Ingevity Corp 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Management’s discussion and analysis of Ingevity’s financial condition and results of operations (“MD&A”) should be read in conjunction with Item 8. Financial Statements and Suppl ementary Data . Investors are cautioned that the forward-looking statements contained in this section and other parts of this Annual Report on Form 10-K involve both risk and uncertainty. Several important factors could cause actual results to differ materially from those anticipated by these statements. Many of these statements are macroeconomic in nature and are, therefore, beyond the control of management. See "Cautionary Statements about Forward-Looking Statements" at the beginning of this Annual Report on Form 10-K for further discussion. Overview Ingevity Corporation ("Ingevity," "the company", "we," "us" or "our") is a leading global manufacturer of specialty chemicals and high performance activated carbon materials. We provide innovative solutions to meet our customers’ unique and demanding requirements through proprietary formulated products. We report in two business segments, Performance Materials and Performance Chemicals. Our Performance Materials segment consists of our automotive technologies and process purification product lines. Performance Materials manufactures products in the form of powder, granular, extruded pellets, extruded honeycombs, and activated carbon sheets. Automotive technologies products are sold into the gasoline vapor emission control applications within the automotive industry, while process purification products are sold into the food, water, beverage, and chemical purification industries. Our Performance Chemicals segment consists of our pavement technologies, oilfield technologies, industrial specialties, and engineered polymers product lines. Performance Chemicals manufactures products derived from crude tall oil ("CTO") and lignin extracted from the kraft pulping process as well as caprolactone monomers and derivatives derived from cyclohexanone and hydrogen peroxide. Performance Chemicals products serve as critical inputs used in a variety of high performance applications, including warm mix paving, pavement preservation, and pavement reconstruction and recycling (pavement technologies product line), oil well service additives and oil production and downstream application (oilfield technologies product line), adhesives, agrochemicals, lubricants, printing inks, and industrial intermediates (industrial specialties product line), coatings, resins, elastomers, adhesives, bio-plastics, and medical devices (engineered polymers product line). Recent Developments 2020 Senior Notes On October 28, 2020, we issued $550.0 million aggregate principal amount of 3.875 percent senior unsecured notes due 2028 (the “2020 Notes”) in a private placement pursuant to an indenture dated as of October 28, 2020, by and among Ingevity, the subsidiary guarantors party thereto and U.S. Bank National Association, as trustee. The net proceeds from the sale of the 2020 Notes, after deducting deferred financing fees of $8.8 million, were used to repay our $375.0 million term loan from 2019, with the remainder being utilized to repay outstanding balances under our revolving credit facility. Interest payments on the 2020 Notes are due semiannually in arrears on November 1st and May 1st of each year, beginning on May 1, 2021, at a rate of 3.875 percent per year. The 2020 Notes will mature on November 1, 2028. Revolving Credit Facility Amendment On October 28, 2020, we entered into Amendment No. 5 to our existing credit agreement, dated as of March 7, 2016. Among other things, Amendment No. 5 extended the maturity date with respect to our revolving credit facility from August 7, 2023 to October 28, 2025 and reduced the aggregate principal amount of revolving commitments thereunder from $750.0 million to $500.0 million. 32 Coronavirus Pandemic On March 11, 2020, the World Health Organization declared COVID-19 a global pandemic and recommended containment and mitigation measures worldwide. COVID-19 has led to adverse impacts on the U.S. and global economies, and created uncertainty regarding potential impacts to our supply chain, operations, and customer demand. We have been classified as an essential business in the jurisdictions that have made this determination to date, allowing us to continue operations. However, our facilities - as well as the operations of our suppliers, customers, and third-party sales agents and distributors - have been, and will continue to be, disrupted by governmental and private sector responses to COVID-19. This includes business shutdowns, work-from-home orders and social distancing protocols, travel or health-related restrictions, as well as quarantines, self-isolations, and disruptions to transportation channels. On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which includes modifications to the limitation on business interest expense and net operating loss provisions, and provided a payment delay of the employer's portion of U.S. Social Security taxes during 2020, after the date of enactment. We deferred $4.7 million of employer U.S. Social Security taxes due in 2020, with 50 percent due by December 31, 2021 and the remaining 50 percent by December 31, 2022. The CARES Act is not expected to have a material impact on our consolidated financial statements. In order to strengthen our short-term liquidity and to ensure financial flexibility, in March 2020, we drew down $250 million from our revolving credit facility as a precautionary measure, all of which was repaid by year end. We also implemented work-from-home policies and protocols for the majority of our global salaried workforce, as well as social distancing practices to ensure the safety of our employees at our manufacturing facilities. During the second quarter, we decreased production at some of our U.S. and China based manufacturing plants due to COVID-19 customer demand impacts and implemented a cost reduction initiative further described in Note 16 to the consolidated financial statements included in Part II Item 8 of this Form 10-K. During the third quarter, we resumed normal production at all manufacturing plants as customer demand improved. While the disruptions caused by the pandemic are currently expected to be temporary, there is uncertainty regarding the virus's duration and severity and the effectiveness of vaccines. COVID-19 has impacted, and will continue to impact, our results of operations, financial position, and liquidity. Results of Operations Years Ended December 31, In millions, except per share data 2020 2019 2018 Net sales $ 1,216.1 $ 1,292.9 $ 1,133.6 Cost of sales 750.6 810.9 716.8 Gross profit 465.5 482.0 416.8 Selling, general and administrative expenses 149.4 163.1 132.4 Research and technical expenses 22.6 19.7 21.5 Separation costs — — — Restructuring and other (income) charges, net 18.5 1.8 (0.5) Acquisition-related costs 1.8 26.9 10.8 Other (income) expense, net (4.1) (4.3) 1.0 Interest expense 47.1 54.6 33.2 Interest income (4.9) (7.7) (3.4) Income (loss) before income taxes 235.1 227.9 221.8 Provision (benefit) for income taxes 53.7 44.2 40.0 Net income (loss) 181.4 183.7 181.8 Less: Net income (loss) attributable to noncontrolling interests — — 12.7 Net income (loss) attributable to Ingevity stockholders $ 181.4 $ 183.7 $ 169.1 33 Net sales The table below shows 2020 and 2019 Net sales and percentage variances from 2019 and 2018, respectively. Percentage change vs. prior year In millions, except percentages Net sales Total change