Ingevity Corp (NGVT) FY 2022 MD&A

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

Management’s discussion and analysis of Ingevity’s financial condition and results of operations (“MD&A”) should be read in conjunction with Item 8. Financial Statements and Supplementary Data. Investors are cautioned that the forward-looking statements contained in this section and other parts of this Annual Report on Form 10-K involve both risk and uncertainty. Several important factors could cause actual results to differ materially from those anticipated by these statements.

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Many of these statements are macroeconomic in nature and are, therefore, beyond the control of management. See "Cautionary Statements about Forward-Looking Statements" at the beginning of this Annual Report on Form 10-K for further discussion.

Overview

Ingevity Corporation is a leading global manufacturer of specialty chemicals and high-performance activated carbon materials. We provide innovative solutions to meet our customers’ unique and demanding requirements through proprietary formulated products. We report in two business segments, Performance Materials and Performance Chemicals.

Our Performance Materials segment manufactures products in the form of powder, granular, extruded pellets, extruded honeycombs, and activated carbon sheets. Automotive technologies products are sold into gasoline vapor emission control applications within the automotive industry, while process purification products are sold into the food, water, beverage, and chemical purification industries.

Our Performance Chemicals segment consists of our pavement technologies, industrial specialties, and engineered polymers product lines. Performance Chemicals manufactures products derived from crude tall oil ("CTO") and lignin extracted from the kraft pulping process as well as caprolactone monomers and derivatives derived from cyclohexanone and hydrogen peroxide. Performance Chemicals products serve as critical inputs used in a variety of high-performance applications, including warm mix paving, pavement preservation, pavement reconstruction and recycling, and road striping thermoplastics and paint (pavement technologies product line), adhesives, agrochemicals, lubricants, printing inks, industrial intermediates and oilfield (industrial specialties product line), coatings, resins, elastomers, adhesives, bio-plastics, and medical devices (engineered polymers product line).

Recent Developments

Ozark Materials

On October 3, 2022, we completed our acquisition of Ozark Materials, LLC and Ozark Logistics, LLC (collectively, “Ozark Materials”). Refer to Note 16 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

Strategic Investments

During 2022, we continued to invest in inorganic strategic investments by obtaining equity positions in four separate privately-held companies for a total of $77.4 million. Refer to Note 5 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

Net Investment Hedge

In 2022, we terminated our fixed-to-fixed cross-currency interest rate swaps, accounted for as net investment hedges, and received proceeds of $14.7 million. Refer to Note 9 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

Financing Activities

On April 27, 2022, we redeemed the $300.0 million outstanding aggregate principal balance of our 4.50% Senior Notes due in 2026 prior to maturity. On June 23, 2022, we repaid our outstanding Term Loan in an aggregate principal amount of $323.0 million and we amended and restated our revolving credit facility. Refer to Note 10 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

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Results of Operations

Net sales

The table below shows 2022 and 2021 Net sales and variances from 2021 and 2020, respectively.

Year Ended December 31, 2022 vs. 2021

The sales increase in 2022 was driven by favorable pricing and sales composition (mix) of $294.2 million (21 percent), primarily driven by an increase in Performance Chemicals of $279.3 million, and a volume increase of $9.4 million (one percent), offset slightly by unfavorable foreign exchange impacts of $26.8 million (two percent).

Year Ended December 31, 2021 vs. 2020

The sales increase in 2021 was driven by a volume increase of $97.0 million (eight percent) primarily related to a volume increase in Performance Chemicals of $110.0 million, favorable pricing of $74.7 million (six percent) and favorable foreign exchange impacts of $3.7 million (less than one percent), offset slightly by a volume decrease in Performance Materials of $13.0 million.

