Item 7. Management’s Discussion and Analysis
Item 7. 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 years ended December 31, 2022 and 2021, and should be read in conjunction with the information included under Item 1. Business and Item 8. Financial Statements and Supplementary Data included elsewhere in this Annual Report. We prepare our financial statements in accordance with accounting principles generally accepted in the United States (“GAAP” or “U.S. GAAP”) and in U.S. Dollars.
This section discusses year-to-year comparisons between 2022 and 2021, except as noted below. For discussions on year-to-year comparison between 2021 and 2020, refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2021 Annual Report in Form 10-K, which was filed with the United States Securities and Exchange Commission (“SEC”) on February 17, 2022 (the “Prior Annual Report”). As described under “Reconciliation of Non-GAAP Financial Measures” below, we implemented certain changes to our financial reporting structure during the fourth quarter of 2022, including the use of new non-GAAP measures (Gross profit per ton) to evaluate our performance, which measures are not discussed in the Prior Annual Report. Accordingly, this section also includes a discussion of year-to-year comparisons of these measures for 2022 compared to 2021, and for 2021 compared to 2020.
Overview
In 2022, our net sales were $2,030.9 million, sales volume was 962.9 kmt, net income was $106.2 million, and Adjusted EBITDA was $312.3 million.
• Specialty Carbon Black Segment —Adjusted EBITDA was $143.9 million, and the Adjusted EBITDA Margin was 21.3%. This segment accounted for 33.3% of our total revenue, 46.1% of total Adjusted EBITDA and 23.3% of our total volume in kmt in 2022.
• Rubber Carbon Black Segment —Adjusted EBITDA was $168.4 million, and Adjusted EBITDA Margin was 12.4%. This segment accounted for 66.7% of our total revenue, 53.9% of total Adjusted EBITDA and 76.7% of our total volume in kmt in 2022.
Key Factors Affecting Our Results of Operations
We believe certain factors had, and will continue to have, a material effect on our results of operations and financial condition. As many of these factors are beyond our control and certain of these factors have historically been volatile, past performance will not necessarily be indicative of future performance, and it is difficult to predict future performance with any degree of certainty. In addition, important factors that could cause our actual results of operations or financial conditions to differ materially from those expressed or implied below, include, but are not limited to, factors indicated under “ Item 1A. Risk Factors ” and “ Cautionary Statement for the Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995 ” elsewhere in this Annual Report.
Recent Developments and Certain Known Trends
General Economic Conditions, Cyclicality and Seasonality
Our 2022 operating results reflect strong demand for Rubber Carbon Black compared to our 2021 fiscal year. However, this was partly offset by lower demand for our Specialty Carbon Black in 2022 compared with our 2021 fiscal year. Operating results were driven by a favorable product mix in both segments and Rubber segment volume growth, as well as our ability to adjust sales prices to conform to energy prices, raw material costs and cost of utilities, to deliver products that drive enhanced performance in customers’ applications, and to increase global and regional capacity utilization. Our ability to generate a financial return on our Rubber Carbon Black business, investments in debottlenecking, yield improvement technologies, etc., including U.S. Environmental Protection Agency (“EPA”) related projects, contributed to improved operating results.
In late February 2022, Russia invaded Ukraine, significantly amplifying already existing geopolitical tensions among Russia and other countries in the region and in the West. Currently, the conflict has impacted exports of Russian crude oil and natural gas. The volatility, trading volumes, and prices in global crude oil and natural gas are expected to continue indefinitely. The extent or length of any adverse effects of the war in Ukraine on the supply of oil and natural gas and the quality and availability of carbon black oil is difficult to quantify. We are monitoring the stability of the natural gas supply in Europe though there is less concern this winter as many businesses and households have reduced consumption. The European Union (“EU”) has proposed a voluntary gas demand reduction target of 15% to be achieved between August 1, 2022 and March 31, 2023. To reach that target, Member States were encouraged to decrease gas consumption by the public sector and businesses, as well as households.
We have identified investments and operational changes which we believe would allow us to achieve between 35% and 40% reduction in natural gas without significantly affecting our production levels.
Reconciliation of Non-GAAP Financial Measures
We present certain financial measures that are not prepared in accordance with GAAP or the accounting standards of any other jurisdiction and may not be comparable to other similarly titled measures of other companies. For a reconciliation of these non-GAAP financial measures to their nearest comparable GAAP measures, see section Reconciliation of Non-GAAP Financial Measures below.
