Stepan Co: Form 10-Q for the period ended Sep 30, 2022

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 about Stepan 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 ended December 31, 2021, including the risks and uncertainties related to the following:

• the impact of the COVID-19 pandemic;
• accidents, unplanned production shutdowns or disruptions in any of the Company’s manufacturing facilities;
• reduced demand for Company products due to customer product reformulations or new technologies;
• the Company’s inability to successfully develop or introduce new products;
• compliance with environmental, health and safety, product registration and anti-corruption laws;
• the Company’s ability to make acquisitions of suitable candidates and successfully integrate acquisitions;
• global competition and the Company’s ability to successfully compete;
• volatility of raw material, natural gas and electricity costs as well as any disruption in their supply;
• disruptions in transportation or significant changes in transportation costs;
• downturns in certain industries and general economic downturns;
• international business risks, including fluctuations in currency exchange rates, legal restrictions and taxes;
• unfavorable resolution of litigation against the Company;
• the Company’s ability to keep and protect its intellectual property rights;
• potentially adverse tax consequences due to the international scope of the Company’s operations;
• downgrades to the Company’s credit ratings or disruptions to the Company’s ability to access well-functioning capital markets;
• conflicts, military actions, terrorist attacks and general instability, particularly in certain energy-producing nations, along with increased security regulations;
• cost overruns, delays and miscalculations in capacity needs with respect to the Company’s expansion or other capital projects;
• interruption of, damage to or compromise of the Company’s IT systems and failure to maintain the integrity of customer, colleague or Company data;
• the Company’s ability to retain its executive management and other key personnel;
• the Company’s ability to operate within the limitations of debt covenants; and
• the other factors set forth under “Risk Factors.”

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 Stepan Company and one or more of its subsidiaries only.

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 66 percent of consolidated net sales for the first nine months of 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 Mexico and Brazil) and two Asian sites (Philippines and Singapore). Recent significant events include:

• In February 2021, the Company acquired 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 represents the latest step in the Company’s bio-surfactant commercialization efforts. See Note 17, Acquisitions, of the notes to the Company’s condensed consolidated financial statements (included in Item 1 of this Form 10-Q) for additional details.
• On September 23, 2022, the Company purchased 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 investment that is scheduled to start up in early 2024. See Note 17, Acquisitions, of the notes to the Company’s condensed consolidated financial statements (included in Item 1 of this Form 10-Q) for additional details.

Polymers – Polymers, which accounted for 30 percent of consolidated net sales for the first nine months of 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 (see the INVISTA acquisition discussion below). Phthalic anhydride is manufactured at the Company’s Millsdale site and specialty polyols are manufactured at the Company’s Columbus, Georgia, site. In Europe, polyurethane polyols are manufactured at the Company’s plants in Germany and the Netherlands (see the INVISTA acquisition discussion below) and specialty polyols are manufactured at the Company’s Poland site. In Asia, polyurethane polyols and specialty polyols are manufactured at the Company’s China plant. Recent significant events include:

• In January 2021, the Company purchased 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 market. The Company believes that the facilities’ available spare capacity, combined with debottlenecking

opportunities in both plants, will allow Stepan to support future market growth in a capital efficient way. See Note 17, Acquisitions, of the notes to the Company’s condensed consolidated financial statements (included in Item 1 of this Form 10-Q) for additional details.

Specialty Products – Specialty products, which accounted for four percent of consolidated net sales for the first nine months of 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 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:

(In millions)

(In millions)

(1) See the Segment Results-Corporate Expenses sections 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 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 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 different U.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 and nine months ended September 30, 2022 and 2021:

(In millions)

24

(In millions)

RESULTS OF OPERATIONS

Three Months Ended September 30, 2022 and 2021

Summary

Net income attributable to the Company in the third quarter of 2022 increased seven percent to $39.4 million, or $1.71 per diluted share, from $36.9 million, or $1.59 per diluted share, in the third quarter of 2021. Adjusted net income increased 27 percent to $46.3 million, or $2.01 per diluted share, from $36.4 million, or $1.57 per diluted share in the third quarter of 2021 (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 attributable to the Company 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 third quarter of 2022 compared to the third quarter of 2021. A detailed discussion of segment operating performance for the third quarter of 2022 compared to the third quarter of 2021 follows the summary.

Consolidated net sales increased $116.5 million, or 19 percent, from the prior year quarter. Higher average selling prices favorably impacted the year-over-year change in net sales by $201.6 million. The increase in average selling prices was mainly attributable to the pass-through of higher raw material and logistics costs as well as more favorable product and customer mix. Consolidated sales volume declined eight percent, which negatively impacted the change in net sales by $49.4 million. Sales volume in the Surfactant and Polymer segments decreased eight and 10 percent, respectively, while sales volume in the Specialty Products segment increased 10 percent. Foreign currency translation negatively impacted the year-over-year change in net sales by $35.7 million due to a stronger U.S. dollar against most currencies in foreign locations where the Company has operations.

