ECOVYST INC. Unless the context requires otherwise, references in this report to "PQ Group Holdings ," "the company," "we," "us" or "our" refer toPQ Group Holdings Inc. and its consolidated subsidiaries. Forward-looking Statements This periodic report on Form 10-Q ("Form 10-Q") includes statements that express our opinions, expectations, beliefs, plans, objectives, assumptions or projections regarding future events or future results and therefore are, or may be deemed to be, "forward-looking statements". The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," "should" and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short- and long-term business operations and objectives, and financial needs. Examples of forward-looking statements include, but are not limited to, statements we make regarding the sale of our Performance Materials segment, the impact of the novel coronavirus ("COVID-19") pandemic on our operations and financial results and our liquidity, including our belief that our existing cash, cash equivalents and cash flow from operations, combined with availability under our asset based lending revolving credit facility will be sufficient to meet our presently anticipated future cash needs for at least the next 12 months. These forward-looking statements are subject to a number of risks, uncertainties and assumptions. Moreover, we operate in a very competitive and rapidly changing environment and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed herein may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Some of the key factors that could cause actual results to differ from our expectations include risks related to: •the impact of the ongoing COVID-19 pandemic on the global economy and financial markets, as well as on our business and our suppliers, and the response of governments and of our company to the outbreak; •our exposure to local business risks and regulations in different countries; •general economic conditions; •exchange rate fluctuations; •legal and regulatory compliance; •significant developments relating to theU.S. administration,U.S. courts' or theUnited Kingdom's exit from theEuropean Union ; •technological or other changes in our customers' products; •our and our competitors' research and development; •fluctuations in prices of raw materials and relationships with our key suppliers; •substantial competition; •non-payment or non-performance by our customers; •reliance on a small number of customers; •potential early termination or non-renewal of customer contracts in our Refining Services segment; •reductions in highway safety spending or taxes earmarked for highway safety spending; •seasonal fluctuations in demand for some of our products; •retention of certain key personnel; •realization of our growth projects; •potential product liability claims; •existing and potential future government regulation; •the extensive environmental, health and safety regulations to which we are subject; •disruption of production and distribution of our products; •risk of loss beyond our available insurance coverage; 38 -------------------------------------------------------------------------------- Table of Contents •product quality; •successful integration of acquisitions; •our joint venture investments; •our failure to protect our intellectual property and infringement on the intellectual property rights of third parties; •information technology risks; •potential labor disruptions; •litigation and other administrative and regulatory proceedings; •our substantial indebtedness; and •other factors set forth in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . The forward-looking statements included herein are made only as of the date hereof. You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Form 10-Q to conform these statements to actual results or to changes in our expectations. Overview We are a leading integrated and innovative global provider of specialty catalysts, materials, chemicals and services. We support customers globally through our strategically located network of manufacturing facilities. We believe that our products, which are predominantly inorganic, and services contribute to improving the sustainability of the environment. We conduct operations through four reporting segments: (1) Refining Services, (2) Catalysts (including our 50% interest in the Zeolyst Joint Venture), (3) Performance Materials, and (4) Performance Chemicals. Refining Services: We are the leading provider of sulfuric acid recycling services to North American refineries for the production of alkylate, an essential gasoline component for lowering vapor pressure and increasing octane to meet stringent gasoline specifications and fuel efficiency standards. We are also a leading North American producer of on-purpose virgin sulfuric acid for water treatment, mining, and industrial applications. Catalysts: We are a global supplier of finished silica catalysts and catalyst supports necessary to produce high strength and high stiffness plastics used in packaging films, bottles, containers, and other molded applications. We are also a leading global supplier of zeolites used for catalysts that remove nitric oxide from diesel engine emissions as well as sulfur from fuels during the refining process. Performance Materials: We are an industry leader inNorth America ,Europe , andSouth America in transportation safety. Our products are used to delineate roads and runways with highly reflective markings, improving safety by enhancing visibility at night and in poor weather. Our microspheres also serve as functional additives in industrial applications, including polymers and plastics, and in abrasive applications for metal surfaces. Performance Chemicals: We are a leading global producer of sodium silicates and downstream specialty silicas as well as other silicate derivative products. These products are used in a wide variety of industrial and consumer applications such as matting agents in surface coatings, clarifying agents for edible oils and beer, precursors for green tires, additives for dental cleaning and personal care products, and as feedstock for our additives and catalyst platforms. Recent Developments OnOctober 15, 2020 , we entered into a definitive agreement to sell our Performance Materials business for$650.0 million . We expect to use after-tax cash proceeds from the sale to reduce debt and return capital to our shareholders, subject to board approval and declaration. The transaction is expected to close by the end of 2020, subject to regulatory approvals and customary closing conditions. Beginning in the fourth quarter of 2020, we expect to present the financial results of the Performance Materials business as discontinued operations. 39 -------------------------------------------------------------------------------- Table of Contents Impact of COVID-19 on our Business and Results InMarch 2020 , the outbreak of COVID-19 was declared a national emergency bythe United States . COVID-19 continues to spread throughout the world and has adversely impacted economic activity and contributed to volatility in financial markets. In response to the COVID-19 pandemic, the federal government, various states, local and foreign governments have issued decrees and orders that have disrupted many businesses and implemented social distancing, travel and other restrictions. In response to these restrictions, we have taken a variety of actions, including an international travel ban, distribution of personal protective equipment to employees, and work-at-home requirements for many of our employees who are not an integral part of our manufacturing operations. We have also implemented and refined our existing business continuity plans in an effort to minimize disruptions to our operations. Our manufacturing operations, as well as the operations of our key vendors and the majority of our key customers, have continued to operate with limited interruptions. Some of the ways our businesses support the battle against COVID-19 include: •In our Refining Services segment, our plants provide critical services that refineries need to produce fuel that powers vehicles that transport goods and people to essential businesses; •In our Catalysts segment, we produce supports used to manufacture polypropylene, which is the most common material used to make surgical masks. We also produce catalysts and supports needed to manufacture polyethylene, which is used in packaging materials for detergents, bleaches, specialized medical equipment and other sanitation items that are critical to preventing the spread of COVID-19; •In our Performance Materials segment, we produce high-quality microspheres which are used in respirators, hospital beds and protective goggles; and •In our Performance Chemicals segment, our silicates are used in cleaning products such as soaps and detergents used in homes, businesses and hospitals. Near Term Trends on Business Segment End Uses The COVID-19 pandemic has led to unprecedented disruptions within the macro economy, which led to an overall lower sales volume demand during the third quarter of 2020. The timing and magnitude of the impact to sales volume demand varied across our portfolio of businesses due to the many end uses. Key end use trends in our business segments during the third quarter and expectations for the balance of the year are described below: •Refining Services: This business segment was impacted the most by COVID-19 but has begun to see a significant rebound in demand from second quarter lows. Stay-at-home mandates enacted at the end of the first quarter, which continued through the second quarter, led to rapid and significant reductions in gasoline demand in theU.S. As stay-at-home restrictions were lifted toward the end of the second quarter, gasoline consumption recovered to approximately 90% of 2019 levels. Virgin sulfuric acid demand from refining and industrial customers rebounded in the third quarter, which mitigated continued pressure within the automotive and industrial production end uses. We expect these trends to continue into the fourth quarter. •Performance Materials: We experienced a reduction in demand for our North American highway safety products as a result of reduced levels of striping activity due to COVID-related work restrictions. InEurope , demand has been showing a steady monthly improvement as countries reopened and customers returned to work on previously approved road striping projects. While the fourth quarter is typically seasonally lower than the third quarter due to weather conditions, we anticipate that demand trends will be comparable to the prior year. Demand for our engineered glass materials showed steady improvement in the third quarter, with volumes increasing for products sold to the general industrial and construction end uses. This more than offset continued slower demand for products sold to the automotive industry. We expect this utilization to extend into the fourth quarter. •Performance Chemicals: Since the second quarter, improving signs of economic recovery are benefiting our products used for consumer product and industrial and process chemicals applications. However, demand for commercial cleaning remained soft as detergents and personal care consumption eased from the strong second-quarter surge by consumers stocking up for COVID-19 stay-at-home mandates. •Catalysts: Our Catalysts segment delivered strong polyolefin catalyst results through the third quarter endedSeptember 30, 2020 . However, with refineries now focused on cash conservation, a number of our customers are now adjusting their change-out schedules. Demand for our emission control catalysts used in heavy-duty diesel vehicles slumped in the third quarter as our customers continued to curtail production to align with lower demand. We anticipate that demand will be well below prior year levels. During the quarter endedSeptember 30, 2020 , we continued to take actions to mitigate the slowdown in our business as a result of the effects of COVID-19, including adjusting our production levels to meet anticipated customer demand, reducing discretionary spending, furloughs, delaying headcount additions and deferring capital maintenance expenditures. 