STEPAN CO (SCL) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 annual periods included in the accompanying consolidated financial statements.

Presentation of Information

The discussion that follows includes a comparison of the Company’s results of operations and liquidity and capital resources for the fiscal years ended December 31, 2021 and 2022. For a discussion of changes from the fiscal year ended December 31, 2020 to the fiscal year ended December 31, 2021, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021 (filed February 25, 2022).

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 68 percent of the Company’s consolidated net sales in 2022, 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 in the United States, two European sites (United Kingdom and France), five Latin American sites (one site in Colombia and two sites in each of Brazil and Mexico) and two Asian sites (Philippines and Singapore). Recent significant events include:

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On September 23, 2022, the Company completed the purchase of PerformanX Specialty Chemicals, LLC’s surfactant business and associated assets. Included in the transaction were intellectual property, customer relationships, inventory and working capital. This acquisition enhanced the Company’s specialty alkoxylates portfolio and provides market diversification opportunities. This acquisition is also expected to deliver additional baseload volumes for the Company’s Pasadena, Texas alkoxylation facility that is scheduled to start up in the first half of 2024. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.

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In February 2021, the Company completed the purchase of a fermentation plant, located in Lake Providence, Louisiana. The Company believes this plant complements the rhamnolipid-based bio-surfactant technology the Company acquired from Logos Technologies in March 2020. Fermentation is a new platform technology for the Company and the Company is focusing efforts to further develop, integrate, produce and commercialize these unique surfactants moving forward. Bio-surfactants, produced via fermentation, are attractive due to their biodegradability, low toxicity, and in some cases, unique antimicrobial properties. These bio-surfactants offer synergies in several strategic end use markets including oilfield, agriculture, personal care and household, industrial and institutional cleaning. The acquisition of this industrial scale fermentation plant is a step in the Company’s bio-surfactant commercialization efforts. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.

Polymers - Polymers, which accounted for 28 percent of consolidated net sales in 2022, 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. In the United States, polyurethane polyols are manufactured at the Company’s Elwood, Illinois (Millsdale), and Wilmington, North Carolina sites. Phthalic anhydride is manufactured at the Company’s Elwood, Illinois (Millsdale) site and specialty polyols are manufactured at the Company’s Columbus, Georgia, site. In Europe, polyurethane polyols are manufactured at the Company’s subsidiaries in Germany and Vlissingen, Netherlands and specialty polyols are manufactured by the Company’s Poland subsidiary. In China, polyurethane polyols and specialty polyols are manufactured at the Company’s Nanjing, China, plant. Recent significant events include:

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In January 2021, the Company completed the purchase of INVISTA’s aromatic polyester polyol business and associated assets. Included in the transaction were two manufacturing sites, one in Wilmington, North Carolina and the other in Vlissingen, Netherlands along with intellectual property, customer relationships, inventory and working capital. This acquisition expanded the Company’s manufacturing capabilities in both the United States and Europe and enhanced the Company’s business continuity capabilities for the polymer market. The Company believes that the available spare capacity, combined with

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debottlenecking opportunities in both plants, allows Stepan to support future market growth in a capital efficient way. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.

Specialty Products – Specialty products, which accounted for four percent of consolidated net sales in 2022, include flavors, emulsifiers and solubilizers used in food, flavoring, nutritional supplement and pharmaceutical applications. Specialty products are primarily manufactured at the Company’s Maywood, New Jersey, site and, in some instances, by third-party contractors.

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 deferred compensation obligations) and the income statement line items in which the effects of the activities were recorded are displayed in the following tables:

(1)
See the Segment Results – Corporate Expenses sections of this MD&A for details regarding the period-over-period changes in deferred compensation.