Operating income in the third quarter of 2022 increased $14.4 million, or 36 percent, versus operating income in the third quarter of 2021. Polymer, Specialty Products and Surfactant operating income increased $12.1 million, $7.2 million, and $4.5 million, respectively, versus the third quarter of 2021. Corporate expenses, including business restructuring and deferred compensation expenses, increased $9.4 million year-over-year. Most of this increase was attributable to $9.9 million of higher environmental remediation reserve expenses in the current year quarter. This environmental reserve increase primarily reflects 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. Higher deferred compensation income ($0.6 million) and lower consulting expenses, partially offset by higher incentive-based compensation expenses, positively impacted the year-over-year change in corporate expenses. Foreign currency translation had a $3.1 million negative impact on operating income in the third quarter of 2022 versus the prior year quarter.

Operating expenses (including deferred compensation and business restructuring) increased $12.1 million, or 23 percent, versus the prior year quarter. Changes in the individual income statement line items that comprise the Company’s operating expenses were as follows:

• Selling expenses increased $0.3 million, or two percent, between years.
• Administrative expenses increased $11.0 million, or 48 percent, primarily due to the higher environmental remediation reserve ($9.9 million) and incentive-based compensation expenses, partially offset by lower consulting expenses.
• Research, development and technical service (R&D) expenses increased $1.4 million, or nine percent, primarily due to higher incentive-based compensation expenses.
• Deferred compensation was $2.1 million of income in the third quarter of 2022 versus $1.5 million of income in the prior year quarter. The $0.6 million increase in deferred compensation income was primarily due to a decrease in the value of mutual fund investment assets held for the plans. Also contributing to this increase was a $7.68 per share decrease in the market price of Company common stock in the third quarter of 2022 compared to a $7.33 per share decrease in the third quarter of 2021. See the Overview and Segment Results-Corporate Expenses section of this MD&A for further details.
• Business restructuring expenses were $0.1 million in both the third quarter of 2022 and 2021. The restructuring costs in both years relate to ongoing decommissioning costs associated with the Company’s Canadian plant closure.

Net interest expense for the third quarter of 2022 increased $0.6 million, or 39 percent, versus the third quarter of 2021. This increase was primarily attributable to higher outstanding debt balances in 2022 versus 2021.

Other, net was $2.0 million of expense in the third quarter of 2022 versus $0.7 million of income in the third quarter of 2021. The Company recognized $1.0 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 the third quarter of 2022 compared to less than $0.1 million of investment losses in the third quarter of 2021. In addition, the Company reported $1.4 million of foreign exchange losses in the third quarter of 2022 versus $0.4 million of foreign exchange gains in the third quarter of 2021. The Company's net periodic pension income was flat between years.

The Company’s effective tax rate was 21.9 percent in the third quarter of 2022 compared to 6.1 percent in the third quarter of 2021. The increase was primarily attributable to: (a) a non-recurring favorable tax benefit recognized in the third quarter of 2021 related to the merger of the Company’s three Brazilian entities into a single entity; and (b) a small increase in state taxes due to an increase in global intangible low-taxed income (GILTI) and lower excess tax benefits related to stock-based compensation.

Segment Results

(Dollars in thousands)

(Dollars in thousands)

Surfactants

Surfactant net sales for the third quarter of 2022 increased $87.1 million, or 22 percent, versus net sales for the third quarter of 2021. Higher average selling prices positively impacted the change in net sales by $136.2 million. The higher average selling prices were mainly attributable to the pass-through of higher raw material and logistics costs as well as improved product and customer mix. Foreign currency translation had a $19.3 million unfavorable impact on the year-over-year change in net sales. Sales volume declined eight percent and negatively impacted the change in net sales by $29.8 million. A comparison of net sales by region follows:

(Dollars in thousands)

26

Net sales for North American operations increased $55.1 million, or 25 percent, year-over-year. Higher average selling prices positively impacted the change in net sales by $68.7 million. The higher average selling prices were mainly attributable to the pass-through of higher raw material and logistics costs along with more favorable product and customer mix. Sales volume declined six percent between years and negatively impacted the change in net sales by $13.2 million. Lower sales volume into the consumer product end markets, principally commodity laundry products, accounted for most of the decline. The decline in commodity laundry products was primarily due to continued raw material availability issues and previously anticipated lost volume at one customer that chose to invest in internal production capabilities as part of the transition to low 1,4 dioxane products. Higher customer demand for products sold into the agricultural and oilfield end markets partially offset the above. Foreign currency translation negatively impacted the change in net sales by $0.4 million.

