Orion S.A. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis summarizes the significant factors affecting our results of operations and financial condition during the three months ended March 31, 2021 and 2020 and should be read in conjunction with the information included under Item 1. Financial Statements and Supplementary Data (Unaudited) included elsewhere in this report. We prepare our financial statements in accordance with accounting principles generally accepted in the United States. PRESENTATION OF CERTAIN FINANCIAL AND OTHER INFORMATION Non-GAAP Financial Measures In this report, we present certain financial measures that are not recognized by the accounting principles generally accepted in the United States (“GAAP”). The non-GAAP financial measures contained in this report are unaudited and have not been prepared in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. For a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures, see below. The non-GAAP financial measures used in this report are Contribution Margin, Contribution Margin per Metric Ton (collectively, “Contribution Margins”), Adjusted EBITDA, Net Working Capital and Capital Expenditures. We define Contribution Margin as revenue less variable costs (such as raw materials, packaging, utilities and distribution costs). We define Contribution Margin per Metric Ton as Contribution Margin divided by volume measured in metric tons. We define Adjusted EBITDA as income from operations before depreciation and amortization, adjusted for acquisition related expenses, restructuring expenses, consulting fees related to Company strategy, share of profit or loss of joint venture and certain other items. Adjusted EBITDA is defined similarly in the Credit Agreement. Adjusted EBITDA is used by our management to evaluate our operating performance and make decisions regarding allocation of capital because it excludes the effects of items that have less bearing on the performance of our underlying core business. We define Net Working Capital as inventories plus current trade receivables minus trade payables. We define Capital Expenditures as cash paid for the acquisition of intangible assets and property, plant and equipment as shown in the Condensed Consolidated Financial Statements. We also use Segment Adjusted EBITDA Margin, which we define as Adjusted EBITDA for the relevant segment divided by the revenue for that segment. We use Adjusted EBITDA, Contribution Margins and Net Working Capital, as well as Adjusted EBITDA by segment and Segment Adjusted EBITDA Margin, as internal measures of performance to benchmark and compare performance among our own operations. We use these measures, together with other measures of performance under GAAP, to compare the relative performance of operations in planning, budgeting and reviewing the performance of our business. We believe these measures are useful measures of financial performance in addition to consolidated net income for the period, income from operations and other profitability measures under GAAP because they facilitate operating performance comparisons from period to period and company to company and, with respect to Contribution Margin, eliminate volatility in feedstock prices. By eliminating potential differences in results of operations between periods or companies caused by factors such as depreciation and amortization methods, historic cost and age of assets, financing and capital structures and taxation positions or regimes, we believe Adjusted EBITDA provides a useful additional basis for comparing the current performance of the underlying operations being evaluated. For these reasons, we believe EBITDA-based measures are often used by the investment community as a means of comparison of companies in our industry. By deducting variable costs (such as raw materials, packaging, utilities and distribution costs) from revenue, we believe that Contribution Margins can provide a useful basis for comparing the current performance of the underlying operations being evaluated by indicating the portion of revenue that is not consumed by these variable costs and therefore contributes to the coverage of all costs and profits. Different companies and analysts may calculate measures based on EBITDA, contribution margins and working capital differently, so making comparisons among companies on this basis should be done carefully. Adjusted EBITDA, Contribution Margins and Net Working Capital are not measures of performance under GAAP and should not be considered in isolation or construed as substitutes for revenue, consolidated net income for the period, income from operations, gross profit and other GAAP measures as an indicator of our operations in accordance with GAAP. 17 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation Reconciliation of Non-GAAP Financial Measures Contribution Margin and Contribution Margin per Metric Ton (Non-GAAP Financial Measures) The following table reconciles Contribution Margin and Contribution Margin per Metric Ton to gross profit: Three Months Ended March 31, 2021 2020 (In millions, unless otherwise indicated) Revenue $ 360.1 $ 336.0 Variable costs (1) (213.0) (204.1) Contribution margin 147.1 131.9 Freight 22.5 19.2 Fixed Costs (2) (67.1) (60.8) Gross profit $ 102.5 $ 90.2 Volume (in kmt) 254.1 235.1 Contribution margin per metric ton $ 578.9 $ 560.8 Gross profit per metric ton $ 403.5 $ 383.6 1. Includes costs such as raw materials, packaging, utilities and distribution. 