Below are the year-end Company common stock market prices used in the computation of deferred compensation income and expense:

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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 into U.S. dollars at average foreign exchange rates appropriate for the reporting period. Because foreign exchange rates fluctuate against the U.S. dollar over time, foreign currency translation affects year-over-year comparisons of financial statement items (i.e., because foreign exchange rates fluctuate, similar year-over-year local currency results for a foreign subsidiary may translate into different U.S. dollar results). The following tables present the effects that foreign currency translation had on the year-over-year changes in consolidated net sales and various income statement line items for 2022 compared to 2021 and 2021 compared to 2020:

Results of Operations

2022 Compared with 2021

Summary

Net income attributable to the Company in 2022 increased seven percent to $147.2 million, or $6.38 per diluted share, from $137.8 million, or $5.92 per diluted share in 2021. Adjusted net income increased seven percent to $153.5 million, or $6.65 per diluted share, from $143.5 million, or $6.16 per diluted share in 2021 (see the “Reconciliation of Non-GAAP Adjusted Net Income and Diluted Earnings per Share” section of this MD&A for a reconciliation of reported net income attributable to the Company and reported earnings per diluted share to non-GAAP adjusted net income and adjusted earnings per diluted share). Below is a summary discussion of the major factors leading to the year-over-year changes in net sales, expenses and income in 2022 compared to 2021. A detailed discussion of segment operating performance for 2022, compared to 2021, follows the summary.

Consolidated net sales increased $427.3 million, or 18 percent, between years. Higher average selling prices positively impacted the year-over-year change in net sales by $676.2 million. The increase in average selling prices was mainly attributable to the pass through of higher raw material, logistics and input costs as well as more favorable product and customer mix. Consolidated sales volume decreased seven percent and negatively impacted the year-over-year change in net sales by $153.5 million. Sales volume in the Surfactant, Polymer and Specialty Products segments decreased six, seven and four percent, respectively. Foreign currency translation negatively impacted the year-over-year change in net sales by $95.4 million due to a stronger U.S. dollar against the majority of currencies where the Company has foreign operations.

Operating income in 2022 increased $36.5 million, or 21 percent, versus operating income in 2021. Polymer and Specialty Products operating income increased $9.3 million and $15.7 million, respectively, year-over-year. Surfactant operating income decreased $3.3 million year-over-year. Corporate expenses, including deferred compensation and business restructuring/asset disposition expenses, decreased $14.8 million year-over-year. Most of this decrease was attributable to a $16.3 million decrease in deferred compensation expenses, a $3.0 million decrease in business restructuring/asset disposition expenses and lower acquisition-related and consulting expenses. These lower expenses were partially offset by $9.5 million of higher environmental remediation reserve expenses and higher incentive-based compensation expenses. The higher environmental reserve expenses primarily reflect revised remediation cost estimates for the Company’s Maywood, New Jersey site due to U.S. Environmental Protection Agency (USEPA) work plan approvals and the receipt of third-party contractor bids during the third quarter of 2022. Foreign currency translation had a $7.2 million negative impact on operating income in 2022 versus the prior year.

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Operating expenses (including deferred compensation, business restructuring/asset disposition expenses and goodwill impairment) decreased $5.3 million, or two percent, year-over-year. 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 $0.2 million between years.

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Administrative expenses increased $9.3 million, or 10 percent, year-over-year primarily due to higher environmental remediation reserve ($9.5 million) and incentive-based compensation expenses, partially offset by lower acquisition-related and consulting expenses.

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Research, development and technical service (R&D) expenses increased $3.9 million, or six percent, year-over-year primarily due to higher salaries and incentive-based compensation expenses.

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Deferred compensation expense decreased $16.3 million, year-over-year, primarily due to a $17.83 per share decrease in the market price of Company common stock during 2022 versus a $4.97 per share increase in the market price of Company common stock during 2021. A decrease in the value of mutual fund investment options selected by some plan participants also contributed to the lower expense year-over-year. See the Overview and Segment Results - Corporate Expenses sections of this MD&A for further details.

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Business restructuring/asset disposition expenses were $0.3 million in 2022 versus $3.4 million in 2021. The 2022 expenses consist of $0.3 million of decommissioning costs associated with the Company’s Canadian plant closure. The 2021 expenses include a $2.7 million loss on the sale of the Company's corporate headquarters building and $0.7 million of decommissioning costs associated with the Company’s Canadian plant closure. See Note 22, Business Restructuring, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.

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Goodwill impairment expenses were $1.0 million in 2022 versus no impairment expense recognition in the prior year. See Note 4, Goodwill and Other Intangible Assets, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.

Net interest expense in 2022 increased $4.1 million, or 71%, versus the prior year. This increase was primarily attributable to higher outstanding debt balances in 2022 versus 2021.

