Ecovyst, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Financial Instruments

Financial Instruments

12 Months Ended

Dec. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

19. Financial Instruments:

The Company uses (1) interest rate related derivative instruments to manage its exposure related to changes in interest rates on its variable-rate debt instruments, (2) commodity derivatives to manage its exposure to commodity price fluctuations, and (3) foreign currency related derivative instruments to manage its foreign currency exposure to its net investments in certain foreign operations. The Company does not speculate using derivative instruments.

By using derivative financial instruments to hedge exposures to changes in interest rates, commodity prices and foreign currency, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is an asset, the counterparty owes the Company, which creates credit risk for the Company. When the fair value of a derivative contract is a liability, the Company owes the counterparty and, therefore, the Company is not exposed to the counterparty’s credit risk in those circumstances. The Company minimizes counterparty credit risk in derivative instruments by entering into transactions with high quality counterparties. The derivative instruments entered into by the Company do not contain credit-risk-related contingent features.

Market risk is the adverse effect on the value of a derivative instrument that results from a change in interest rates, currency exchange rates or commodity prices. The market risk associated with interest rate and commodity price contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

Use of Derivative Financial Instruments to Manage Commodity Price Risk. The Company is exposed to risks in energy costs due to fluctuations in energy prices, particularly natural gas. The Company has a hedging program in the United States which allows the Company to mitigate exposure to natural gas volatility with natural gas swap agreements. Fair value is determined based on estimated amounts that would be received or paid to terminate the contracts at the reporting date based on quoted market prices of comparable contracts. The respective current and non-current liabilities are recorded in accrued liabilities and other long-term liabilities and the respective current and non-current assets are recorded in prepaid and other current assets and other long-term assets, as applicable, in the Company’s consolidated balance sheet. As the derivatives are designated and qualify as cash flow hedges, the gains or losses on the natural gas swaps are recorded in stockholders’ equity as a component of other comprehensive income (loss) (“OCI”), net of tax. Reclassifications of the gains and losses on natural gas hedges into earnings are included in production costs and subsequently charged to cost of goods sold in the consolidated statements of income in the period in which the associated inventory is sold. As of December 31, 2019, the Company’s natural gas swaps had a remaining notional quantity of 3.6 million MMBTU to mitigate commodity price volatility through December 2021.

Use of Derivative Financial Instruments to Manage Interest Rate Risk. The Company is exposed to fluctuations in interest rates on its senior secured credit facilities. Changes in interest rates will not affect the market value of such debt but will affect the amount of the Company’s interest payments over the term of the loans. Likewise, an increase in interest rates could have a material impact on the Company’s cash flow. The Company hedges the interest rate fluctuations on debt obligations through interest rate cap agreements. The Company records these agreements at fair value as assets or liabilities in its consolidated balance sheet. As the derivatives are designated and qualify as cash flow hedges, the gains or losses on the interest rate cap agreements are recorded in stockholders’ equity as a component of OCI, net of tax. Reclassifications of the gains and losses on the interest rate cap agreements into earnings are recorded as part of interest expense in the consolidated statements of income as the Company makes its interest payments on the hedged portion of its senior secured credit facilities. Fair value is determined based on estimated amounts that would be received or paid to terminate the contracts at the reporting date based on quoted market prices.

In July 2016, the Company entered into interest rate cap agreements, paying a premium of $1,551 to mitigate interest rate volatility from July 2016 through July 2020 by employing varying cap rates, ranging from 1.50% to 3.00% on $1,000,000 of notional variable-rate debt. The cap rate in effect at December 31, 2019 was 3.00%. In November 2018, the Company entered into additional interest rate cap agreements to mitigate interest rate volatility from July 2020 through July 2022, with a cap rate of 3.50% on $500,000 of notional variable-rate debt. During the quarter ended December 31, 2019, the Company discontinued cash flow hedging on $53,000 of its $1,000,000 notional on its remaining July 2016 interest rate cap agreement. With the Company’s prepayments on its Term Loan Facility during 2019 (see Note 17 to these consolidated financial statements for additional information), the original forecasted interest rate payments associated with the dedesginated portion of the interest rate cap agreement are no longer probable of occurring. As a result of the discontinuance of cash flow hedge accounting on this portion of the interest rate cap agreement, the Company immediately reclassified into earnings the loss deferred in AOCI related to the dedesignated portion of the hedge, which was not material. Any future gains and losses associated with the dedesignated portion of the interest rate cap agreement through its maturity in July 2020 will be recognized in earnings.

Use of Derivative Financial Instruments to Manage Foreign Currency Risk. The Company is exposed to risks related to its net investments in foreign operations due to fluctuations in foreign currency exchange rates, particularly between the United States dollar and the Euro. In connection with the February 2018 term loan refinancing (see Note 17 to these consolidated financial statements), the Company entered into multiple cross currency interest rate swap arrangements with an aggregate notional amount of €280,000 to hedge this exposure on the net investments of certain of its Euro-denominated subsidiaries. The Company records these swap agreements at fair value as assets or liabilities in its consolidated balance sheet.

