Stepan Co: Form 10-Q for the period ended Sep 30, 2019

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 I-Item IA. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 inclusive of: (a) the risks and uncertainties related to accidents, unplanned production shutdowns or disruptions in any of the Company’s manufacturing facilities; (b) global competition and the Company’s ability to successfully compete; (c) volatility of raw material, natural gas and electricity costs as well as any disruption in their supply; (d) disruptions in transportation or significant changes in transportation costs; (e) reduced demand for Company products due to customer product reformulations or new technologies; (f) the Company’s ability to make acquisitions of suitable candidates and successfully integrate acquisitions; (g) the Company’s ability to keep and protect its intellectual property rights; (h) international business risks, including fluctuations in currency exchange rates, legal restrictions and taxes; (i) potentially adverse tax consequences due to the international scope of the Company’s operations; (j) compliance with anti-corruption, environmental, health and safety and product registration laws; (k) the Company’s ability to operate within the limitations of its debt covenants; (l) downgrades to the Company’s credit ratings or disruptions to the Company’s ability to access well-functioning capital markets; (m) downturns in certain industries and general economic downturns; (n) conflicts, military actions, terrorist attacks and general instability, particularly in certain energy-producing nations, along with increased security regulations; (o) cost overruns, delays and miscalculations in capacity needs with respect to the Company’s expansion or other capital projects; (p) interruption of, damage to or compromise of the Company’s IT systems and failure to maintain the integrity of customer, colleague or Company data; (q) unfavorable resolution of litigation against the Company; (r) and the Company’s ability to retain its executive management and other key personnel.

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 also could harm 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 comprises three reportable segments:

• Surfactants – Surfactants, which accounted for 68 percent of Company consolidated net sales for the first nine months of 2019, are principal ingredients in consumer and industrial cleaning 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, 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:
• During January 2019 the Company’s plant in Ecatepec, Mexico experienced a sulfonation equipment failure that contributed to an operating loss at the site for the first nine months of 2019. The Ecatepec facility is now fully operational and the Company’s insurance provider has acknowledged this incident is a covered event. The Company is pursuing insurance recovery. This plant, and a portion of its related surfactant business, was acquired from BASF in March 2018 (see Note 18, Acquisition, for additional details).
• During the fourth quarter of 2018, the Company shut down Surfactant operations at its plant site in Germany. The Company ceased Surfactant production at this site to further reduce its fixed cost base, refocus Surfactant resources on higher margin end markets and allow for select assets to be repurposed to support future polyol growth. Decommissioning costs associated with the shutdown are expected to be incurred throughout 2019 (see Note 17, Business Restructuring, for additional details).
• In 2016, the Company shut down its production facility in Canada, moving the production of goods previously manufactured in Canada to other Company North American production sites. Manufacturing operations at the facility ceased in the fourth quarter of 2016, but decommissioning activities occurred in 2017 and 2018 and will continue throughout 2019 (see Note 17, Business Restructuring, for additional details).
• Polymers – Polymers, which accounted for 28 percent of consolidated net sales for the first nine months of 2019, 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). 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 and phthalic anhydride are manufactured at the Company’s Millsdale, Illinois, site and specialty polyols are manufactured at the Company’s Columbus, Georgia, site. In Europe, polyurethane polyols are manufactured by the Company’s subsidiary in Germany, 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.
• Specialty Products – Specialty Products, which accounted for four percent of consolidated net sales for the first nine months of 2019, 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, at outside contractors.
• During the first quarter of 2019 the Company approved a plan to restructure its Specialty Product office in the Netherlands and eliminate positions from the site’s supply chain, quality control and research and development areas. This restructuring was designed to better align the number of personnel with current business requirements and reduce costs at the site (see Note 17, Business Restructuring, for additional details).

