporation civil complaint settlement, the adjustment of income tax provisions and for the OFFP and FCPA settlement accrual, was 15.8% in 2011 compared with 13.6% in 2010. 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.

(in millions, except ratios) 2011 2010 Income before income taxes $ 52.6 $ 70.7 Add back NewMarket Corporation civil complaint settlement 45.0 0.0 Add back OFFP/FCPA settlement accrual 0.0 (3.0 ) $ 97.6 $ 67.7 Income taxes $ 3.7 $ (3.0 ) Add back tax on NewMarket Corporation civil complaint settlement 15.7 0.0 Add back adjustment of income tax provisions (4.0 ) 12.2 $ 15.4 $ 9.2 GAAP effective tax rate 7.0 % (4.2 )% Adjusted effective tax rate 15.8 % 13.6 % 40 -------------------------------------------------------------------------------- Table of Contents In addition to those mentioned above, the following factors had a significant impact on the Company's effective tax rate as compared to the U.S. federal income tax rate of 35%: (in millions) 2011 2010 Foreign tax rate differential $ (9.9 ) $ (9.5 ) Foreign income inclusions 10.7 5.0 Foreign tax credits (13.5 ) (5.0 ) Tax deductibility of the OFFP/FCPA settlement accrual 0.0 (2.0 ) Deferred tax credit from United Kingdom income tax rate reduction $ (2.5 ) $ (1.1 ) The impact on the effective tax rate from profits earned in foreign jurisdictions with lower tax rates varies as the geographical mix of the Company's profits changes year on year. In 2011, the Company's income tax expense benefited from a greater proportion of its overall profits arising in Switzerland than in 2010, primarily reflecting increased sales in our Octane Additives segment due to the timing of shipments to major customers. This resulted in an $8.9 million benefit in Switzerland (2010 - $6.5 million). In addition, there was a $0.1 million benefit in relation to the United Kingdom (2010 - $3.2 million) and a $0.9 million benefit in relation to Germany (2010 - $0.0 million).

Foreign income inclusions arise each year from certain types of income earned overseas being taxable under U.S. tax regulations. These types of income include Subpart F income, principally from foreign based company sales in the United Kingdom, including the associated Section 78 tax gross up, and also from the income earned by certain overseas subsidiaries taxable under the U.S. tax regime. In 2011, the amount of Subpart F income and the associated Section 78 gross up amounted to $3.0 million (2010 - $2.1 million). The income earned by certain overseas subsidiaries taxable under the U.S. tax regime reduced to $2.0 million from $2.9 million in 2010. In addition, a dividend from an overseas subsidiary, remitted to the U.S., increased foreign income inclusions by $5.5 million during 2011 (2010 - $0.0 million).

Foreign tax credits can fully or partially offset these incremental U.S. taxes from foreign income inclusions. The utilization of foreign tax credits varies year on year as this is dependent on a number of variable factors which are difficult to predict and may in certain years prevent any offset of foreign tax credits. During 2011, an additional $6.1 million of foreign tax credit carry forwards were generated, primarily due to the overseas dividend remitted to the U.S. in the year. This increase in foreign tax credit carry forwards and accompanying extension of expiration period allowed the recognition of a further $9.4 million of foreign tax credit carry forwards as compared to $2.7 million in 2010.

Following the United Kingdom's 2% reduction in the corporation tax rate from 27% to 25% in April 2012, enacted in July 2011, the Company benefited from a net deferred tax credit of $2.5 million in the third quarter of 2011 primarily in respect of pension plan unrecognized actuarial net losses.

Further details are given in Note 10 of the Notes to the Consolidated Financial Statements.

41 -------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND FINANCIAL CONDITION Working Capital 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 represent factors which do not fluctuate in line with the day to day working capital needs of the business.

(in millions) 2012 2011 Total current assets $ 296.6 $ 320.3 Total current liabilities (147.3 ) (146.0 ) Working capital 149.3 174.3 Less cash and cash equivalents (22.4 ) (76.2 ) Less short-term investments (5.1 ) (4.8 ) Less current portion of deferred tax assets (11.0 ) 0.0 Add back accrued income taxes 3.2 2.0 Add back current portion of long-term debt 5.0 5.0 Add back current portion of plant closure provisions 5.1 4.1 Add back current portion of unrecognized tax benefits 3.0 3.2 Add back current portion of deferred tax liabilities 0.2 0.0 Add back current portion of deferred income 1.4 1.4 Adjusted working capital $ 128.7 $ 109.0 In 2012 our adjusted working capital (defined by the Company as trade and other accounts receivable, inventories, prepaid expenses, accounts payable and the current portion of accrued liabilities rather than total current assets less total current liabilities) increased by $19.7 million of which $2.2 million related to the working capital of Strata purchased on December 24, 2012 and included in the consolidated balance sheet as at December 31, 2012.