2. Includes costs such as depreciation, amortization and impairment of intangible assets, right of use assets, and property, plant and equipment, personnel and other production related costs. Adjusted EBITDA (Non-GAAP Financial Measure) The following table presents a reconciliation of Adjusted EBITDA to consolidated net income for each of the periods indicated: Three Months Ended March 31, 2021 2020 (In millions) Net income $ 23.5 $ 18.0 Add back income tax expense 8.3 7.6 Add back equity in earnings of affiliated companies, net of tax (0.1) (0.1) Pre-tax income before equity in earnings of affiliated companies 31.7 25.5 Add back interest and other financial expense, net 10.0 9.6 Add back reclassification of actuarial losses from AOCI 1.2 2.4 Income from operations 42.9 37.5 Add back depreciation, amortization and impairment of intangible assets, right of use assets, and property, plant and equipment 25.6 23.8 EBITDA 68.5 61.4 Equity in earnings of affiliated companies, net of tax 0.1 0.1 Long term incentive plan 1.1 (1.1) EPA-related expenses 1.7 2.6 Other adjustments (0.6) 0.9 Adjusted EBITDA $ 70.9 $ 63.8 Thereof Adjusted EBITDA Specialty Carbon Black $ 39.7 $ 28.1 Thereof Adjusted EBITDA Rubber Carbon Black $ 31.2 $ 35.8 18 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation Operating Results For the three months ended March 31, 2021 compared to three months ended March 31, 2020 The table below presents our historical results derived from our Condensed Consolidated Financial Statements for the periods indicated. Statement of operations data Three Months Ended March 31, 2021 2020 (In millions) Net sales $ 360.1 $ 336.0 Cost of sales 257.6 245.8 Gross profit 102.5 90.2 Selling, general and administrative expenses 52.4 44.5 Research and development costs 4.8 5.0 Other expenses, net 2.6 3.2 Income from operations 42.9 37.5 Interest and other financial expense, net 10.0 9.6 Reclassification of actuarial losses from AOCI 1.2 2.4 Pre-tax income before equity in earnings of affiliated companies 31.7 25.5 Income tax expense 8.3 7.6 Equity in earnings of affiliated companies, net of tax 0.1 0.1 Net income $ 23.5 $ 18.0 Net sales Net sales increased by $24.1 million, or 7.2%, from $336.0 million ($119.8 million in our Specialty Carbon Black segment and $216.2 million in our Rubber Carbon Black segment) in the first quarter of 2020 to $360.1 million ($144.2 million in our Specialty Carbon Black segment and $215.9 million in our Rubber Carbon Black segment) in the first quarter of 2021 driven primarily by higher sales volume, partially offset by unfavorable product mix. Volume increased by 19.0 kmt or 8.1%, from 235.1 kmt (58.3 kmt in our Specialty Carbon Black segment and 176.8 kmt in our Rubber Carbon Black segment) in the first quarter of 2020 to 254.1 kmt (71.4 kmt in our Specialty carbon Black segment and 182.7 kmt in our Rubber Carbon Black segment) in the first quarter of 2021, with higher demand in both segments, primarily driven by the broader global economic recovery. Cost of sales and Gross profit Cost of sales increased by $11.7 million, or 4.8%, from $245.8 million in the first quarter of 2020 to $257.6 million in the first quarter of 2021, mainly as a result of higher volumes. Gross profit increased for reasons described above by $12.3 million, or 13.7% from $90.2 million ($39.7 million in our Specialty Carbon Black segment and $50.5 million in our Rubber Carbon Black segment) in the first quarter of 2020 to $102.5 million ($53.4 million in our Specialty Carbon Black segment and $49.1 million in our Rubber Carbon Black segment) in the first quarter of 2021. Selling, general and administrative expenses Selling, general and administrative expenses increased by $7.8 million, or 17.6%, from $44.5 million in the first quarter of 2020 to $52.4 million in the first quarter of 2021, driven primarily by higher freight costs due to increase in sales volumes and higher incentive compensation accruals. Income from operations Income from operations rose by $5.3 million, or 14.1%, to $42.9 million, primarily driven by higher sales volume, partially offset by higher selling, general and administrative costs. 19 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation Reclassification of actuarial losses from AOCI The actuarial losses associated with our pension obligations recorded in prior years in accumulated other comprehensive income exceeding 10% of the defined benefit obligation are recorded ratably over the current year through profit and loss separately from income from operations and amounted to $1.2 million and $2.4 million in the three months ended March 31, 2021 and 2020, respectively. Pre-tax income before equity in earnings of affiliated companies Income from operations before income taxes and equity in earnings of affiliated companies increased by $6.1 million, primarily due to higher sales volume driven by the global economic recovery, partially offset by unfavorable product mix. Net income Net income increased by $5.5 million, reflecting all the items described above. Contribution Margin and Contribution Margin per Metric Ton (Non-GAAP Financial Measures) Contribution Margin increased by $15.2 million, or 11.6%, to $147.1 million, year over year, primarily due to higher sales volume, partially offset by unfavorable product mix. Adjusted EBITDA (Non-GAAP Financial Measure) Adjusted EBITDA increased by $7.0 million, or 11.0%, to $70.9 million, year over year, primarily due to higher volume. Segment Discussion Our business operations are divided into two operating segments: the Specialty Carbon Black segment and the Rubber Carbon Black