Net sales for European operations increased $13.1 million, or 18 percent, versus the prior year quarter. Higher average selling prices positively impacted the year-over-year change in net sales by $32.4 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 six percent and negatively impacted the change in net sales by $4.5 million. Lower sales volume into the laundry and cleaning end markets, mostly commodity laundry products, was partially offset by higher demand for products sold into the functional products and institutional cleaning end markets. Foreign currency translation negatively impacted the change in net sales by $14.8 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 increased $17.1 million, or 21 percent, primarily due to higher average selling prices which positively impacted the change in net sales by $28.2 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 11 percent and negatively impacted the change in net sales by $8.9 million. The sales volume decline 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 end markets. A stronger U.S. dollar relative to all currencies within the region led to a $2.2 million unfavorable foreign currency translation effect.

Net sales for Asian operations increased $1.8 million, or 11 percent, versus the prior year quarter. Higher average selling prices positively impacted the change in net sales by $5.7 million. The higher average selling prices primarily reflect the pass-through of higher raw material costs. A 13 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by $2.0 million and $1.9 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 with one major customer, and lower demand from our distribution partners.

Surfactant operating income for the third quarter of 2022 increased $4.5 million, or 13 percent, versus operating income for the third quarter of 2021. Gross profit increased $6.7 million, or 11 percent, and operating expenses increased $2.2 million, or eight percent. Comparisons of gross profit by region and total segment operating expenses and operating income follow:

(Dollars in thousands)

Gross profit for North American operations increased $6.0 million, or 17 percent, versus the prior year primarily due to higher average unit margins. The higher average unit margins positively impacted the change in gross profit by $8.2 million and were mostly attributable to more favorable product and customer mix. A six percent decline in sales volume negatively impacted the year-over-year change in gross profit by $2.2 million. Gross profit was negatively impacted by ongoing supply chain challenges, inclusive of raw material constraints and inflationary pressures.

Gross profit for European operations increased $0.3 million, or three percent, primarily due to higher average unit margins. The higher average unit margins positively impacted the change in gross profit by $2.5 million and were mostly attributable to more favorable product and customer mix. The unfavorable impact of foreign currency translation and a six percent decline in sales volume negatively impacted the change in gross profit by $1.6 million and $0.6 million, respectively.

Gross profit for Latin American operations increased $1.9 million, or 16 percent, primarily due to improved average unit margins. The higher average unit margins positively impacted the change in gross profit by $3.5 million and mostly reflect improved product and customer mix. An 11 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the year-over-year change in gross profit by $1.3 million and $0.3 million, respectively.

Gross profit for Asia operations decreased $1.5 million, or 43 percent, from the prior year quarter primarily due to lower average unit margins. The lower average unit margins negatively impacted the change in gross profit by $1.1 million. A 13 percent decline in sales volume negatively impacted the change in gross profit by $0.4 million.

Operating expenses for the Surfactant segment increased $2.2 million, or eight percent, in the third quarter of 2022 versus the third quarter of 2021. This increase was mainly attributable to higher incentive-based compensation expenses in the third quarter of 2022.

Polymers

Polymer net sales for the third quarter of 2022 increased $16.0 million, or eight percent, versus net sales for the same period of 2021. Higher average selling prices positively impacted the change in net sales by $51.4 million. The higher average selling prices were mainly due to the pass through of higher raw material costs and margin recovery. A 10 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by $19.8 million and $15.6 million, respectively. A comparison of net sales by region follows:

(Dollars in thousands)

Net sales for North American operations increased $24.9 million, or 24 percent, primarily due to higher average selling prices. Higher average selling prices positively impacted the change in net sales by $29.1 million. The higher average selling prices were mainly due to the pass-through of higher raw material costs and margin recovery. Sales volume declined four percent between years and had a $4.2 million unfavorable impact on the change in net sales. The decline in sales volume reflects lower demand within the phthalic anhydride and specialty polyols businesses.

Net sales for European operations decreased $6.9 million, or eight percent, year-over-year. The unfavorable impact of foreign currency translation and a 16 percent decrease in sales volume negatively impacted the change in net sales by $15.0 million and $13.6 million, respectively. A stronger U.S. dollar relative to the Polish zloty and British pound sterling led to the unfavorable foreign currency translation effect. The decline in sales volume reflects weakening construction demand due to the energy crisis in Europe and customer share loss. Higher average selling prices positively impacted the change in net sales by $21.7 million. The higher average selling prices were primarily due to pass-through of higher raw material costs.