40 -------------------------------------------------------------------------------- Table of Contents Operations and Supply Although the full impact of COVID-19 on our business is currently unknown, our manufacturing facilities have continued to operate and have been providing critical materials necessary to aid in combating the COVID-19 pandemic and products we manufacture for other essential businesses. Our manufacturing plants require a limited number of on-site employees in order to continue to operate effectively. We have not experienced any material production issues to date, but have had limited and temporary shutdowns or slowdowns in some of our facilities. Several of our manufacturing facilities experienced production delays as a result of employee absenteeism related to COVID-19. We have also seen limited disruptions in the availability of certain of our raw materials and other supplies, which to date have not had a material impact on production. Liquidity As ofSeptember 30, 2020 , we had cash and cash equivalents of$164.3 million and total available liquidity of$345.4 million . During the quarter endedMarch 31, 2020 , we amended our Term Loan Facility to reduce the applicable interest rate and extend the maturity of the facility toFebruary 2027 . We also amended our existing ABL Facility to reduce the applicable interest rate, extend the maturity, and increase the aggregate amount of the revolving loan commitments available by$50.0 million to$250.0 million . InJuly 2020 , we entered into an agreement for a new senior secured term loan facility of$650.0 million , the proceeds of which were used to refinance our existing 6.75% Senior Secured Notes due 2022 and pay the associated early redemption premiums. The new senior secured term loan facility will reduce our interest expense and will mature inFebruary 2027 . Following these actions, we have no significant debt maturities prior toNovember 2025 and our outstanding debt obligations do not contain material financial covenants requiring us to maintain a leverage ratio below a particular level. Coronavirus Aid, Relief and Economic Security ("CARES") Act OnMarch 27, 2020 , the CARES Act was signed into law. The provisions of the CARES Act provide substantial stimulus and financial assistance measures intended to mitigate the impact of the COVID-19 pandemic, including certain tax relief provisions. As permitted within the CARES Act, we began deferring payment of the employer portion of social security taxes in the second quarter and expect to continue to do so through the end of 2020, with 50% of the deferred amount dueDecember 31, 2021 and the remaining 50% dueDecember 31, 2022 . This deferral is expected to provide approximately$6.0 million in additional liquidity in 2020. We continue to monitor any effects that may result from the CARES Act. Key Performance Indicators Adjusted EBITDA and Adjusted Net Income Adjusted EBITDA and adjusted net income are financial measures that are not prepared in accordance with accounting principles generally accepted inthe United States ("GAAP") and that we use to evaluate our operating performance, for business planning purposes and to measure our performance relative to that of our competitors. Adjusted EBITDA and adjusted net income are presented as key performance indicators as we believe these financial measures will enhance a prospective investor's understanding of our results of operations and financial condition. EBITDA consists of net income (loss) attributable toPQ Group Holdings before interest, taxes, depreciation and amortization. Adjusted EBITDA consists of EBITDA adjusted for (i) non-operating income or expense, (ii) the impact of certain non-cash, nonrecurring or other items included in net income (loss) and EBITDA that we do not consider indicative of our ongoing operating performance, and (iii) depreciation, amortization and interest of our 50% share of the Zeolyst Joint Venture. Adjusted net income consists of net income (loss) attributable toPQ Group Holdings adjusted for (i) non-operating income or expense and (ii) the impact of certain non-cash, nonrecurring or other items included in net income (loss) that we do not consider indicative of our ongoing operating performance. We believe that these non-GAAP financial measures provide investors with useful financial metrics to assess our operating performance from period-to-period by excluding certain items that we believe are not representative of our core business. You should not consider adjusted EBITDA or adjusted net income in isolation or as alternatives to the presentation of our financial results in accordance with GAAP. The presentation of adjusted EBITDA and adjusted net income financial measures may differ from similar measures reported by other companies and may not be comparable to other similarly titled measures. In evaluating adjusted EBITDA and adjusted net income, you should be aware that we are likely to incur expenses similar to those eliminated in this presentation in the future and that certain of these items could be considered recurring in nature. Our presentation of adjusted EBITDA and adjusted net income should not be construed as an inference that our future results will be unaffected by unusual or nonrecurring items. Reconciliations of adjusted EBITDA and adjusted net income to GAAP net income (loss) are included in the results of operations discussion that follows for each of the respective periods. 41 -------------------------------------------------------------------------------- Table of Contents Key Factors and Trends Affecting Operating Results and Financial Condition Sales Over the past few months, our sales have been negatively impacted by COVID-19. Declining gross domestic product inthe United States andEurope , reduced demand for gasoline, stay-at-home requirements and work restrictions to improve safety have temporarily reduced demand for products across our portfolio. We believe the second quarter was the trough of our demand decline as we have experienced improvement in most areas of our business during the third quarter. Refer to the discussion above under "Impact of COVID-19 on our Business and Results" for additional commentary. Sales in our Refining Services, Performance Chemicals and Catalysts segments are made on both a purchase order basis and pursuant to long-term contracts. Product sales in our Performance Materials segment are made principally on a purchase order basis. Historically, our Performance Materials and Performance Chemicals segments have experienced relatively stable demand throughout economic cycles due to the diverse consumer and industrial end uses that our products serve. There may be modest fluctuations in timing of orders, but orders are mainly driven by demand and general economic conditions. Cost of Goods Sold Cost of goods sold consists of variable product costs, fixed manufacturing expenses, depreciation expense and freight expenses. Variable product costs include all raw materials, energy and packaging costs that are directly related to the manufacturing process. Fixed manufacturing expenses include all plant employment costs, manufacturing overhead and periodic maintenance costs. The primary raw materials for our Refining Services segment include spent sulfuric acid, sulfur, acids, bases (including sodium hydroxide, or "caustic soda"), and certain metals. The primary raw materials used in the manufacture of products in our Performance Materials, Performance Chemicals and Catalysts segments include soda ash, industrial sand, aluminum trihydrate, sodium hydroxide, and cullet. Most of our Refining Services contracts feature take-or-pay volume protection and/or quarterly price adjustments for commodity inputs, labor, the Chemical Engineering Index (U.S. chemical plant construction cost index) and natural gas. Spent acid for our Refining Services segment is supplied by customers for a nominal charge as part of their contracts. Over 90% of our Refining Services segment sales for the year endedDecember 31, 2019 were under contracts featuring quarterly price adjustments. The price adjustments generally reflect actual costs for producing acid and tend to protect us from volatility in labor, fixed costs and raw material pricing. The take-or-pay volume protection allows us to cover fixed costs through intermittent, temporary production issues at customer refineries. For the year endedDecember 31, 2019 , approximately 50% of ourAmericas silicate sales, which is a significant portion of our Performance Chemicals segment sales, were derived from contracts that included raw material pass-through clauses. Under these contracts, there generally is a time lag of three to nine months for price changes to pass through, depending on the magnitude of the change in cost and other market dynamics. Freight expenses are generally passed through directly to customers. While natural gas is not a direct feedstock for any product, all businesses use natural gas powered furnaces to heat raw materials and create the chemical reactions necessary to produce end-products. We maintain multiple suppliers wherever possible, hedge exposure to fluctuations in prices for natural gas purchases inthe United States , make forward purchases of natural gas inthe United States ,Canada , andEurope to mitigate our exposure to price volatility, and structure our customer contracts when possible to allow for the pass-through of raw material and natural gas costs. Joint Ventures We account for our investments in our equity joint ventures under the equity method. Our largest joint venture, the Zeolyst Joint Venture, manufactures high performance, specialty, zeolite-based catalysts for use in the packaging and engineered plastics, emission control, refining and petrochemical industries and other areas of the broader chemicals industry. We share proportionally in the management of our joint ventures with the other parties to each such joint venture. Seasonality Seasonal changes and weather conditions typically affect our Performance Materials and Refining Services segments. In particular, our Performance Materials segment generally experiences lower sales and profit in the first and fourth quarters of the year because highway striping projects typically occur during warmer weather months. Our Refining Services segment typically experiences similar seasonal fluctuations as a result of higher demand for gasoline products in the summer months. As a result, working capital requirements tend to be higher in the first and second quarters of the year, which can adversely affect our liquidity and cash flows. Because