segment. We use segment revenue, segment gross profit, segment volume, Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin as measures of segment performance and profitability. The table below presents our segment results derived from our unaudited Condensed Consolidated Financial Statements for the periods indicated. Three Months Ended March 31, 2021 2020 (In millions, unless otherwise indicated) Specialty Carbon Black Net sales $ 144.2 $ 119.8 Cost of sales (90.8) (80.0) Gross profit $ 53.4 $ 39.7 Volume (kmt) 71.4 58.3 Adjusted EBITDA $ 39.7 $ 28.1 Adjusted EBITDA Margin (%) (1) 27.5 23.4 Rubber Carbon Black Net sales $ 215.9 $ 216.2 Cost of sales (166.8) (165.8) Gross profit $ 49.1 $ 50.5 Volume (kmt) 182.7 176.8 Adjusted EBITDA $ 31.2 $ 35.8 Adjusted EBITDA Margin (%) (1) 14.4 16.5 (1) Defined as Adjusted EBITDA divided by Net sales. Specialty Carbon Black 2021 Compared to 2020 Three months ended March 31, 2021 compared to three months ended March 31, 2020 Net sales of the Specialty Carbon Black segment increased by $24.4 million, or 20.4% to $144.2 million, year over year, primarily driven by a 22.4% volume increase, partially offset by unfavorable product mix. Volume gains were principally concentrated in the EMEA and Asia Pacific regions and reflected a broad-based demand increase across nearly all applications. 20 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation Specialty Carbon Black segment volumes increased by 13.0 kmt, or 22.4%, to 71.4 kmt, year over year, primarily in EMEA and Asia. Gross profit of the Specialty Carbon Black segment increased by $13.7 million, or 34.4%, to $53.4 million, year over year, as a result of higher volumes. Adjusted EBITDA of the Specialty Carbon Black segment increased by $11.6 million, or 41.3% to $39.7 million, year over year, primarily due to higher volumes. Adjusted EBITDA margin rose 410 basis points to 27.5%year over year. Rubber Carbon Black 2021 Compared to 2020 Three months ended March 31, 2021 compared to three months ended March 31, 2020 Net sales declined marginally by $0.3 million, or 0.1% to $215.9 million, year over year, primarily reflecting higher sales volume, partially offset by the pass through of lower feedstock costs. Rubber Carbon Black segment volumes increased by 5.9 kmt, or 3.3%, to 182.7 kmt, year over year. reflecting the broader global economic recovery, particularly in the Asia Pacific region. Gross profit of the Rubber Carbon Black segment decreased by $1.3 million, or 2.6% to $49.1 million, year over year, primarily due to higher feedstock costs, partially offset by higher volume. Rubber Adjusted EBITDA declined by $4.6 million, or 12.9%, to $31.2 million, year over year, despite moderately higher volume, primarily due to higher selling, general and administrative expenses and one-time impacts related to Winter Storm Uri. Adjusted EBITDA margin declined 210 basis points to 14.4%, year over year. Liquidity and Capital Resources Historical Cash Flows The tables below present our historical cash flows derived from our unaudited Condensed Consolidated Financial Statements for the periods indicated. Three Months Ended March 31, 2021 2020 (In millions) Net cash provided by operating activities $ 1.8 $ 4.9 Net cash used in investing activities (27.2) (50.9) Net cash provided by financing activities 25.6 94.6 2021 Net cash provided by operating activities during the three months ended March 31, 2021 was $1.8 million. The cash provided by operating activities primarily reflected our net income, adjusted for non-cash items and changes in working capital. Net cash used in investing activities in the three months ended March 31, 2021 amounted to $27.2 million. These expenditures were comprised of a combination of safety, sustainability and growth investments as well as expenditures associated with our ongoing efforts to install emissions reduction technology to meet EPA requirements in the U.S. Net cash provided by financing activities during the three months ended March 31, 2021 amounted to $25.6 million. Cash inflows during the three months of $27.7 million were primarily related to net drawings under our local bank loan facilities, and under our senior secured revolving credit facilities (“RCF”), partially offset by scheduled debt repayments of $2.1 million. 2020 Net cash provided by operating activities for the three months ended March 31, 2020 amounted to $4.9 million. The cash provided by operating activities primarily reflected our net income, adjusted for non-cash items and changes in the components of our working capital. Net cash used in investing activities for the three months ended March 31, 2020 amounted to 50.9 million. These expenditures were comprised of a combination of safety, sustainability and growth investments as well as expenditures associated with our ongoing efforts to install emissions reduction technology to meet EPA requirements in the U.S. 21 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation Net cash provided by financing activities for the three months ended March 31, 2020 amounted to $94.6 million, primarily reflecting the company drawing under its revolver to bolster its cash position and enhance financial flexibility to successfully manage through the pandemic. Sources of Liquidity Our principal sources of liquidity are (i) cash on hand, (ii) net cash generated from operating activities, primarily driven by our operating results and changes in working capital requirements, and (iii) cash available through from financing activities, primarily driven by borrowing