Net sales for Asia and Other operations decreased $2.1 million, or 18 percent, primarily due to a 16 percent decline in sales volume and the unfavorable impact of foreign currency translation. These items negatively impacted the year-over-year change in net sales by $1.9 million and $0.5 million, respectively. The decline in sales volume was primarily attributable to suppressed demand resulting from recent COVID lockdowns and restrictions in China. Higher average selling prices positively impacted the change in net sales by $0.3 million.

Polymer operating income in the third quarter of 2022 increased $12.1 million, or 61 percent, versus operating income in the third quarter of 2021. Gross profit increased $12.2 million, or 44 percent and operating expenses were flat between years. Comparisons of gross profit by region and total segment operating expenses and operating income follow:

(Dollars in thousands)

28

Gross profit for North American operations increased $13.4 million primarily due to higher average unit margins. The higher unit margins positively impacted the year-over-year change in gross profit by $14.0 million. The higher unit margins reflect margin recovery and more favorable product and customer mix. Sales volume declined four percent and negatively impacted the change in gross profit by $0.6 million.

Gross profit for European operations decreased $0.7 million, or six percent, versus the third quarter of 2021. The decrease was primarily due to the unfavorable impact of foreign currency translation and a 16 percent decrease in sales volume. These two items negatively impacted the year-over-year change in gross profit by $2.2 million and $2.1 million respectively. Higher average unit margins positively impacted the change in gross profit by $3.6 million.

Gross profit for Asia and Other operations decreased $0.5 million, or 43 percent, due to lower average unit margins and a 16 percent decline in sales volume. These items negatively impacted the change in gross profit by $0.3 million and $0.2 million, respectively.

Operating expenses for the Polymers segment were flat between years.

Specialty Products

Specialty Products net sales for the third quarter of 2022 increased $13.4 million, or 83 percent, versus net sales for the third quarter of 2021. This increase reflects higher average selling prices and a 10 percent increase in sales volume. Gross profit and operating income increased $7.0 million and $7.2 million, respectively, year-over-year. 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 and other operating expenses that are not allocated to the reportable segments, increased $9.4 million between quarters. Corporate expenses were $25.9 million in the third quarter of 2022 versus $16.4 million in the third quarter of 2021. This year-over-year increase was primarily attributable to $9.9 million of higher environmental reserve expenses, mostly related to revised remediation cost estimates associated with the Company's Maywood, New Jersey site. The Company anticipates that the majority of Maywood soil remediation would be completed over the next two to three years.

The $0.6 million increase in deferred compensation income was primarily driven by a decrease in the value of mutual fund investment assets held for the plans. Also contributing to this increase was a $7.68 per share decrease in the market price of Company common stock in the third quarter of 2022 compared to a $7.33 per share decrease in the third quarter of 2021. 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 ended September 30, 2022 and 2021:

Nine Months Ended September 30, 2022 and 2021

Summary

Net income attributable to the Company in the first nine months of 2022 increased 13 percent to $136.3 million, or $5.90 per diluted share, from $120.8 million, or $5.19 per diluted share, in the first nine months of 2021. Adjusted net income increased 16 percent to $140.0 million, or $6.06 per diluted share, versus $121.0 million or $5.20 per diluted share, in the prior year (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 attributable to the Company 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 year-over-year changes in net sales, expenses and income in the first nine months of 2022 compared to the first nine months of 2021. A detailed discussion of segment operating performance for the first nine months of 2022 compared to the first nine months of 2021 follows the summary.

Consolidated net sales increased $410.2 million, or 24 percent, year-over-year. Higher average selling prices positively impacted the change in net sales by $540.8 million. The increase in average selling prices was mainly attributable to the pass through of higher raw material and logistics costs as well as more favorable product and customer mix. Consolidated sales volume declined three percent and negatively impacted the year-over-year change in net sales by $57.7 million. Sales volume in the Surfactant, Polymer and Specialty Products segments decreased four percent, two percent and three percent, respectively. Foreign currency translation negatively impacted the year-over-year change in net sales by $72.9 million due to a stronger U.S. dollar against the majority of currencies in foreign locations where the Company has operations.

Operating income for the first nine months of 2022 increased $44.9 million, or 30 percent, versus operating income for the first nine months of 2021. Polymer, Specialty Products and Surfactant operating income increased $19.2 million, $11.2 million, and $7.4 million, respectively. Corporate expenses, including business restructuring and deferred compensation expenses, decreased $7.1 million year-over-year. Most of this decrease was attributable to a $15.2 million decrease in deferred compensation expenses and lower acquisition-related expenses that were partially offset by $10.2 million of higher environmental remediation reserve expenses and higher incentive-based compensation expenses. Foreign currency translation had a $6.7 million negative impact on operating income in the first nine months of 2022 versus the first nine months of 2021.