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These non-GAAP measures include, but are not limited to, Gross profit per metric ton, Adjusted EBITDA, Net Working Capital, Capital Expenditures and Segment Adjusted EBITDA Margin (in percentage).
We define:
• Gross profit per metric ton —Gross profit divided by volume measured in metric tons.
• Adjusted EBITDA —Income from operations before depreciation and amortization, share-based compensation, and non-recurring items (such as, restructuring expenses, consulting fees related to Company strategy, legal settlement gain, etc.) plus Earnings in affiliated companies, net of tax.
• Net Working Capital —Inventories, net plus Accounts receivable, net minus Accounts payable.
• Capital Expenditures —Cash paid for the acquisition of property, plant and equipment.
• Segment Adjusted EBITDA Margin (in percentage )—Segment Adjusted EBITDA divided by segment revenue.
Adjusted EBITDA is used by our chief operating decision maker (“CODM”) to evaluate our operating performance and to 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 use this measure, together with other measures of performance under GAAP, to compare the relative performance of operations in planning, budgeting and reviewing our business. We believe these measures are useful measures of financial performance in addition to Net income, Income from operations and other profitability measures under GAAP, because they facilitate operating performance comparisons from period to period. By eliminating potential differences in results of operations between periods caused by factors such as depreciation and amortization, historic cost and age of assets, financing and capital structures and taxation positions or regimes, we believe that Adjusted EBITDA provides a useful additional basis for evaluating and comparing the current performance of the underlying operations. In addition, we believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business.
However, other companies and analysts may calculate non-GAAP financial measures differently, so making comparisons among companies on this basis should be done carefully. Non-GAAP measures are not performance measures under GAAP and should not be considered in isolation or construed as substitutes for Net sales, Net income, Income from operations, Gross profit and other GAAP measures as an indicator of our operations in accordance with GAAP.
Reconciliation of Non-GAAP Financial Measures
Gross profit per metric ton (A Non-GAAP Financial Measure)
In the fourth quarter of 2022, we implemented certain changes to our financial reporting structure. We now use Gross profit and Gross profit per metric ton to evaluate our performance instead of Contribution margin and Contribution margin per metric ton. This change had no impact on our historical Consolidated Financial Statements or the Footnotes to the Consolidated Financial Statements. This change was made because we believe Gross profit and Gross profit per metric ton better reflect the overall operation of our business.
Reconciliation of Gross profit per metric ton is as follows:
Year Ended December 31, Year-Over-Year
2022 2021 2020 Delta
2022 vs. 2021 2021 vs 2020
(In millions, except per ton data and percentage)
Net sales
$ 2,030.9 $ 1,546.8 $ 1,136.4 $ 484.1 31.3 % $ 410.4 36.1 %
Cost of sales
(1,582.1) (1,160.2) (844.1) (421.9) 36.4 % (316.1) 37.4 %
Gross profit $ 448.8 $ 386.6 $ 292.3 $ 62.2 16.1 % $ 94.3 32.3 %
Volume (in kmt) 962.9 964.3 866.8 (1.4) (0.1) % 97.5 11.2 %
Gross profit per metric ton $ 466.1 $ 400.9 $ 337.3 $ 65.2 16.3 % 63.6 18.9 %
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Reconciliation of Net income to Adjusted EBITDA (A Non-GAAP financial Measure)
Reconciliation of Net income to Adjusted EBITDA is as follows:
Year Ended December 31, Year-Over-Year
2022 2021 Delta
(In millions) %
Net income $ 106.2 $ 134.7 $ (28.5) (21.2) %
Add back Income tax expense 51.5 51.7 (0.2) (0.4) %
Add back Earnings in affiliated companies, net of tax (0.5) (0.7) 0.2 (28.6) %