Other, net was $8.8 million of expense in 2022 versus $7.5 million of income in 2021. The Company recognized $6.4 million of investment losses (including realized and unrealized gains and losses) for the Company’s deferred compensation and supplemental defined contribution mutual fund assets in 2022 compared to $5.2 million of income in 2021. The Company also recognized $2.9 million of foreign exchange losses in 2022 versus $0.5 million of foreign exchange gains in 2021. In addition, the Company recognized $0.5 million of income related to net periodic pension and other retirement obligations in 2022 versus $0.9 million of income in 2021. The Company also recognized $1.0 million of income related to the dissolution of its China joint venture in 2021.

The Company’s effective tax rate was 22.0 percent in 2022 compared to 20.1 percent in 2021. The increase was primarily attributable to a non-recurring favorable tax benefit recognized in 2021, related to the anticipated utilization of a foreign tax credit attribute, for years prior to 2021. See Note 9, Income Taxes, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for a reconciliation of the statutory U.S. federal income tax rate to the effective tax rate.

Segment Results

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Surfactants

Surfactant 2022 net sales increased $320.0 million, or 20 percent, versus 2021 net sales. Higher average selling prices positively impacted the change in net sales by $469.5 million. The higher average selling prices were primarily due to the pass-through of higher raw material, logistics and input costs along with improved product and customer mix. Sales volume declined six percent and negatively impacted the change in net sales by $100.9 million. Foreign currency translation had a $48.6 million unfavorable impact on the year-over-year change in net sales. A year-over-year comparison of net sales by region follows:

Net sales for North American Surfactant operations increased $195.1 million, or 22 percent, between years. Higher average selling prices positively impacted the change in net sales by $244.6 million. The higher average selling prices were primarily due to the pass-through of higher raw material, logistics and input costs along with more favorable product and customer mix. Sales volume declined five percent and negatively impacted the year-over-year change in net sales by $47.8 million. Lower sales volume into the consumer products end markets, principally commodity laundry and personal care products, accounted for most of this decline and was largely due to raw material availability issues, customer inventory destocking efforts and previously anticipated lost volume at one customer that chose to invest in internal production as part of the transition to low 1,4 dioxane products. Partially offsetting the above was higher demand for products sold into the functional products end markets and higher demand from the Company’s Tier 2/3 customers. Foreign currency translation negatively impacted 2022 net sales by $1.7 million.

Net sales for European Surfactant operations increased $60.9 million, or 21 percent, year-over-year. Higher average selling prices positively impacted the change in net sales by $115.5 million. The higher average selling prices were primarily due to the pass-through of higher raw material costs and improved product and customer mix. Foreign currency translation and a four percent decline in sales volume negatively impacted the year-over-year change in net sales by $42.2 million and $12.4 million, respectively. A stronger U.S. dollar relative to the European euro and British pound sterling led to the unfavorable foreign currency translation effect. The lower sales volume was primarily due to lower demand for commodity laundry products sold within the consumer products business partially offset by higher demand for products sold into the functional products and institutional cleaning end markets.

Net sales for Latin American Surfactant operations increased $64.2 million, or 21 percent, between years primarily due to higher average selling prices that positively impacted the change in net sales by $84.6 million. The higher average selling prices were primarily due to the pass-through of higher raw material costs and improved product and customer mix. Sales volume declined seven percent and negatively impacted the change in net sales by $22.2 million. The decline in sales volume was primarily due to lower demand for commodity laundry products within the consumer products business partially offset by higher demand for products sold into the functional products and institutional cleaning end markets. Foreign currency translation positively impacted the change in net sales by $1.8 million.

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Net sales for Asian Surfactant operations decreased $0.3 million year-over-year. A 20 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by $14.0 million and $6.5 million, respectively. The decline in sales volume primarily reflects lower demand for commodity laundry products sold within the consumer products business, partially attributable to lost market share at one major customer, and lower demand from our distribution partners. A stronger U.S. dollar relative to the Philippine peso accounted for most of the unfavorable foreign currency translation effect. Higher average selling prices positively impacted the year-over-year change in net sales by $20.2 million and primarily reflected the pass-through of higher raw material costs.

