STEPAN COMPANY The following is management's discussion and analysis (MD&A) of certain significant factors that have affected the Company's financial condition and results of operations during the interim periods included in the accompanying condensed consolidated financial statements. Certain statements in this Quarterly Report on Form 10-Q, other than purely historical information, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These statements include statements aboutStepan Company's and its subsidiaries' (the Company) plans, objectives, strategies, financial performance and outlook, trends, the amount and timing of future cash distributions, prospects or future events and involve known and unknown risks that are difficult to predict. As a result, the Company's actual financial results, performance, achievements or prospects may differ materially from those expressed or implied by these forward-looking statements. In some cases, forward-looking statements can be identified by the use of words such as "may," "could," "expect," "intend," "plan," "seek," "anticipate," "believe," "estimate," "guidance," "predict," "potential," "continue," "likely," "will," "would," "should," "illustrative" and variations of these terms and similar expressions, or the negative of these terms or similar expressions. Such forward-looking statements are necessarily based upon estimates and assumptions that, while considered reasonable by the Company and its management based on their knowledge and understanding of the business and industry, are inherently uncertain. These statements are not guarantees of future performance, and stockholders should not place undue reliance on forward-looking statements. There are a number of risks, uncertainties and other important factors, many of which are beyond the Company's control, that could cause the Company's actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q. Such risks, uncertainties and other important factors, include, among others, the risks, uncertainties and factors set forth under "Part II-Item IA - Risk Factors" of this Quarterly Report on Form 10-Q and under "Part I-Item IA. Risk Factors" in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2022 , including the risks and uncertainties related to the following:
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accidents, unplanned production shutdowns or disruptions in any of the Company's manufacturing facilities;
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reduced demand for Company products due to customer product reformulations or new technologies;
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the Company's inability to successfully develop or introduce new products;
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compliance with environmental, health and safety, product registration and anti-corruption laws;
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the Company's ability to make acquisitions of suitable candidates and successfully integrate acquisitions;
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global competition and the Company's ability to successfully compete;
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volatility of raw material, natural gas and electricity costs as well as any disruption in their supply;
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disruptions in transportation or significant changes in transportation costs;
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downturns in certain industries and general economic downturns;
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international business risks, including fluctuations in currency exchange rates, legal restrictions and taxes;
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unfavorable resolution of litigation against the Company;
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the Company's ability to keep and protect its intellectual property rights;
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potentially adverse tax consequences due to the international scope of the Company's operations;
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downgrades to the Company's credit ratings or disruptions to the Company's ability to access well-functioning capital markets;
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conflicts, military actions, terrorist attacks and general instability, particularly in certain energy-producing nations, along with increased security regulations;
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cost overruns, delays and miscalculations in capacity needs with respect to the Company's expansion or other capital projects;
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interruption of, damage to or compromise of the Company's IT systems and failure to maintain the integrity of customer, colleague or Company data;
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the Company's ability to retain its executive management and other key personnel;
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the Company's ability to operate within the limitations of debt covenants; and
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the other factors set forth under "Risk Factors."
18
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These factors are not necessarily all of the important factors that could cause
the Company's actual financial results, performance, achievements or prospects
to differ materially from those expressed in or implied by any of its
forward-looking statements. Other unknown or unpredictable factors could also
impact the Company's results. All forward-looking statements attributable to the
Company or persons acting on the Company's behalf are expressly qualified in
their entirety by the cautionary statements set forth above. Forward-looking
statements speak only as of the date they are made, and the Company does not
undertake or assume any obligation to update publicly any of these
forward-looking statements to reflect actual results, new information or future
events, changes in assumptions or changes in other factors affecting
forward-looking statements, except to the extent required by applicable laws. If
the Company updates one or more forward-looking statements, no inference should
be drawn that the Company will make additional updates with respect to those or
other forward-looking statements.