Currency effect Price/Mix Volume Year Ended December 31, 2020 $ 1,216.1 (6)% —% 1% (7)% Year Ended December 31, 2019 1,292.9 14% (1)% 4% 11% Year Ended December 31, 2020 vs. 2019 The sales decrease in 2020 was driven by a volume decline of $85.2 million (seven percent of sales), primarily related to a volume decline in Performance Chemicals of $89.1 million, offset slightly by a volume increase in Performance Materials of $3.9 million, favorable pricing and product mix of $7.6 million (one percent of sales) and favorable foreign exchange impacts of $0.8 million (less than one percent of sales). Year Ended December 31, 2019 vs. 2018 The sales increase in 2019 was driven primarily by a volume increase of $123.7 million (11 percent of sales). Performance Materials and Performance Chemicals contributed $70.1 million and $53.6 million, respectively, to the volume growth during the year. The acquisition of Caprolactone Business ("Caprolactone Acquisition"), completed in the first quarter of 2019, contributed $122.1 million to the favorable volume growth during the period. Additionally, the favorable pricing and product mix of $43.2 million (four percent of sales) across both segments, offset partially by unfavorable foreign exchange impacts of $7.6 million (one percent of sales) resulted in the year over year Net sales increase. Gross Profit Year Ended December 31, 2020 vs. 2019 Gross profit decline of $16.5 million was driven by unfavorable sales volume impacting gross profit by $35.8 million, increased manufacturing costs of $2.3 million due to reduced plant throughput, and unfavorable foreign currency exchange of $0.8 million, which were partially offset by favorable pricing and product mix improvement of $14.0 million. Additionally, the prior year was negatively impacted by inventory step-up amortization related to the Caprolactone Acquisition of $8.4 million (see Note 17 within the consolidated financial statements included within Part II. Item 8 of the Form 10-K for more information). Refer to the Segment Operating Results section included within this MD&A for more information on the drivers to the changes in gross profit period over period for both segments. Year Ended December 31, 2019 vs. 2018 Gross profit improvement of $65.2 million was driven by favorable sales volume contributing $62.0 million of additional gross profit, pricing and product mix improvement of $39.5 million. These positive impacts were offset by increased manufacturing costs of $26.0 million, inventory step-up amortization related to the acquisitions of the Pine Chemical Business and the Caprolactone Business of $7.0 million (see Note 17 within the consolidated financial statements included within Part II. Item 8 of the Form 10-K for more information), and unfavorable foreign currency exchange of $3.3 million. Refer to the Segment Operating Results section included within this MD&A for more information on the drivers to the changes in gross profit period over period for both segments. 34 Selling, general and administrative expenses Year Ended December 31, 2020 vs. 2019 Selling, general and administrative ("SG&A") expenses were $149.4 million (12 percent of sales) and $163.1 million (13 percent of sales) for the years ended December 31, 2020 and 2019, respectively. The decrease in SG&A expenses is primarily due to reduced travel and other miscellaneous costs of $12.8 million, due to the COVID-19 pandemic, decreased intellectual property litigation costs of $5.0 million, and lower employee-related incentive costs of $3.0 million. The positive impact was partially offset by an increase in amortization costs associated with intangible assets acquired from in Caprolactone Acquisition (see Note 17 within the consolidated financial statements included within Part II. Item 8 of the Form 10-K for more information) and an increase in our credit allowance reserve which increased by a combined $7.1 million. Year Ended December 31, 2019 vs. 2018 SG&A expenses were $163.1 million (13 percent of sales) and $132.4 million (12 percent of sales) for the years ended December 31, 2019 and 2018, respectively. The increase in SG&A is primarily due to intangible asset amortization associated with the Caprolactone Acquisition and Pine Chemical Acquisition of $16.5 million and increased intellectual property litigation costs associated with our Performance Materials' intellectual property litigation of $10.2 million, and increased spending related to the new engineered polymers product line. Research and technical expenses Years Ended December 31, 2020, 2019, and 2018 Research and technical expenses as a percentage of Net sales remained relatively consistent period over period, increasing to 1.9 percent in the year ended December 31, 2020 from 1.5 percent and 1.9 percent in the years ended December 31, 2019 and 2018, respectively. Restructuring and other (income) charges, net Restructuring and other (income) charges, net, of $18.5 million, $1.8 million, and $(0.5) million for the years ended December 31, 2020, 2019, and 2018, respectively, with the increase in 2020 primarily attributable to our business transformation initiative and certain cost reduction initiatives. See Note 16 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information. Acquisition-related costs Years Ended December 31, 2020, 2019, and 2018 Acquisition costs of $1.8 million, $26.9 million, and $10.8 million for the years ended December 31, 2020, 2019, and 2018, respectively, were comprised of charges incurred in connection with the Caprolactone Acquisition and Pine Chemical Acquisition. See Note 17 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information. Other (income) expense, net Years Ended December 31, 2020, 2019, and 2018 Years Ended December 31, In millions 2020 2019 2018 Foreign currency exchange (income) loss $ (5.8) $ 0.2 $ 2.0 Royalty and sundry (income) loss (0.4) (1.9) (0.8) Impairment of equity investment (1) 1.4 — 1.5 Other (income) expense, net 0.7 (2.6) (1.7) Total Other (income) expense, net $ (4.1) $ (4.3) $ 1.0 _______________ (1) Represents an impairment charge related to an equity investment within our Performance Materials segment. 35 Interest expense Years Ended December 31, 2020, 2019, and 2018 Years Ended December 31, In millions 2020 2019 2018 Interest expense on finance lease obligations $ 6.8 $ 6.1 $ 6.2 Interest expense on revolving credit facility and term loans 22.4 36.2 14.9 Interest expense on senior notes 18.1 13.5 13.0 Capitalized interest (0.8) (1.6) (1.1) Other 0.6 0.4 0.2 Total interest expense $ 47.1 $ 54.6 $ 33.2 Interest income Years Ended December 31 2020, 2019, and 2018 Years Ended December 31, In millions 2020 2019 2018 Interest income on restricted investment (1) $ 2.0 $ 2.0 $ 2.0 Interest income on fixed-to-fixed cross-currency interest rate swap (2) 1.6 2.3 — Other 1.3 3.4 1.4 Total interest expense $ 4.9 $ 7.7 $ 3.4 _______________ (1) See Note 6 to the consolidated financial statements included in Part II. Item 8 of this Form 10-K for more information. (2) See Note 10 to the consolidated financial statements included in Part II. Item 8 of this Form 10-K for more information. Provision (benefit) for income taxes Years Ended December 31, 2020, 2019, and 2018 For the years ended December 31, 2020, 2019, and 2018, our effective tax rate was 22.8 percent, 19.4 percent, and 18.0 percent respectively. An explanation of the change in the effective tax rate is presented in Note 18 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K. Net income (loss) attributable to noncontrolling interests Year Ended December 31, 2020, 2019, and 2018 Net income (loss) attributable to noncontrolling interests was zero, zero and $12.7 million for the years ended December 31, 2020, 2019, and 2018, respectively. Our noncontrolling interest represented the 30 percent ownership interest held by a third-party U.S.