amounts available under our committed multicurrency, senior secured RCF, and related ancillary facilities, various uncommitted local credit lines and, from time to time, term loan borrowings. We expect cash on hand and cash provided by operating activities and borrowings will be sufficient to pay our operating expenses, satisfy debt service obligations and fund capital expenditures for the foreseeable future. As of March 31, 2021, the company had total liquidity of $310.3 million, including cash and equivalents of $62.6 million, $210.1 million under our revolving credit facility capacity, including ancillary lines, and $37.6 million of capacity under other available credit lines. Net debt was $686.9 million and net leverage was 3.32x. Net Working Capital (Non-GAAP Financial Measure) We define Net Working Capital as the total of inventories and current trade receivables, less trade payables. Net Working Capital is a non-GAAP financial measure, and other companies may use a similarly titled financial measure that is calculated differently from the way we calculate Net Working Capital. The following tables set forth the principal components of our Net Working Capital as of the dates indicated. March 31, 2021 December 31, 2020 (In millions) Inventories $ 157.5 $ 141.5 Trade receivables 257.7 234.8 Trade payables (141.5) (131.2) Net working capital $ 273.7 $ 245.0 Our Net Working Capital position can vary significantly from month to month, mainly due to fluctuations in oil prices and receipts of carbon black oil shipments. In general, increases in the cost of raw materials lead to an increase in our Net Working Capital requirements, as our inventories and trade receivables increase as a result of higher carbon black oil prices and related sales levels. These increases are partially offset by related increases in trade payables. Due to the quantity of carbon black oil that we typically keep in stock, such increases in Net Working Capital occur gradually over a period of two to three months. Conversely, decreases in the cost of raw materials lead to a decrease in our Net Working Capital requirements over the same period of time. Based on expected 2021 Net Working Capital requirements and normalized business activities, we estimate that a $10 per barrel movement in the Brent crude oil price correlates to a movement in our Net Working Capital of approximately $27 million to $30 million within about a two to three-month period. Our Net Working Capital increased from $245.0 million as of December 31, 2020 to $273.7 million as of March 31, 2021. The components of working capital that used or provided cash were: • Inventories—due to higher oil prices and increase in production to meet forecasted demand resulted in raw material and finished goods inventory increases; and • Trade receivables—increase was driven by higher sales due to higher product demand. Those increases were partially offset by: • Accounts payable—higher production and higher oil prices resulted in increased accounts payable. Capital Expenditures (Non-GAAP Financial Measure) We define Capital Expenditures as cash paid for the acquisition of intangible assets and property, plant and equipment as shown in the unaudited Condensed Consolidated Financial Statements. Our Capital Expenditures amounted to $50.9 million in the three months ended March 31, 2020 and $27.2 million in the three months ended March 31, 2021. We plan to finance our Capital Expenditures with cash generated by our operating activities. With the exception of required expenditures in association with our settlement with the EPA we currently do not have any material obligatory commitments to make Capital Expenditures outside the ordinary course of our business. For further discussion on EPA settlement, see “ Note M. Commitments and Contingencies ”. 22 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation Capital Expenditures during the three months ended March 31, 2021 amounted to $27.2 million is primarily associated with safety, sustainability and growth investments as well as expenditures associated with our ongoing efforts to install emissions reduction technology to meet EPA requirements in the U.S. Capital Expenditures in the three months ended March 31, 2020 amounted to $50.9 million and were mainly comprised of preservation and overhaul projects and in expenditures related to investments required to address the EPA requirements in the United States. Off-Balance Sheet Arrangements As of March 31, 2021, we did not have any off-balance sheet arrangements. Note Regarding Forward-Looking Statements This report contains and refers to certain forward-looking statements with respect to our financial condition, results of operations and business. These statements constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are statements of future expectations that are based on management’s current expectations and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in these statements. Forward-looking statements include, among others, statements concerning the potential exposure to market risks, statements expressing management’s expectations, beliefs, estimates, forecasts, projections and assumptions and statements that are not limited to statements of historical or present facts or conditions. Forward-looking statements are typically identified by words such as “anticipate,” “assume,” “assure,” “believe,” “confident,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “objectives,” “outlook,” “probably,” “project,” “will,” “seek,” “target,” “to be,” and other words