Surfactant operating income for 2022 decreased $3.3 million, or two percent, versus operating income reported in 2021. Gross profit increased $3.8 million, or one percent, and operating expenses increased $7.1 million, or seven percent. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

Gross profit for North American Surfactant operations increased $5.4 million, or three percent, year-over-year. Higher average unit margins positively impacted the year-over-year change in gross profit by $14.4 million. The higher average unit margins were mostly attributable to more favorable product and customer mix that was partially offset by higher raw material, manufacturing and transportation costs, which were not fully recovered in the market, and higher expenses associated with the Company’s transition to low 1,4 dioxane capabilities. A five percent decline in sales volume negatively impacted the change in gross profit by $8.9 million. Foreign currency translation negatively impacted the change in gross profit by $0.1 million.

Gross profit for European Surfactant operations increased $3.1 million, or eight percent, year-over-year. Higher average unit margins positively impacted the year-over-year change in gross profit by $9.4 million. The higher average unit margins primarily reflect a more favorable product and customer mix. The unfavorable impact of foreign currency translation and a four percent decline in sales volume negatively impacted the year-over-year change in gross profit by $4.7 million and $1.6 million, respectively. A stronger U.S. dollar relative to the European euro and British pound sterling led to the unfavorable foreign currency translation effect.

Gross profit for Latin American Surfactant operations decreased $1.3 million, or two percent, primarily due to a seven percent decline in sales volume that negatively impacted the year-over-year change in gross profit by $4.1 million. Higher average unit margins and the favorable impact of foreign currency translation positively impacted the year-over-year change in gross profit by $2.4 million and $0.4 million, respectively. The higher unit margins primarily reflect a more favorable customer and product mix.

Gross profit for Asian Surfactant operations decreased $3.4 million, or 30 percent, year-over-year. A 20 percent decline in sales volume and lower unit margins negatively impacted the change in gross profit by $2.2 million and $1.4 million, respectively. Foreign currency translation positively impacted the change in gross profit by $0.2 million.

Operating expenses for the Surfactant segment increased $7.1 million, or seven percent, year-over-year. Most of this increase was attributable to higher incentive-based compensation and travel-related expenses, a goodwill impairment charge at the Company’s Philippines subsidiary and higher bad debt provision expense.

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Polymers

Polymer 2022 net sales increased $75.6 million, or 11 percent, versus net sales in 2021. Higher average selling prices favorably impacted the year-over-year change in net sales by $169.6 million. The higher average selling prices were mainly due to the pass through of higher raw material, logistics and input costs along with margin recovery. A seven percent decrease in sales volume and the unfavorable impact of foreign currency translation negatively impacted the year-over-year change in net sales by $49.2 million and $44.8 million, respectively. A year-over-year comparison of net sales by region follows:

Net sales for North American Polymer operations increased $72.9 million, or 20 percent, primarily due to higher average selling prices that positively impacted the change in net sales by $99.1 million. The higher average selling prices were mainly due to the pass-through of higher raw material, logistics and input costs along with margin recovery. Sales volume declined seven percent and negatively impacted the change in net sales by $26.2 million. Sales volume of polyols used in rigid foam applications decreased three percent year-over-year. Sales volume within the phthalic anhydride and specialty polyols businesses decreased 19 percent and 15 percent, respectively. The year-over-year decline in sales volume reflects customer inventory destocking, lower construction-related activities and general economic concerns. In addition, sales volume in 2022 was impacted by a January 2022 power outage at the Company’s Elwood, Illinois (Millsdale) plant site that negatively impacted Polymer production. The production disruption resulted in the declaration of force majeure for select products. Production resumed in February 2022 and the force majeure was lifted in April 2022. The Company was able to mitigate a portion of this production disruption by supplying customers from its Wilmington, North Carolina site, which was acquired a part of the acquisition of INVISTA's aromatic polyester polyol business in 2021.

Net sales for European Polymer operations increased $5.3 million, or two percent, year-over-year. Higher average selling prices favorably impacted the change in net sales by $67.4 million. The higher average selling prices were mainly due to the pass-through of higher raw material costs. The unfavorable impact of foreign currency translation and a six percent decline in sales volume negatively impacted the change in net sales by $43.2 million and $18.9 million, respectively. A stronger U.S dollar relative to the Polish zloty and British pound sterling led to the unfavorable foreign currency translation impact. The decline in sales volume reflects lower construction-related activities, customer inventory destocking and the effects of general economic concerns.