Income before earnings in affiliated companies and income taxes 157.2 185.7 (28.5) (15.3) %
Add back Interest and other financial expense, net 39.9 38.0 1.9 5.0 %
Add back Reclassification of actuarial losses from AOCI — 4.8 (4.8) (100.0) %
Income from operations 197.1 228.5 (31.4) (13.7) %
Add back Depreciation of property, plant and equipment and amortization of intangible assets and right of use assets 105.7 104.1 1.6 1.5 %
EBITDA 302.8 332.6 (29.8) (9.0) %
Earnings in affiliated companies, net of tax 0.5 0.7 (0.2) (28.6) %
Gain related to litigation settlement — (82.9) 82.9 (100.0) %
Long term incentive plan 7.7 5.2 2.5 48.1 %
EPA-related expenses — 2.3 (2.3) (100.0) %
Environmental reserve accrual (0.4) 7.2 (7.6) (105.6) %
Other adjustments 1.7 3.3 (1.6) (48.5) %
Adjusted EBITDA $ 312.3 $ 268.4 $ 43.9 16.4 %
Specialty Carbon Black Adjusted EBITDA
$ 143.9 $ 148.4 $ (4.5) (3.0) %
Rubber Carbon Black Adjusted EBITDA
$ 168.4 $ 120.0 $ 48.4 40.3 %
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Orion Engineered Carbons S.A
Operating Result s
2022 Compared to 2021
Operating results for the periods discussed are as follows:
Year Ended December 31, Year-Over-Year
2022 2021 Delta
(In millions) %
Net sales $ 2,030.9 $ 1,546.8 $ 484.1 31.3%
Cost of sales 1,582.1 1,160.2 421.9 36.4%
Gross profit 448.8 386.6 62.2 16.1%
Selling, general and administrative expenses 227.1 210.4 16.7 7.9%
Research and development costs 21.7 22.0 (0.3) (1.4)%
Gain related to litigation settlement — (82.9) 82.9 (100.0)%
Other expenses, net 2.9 8.6 (5.7) (66.3)%
Income from operations 197.1 228.5 (31.4) (13.7)%
Interest and other financial expense, net 39.9 38.0 1.9 5.0%
Reclassification of actuarial losses from AOCI — 4.8 (4.8) (100.0)%
Income before earnings in affiliated companies and income taxes 157.2 185.7 (28.5) (15.3)%
Income tax expense 51.5 51.7 (0.2) (0.4)%
Earnings in affiliated companies, net of tax 0.5 0.7 (0.2) (28.6)%
Net income $ 106.2 $ 134.7 $ (28.5) (21.2)%
Net sales
Net sales increased by $484.1 million, or 31.3%, from $1,546.8 million in 2021 to $2,030.9 million in 2022, driven primarily by improved base price, passing through higher feedstock costs, impact of favorable product mix across both segments, plus higher volume in the Rubber Carbon Black segment. Those were partially offset by lower volume in the Specialty Carbon Black segment, and unfavorable foreign currency translation impacted both segments. Increased cogeneration revenue, a by-product, also benefited both segments.
Volumes decreased by 1.4 kmt, or 0.1%, to 962.9 kmt, year-over-year.
Cost of sales
Cost of sales increased by $421.9 million, or 36.4%, from $1,160.2 million in 2021 to $1,582.1 million in 2022, primarily due to higher raw material costs and production-associated costs.
Gross profit
2022 Gross profit increased by $62.2 million or 16.1%, from $386.6 million in 2021 to $448.8 million in 2022, and gross profit per metric ton increased by 16.3% or $65.2 to $466.1.
The increase was primarily driven by improved base price, favorable product mix in both segments and higher volume in the Rubber Carbon Black segment. Those were partially offset by lower volume in the Specialty Carbon Black segment. Higher margins per ton resulted from price increases to recover environmental and reliability-related capital expenditures.
2021 Gross profit increased by $94.3 million or 32.3% from $292.3 million in 2020 to $386.6 million in 2021 and gross profit per metric ton increased by 18.9% or $63.6 to $400.9.
The increase was primarily driven by passing through of higher feedstock costs, higher sales volume due to sharp global recovery from COVID-19 across all regions and segments, favorable product mix and higher energy sales.
Selling, general and administrative expenses
Selling, general and administrative expenses increased by $16.7 million, or 7.9%, from $210.4 million in 2021 to $227.1 million in 2022 driven primarily by higher freight and personnel costs, partially offset by the impact of foreign currency translation.