of similar meaning. These forward-looking statements include, without limitation, statements about the following matters: • our strategies for (i) mitigating the impacts of the global outbreak of the coronavirus, (ii) strengthening our position in specialty carbon blacks and rubber carbon blacks, (ii) strengthening our position in specialty carbon blacks and rubber carbon blacks, (iii) increasing our rubber carbon black margins and (iv) strengthening the competitiveness of our operations; • the ability to pay dividends at historical dividend levels or at all; • cash flow projections; • the installation of pollution control technology in our U.S. manufacturing facilities pursuant to the EPA consent decree described herein; • the outcome of any in-progress, pending or possible litigation or regulatory proceedings; and • our expectation that the markets we serve will continue to grow. All these forward-looking statements are based on estimates and assumptions that, although believed to be reasonable, are inherently uncertain. Therefore, undue reliance should not be placed upon any forward-looking statements. There are important factors that could cause actual results to differ materially from those contemplated by such forward-looking statements. These factors include, among others: • the effects of the COVID-19 pandemic on our business and results of operations; • negative or uncertain worldwide economic conditions; • volatility and cyclicality in the industries in which we operate; • operational risks inherent in chemicals manufacturing, including disruptions as a result of severe weather conditions and natural disasters; • our dependence on major customers and suppliers; • our ability to compete in the industries and markets in which we operate; • our ability to address changes in the nature of future transportation and mobility concepts which may impact our customers and our business; • our ability to develop new products and technologies successfully and the availability of substitutes for our products; • our ability to implement our business strategies; • volatility in the costs and availability of raw materials (including but not limited to any and all effects from restrictions imposed by the MARPOL convention and respective International Maritime Organization (IMO) regulations in particular to reduce sulfur oxides (SOx) emissions from ships) and energy; • our ability to respond to changes in feedstock prices and quality; 23 Orion Engineered Carbons S.A. Management’s Discussion and Analysis of Financial Condition and Results of Operation • our ability to realize benefits from investments, joint ventures, acquisitions or alliances; • our ability to realize benefits from planned plant capacity expansions and site development projects and the potential delays to such expansions and projects; • information technology system failures, network disruptions and breaches of data security; • our relationships with our workforce, including negotiations with labor unions, strikes and work stoppages; • our ability to recruit or retain key management and personnel; • our exposure to political or country risks inherent in doing business in some countries; • geopolitical events in the European Union, and in particular the ultimate future relations between the European Union and the United Kingdom resulting from “Brexit” which may impact the Euro; • environmental, health and safety regulations, including nanomaterial and greenhouse gas emissions regulations, and the related costs of maintaining compliance and addressing liabilities; • possible future investigations and enforcement actions by governmental or supranational agencies; • our operations as a company in the chemical sector, including the related risks of leaks, fires and toxic releases; • market and regulatory changes that may affect our ability to sell or otherwise benefit from co-generated energy; • litigation or legal proceedings, including product liability and environmental claims; • our ability to protect our intellectual property rights and know-how; • our ability to generate the funds required to service our debt and finance our operations; • fluctuations in foreign currency exchange and interest rates; • the availability and efficiency of hedging; • changes in international and local economic conditions, including with regard to the Euro, dislocations in credit and capital markets and inflation or deflation; • potential impairments or write-offs of certain assets; • required increases in our pension fund contributions; • the adequacy of our insurance coverage; • changes in our jurisdictional earnings mix or in the tax laws or accepted interpretations of tax laws in those jurisdictions; • our indemnities to and from Evonik (as defined below); • challenges to our decisions and assumptions in assessing and complying with our tax obligations; and • potential difficulty in obtaining or enforcing judgments or bringing actions against us in the United States. In light of these risks, our results could differ materially from the forward-looking statements contained in this report and no undue reliance should be placed on those forward-looking statements. For further information regarding factors that could affect our business and financial results and the related forward-looking statements, see “ Item 1A. Risk Factors .” Item 3. Quantitative and Qualitative Disclosures About Market Risk Information about market risks for the period ended March 31, 2021 does not differ materially from that discussed under Item 7A of our 2020 Form 10-K.