Gross profit

Year Ended December 31, 2022 vs. 2021

Gross profit increase of $57.3 million was driven by favorable pricing and sales composition (mix) of $291.5 million and favorable sales volume of $6.3 million, partially offset by increased manufacturing costs of $238.0 million primarily due to raw material and energy cost inflationary pressure, and unfavorable foreign exchange impacts of $2.5 million. Refer to the Segment Operating Results section included within this MD&A for more information on the drivers of the changes in gross profit period over period for both segments.

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Year Ended December 31, 2021 vs. 2020

Gross profit increase of $47.3 million was driven by favorable pricing improvement of $73.0 million, favorable sales volume of $30.6 million, and favorable foreign currency exchange of $1.3 million, partially offset by increased manufacturing costs of $57.6 million due to raw material and energy cost inflationary pressure. Refer to the Segment Operating Results section included within this MD&A for more information on the drivers to the changes in gross profit period over period for both segments.

Selling, general, and administrative expenses

Year Ended December 31, 2022 vs. 2021

Selling, general, and administrative ("SG&A") expenses were $198.8 million (12 percent of Net sales) and $179.3 million (13 percent of Net sales) for the years ended December 31, 2022 and 2021, respectively. The increase in SG&A expenses is primarily due to higher employee-related costs of $11.3 million and increased travel and other miscellaneous costs of $10.6 million. This was partially offset by a decrease in litigation defense costs of $2.4 million.

Year Ended December 31, 2021 vs. 2020

SG&A expenses were $179.3 million (13 percent of Net sales) and $149.4 million (12 percent of Net sales) for the years ended December 31, 2021 and 2020, respectively. The increase in SG&A expenses is primarily due to higher employee-related costs of $27.7 million and increased travel and other miscellaneous costs of $3.2 million. This was partially offset by a decrease in litigation defense costs of $1.0 million.

Research and technical expenses

Years Ended December 31, 2022, 2021, and 2020

Research and technical expenses as a percentage of Net sales remained relatively consistent period over period, totaling 1.8 percent of sales in the year ended December 31, 2022 compared to 1.9 percent in the years ended December 31, 2021 and 2020, respectively.

Restructuring and other (income) charges, net

Years Ended December 31, 2022, 2021, and 2020

Restructuring and other (income) charges, net, were $13.8 million, $16.2 million, and $18.5 million for the years ended December 31, 2022, 2021, and 2020, respectively. For all years presented the majority of the charges were related to our digital transformation initiative. See Note 15 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

Acquisition-related costs

Years Ended December 31, 2022, 2021, and 2020

Acquisition costs were $5.0 million, $0.6 million, and $1.8 million for the years ended December 31, 2022, 2021, and 2020, respectively. For the twelve months ended December 31, 2022, all charges related to the integration of Ozark Materials into our Performance Chemicals segment. For the twelve months ended December 31 2021 and 2020, all charges incurred were in connection with the Caprolactone Acquisition. See Note 16 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

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Other (income) expense, net

Years Ended December 31, 2022, 2021, and 2020

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(1) See Note 18 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

Interest expense

Years Ended December 31, 2022, 2021, and 2020

Interest income

Years Ended December 31 2022, 2021, and 2020

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(1) See Note 5 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

(2) See Note 9 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information.

Provision (benefit) for income taxes

Years Ended December 31, 2022, 2021, and 2020

For the years ended December 31, 2022, 2021, and 2020, our effective tax rate was 21.5 percent, 27.5 percent, and 22.8 percent respectively. An explanation of the change in the effective tax rate is presented in Note 17 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K.

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Segment Operating Results

In addition to the information discussed above, the following sections discuss the results of operations for each of Ingevity's segments. Our segments are (i) Performance Materials and (ii) Performance Chemicals. Segment Earnings before Interest, Taxes, Depreciation and Amortization ("EBITDA") is the primary measure used by the Company's chief operating decision maker to evaluate the performance of and allocate resources among our operating segments. Segment EBITDA is defined as segment revenue less segment operating expenses (segment operating expenses consist of costs of sales, selling, general and administrative expenses, other (income) expense, net, excluding depreciation and amortization). We have excluded the following items from segment EBITDA: interest expense, net, associated with corporate debt facilities, income taxes, depreciation, amortization, restructuring and other (income) charges, net, acquisition and other-related costs, litigation verdict charges, pension and postretirement settlement and curtailment (income) charge, net. In general, the accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies in Note 2 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K.