The "Company," "we," "our" or "us" means
Overview The Company produces and sells intermediate chemicals that are used in a wide variety of applications worldwide. The overall business is comprised of three reportable segments: Surfactants - Surfactants, which accounted for 72 percent of consolidated net sales for the first three months of 2023, are principal ingredients in consumer and industrial cleaning and disinfection products such as detergents for washing clothes, dishes, carpets, floors and walls, as well as shampoos and body washes. Other applications include fabric softeners, germicidal quaternary compounds, disinfectants, lubricating ingredients, emulsifiers for spreading agricultural products and industrial applications such as latex systems, plastics and composites. Surfactants are manufactured at five sites inthe United States , two European sites (United Kingdom andFrance ), five Latin American sites (one site inColombia and two sites in each ofMexico andBrazil ) and two Asian sites (Philippines andSingapore ). Polymers - Polymers, which accounted for 25 percent of consolidated net sales for the first three months of 2023, include polyurethane polyols, polyester resins and phthalic anhydride. Polyurethane polyols are used in the manufacture of rigid foam for thermal insulation in the construction industry and are also a base raw material for coatings, adhesives, sealants and elastomers (collectively, CASE products). Powdered polyester resins are used in coating applications. CASE and powdered polyester resins are collectively referred to as specialty polyols. Phthalic anhydride is used in unsaturated polyester resins, alkyd resins and plasticizers for applications in construction materials and components of automotive, boating and other consumer products. In addition, the Company uses phthalic anhydride internally in the production of polyols. Inthe United States , polyurethane polyols are manufactured at the Company'sElwood, Illinois (Millsdale) andWilmington, North Carolina sites. Phthalic anhydride is manufactured at the Company's Millsdale site and specialty polyols are manufactured at the Company'sColumbus, Georgia , site. InEurope , polyurethane polyols are manufactured at the Company's plants inGermany andthe Netherlands and specialty polyols are manufactured at the Company'sPoland site. InAsia , polyurethane polyols and specialty polyols are manufactured at the Company'sChina plant. Specialty Products - Specialty products, which accounted for three percent of consolidated net sales for the first three months of 2023, include flavors, emulsifiers and solubilizers used in food, flavoring, nutritional supplement and pharmaceutical applications. Specialty products are primarily manufactured at the Company'sMaywood, New Jersey , site and, in some instances, by third-party contractors. 19 --------------------------------------------------------------------------------
Deferred Compensation Plans
The accounting for the Company's deferred compensation plans can cause
period-to-period fluctuations in Company income and expenses. Compensation
expense is recognized when the value of Company common stock and mutual fund
investment assets held for the plans increase, and compensation income is
recognized when the value of Company common stock and mutual fund investment
assets decline. The pretax effect of all deferred compensation-related
activities (including realized and unrealized gains and losses on the mutual
fund assets held to fund the deferred compensation obligations) and the income
statement line items in which the effects of the activities were recorded are
displayed in the following table:
Income (Expense)
For the Three Months
Ended March 31,
(In millions) 2023 2022 Change
Deferred Compensation (Administrative
expenses) $ (1.5 ) $ 7.5 $ (9.0 ) (1)
Realized/Unrealized Gains (Losses) on
Investments (Other, net) 1.5 (2.5 ) 4.0
Investment Income (Other, net) 0.1 0.2 (0.1 )
Pretax Income Effect $ 0.1 $ 5.2 $ (5.1 )
(1)See the Segment Results-Corporate Expenses section of this MD&A for details regarding the period-over-period changes in deferred compensation.
Effects of Foreign Currency Translation
The Company's foreign subsidiaries transact business and report financial results in their respective local currencies. As a result, foreign subsidiary income statements are translated intoU.S. dollars at average foreign exchange rates appropriate for the reporting period. Because foreign exchange rates fluctuate against theU.S. dollar over time, foreign currency translation affects period-to-period comparisons of financial statement items (i.e., because foreign exchange rates fluctuate, similar period-to-period local currency results for a foreign subsidiary may translate into differentU.S. dollar results). The following table presents the effects that foreign currency translation had on the period-over-period changes in consolidated net sales and various income statement line items for the three months endedMarch 31, 2023 and 2022: For the Three Months Ended March 31, (Decrease) Due to Foreign (In millions) 2023 2022 Decrease Translation Net Sales$ 651.4 $ 675.3 $ (23.9 ) $ (12.5 ) Gross Profit 73.6 109.2 (35.6 ) (1.5 ) Operating Income 21.1 63.3 (42.2 ) (1.1 ) Pretax Income 19.9 59.4 (39.5 ) (1.1 ) RESULTS OF OPERATIONS
Three Months Ended
Summary
Net income in the first quarter of 2023 decreased 64 percent to$16.1 million , or$0.70 per diluted share, from$44.8 million , or$1.93 per diluted share, in the first quarter of 2022. Adjusted net income decreased 60 percent to$16.4 million , or$0.71 per diluted share, from$40.7 million , or$1.76 per diluted share in the first quarter of 2022 (see the "Reconciliation of Non-GAAP Adjusted Net Income and Diluted Earnings per Share" section of this MD&A for a reconciliation between reported net income and reported earnings per diluted share and non-GAAP adjusted net income and adjusted earnings per diluted share). Below is a summary discussion of the major factors leading to the changes in net sales, expenses and income in the first quarter of 2023 compared to the first quarter of 2022. A detailed discussion of segment operating performance for the first quarter of 2023 compared to the first quarter of 2022 follows the summary. Consolidated net sales decreased$23.8 million , or four percent, versus the prior year quarter. Consolidated sales volume declined 14 percent, which negatively impacted the change in net sales by$97.6 million . Sales volume in the Surfactant, Polymer and Specialty Products segments decreased 13 percent, 18 percent and seven percent, respectively. The decline in sales volume was primarily due to lower market demand and continued customer and channel inventory destocking. Foreign currency translation negatively impacted the 20 -------------------------------------------------------------------------------- year-over-year change in net sales by$12.5 million due to a strongerU.S. dollar against most currencies in foreign locations where the Company has operations. Higher average selling prices positively impacted the year-over-year change in net sales by$86.3 million . The increase in average selling prices was mainly attributable to the pass-through of higher raw material and input costs as well as more favorable product and customer mix. Operating income in the first quarter of 2023 decreased$42.3 million , or 67 percent, versus operating income in the first quarter of 2022. Surfactant, Polymer and Specialty Products operating income decreased$26.7 million ,$4.1 million , and$1.2 million , respectively, versus the first quarter of 2022. Corporate expenses, including business restructuring and deferred compensation expenses, increased$10.3 million year-over-year. Most of this increase was attributable to$9.0 million of higher deferred compensation expense in the current year quarter. Foreign currency translation had a$1.1 million unfavorable impact on operating income in the first quarter of 2023 versus the prior year. Operating expenses (including deferred compensation and business restructuring) increased$6.6 million , or 14 percent, versus the prior year quarter. Changes in the individual income statement line items that comprise the Company's operating expenses were as follows:
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Selling expenses decreased
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Administrative expenses increased$1.1 million , or five percent, primarily due to the higher salaries, cloud-based application costs, patent and trademark expenses, and other smaller items that more than offset lower incentive-based compensation expenses.