Net sales for Asian and Other Polymer operations decreased $2.6 million, or six percent, primarily due to an eight percent decline in sales volume and the unfavorable impact of foreign currency translation. These two factors negatively impacted the year-over-year change in net sales by $3.9 million and $1.6 million, respectively. The decline in sales volume was primarily attributable to suppressed demand resulting from COVID lockdowns and restrictions in China. Higher average selling prices positively impacted the year-over-year change in net sales by $2.9 million.

Polymer operating income for 2022 increased $9.3 million, or 13 percent, versus operating income for 2021. Gross profit increased $9.7 million, or nine percent, and operating expenses were up $0.4 million, or one percent, year-over-year. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

Gross profit for North American Polymer operations increased $10.2 million, or 19 percent, primarily due to higher average unit margins. The higher average unit margins favorably impacted the year-over-year change in gross profit by $14.0 million. The higher

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average unit margins primarily reflect year-over-year margin recovery. Sales volume declined seven percent and negatively impacted the year-over-year change in gross profit by $3.8 million.

Gross profit for European Polymer operations increased $0.4 million, or one percent, primarily due to higher average unit margins that favorably impacted the change in gross profit by $9.4 million. The higher average unit margins primarily reflect year-over-year margin recovery. The unfavorable impact of foreign currency translation and a six percent decline in sales volume negatively impacted the change in gross profit by $6.1 million and $2.9 million, respectively.

Gross profit for Asia and Other Polymer operations declined $0.8 million, or 16 percent, due to an eight percent decline in sales volume, lower average unit margins and the negative impact of the foreign currency translation. These items negatively impacted the year-over-year change in gross profit by $0.4 million, $0.2 million and $0.2 million, respectively.

Operating expenses for the Polymers segment increased $0.4 million, or one percent, year-over-year mainly due to higher incentive-based compensation and travel-related expenses.

Specialty Products

Specialty Products net sales in 2022 increased $31.7 million, or 45 percent versus net sales in 2021. This increase reflects higher average selling prices that were partially offset by a four percent decline in sales volume. Gross profit and operating income increased $15.1 million and $15.7 million, respectively. The year-over-year improvements in gross profit and operating income were mostly attributable to improved margins and customer mix within the medium chain triglycerides (MCTs) product line.

Corporate Expenses

Corporate expenses, which include deferred compensation, business restructuring/asset disposition and other operating expenses that are not allocated to the reportable segments, decreased $14.8 million between years. Corporate expenses were $68.2 million in 2022 versus $83.0 million in the prior year. This decrease was primarily attributable to $9.4 million of deferred compensation income recognized in 2022 versus $6.9 million of deferred compensation expense recognized in 2021. Also contributing to the reduction in corporate expenses were lower year-over-year acquisition-related expenses, consulting expenses and the non-recurrence of a $2.7 million loss incurred on the sale of a corporate headquarter building in 2021. Partially offsetting the decreases above were higher year-over-year environmental remediation reserve ($10.2 million) and incentive-based compensation expenses. The higher environmental reserve expenses were primarily due to revised remediation cost estimates associated with the Company’s Maywood, New Jersey site.

Deferred compensation expense decreased $16.3 million between years. This decrease was primarily due to a $17.83 per share decrease in the market price of the Company’s common stock during 2022 compared to a $4.97 per share increase during 2021. A decrease in the value of mutual fund investment options selected by some plan participants also contributed to the lower expense year-over-year. The following table presents the period-end Company common stock prices used in the computation of deferred compensation income/expense in 2022 and 2021:

Liquidity and Capital Resources

Overview

Historically, the Company’s principal sources of liquidity have included cash flows from operating activities, available cash and cash equivalents and the proceeds from debt issuance and borrowings under credit facilities. The Company’s principal uses of cash have included funding operating activities, capital investments and acquisitions. The Company’s generation of cash from operations, cash on hand, committed credit facilities and ability to access capital markets are expected to meet the Company’s short-term and long-term cash requirements for working capital, capital expenditures, debt maturities, contributions to pension plans, dividend distributions to stockholders, share repurchases and other needs.