of this seasonality associated with certain of our segments, results for any one quarter are not necessarily indicative of the results that may be achieved for any other quarter or for the full year. 42 -------------------------------------------------------------------------------- Table of Contents Foreign Currency As a global business, we are subject to the impact of gains and losses on currency translations, which occur when the financial statements of foreign operations are translated intoU.S. dollars. We operate a geographically diverse business with approximately 40% of our sales for the nine months endedSeptember 30, 2020 and the year endedDecember 31, 2019 in currencies other than theU.S. dollar. Because our consolidated financial results are reported inU.S. dollars, sales or earnings generated in currencies other than theU.S. dollar can result in a significant increase or decrease in the amount of those sales and earnings when translated toU.S. dollars. The foreign currencies to which we have the most significant exchange rate exposure include the Euro, British pound, Canadian dollar, Brazilian real and the Mexican peso. Results of Operations Three Months EndedSeptember 30, 2020 Compared to the Three Months EndedSeptember 30, 2019 Highlights The following is a summary of our financial performance for the three months endedSeptember 30, 2020 compared with the three months endedSeptember 30, 2019 . Sales •Sales decreased$43.5 million to$380.3 million . The decrease in sales was primarily due to lower sales volumes and the unfavorable effects of foreign currency translation of$2.5 million . Gross Profit •Gross profit decreased$16.4 million to$96.5 million . The decrease in gross profit was primarily due to the decline in sales volumes, partially offset by lower production costs. Operating Income •Operating income decreased by$10.6 million to$47.0 million . The decrease in operating income was due to lower gross profit, which was partly offset by a gain on the sale of a non-core product line and reduced selling, general and administrative expenses. Equity in Net Income of Affiliated Companies •Equity in net income of affiliated companies for the three months endedSeptember 30, 2020 was$0.2 million , compared to$17.3 million for the three months endedSeptember 30, 2019 . The decrease of$17.1 million was due to lower earnings generated by the Zeolyst Joint Venture for the three months endedSeptember 30, 2020 . 43 -------------------------------------------------------------------------------- Table of Contents The following is our unaudited condensed consolidated statements of income and a summary of financial results for the three months endedSeptember 30, 2020 and 2019: Three months ended September 30, Change 2020 2019 $ % (in millions, except percentages) Sales$ 380.3 $ 423.8 $ (43.5) (10.3) % Cost of goods sold 283.8 310.9 (27.1) (8.7) % Gross profit 96.5 112.9 (16.4) (14.5) % Gross profit margin 25.4 % 26.6 %
Selling, general and administrative
expenses 37.1 39.5 (2.4) (6.1) % Other operating expense, net 12.4 15.7 (3.3) (21.0) % Operating income 47.0 57.6 (10.6) (18.4) % Operating income margin 12.4 % 13.6 %
Equity in net (income) from affiliated
companies (0.2)
(17.3) 17.1 (98.8) %
Interest expense, net 18.6 27.7 (9.1) (32.9) % Debt extinguishment costs 14.0 1.8 12.2 677.8 % Other (income) expense, net (5.0) 1.9 (6.9) (363.2) %
Income before income taxes and
noncontrolling interest 19.6 43.5
(23.9) (54.9) %
Provision for income taxes 11.8 16.7 (4.9) (29.3) % Effective tax rate 60.1 % 38.4 % Net income 7.8 26.8 (19.0) (70.9) %
Less: Net income attributable to the
noncontrolling interest 0.3 0.1
0.2 200.0 %
Net income attributable to
Holdings Inc.$ 7.5 $ 26.7 $ (19.2) (71.9) % Sales Three months ended September 30, Change 2020 2019 $ % (in millions, except percentages) Sales: Refining Services$ 107.6 $ 118.3 $ (10.7) (9.0) % Catalysts 23.1 25.6 (2.5) (9.8) % Performance Materials 104.6 115.1 (10.5) (9.1) % Performance Chemicals 148.5 167.9 (19.4) (11.6) % Eliminations (3.5) (3.1) (0.4) Total sales$ 380.3 $ 423.8 $ (43.5) (10.3) % Refining Services: Sales in Refining Services for the three months endedSeptember 30, 2020 were$107.6 million , a decrease of$10.7 million , or 9.0%, compared to sales of$118.3 million for the three months endedSeptember 30, 2019 . The decrease in sales was primarily due to lower average selling prices of$5.9 million and lower volumes of$4.8 million . The decline in sales was the result of lower gasoline production due to the COVID-19 pandemic, refining disruptions caused by Hurricane Laura and the pass-through of lower sulfur pricing of$3.7 million in our virgin sulfuric acid product group. Catalysts: Sales in Silica Catalysts for the three months endedSeptember 30, 2020 were$23.1 million , a decrease of$2.5 million , or 9.8%, compared to sales of$25.6 million for the three months endedSeptember 30, 2019 . The decrease in sales was primarily due to a decrease in volumes of$2.4 million . The decrease in sales was due to a decline in methyl methacrylate sales which were partially offset by continued strong demand for our polyolefin catalysts. 44 -------------------------------------------------------------------------------- Table of Contents Performance Materials: Sales in Performance Materials for the three months endedSeptember 30, 2020 were$104.6 million , a decrease of$10.5 million , or 9.1%, compared to sales of$115.1 million for the three months endedSeptember 30, 2019 . The decrease in sales was primarily due to lower volumes of$13.0 million which were offset by higher average selling price from favorable customer mix of$2.0 million . The decrease in sales volumes was a result of lower European demand for our highway safety products, lower industrial application demand for our engineered glass products and an absence of thermoplastic sales as a result of the first quarter asset swap. The decline in sales volumes was offset by higher average selling prices for highway safety products sold inNorth America . Performance Chemicals: Sales in Performance Chemicals for the three months endedSeptember 30, 2020 were$148.5 million , a decrease of$19.4 million , or 11.6%, compared to sales of$167.9 million for the three months endedSeptember 30, 2019 . The decrease in sales was primarily due to lower sales volumes of$18.9 million and the unfavorable effects of foreign currency translation of$2.9 million , which were partially offset by favorable sales mix of$2.4 million . The decrease in sales was primarily a result of lower volumes of sodium silicate, sold across multiple applications, as a result of COVID-19 related customer slowdowns in production and continued decline in the zeolites market's in which we operate. The unfavorable effects of foreign currency translation were driven by the strongerU.S. dollar. Gross Profit Gross profit for the three months endedSeptember 30, 2020 was$96.5 million , a decrease of$16.4 million , or 14.5%, compared with$112.9 million for the three months endedSeptember 30, 2019 . The decrease in gross profit was due to lower volumes of$19.8 million , unfavorable product mix of$3.6 million and unfavorable customer pricing of$1.8 million , which were partially offset by favorable manufacturing costs of$10.4 million . The decrease in volumes was a result of lower demand for sodium silicate sold across multiple applications and the impact of COVID-19 on gasoline production, which resulted in lower demand for our regeneration services and catalyst products. The unfavorable product mix was a result of increased sales of lower-margin products sold in our North American highway product group. The favorable change in manufacturing costs was a result of lower production costs related to our European operations. Selling, General and Administrative Expenses Selling, general and administrative expenses for the three months endedSeptember 30, 2020 were$37.1 million , a decrease of$2.4 million compared with$39.5 million for the three months endedSeptember 30, 2019 . The decrease in selling, general and administrative expenses was due to cost controlling initiatives. Other Operating Expense, Net Other operating expense, net for the three months endedSeptember 30, 2020 was$12.4 million , a decrease of$3.3 million , compared with$15.7 million for the three months endedSeptember 30, 2019 . The decrease in other operating expense, net was due to a gain on the sale of a product group in the current year period and lower environmental costs, which were partially offset by an increase in business optimization charges. Equity in Net Income of Affiliated Companies Equity in net income of affiliated companies for the three months endedSeptember 30, 2020 was$0.2 million , compared to$17.3 million for the three months endedSeptember 30, 2019 . The decrease was primarily due to$17.2 million of lower earnings from the Zeolyst Joint Venture during the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 . The decrease in earnings from the Zeolyst Joint Venture was due to a decrease of specialty catalyst orders and the impact of COVID-19 on sales for our emission control and hydrocracking catalysts. Interest Expense, Net Interest expense, net for the three months endedSeptember 30, 2020 was$18.6 million , a decrease of$9.1 million , as compared with$27.7 million for the three months endedSeptember 30, 2019 . The decrease in interest expense, net was primarily due to lower interest rates on our variable debt, along with lower average debt balances and a favorable increase in variable versus fixed rate debt during the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 . 45 -------------------------------------------------------------------------------- Table of Contents Debt Extinguishment Costs Debt extinguishment costs for the three months endedSeptember 30, 2020 and 2019 were$14.0 million and$1.8 million , respectively. OnJuly 22, 2020 , we entered into an agreement for a new senior secured term loan facility in an aggregate principal amount of$650.0 million , which was used to repay the remaining outstanding balance of$625.0 million on the 6.75% Senior Secured Notes due 2022. In conjunction with the issuance of the senior secured term loan facility, we paid$10.6 million in prepayment premiums and recorded$0.1 million of new creditor and third-party financing fees as debt extinguishment costs. In addition, previous unamortized deferred financing costs of$2.1 million and original issue discount of$1.2 million associated with the 6.75% Senior Secured Notes due 2022 were written off as debt extinguishment costs. During the quarter endedSeptember 30, 2019 , the Company prepaid$100.0 million of outstanding principal balance on the Term Loan Facility. The Company wrote off$0.5 million of previously unamortized deferred financing costs and original issue discount of$1.2 million as debt extinguishment costs for the three months endedSeptember 30, 2019 . Other Expense, Net Other expense, net for the three months endedSeptember 30, 2020 was income of$5.0 million , an increase of$6.9 million , as compared with an expense of$1.9 million for the three months endedSeptember 30, 2019 . The change in other expense, net primarily consisted of foreign currency activity related to the non-permanent intercompany debt denominated in local currency and translated to theU.S. dollar. During the three months endedSeptember 30, 2020 , the foreign currency activity