-based company in our consolidated Purification Cellutions, LLC legal entity, prior to our purchase of this remaining interest on August 1, 2018. 36 Segment Operating Results In addition to the information discussed above, the following sections discuss the results of operations for each of Ingevity's segments. Our segments are (i) Performance Materials and (ii) Performance Chemicals. Segment Earnings before Interest, Taxes, Depreciation and Amortization ("EBITDA") is the primary measure used by the Company's chief operating decision maker to evaluate the performance of and allocate resources among our operating segments. Segment EBITDA is defined as segment revenue less segment operating expenses (segment operating expenses consist of costs of sales, selling, general and administrative expenses, other (income) expense, net, excluding depreciation and amortization). We have excluded the following items from segment EBITDA: interest expense associated with corporate debt facilities, income taxes, depreciation, amortization, restructuring and other (income) charges, net, acquisition and other-related costs, pension and postretirement settlement and curtailment (income) charge. In general, the accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies in Note 3 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K. Performance Materials In millions Years Ended December 31, 2020 2019 2018 Net sales Automotive Technologies product line $ 477.7 $ 454.9 $ 362.0 Process Purification product line 32.3 35.7 38.4 Total Performance Materials - Net sales $ 510.0 $ 490.6 $ 400.4 Segment EBITDA 249.2 213.4 169.4 Net Sales Comparison of Years Ended December 31, 2020, 2019, and 2018 Percentage change vs. prior year In millions, except percentages Net sales Total change Currency effect Price/Mix Volume Year Ended December 31, 2020 $ 510.0 4 % — % 3 % 1 % Year Ended December 31, 2019 $ 490.6 23 % (1) % 6 % 18 % Year Ended December 31, 2020 vs. 2019 Segment net sales. The increase in 2020 was driven by favorable pricing and product mix of $13.6 million (three percent of sales). Additionally, $3.9 million (one percent of sales) in volume improvements in automotive evaporative emission canister products due to stricter environmental regulation in the Chinese, North American, and European automotive markets and favorable foreign currency exchange impacts of $1.9 million (less than one percent of sales) contributed to the overall increase. Segment EBITDA. Segment EBITDA increased $35.8 million due to favorable pricing and product mix, which contributed $18.7 million, favorable volume, primarily in the automotive evaporative emission canister products, which contributed $2.8 million, lower manufacturing costs of $5.0 million and decreased SG&A expenses and research and technical costs of $8.0 million, primarily due to reduced travel and decreased intellectual property litigation costs. Favorable foreign currency exchange impacts, offset slightly by other miscellaneous charges, also contributed $1.3 million to the increase. Year Ended December 31, 2019 vs. 2018 Segment net sales. The increase in 2019 was driven by $70.1 million (18 percent of sales) in volume improvements in automotive evaporative emission canister products due to stricter environmental regulation in the Chinese, North American, and European automotive markets. These gains were further bolstered by favorable pricing and product mix of $22.9 million (six percent of sales), partially offset by unfavorable foreign currency exchange impacts of $2.8 million (one percent of sales). Segment EBITDA. Segment EBITDA increased $44.0 million due to favorable volume primarily in the automotive carbon application, which contributed $41.3 million and favorable pricing and product mix, which contributed $18.9 million. 37 These gains were partially offset by increased manufacturing costs of $5.4 million and increased SG&A expenses and research and technical costs of $14.6 million, primarily due to increased intellectual property litigation costs of $10.2 million. Favorable foreign currency exchange impacts and other miscellaneous income of $3.8 million also contributed to the increase. Performance Chemicals Years Ended December 31, In millions 2020 2019 2018 Net sales Oilfield Technologies product line $ 75.6 $ 111.4 $ 114.2 Pavement Technologies product line 186.8 183.3 178.5 Industrial Specialties product line 316.0 385.5 440.5 Engineered Polymers product line 127.7 122.1 — Total Performance Chemicals - Net sales $ 706.1 $ 802.3 $ 733.2 Segment EBITDA 148.7 183.5 151.1 Net Sales Comparison of Years Ended December 31, 2020, 2019, and 2018 Percentage change vs. prior year In millions, except percentages Net sales Total Change Currency effect Price/Mix Volume Year Ended December 31, 2020 $ 706.1 (12) % — % (1) % (11) % Year Ended December 31, 2019 $ 802.3 9 % (1) % 3 % 7 % Pine Chemical Business and Caprolactone Business The Pine Chemical Business has been integrated into our Performance Chemicals segment and has been included within our results of operations since March 8, 2018. The Caprolactone Business has been integrated into our Performance Chemicals segment and has been included within our results of operations since it was acquired on February 13, 2019. The information presented below includes the results of these acquisitions as compared to historical results. For a pro forma comparative analysis of 2020 versus 2019 and 2019 versus 2018 results, refer to the section below titled "Performance Chemicals Pro Forma Financial Results with the Pine Chemical Business and Caprolactone Business." Year Ended December 31, 2020 vs. 2019 Segment net sales. The sales decrease was driven by unfavorable volume of $89.1 million (11 percent of sales), which consisted of volume declines in industrial specialties ($60.1 million) and oilfield technologies ($35.8 million), partially offset by volume growth in engineered polymers ($5.9 million) and pavement technologies product lines ($0.9 million). Also driving the net sales decline was unfavorable pricing and product mix of $6.0 million (one percent of sales) in industrial specialties ($9.0 million), which was partially offset by favorable pricing and product mix in oilfield technologies ($0.1 million) and pavement technologies product lines ($2.9 million). Unfavorable foreign currency of $1.1 million (less than one percent of sales) contributed to the overall decline impact. Segment EBITDA. Segment EBITDA decreased $34.8 million, mainly due to the decline in volume of $38.6 million, unfavorable pricing and product mix of $4.7 million, and unfavorable foreign currency exchange impacts and other miscellaneous charges of $2.0 million. Favorable SG&A expenses due to reduced travel and lower employee-related costs of $10.3 million and favorable manufacturing productivity of $0.2 million offset part of the overall decline. Year Ended December 31, 2019 vs. 2018 Segment net sales. The sales increase was driven by favorable volume of $53.6 million (seven percent of sales), which consisted of a favorable increase in engineered polymers ($122.1 million), partially offset by volume declines in industrial specialties ($63.9 million), oilfield technologies ($3.3 million) and pavement technologies product lines ($1.3 million). Also 38 driving the net sales increase was pricing and product mix of $20.3 million (three percent of sales) in industrial specialties ($12.3 million), oilfield technologies ($0.8 million), and pavement technologies product lines ($7.2 million), which were partially offset by unfavorable $4.8 million (one percent of sales) of foreign currency exchange. Segment EBITDA. Segment EBITDA increased $32.4 million due to favorable volume of $20.7 million, favorable price and product mix of $20.6 million, as well as favorable SG&A expenses of $2.0 million. These favorable operating results were partially offset by $10.4 million of unfavorable manufacturing productivity, primarily driven by higher freight costs, and unfavorable foreign currency exchange impacts and other miscellaneous charges of $0.5 million. Performance Chemical Pro Forma Financial Results with the Pine Chemical Business and Caprolactone Business We believe that reviewing our operating results by combining actual and pro forma results for our Performance Chemicals segment is useful in identifying trends in, or reaching conclusions regarding, the overall operating performance. Our pro forma segment information includes adjustments as if the acquisitions had occurred on January 1st, in the year preceding the year of acquisition. Our pro forma results are adjusted for the effects of acquisition accounting but do not include adjustments for costs related to integration activities, cost savings or synergies that might be achieved by the combined businesses. Pro forma amounts presented are not necessarily indicative of what our results would have been had we operated the Pine Chemical Business and Caprolactone Business since January 1st in the year preceding the acquisition, nor are the pro forma amounts necessarily indicative of future results. Performance Chemical Pro Forma Financial Results Comparison Years Ended December 31, In millions 2020 2019 Pro Forma 2018 Pro Forma Net sales Performance Chemicals, as reported (1) $ 706.1 $ 802.3 $ 733.2 Pine Chemical Business and Caprolactone Business, pro forma (2) — 17.7 187.2 Net Sales (3) $ 706.1 $ 820.0 $ 920.4 Segment EBITDA Performance Chemicals, as reported (1) $ 148.7 $ 183.5 $ 151.1 Pine Chemical Business and Caprolactone Business, pro forma (2) — 5.5 65.9 Segment EBITDA (3) $ 148.7 $ 189.0 $ 217.0 _______________ (1) As reported amounts are the results of operations of Performance Chemicals, including the results of the Pine Chemical Business and Caprolactone Business, post acquisition dates of March 8, 2018 and February 13, 2019, respectively. (2) Pro forma amounts include historical results of the Pine Chemical Business and Caprolactone Business, prior to the acquisition dates of March 8, 2018 and February 13, 2019, respectively. These amounts also include adjustments as if the acquisitions had occurred on January 1st in the year preceding the acquisition, including the effects of purchase accounting. The pro forma amounts do not include adjustments for expenses related to integration activities, cost savings, or synergies that have been or may have been realized. (3) The pro forma combined results are not necessarily indicative of what the results would have been had we acquired the Pine Chemical Business and Caprolactone Business on January 1st in the year preceding the acquisition, nor are they indicative of future results. 39 Performance Chemicals Pro Forma Net Sales Comparison Years Ended December 31, In millions 2020 2019 Pro Forma 2018 Pro Forma Oilfield Technologies product line $ 75.6 $ 111.4 $ 118.8 Pavement Technologies product line 186.8 183.3 178.7 Industrial Specialties product line 316.0 385.5 455.9 Engineered Polymers product line 127.7 139.8 167.0 Net Sales - Performance Chemicals $ 706.1 $ 820.0 $ 920.4 Pro Forma Comparison of Year Ended December 31, 2020, 2019, and 2018 Percentage change vs. prior year Performance Chemicals (In millions, except percentages) Net Sales Total change Currency effect Price/Mix Volume Year Ended December 31, 2020 $ 706.1 (14) % — % (1) % (13) % Year Ended December 31, 2019 $ 820.0 (11) % (1) % 3 % (13) % Pro Forma Results Comparison - Year Ended December 31, 2020 vs. 2019 Net Sales. The decrease was driven by unfavorable volume of $106.8 million (13 percent of sales), which consisted of unfavorable volumes in industrial specialties ($60.1 million), oilfield technologies ($35.8 million) and engineered polymers product lines ($11.8 million), partially offset by a slight increase in pavement technologies ($0.9 million). Also contributing to the decline was unfavorable pricing and product mix of $6.0 million (one percent of sales) driven by unfavorable price and product mix in industrial specialties product lines ($9.0 million), partially offset by pavement technologies ($2.9 million) and oilfield technologies ($0.1 million). In addition, unfavorable foreign currency exchange impacted Net sales by $1.1 million (less than one percent of sales). Segment EBITDA . Pro Forma Segment EBITDA decreased by $40.3 million primarily due to decreased volumes of $44.0 million, increased manufacturing, freight and warehousing costs of $2.0 million, unfavorable pricing and product mix of $4.7 million, and unfavorable foreign currency exchange impact of $1.6 million. These declines were partially offset by $12.0 million of favorable SG&A expenses. Pro Forma Results Comparison - Year Ended December 31, 2019 vs. 2018 Net Sales. The decrease was driven by unfavorable volume of $115.4 million (13 percent of sales), which consisted of unfavorable volumes in industrial specialties ($79.2 million), engineered polymers ($26.7 million), pavement technologies ($1.6 million), and oilfield technologies product lines ($7.9 million). This decline was partially offset by pricing and product mix increase of $20.3 million (three percent of sales) driven by favorable price and product mix in oilfield technologies ($0.8 million), pavement technologies ($7.2 million), and industrial specialties product lines ($12.3 million). In addition, unfavorable foreign currency exchange impacted Net sales by $5.3 million (less than one percent of sales). Segment EBITDA . Pro Forma Segment EBITDA decreased by $28.0 million primarily due to decreased volumes of $50.3 million, increased manufacturing, freight and warehousing costs of $5.9 million, and unfavorable foreign currency exchange impact of $1.9 million. These declines were partially offset by $19.8 million of favorable pricing and product mix and $10.3 million of favorable SG&A expenses. Use of Non-GAAP Financial Measures Ingevity has presented the financial measure, Adjusted EBITDA, defined below, which has not been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and has provided a reconciliation to net income, the 40 most directly comparable financial measure calculated in accordance with GAAP. Adjusted EBITDA is not meant to be considered in isolation or as a substitute for the most directly comparable financial measure calculated in accordance with GAAP. Adjusted EBITDA is utilized by management as a measure of profitability. We believe this non-GAAP financial measure provides management as well as investors, potential investors, securities analysts and others with useful information to evaluate the performance of the business, because such measure, when viewed together with our financial results computed in accordance with GAAP, provides a more complete understanding of the factors and trends affecting our historical financial performance and projected future results. We believe Adjusted EBITDA is a useful measure because it excludes the effects of financing and investment activities as well as non-operating