For 2022, cash generated from operating activities was a cash source of $160.8 million versus a source of $72.1 million in 2021. For 2022, investing cash outflows were $308.1 million versus cash outflows of $376.8 million in 2021. Financing activities were a cash source of $166.2 million in 2022 versus a source of $117.3 million in 2021. Cash and cash equivalents increased by $14.6 million compared to December 31, 2021, inclusive of $4.3 million of unfavorable foreign exchange rate impacts.

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As of December 31, 2022, the Company’s cash and cash equivalents totaled $173.8 million. Cash in U.S. demand deposit accounts and money market funds totaled $11.8 million and $64.9 million, respectively. The Company’s non-U.S. subsidiaries held $97.1 million of cash outside the United States as of December 31, 2022.

Operating Activities

Net income in 2022 increased by $9.3 million versus the comparable period in 2021. Working capital was a cash use of $75.7 million in 2022 versus a cash use of $140.5 million in 2021.

Accounts receivable were a cash use of $26.2 million in 2022 compared to a use of $104.2 million in 2021. Inventories were a cash use of $99.4 million in 2022 versus a use of $79.3 million in 2021. Accounts payable and accrued liabilities were a cash source of $54.2 million in 2022 compared to a source of $44.4 million in 2021.

Working capital in 2022 was a lower use of cash versus the prior year primarily due to the changes noted in the preceding paragraph. The major driver of the year-over-year decrease was accounts receivable. The lower accounts receivable cash usage reflects lower sales volume, particularly in the second half of the year, due to a slow down in customer demand across most end use markets and customer inventory destocking. 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 decreased $68.7 million year-over-year. This decrease primarily reflects the Company’s 2021 acquisition of INVISTA’s aromatic polyester polyol business and associated assets for $183.7 million, net of cash received. Cash used for capital expenditures was $301.6 million in 2022 versus $194.5 million in 2021. The higher capital spending in 2022 was largely attributable to the alkoxylation plant the Company is building at its Pasadena, Texas site and equipment upgrades to meet new regulatory limits on 1,4 Dioxane in the United States.

For 2023, the Company estimates that total capital expenditures will range from $240.0 million to $270.0 million. This projected spending includes the new alkoxylation plant that is being built in Pasadena, Texas, equipment upgrades to meet new regulatory limits on 1,4 Dioxane in the United States, growth initiatives, infrastructure, and optimization spending in the United States and Mexico.

Financing Activities

Cash flow from financing activities was a source of $166.2 million in 2022 versus a source of $117.3 million in 2021. The year-over-year change is primarily due to a higher level of borrowings under the Company’s revolving credit facility and a $98.8 million delayed draw term loan borrowing during 2022, partially offset by lower cash proceeds received from the issuance of senior unsecured notes in 2022 versus 2021.

The Company purchases shares of its common stock in the open market or from its U.S. pension plan 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 the SEC. 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. During the twelve months ended December 31, 2022, the Company purchased 251,120 shares of its common stock on the open market at a total cost of $24.9 million. At December 31, 2022, 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 $363.6 million on December 31, 2021 to $587.1 million on December 31, 2022, primarily due to higher domestic debt, which includes borrowings from the Company’s revolving credit agreement and new senior unsecured notes issued during the first quarter of 2022. Net debt (which is defined as total debt minus cash – See the “Reconciliation of Non-GAAP Net Debt” section of this MD&A) increased by $209.0 million in 2022, from $204.4 million on December 31, 2021 to $413.4 million on December 31, 2022. This change was due to a debt increase of $223.6 million partially offset by a cash increase of $14.6 million. The cash increase primarily reflects the new debt borrowings and cash from operations, largely offset by scheduled debt repayments, capital expenditures, dividends, share repurchases and the previously announced third quarter 2022 acquisition of the PerformanX Specialty Chemicals surfactant business.

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As of December 31, 2022, the ratio of total debt to total debt plus shareholders’ equity was 33.5 percent compared to 25.3 percent at December 31, 2021. As of December 31, 2022, the ratio of net debt to net debt plus shareholders’ equity was 26.2 percent versus 16.0 percent as of December 31, 2021. On December 31, 2022, the Company’s debt included $397.9 million of senior 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 $98.8 million delayed-draw term loan borrowed pursuant to the Company’s credit agreement, $90.5 million of short-term loans borrowed under the Company’s revolving credit facility and no foreign credit line borrowings. The proceeds from the senior unsecured note issuances have been the Company’s primary source of long-term debt financing and are supplemented by borrowings under revolving and other bank credit facilities to meet short and medium-term liquidity needs.