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Research, development and technical service (R&D) expenses decreased
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Deferred compensation was$1.5 million of expense in the first quarter of 2023 versus$7.5 million of income in the prior year quarter. The$9.0 million increase in deferred compensation expense was primarily due to a$25.48 per share decrease in the market price of Company common stock in the first quarter of 2022 compared to a$3.43 per share decrease in the first quarter of 2023. A year-over-year increase in the market value of mutual fund investment assets held for the plans in the first quarter of 2023, versus a decrease in the first quarter of 2022, also contributed to the higher expense in the first quarter of 2023. See the Overview and Segment Results-Corporate Expenses section of this MD&A for further details. Net interest expense for the first quarter of 2023 increased$0.5 million , or 22 percent, versus the first quarter of 2022. This increase was primarily attributable to higher outstanding debt balances and higher interest rates in 2023 versus 2022. Other, net was$1.7 million of income in the first quarter of 2023 versus$1.7 million of expense in the first quarter of 2022. The Company recognized$1.7 million of investment income (including realized and unrealized gains and losses) for the Company's deferred compensation and supplemental defined contribution mutual fund assets in the first quarter of 2023 compared to$2.3 million of investment losses in the first quarter of 2022. In addition, the Company reported$0.3 million of foreign exchange losses in the first quarter of 2023 versus$0.3 million of foreign exchange gains in the first quarter of 2022. The Company's net periodic pension income was flat between years. The Company's effective tax rate was 18.9 percent in the first quarter of 2023 versus 24.6 percent in the first quarter of 2022. The decrease was primarily attributable to more favorable tax benefits derived from stock-based compensation awards exercised or distributed in the first quarter of 2023 versus the first quarter of 2022. Segment Results For the Three Months Ended (Dollars in thousands) March 31, Increase Percent Net Sales 2023 2022 (Decrease) Change Surfactants$ 467,828 $ 468,266 $ (438 ) 0 Polymers 161,127 187,079 (25,952 ) -14 Specialty Products 22,481 19,931 2,550 13 Total Net Sales$ 651,436 $ 675,276 $ (23,840 ) -4 21
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For the Three Months Ended
(Dollars in thousands) March 31,
Increase Percent
Operating Income 2023 2022 (Decrease) Change
Surfactants $ 27,056 $ 53,769 $ (26,713 ) -50
Polymers 10,004 14,129 (4,125 ) -29
Specialty Products 2,530 3,695 (1,165 ) -32
Segment Operating Income $ 39,590 $ 71,593 $ (32,003 ) -45
Corporate Expenses, Excluding Deferred
Compensation
and Restructuring $ 16,874 $ 15,696 $ 1,178 8
Deferred Compensation Expense (Income) 1,502 (7,501 ) 9,003 -120
Business Restructuring 157 52 105 202
Total Operating Income $ 21,057 $ 63,346 $ (42,289 ) -67
Surfactants
Surfactant net sales for the first quarter of 2023 decreased $0.4 million versus
net sales for the first quarter of 2022. Higher average selling prices
positively impacted the change in net sales by $67.5 million . The higher average
selling prices were mainly attributable to the pass-through of higher raw
material and input costs as well as improved product and customer mix. Sales
volume declined 13 percent and negatively impacted the change in net sales by
$62.0 million . Foreign currency translation had a $5.9 million unfavorable
impact on the year-over-year change in net sales. A comparison of net sales by
region follows:
For the Three Months Ended
(Dollars in thousands) March 31,
Increase Percent
Net Sales 2023 2022 (Decrease) Change
North America $ 277,139 $ 273,228 $ 3,911 1
Europe 91,120 91,017 103 0
Latin America 81,099 85,434 (4,335 ) -5
Asia 18,470 18,587 (117 ) -1
Total Surfactants Segment $ 467,828 $ 468,266 $ (438 ) 0
Net sales for North American operations increased $3.9 million , or one percent,
year-over-year. Higher average selling prices positively impacted the change in
net sales by $52.7 million . The higher average selling prices were mainly
attributable to the pass-through of higher raw material and input costs along
with more favorable product and customer mix. Sales volume declined 18 percent
between years and negatively impacted the change in net sales by $47.9 million .