In October 2019, the Company settled all of its February 2018 swaps and concurrently entered into the October 2019 swaps with the same notional amount of €280,000 ($313,656 as of December 31, 2019) and same maturity date of February 2023, which resulted in cash proceeds to the Company of $38,070. Consistent with the February 2018 swaps, the October 2019 swaps are designed to enable the Company to effectively convert a portion of its fixed-rate U.S. dollar-denominated debt obligations under the Term Loan Facility into a Euro-denominated equivalent. The October 2019 swaps have been designated and qualify as net investment hedges of the Company’s foreign currency exchange rate exposure on the net investments of certain of its Euro-denominated subsidiaries.

As the derivatives are designated and qualify as net investment hedges, changes in the fair value of the swaps attributable to changes in the spot exchange rates are recognized in cumulative translation adjustment (“CTA”) within OCI and are held there until the hedged net investments are sold or substantially liquidated. Changes in the fair value of the swaps attributable to the cross currency basis spread are excluded from the assessment of hedge effectiveness and are recorded in current period earnings. Upon such sale or liquidation, the amount recognized in CTA is reclassified to earnings and reported in the same line item as the gain or loss on the liquidation of the net investments.

The fair values of derivative instruments held as of December 31, 2019 and 2018 are shown below:



		December 31,
	Balance sheet location	2019		2018
Derivative assets:
Derivatives designated as cash flow hedges:
Natural gas swaps	Prepaid and other current assets	$	—	$	21
Interest rate caps	Prepaid and other current assets	—		1,358
Interest rate caps	Other long-term assets	—		546
		—		1,925
Derivatives designed as net investment hedges:
Cross currency swaps	Prepaid and other current assets	3,928		5,499
Cross currency swaps	Other long-term assets	—		13,344
		3,928		18,843
Total derivative assets		$	3,928	$	20,768

Derivative liabilities:
Derivatives designated as cash flow hedges:
Natural gas swaps	Accrued liabilities	$	813	$	36
Interest rate caps	Accrued liabilities	420		—
Natural gas swaps	Other long-term liabilities	226		148
Interest rate caps	Other long-term liabilities	2,822		1,842
		4,281		2,026
Derivatives designated as net investment hedges:
Cross currency swaps	Other long-term liabilities	8,134		—
Total derivative liabilities		$	12,415	$	2,026

The following table shows the effect of the Company’s derivative instruments designated as hedges on accumulated other comprehensive income (loss) (“AOCI”) and the statements of income for the years ended December 31, 2019, 2018 and 2017:



		Years ended December 31,
		2019						2018						2017
	Location of gain (loss) reclassified from AOCI into income	Amount of gain (loss) recognized in OCI on derivatives			Amount of gain (loss) reclassified from AOCI into income			Amount of gain (loss) recognized in OCI on derivatives			Amount of gain (loss) reclassified from AOCI into income			Amount of gain (loss) recognized in OCI on derivatives			Amount of gain (loss) reclassified from AOCI into income
Interest rate caps	Interest (expense) income	$	(3,304	)	$	(625	)	$	(981	)	$	(256	)	$	(4,760	)	$	(40	)
Natural gas swaps	Cost of goods sold	(1,210		)	(335		)	637			353			(1,300		)	(222		)
		$	(4,514	)	$	(960	)	$	(344	)	$	97		$	(6,060	)	$	(262	)

The following table shows the effect of the Company’s cash flow hedge accounting on the consolidated statements of income for the years ended December 31, 2019, 2018 and 2017:



	Location and amount of gain (loss) recognized in income on cash flow hedging relationships
	Years ended December 31,
	2019						2018						2017
	Cost of goods sold			Interest (expense) income			Cost of goods sold			Interest (expense) income			Cost of goods sold			Interest (expense) income
Total amounts of income and expense line items presented in the statement of income in which the effects of cash flow hedges are recorded	$	(1,176,550	)	$	(111,525	)	$	(1,226,520	)	$	(113,723	)	$	(1,095,265	)	$	(179,044	)

The effects of cash flow hedging:
Gain (loss) on cash flow hedging relationships:
Interest contracts:
Amount of gain (loss) reclassified from AOCI into income	—			(625		)	—			(256		)	—			(40		)
Commodity contracts:
Amount of gain (loss) reclassified from AOCI into income	(335		)	—			353			—			(222		)	—

The following table shows the effect of the Company’s net investment hedges on AOCI and the consolidated statements of income for the years ended December 31, 2019, 2018 and 2017:



	Amount of gain (loss) recognized in OCI on derivative						Location of gain (loss) reclassified from AOCI into income	Amount of gain (loss) reclassified from AOCI into income						Location of gain (loss) recognized in income on derivative (amount excluded from effectiveness testing)	Amount of gain (loss) recognized in income on derivative (amount excluded from effectiveness testing)
	Years ended December 31,							Years ended December 31,							Years ended December 31,
	2019		2018		2017			2019		2018		2017			2019		2018		2017
Cross currency swaps	$	17,077	$	18,843	$	—	Gain (loss) on sale of subsidiary	$	—	$	—	$	—	Interest (expense) income	$	8,035	$	7,898	$	—

Amounts of unrealized losses in AOCI that are expected to be reclassified to the consolidated statement of income over the next twelve months are $1,442 as of December 31, 2019.