Performance Materials

Performance Summary

Our Performance Materials segment experienced solid automotive volume growth from improved semiconductor chip availability and China automobile production stimulus. Additionally, the segment also recognized volume improvement in process purification products and we were able to increase prices to capture more of the value from our highly differentiated carbon. These top-line improvements were largely offset by continued pressure from higher raw material input costs and higher logistic costs driven by inflation. The strengthening of the U.S. dollar against the Chinese renminbi and the euro also contributed to the pressure on EBITDA when compared to the prior year.

Net Sales Comparison of Years Ended December 31, 2022, 2021, and 2020

Year Ended December 31, 2022 vs. 2021

Segment net sales. The increase in 2022 was driven by a volume increase of $28.6 million (six percent) and favorable pricing and sales composition (mix) of $14.9 million (three percent), partially offset by unfavorable foreign currency exchange impacts of $11.8 million.

Segment EBITDA. Segment EBITDA increased by $2.8 million due to favorable volume of $15.6 million, pricing and sales composition (mix) of $13.8 million, and decreased SG&A expenses and research and technical costs of $0.5 million. The increase was largely offset by higher manufacturing costs of $21.5 million and unfavorable foreign currency exchange impacts of $5.6 million.

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Year Ended December 31, 2021 vs. 2020

Segment net sales. The increase in 2021 was driven by favorable pricing of $12.6 million (three percent) and favorable foreign currency exchange impacts of $7.2 million (less than one percent). The increase was partially offset by $13.0 million (three percent) in volume decline in automotive evaporative emission canister products due to semiconductor shortages in automotive markets.

Segment EBITDA. Segment EBITDA increased by $0.2 million due to favorable pricing contributing $11.3 million, and lower manufacturing costs of $2.4 million. The increase was partially offset by unfavorable volume of $11.2 million, primarily in the automotive evaporative emission canister products, and increased SG&A expenses and research and technical costs of $7.4 million, due to increased travel, outside services, and consulting expenses. Favorable foreign currency exchange impacts also contributed $5.1 million to the increase.

Performance Chemicals

Performance Summary

Our Performance Chemicals segment saw strong revenue growth versus the prior year on continued price improvement and favorable mix upgrade to higher margin products. These price increases were necessary to keep pace with the inflationary increases related to energy, raw material, and logistic costs.

Pavement Technologies sales increased by 23.5 percent due primarily to improved volumes and price increases. Volume growth was driven by technology adoption and highway funding in the United States, as well as the acquisition of Ozark Materials.

Industrial Specialties sales increased by 28.4 percent driven by price improvements with strong performance across all markets, particularly in oilfield and adhesive end markets. Price improvements were supplemented by a favorable mix shift to higher-value derivative products as volumes were negatively impacted by raw material availability.

Our Engineered Polymers business grew 31.7 percent as the business increased pricing to offset inflationary costs for raw materials, logistics, and particularly energy costs which continued to rise throughout 2022. Volume improvement was driven by stronger sales in automotive applications and footwear and apparel, mainly in Asia and Europe. These positive volume improvements were slightly offset by a decline in the Americas where some polyurethane customers experienced availability issues with key raw materials.

Net Sales Comparison of Years Ended December 31, 2022, 2021, and 2020

Year Ended December 31, 2022 vs. 2021

Segment net sales. The sales increase was driven by favorable pricing and sales composition (mix) of $279.3 million (32 percent) in industrial specialties ($201.8 million), engineered polymers ($62.4 million), and pavement technologies product

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lines ($15.1 million), partially offset by a volume decrease of $19.2 million (two percent) and unfavorable foreign currency exchange impacting Net sales by $15.0 million (two percent).