resulted in gains and, during the three months endedSeptember 30, 2019 , the foreign currency activity resulted in losses. Provision for Income Taxes The provision for income taxes for the three months endedSeptember 30, 2020 was$11.8 million compared to a$16.7 million provision for the three months endedSeptember 30, 2019 . The effective income tax rate for the three months endedSeptember 30, 2020 was 60.1% compared to 38.4% for the three months endedSeptember 30, 2019 . The Company's effective income tax rate fluctuates based primarily on changes in income mix (including the effect of loss companies), the impacts of the Global Intangible Low Taxed Income ("GILTI") tax rules and changes in foreign exchange gains and losses, which create permanent differences in certain jurisdictions. The difference between theU.S. federal statutory income tax rate and the Company's effective income tax rate for the three months endedSeptember 30, 2020 was mainly due to the tax effect of permanent differences related to foreign currency exchange gain or loss, the inclusion of foreign earnings inU.S. taxable income, the discrete impact of the product line and asset sales, foreign tax rate changes, pre-tax losses with no associated tax benefit and state taxes. Net Income Attributable toPQ Group Holdings For the foregoing reasons and after the effect of the non-controlling interest in earnings of subsidiaries for each period presented, net income attributable toPQ Group Holdings was$7.5 million for the three months endedSeptember 30, 2020 compared with net income of$26.7 million for the three months endedSeptember 30, 2019 . Adjusted EBITDA Summarized Segment Adjusted EBITDA information is shown below in the following table: Three months ended September 30, Change 2020 2019 $ % (in millions, except percentages)
Segment Adjusted EBITDA:(1)
Refining Services $ 44.3 $ 51.2 $ (6.9) (13.5) %
Catalysts(2) 11.8 31.6 (19.8) (62.7) %
Performance Materials 25.3 25.8 (0.5) (1.9) %
Performance Chemicals 33.9 36.8 (2.9) (7.9) %
Total Segment Adjusted EBITDA(3) 115.3 145.4 (30.1) (20.7) %
Unallocated corporate expenses (6.7) (7.7) 1.0 13.0 %
Total Adjusted EBITDA $ 108.6 $ 137.7 $ (29.1) (21.1) %
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(1)We define Segment Adjusted EBITDA as EBITDA adjusted for certain items as noted in the reconciliation below. Our management evaluates the performance of our segments and allocates resources based primarily on Segment Adjusted EBITDA. Segment Adjusted EBITDA does not represent cash flow for periods presented and should not be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flows as a source of liquidity. Segment Adjusted EBITDA may not be comparable with EBITDA or Adjusted EBITDA as defined by other companies. (2)The Adjusted EBITDA from the Zeolyst Joint Venture included in the Catalysts segment was$5.3 million for the three months endedSeptember 30, 2020 , which includes$0.1 million of equity in net income, excluding$1.7 million of amortization of investment in affiliate step-up plus$3.6 million of joint venture depreciation, amortization and interest. The Adjusted EBITDA from the Zeolyst Joint Venture included in the Catalysts segment was$22.6 million for the three months endedSeptember 30, 2019 , which includes$17.2 million of equity in net income, excluding$1.7 million of amortization of investment in affiliate step-up plus$3.7 million of joint venture depreciation, amortization and interest. (3)Our total Segment Adjusted EBITDA differs from our total consolidated Adjusted EBITDA due to unallocated corporate expenses. Refining Services: Adjusted EBITDA for the three months endedSeptember 30, 2020 was$44.3 million , a decrease of$6.9 million , or 13.5%, compared with$51.2 million for the three months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was a result of reduced sales volumes partially offset by cost cutting initiatives. Catalysts: Adjusted EBITDA for the three months endedSeptember 30, 2020 was$11.8 million , a decrease of$19.8 million , or 62.7%, compared with$31.6 million for the three months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was primarily a result of reduced volumes on timing of customer orders and unfavorable fixed cost absorption as production was reduced to align with anticipated lower demand. Performance Materials: Adjusted EBITDA for the three months endedSeptember 30, 2020 was$25.3 million , a decrease of$0.5 million , or 1.9%, compared with$25.8 million for the three months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was a result of lower sales volumes offset by operational optimization and efforts to minimize costs. Performance Chemicals: Adjusted EBITDA for the three months endedSeptember 30, 2020 was$33.9 million , a decrease of$2.9 million , or 7.9%, compared with$36.8 million for the three months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was due to a decline in customer orders due to the COVID-19 pandemic. 47
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A reconciliation of net income attributable to
Three months ended
September 30,
2020 2019
(in millions)
Reconciliation of net income attributable to
Holdings Inc. to Segment Adjusted EBITDA
Net income attributable to PQ Group Holdings Inc.$ 7.5 $ 26.7 Provision for income taxes 11.8 16.7 Interest expense, net 18.6 27.7 Depreciation and amortization 45.8 44.2 EBITDA 83.7
115.4
Joint venture depreciation, amortization and interest(a) 3.6 3.7 Amortization of investment in affiliate step-up(b) 1.7 1.7 Debt extinguishment costs 14.0 1.8 Net (gain) loss on asset disposals(c) (4.5) 1.1 Foreign currency exchange (gain) loss(d) (4.6) 4.5 LIFO (benefit) expense(e) (0.8) 0.5 Transaction and other related costs(f) 3.3 0.7 Equity-based compensation 6.1 4.8
Restructuring, integration and business optimization
expenses(g) 4.6 0.7 Defined benefit pension plan cost(h) 0.4 0.8 Other(i) 1.1 2.1 Adjusted EBITDA 108.6 137.7 Unallocated corporate expenses 6.7 7.7 Segment Adjusted EBITDA$ 115.3 $ 145.4 (a)We use Adjusted EBITDA as a performance measure to evaluate our financial results. Because our Catalysts segment includes our 50% interest in the Zeolyst Joint Venture, we include an adjustment for our 50% proportionate share of depreciation, amortization and interest expense of the Zeolyst Joint Venture. (b)Represents the amortization of the fair value adjustments associated with the equity affiliate investment in the Zeolyst Joint Venture as a result of the combination of the businesses ofPQ Holdings Inc. andEco Services Operations LLC inMay 2016 (the "Business Combination"). We determined the fair value of the equity affiliate investment and the fair value step-up was then attributed to the underlying assets of the Zeolyst Joint Venture. Amortization is primarily related to the fair value adjustments associated with fixed assets and intangible assets, including customer relationships and technical know-how. (c)When asset disposals occur, we remove the impact of net gain/loss of the disposed asset because such impact primarily reflects the non-cash write-off of long-lived assets no longer in use. (d)Reflects the exclusion of the foreign currency transaction gains and losses in the statements of income which primarily relates to the non-permanent intercompany debt denominated in local currency translated toU.S. dollars. (e)Represents non-cash adjustments to the Company's LIFO reserves for certain inventories in theU.S. that are valued using the LIFO method, which we believe provides a means of comparison to other companies that may not use the same basis of accounting for inventories. (f)Relates to certain transaction costs, including debt financing, due diligence and other costs related to transactions that are completed, pending or abandoned, that we believe are not representative of our ongoing business operations. (g)Includes the impact of restructuring, integration and business optimization expenses which are incremental costs that are not representative of our ongoing business operations. (h)Represents adjustments for defined benefit pension plan (benefit) costs in our statements of income. More than two-thirds of our defined benefit pension plan obligations are under defined benefit pension plans that are frozen, and the remaining obligations 48 -------------------------------------------------------------------------------- Table of Contents primarily relate to plans operated in certain of our non-U.S. locations that, pursuant to jurisdictional requirements, cannot be frozen. As such, we do not view such expenses as core to our ongoing business operations. (i)Other costs consist of certain expenses that are not core to our ongoing business operations, including environmental remediation-related costs associated with the legacy operations of our business prior to the Business Combination, capital and franchise taxes, non-cash asset retirement obligation accretion and the initial implementation of procedures to comply with Section 404 of the Sarbanes-Oxley Act. Included in this line-item are rounding discrepancies that may arise from rounding from dollars (in thousands) to dollars (in millions). Adjusted Net Income Summarized adjusted net income information is shown below in the following table: Three months ended September 30, 2020 2019 Tax expense Tax expense Pre-tax (benefit) After-tax Pre-tax (benefit) After-tax (in millions) Reconciliation of net income attributable to PQ Group Holdings Inc. to Adjusted Net Income(1)(2) Net income before non-controlling interest$ 19.6 $ 11.8 $ 7.8 $ 43.5 $ 16.7 $ 26.8 Less: Net income attributable to non-controlling interest 0.3 - 0.3 0.1 - 0.1 Net income attributable to PQ Group Holdings Inc. 19.3 11.8 7.5 43.4 16.7 26.7 Amortization of investment in affiliate step-up(b) 1.7 0.8 0.9 1.7 0.6 1.1 Debt extinguishment costs 14.0 6.1 7.9 1.8 0.6 1.2 Net (gain) loss on asset disposals(c) (4.5) (2.6) (1.9) 1.1 0.3 0.8 Foreign currency exchange (gain) loss(d) (4.6) (1.1) (3.5) 4.5 0.6 3.9 LIFO (benefit) expense(e) (0.8) (0.4) (0.4) 0.5 0.1 0.4 Transaction and other related costs(f) 3.3 1.5 1.8 0.7 0.3 0.4 Equity-based compensation 6.1 3.0 3.1 4.8 1.6 3.2 Restructuring, integration and business optimization expenses(g) 4.6 2.1 2.5 0.7 0.2 0.5 Defined benefit pension plan (benefit) cost(h) 0.4 0.2 0.2 0.8 0.3 0.5 Other(i) 1.1 0.6 0.5 2.1 0.7 1.4 Adjusted Net Income, including non-cash GILTI tax$ 40.6 $ 22.0 $ 18.6 $ 62.1 $ 22.0 $ 40.1 Impact of non-cash GILTI tax(3) - (7.3) 7.3 - (8.2) 8.2 Impact of tax reform(4) - (1.6) 1.6 - - - Adjusted Net Income$ 40.6 $ 13.1 $ 27.5 $ 62.1 $ 13.8 $ 48.3 (1)We define adjusted net income as net income attributable toPQ Group Holdings adjusted for non-operating income or expense and the impact of certain non-cash or other items that are included in net income that we do not consider indicative of our ongoing operating performance. Adjusted net income is presented as a key performance indicator as we believe it will enhance a prospective investor's understanding of our results of operations and financial condition. Adjusted net income may not be comparable with net income or adjusted net income as defined by other companies. (2)Refer to the Adjusted EBITDA notes above for more information with respect to each adjustment. (3)Amount represents the impact to tax expense in net income before non-controlling interest and the related adjustments to net income associated with the GILTI provisions of the Tax Cuts and Jobs Act of 2017 ("TCJA"). BeginningJanuary 1, 2018 , GILTI results in taxation of "excess of foreign earnings," which is defined as amounts greater than a 10% rate of return on applicable foreign tangible asset basis. The Company is required to record incremental tax provision impact with respect to GILTI as a result of having historicalU.S. net operating loss ("NOL") amounts to offset the GILTI taxable income inclusion. This NOL utilization precludes us from recognizing foreign tax credits ("FTCs") which would otherwise help offset the tax impacts of GILTI. No FTCs will be recognized with respect to GILTI until our cumulative NOL balance has been exhausted. 