Operating expenses (including deferred compensation, business restructuring, and goodwill impairment) increased $1.9 million, or one percent, between years. Changes in the individual income statement line items that comprise the Company’s operating expenses were as follows:

• Selling expenses increased $1.6 million, or four percent, year-over-year mainly due to higher incentive-based compensation expenses, travel-related expenses and higher bad debt provision expenses related to higher global accounts receivable balances and the ongoing conflict in Ukraine.
• Administrative expenses increased $10.1 million, or 14 percent, year-over-year primarily due to higher environmental remediation reserve expenses ($10.2 million) and higher incentive-based compensation expenses, partially offset by lower acquisition-related and consulting expenses.
• R&D expenses increased $4.5 million, or 10 percent, year-over-year primarily due to higher salaries and incentive-based compensation expenses.
• Deferred compensation expense decreased $15.2 million, year-over-year, primarily due to a decrease in the value of the mutual fund investment assets held for the plans and a $30.60 per share decrease in the market price of Company common stock in the first nine months of 2022 compared to a $6.38 per share decrease in the first nine months of 2021. See the Overview and Segment Results-Corporate Expenses section of this MD&A for further details.
• Business restructuring expenses were flat between years. The restructuring charges in both years relate to ongoing decommissioning costs associated with the Company’s Canadian plant closure.
• Goodwill impairment expenses were $1.0 million in the first nine months of 2022 versus no impairment expense recognition in the prior year. See Note 18, Goodwill Impairment, of the notes to the Company’s condensed consolidated financial statements (included in Item 1 of this Form 10-Q) for additional details.

Net interest expense for the first nine months of 2022 increased $2.6 million, or 55 percent, compared to net interest expense for the first nine months of 2021. This increase was primarily attributable to higher outstanding debt balances in the first nine months of 2022 versus the first nine months of 2021.

Other, net was $9.0 million of expense for the first nine months of 2022 compared to $4.2 million of income for the first nine months of 2021. The Company recognized $7.6 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 the first nine months of 2022 compared to $3.2 million of income in the first nine months of 2021. In addition, the Company reported foreign exchange losses of $2.6 million in the first nine months of 2022 versus $0.1 million of foreign exchange gains in the first nine months of 2021. The Company also reported $0.3 million of higher net periodic pension income in the first nine months of 2022 versus the first nine months of the prior year.

The Company’s effective tax rate was 24.0 percent in the first nine months of 2022 versus 19.6 percent in the first nine months of 2021. The year-over-year increase was primarily attributable to: (a) a non-recurring favorable tax benefit recognized in the third quarter of 2021 related to the merger of the Company’s three Brazilian entities into a single entity; and (b) a small increase in state taxes due to an increase in GILTI and lower excess tax benefits related to stock-based compensation.

(In thousands)

30

(In thousands)

Segment Results

Surfactants

Surfactant net sales for the first nine months of 2022 increased $285.5 million, or 25 percent, versus net sales for the first nine months of 2021. Higher average selling prices positively impacted the change in net sales by $365.7 million. The higher average selling prices were mainly attributable to the pass-through of higher raw material and logistics costs as well as improved product and customer mix. Sales volume declined four percent and negatively impacted the change in net sales by $43.5 million. Foreign currency translation had a $36.7 million unfavorable impact on the year-over-year change in net sales. A year-over-year comparison of net sales by region follows:

(In thousands)

Net sales for North American operations increased $164.0 million, or 25 percent, year-over-year. Higher average selling prices favorably impacted the change in net sales by $175.6 million. The higher average selling prices were mainly attributable to the pass-through of higher raw material and logistics costs along with more favorable product and customer mix. A two percent decrease in sales volume negatively impacted the change in net sales by $10.8 million between years. The lower sales volume primarily reflects lower demand for products within the consumer products end markets, principally commodity laundry products, due to continued raw material availability issues 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. This decline was partially offset by higher demand for products sold into the functional products end markets. Foreign currency translation negatively impacted the change in net sales by $0.8 million year-over-year.

Net sales for European operations increased $60.3 million, or 29 percent, year-over-year. Higher average selling prices positively impacted the year-over-year change in net sales by $93.7 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 one percent decline in sales volume negatively impacted the year-over-year change in net sales by $31.7 million and $1.7 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 one percent decrease in sales volume primarily reflects 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 operations increased $60.4 million, or 27 percent, primarily due to higher average selling prices that positively impacted the change in net sales by $76.0 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 $15.7 million. The sales volume decline 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 end markets. Foreign currency translation positively impacted the change in net sales by $0.1 million.