The $16.3 million increase in trade and other accounts receivable was predominantly focused in our Fuel Specialties segment whose fourth quarter sales increased 7%, or $10.3 million, compared to the fourth quarter in 2011. In addition, days' sales outstanding in our Fuel Specialties segment worsened from 40 days as at December 31, 2011 to 44 days as at December 31, 2012, though this was partially offset by a corresponding improvement in our Performance Chemicals segment over the same period from 45 days to 43 days. Trade receivables in our Octane Additives segment are primarily driven by the timing of shipments to major customers, and the associated sales terms of those shipments, of which there was a significant shipment in both December 2012 and 2011 and accordingly trade and other accounts receivable in that segment were largely unchanged.

42-------------------------------------------------------------------------------- Table of Contents The $2.4 million increase in inventories was focused in our Performance Chemicals segment following the decision to build certain product inventories of strategic importance, and to facilitate the 9% sales growth achieved during the fourth quarter and anticipated sales growth in 2013. Days' sales in inventory in our Fuel Specialties segment declined from 72 days as at December 31, 2011 to 69 days as at December 31, 2012. However, days' sales in inventory in our Performance Chemicals segment increased substantially over the same period from 91 days to 101 days as we built inventories.

Prepaid expenses increased marginally from $4.0 million to $4.1 million.

The moderate $0.9 million decrease in accounts payable and the current portion of accrued liabilities was primarily due to payments made in 2012 to the Government Authorities. Outside of those payments, accounts payable and the current portion of accrued liabilities in each of our reporting segments as at December 31, 2012 and 2011, were largely unchanged except for Performance Chemicals for which creditor days increased from 22 days to 41 days and absolute level of accounts payable and the current portion of accrued liabilities increased in line with production and inventories.

Operating Cash Flows We generated cash from operating activities of $61.3 million, $34.7 million and $58.2 million in 2012, 2011 and 2010, respectively. The increase in cash provided by operating activities from 2011 to 2012 of $26.6 million was primarily due to our increased profitability rather than trading levels, as net income increased by $19.4 million from $48.9 million to $68.3 million. In addition, in 2012 we benefited from more stable working capital levels compared to 2011. In 2011 our working capital requirements increased by $43.3 million in order to support the substantially increased trading levels when net sales increased by 13.3%, or $91.2 million, from $683.2 million to $774.4 million. In 2012 net sales increased by 0.3%, or $2.0 million, from $774.4 million to $776.4 million. The decrease in cash provided by operating activities from 2010 to 2011 of $23.5 million was primarily due to the $25.0 million paid in cash in September 2011 in settlement of the NewMarket Corporation civil complaint.

Cash At December 31, 2012 and 2011 we had cash and cash equivalents of $22.4 million and $76.2 million, respectively, of which $17.5 million and $74.1 million, respectively, were held by non-U.S. subsidiaries principally in the United Kingdom. The Company is in a position to control whether or not to repatriate foreign earnings and intends to reinvest earnings to fund overseas subsidiaries.

We currently do not expect to make a further repatriation in the foreseeable future and hence have not provided for future income taxes on the cash held by overseas subsidiaries. If circumstances were to change that would cause these earnings to be repatriated an additional U.S. tax liability could be incurred, and we continue to monitor this position.

Short-term Investments At December 31, 2012 and 2011 we had short-term investments of $5.1 million and $4.8 million, respectively.

43 -------------------------------------------------------------------------------- Table of Contents Debt On December 14, 2011, we entered into a five-year revolving credit facility which provides for borrowings by us of up to $100.0 million. The credit facility carries an interest rate based on U.S. LIBOR plus a margin of between 1.50% and 2.25% which is dependent on the Company's ratio of net debt to EBITDA. EBITDA is a non-GAAP measure of liquidity defined in the credit facility. The credit facility can be drawn down until it expires on December 14, 2016 and may be drawn down in full in the U.S..

The current credit facility contains restrictions which may limit our activities, and 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 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.

In addition, the 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 2.5:1 and (2) our ratio of EBITDA to net interest must not be less than 4.0:1. Management has determined that the Company has not breached these covenants throughout the period to December 31, 2012 and expects to not breach these covenants for the next 12 months. The credit facility is secured by a number of fixed and floating charges over certain assets which include key operating sites of the Company and its subsidiaries.

As at December 31, 2012, we had $20.0 million of debt outstanding under the revolving credit facility.

Under the terms of our September 13, 2011 settlement with NewMarket Corporation, we issued a $15.0 million promissory note to NewMarket Corporation payable in three equal annual installments (carrying simple interest at 1% per annum). The first installment was paid on September 7, 2012.

The debt maturity profile as at December 31, 2012 is set out below: (in millions) 2013 $ 5.0 2014 5.0 2015 0.0 2016 20.0 30.0 Current portion of long-term debt (5.0 ) Long-term debt, net of current portion $ 25.0 44 -------------------------------------------------------------------------------- Table of Contents Outlook At December 31, 2012, the Company had cash, cash equivalents and short-term investments of $27.5 million and debt of $30.0 million resulting in net debt of $2.5 million.