activities. Adjusted EBITDA is defined as net income (loss) plus provision (benefit) for income taxes, interest expense, net, depreciation, amortization, restructuring and other (income) charges, net, acquisition and other-related costs, and pension and postretirement settlement and curtailment (income) charges, net. This non-GAAP measure is not intended to replace the presentation of financial results in accordance with GAAP and investors should consider the limitations associated with these non-GAAP measures, including the potential lack of comparability of these measures from one company to another. A reconciliation of Adjusted EBITDA to net income is set forth within this section. Reconciliation of Net Income to Adjusted EBITDA Years Ended December 31, In millions 2020 2019 2018 Net income (loss) (GAAP) $ 181.4 $ 183.7 $ 181.8 Interest expense 47.1 54.6 33.2 Interest income (4.9) (7.7) (3.4) Provision (benefit) for income taxes 53.7 44.2 40.0 Depreciation and amortization - Performance Materials 31.2 24.2 22.2 Depreciation and amortization - Performance Chemicals 69.0 60.8 34.8 Pension and postretirement settlement and curtailment income (charges), net 0.1 — 0.2 Restructuring and other (income) charges, net 18.5 1.8 (0.5) Acquisition and other-related costs (1) 1.8 35.3 12.2 Adjusted EBITDA (Non-GAAP) $ 397.9 $ 396.9 $ 320.5 _______________ (1) These charges are associated with the acquisition and integration of the Pine Chemical Business and the acquisition and integration of the Caprolactone Business. See below for more detail on the charges incurred. Years Ended December 31, In millions 2020 2019 2018 Legal and professional service fees (i) $ 1.8 $ 14.2 $ 6.9 Inventory fair value step-up amortization (ii) — 8.4 1.4 Purchase price hedge adjustment (i) — 12.7 3.9 Acquisition and other-related costs $ 1.8 $ 35.3 $ 12.2 _______________ (i) Included within "Acquisition-related costs" on the consolidated statements of operations. (ii) Included within "Cost of sales" on the consolidated statements of operations. Adjusted EBITDA Year Ended December 31, 2020, 2019 and 2018 The factors that impacted Adjusted EBITDA period to period are the same factors that affected earnings discussed in the sections entitled "Results of Operations" and "Segment Operating Results" within MD&A. 41 Total Company Outlook and 2021 Guidance For revenue, we expect favorable volume growth in Performance Materials’ automotive technologies product line largely due to continued industry efforts to refill the vehicle pipeline and despite the absence of any significant new gasoline vapor emission control regulations. In Performance Chemicals, we expect moderate growth in demand for pavement technologies and engineered polymers based on strong paving project backlog, continued Evotherm® warm mix technology adoption, and increased demand for thermoplastics. We also anticipate growth in merchant rosin sales and our agricultural dispersants products within industrial specialties, which will be partially offset by continued softness in publication inks and our oilfield chemicals business. Our outlook reflects our expectation that the first half of 2021 will continue to be impacted by the COVID-19 pandemic and by the microchip shortage, which is disrupting the global automotive supply chain. Adjusted EBITDA is expected to grow by one percent to six percent versus 2020. In the Performance Materials segment, growth will be driven by continued volume, price, and mix improvements, due in part to a slight uptick in demand over 2020, and a continued refilling of the automotive pipeline. This growth will be partially offset by higher logistics costs, increased compensation costs, and continued legal costs to defend our Performance Materials' intellectual property. In our Performance Chemicals segment, continued profitable growth in pavement technologies and a return to growth in engineered polymers is expected to be partially offset by somewhat lower volumes in oilfield technologies, and modest inflationary costs for freight and primary raw materials. Some risks to the 2021 outlook include lower than anticipated U.S., China, Canadian, and European vehicle sales and production, higher non-primary raw materials costs, a shift towards smaller vehicles in the U.S. (versus the shift towards light trucks as seen in recent years), and further declines in oil drilling and production in oilfield technologies, negative impacts from Brexit, and prolonged disruptions in the global supply chain. We expect to deliver fiscal year 2021 Adjusted EBITDA of $400 million to $420 million. These estimates assume that the first half of the year will continue to impacted by the COVID-19 pandemic, with improvements in economic conditions over the second half of the year. A reconciliation of net income to adjusted EBITDA as projected for 2021 is not provided. Ingevity does not forecast net income as it cannot, without unreasonable effort, estimate or predict with certainty various components of net income. These components, net of tax, include further restructuring and other income (charges), net; additional acquisition and other related costs in connection with the Perstorp Holding AB’s Capa caprolactone business; additional pension and postretirement settlement and curtailment (income) charges; and revisions due to future guidance and assessment of U.S. tax reform. Additionally, discrete tax items could drive variability in our projected effective tax rate. All of these components could significantly impact such financial measures. Further, in the future, other items with similar characteristics to those currently included in adjusted EBITDA, that have a similar impact on comparability of periods, and which are not known at this time, may exist and impact adjusted EBITDA. 42 Liquidity and Capital Resources The primary source of liquidity for our business is the cash flow provided by operating activities. We expect our cash flow provided by operations combined with cash on hand and available capacity under our revolving credit facility to be sufficient to meet our working capital needs. Over the next twelve months, we expect to make interest payments, capital expenditures, expenditures related to our business transformation initiative, principal repayments, purchases pursuant to our stock repurchase program, and income tax payments, and to incur additional spending associated with our Performance Materials' intellectual property litigation. In addition, from time to time we may repurchase any of our outstanding 4.50 percent senior unsecured notes due in 2026 in open market or privately negotiated transactions or otherwise. We believe our sources of liquidity will be sufficient to fund our planned operations and meet our interest and other contractual obligations for at least the next twelve months. As of December 31, 2020, our undrawn capacity under our revolving credit facility was $497.7 million. In addition, we also evaluate and consider strategic acquisitions, and joint ventures, as well as other transactions to create stockholder value and enhance financial performance. Such transactions may require cash expenditures. In connection with such transactions, or to fund other anticipated uses of cash, we may modify our existing debt facilities, seek additional debt financing, issue equity securities, or some combination thereof. Cash and cash equivalents totaled $257.7 million at December 31, 2020. We continuously monitors deposit concentrations and the credit quality of the financial institutions that hold our cash and cash equivalents, as well as the credit quality of