Net sales for Asian operations increased $0.8 million, or one percent, year-over-year. Higher average selling prices positively impacted the year-over-year change in net sales by $15.1 million and primarily reflected the pass-through of higher raw material costs. A 19 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by $9.9 million and $4.4 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.

Surfactant operating income for the first nine months of 2022 increased $7.4 million, or six percent, versus operating income for the first nine months of 2021. Gross profit increased $14.0 million, or seven percent, and operating expenses increased $6.5 million, or eight percent. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

(In thousands)

Gross profit for North American operations increased $7.9 million, or six percent, year-over-year. Higher average unit margins positively impacted the year-over-year change in gross profit by $10.1 million. The higher average unit margins were mostly attributable to more favorable product and customer mix that was partially offset by ongoing supply chain challenges and inflationary pressures. A two percent decline in sales volume negatively impacted the change in gross profit by $2.2 million.

Gross profit for European operations increased $5.3 million, or 18 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 one percent decline in sales volume negatively impacted the year-over-year change in gross profit by $3.8 million and $0.3 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 operations increased $1.0 million, or two percent, primarily due to improved average unit margins. The higher average unit margins positively impacted the year-over-year change in gross profit by $3.9 million. A seven percent decline in sales volume negatively impacted the change in gross profit by $3.0 million. Foreign currency translation had a slightly favorable $0.1 million impact on the year-over-year change in gross profit.

Gross profit for Asian operations decreased $0.2 million, or three percent. A 19 percent decline in sales volume negatively impacted the change in gross profit by $1.6 million. Higher average unit margins positively impacted the year-over-year change in gross profit by $1.4 million.

Operating expenses for the Surfactant segment increased $6.5 million, or eight percent, year-over-year. This increase was mainly 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.

Polymers

Polymer net sales for the first nine months of 2022 increased $101.0 million, or 19 percent, versus net sales for the same period of 2021. Higher average selling prices favorably impacted the year-over-year change in net sales by $146.7 million. The higher average selling prices were mainly due to the pass through of higher raw material costs and margin recovery. The unfavorable impact of foreign currency translation and a two percent decrease in sales volume negatively impacted the year-over-year change in net sales by $34.6 million and $11.1 million, respectively. A year-over-year comparison of net sales by region follows:

(In thousands)

32

Net sales for North American operations increased $86.8 million, or 32 percent, primarily due to higher average selling prices that positively impacted the year-over-year change in net sales by $88.4 million. The higher average selling prices were mainly due to the pass-through of higher raw material costs and margin recovery. Sales volume declined one percent and negatively impacted the change in net sales by $1.6 million. Sales volume of polyols used in rigid foam applications increased three percent during the first nine months of 2022 but was more than offset by lower sales volume within the phthalic anhydride and specialty polyols businesses. Sales volume during the first nine months of 2022 was also 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.

Net sales for European operations increased $17.6 million, or eight percent, year-over-year. Higher average selling prices favorably impacted the change in net sales by $55.3 million. The higher average selling prices were primarily due to the pass-through of higher raw material costs. The unfavorable impact of foreign currency translation and a one percent decline in sales volume negatively impacted the change in net sales by $34.2 million and $3.5 million, respectively. A stronger U.S. dollar relative to the Polish zloty and British pound sterling led to the unfavorable foreign currency translation effect. The decline in sales volume reflects weakening construction demand due to the energy crisis in Europe and customer share loss.

Net sales for Asia and Other operations decreased $3.4 million, or nine percent, largely due to a 15 percent decline in sales volume which had a $5.4 million negative impact on the year-over-year change in net sales. The decline in sales volume was primarily attributable to suppressed demand resulting from recent COVID lockdowns and restrictions in China. Higher average selling prices positively impacted the year-over-year change in net sales by $2.4 million. The unfavorable impact of foreign currency translation had a $0.4 million negative impact on the change in net sales between years.

Polymer operating income for the first nine months of 2022 increased $19.2 million, or 32 percent, versus operating income for the first nine months 2021. Gross profit increased $20.6 million, or 25 percent, and operating expenses were up $1.5 million, or six percent. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

(In thousands)

Gross profit for North American operations increased $18.3 million, or 42 percent, primarily due to higher average unit margins. The higher unit margins positively impacted the year-over-year change in gross profit by $18.6 million. The higher average unit margins reflect margin recovery and more favorable product and customer mix as higher rigid polyol sales volume offset lower phthalic anhydride sales volume. Sales volume declined one percent and negatively impacted the change in gross profit by $0.3 million.