The Company expects to fund its operations over at least the next 12 months from a combination of operating cash flows and its revolving credit facility. Under the credit facility we have the ability to draw down up to $100.0 million, of which $20.0 million was drawn down at December 31, 2012, so long as we are in compliance with all financial covenants therein.

Contractual Commitments The following represents contractual commitments at December 31, 2012 and the effect of those obligations on future cash flows: (in millions) Total 2013 2014-15 2016-17 Thereafter Operating activities OFFP/FCPA payments $ 3.7 $ 3.7 $ 0.0 $ 0.0 $ 0.0 Compliance monitor 1.3 1.3 0.0 0.0 0.0 Planned funding of pension obligations 58.6 11.2 22.4 14.4 10.6 Remediation payments 29.3 5.0 5.5 2.7 16.1 Severance payments 1.1 0.1 1.0 0.0 0.0 Operating lease commitments 7.5 2.1 2.6 1.9 0.9 Raw material purchase obligations 18.1 6.0 6.0 6.1 0.0 Interest payments on debt 2.5 0.6 1.2 0.7 0.0 Investing activities Capital commitments 2.7 2.7 0.0 0.0 0.0 Financing activities Long-term debt obligations 30.0 5.0 5.0 20.0 0.0 Acquisition-related contingent consideration 5.0 0.0 5.0 0.0 0.0 Total $ 159.8 $ 37.7 $ 48.7 $ 45.8 $ 27.6 Operating activities Following the previously-disclosed resolution of certain government investigations and other matters, further details of which are given in Note 17 of the Notes to the Consolidated Financial Statements, the Company is committed to paying associated fines, penalties and disgorgements over a period of four years commencing 2010; and the future compliance monitor expenses until December 31, 2013.

The amounts related to pension obligations refer to the likely levels of funding of our United Kingdom defined benefit pension plan (the "Plan"). The Plan is closed to future service accrual, but has a large number of deferred and current pensioners. The Company expects its 45-------------------------------------------------------------------------------- Table of Contents annual cash contribution to be $11.2 million in 2013-15, $7.2 million in 2016-17 and $5.3 million in 2018-19. It is not considered meaningful to predict amounts beyond 2019 since there are too many uncertainties including future returns on assets, pension increases and inflation.

Remediation payments represent those cash flows that the Company is currently obligated to pay in respect of environmental remediation of current and former facilities. It does not include any discretionary remediation costs that the Company may choose to incur.

Severance payments represent those cash flows that the Company is currently obligated to pay in respect of severance costs associated with exit or disposal activities and post-employment benefits.

Operating lease commitments relate primarily to 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.

Raw material purchase obligations relate to certain long-term raw material contracts which stipulate fixed or minimum quantities to be purchased; fixed, minimum or variable cost provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.

The estimated payments included in the table above reflect the variable interest charge on long-term debt obligations. Estimated commitment fees are also included and interest income is 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 10 of the Notes to the Consolidated Financial Statements.

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

Financing activities On December 14, 2011, we entered into a five-year revolving credit facility which provides for borrowings of up to $100.0 million. The credit facility can be drawn down until it expires on December 14, 2016. At December 31, 2012, $20.0 million was drawn under the revolving credit facility.

On September 13, 2011, the Company settled the NewMarket Corporation civil complaint. The settlement agreement included the Company issuing a $15.0 million promissory note to NewMarket Corporation payable in three equal annual installments (carrying simple interest at 1% per annum), the first installment of which was paid on September 7, 2012.

46-------------------------------------------------------------------------------- Table of Contents On December 24, 2012, the Company acquired 100% of the voting equity interests in Strata Control Services, Inc. ("Strata"), a private company based in Crowley, Louisiana, for a consideration of approximately $60.0 million. Of this consideration, $5.0 million is payable in cash in 2015 contingent upon the achievement of certain pre-determined financial targets which we currently expect to be achieved. For accounting purposes only, we are required under GAAP, in accordance with our accounting policy, to discount this acquisition-related contingent consideration to its fair value of $4.3 million.

Environmental Matters and Plant Closures Under certain environmental laws the Company is responsible for the 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 remediation of contaminated properties is likely to be determined under non-U.S. law.

We evaluate costs for remediation, decontamination and demolition projects on a regular basis. Full provision is made for those costs to which we are committed under environmental laws. Full provision has been made for the committed costs of $29.3 million at December 31, 2012. Expenditure against provisions was $2.1 million, $3.1 million and $2.7 million in the years 2012, 2011 and 2010, respectively.

Total severance expenditure was $0.6 million, $0.7 million and $0.4 million in the years 2012, 2011 and 2010, respectively.

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