The lower sales volume was primarily due to lower commodity laundry demand,
startup delays associated with our low 1,4 dioxane transition and the previously
disclosed backward integration by one customer in the third quarter of 2022,
lower demand in the personal care end market and continued customer and channel
inventory destocking. Higher demand for products sold into the agricultural end
market partially offset the above. Foreign currency translation negatively
impacted the change in net sales by $0.9 million .
Net sales for European operations increased $0.1 million versus the prior year
quarter. Higher average selling prices positively impacted the year-over-year
change in net sales by $13.3 million . The higher average selling prices were
primarily due to the pass-through of higher raw material costs. Sales volume
declined eight percent and negatively impacted the change in net sales by $7.5
million . Lower sales volume into the laundry and cleaning end market, mostly
commodity laundry products, the personal care end market and to our distribution
partners was partially offset by higher demand for products sold into the
agriculture end market. Foreign currency translation negatively impacted the
change in net sales by $5.7 million . A stronger U.S. dollar relative to the
European euro and British pound sterling led to the unfavorable foreign currency
translation effect.
Net sales for Latin American operations decreased $4.3 million , or five percent,
primarily due to a five percent decrease in sales volume and lower average
selling prices. These items negatively impacted the change in net sales by $4.1
million and $1.9 million , respectively. The lower sales volume was primarily due
to lower demand for commodity laundry products sold within the consumer products
business and lower demand for products sold into the functional product end
markets. Foreign currency translation positively impacted the change in net
sales by $1.7 million .
Net sales for Asian operations decreased $0.1 million , or one percent, versus
the prior year quarter. Higher average selling prices positively impacted the
change in net sales by $4.1 million . The higher average selling prices primarily
reflect the pass-through of higher raw material costs and improved product and
customer mix. A 17 percent decline in sales volume and the unfavorable impact of
foreign currency translation negatively impacted the change in net sales by $3.1
million and $1.1 million , respectively. The decline in
22
--------------------------------------------------------------------------------sales volume was primarily due to lower demand for products sold into the personal care end market that was partially offset by higher sales into the functional product end markets and higher demand from our distribution partners.
Surfactant operating income for the first quarter of 2023 decreased$26.7 million , or 50 percent, versus operating income for the first quarter of 2022. Gross profit decreased$29.2 million , or 36 percent, and operating expenses decreased$2.5 million , or nine percent. Comparisons of gross profit by region and total segment operating expenses and operating income follow: For the Three Months Ended (Dollars in thousands) March 31, Percent Gross Profit and Operating Income 2023 2022 (Decrease) Change North America$ 35,213 $ 53,168 $ (17,955 ) -34 Europe 10,220 13,159 (2,939 ) -22 Latin America 7,172 13,139 (5,967 ) -45 Asia 283 2,641 (2,358 ) -89 Surfactants Segment Gross Profit$ 52,888 $ 82,107 $ (29,219 ) -36 Operating Expenses 25,832 28,338 (2,506 ) -9
Surfactants Segment Operating Income
Gross profit for North American operations decreased$18.0 million , or 34 percent, versus the prior year primarily due to an 18 percent decline in sales volume and lower average unit margins. These items negatively impacted the year-over-year change in gross profit by$9.3 million and$8.6 million , respectively. Gross profit was negatively impacted by higher costs due to inflation, higher pre-commissioning expenses related to the new alkoxylation production facility inPasadena, Texas and startup expenses related to the Company's new low 1,4 dioxane capacity inthe United States . Foreign currency translation negatively impacted the change in gross profit by$0.1 million . Gross profit for European operations decreased$2.9 million , or 22 percent, due to lower average unit margins, an eight percent decrease in sales volume and the unfavorable impact of foreign currency translation. These items negatively impacted the year-over-year change in gross profit by$1.2 million ,$1.1 million and$0.6 million , respectively. The lower average unit margins were mostly due to less favorable product and customer mix along with higher costs due to inflation. Gross profit for Latin American operations decreased$6.0 million , or 45 percent, primarily due to lower average unit margins. The lower average unit margins negatively impacted the change in gross profit by$5.3 million and primarily reflect a less favorable product and customer mix, mostly due to lower demand for products sold into the agricultural end market, and higher costs due to inflation. A five percent decline in sales volume negatively impacted the year-over-year change in gross profit by$0.7 million . Gross profit forAsia operations decreased$2.4 million , or 89 percent, primarily due to lower average unit margins. The lower average unit margins negatively impacted the change in gross profit by$1.9 million and were mostly attributable to higher unit overhead costs due to the timing of production runs. A 17 percent decline in sales volume negatively impacted the change in gross profit by$0.4 million . The unfavorable impact of foreign currency translation negatively impacted the change in gross profit by$0.1 million . Operating expenses for the Surfactant segment decreased$2.5 million , or nine percent, in the first quarter of 2023 versus the first quarter of 2022. This decrease was mainly attributable to lower incentive-based compensation expenses.