Gain related to litigation settlement
During the second quarter of 2021, Evonik agreed to make a one-time cash payment of €66.55 million ($79.5 million) to settle a dispute which originated from the acquisition of the carbon black business by Rhône Capital and Triton Partners in 2011. The 2011 acquisition
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agreement provided for a partial indemnity from Evonik against various exposures, including capital investments, fines and costs arising in connection with U.S. Clean Air Act violations that occurred prior to the closing of the 2011 acquisition (i.e., under Evonik’s control). In addition, we released $3.4 million of net legal reserves related to this dispute. This was not repeated in 2022.
Income tax expense
Income tax expense was $51.5 million and $51.7 million in 2022 and 2021, respectively.
The 2022 effective income tax rate was 32.7% compared with 27.7% in 2021. The increase in the effective tax rate was mainly due to change in valuation allowance and tax rate differences. Those were partially offset by the effects of earnings in various countries with lower statutory tax rates and tax-free income. For details regarding this deviation, see Item 8. Financial Statements and Supplementary Data and Note P. Income Taxes to the audited Consolidated Financial Statements.
Adjusted EBITDA (A Non-GAAP Financial Measure)
Adjusted EBITDA increased by $43.9 million, or 16.4%, from $268.4 million in 2021 to $312.3 million in 2022. The increase was primarily due to improved base price, impact of favorable product mix across both segments and higher volume in the Rubber Carbon Black segment. Those were partially offset by lower volume in the Specialty Carbon Black segment and the unfavorable impact of foreign currency translation. Increased cogeneration revenue, a by-product, also benefited both segments.
Comprehensive Income
Year Ended December 31, Year-Over-Year
2022 2021 2020 Delta
2022 vs. 2021 2021 vs 2020
(In millions)
Comprehensive income
$ 142.2 $ 134.9 $ 3.8 $ 7.3 $ 131.1
2022 vs 2021 ―Comprehensive income increased by $7.3 million, from $134.9 million to $142.2 million, primarily due to:
• $32.5 million related to financial derivative instruments primarily driven by net periodic changes in cross currency and interest rate swaps, and
• $9.1 million related to net changes in defined pension and other post-retirement benefits driven by discount rates and higher actual returns.
Those increases were partially offset by
• $28.5 million of lower net income; 2021 net income included gain related to litigation legal settlement not repeated in 2022, and
• $5.8 million of net unfavorable impacts of unrealized changes in foreign currency translation adjustments. Relative to the U.S. dollar, the value of the euro weakened during 2022, resulting in net losses related to unrealized changes in foreign currency translation which are reflected in the Consolidated Statements of Comprehensive Income.
2021 vs 2020 ―Comprehensive income increased by $131.1 million from $3.8 million to $134.9 million, primarily due to:
• $116.5 million of higher net income; 2021 net income included gain related to litigation legal settlement not included in 2020,
• $6.7 million net favorable impacts of unrealized changes in foreign currency translation adjustments. Relative to the U.S. dollar, the value of the euro increased during 2021, resulting in net gain related to unrealized changes in foreign currency translation which are reflected in the Consolidated Statements of Comprehensive Income,
• $5.3 million of net favorable impacts of financial derivative instruments primarily driven by periodic changes in cross currency and interest rate swaps and
• $2.6 million of net favorable changes in defined pension and other post-retirement benefits.
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Segment Discussion
Our business operations are divided into two operating segments—Specialty Carbon Black and Rubber Carbon Black. We use Segment Adjusted EBITDA as measures of segment performance and profitability. The table below presents our segment results for 2022, and 2021.
Year Ended December 31, Year-Over-Year
2022 2021 Delta
(In millions, unless otherwise indicated) %
Specialty Carbon Black
Net sales $ 675.4 $ 598.2 $ 77.2 12.9 %
Cost of sales (474.7) (400.6) (74.1) 18.5 %
Gross profit $ 200.7 $ 197.6 $ 3.1 1.6 %
Volume (kmt) (1)
224.3 263.2 (38.9) (14.8) %
Adjusted EBITDA $ 143.9 $ 148.4 $ (4.5) (3.0) %
Adjusted EBITDA Margin (%) 21.3 24.8 (3.5) (14.1) %
Rubber Carbon Black
Net sales $ 1,355.5 $ 948.6 $ 406.9 42.9 %
Cost of sales (1,107.4) (759.6) (347.8) 45.8 %
Gross profit $ 248.1 $ 189.0 $ 59.1 31.3 %
Volume (kmt) 738.6 701.1 37.5 5.3 %
Adjusted EBITDA $ 168.4 $ 120.0 $ 48.4 40.3 %
Adjusted EBITDA Margin (%) 12.4 12.7 (0.3) (2.4) %
Specialty Carbon Black
2022 Compared to 2021
Net sales of the Specialty Carbon Black segment increased by $77.2 million, or 12.9%, from $598.2 million in 2021 to $675.4 million in 2022. The net sales increase in 2022 was primarily driven by improved base price and favorable product mix, partially offset by lower sales volume and an unfavorable impact of foreign currency translation.