Segment EBITDA. Segment EBITDA increased $27.6 million, mainly due to favorable pricing and sales composition (mix) of $277.7 million, favorable foreign currency exchange impacts and other miscellaneous charges of $6.4 million. These increases were partially offset by higher manufacturing costs of $218.1 million due to inflationary raw material and energy costs and increased SG&A expenses of $29.1 million due to increased spending on growth initiatives, compensation, and travel. Volume declines further offset the overall increase by $9.3 million.

Year Ended December 31, 2021 vs. 2020

Segment net sales. The sales increase was driven by favorable volume of $110.0 million (15 percent), which consisted of volume growth in all business lines: industrial specialties ($64.9 million), engineered polymers ($43.5 million), and pavement technologies product lines ($1.6 million). Also driving the net sales increase was favorable pricing and product mix of $62.1 million (nine percent) in industrial specialties ($35.3 million), engineered polymers ($20.7 million), and pavement technologies product lines ($6.1 million). In addition, unfavorable foreign currency exchange impacted Net sales by $3.5 million (less than one percent).

Segment EBITDA. Segment EBITDA increased $24.1 million, mainly due to favorable pricing and product mix of $61.7 million, and an increase in volume of $41.8 million. These increases were partially offset by higher manufacturing costs of $51.6 million due to inflationary raw material and energy costs and increased SG&A expenses of $23.6 million due to increased spending on growth initiatives, compensation, and travel. Unfavorable foreign currency exchange impacts and other miscellaneous charges of $4.2 million also contributed to increased costs.

Use of Non-GAAP Financial Measures

Ingevity has presented the financial measure, Adjusted EBITDA, defined below, which has not been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and has provided a reconciliation to net income, the most directly comparable financial measure calculated in accordance with GAAP. Adjusted EBITDA is not meant to be considered in isolation nor as a substitute for the most directly comparable financial measure calculated in accordance with GAAP. Adjusted EBITDA is utilized by management as a measure of profitability.

We believe this non-GAAP financial measure provides management as well as investors, potential investors, securities analysts, and others with useful information to evaluate the performance of the business, because such measure, when viewed together with our financial results computed in accordance with GAAP, provides a more complete understanding of the factors and trends affecting our historical financial performance and projected future results. We believe Adjusted EBITDA is a useful measure because it excludes the effects of financing and investment activities as well as non-operating activities.

Adjusted EBITDA is defined as net income (loss) plus provision (benefit) for income taxes, interest expense, net, depreciation, amortization, restructuring and other (income) charges, net, acquisition, and other-related costs, litigation verdict charges, and pension and postretirement settlement and curtailment (income) charges, net.

This non-GAAP measure is not intended to replace the presentation of financial results in accordance with GAAP and investors should consider the limitations associated with these non-GAAP measures, including the potential lack of comparability of these measures from one company to another. A reconciliation of Adjusted EBITDA to net income is set forth within this section.

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Adjusted EBITDA

Year Ended December 31, 2022, 2021 and 2020

The factors that impacted Adjusted EBITDA period to period are the same factors that affected earnings discussed in the sections entitled "Results of Operations" and "Segment Operating Results" within MD&A.

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Total Company Outlook and 2023 Guidance

Net sales are expected to be between $1.9 billion and $2.1 billion. Growth drivers in our Performance Chemicals segment include our pavement technologies product line as municipalities take advantage of increased infrastructure spending and continue to adopt our Evotherm® warm mix technology and new road markings products. We also anticipate growth in our agrochemicals and oilfield products within our industrial specialties product line. Our engineered polymers product line is expected to continue increasing its presence in key end markets like automotive, consumer packaging, and footwear and apparel. We expect global automobile production to improve, which will support growth in Performance Materials.