Polymers
Polymer net sales for the first quarter of 2023 decreased$26.0 million , or 14 percent, versus net sales for the same period of 2022. An 18 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by$34.1 and$6.3 million , respectively. Higher average selling prices positively impacted the change in net sales by$14.4 million . The higher average selling prices were mainly due to the pass through of higher raw material and input costs along with margin recovery. A comparison of net sales by region follows: For the Three Months Ended (Dollars in thousands) March 31, Percent Net Sales 2023 2022 (Decrease) Change North America$ 81,169 $ 94,856 $ (13,687 ) -14 Europe 69,057 80,783 (11,726 ) -15 Asia and Other 10,901 11,440 (539 ) -5 Total Polymers Segment$ 161,127 $ 187,079
Net sales for North American operations decreased$13.7 million , or 14 percent, primarily due to a 25 percent decrease in sales volume. The decline in sales volume negatively impacted the change in net sales by$23.5 million . Sales volume of polyols used in 23 -------------------------------------------------------------------------------- rigid foam applications decreased 30 percent year-over-year. Sales volume within the phthalic anhydride and specialty polyols businesses decreased 13 percent and 12 percent, respectively. The year-over-year decline in sales volume reflects customer inventory destocking and lower construction-related activity. Higher average selling prices positively impacted the change in net sales by$9.8 million . The higher average selling prices were mainly due to the pass-through of higher raw material and input costs. Net sales for European operations decreased$11.7 million , or 15 percent, year-over-year. A 17 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by$13.3 million and$5.5 million , respectively. The decline in sales volume reflects customer inventory destocking, lower construction-related activity and customer share loss. A strongerU.S. dollar relative to the Polish zloty and British pound sterling led to the unfavorable foreign currency translation effect. Higher average selling prices positively impacted the change in net sales by$7.1 million . The higher average selling prices were primarily due to the pass-through of higher raw material costs and margin recovery. Net sales forAsia and Other operations decreased$0.5 million , or five percent, primarily due to a decline in average selling prices and the unfavorable impact of foreign currency translation. These items negatively impacted the year-over-year change in net sales by$1.5 million and$0.8 million , respectively. Sales volume increased 16 percent and positively impacted the change in net sales by$1.8 million . The higher sales volume reflects the loosening of COVID lockdowns and restrictions inChina . Polymer operating income in the first quarter of 2023 decreased$4.1 million , or 29 percent, versus operating income in the first quarter of 2022. Gross profit decreased$5.0 million , or 22 percent and operating expenses decreased$0.9 million or 11 percent between years. Comparisons of gross profit by region and total segment operating expenses and operating income follow: For the Three Months Ended (Dollars in thousands) March 31, Percent Gross Profit and Operating Income 2023 2022 (Decrease) Change North America$ 6,144 $ 8,280 $ (2,136 ) -26 Europe 10,312 12,861 (2,549 ) -20 Asia and Other 867 1,171 (304 ) -26 Polymers Segment Gross Profit$ 17,323 $ 22,312 $ (4,989 ) -22 Operating Expenses 7,319 8,183 (864 ) -11
Polymers Segment Operating Income
Gross profit for North American operations decreased
Gross profit for European operations decreased$2.5 million , or 20 percent, versus the first quarter of 2022. The decrease was primarily due to a 17 percent decline in sales volume and the unfavorable impact of foreign currency translation. These items negatively impacted the year-over-year change in gross profit by$2.1 million and$0.8 million , respectively. Higher average unit margins positively impacted the change in gross profit by$0.4 million . Gross profit forAsia and Other operations decreased$0.3 million , or 26 percent, primarily to lower average unit margins and the unfavorable impact of foreign currency translation. These items negatively impacted the change in gross profit by$0.4 million and$0.1 million , respectively. Sales volume increased 16 percent and positively impacted the change in gross profit by$0.2 million .
