Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our major market risk exposure is potential losses arising from changing rates and prices regarding foreign currency exchange rate risk, interest rate risk and credit risk. The audit committee of our board of directors regularly reviews foreign exchange and interest rate hedging activity, and monitors compliance with our hedging policy. We do not use financial instruments for speculative purposes, and we limit our hedging activity to the underlying economic exposure.
Foreign Exchange Risk
Our financial results are subject to the impact of gains and losses on currency translations, which occur when the financial statements of foreign operations are translated into U.S. dollars. We operate a geographically diverse business with approximately 6% of our sales during the years ended December 31, 2022 and 2021, respectively, coming from our international operations in currencies other than the U.S. dollar. Because consolidated financial results are reported in U.S. dollars, sales or earnings generated in currencies other than the U.S. dollar can result in a significant increase or decrease in the amount of those sales and earnings when translated to U.S. dollars. The financial statements of our operations outside the United States, where the local currency is considered to be the functional currency, are translated into U.S. dollars using the exchange rate in effect at each balance sheet date for assets and liabilities and the average exchange rate for each period for sales, expenses, gains, losses and cash flows. The exchange rates between these currencies and the U.S. dollar in recent years have fluctuated significantly and may continue to do so in the future. The foreign currency to which we have the most significant exchange rate exposure is the British pound. Sales in this currency represented approximately 5% of our sales during the year ended December 31, 2022. A 10% change in the average British pound to U.S. dollar exchange rate during the year ended December 31, 2022 would have impacted sales by approximately $3.8 million over the same period, or 0.5% of our total sales, assuming product pricing remained constant. The effect of translating foreign subsidiaries’ balance sheets into U.S. dollars is included in other
70
comprehensive income. The impact of gains and losses on transactions denominated in currencies other than the functional currency of the relevant operations are included in other expense (income), net in the consolidated statements of income. Income and expense items are translated at average exchange rates during the year. Net foreign currency exchange gains and losses included in other expense (income), net was a $1.0 million loss for the year ended December 31, 2022. The foreign currency loss realized in the year ended December 31, 2022 was primarily driven by the non-permanent intercompany debt denominated in local currency and translated to U.S. dollars, and was principally non-cash in nature.
Interest Rate Risk
We are exposed to fluctuations in interest rates on our Senior Secured Credit Facilities. Changes in interest rates will not affect the market value of such debt but will affect the amount of our interest payments over the term of the loans. Likewise, an increase in interest rates could have a material impact on our cash flow. As of December 31, 2022, a 100 basis point increase in assumed interest rates for our variable interest credit facilities, before impact of any hedges, would have an annual impact of approximately $8.9 million on interest expense.
We hedge the interest rate fluctuations on debt obligations through interest rate cap agreements. We record the fair value of these hedges as assets or liabilities and the related unre alized gains or losses are deferred in stockholders’ equity as a component of other comprehensive income (loss), net of tax. The interest rate caps had a fair value net asset of $32.3 million and $(0.2) million at December 31, 2022 and 2021, respectively. Fair value is determined based on estimated amounts that would be received or paid to terminate the contracts at the reporting date based on quoted market prices.
In July 2016, we entered into interest rate cap agreements, paying a premium of $1.6 million to mitigate interest rate volatility from July 2016 through July 2020 by employing varying cap rates ranging from 1.50% to 3.00% on $1.0 billion of notional variable debt. In November 2018, the Company entered into additional interest rate cap agreements to mitigate interest rate volatility from July 2020 through July 2022, with a cap rate of 3.50% on $500.0 million of notional variable-rate debt and a $0.5 million premium annuitized during the effective period.
In February 2020, we restructured our $500.0 million notional interest rate cap agreements from July 31, 2020 through July 31, 2022 to lower the interest cap rate to 2.50% with a $0.1 million premium annuitized during the effective period. In March 2020, we further restructured our $500.0 million notional interest rate cap agreements from July 31, 2020 through July 31, 2022 to lower the interest rate cap to 0.84% with a $0.9 million premium annuitized during the effective period. Including premiums on the original November 2018 agreement and the February and March 2020 restructurings, the total cumulative annuitized premium of $4.4 million will be paid through July 31, 2022 on our interest rate cap agreements.
In July 2020, we entered into additional interest rate cap agreements to mitigate interest rate volatility from August 2020 to August 2023, with a cap rate of 1.00% on $400.0 million of notional variable-rate debt.
In August 2021, PQ Corporation novated $900.0 million of its interest rate caps to Ecovyst Catalyst Technologies LLC.
In January 2022, the Company entered into two new interest rate cap agreements, with notional amounts of $250.0 million each and cap rates of 1.00% and paid $4.5 million in premiums. The term for one of the interest rate caps is August 2022 through October 2024 and the term for the other is September 2023 through October 2025.
In November 2022, the Company entered into a new interest rate cap agreement to mitigate interest rate volatility from July 2023 through July 2024, with a cap rate of 1.00% on $150.0 million of notional variable-rate debt and annuitized premium of $5.3 million during the effective period, and mitigate interest rate volatility from July 2024 through July 2026, with a cap rate of 1.00% and 175.0 million notional variable-rate debt and annuitized premium of $6.1 million during the effective period.
Credit Risk
We are exposed to credit risk on financial instruments to the extent our counterparty fails to perform certain duties as required under the provisions of an agreement. We only transact with counterparties having an appropriate credit rating for the risk involved. Credit exposure is managed through credit approval and monitoring procedures.
Concentration of credit risk can result primarily from trade receivables, for example, with certain customers operating in the same industry or customer groups located in the same geographic region. Credit risk related to these
71
types of receivables is managed through credit approval and monitoring procedures. In the year ended December 31, 2022, we wrote off a nominal amount of bad debt on total sales of $820.2 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements, supplementary information and financial statement schedules of the Company are set forth beginning on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.