On March 1, 2022, pursuant to a note purchase and master note agreement dated as of June 10, 2021 (the NYL note purchase agreement), the Company issued and sold $25.0 million in aggregate principal amount of its 2.83% Senior Notes, Series 2022-A, due March 1, 2032 (the Series 2022-A Notes). In addition, on March 1, 2022, pursuant to a note purchase and private shelf agreement dated as of June 10, 2021 (the Prudential note purchase agreement), the Company issued and sold $50.0 million in aggregate principal amount of its 2.83% Senior Notes, Series 2022-B, due March 1, 2032 (the Series 2022-B Notes). The Series 2022-A Notes and the Series 2022-B Notes bear interest at a fixed rate of 2.83%, with interest to be paid semi-annually and with equal annual principal payments beginning on March 1, 2026 and continuing through final maturity on March 1, 2032. The proceeds of the issuance of the Series 2022-A Notes and the Series 2022-B Notes are being used primarily for capital expenditures, to pay down existing debt and for working capital and other general corporate purposes. The NYL note purchase agreement and the Prudential note purchase agreement require the maintenance of certain financial ratios and covenants that are substantially similar to the Company’s existing long-term debt and provide for customary events of default.

On June 24, 2022, the Company entered into a credit agreement with a syndicate of banks. The credit agreement 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 on June 24, 2027. This credit agreement replaced the Company’s prior $350.0 million revolving credit agreement. This credit agreement allows the Company to make unsecured borrowings, as requested from time to time, to finance working capital needs, permitted acquisitions, capital expenditures and for general corporate purposes. This unsecured facility is the Company’s primary source of short-term borrowings. As of December 31, 2022, the Company had outstanding letters of credit totaling $10.9 million and $189.2 million of outstanding borrowings under the credit agreement, inclusive of a $98.8 million delayed-draw term loan, with $249.8 million remaining available.

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. At December 31, 2022, the Company’s foreign subsidiaries had no 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. As of December 31, 2022, testing for these agreements was based on the Company’s consolidated financial statements. Under the most restrictive of these debt covenants:

The Company believes it was in compliance with the covenants under its material debt agreements as of December 31, 2022.

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Material Cash Requirements

At December 31, 2022, the Company’s material cash requirements included the following contractual obligations (including estimated payments by period):

(1)
Excludes unamortized debt issuance costs of $0.7 million.

(2)
Interest payments on debt obligations represent interest on all Company debt at December 31, 2022. Future interest rates may change, and, therefore, actual interest payments could differ from those disclosed in the above table.

(3)
The majority of operating lease obligations consist of railcar and real estate leases.

(4)
Purchase obligations consist of raw material, utility and telecommunication service purchases made in the normal course of business.

(5)
The “Other” category comprises deferred revenues that represent commitments to deliver products, expected 2023 required contributions to the Company’s funded defined benefit pension plans, estimated payments related to the Company’s unfunded defined benefit supplemental executive and outside director pension plans, estimated payments (undiscounted) related to the Company’s asset retirement obligations, environmental remediation payments for which amounts and periods can be reasonably estimated and income tax liabilities for which payments and periods can be reasonably estimated.

The above table does not include $43.2 million of other non-current liabilities recorded on the balance sheet at December 31, 2022, as summarized in Note 15, Other Non-Current Liabilities, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K). The significant non-current liabilities excluded from the table are defined benefit pension, deferred compensation, environmental and legal liabilities and unrecognized tax benefits for which payment periods cannot be reasonably determined. In addition, deferred income tax liabilities are excluded from the table due to the uncertainty of their timing.

During the periods covered by this Form 10-K, the Company was not party to any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, cash requirements or capital resources.

Pension Plans

The Company sponsors a number of defined benefit pension plans, the most significant of which cover employees in the Company’s U.S. and U.K. locations. The U.S. and U.K. plans are frozen, and service benefit accruals are no longer being made. The overfunded status (pretax) of the Company’s U.S and U.K. defined benefit pension plans was $8.2 million at December 31, 2022, versus overfunded status (pretax) of $7.9 million at December 31, 2021. See Note 13, Postretirement Benefit Plans, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.