Adjusted EBITDA is expected to grow to between $495 million to $515 million. In Performance Chemicals, we anticipate lower energy costs will benefit our engineered polymers product line, and a focus on higher-value end markets in the industrial specialties product line, as well as continued growth in the pavement technologies product line, will help offset what we expect to be an increase in the cost of a primary raw material, CTO. We expect EBITDA growth for our Performance Materials segment as volumes shift throughout 2023 to higher margin automotive carbon and automotive production supply chain dynamics improve.

A reconciliation of net income to adjusted EBITDA as projected for 2023 is not provided. Ingevity does not forecast net income as it cannot, without unreasonable effort, estimate or predict with certainty various components of net income. These components, net of tax, include further restructuring and other income (charges), net; additional acquisition and other-related costs; litigation verdict charges; additional pension and postretirement settlement and curtailment (income) charges; and revisions due to legislative tax rate changes. Additionally, discrete tax items could drive variability in our projected effective tax rate. All of these components could significantly impact such financial measures. Further, in the future, other items with similar characteristics to those currently included within adjusted EBITDA, that have a similar impact on the comparability of periods, and which are not known at this time, may exist and impact adjusted EBITDA.

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Liquidity and Capital Resources

The primary source of liquidity for our business is the cash flow provided by operating activities. We expect our cash flow provided by operations combined with cash on hand and available capacity under our revolving credit facility to be sufficient to fund our planned operations and meet our interest and other contractual obligations for at least the next twelve months. As of December 31, 2022, our undrawn capacity under our revolving credit facility was $169.7 million. Over the next twelve months, we expect to fund the following: interest payments, capital expenditures, expenditures related to our business transformation initiative, debt principal repayments, purchases pursuant to our stock repurchase program, income tax payments, and to incur additional spending associated with our Performance Materials' intellectual property litigation. In addition, we may also evaluate and consider strategic acquisitions, joint ventures, or other transactions to create stockholder value and enhance financial performance. In connection with such transactions, or to fund other anticipated uses of cash, we may modify our existing revolving credit facility, redeem all or part of our outstanding senior notes, seek additional debt financing, issue equity securities, or some combination thereof.

Cash and cash equivalents totaled $76.7 million at December 31, 2022. We continuously monitor deposit concentrations and the credit quality of the financial institutions that hold our cash and cash equivalents, as well as the credit quality of our insurance providers, customers, and key suppliers.

Due to the global nature of our operations, a portion of our cash is held outside the U.S. The cash and cash equivalents balance at December 31, 2022, included $71.7 million held by our foreign subsidiaries. Cash and earnings of our foreign subsidiaries are generally used to finance our foreign operations and their capital expenditures. We believe that our foreign holdings of cash will not have a material adverse impact on our U.S. liquidity. If these earnings were distributed, such amounts would be subject to U.S. federal income tax at the statutory rate less the available foreign tax credits, if any, and would potentially be subject to withholding taxes in the various jurisdictions. The potential tax implications of the repatriation of unremitted earnings are driven by facts at the time of distribution, therefore, it is not practicable to estimate the income tax liabilities that might be incurred if such cash and earnings were repatriated to the U.S. Management does not currently expect to repatriate cash earnings from our foreign operations in order to fund U.S. operations.

Debt and Finance Lease Obligations

Refer to Note 10 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for a summary of our outstanding debt obligations and revolving credit facility.

Other Potential Liquidity Needs

Share Repurchases

On July 25, 2022, our Board of Directors authorized the repurchase of up to $500.0 million of our common stock (the "2022 Authorization") and rescinded the prior outstanding repurchase authorization with respect to the shares that remained unused under the prior authorization. Shares under the current repurchase authorization may be purchased through open market or privately negotiated transactions at the discretion of management based on its evaluation of market prevailing conditions and other factors, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.