Operating expenses for the Polymers segment declined
Specialty Products
Specialty Products net sales for the first quarter of 2023 increased$2.6 million , or 13 percent, versus net sales for the first quarter of 2022. This increase reflects higher average selling prices which more than offset a seven percent decline in sales volume. Gross profit and operating income decreased$1.5 million and$1.2 million , respectively, year-over-year. The year-over-year declines in gross profit and operating income were mostly attributable to lower sales volume and unit margins within the medium chain triglycerides (MCTs) product line. 24 --------------------------------------------------------------------------------
Corporate Expenses
Corporate expenses, which include deferred compensation, business restructuring and other operating expenses that are not allocated to the reportable segments, increased$10.3 million between quarters. Corporate expenses were$18.5 million in the first quarter of 2023 versus$8.2 million in the first quarter of 2022. This year-over-year increase was primarily attributable to$9.0 million of higher deferred compensation expenses. The$9.0 million increase in deferred compensation expense was primarily due to a$25.48 per share decrease in the market price of Company common stock in the first quarter of 2022 compared to a$3.43 per share decrease in the first quarter of 2023. A year-over-year increase in the market value of mutual fund investment assets held for the plans in the first quarter of 2023, versus a decrease in the first quarter of 2022, also contributed to the higher expense in the first quarter of 2023. The following table presents the quarter-end Company common stock market prices used in the computation of deferred compensation income/expense for the three months endedMarch 31, 2023 and 2022: 2023 2022 2021 March 31 December 31 March 31 December 31 Company Common Stock Price$ 103.03 $ 106.46 $ 98.81 $ 124.29
LIQUIDITY AND CAPITAL RESOURCES
Overview
For the three months endedMarch 31, 2023 , operating activities were a cash use of$72.1 million versus a cash use of$20.9 million for the comparable period in 2022. For the first three months of 2023, investing cash outflows totaled$90.3 million versus cash outflows of$57.1 million in the prior year period. Financing activities were a cash source of$113.5 million versus a cash source of$154.8 million in the prior year period. Cash and cash equivalents decreased$46.8 million compared toDecember 31, 2022 , inclusive of a$2.1 million favorable foreign exchange rate impact. OnMarch 31, 2023 , the Company's cash and cash equivalents totaled$127.0 million . Cash inU.S. demand deposit accounts and certificates of deposit totaled$8.2 million and cash inU.S. money market funds totaled$9.1 million . The Company's non-U.S. subsidiaries held$109.7 million of cash as ofMarch 31, 2023 .
Operating Activities
Net income during the first three months of 2023 decreased$28.7 million versus the comparable period in 2022. Working capital was a cash use of$109.9 million during the first three months of 2023 versus a use of$85.0 million in the comparable period in 2022. Accounts receivable were a cash use of$40.4 million during the first three months of 2023 compared to a cash use of$80.3 million for the comparable period of 2022. Inventories were a cash source of$38.3 million in 2023 versus a cash source of$0.5 million in 2022. Accounts payable and accrued liabilities were a cash use of$98.5 million in 2023 compared to a cash use of$1.2 million for the same period in 2022. Working capital requirements were higher in the first three months of 2023 compared to 2022 primarily due to the changes noted above. The lower accounts receivable cash usage reflects lower sales volume principally due to a slow down in customer demand across most end use markets and customer inventory and channel destocking. The higher cash source from inventories was due to lower quantities and prices in 2023. The higher accounts payable cash usage reflects lower quantities of raw materials purchased during the first quarter of 2023 and the payment of higher 2022 year-end accruals during the first quarter of 2023. It is management's opinion that the Company's liquidity is sufficient to provide for potential increases in working capital requirements during 2023.
Investing Activities
Cash used for investing activities increased$33.2 million year-over-year. Cash used for capital expenditures was$92.2 million in the first three months of 2023 versus$60.3 million in 2022. The higher capital spending in 2023 is largely attributable to the alkoxylation plant the Company is building at itsPasadena, Texas site. For 2023, the Company estimates that total capital expenditures will be in the range of$220.0 million to$240.0 million . This projected spending includes the new alkoxylation plant that is being built inPasadena, Texas , equipment upgrades to meet new regulatory limits in 1,4 Dioxane inthe United States , growth initiatives, infrastructure and optimization spending inthe United States andMexico . The equipment upgrades to meet the new regulatory limits in 1,4 Dioxane are expected to be completed by the end of the second quarter of 2023 and the new alkoxylation plant is expected to start up in the first half of 2024. 25 --------------------------------------------------------------------------------
Financing Activities
Cash flow from financing activities was a source of
The Company purchases shares of its common stock in the open market or from its benefit plans from time to time to fund its own benefit plans and to mitigate the dilutive effect of new shares issued under its compensation plans. The Company may, from time to time, seek to purchase additional amounts of its outstanding equity and/or retire debt securities through cash purchases and/or exchanges for other securities, in open market purchases, privately negotiated transactions or otherwise, including pursuant to plans meeting the requirements of Rule 10b5-1 promulgated by theSEC . Such repurchases or exchanges, if any, will depend on prevailing market conditions, the Company's liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. For the three months endedMarch 31, 2023 , the Company did not purchase any shares of its common stock on the open market. AtMarch 31, 2023 , the Company had$125.1 million remaining under the share repurchase program authorized by its Board of Directors.