49 -------------------------------------------------------------------------------- Table of Contents Because the GILTI provision does not impact our cash taxes (given availableU.S. NOLs), and given that we expect to recognize FTCs to offset GILTI impacts once the NOLs are exhausted, we do not view this item as a component of core operations. (4)Represents the transaction tax adjustment for the impact of the rate change in theUnited Kingdom related to theUK Finance Act recorded in net income. The adjustments to net income attributable toPQ Group Holdings Inc. are shown net of applicable tax rates as determined by the calculation of our quarterly tax provision under interim financial reporting for the three months endedSeptember 30, 2020 andSeptember 30, 2019 , except for the foreign currency exchange loss, the effects of our sales of non-core product lines and the sale of assets for which the taxes are calculated as discrete items using the applicable statutory income tax rates. Results of Operations Nine Months EndedSeptember 30, 2020 Compared to the Nine Months EndedSeptember 30, 2019 Highlights The following is a summary of our financial performance for the nine months endedSeptember 30, 2020 compared with the nine months endedSeptember 30, 2019 . Sales •Sales decreased$113.3 million to$1,101.4 million . The decrease in sales was primarily due to lower sales volumes and the unfavorable effects of foreign currency translation of$18.1 million . Gross Profit •Gross profit decreased$31.4 million to$277.9 million . The decrease in gross profit was primarily due to the decrease in sales volumes, which were partially offset by lower manufacturing costs. Operating Income •Operating income decreased by$45.6 million to$111.6 million . The decrease in operating income was due to lower gross profit during the current year period. Equity in Net Income of Affiliated Companies •Equity in net income of affiliated companies for the nine months endedSeptember 30, 2020 was$20.0 million , compared with$31.6 million for the nine months endedSeptember 30, 2019 . The decrease of$11.6 million was due to a decrease in earnings generated by the Zeolyst Joint Venture for the nine months endedSeptember 30, 2020 . 50 -------------------------------------------------------------------------------- Table of Contents The following is our unaudited condensed consolidated statements of income and a summary of financial results for the nine months endedSeptember 30, 2020 and 2019: Nine months ended September 30, Change 2020 2019 $ % (in millions, except percentages) Sales$ 1,101.4 $ 1,214.7 $ (113.3) (9.3) % Cost of goods sold 823.5 905.4 (81.9) (9.0) % Gross profit 277.9 309.3 (31.4) (10.2) % Gross profit margin 25.2 % 25.5 % Selling, general and administrative expenses 119.3 123.6 (4.3) (3.5) % Other operating expense, net 47.0 28.4 18.6 65.5 % Operating income 111.6 157.2 (45.6) (29.0) % Operating income margin 10.1 % 13.0 % Equity in net (income) from affiliated companies (20.0) (31.6) 11.6 (36.7) % Interest expense, net 65.4 84.9 (19.5) (23.0) % Debt extinguishment costs 16.5 1.8 14.7 816.7 % Other (income) expense, net (4.3) 1.8 (6.1) (338.9) % Income before income taxes and noncontrolling interest 54.0 100.4 (46.4) (46.2) % Provision for income taxes 29.4 39.5 (10.1) (25.6) % Effective tax rate 54.5 % 39.3 % Net income 24.6 60.9 (36.3) (59.6) % Less: Net income attributable to the noncontrolling interest 0.9 0.5 0.4 80.0 % Net income attributable to PQ Group Holdings Inc.$ 23.7 $ 60.4 $ (36.7) (60.8) % Sales Nine months ended September 30, Change 2020 2019 $ % (in millions, except percentages) Sales: Refining Services$ 298.7 $ 341.5 $ (42.8) (12.5) % Catalysts 73.1 62.3 10.8 17.3 % Performance Materials 274.3 295.1
(20.8) (7.0) %
Performance Chemicals 465.4 526.2 (60.8) (11.6) %
Eliminations (10.1) (10.4) 0.3
Total sales $ 1,101.4 $ 1,214.7 $ (113.3) (9.3) %
Refining Services: Sales in Refining Services for the nine months ended
September 30, 2020 were $298.7 million , a decrease of $42.8 million , or 12.5%,
compared to sales of $341.5 million for the nine months ended September 30,
2019 . The decrease in sales was due to lower sales volumes of $24.1 million and
lower average selling prices of $18.7 million .
The decline in sales was a result of lower gasoline production due to the
COVID-19 pandemic and the pass-through of lower sulfur pricing of $18.4 million
in our virgin sulfuric acid product group.
Catalysts: Sales in Catalysts for the nine months ended September 30, 2020 were
$73.1 million , an increase of $10.8 million , or 17.3%, compared to sales of
$62.3 million for the nine months ended September 30, 2019 . The increase in
sales was primarily due to an increase in sales volumes of $12.1 million from
higher demand for polyolefin catalysts and timing of customer orders in our
chemical catalysts product lines.
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Performance Materials: Sales in Performance Materials for the nine months ended
September 30, 2020 were $274.3 million , a decrease of $20.8 million , or 7.0%,
compared with sales of $295.1 million for the nine months ended September 30,
2019 . The decrease in sales was primarily due to lower sales volumes of $24.1
million and the unfavorable effects of foreign currency translation of $2.5
million , which were partially offset by higher average selling prices and
favorable customer mix of $5.8 million .
The decrease in sales volumes was a result of lower European demand for our
highway safety products, lower industrial application demand for our engineered
glass products and an absence of thermoplastic sales as a result of the first
quarter asset swap. The decline in sales volumes was offset by higher average
selling prices for highway safety products sold in North America . The
unfavorable effects of foreign currency translation were driven by the stronger
U.S. dollar.
Performance Chemicals: Sales in Performance Chemicals for the nine months ended
September 30, 2020 were $465.4 million , a decrease of $60.8 million , or 11.6%,
compared to sales of $526.2 million for the nine months ended September 30,
2019 . The decrease in sales was primarily due to lower sales volumes of $54.3
million and the unfavorable effects of foreign currency translation of $15.0
million , which were partially offset by higher average selling price and
favorable mix of $8.5 million .
The decrease in sales was a result of lower volumes of sodium silicate sold
across multiple applications in addition to reduced demand within the consumer
cleaning end market as a result of COVID-19 related customer slowdowns in
production, which more than offset favorable increases in product mix. The
unfavorable effects of foreign currency translation were driven by the stronger
U.S. dollar.
Gross Profit
Gross profit for the nine months ended September 30, 2020 was $277.9 million , a
decrease of $31.4 million , or 10.2%, compared with $309.3 million for the nine
months ended September 30, 2019 . The decrease in gross profit was due to lower
sales volumes of $38.0 million , unfavorable product mix of $13.4 million ,
unfavorable customer pricing of $4.9 million and the unfavorable effects of
foreign currency translation of $4.3 million , which was partially offset by
lower manufacturing costs of $31.3 million .
Sales volumes declined as a result of lower volumes of product sold for
industrial and process chemicals and consumer products end uses and lower
gasoline production due to the COVID-19 pandemic. The unfavorable product mix
was a result of increased sales of lower-margin products sold in our North
American highway product group. The unfavorable effects of foreign currency were
driven by the stronger U.S. dollar. The change in manufacturing costs was a
result of the timing of plant maintenance projects and lower production costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the nine months ended September
30, 2020 was $119.3 million , a decrease of $4.3 million as compared to $123.6
million for the nine months ended September 30, 2019 . The decrease in selling,
general and administrative expenses was due to reductions in discretionary
spending partially offset by an increase in stock compensation expense.
Other Operating Expense, Net
Other operating expense, net for the nine months ended September 30, 2020 was
$47.0 million , an increase of $18.6 million , compared with $28.4 million for the
nine months ended September 30, 2019 . During the nine months ended September 30,
2020 , other operating expense, net was driven by transaction and business
optimization costs associated with the sale of various non-core assets and the
resulting write-off of those non-core assets. During the nine months ended
September 30, 2019 , asset disposals were offset by a net gain on disposition of
assets related to a non-core product line.
Equity in Net Income of Affiliated Companies
Equity in net income of affiliated companies for the nine months ended September
30, 2020 was $20.0 million , compared to $31.6 million for the nine months ended
September 30, 2019 . The decrease was primarily due to $11.7 million of lower
earnings from the Zeolyst Joint Venture during the nine months ended September
30, 2020 . The decline in earnings was a result of COVID-19 related slowdowns
impacting oil refineries and the automotive industry, which led to a decrease in
demand for our emission control and hydrocracking catalysts.
Interest Expense, Net
Interest expense, net for the nine months ended September 30, 2020 was $65.4
million , a decrease of $19.5 million , as compared with $84.9 million for the
nine months ended September 30, 2019 . The decrease in interest expense was
primarily due to lower interest rates on our variable debt, along with lower
average debt balances and a favorable increase in variable versus fixed rate
debt.
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Debt Extinguishment Costs
Debt extinguishment costs for the nine months ended September 30, 2020 and 2019
were $16.5 million and $1.8 million , respectively. On July 22, 2020 , we entered
into an agreement for a new senior secured term loan facility in an aggregate
principal amount of $650.0 million , which was used to repay the remaining
outstanding balance of $625.0 million on the 6.75% Senior Secured Notes due
2022. In conjunction with the issuance of the senior secured term loan facility,
we paid $10.6 million in prepayment premiums and recorded $0.1 million of new
creditor and third-party financing fees as debt extinguishment costs. In
addition, previous unamortized deferred financing costs of $2.1 million and
original issue discount of $1.2 million associated with the 6.75% Senior Secured
Notes due 2022 were written off as debt extinguishment costs.