During the year ended December 31, 2022, we repurchased $145.2 million in common shares, representing 2,112,463 shares of our common stock at a weighted average cost per share of $68.73. At December 31, 2022, $444.7 million remained available for purchase under our Board-authorized repurchase program.

Capital Expenditures

Projected 2023 capital expenditures are expected to be $140 million to $160 million. We have no material commitments associated with these projected capital expenditures as of December 31, 2022.

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Cash flow comparison of Years Ended December 31, 2022, 2021, and 2020

Cash flows provided by (used in) operating activities

Cash flows provided by (used in) operating activities, which consists of net income (loss) adjusted for non-cash items including the cash impact from changes in operating assets and liabilities (i.e., working capital), totaled $313.1 million for the year ended December 31, 2022.

Cash provided by (used in) operating activities for 2022 was driven by higher cash earnings of $43.8 million offset by a net increase in overall working capital of $15.3 million which includes an increase in trade working capital (accounts receivable, inventory, and accounts payable) of $8.3 million. The build in trade working capital was due primarily to higher end of year accounts receivable on higher sales and higher inventory value due to continued inflation experienced during 2022. Cash flow from operations was further reduced by an increase in cash interest paid of $7.3 million due to the rising interest rates during 2022 when compared to 2021 as well as $1.1 million of additional tax payments. The higher tax payments were driven by the higher year over year earnings offset by refunds received in 2022 on prior years' earnings.

Cash provided by (used in) operating activities for 2021 was driven by higher cash earnings of $26.1 million offset by a net increase in overall working capital of $70.5 million which includes an increase in trade working capital (accounts receivable, inventory, and accounts payable) of $89.3 million. The build in trade working capital was due primarily to higher end of year accounts receivable on higher sales and higher inventory value due to inflation experienced during 2021 compared to 2020. Cash flow from operations was further reduced by an increase in cash interest paid of $7.9 million primarily due to a full year of interest on our 3.88% Senior Notes due 2028 as well as an increase in cash tax payments of $7.1 million. Higher earnings in 2021 compared to 2020 contributed to the increase in tax payments in 2021 further compounded by the depletion of net operating losses in prior years.

Cash flows provided by (used in) investing activities

For the year ended December 31, 2022, investing activities were driven by capital spending, the Ozark Materials acquisition, and the purchase of strategic investments. Capital spending included the base maintenance capital supporting ongoing operations and cost improvement and growth spending primarily related to our business transformation initiative (refer to Note 15 within the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information). Also, during the year ended December 31, 2022, we acquired Ozark Materials (refer to Note 16 within the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information) and we entered into multiple strategic investments (refer to Note 5 within the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information).

For the year ended December 31, 2021, investing activities were driven by capital spending and strategic investments. Capital spending included the base maintenance capital supporting ongoing operations and growth and cost improvement spending primarily related to our business transformation initiative (refer to Note 15 within the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information). Also, during twelve months ended December 31, 2021, we entered into multiple strategic investments (refer to Note 5 within the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information).

For the year ended December 31, 2020, investing activities were driven by capital spending. Our Performance Materials' facilities, including Covington, Virginia, Wickliffe, Kentucky, and Waynesboro, Georgia, incurred expenditures for growth and expansion projects, as well as base maintenance and safety spending. Our Performance Chemicals' facility in Warrington, United Kingdom, completed a large, multi-year growth and cost improvement project, and there was additional spending at all of our Performance Chemicals' facilities for base maintenance and safety spending. Additionally, we had capital expenditures related to our business transformation initiative (see Note 15 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information) and our new corporate headquarters.

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Cash flows provided by (used in) financing activities

Cash provided by financing activities for the year ended December 31, 2022, was $48.1 million and was driven by net proceeds from the revolving credit facility of $828.0 million, offset by payments on long-term borrowings of $628.1 million, payments, and share repurchases of $145.2 million.