Volume of the Specialty Carbon Black segment decreased by 38.9 kmt, or 14.8%, from 263.2 kmt in 2021 to 224.3 kmt in 2022. The volumes were lower due to customer destocking and lower demand, primarily in polymers, related to the weakening economy.
Gross profit of the Specialty Carbon Black segment increased marginally by $3.1 million, or 1.6%, from $197.6 million in 2021 to $200.7 million in 2022, primarily driven by higher margins and favorable product mix.
Adjusted EBITDA of the Specialty Carbon Black segment decreased by $4.5 million, or 3.0%, from $148.4 million in 2021 to $143.9 million in 2022. Adjusted EBITDA decrease was due to lower volume, impact of unfavorable foreign currency translation and higher selling, general and administrative costs. Those were partially offset by higher profit margins and favorable product mix.
Rubber Carbon Black
2022 Compared to 2021
Net sales of the Rubber Carbon Black segment increased by $406.9 million, or 42.9%, from $948.6 million in 2021 to $1,355.5 million in 2022. The increase was primarily due to improved base price, pass through of feed stock costs, higher volume and favorable product mix, partially offset by the impact of unfavorable foreign currency translation.
Volume of the Rubber Carbon Black segment increased by 37.5 kmt, or 5.3%, from 701.1 kmt in 2021 to 738.6 kmt in 2022. The increase reflects higher demand in Americas and Europe/Middle East/Africa.
Gross profit of the Rubber Carbon Black segment increased by $59.1 million, or 31.3%, from $189.0 million in 2021 to $248.1 million in 2022. The increase in the period was primarily driven by higher profit margins, higher volume and favorable product mix, partially offset by the impact of unfavorable foreign currency translation. Higher profit margins resulted from base price increases to recover environmental and reliability-related capital expenditures.
Adjusted EBITDA of the Rubber Carbon Black segment increased by $48.4 million, or 40.3%, from $120.0 million in 2021 to $168.4 million in 2022. The increase was primarily due to pricing, higher volume and product mix, partially offset by the impact of unfavorable foreign currency translation and higher selling, general and administrative costs.
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Liquidity and Capital Resources
Historical Cash Flows
The table below presents cash flows derived from our Consolidated Financial Statements.
Year Ended December 31,
2022 2021
(In millions)
Net cash provided by operating activities $ 81.0 $ 145.2
Net cash used in investing activities (232.8) (214.7)
Net cash provided by financing activities 149.3 73.3
2022
Operating Activities —Cash provided by operating activities primarily reflected our Net income, adjusted for non-cash items and changes in working capital.
Investing Activities— Cash used by investing activities primarily reflects $165.8 million expenditures for safety, maintenance and growth investments and $67.0 million to install emissions reduction technology to meet the Environmental Protection Agency (“EPA”) requirements in the U.S. See “ Note Q. Commitments and Contingencies ” to the accompanying Consolidated Financial Statements for further discussion of the Company’s commitments and contingencies relating to the EPA.
Financing Activities— $149.3 million of cash provided by financing activities primarily reflects $91.0 million of net borrowings under our Revolving credit facilities (“RCF”) and ancillary facilities, $47.8 million to partially finance the construction of our Huaibei facility, China, $36.3 million proceeds from Repurchase agreement, and Other short-term debt and obligations, net. Those were partially offset by a $30.2 million reduction in local uncommitted credit lines, scheduled debt repayments, dividend distributions and stock buybacks. See Note J. Debt and Other Obligations to the accompanying Consolidated Financial Statements for further information regarding the Company’s indebtedness.
2021
Operating Activities —The cash provided by operating activities primarily reflected our Net income, adjusted for non-cash items, changes in working capital and $82.9 million related to Evonik legal settlement gain.