Gross profit for European operations increased $3.3 million, or nine percent, primarily due to higher average unit margins that favorably impacted the change in gross profit by $9.0 million. The unfavorable impact of foreign currency translation and a one percent decline in sales volume negatively impacted the change in gross profit by $5.2 million and $0.5 million, respectively.

Gross profit for Asia and Other operations declined $1.0 million, or 25 percent, due to a 15 percent decline in sales volume and lower average unit margins. These items negatively impacted the year-over-year change in gross profit by $0.6 million and a $0.4 million, respectively.

Operating expenses for the Polymers segment increased $1.5 million, or six percent, year-over-year mainly due to higher incentive-based compensation and travel-related expenses.

Specialty Products

Specialty Products net sales for the first nine months of 2022 increased $23.6 million, or 44 percent, versus net sales for the first nine months of 2021. This increase reflects higher average selling prices that were partially offset by a three percent decline in sales volume. Gross profit and operating income increased by $10.8 and $11.2 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 and other operating expenses that are not allocated to the reportable segments, decreased $7.1 million between years. Corporate expenses were $48.5 million in the first nine months of 2022 versus $55.6 million in the first nine months of 2021. This decrease was primarily attributable to $13.0 million of deferred compensation income recognized in the first nine months of 2022 versus $2.1 million of deferred compensation expense recognized in the first nine months of 2021. Partially offsetting this decrease was $10.2 million of higher environmental remediation reserve expenses recorded in the first nine months of 2022 versus the first nine months of 2021. The higher environmental expenses were primarily related to revised remediation cost estimates associated with the Company's Maywood, New Jersey site. Lower year-over-year acquisition-related and consulting expenses, partially offset by higher incentive-based compensation expenses, positively impacted the change in corporate expenses.

The $15.2 million decrease in deferred compensation expense was primarily due to a decrease in the value of mutual fund investment assets held for the plans. In addition, during the first nine months of 2022 the market price of the Company’s common stock decreased $30.62 per share versus a $6.38 per share decrease during the first nine months of 2021. The following table presents the period-end Company common stock market prices used in the computation of deferred compensation income/expense for the nine months ended September 30, 2022 and 2021:

LIQUIDITY AND CAPITAL RESOURCES

Overview

For the nine months ended September 30, 2022, operating activities were a cash source of $74.9 million versus a source of $21.4 million for the comparable period in 2021. For the first nine months of 2022, investing cash outflows totaled $211.9 million versus cash outflows of $306.0 million in the prior year period. Financing activities were a source of $154.6 million versus a source of $43.0 million in the prior year period.

Cash and cash equivalents increased $6.5 million compared to December 31, 2021, inclusive of an $11.1 million unfavorable foreign exchange rate impact. On September 30, 2022, the Company’s cash and cash equivalents totaled $165.7 million. Cash in U.S. demand deposit accounts and certificates of deposit totaled $45.6 million and cash in U.S. money market funds totaled $17.6 million. The Company’s non-U.S. subsidiaries held $102.5 million of cash as of September 30, 2022.

Operating Activity

Net income during the first nine months of 2022 increased $15.5 million versus the comparable period in 2021. Working capital was a cash use of $145.0 million during the first nine months of 2022 versus a use of $121.7 million in the comparable period in 2021.

Accounts receivable were a use of $82.5 million during the first nine months of 2022 compared to a use of $96.8 million for the comparable period of 2021. Inventories were a use of $100.1 million in 2022 versus a use of $63.8 million in 2021. Accounts payable and accrued liabilities were a source of $42.6 million in 2022 compared to a source of $39.2 million for the same period in 2021.

Working capital requirements were higher in the first nine months of 2022 compared to 2021 primarily due to the changes noted above. The major driver of the increase in working capital was inventories due to both higher quantities and raw material costs. The higher quantities partially reflect inventory builds in advance of the Company's planned maintenance activity at its North American phthalic anhydride plant during the fourth quarter of 2022. It is management’s opinion that the Company’s liquidity is sufficient to provide for potential increases in working capital requirements during 2022.

Investing Activity

Cash used for investing activities decreased $94.2 million year-over-year. This decrease primarily reflects the Company’s acquisition of INVISTA’s aromatic polyester polyol business and associated assets for $183.7 million, net of cash received, during the first nine months in 2021. Partially offsetting the above, cash used for capital expenditures was $205.3 million in the first nine months of 2022 versus $119.5 million in 2021. The higher capital spending in 2022 is largely attributable to the alkoxylation plant the Company is building at its Pasadena, Texas site and equipment upgrades to meet future regulatory limits on 1,4 Dioxane in the United States.