Cash used in financing activities for the year ended December 31, 2021, was $133.1 million, and was driven by the repurchase of common stock of $109.4 million, payments on long-term borrowings of $23.4 million, and tax payments related to withholding tax on vested equity awards of $2.4 million.

Cash used in financing activities for the year ended December 31, 2020, was $50.2 million, and was driven by proceeds from long-term borrowings from the senior notes that were issued in the fourth quarter of $550.0 million, net of debt issuance costs of $8.8 million. We used these proceeds to repay the outstanding balance on the revolving credit facility of $131.2 million and the 2019 term loan of $375.0 million. We also paid $2.2 million in debt issuance costs for the amendment to our revolving credit facility (refer to Note 10 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information). Additionally, we repaid $14.1 million of other long-term borrowings, repurchased $88.0 million of our common stock, and made payments of $3.2 million related to withholding tax on vested equity awards.

New Accounting Guidance

Refer to Note 3 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for a full description of recent accounting pronouncements including the respective expected dates of adoption and expected effects on our Consolidated Financial Statements.

Critical Accounting Policies and Estimates

Our principal accounting policies are described in Note 2 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K. Our Consolidated Financial Statements are prepared in conformity with GAAP. The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We have reviewed these accounting policies, identifying those that we believe to be critical to the preparation and understanding of our financial statements. Critical accounting policies are central to our presentation of results of operations and financial condition and require management to make estimates and judgments on certain matters. We base our estimates and judgments on historical experience, current conditions, and other reasonable factors.

The following is a list of those accounting policies that we have deemed most critical to the presentation and understanding of our results of operations and financial condition:

Revenue recognition

Our revenue is derived from contracts with customers, and substantially all our revenue is recognized when products are either shipped from our manufacturing and warehousing facilities or delivered to the customer. Revenue, net of returns and customer incentives, is based on the sale of manufactured products. Revenues are recognized when performance obligations under the terms of a contract with our customer are satisfied; generally, this occurs with the transfer of control of our products. For certain limited contracts, where we are producing goods with no alternative use and for which we have an enforceable right to payment for performance completed to date, we are recognizing revenue as goods are manufactured, rather than when they are shipped. Revenues are presented as Net sales on the consolidated statements of operations.

Since Net sales are derived from product sales only, we have disaggregated our Net sales by our product lines within each reportable segment. Net sales are measured as the amount of consideration we expect to receive in exchange for transferring goods. Sales, value add, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. Sales returns and allowances are not a normal practice in the industry and are not significant. Certain customers may

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receive cash-based incentives, including discounts and volume rebates, which are accounted for as variable consideration and included within Net sales. Shipping and handling fees billed to customers are included in Net sales. If we pay for the freight and shipping, we recognize the cost when control of the product has transferred to the customer as an expense within Cost of sales on the consolidated statements of operations. Payment terms with our customers are typically in the range of zero to sixty days. Because the period between when we transfer a promised good to a customer and when the customer pays for that good will be one year or less, we elect not to adjust the promised amount of consideration for the effects of any financing component, as it is not significant.

Valuation of tangible and intangible long-lived assets and goodwill

Our long-lived assets primarily include property, plant, and equipment, and other intangible assets. We periodically evaluate whether current events or circumstances indicate that the carrying value of long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to carrying value to determine whether an impairment exists.

If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows. We report an asset to be disposed of at the lower of its carrying value or its estimated net realizable value.

Goodwill represents the excess of cost of an acquired business over the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed in a business combination. We conduct a required annual review of goodwill for potential impairment at October 1, or sooner if events or changes in circumstances indicate that the fair value of a reporting unit is below its carrying value. Our reporting units are our operating segments, i.e., Performance Chemicals and Performance Materials. If the carrying value of a reporting unit that includes goodwill exceeds its fair value, which is determined using both the income approach and market approach, goodwill is considered impaired. The income approach determines fair value based on discounted cash flow model derived from a reporting unit’s long-term forecasted cash flows. The market approach determines fair value based on the application of earnings multiples of comparable companies to the projected earnings of the reporting unit. The amount of impairment loss is measured as the difference between the carrying value and the fair value of a reporting unit but is limited to the total amount of goodwill allocated to the reporting unit. In performing the fair value analysis, management makes various judgments, estimates, and assumptions, the most significant of which is the assumption related to revenue growth rates.