Investing Activities— Approximately $119.8 million related to capital expenditures comprises a combination of safety, maintenance, sustainability and growth investments. Additionally, approximately $94.9 million was associated with our ongoing efforts to install emissions reduction technology to meet EPA requirements.
Financing Activities— Net cash provided by financing activities is composed primarily of net borrowings under our revolving credit facility of $75.8 million for our working capital. Our financing activity included refinancing of our Term-loan and associated costs. See Note J. Debt and Other Obligations to the accompanying Consolidated Financial Statements for further discussion on our Term-loan refinancing.
Sources of Liquidity
Our principal sources of liquidity are the net cash generated (i) from operating activities, primarily driven by our operating results and changes in working capital requirements and (ii) 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 and Accounts receivable factoring.
We believe our anticipated future operating cash flow, the capacity under our existing credit facilities and uncommitted bilateral lines of credit, along with access to surety bonds, will be sufficient to finance our planned capital expenditures, settle our commitments and contingencies, and address our normal anticipated working capital needs for the foreseeable future.
As of December 31, 2022, the Company had liquidity of $292.2 million, including cash and equivalents of $60.8 million, $165.9 million in availability remaining under our revolving credit facility, including ancillary lines, $25.0 million undrawn on the term-loan for Huaibei, China, and $40.5 million under other available credit lines.
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Net Working Capital (Non-GAAP Financial Measure)
We define Net Working Capital as the total of Inventories, net and Accounts receivable, net, less Accounts payable. 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 components of Net Working Capital at December 31, are as follows:
2022 2021
(In millions)
Inventories, net $ 277.9 $ 229.8
Accounts receivable, net 367.8 288.9
Accounts payable (184.1) (195.1)
$ 461.6 $ 323.6
Our Net Working Capital position can vary significantly 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. Our inventories and trade receivables increased primarily due to higher carbon black oil prices and higher Rubber Carbon Back sales volume. These increases are partially offset by related increases in Accounts payable. 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.
Our Net Working Capital increased to $461.6 million as of December 31, 2022 compared to $323.6 million as of December 31, 2021. The components of working capital that used or provided cash were as follows:
• Inventories, net —Higher oil prices and an increase in production to meet forecasted demand resulted in increased raw material and finished goods inventory; and
• Accounts receivable, net —Increase was driven by higher sales due to higher product demand and passing through of higher feedstock costs.
Those increases were partially offset by:
• Accounts payable —Decrease in accounts payable was primarily due to timing of payments, partially offset by higher production and higher oil prices.
Capital Requirements
Capital Expenditures —We define Capital Expenditures as cash paid for the Acquisition of property, plant and equipment. We plan to finance our capital expenditures with cash generated by our operating activities and/or utilizing existing debt capacity. We currently do not have any material commitments to make capital expenditures and do not plan to make capital expenditures outside the ordinary course of our business. See “ Note Q. Commitments and Contingencies ” to the accompanying Consolidated Financial Statements for further details regarding our prior settlement with the EPA.
Debt and Other Obligations —Our gross debt balance as of December 31, 2022 was $919.7 million, an increase of $131.2 million compared to December 31, 2021. Maturities of $3.0 million of term loan debt, due in 2023, excluding net unamortized premiums and discounts, will be paid from current cash balances and cash generated by operations. For more information on Debt, refer to Note J. Debt and Other Obligations to the accompanying Consolidated Financial Statements.
Contractual Obligations —We do not have material contractual obligations. We believe other contractual obligations would be met with cash generated by our operating activities and/or utilizing existing debt capacity. For more information on Contractual obligations, refer to “ Note Q. Commitments and Contingencies ” to the accompanying Consolidated Financial Statements.
Leases —We do not have material short-term lease obligations. We believe lease obligations would be met with cash generated by our operating activities and/or utilizing existing debt capacity. For operating and finance leases, refer to Note G. Leases to the accompanying Consolidated Financial Statements.
Trend Information
See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Recent Developments and Certain Known Trends.
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Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. The policies and estimates discussed below are considered by our management to be critical to an understanding of the Consolidated Financial Statements, because their application requires the most significant judgments from management in estimating matters for financial reporting that are inherently uncertain. This discussion should be read in conjunction with our Consolidated Financial Statements and related notes included in this Annual Report in Form 10-K.
