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Goodwill

12 Months Ended

Dec. 31, 2012

Note 6. Goodwill

The following table analyzes goodwill for 2012 and 2011. The change in the gross cost between 2011 and 2012 is due to foreign currency exchange rate fluctuations.


(in millions)	Fuel Specialties			Performance Chemicals		Octane Additives			Total
At January 1, 2011
Gross cost	$	108.9		$	30.1	$	236.6		$	375.6
Accumulated impairment losses		0.0			0.0		(232.0	)		(232.0	)

Net book amount		108.9			30.1		4.6			143.6

Exchange effect		(0.1	)		0.0		0.0			(0.1	)
Impairment losses		0.0			0.0		(2.0	)		(2.0	)

At December 31, 2011
Gross cost		108.8			30.1		236.6			375.5
Accumulated impairment losses		0.0			0.0		(234.0	)		(234.0	)

Net book amount		108.8			30.1		2.6			141.5

Exchange effect		0.1			0.0		(0.1	)		0.0
Acquisitions		8.7			0.0		0.0			8.7
Impairment losses		0.0			0.0		(1.2	)		(1.2	)

At December 31, 2012
Gross cost		117.6			30.1		236.5			384.2
Accumulated impairment losses		0.0			0.0		(235.2	)		(235.2	)

Net book amount	$	117.6		$	30.1	$	1.3		$	149.0

Gross cost is net of $8.7 million, $0.3 million and $289.5 million of historical accumulated amortization in respect of the Fuel Specialties, Performance Chemicals and Octane Additives reporting segments, respectively.

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) have similar economic characteristics and the segments, therefore, reflect the lowest level at which operations and cash flows can be clearly 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.

To determine the fair value of each of our segments we utilize a discounted cash flow methodology based on the forecasted future after-tax cash flows from operations for each since we believe this provides the best approximation of fair value. This methodology requires us to make assumptions and estimates including those in respect of future revenue growth and gross margins, which are based upon our long range plans, and the Company’s weighted average cost of capital. Our long range plans are regularly updated as part of our planning processes and are reviewed and approved by management and our Board of Directors. We assume terminal values for the Fuel Specialties and Performance Chemicals reporting units which are added to the present value of the relevant forecasted future cash flows. We assume no terminal value for the Octane Additives reporting unit beyond its estimated future life. The discounted cash flow methodology does not assume a control premium. We use a discount rate equivalent to the Company’s weighted average cost of capital which is estimated by reference to the overall after-tax rate of return required by equity and debt market participants in the Company. We assign assets and liabilities, including deferred taxes and goodwill, to our reporting units if the asset or liability relates to the operations of that reporting unit and is included in determining the fair value of the reporting unit. Cash and debt obligations are excluded from the carrying value of our reporting units.

In 2012 some of the assumptions and estimates underpinning our discounted cash flows were revised as part of our planning processes although the methodology was unchanged. The most significant revisions were that the Company’s weighted average cost of capital was changed to reflect the changing proportion of debt to equity funding of the Company.

The Company elected to perform its annual tests in respect of Fuel Specialties and Performance Chemicals goodwill as at December 31 each year. 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. At this date we performed annual impairment tests and concluded that there had been no impairment of goodwill in respect of those reporting segments.

In light of the continuing decline in the Octane Additives market globally, as the Company makes sales of Octane Additives in each quarter, the remaining sales and corresponding cash flows that can be derived from the Octane Additives segment are reduced, and accordingly the fair value of the Octane Additives reporting unit is reduced. As a result, the Company determined that quarterly impairment tests 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. There was $1.3 million of goodwill remaining at December 31, 2012 which relates to the Octane Additives segment. Given the quantum 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.

The table below presents the impact a change in the following significant assumptions would have had on our impairment charge recognized at December 31, 2012 (in respect of goodwill, other intangible assets and property, plant and equipment) assuming all other assumptions and factors remained constant:


(in millions)				Approximate Increase/(Decrease) to Impairment Charge
	Change			Fuel Specialties		Performance Chemicals		Octane Additives
Credit-adjusted risk-free rate		+10	%	$	0.0	$	0.0	$	0.0
Credit-adjusted risk-free rate		-10	%		0.0		0.0		0.0
After-tax cash flows		+10	%		0.0		0.0		(2.4	)
After-tax cash flows		-10	%	$	0.0	$	0.0	$	2.4

We believe that the assumptions used in our annual and quarterly impairment tests are reasonable, but that they are judgmental, and variations in any of the assumptions may result in materially different calculations of impairment charges, if any.

Acquisitions

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. Strata is a leading supplier of mud and fluid loss solutions to oil and gas drilling operations, with annual sales in 2012 of approximately $20.0 million. Its products and services prevent the unnecessary loss of valuable materials into the formation matrix thereby lowering the cost of operations. We acquired Strata in order to build out our presence in the growing market that it serves.

Purchase price and fair values of assets acquired and liabilities assumed

The following table summarizes the calculation of the total purchase price and the preliminary allocation of the purchase price to the assets acquired and liabilities assumed. The purchase price allocation and related valuation process is not yet complete. Final determination of the fair values may result in further adjustments to the amounts presented below:


(in millions)	Strata
Other intangible assets	$	48.0
Goodwill		8.7
Other net assets		2.7

Purchase price, net of cash acquired	$	59.4

Strata, and the associated goodwill, will be included within our Fuel Specialties segment for management and reporting purposes. See Note 7 of the Notes to the Consolidated Financial Statements for further information on the other intangible assets. The purchase price comprises $53.1 million paid immediately on December 24, 2012, and $5.0 million 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. In addition, if the pre-determined financial targets are achieved, we will in 2015 transfer 60,368 of Innospec common stock to Strata’s previous owner, the fair value of these contingently issuable shares at the acquisition date was $2.0 million which has been deducted from additional paid-in capital.

Supplemental unaudited condensed combined pro forma information

No amounts of revenue or earnings of Strata since the acquisition date have been included in our results for the year ended December 31, 2012 since they are not material. For illustrative purposes only, however, pro forma information of the enlarged group is provided below but is not necessarily indicative of what the financial position or results of operations would have been had the acquisition been completed as of January 1, 2011. In addition, the unaudited pro forma financial information is not indicative of, nor does it purport to project, the future financial position of operating results of the enlarged group.


(in millions, except per share data)	2012		2011
Net sales	$	793.5	$	790.1
Net income	$	73.4	$	51.9
Earnings per share – basic	$	3.16	$	2.19
– diluted	$	3.07	$	2.11

Included in the unaudited pro forma financial information is additional amortization in respect of the acquired other intangible assets. The acquisition-related costs incurred in respect of the transaction of $0.7 million have been excluded.