On February 7, 2020 , we amended our existing senior secured term loan facility
to reduce the applicable interest rates and extend the maturity of the facility
to February 2027 . We recorded $2.2 million of new creditor and third-party
financing fees as debt extinguishment costs for the nine months ended September
30, 2020 . In addition, previously unamortized deferred financing costs of
$0.1 million and original issue discount of $0.2 million associated with the
existing senior secured term loan facility were written off as debt
extinguishment costs for the nine months ended September 30, 2020 .
During the nine months ended September 30, 2019 , the Company prepaid $100.0
million of outstanding principal balance on the Term Loan Facility. The Company
wrote off $0.5 million of previously unamortized deferred financing costs and
original issue discount of $1.2 million as debt extinguishment costs.
Other Expense, Net
Other expense, net for the nine months ended September 30, 2020 was income of
$4.3 million , an increase of $6.1 million , as compared with expense of $1.8
million for the nine months ended September 30, 2019 . The change in other
expense, net primarily consisted of an increase in foreign currency gains for
the nine months ended September 30, 2020 as compared to foreign currency losses
for the nine months ended September 30, 2019 and gains related to our defined
benefit plan assets. Foreign currency gains and losses are primarily driven by
the fluctuations in our non-permanent intercompany debt denominated in local
currency and translated to U.S. dollars.
Provision for Income Taxes
The provision for income taxes for the nine months ended September 30, 2020 was
$29.4 million compared to a $39.5 million provision for the nine months ended
September 30, 2019 . The effective income tax rate for the nine months ended
September 30, 2020 was 54.5% compared to 39.3% for the nine months ended
September 30, 2019 .
The Company's effective income tax rate fluctuates primarily due to income mix
(including the effect of loss companies), the impacts of GILTI and changes in
foreign exchange gains and losses, which create permanent differences in certain
jurisdictions.
The difference between the U.S. federal statutory income tax rate and the
Company's effective income tax rate for the nine months ended September 30, 2020
was mainly due to the impacts of GILTI, the discrete tax impacts related to the
asset swap agreement, the discrete impact of the product line and asset sales,
the tax effect of permanent differences related to foreign currency exchange
gain or loss, foreign tax rate changes, pre-tax losses with no associated tax
benefit and state taxes.
Net Income Attributable to PQ Group Holdings
For the foregoing reasons and after the effect of the non-controlling interest
in earnings of subsidiaries for each period presented, net income attributable
to PQ Group Holdings was $23.7 million for the nine months ended September 30,
2020 compared with net income of $60.4 million for the nine months ended
September 30, 2019 .
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Adjusted EBITDA
Summarized Segment Adjusted EBITDA information is shown below in the following
table:
Nine months ended
September 30, Change
2020 2019 $ %
(in millions, except percentages)
Segment Adjusted EBITDA:(1)
Refining Services $ 116.5 $
133.7
Catalysts(2) 59.7
79.4 (19.7) (24.8) %
Performance Materials 66.1
65.5 0.6 0.9 %
Performance Chemicals 108.4
120.6 (12.2) (10.1) %
Total Segment Adjusted EBITDA(3) 350.7
399.2 (48.5) (12.1) %
Unallocated corporate expenses (26.0)
(28.0) 2.0 7.1 %
Total Adjusted EBITDA$ 324.7 $ 371.2 $ (46.5) (12.5) % (1)We define Segment Adjusted EBITDA as EBITDA adjusted for certain items as noted in the reconciliation below. Our management evaluates the performance of our segments and allocates resources based primarily on Segment Adjusted EBITDA. Segment Adjusted EBITDA does not represent cash flow for periods presented and should not be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flows as a source of liquidity. Segment Adjusted EBITDA may not be comparable with EBITDA or Adjusted EBITDA as defined by other companies. (2)The Adjusted EBITDA from the Zeolyst Joint Venture included in the Catalysts segment is$35.9 million for the nine months endedSeptember 30, 2020 , which includes$19.9 million of equity in net income, excluding$5.0 million of amortization of investment in affiliate step-up plus$11.1 million of joint venture depreciation, amortization and interest. The Adjusted EBITDA from the Zeolyst Joint Venture included in the Catalysts segment is$48.6 million for the nine months endedSeptember 30, 2019 , which includes$31.5 million of equity in net income, excluding$5.9 million of amortization of investment in affiliate step-up plus$11.2 million of joint venture depreciation, amortization and interest. (3)Our total Segment Adjusted EBITDA differs from our total consolidated Adjusted EBITDA due to unallocated corporate expenses. Rounding discrepancies may arise when rounding segment results from dollars (in thousands) to dollars (in millions). Refining Services: Adjusted EBITDA for the nine months endedSeptember 30, 2020 was$116.5 million , a decrease of$17.2 million , or 12.9%, compared with$133.7 million for the nine months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was related to reduced sales driven by lower gasoline consumption partially offset by the timing of plant maintenance projects. Catalysts: Adjusted EBITDA for the nine months endedSeptember 30, 2020 was$59.7 million , a decrease of$19.7 million , or 24.8%, compared with$79.4 million for the nine months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was a result of lower customer demand for our catalysts and unfavorable fixed cost absorption. Performance Materials: Adjusted EBITDA for the nine months endedSeptember 30, 2020 was$66.1 million , an increase of$0.6 million , or 0.9%, compared with$65.5 million for the nine months endedSeptember 30, 2019 . The increase in Adjusted EBITDA was a result of favorable pricing for our North American highway safety products and operating and cost optimization, partially offset by lower industrial application demand for engineered glass materials. Performance Chemicals: Adjusted EBITDA for the nine months endedSeptember 30, 2020 was$108.4 million , a decrease of$12.2 million , or 10.1%, compared with$120.6 million for the nine months endedSeptember 30, 2019 . The decrease in Adjusted EBITDA was due to a decline in customer orders due to the COVID-19 pandemic. 54
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A reconciliation of net income attributable to
Nine months ended
September 30,
2020 2019
(in millions)
Reconciliation of net income attributable to PQ Group Holdings
Inc. to Segment Adjusted EBITDA
Net income attributable to PQ Group Holdings Inc. $ 23.7 $ 60.4
Provision for income taxes 29.4 39.5
Interest expense, net 65.4 84.9
Depreciation and amortization 136.3 135.2
EBITDA 254.8 320.1
Joint venture depreciation, amortization and interest(a) 11.1 11.2
Amortization of investment in affiliate step-up(b) 5.0 5.9
Debt extinguishment costs 16.5 1.8 Net (gain) loss on asset disposals(c) 3.9 (7.7) Foreign currency exchange (gain) loss(d) (2.1) 5.4 LIFO (benefit) expense(e)
(2.5) 10.8
Transaction and other related costs(f) 6.1 1.7 Equity-based compensation 18.4 13.6 Restructuring, integration and business optimization expenses(g) 10.2 1.4 Defined benefit pension plan (benefit) cost(h) (0.1) 2.4 Other(i) 3.4 4.7 Adjusted EBITDA 324.7 371.2 Unallocated corporate expenses 26.0 28.0 Segment Adjusted EBITDA$ 350.7 $ 399.2 (a)We use Adjusted EBITDA as a performance measure to evaluate our financial results. Because our Catalysts segment includes our 50% interest in the Zeolyst Joint Venture, we include an adjustment for our 50% proportionate share of depreciation, amortization and interest expense of the Zeolyst Joint Venture. (b)Represents the amortization of the fair value adjustments associated with the equity affiliate investment in the Zeolyst Joint Venture as a result of the Business Combination. We determined the fair value of the equity affiliate investment and the fair value step-up was then attributed to the underlying assets of the Zeolyst Joint Venture. Amortization is primarily related to the fair value adjustments associated with fixed assets and intangible assets, including customer relationships and technical know-how. (c)When asset disposals occur, we remove the impact of net gain/loss of the disposed asset because such impact primarily reflects the non-cash write-off of long-lived assets no longer in use. (d)Reflects the exclusion of the foreign currency transaction gains and losses in the statements of income primarily related to the non-permanent intercompany debt denominated in local currency translated toU.S. dollars. (e)Represents non-cash adjustments to the Company's LIFO reserves for certain inventories in theU.S. that are valued using the LIFO method, which we believe provides a means of comparison to other companies that may not use the same basis of accounting for inventories. (f)Relates to certain transaction costs, including debt financing, due diligence and other costs related to transactions that are completed, pending or abandoned, that we believe are not representative of our ongoing business operations. (g)Includes the impact of restructuring, integration and business optimization expenses which are incremental costs that are not representative of our ongoing business operations. (h)Represents adjustments for defined benefit pension plan (benefit) costs in our statements of income. More than two-thirds of our defined benefit pension plan obligations are under defined benefit pension plans that are frozen, and the remaining obligations 55 -------------------------------------------------------------------------------- Table of Contents primarily relate to plans operated in certain of our non-U.S. locations that, pursuant to jurisdictional requirements, cannot be frozen. As such, we do not view such income or expenses as core to our ongoing business operations. (i)Other costs consist of certain expenses that are not core to our ongoing business operations, including environmental remediation-related costs associated with the legacy operations of our business prior to a business combination consummated in a prior year period, capital and franchise taxes, non-cash asset retirement obligation accretion and the initial implementation of procedures to comply with Section 404 of the Sarbanes-Oxley Act. Included in this line-item are rounding discrepancies that may arise from rounding from dollars (in thousands) to dollars (in millions). Adjusted Net Income Summarized adjusted net income information is shown below in the following table: Nine months ended September 30, 2020 2019 Tax expense Tax expense Pre-tax (benefit) After-tax Pre-tax (benefit) After-tax (in millions) Reconciliation of net income attributable to PQ Group Holdings Inc. to Adjusted Net Income(1)(2) Net income before non-controlling interest$ 54.0 $ 29.4 $ 24.6 $
100.4
Less: Net income attributable to non-controlling interest 0.9 - 0.9 0.5 - 0.5 Net income attributable to PQ Group Holdings Inc. 53.1 29.4 23.7 99.9 39.5 60.4