Use of Estimates —We consider an accounting estimate to be critical to the financial statements if (i) the estimate is complex in nature or requires a high degree of judgment and (ii) if different estimates and assumptions were used, the results could have a material impact on the Consolidated Financial Statements. Estimates and assumptions are based on information available at the time such estimates and assumptions are made. Adjustments made with respect to the use of these estimates and assumptions often relate to information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of the Consolidated Financial Statements. We evaluate our estimates and the application of our policies on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
Inventories —W e account for our raw materials, work-in-progress and finished goods inventories using average cost method of accounting. The cost of raw materials, which represents a substantial portion of our operating expenses and energy costs generally follow price trends for crude oil and/or natural gas.
We periodically review inventory for both potential obsolescence and potential declines in anticipated selling prices. Due to natural inventory composition changes, variation in pricing from period to period does not necessarily result in a linear lower of cost or market (“LCM”) impact. Fluctuation in the prices from period to period may result in the recognition of charges to adjust the value of inventory to the lower of cost or market in periods of falling prices and the reversal of those charges in subsequent interim periods as market prices recover. We write down the value of our inventories by an amount equal to the difference between the cost of the inventory and its estimated net realizable value. Historically, such write-downs have not been material. However, if actual market conditions are less favorable than those projected by management at the time of the assessment, additional inventory write-downs may be required, which could reduce our gross profit and our earnings.
Goodwill Impairment —We record goodwill for the excess of the cost of an acquisition over the fair value of the net assets of the acquired business. Goodwill is reviewed for impairment at least annually or more frequently if an event or change in circumstance indicates that an impairment may have occurred.
We also have the option to proceed directly to the quantitative impairment test. Under the quantitative impairment test, the fair value of each reporting unit, calculated using a discounted cash flow model, is compared to its carrying value including goodwill. The discounted cash flow model inherently utilizes a significant number of estimates and assumptions including operating margins, tax rates, discount rates, capital expenditures and working capital changes. If the carrying value of the reporting unit including goodwill exceeds its fair value, an impairment charge equal to the excess would be recognized, up to a maximum amount of goodwill allocated to that reporting unit.
For 2022 and 2021, we performed a qualitative impairment assessment of our reporting units. Both periods indicated the fair value of our reporting units was greater than their carrying value including goodwill. Accordingly, a quantitative goodwill impairment test was not required and no goodwill impairment was recognized in 2022 or 2021.
Loss Contingencies —We record liabilities for loss contingencies when it is probable that a liability has been incurred and the amount of loss is reasonably estimable. We provide disclosure when there is a reasonable possibility that the ultimate loss will exceed the recorded provision by a material amount or if the loss is not reasonably estimable but is expected to be material to our financial results. We are currently involved in litigation and other proceedings, as discussed in Note Q. Commitments and Contingencies to the accompanying Consolidated Financial Statements. We have accrued our estimates of the probable losses associated with these matters and associated legal costs are generally recognized as incurred. However, our losses are typically resolved over long periods of time and are often difficult to estimate due to various factors including the possibility of multiple actions by third parties. Therefore, it is possible future earnings could be affected by changes in our estimates related to these matters.
Accruals for Taxes Based on Income —The determination of our provision for income taxes and the calculation of our tax benefits and liabilities is subject to management’s estimates and judgments due to the complexity of the tax laws and regulations in the tax jurisdictions in which we operate. Uncertainties exist with respect to interpretation of these complex laws and regulations.
Deferred tax assets and liabilities are determined based on temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse.
We recognize future tax benefits to the extent that the realization of these benefits is more likely than not. Our current provision for income taxes is impacted by the recognition and release of valuation allowances related to net deferred tax assets in certain jurisdictions. Further changes to these valuation allowances may impact our future provision for income taxes, which will include no tax benefit with respect to
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Orion Engineered Carbons S.A
losses incurred and no tax expense with respect to income generated in these countries until the respective valuation allowance is eliminated.
We recognize the financial statement benefits with respect to an uncertain income tax position that we have taken or may take on an income tax return when we believe it is more likely than not that the position will be sustained with the tax authorities.
ACCOUNTING AND REPORTING CHANGES
For a discussion of the potential impact of new accounting pronouncements on our Consolidated Financial Statements, see Note B. Recent Accounting Pronouncements to the accompanying Consolidated Financial Statements.