Debt and Credit Facilities
Consolidated balance sheet debt increased from$587.1 million onDecember 31, 2022 to$711.0 million onMarch 31, 2023 , primarily due to higher domestic borrowings from the Company's revolving credit facility. Net debt (which is defined as total debt minus cash - see the "Reconciliation of Non-GAAP Net Debt" section of this MD&A) increased$170.7 million , from$413.3 million atDecember 31, 2022 to$584.0 million atMarch 31, 2023 . This change was due to a debt increase of$123.9 million and a cash decrease of$46.8 million . As ofMarch 31, 2023 , the ratio of net debt to net debt plus shareholders' equity was 32.9 percent versus 26.2 percent atDecember 31, 2022 (see the "Reconciliation of Non-GAAP Net Debt" section in this MD&A for further details). OnMarch 31, 2023 , the Company's debt included$397.8 million of unsecured notes, with maturities ranging from 2023 through 2032, that were issued to insurance companies in private placement transactions pursuant to note purchase agreements, a$98.1 million delayed draw term loan borrowed pursuant to the Company's credit agreement,$209.0 million of short term loans borrowed under its revolving credit facility and$6.1 million of foreign credit line borrowings. The proceeds from the note issuances have been the Company's primary source of long-term debt financing and are supplemented by borrowings under bank credit facilities to meet short and medium-term liquidity needs. The Company's credit agreement with a syndicate of banks provides for credit facilities in an initial aggregate principal amount of$450.0 million , consisting of (a) a$350.0 million multi-currency revolving credit facility and (b) a$100.0 million delayed draw term loan credit facility, each of which matures onJune 24, 2027 . The Company maintains import letters of credit, and standby letters of credit under its workers' compensation insurance agreements and for other purposes, as needed from time to time, which are issued under the revolving credit agreement. As ofMarch 31, 2023 , the Company had outstanding loans totaling$307.1 million , inclusive of a$98.1 million delayed draw term loan, and letters of credit totaling$11.5 million under the credit agreement, with$129.5 million remaining available. The Company anticipates that cash from operations, committed credit facilities and cash on hand will be sufficient to fund anticipated capital expenditures, working capital, dividends and other planned financial commitments for the foreseeable future. Certain foreign subsidiaries of the Company maintain short-term bank lines of credit in their respective local currencies to meet working capital requirements as well as to fund capital expenditures and acquisitions. AtMarch 31, 2023 , the Company's foreign subsidiaries had$6.1 million of outstanding debt. The Company is subject to covenants under its material debt agreements that require the maintenance of minimum interest coverage and minimum net worth. These agreements also limit the incurrence of additional debt as well as the payment of dividends and repurchase of shares. Under the most restrictive of these debt covenants:
1. The Company is required to maintain a minimum interest coverage ratio,
as defined within the agreements, of 3.50 to 1.00, for the preceding
four calendar quarters.
2. The Company is required to maintain a maximum net leverage ratio, as
defined within the agreements, not to exceed 3.50 to 1.00.
3. The Company is required to maintain net worth of at least
4. The Company is permitted to pay dividends and purchase treasury shares
after
of net income and cash proceeds of stock option exercises, measured
cumulatively beginning
that could have been paid within this limitation is disclosed as
unrestricted retained earnings in Note 14, Debt, of the notes to the
Company's condensed consolidated financial statements (included in Item
1 of this Form 10-Q).
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The Company believes it was in compliance with all of its debt covenants as of
ENVIRONMENTAL AND LEGAL MATTERS
The Company's operations are subject to extensive federal, state and local environmental laws and regulations and similar laws in the other countries in which the Company does business. Although the Company's environmental policies and practices are designed to ensure compliance with these laws and regulations, future developments and increasingly stringent environmental regulation may require the Company to make additional unforeseen environmental expenditures. The Company will continue to invest in the equipment and facilities necessary to comply with existing and future regulations. During the first three months of 2023 and 2022, the Company's expenditures for capital projects related to environmental matters were$1.5 million and$2.5 million , respectively. These projects are capitalized and depreciated over their estimated useful lives, which are typically 10 years. Recurring costs associated with the operation and maintenance of facilities for waste treatment and disposal and managing environmental compliance in ongoing operations at the Company's manufacturing locations were$8.9 million and$8.2 million for the three months endedMarch 31, 2023 and 2022, respectively. Over the years, the Company has received requests for information related to or has been named by the government as a potentially responsible party at a number of waste disposal sites where cleanup costs have been or may be incurred under CERCLA and similar state or foreign statutes. In addition, damages are being claimed against the Company in general liability actions for alleged personal injury or property damage in the case of some disposal and plant sites. The Company believes that it has made adequate provisions for the costs it is likely to incur with respect to these sites. It is the Company's accounting policy to record liabilities when environmental assessments and/or remedial efforts are probable, and the cost or range of possible