The factors we considered in developing our estimates and projections for cash flows include, but are not limited to, the following: (i) macroeconomic conditions; (ii) industry and market considerations; (iii) costs, such as increases in raw materials, labor, or other costs; (iv) our overall financial performance; and (v) other relevant entity-specific events that impact our reporting units.

The determination of whether goodwill is impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated fair values of our reporting units. We believe that the estimates and assumptions used in our impairment assessment are reasonable; however, these assumptions are judgmental and variations in any assumptions could result in materially different calculations of fair value. We will continue to evaluate goodwill on an annual basis as of October 1, and whenever events or changes in circumstances, such as significant adverse changes in operating results, market conditions, or changes in management’s business strategy indicate that there may be a probable indicator of impairment. It is possible that the assumptions used by management related to the evaluation may change or that actual results may vary significantly from management’s estimates.

Business Combinations

Accounting for business combinations, which requires, among other things, the acquiring entity in a business combination to recognize the fair value of the assets acquired and liabilities assumed; the recognition of acquisition-related costs within the consolidated results of operations; the recognition of restructuring costs within the consolidated results of operations for which the acquirer becomes obligated after the acquisition date; and contingent purchase consideration to be recognized at fair value on the acquisition date with subsequent adjustments recognized on the consolidated statements of operations. We generally use qualified third-party consultants to assist management in determining the fair value of assets acquired and liabilities assumed. This includes, when necessary, assistance with the determination of lives and valuation of

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tangible property, plant, and equipment and identifiable intangibles, assisting management in determining the fair value of obligations associated with employee-related liabilities and assisting management in assessing obligations associated with legal and environmental claims.

The fair value assigned to identifiable intangible assets acquired is determined primarily by using an income approach, which is based on assumptions and estimates made by management. Significant assumptions utilized in the income approach are the attrition rate, revenue growth rates, EBITDA margins, royalty rates, and the discount rate. These assumptions are based on company-specific information and projections, which are not observable in the market and are therefore considered Level 2 and Level 3 measurements. The excess of the purchase price over the fair value of the identified assets and liabilities is recorded as goodwill. Based on the acquired business’ end markets and products, as well as how the chief operating decision maker will review the business results, determines the most appropriate operating segment for which to integrate the acquired business. Goodwill acquired, if any, is allocated to the reporting unit within or at the operating segment for which the acquired business will be integrated. Selection of the appropriate reporting unit is based on the level at which discrete financial information is available and reviewed by business management post-integration. Operating results of the acquired entity are reflected within the Consolidated Financial Statements from the date of acquisition.

Income taxes

We are subject to income taxes in the U.S. and numerous foreign jurisdictions, including China and the United Kingdom. The provision for income taxes includes income taxes paid, currently payable or receivable, and deferred taxes. We follow the liability method of accounting for income taxes in accordance with current accounting standards regarding the accounting for income taxes. Under this method, deferred income taxes are recorded based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws in effect at the time the underlying assets or liabilities are recovered or settled. The ability to realize deferred tax assets is evaluated through the forecasting of taxable income, historical and projected future operating results, the reversal of existing temporary differences, and the availability of tax planning strategies. Valuation allowances are recognized to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. We do not provide income taxes on undistributed earnings of consolidated foreign subsidiaries as it is our intention that such earnings will remain invested in those companies.

We recognize income tax positions that are more likely than not to be realized and accrue interest related to unrecognized income tax positions, which is included as a component of the income tax provision, on the consolidated statements of operations.