For 2022, the Company estimates that total capital expenditures will be in the range of $330.0 million to $350.0 million. This projected spending includes the new alkoxylation plant that is being built in Pasadena, Texas, equipment upgrades to meet future regulatory limits on 1,4 Dioxane in the United States, growth initiatives, infrastructure and optimization spending in the United States, Germany and Mexico.

Financing Activity

Cash flow from financing activities was a source of $154.6 million in 2022 versus a source of $43.0 million in 2021. The year-over-year change is primarily due to a higher level of borrowing from the Company’s revolving credit facility and a $100.0 million delayed draw term loan during the first nine months of 2022 versus the same period in 2021.

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 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. For the nine months ended September 30, 2022, the Company purchased 222,720 shares of its common stock on the open market at a total cost of $22.3 million. At September 30, 2022, the Company had $127.7 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 $564.9 million on September 30, 2022, primarily due to higher domestic debt, which includes borrowings from the Company’s revolving credit agreement and new private placement 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 $194.8 million, from $204.4 million at December 31, 2021 to $399.2 million at September 30, 2022. This change was due to a debt increase of $201.3 million partially offset by a cash increase of $6.5 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.

As of September 30, 2022, the ratio of net debt to net debt plus shareholders’ equity was 26.1 percent versus 16.0 percent at December 31, 2021 (see the “Reconciliation of Non-GAAP Net Debt” section in this MD&A for further details). On September 30, 2022, the Company’s debt included $407.1 million of unsecured notes, with maturities ranging from 2022 through 2032, that were issued to insurance companies in private placement transactions pursuant to note purchase agreements, a $100.0 million delayed draw term loan borrowed pursuant to the Company's credit agreement, $55.0 million of short term loans borrowed under its revolving credit facility and $2.8 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.

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 other 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 September 30, 2022, the Company had outstanding loans totaling $155.0 million, inclusive of a $100.0 million delayed draw term loan, and letters of credit totaling $6.8 million under the credit agreement, with $288.2 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. At September 30, 2022, the Company’s foreign subsidiaries had $2.8 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 $750.0 million.

4. The Company is permitted to pay dividends and purchase treasury shares after June 24, 2022, in amounts of up to $100.0 million plus 100 percent of net income and cash proceeds of stock option exercises, measured cumulatively beginning January 1, 2022. The maximum amount of dividends 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).

The Company believes it was in compliance with all of its debt covenants as of September 30, 2022.

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 nine months of 2022 and 2021, the Company’s expenditures for capital projects related to the environment were $8.5 million and $8.8 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 $26.8 million and $24.8 million for the nine months ended September 30, 2022 and 2021, 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 $33.3 million to $57.0 million at September 30, 2022 and $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; these accruals totaled $33.3 million at September 30, 2022 and $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. Because the liabilities accrued are estimates, actual amounts could differ materially from the amounts reported. Cash expenditures related to legal and environmental matters were $1.5 million for the nine months ended September 30, 2022, compared to $2.5 million for the same period 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 upon 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 the SEC, 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 that its Surfactant, Polymer and Specialty Products segments should all deliver full year earnings growth versus the prior year. Management believes that Surfactant products sold into the functional products and industrial cleaning end markets should deliver full year volume growth versus 2021. Despite short-term volatility and challenges, management believes the long-term outlook for rigid polyols will remain attractive as energy conservation efforts and more stringent building codes are expected to continue. Management anticipates higher incremental expenses, primarily related to planned maintenance activity at the Company's North American phthalic anhydride plant and low 1,4 dioxane transition costs, during the fourth quarter of 2022. Looking forward to the next few quarters, management believes the Company will be challenged by slowing global economic growth, weakening consumer and construction demand, continued inflationary pressures and a stronger U.S. dollar.

CRITICAL ACCOUNTING POLICIES

The Company no longer considers the prior year (a) Business Combinations and (b) Goodwill and Intangible Assets accounting policies as continuing to be critical during the first nine months of 2022 because the Company has made no material acquisitions in 2022. Other than these items there have been no material changes to the critical accounting policies disclosed in the Company’s 2021 Annual Report on Form 10-K.

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.

(In millions, except per share amounts)

(In millions, except per share amounts)

38

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.

(In millions)

39

a. Evaluation of Disclosure Controls and Procedures

We have conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of September 30, 2022. Based on this evaluation of our disclosure controls and procedures, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2022, such that the information required to be disclosed in our Securities and Exchange Commission reports is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

b. Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the risk factors disclosed in the Company’s 2021 Annual Report on Form 10-K and in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2022.