costs can be reasonably estimated. When no amount within the range is a better estimate than any other amount, the minimum is accrued. Estimating the possible costs of remediation requires making assumptions related to the nature and extent of contamination and the methods and resulting costs of remediation. Some of the factors on which the Company bases its estimates include information provided by decisions rendered by State and Federal environmental regulatory agencies, information provided by feasibility studies, and remedial action plans developed. After partial remediation payments at certain sites, the Company has estimated a range of possible environmental and legal losses of$29.2 million to$52.9 million atMarch 31, 2023 and$32.6 million to$56.4 million atDecember 31, 2022 . Within the range of possible environmental losses, management has currently concluded that no single amount is more likely to occur than any other amounts in the range and, thus, has accrued at the lower end of the range; these accruals totaled$29.2 million atMarch 31, 2023 and$32.6 million atDecember 31, 2022 . Because the liabilities accrued are estimates, actual amounts could differ materially from the amounts reported. Cash expenditures related to environmental remediation and certain legal matters were$3.5 million for the three months endedMarch 31, 2023 , compared to$0.4 million for the same period in 2022. For certain sites, the Company has responded to information requests made by federal, state or local government agencies but has received no response confirming or denying the Company's stated positions. As such, estimates of the total costs, or range of possible costs, of remediation, if any, or the Company's share of such costs, if any, cannot be determined with respect to these sites. Consequently, the Company is unable to predict the effect thereof on the Company's financial position, cash flows and results of operations. Based on the Company's present knowledge with respect to its involvement at these sites, the possibility of other viable entities' responsibilities for cleanup, and the extended period over which any costs would be incurred, management believes that the Company has no material liability at these sites and that these matters, individually and in the aggregate, will not have a material effect on the Company's financial position. Certain of these matters are discussed in Item 1, Part 2, of the Company's Annual Report on Form 10-K, Legal Proceedings, in this report and in other filings of the Company with theSEC , which are available upon request from the Company. See also Note 8, Contingencies, in the notes to the Company's condensed consolidated financial statements (included in Item 1 of this Form 10-Q) for a summary of the significant environmental proceedings related to certain environmental sites.
OUTLOOK
Management believes the Company's second quarter 2023 sales volume will remain depressed versus the prior year as markets continue to reconcile future demand with current inventory levels. Management expects year-over-year volume growth during the second half of the year driven by modest recovery in demand for Rigid polyols, growth in Surfactant sales volume associated with new contracted business and a low comparable base. The Company remains committed to advancing its strategic and innovation initiatives that are instrumental to long-term growth and will continue to actively control costs and execute its productivity programs. CRITICAL ACCOUNTING POLICIES
There have been no material changes to the critical accounting policies disclosed in the Company's 2022 Annual Report on Form 10-K.
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--------------------------------------------------------------------------------NON-GAAP RECONCILIATIONS
The Company believes that certain non-GAAP measures, when presented in conjunction with comparable GAAP measures, are useful for evaluating the Company's performance and financial condition. Internally, the Company uses this non-GAAP information as an indicator of business performance and evaluates management's effectiveness with specific reference to these indicators. These measures should be considered in addition to, not as substitutes for or superior to, measures of financial performance prepared in accordance with GAAP. The Company's definitions of these measures may differ from similarly titled measures used by other entities.
Reconciliation of Non-GAAP Adjusted Net Income and Earnings Per Share
Management uses the non-GAAP adjusted net income metric to evaluate the
Company's operating performance. Management excludes the items listed in the
table below because they are non-operational items. The cumulative tax effect
was calculated using the statutory tax rates for the jurisdictions in which the
noted transactions occurred.
Three Months Ended
(In millions, except per share amounts) March 31, 2023
Net Income Diluted EPS Net Income Diluted EPS
Net Income Attributable to the Company
as Reported $ 16.1 $ 0.70 Deferred Compensation (Income) Expense (including related investment activity) (0.1 ) - (5.2 ) (0.22 ) Business Restructuring 0.1 - - - Cash Settled Stock Appreciation Rights - - (0.5 ) (0.02 ) Remediation Expenses 0.4 0.01 0.3 0.01 Cumulative Tax Effect on Above Adjustment Items (0.1 ) - 1.3 0.06 Adjusted Net Income$ 16.4 $ 0.71 $ 40.7 $ 1.76
Reconciliation of Non-GAAP Net Debt
Management uses the non-GAAP net debt metric to gain a more complete picture of the Company's overall liquidity, financial flexibility and leverage level.
March 31 , December
31,
(In millions) 2023 2022 Current Maturities of Long-Term Debt as Reported$ 257.3 $ 132.1 Long-Term Debt as Reported 453.7 455.0 Total Debt as Reported 711.0 587.1 Less Cash and Cash Equivalents as Reported (127.0 ) (173.8 ) Net Debt$ 584.0 $ 413.3 Equity$ 1,189.9 $ 1,166.1 Net Debt plus Equity$ 1,773.9 $ 1,579.4 Net Debt/Net Debt plus Equity 33 % 26 % 28
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