The Company contributed $0.8 million to its U.S. and U.K. defined benefit plans in 2022. In 2023, the Company expects to contribute a total of $0.5 million to the U.K. defined benefit plan. As a result of pension funding relief included in the Highway and Transportation Funding Act of 2014, the Company has no 2023 contribution requirement to the U.S. qualified defined benefit plans. The company expects to contribute $0.3 million in 2023 to the unfunded non-qualified U.S. pension plans.

Letters of Credit

The Company maintains standby letters of credit under its workers’ compensation insurance agreements and for other purposes as needed. The insurance letters of credit are renewed annually and amended to the amounts required by the insurance agreements. As of December 31, 2022, the Company had a total of $10.9 million of outstanding standby letters of credit.

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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 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 2022, the Company’s expenditures for capital projects related to environmental matters were $11.8 million. Expenditures for capital projects related to environmental matters are capitalized and depreciated over their estimated useful lives, which are typically 10 years to 15 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 approximately $37.2 million for 2022, $34.9 million for 2021 and $35.4 million for 2020.

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. See the Critical Accounting Policies section that follows for a discussion of the Company’s environmental liabilities accounting policy. After partial remediation payments at certain sites, the Company has estimated a range of possible environmental and legal losses from $32.6 million to $56.4 million at December 31, 2022, compared to $23.1 million to $41.7 million at December 31, 2021. 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. The Company’s environmental and legal accruals totaled $32.6 million at December 31, 2022 as compared to $23.1 million at December 31, 2021. This increase primarily reflects revised environmental cost estimates for the Company’s Maywood, New Jersey site due to USEPA work plan approvals and the receipt of third party contractor bids during the third quarter of 2022. Remediation work has commenced at a portion of the Maywood site and the Company anticipates increased cash spending to occur in 2023. Because the liabilities accrued are estimates, actual amounts could differ materially from the amounts reported. During 2022, cash expenditures related to environmental remediation and certain other legal matters approximated $2.3 million compared to $3.5 million expensed in 2021.

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 and 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.

See Item 3. Legal Proceedings, in this Form 10-K and Note 16, Contingencies, in the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for a summary of the significant environmental proceedings related to certain environmental sites.

Outlook

Management believes the macro environment in 2023 will continue to be challenged by elevated inflation and high interest rates which could negatively impact consumer demand and construction-related activity, thereby impacting the Company’s Surfactant and Polymer segments. Additionally, management believes higher overall cost inflation, higher depreciation and pre-start up expenses associated with the Company’s new Pasadena facility, will challenge the Company’s ability to deliver earnings growth in 2023. The Company is seeking to partially offset these 2023 headwinds with productivity improvements, pricing increases where possible, and furthering its efforts to improve product and customer mix. The Company remains committed to executing its long-term growth strategy.

Climate Change Legislation

Based on currently available information, the Company does not believe that existing or pending climate change legislation or regulation is reasonably likely to have a material effect on the Company’s financial position, results of operations or cash flows.

Critical Accounting Policies

The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (generally accepted accounting principles or GAAP). Preparation of financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets,

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liabilities, income and expenses at the date of the financial statements and to provide disclosures of contingent assets, liabilities and related amounts of revenues and expenses during the reporting period. The following is a summary of the accounting policies the Company believes are the most important to aid in understanding its financial results:

Environmental Liabilities

It is the Company’s accounting policy to record environmental 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 a range of possible costs is a better estimate than any other amount, the minimum amount in the range 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.

Estimates for environmental liabilities are subject to potentially significant fluctuations as new facts emerge related to the various sites where the Company is exposed to liability for the remediation of environmental contamination. See the Environmental and Legal Matters section of this MD&A for discussion of the Company’s recorded liabilities and range of cost estimates.

Recent Accounting Pronouncements

See Note 1, Summary of Significant Accounting Policies, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for information on recent accounting pronouncements which affect the Company.

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 adjusted measures may differ from similarly titled measures used by other entities.

Reconciliations of Non-GAAP Adjusted Net Income and Dilutive 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 transactions occurred.

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Reconciliations of Non-GAAP Net Debt

Management uses the non-GAAP net debt metric to show a more complete picture of the Company’s overall liquidity, financial flexibility and leverage level.

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