Amortization of
investment in
affiliate step-up(b) 5.0 2.1 2.9 5.9 2.1 3.8
Debt extinguishment
costs 16.5 7.0 9.5 1.8 0.6 1.2
Net (gain) loss on
asset disposals(c) 3.9 (0.2) 4.1 (7.7) (1.6) (6.1)
Foreign currency
exchange (gain)
loss(d) (2.1) (0.1) (2.0) 5.4 (0.6) 6.0
LIFO (benefit)
expense(e) (2.5) (1.0) (1.5) 10.8 3.8 7.0
Transaction and
other related
costs(f) 6.1 2.6 3.5 1.7 0.6 1.1
Equity-based
compensation 18.4 7.8 10.6 13.6 4.8 8.8 Restructuring, integration and business optimization expenses(g) 10.2 4.3 5.9 1.4 0.5 0.9
Defined benefit
pension plan
(benefit) cost(h) (0.1) - (0.1) 2.4 0.8 1.6 Other(i) 3.4 1.5 1.9 4.7 1.5 3.2
Adjusted Net Income,
including non-cash
GILTI tax$ 111.9 $ 53.4 $ 58.5 $ 139.9 $ 52.0 $ 87.9 Impact of non-cash GILTI tax(3) - (19.1) 19.1 - (19.3) 19.3 Impact of tax reform(4) - (1.6) 1.6 - - -
Adjusted Net Income
(1)We define adjusted net income as net income attributable toPQ Group Holdings adjusted for non-operating income or expense and the impact of certain non-cash or other items that are included in net income that we do not consider indicative of our ongoing operating performance. Adjusted net income is presented as a key performance indicator as we believe it will enhance a prospective investor's understanding of our results of operations and financial condition. Adjusted net income may not be comparable with net income or adjusted net income as defined by other companies. (2)Refer to the Adjusted EBITDA notes above for more information with respect to each adjustment. (3)Amount represents the impact to tax expense in net income before non-controlling interest and the related adjustments to net income associated with the GILTI provisions of the TCJA. As ofJanuary 1, 2018 , GILTI results in taxation of "excess of foreign earnings," which is defined as amounts greater than a 10% rate of return on applicable foreign tangible asset basis. The Company is required to record incremental tax provision impact with respect to GILTI as a result of having historicalU.S. NOLs to offset the GILTI taxable income inclusion. This NOL utilization precludes us from recognizing FTCs which would otherwise help offset the tax impacts of GILTI. No FTCs will be recognized with respect to GILTI until our cumulative NOL balance has been exhausted. Because the GILTI provision does not impact our cash taxes (given availableU.S. NOLs), and given that we expect 56 -------------------------------------------------------------------------------- Table of Contents to recognize FTCs to offset GILTI impacts once the NOLs are exhausted, we do not view this item as a component of core operations. (4)Represents the transaction tax adjustment for the impact of the rate change in theUnited Kingdom related to theUK Finance Act recorded in net income. The adjustments to net income attributable toPQ Group Holdings Inc. are shown net of applicable tax rates of 42.6% and 34.9% for the nine months endedSeptember 30, 2020 and 2019, respectively, except for the foreign currency exchange loss, the effects of our sales of non-core product lines and the sale of assets for which the taxes are calculated as discrete items using the applicable statutory income tax rates. 57
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Financial Condition, Liquidity and Capital Resources Our primary sources of liquidity consist of cash flow from operations, existing cash balances as well as funds available under our asset based lending revolving credit facility. We expect that ongoing requirements for debt service and capital expenditures will be funded from these sources of funds. Our primary liquidity requirements include funding working capital requirements (primarily inventory and accounts receivable, net of accounts payable and other accrued liabilities), debt service requirements and capital expenditures. Our capital expenditures include both maintenance of business, which include spending on maintenance and health, safety and environmental initiatives as well as growth, which includes spending to drive organic sales growth and cost savings initiatives. We believe that our existing cash, cash equivalents and cash flows from operations, combined with availability under our asset based lending revolving credit facility, will be sufficient to meet our presently anticipated future cash needs for at least the next twelve months. We may also pursue strategic acquisition or divestiture opportunities, which may impact our future cash requirements. We may, from time to time, increase borrowings under our asset based lending revolving credit facility to meet our future cash needs. As ofSeptember 30, 2020 , we had cash and cash equivalents of$164.3 million and availability of$181.1 million under our asset based lending revolving credit facility, after giving effect to$18.6 million of outstanding letters of credit, for a total available liquidity of$345.4 million . We did not have any revolving credit facility borrowings as ofSeptember 30, 2020 . As ofSeptember 30, 2020 , we were in compliance with all covenants under our debt agreements. Included in our cash and cash equivalents balance as ofSeptember 30, 2020 was$48.4 million of cash and cash equivalents held in foreign jurisdictions. We repatriate cash held outside ofthe United States from certain foreign subsidiaries in order to meet domestic liquidity needs. Depending on domestic and foreign cash balances, we have certain flexibility to repatriate funds in order to meet those needs. Specifically, we have an intercompany loan structure in place with several of our foreign subsidiaries that allows us to repatriate foreign cash in a tax efficient manner from those subsidiaries. In certain cases, the repatriation of foreign cash under previousU.S. tax law had generally been subject toU.S. income taxes at the time of cash distribution. Due to the enactment of the TCJA inDecember 2017 , future overseas earnings repatriation will generally no longer be subject toU.S. federal income taxes at the time of cash distribution. However, future foreign earnings may still be taxed for state income tax purposes, as well as subject to certain foreign withholding tax obligations, when cash amounts are distributed back to theU.S. Our liquidity requirements are significant, primarily due to debt service requirements. As reported, our cash interest paid for the nine months endedSeptember 30, 2020 and 2019 was approximately$75.3 million and$82.3 million , respectively. Before any impact of hedges, a one percent change in assumed interest rates for our variable interest credit facilities would have an annual impact of approximately$16.1 million on interest expense. We hedge the interest rate fluctuations on debt obligations through interest rate cap agreements. As ofSeptember 30, 2020 , we had interest rate caps on$500.0 million of notional variable debt with a cap rate of 0.84% throughJuly 2022 . InJuly 2020 , we entered into additional interest rate cap agreements to mitigate interest rate volatility fromAugust 2020 toAugust 2023 , with a cap rate of 1.00% on$400.0 million of notional variable-rate debt. Cash Flow Nine months ended September 30, 2020 2019 (in millions) Net cash provided by (used in): Operating activities$ 150.6 $ 181.9 Investing activities (42.1) (54.7) Financing activities
(10.3) (103.2) Effect of exchange rate changes on cash, cash equivalents and restricted cash
(5.9) (3.4)
Net change in cash, cash equivalents and restricted cash 92.3 20.6 Cash, cash equivalents and restricted cash at beginning of period
73.9 59.7
Cash, cash equivalents and restricted cash at end of period
58
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Nine months ended
September 30,
2020 2019
(in millions)
Net income $ 24.6 $ 60.9
Non-cash and non-working capital related activities(1) 174.6 149.7
Changes in working capital (39.6) (21.5)
Other operating activities (9.0) (7.2)
Net cash provided by operating activities $ 150.6 $ 181.9 (1)Includes depreciation, amortization, amortization of deferred financing costs and original issue discount, debt extinguishment costs, foreign currency exchange gains and losses, deferred income tax provision (benefit), net (gains) losses on asset disposals, stock compensation expense, net interest proceeds on swaps designated as net investment hedges (which is reflected below in net cash used in investing activities) and equity in net income and dividends received from affiliated companies. Nine months endedSeptember 30, 2020 2019 (in millions)
Working capital changes that provided (used) cash:
Receivables $ (20.7) $ (22.5)
Inventories 8.6 (1.8)
Prepaids and other current assets (0.4) 0.3
Accounts payable (10.1) (4.1)
Accrued liabilities (17.0) 6.6
$ (39.6) $ (21.5)
Nine months ended
September 30,
2020 2019
(in millions)
Purchases of property, plant and equipment $
(76.8)
Net interest proceeds on swaps designated as net investment
hedges
4.6 8.4
Proceeds from sale of product line
18.0 28.0
Proceeds from sale of assets 10.3 - Proceeds from sale of investment 1.8 - Other, net
- 0.6
Net cash used in investing activities$ (42.1) $ (54.7) Nine months ended September 30, 2020 2019 (in millions)
Net revolving credit facilities borrowings $ 0.7 $ 1.3
Net cash borrowings (repayments) on debt obligations 12.8 (105.8)
Other financing activities (23.8) 1.3
Net cash used in financing activities $ (10.3) $ (103.2)
59-------------------------------------------------------------------------------- Table of Contents Net cash provided by operating activities was$150.6 million for the nine months endedSeptember 30, 2020 , compared to$181.9 million provided for the nine months endedSeptember 30, 2019 . Cash generated by operating activities, other than changes in working capital, was lower during the nine months endedSeptember 30, 2020 by$13.3 million compared to the same period in the prior year. The change in working capital during the nine months endedSeptember 30, 2020 was unfavorable compared to the nine months endedSeptember 30, 2019 . Cash used to fund working capital was$39.6 million and$21.5 million for the nine months endedSeptember 30, 2020 and 2019, respectively. The decrease in cash generated by operating activities, other than changes in working capital, was lower by$13.3 million as compared to the prior year period primarily due to a decline in sales as a result of the COVID-19 pandemic and a decrease in dividends received from affiliated companies. The decrease in cash from working capital of$18.1 million as compared to the prior year was primarily due to unfavorable changes in accrued liabilities and accounts payable which were partially offset by favorable changes in inventory and accounts receivable. The unfavorable change in accrued liabilities relates to the timing of accrued interest payments and changes in various expense accruals. The unfavorable change in accounts payable was a result of lower current production and the timing of plant maintenance expenditures. The favorable change in inventory was driven by lower production. The favorable change in accounts receivable was driven by the decline in sales volumes. Net cash used in investing activities was$42.1 million for the nine months endedSeptember 30, 2020 , compared to cash used of$54.7 million during the same period in 2019. Cash used in investing activities primarily consisted of utilizing$76.8 million and$91.7 million to fund capital expenditures during the nine months endedSeptember 30, 2020 and 2019, respectively. We received$4.6 million and$8.4 million in interest proceeds related to our cross-currency swaps during the nine months endedSeptember 30, 2020 and 2019, respectively. We received proceeds of$18.0 million related to the sale of a non-core product line and$12.1 million related to the sale of non-core assets and investments during the nine months endedSeptember 30, 2020 and$28.0 million of proceeds related to the sale of a non-core product line during the nine months endedSeptember 30, 2019 . Net cash used in financing activities was$10.3 million for the nine months endedSeptember 30, 2020 , compared to net cash used of$103.2 million during the same period in 2019. Net cash used in financing activities was primarily driven by$12.8 million of net debt borrowings, which was offset by other financing activities related to$10.6 million of debt prepayment charges,$9.0 million in debt issuance costs and$4.1 million of stock buybacks during the nine months endedSeptember 30, 2020 . Net cash used in financing activities was primarily driven by$105.8 million of long-term debt repayments partially offset by$1.3 million of net borrowings under our revolving credit facilities made through the nine months endedSeptember 30, 2019 . DebtSeptember 30 ,December 31, 2020 2019 (in millions)