our insurance providers, customers, and key suppliers. Due to the global nature of our operations, a portion of our cash is held outside the U.S. The cash and cash equivalents balance at December 31, 2020 includ ed $88.2 million held by our foreign subsidiaries. Cash and earnings of our foreign subsidiaries are generally used to finance our foreign operations and their capital expenditures. We believe that our foreign holdings of cash will not have a material adverse impact on our U.S. liquidity. If these earnings were distributed, such amounts would be subject to U.S. federal income tax at the statutory rate less the available foreign tax credits, if any, and potentially subject to withholding taxes in the various jurisdictions. The potential tax implications of the repatriation of unremitted earnings are driven by facts at the time of distribution, therefore, it is not practicable to estimate the income tax liabilities that might be incurred if such cash and earnings were repatriated to the U.S. Management does not currently expect to repatriate cash earnings from our foreign operations in order to fund U.S. operations. Debt Obligations and Facilities Refer to Note 11 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for a summary of our outstanding debt obligations and revolving credit facility. Other Potential Liquidity Needs Share Repurchases On February 28, 2020, our Board of Directors authorized the repurchase of up to $500.0 million of our common stock, and at December 31, 2020, $412.0 million remained unused under this program. We currently do not have any specific timetable or price targets for repurchasing shares, and may suspend or terminate the program at any time. Shares may be purchased through open market or privately negotiated transactions at the discretion of management based on its evaluation of market prevailing conditions and other factors. In the year ended December 31, 2020, we repurchased $88.0 million in common shares, representing 1,533,442 shares of our common stock at a weighted average cost per share of $57.38. At December 31, 2020, $412.0 million remained unused under our Board-authorized repurchase program. Capital Expenditures Projected 2021 capital expenditures are expected to be $100 million to $120 million. We have no material commitments associated with these projected capital expenditures as of December 31, 2020. 43 Cash flow comparison of Years Ended December 31, 2020, 2019, and 2018 Years Ended December 31, In millions 2020 2019 2018 Net cash provided by (used in) operating activities $ 352.4 $ 275.7 $ 252.0 Net cash provided by (used in) investing activities (110.6) (658.3) (414.4) Net cash provided by (used in) financing activities (50.2) 369.2 153.7 Cash flows provided by (used in) operating activities During the year ended December 31, 2020, cash flow provided by operations increased primarily due to working capital decreases compared to 2019, which are further explained below. Current Assets and Liabilities December 31, In millions 2020 2019 Cash and cash equivalents $ 257.7 $ 56.5 Accounts receivable, net 148.0 150.0 Inventories, net 189.0 212.5 Prepaid and other current assets 34.0 44.2 Total current assets $ 628.7 $ 463.2 Current assets as of December 31, 2020, increased $165.5 million compared to December 31, 2019, primarily due to an increase in cash of $201.2 million. This increase was partially offset by a decrease Inventories, net, of $23.5 million, due to a concerted effort to control inventory levels in 2020 due to the COVID-19 pandemic and higher that expected customer demand in the fourth quarter. Prepaid and other current assets decreased by $10.2 million primarily related to a reduction in restricted cash from our New Market Tax Credit transaction (see Note 11 in the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information). Accounts receivable, net, was relatively flat, decreasing by $2.0 million in 2020. December 31, In millions 2020 2019 Accounts payable $ 104.2 $ 99.1 Accrued expenses 46.6 33.3 Accrued payroll and employee benefits 25.1 28.2 Current operating lease liabilities 16.2 17.1 Notes payable and current portion of long-term debt 26.0 22.5 Income taxes payable 5.3 15.3 Total current liabilities $ 223.4 $ 215.5 Current liabilities as of December 31, 2020, increased by $7.9 million compared to December 31, 2019, driven primarily by the increase in Accrued expenses of $13.3 million, related to an increase in accrued taxes of $4.7 million, accrued interest of $2.8 million, and accrued rebates of $2.1 million. Also increasing current liabilities was a $3.5 million increase in the current portion of long-term debt (see Note 11 in the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information on our debt balances). These increases were partially offset by a decrease of $10.0 million on our Income taxes payable (see Note 18 in the taxes and related balances) and a decrease of $3.1 million in Accrued payroll and employee benefits, primarily related to lower accrued incentive costs in the current year as compared to the year ended December 31, 2019. 44 Cash flows provided by (used in) investing activities The cash used in investing activities for the year ended December 31, 2020 was primarily driven by capital and finance lease expenditures. See the table below for the capital expenditure spending by category. The cash used in investing activities for the year ended December 31, 2019 was primarily driven by the $537.9 million purchase of the Caprolactone Business (see Note 17 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information). The remaining cash used by investing activities was primarily driven by capital expenditures. See the table below for the capital expenditure spending by category. The cash used in investing activities for the year ended December 31, 2018 was primarily driven by the $315.5 million purchase of the Pine Chemical Business. The remaining cash used by investing activities was primarily driven by capital expenditures. For the year ended December 31, 2020, capital spending was driven primarily by maintenance and growth spending. Our Performance Materials' facilities, including Covington, Virginia, Wickliffe, Kentucky, and Waynesboro, Georgia, incurred expenditures for growth and expansion projects, as well as base maintenance and safety spending. Our Performance Chemicals' facility in Warrington, United Kingdom, completed a large, multi-year growth and cost improvement project, and there was additional spending at all of our Performance Chemicals' facilities for base maintenance and safety spending. Additionally, we had capital expenditures related to our business transformation initiative (see Note 16 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information) and our new corporate headquarters. For the year ended December 31, 2019, capital spending was driven primarily by maintenance and growth spending. Our Covington, Virginia facility incurred expenditures for its expansion project, along with base maintenance and other various equipment purchases. Also, we incurred cost improvement spending at our DeRidder, Louisiana location related to installation of new CTO tanks as well as base maintenance spending, and our Waynesboro, Georgia location expended funds primarily for growth and cost improvement. We also invested capital spending in our newest location in Warrington, United Kingdom to enable further growth and cost improvement as well as base maintenance. For the year ended December 31, 2018, capital spending included both growth and maintenance spending for expansion and specialized equipment at our Covington, Virginia, Waynesboro, Georgia, and Changshu, China facilities, as well as base maintenance spending to support ongoing operations across both segments. In addition, we expended funds for cost improvement related to CTO tanks at our DeRidder, Louisiana facility. Capital expenditure categories Years Ended December 31, In millions 2020 2019 2018 Maintenance $ 49.1 $ 44.6 $ 41.1 Safety, health and environment 14.9 11.2 9.6 Growth and cost improvement 18.1 59.0 43.2 Total capital expenditures $ 82.1 $ 114.8 $ 93.9 Cash flows provided by (used in) financing activities Cash provided by financing activities for the year ended December 31, 2020 was $50.2 million, and was driven by proceeds from long-term borrowings from the senior notes that were issued in the fourth quarter of $550.0 million, net of debt issuance costs of $8.8 million. We used these proceeds to repay the outstanding balance on the revolving credit facility of $131.2 million and the 2019 term loan of $375.0 million. We also paid $2.2 million in debt issuance costs for the amendment to our revolving credit facility (refer to Note 11 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information). Additionally, we repaid $14.1 million of other long-term borrowings, repurchased $88.0 million of our common stock, and made payments of $3.2 million related to withholding tax on vested equity awards. Cash provided by financing activities for the year ended December 31, 2019 was $369.2 million, and was driven by proceeds from long-term borrowings from a new term loan in the first quarter of 2019 of $375.0 million and $131.3 million in net borrowings related to our revolving credit facility (refer to Note 11 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information). This was offset by repayments of $122.5 million on our long-term borrowings. Additionally, we made payments of $14.3 million related to withholding tax on vested equity awards. 45 Cash provided by financing activities for the year ended December 31, 2018 was $153.7 million, and was driven by proceeds from long-term borrowings from the issuance of $300.0 million senior notes (refer to Note 11 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information), offset by our purchase of the remaining portion of our joint venture with Purification Cellutions, LLC of $80.0 million (refer to Note 13 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information), $47.4 million to repurchase shares under a share repurchase program (also refer to Note 13 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information), and noncontrolling interest distributions of $15.3 million. Off-Balance Sheet Arrangements Ingevity is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on Ingevity's financial condition, results of operations or cash flows. Contractual Obligations We enter into various contractual obligations throughout the year. Presented below are the contractual obligations of Ingevity as of December 31, 2020, and the time period in which payments under the obligations are due. Included below are disclosures regarding the amounts due under purchase obligations. A purchase obligation is defined as an agreement to purchase goods or services that is enforceable and legally binding on Ingevity and that specifies all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. We have included in the below disclosure all normal and recurring purchase orders, take-or-pay contracts and supply arrangements as well as other purchase commitments that management believes meet the above definition of a purchase obligation. See Note 11 and Note 14 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for more information. Payments due in period In millions Total at December 31, 2020 2021 2022-2023 2024-2025 2026 and beyond Contractual obligations Debt maturities $ 1,203.4 $ 25.3 $ 328.1 $ — $ 850.0 Contractual interest (1) 258.5 40.7 77.5 69.6 70.7 Finance lease obligations (2) 154.2 8.1 16.3 16.6 113.2 Operating lease obligations 57.0 18.3 24.5 9.9 4.3 Purchase obligations 152.2 151.1 1.1 — — Total $ 1,825.3 $ 243.5 $ 447.5 $ 96.1 $ 1,038.2 _______________ (1) Contractual interest is the interest we are contracted to pay on our long-term debt obligations. We had $353.4 million of long-term debt subject to variable interest rates at December 31, 2020 and $850.0 million of debt subject to fixed interest rates. The rate assumed for the variable interest component of the contractual interest obligation was the rate in effect at December 31, 2020. Variable rates are determined by the market and will fluctuate over time. (2) Amounts include the interest payments, as well as the principal payment due in 2027, for the finance lease related to assets at our Wickliffe, Kentucky facility, and payments related to the finance lease for our North Charleston, South Carolina corporate headquarters which will be paid through the lease term ending in 2035. 46 New Accounting Guidance Refer to the Note 4 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K for a full description of recent accounting pronouncements including the respective expected dates of adoption and expected effects on our consolidated financial statements. Critical Accounting Policies Our principal accounting policies are described in Note 3 to the consolidated financial statements included within Part II. Item 8 of this Form 10-K. Our consolidated financial statements are prepared in conformity with GAAP. The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We have reviewed these accounting policies, identifying those that we believe to be critical to the preparation and understanding of our financial statements. Critical accounting policies are central to our presentation of results of operations and financial condition and require management to make estimates and judgments on certain matters. We base our estimates and judgments on historical experience, current conditions and other reasonable factors. The following is a list of those accounting policies that we have deemed most critical to the presentation and understanding of our results of operations and financial condition: Revenue recognition Our revenue is derived from contracts with customers, and substantially all our revenue is recognized when products are either shipped from our manufacturing and warehousing facilities or delivered to the customer. Revenue, net of returns and customer incentives, are based on the sale of manufactured products. Revenues are recognized when performance obligations under the terms of a contract with our customer are satisfied; generally, this occurs with the transfer of control of our products. For certain limited contracts, where we are producing goods with no alternative use and for which we have an enforceable right to payment for performance completed to date, we are recognizing revenue as goods are manufactured, rather than when they are shipped. Revenues are presented as Net sales on the consolidated statements of operations to the consolidated financial statements. Since Net sales are derived from product sales only, we have disaggregated our Net sales by our product lines within each reportable segment. Net sales are measured as the amount of consideration we expect to receive in exchange for transferring goods. Sales, value add, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. Sales returns and allowances are not a normal practice in the industry and are not significant. Certain customers may receive cash-based incentives, including discounts and volume rebates, which are accounted for as variable consideration and included