Senior Secured Term Loan Facility due
$ 947.5 New Senior Secured Term Loan Facility due February 2027 648.4 - 6.75% Senior Secured Notes due 2022 - 625.0 5.75% Senior Unsecured Notes due 2025 295.0 295.0 ABL Facility - - Other 65.1 64.6 Total debt 1,956.0 1,932.1 Original issue discount (22.2) (13.4) Deferred financing costs (14.3) (11.7)
Total debt, net of original issue discount and deferred financing costs
1,919.5 1,907.0
Less: current portion (14.5) (7.8)
Total long-term debt, excluding current portion $ 1,905.0 As ofSeptember 30, 2020 , our total debt was$1,956.0 million , including$13.3 million of other foreign debt and$51.8 million of notes payable for the New Market Tax Credit financing and excluding the original issue discount of$22.2 million and deferred financing fees of$14.3 million for our senior secured credit facilities and notes. Our net debt as ofSeptember 30, 2020 was$1,791.7 million , including cash and cash equivalents of$164.3 million . We may seek, subject to market conditions and other factors, opportunities to repurchase, refinance or otherwise reprice our debt. 60 -------------------------------------------------------------------------------- Table of Contents Capital Expenditures Maintenance capital expenditures include spending on maintenance of business, health, safety and environmental initiatives. Growth capital expenditures include spending to drive organic sales growth and cost savings initiatives. These capital expenditures represent our "book" capital expenditures for which the company has recorded, but not necessarily paid for the capital expenditures. Nine months ended September 30, 2020 2019 (in millions) Maintenance capital expenditures$ 46.6 $ 59.5 Growth capital expenditures 13.7 20.5 Total capital expenditures$ 60.3 $ 80.0 Capital expenditures remained at a level sufficient for required maintenance and certain expansion growth initiatives during these periods. Maintenance capital expenditures were lower in the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 due to fewer plant maintenance projects incurred during the period. Growth capital expenditures were lower in the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 due to deferral of project costs. Pension Funding We paid$8.7 million and$8.9 million in cash contributions into our defined benefit pension plans and other post-retirement plans during the nine months endedSeptember 30, 2020 and 2019, respectively. The net periodic pension expense was$0.6 million and$2.7 million for those same periods, respectively. Off-Balance Sheet Arrangements We had$18.6 million of outstanding letters of credit on our ABL Facility as ofSeptember 30, 2020 . Contractual Obligations Information related to our contractual obligations atDecember 31, 2019 can be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theSEC onFebruary 27, 2020 , which we refer to as our Annual Report on Form 10-K. During the nine months endedSeptember 30, 2020 , there have been no significant changes to our contractual obligations as disclosed in our Annual Report on Form 10-K, other than the following items. During the quarter endedMarch 31, 2020 , we amended our Term Loan Facility to reduce the applicable interest rate to LIBOR (with a 0% floor) plus 2.25% per annum and extend the maturity of the facility toFebruary 2027 . We anticipate that the reduction in interest rates will result in a$2.4 million reduction in interest payments per year at current interest rates. During the quarter endedMarch 31, 2020 , we amended our ABL Facility to increase the aggregate amount of the revolving loan commitments to$250.0 million , reduce the interest rate and extend the maturity toMarch 2025 . InJuly 2020 , we redeemed our existing 6.75% Senior Secured Notes due 2022 with the proceeds from a new senior secured term loan facility in an aggregate principal amount of$650.0 million with an original issue discount of 1.5% and interest at a floating rate of LIBOR (with a 1.0% minimum LIBOR floor) plus 3.0% per annum. Our New Markets Tax Credit ("NMTC") financing arrangements include put/call provisions that can be exercised seven years after funding of the respective loans, whereby we may be obligated or entitled to repurchase the given NMTC investor's interest in the respective investment fund for a de minimis amount. InOctober 2020 , an affiliate ofJPMorgan Chase Bank N.A . ("Chase") exercised its put option under theOctober 24, 2013 NMTC financing arrangement among Chase and several of its affiliates, TX CDE V LLC, an affiliate ofTexas LIC Development Company LLC d/b/a/Texas Community Development Capital , and our company (the "2013 NMTC"). After the exercise of the put option we acquired ownership of the Chase investment fund, and subsequently the loans between our company and the Chase investment fund, and between TX CDE V LLC and our company, were settled. This resulted in the retirement of$21.0 million of debt related to the 2013 NMTC and a corresponding$15.6 million note receivable. Refer to Note 13, "Long-term Debt" and Note 22, "Subsequent Events," to our condensed consolidated financial statements under Item 1, "Financial Statements," in this Quarterly Report on Form 10-Q for additional information. 61
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Table of Contents Critical Accounting Policies and Estimates We prepare our condensed consolidated financial statements in conformity with GAAP and our significant accounting policies are described in Note 2 to our audited consolidated financial statements included in our Annual Report on Form 10-K. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. We base our estimates and judgments on historical experience and other relevant factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We evaluate our critical accounting estimates, assumptions and judgments on an ongoing basis. There has been no material change in our critical accounting policies and use of estimates from those described in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in our Annual Report on Form 10-K, other than the following item.Goodwill and Intangible AssetsGoodwill and intangible assets with indefinite lives are not amortized, but are tested for impairment annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. We perform our annual impairment tests of goodwill and indefinite-lived intangible assets as ofOctober 1 of each year. For the purposes of the quantitative goodwill impairment test, we determine the fair value of our reporting units using a combination of a market approach and an income, or discounted cash flow, approach. Estimating the fair value of a reporting unit requires various assumptions including the use of projections of future cash flows and discount rates that reflect the risks associated with achieving those cash flows. The key assumptions used in estimating the fair value are operating margin growth rates, revenue growth rates, the weighted average cost of capital, the perpetual growth rate, and the estimated earnings market multiples of each reporting unit. The market value is estimated using publicly traded comparable company values by applying their most recent annual EBITDA multiples to the reporting unit's EBITDA for the trailing twelve months. The income approach value is estimated using a discounted cash flow approach. The assumptions about future cash flows and growth rates are based on our assessment of a number of factors including the reporting unit's recent performance against budget as well as management's ability to execute on planned future strategic initiatives. Discount rate assumptions are based on an assessment of the risk inherent in those future cash flows. The fair values of the Company's four reporting units exceeded their respective carrying amounts as of the last annual goodwill impairment test date onOctober 1, 2019 by the following percentages: 179% for Refining Services, 67% for Catalysts, 27% for Performance Materials and 18% for Performance Chemicals. Based on the operating results for the three and nine months endedSeptember 30, 2020 and other considerations, we believe that it is more likely than not that the fair values for each of our reporting units and of our indefinite-lived intangible assets are still greater than their respective carrying values. Accordingly, no interim goodwill or intangible asset impairment assessments were considered necessary atSeptember 30, 2020 . The Company will continue to monitor business plans throughout 2020 to determine if an interim goodwill and intangible assets impairment evaluation should be conducted. Changes in assumptions regarding future business performance and macroeconomic conditions, particularly those associated with the COVID-19 pandemic, may have a significant impact on future cash flows and reporting unit or intangible asset valuations. A significant downturn in global economic growth, or recessionary conditions in theU.S. ,Europe ,South America andAsia for prolonged periods, may lead to reduced customer demand for the Company's reporting units, or material supply chain interruptions or product shortages. To the extent that such developing economic conditions negatively impact customer demand for our products or product availability over an extended period, our businesses, results of operations and financial condition could be significantly and adversely affected, which could result in future impairments of goodwill and intangible assets. Accounting Standards Not Yet Adopted See Note 2 to our unaudited condensed consolidated financial statements for a discussion of recently issued accounting standards and their effect on us.
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