in Net sales. Shipping and handling fees billed to customers are included with Net sales. If we pay for the freight and shipping, we recognize the cost when control of the product has transferred to the customer as an expense in Cost of sales on the consolidated statements of operations. Although very rare, from time to time we incur expenses to obtain a sales contract. In these cases, if these costs are for orders that are fulfilled in one year or less, we expense these costs as they are incurred. Payment terms with our customers are typically in the range of zero to sixty days. Because the period between when we transfer a promised good to a customer and when the customer pays for that good will be one year or less, we elect not to adjust the promised amount of consideration for the effects of any financing component, as it is not significant. Valuation of tangible and intangible long-lived assets and goodwill Our long-lived assets primarily include property, plant and equipment and other intangible assets. We periodically evaluate whether current events or circumstances indicate that the carrying value of long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to carrying value to determine whether an impairment exists. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows. We report an asset to be disposed of at the lower of its carrying value or its estimated net realizable value. Goodwill represents the excess of cost of an acquired business over the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed in a business combination. We conduct a required annual review of goodwill for potential impairment at October 1, or sooner if events or changes in circumstances indicate that the fair value of a reporting 47 unit is below its carrying value. Our reporting units are our operating segments, i.e. Performance Chemicals and Performance Materials. If the carrying value of a reporting unit that includes goodwill exceeds its fair value, which is determined using both the income approach and market approach, goodwill is considered impaired. The income approach determines fair value based on discounted cash flow model derived from a reporting unit’s long-term forecasted cash flows. The market approach determines fair value based on the application of earnings multiples of comparable companies to projected earnings of the reporting unit. The amount of impairment loss is measured as the difference between the carrying value and the fair value of a reporting unit but is limited to the total amount of goodwill allocated to the reporting unit. In performing the fair value analysis, management makes various judgments, estimates and assumptions, the most significant of which is the assumption related to revenue growth rates. The factors we considered in developing our estimates and projections for cash flows include, but are not limited to, the following: (i) macroeconomic conditions; (ii) industry and market considerations; (iii) costs, such as increases in raw materials, labor, or other costs; (iv) our overall financial performance; and, (v) other relevant entity-specific events that impact our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated fair values of our reporting units. We believe that the estimates and assumptions used in our impairment assessment are reasonable; however, these assumptions are judgmental and variations in any assumptions could result in materially different calculations of fair value. We will continue to evaluate goodwill on an annual basis as of October 1, and whenever events or changes in circumstances, such as significant adverse changes in operating results, market conditions, or changes in management’s business strategy indicate that there may be a probable indicator of impairment. It is possible that the assumptions used by management related to the evaluation may change or that actual results may vary significantly from management’s estimates. Business Combinations We account for business combinations in accordance with ASC 805 “Business Combinations” which requires, among other things, the acquiring entity in a business combination to recognize the fair value of the assets acquired and liabilities assumed; the recognition of acquisition-related costs in the consolidated results of operations; the recognition of restructuring costs in the consolidated results of operations for which the acquirer becomes obligated after the acquisition date; and contingent purchase consideration to be recognized at fair value on the acquisition date with subsequent adjustments recognized in the consolidated results of operations. We generally use third-party qualified consultants to assist management in determining the fair value of assets acquired and liabilities assumed. This includes, when necessary, assistance with the determination of lives and valuation of property and identifiable intangibles, assisting management in determining the fair value of obligations associated with employee related liabilities and assisting management in assessing obligations associated with legal and environmental claims. The fair value assigned to identifiable intangible assets acquired are determined primarily by using an income approach, which is based on assumptions and estimates made by management. Significant assumptions utilized in the income approach are the attrition rate, growth rate, and discount rate. These assumptions are based on company specific information and projections, which are not observable in the market and are therefore considered Level 2 and Level 3 measurements. The excess of the purchase price over the fair value of the identified assets and liabilities is recorded as goodwill. Based on the acquired business’ end markets and products as well as how the chief operating decision maker will review the business results determines the most appropriate operating segment for which to integrate the acquired business. Goodwill acquired, if any, is allocated to the reporting unit within or at the operating segment for which the acquired business will be integrated. Operating results of the acquired entity are reflected in the consolidated financial statements from date of acquisition. Income taxes We are subject to income taxes in the U.S. and numerous foreign jurisdictions, including China and the United Kingdom. The provision for income taxes includes income taxes paid, currently payable or receivable, and deferred taxes. We follow the liability method of accounting for income taxes in accordance with current accounting standards regarding the accounting for income taxes. Under this method, deferred income taxes are recorded based upon the differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws in effect at the time the underlying assets or liabilities are recovered or settled. The ability to realize deferred tax assets is evaluated through the forecasting of taxable income, historical and projected future operating results, the reversal of existing temporary differences, and the availability of tax planning strategies. Valuation allowances are recognized to reduce deferred tax assets when it is more 48 likely than not that a tax benefit will not be realized. We do not provide income taxes on undistributed earnings of consolidated foreign subsidiaries as it is our intention that such earnings will remain invested in those companies. We recognize income tax positions that are more likely than not to be realized and accrue interest related to unrecognized income tax positions, which is included as a component of the income tax provision, on the consolidated statements of operations.