Change in Accounting Principle

During the first quarter of 2019 the Company elected to change its method of accounting for U.S. inventory valuation from the LIFO basis to the FIFO basis. Non-U.S. inventories have historically been maintained on the FIFO basis. The Company believes that this change to the FIFO method of inventory valuation is preferable as it provides a better matching of costs with the physical flow of goods, more accurately reflects the current market value of inventory presented on the Company’s consolidated balance sheet, standardizes the Company’s inventory valuation methodology and improves comparability with the Company’s industry peers. The Company has retrospectively applied this change to its prior year financial statement comparables. See Note 2, Change in Method of Accounting for Inventory Valuation, for additional details.

Deferred Compensation Plans

The accounting for the Company’s deferred compensation plans can cause period-to-period fluctuations in Company expenses and profits. Compensation expense results when the values of Company common stock and mutual fund investment assets held for the plans increase, and compensation income results when the values 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 tables:

(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 expense.

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 tables present 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, 2019 and 2018:

(In millions)

28

(In millions)

(1) The 2018 gross profit, operating income and pretax income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2019 and 2018

Summary

Net income attributable to the Company for the third quarter of 2019 increased 19 percent to $25.9 million, or $1.11 per diluted share, from $21.8 million, or $0.93 per diluted share, for the third quarter of 2018. Adjusted net income increased six percent to $27.9 million, or $1.20 per diluted share, from $26.4 million, or $1.13 per diluted share, in 2018 (see the “Reconciliation of Non-GAAP Adjusted Net Income and Diluted Earnings per Share” section of this MD&A for reconciliations between reported net income attributable to the Company and related earnings per diluted share and non-GAAP adjusted net income and related earnings per diluted share). Below is a summary discussion of the major factors leading to the quarter-over-quarter changes in net sales, profits and expenses. A detailed discussion of segment operating performance for the third quarter of 2019 compared to the third quarter of 2018 follows the summary.

Consolidated net sales decreased $56.4 million, or 11 percent, between quarters. Consolidated sales volume declined six percent, which had a $29.1 million unfavorable impact on the quarter-over-quarter change in net sales. Sales volume in the Surfactant and Specialty Product segments decreased eight percent and two percent, respectively, while sales volume in the Polymer segment increased three percent. Approximately 27 percent of the decline in Surfactant volume was due to the Company’s exit from its sulfonation business in Germany during the fourth quarter of 2018. Lower average selling prices negatively impacted the quarter-over-quarter change in net sales by $20.1 million. The decrease in average selling prices was primarily due to the pass through of lower raw material costs. Foreign currency translation negatively impacted the quarter-over-quarter change in net sales by $7.2 million due to a stronger U.S. dollar against the majority of currencies where the Company has foreign operations.

Operating income for the third quarter of 2019 increased $0.8 million, or three percent, versus operating income for the third quarter of 2018. A $6.2 million decline in gross profit was more than offset by lower corporate, deferred compensation and business restructuring expenses. These expenses decreased by $2.5 million, $2.6 million and $1.3 million quarter-over-quarter, respectively. From a segment perspective, Polymer operating income improved by $4.0 million, whereas Surfactant and Specialty Product operating income declined by $9.2 and $0.4 million, respectively. Foreign currency translation had a $0.5 million unfavorable effect on quarter-over-quarter consolidated operating income.

Operating expenses (including deferred compensation and business restructuring expense) decreased $7.0 million, or 12 percent, between quarters. Changes in the individual income statement line items that comprise the Company’s operating expenses were as follows:

• Selling expenses decreased $0.4 million, or three percent, quarter-over-quarter.
• Administrative expenses decreased $2.2 million, or 10 percent, quarter-over-quarter. This decrease was primarily due to non-recurring employee separation costs ($2.1 million) incurred during the third quarter of 2018.
• Research, development and technical service (R&D) expenses decreased $0.5 million, or four percent, quarter-over-quarter, primarily due to lower incentive-based compensation expense.
• Deferred compensation expense declined $2.6 million, quarter-over-quarter, primarily due to a $5.15 per share increase in the market price of Company common stock in the third quarter of 2019 compared to a $9.00 per share increase in the third quarter of 2018. See the Overview and Segment Results-Corporate Expenses sections of this MD&A for further details.
• Business restructuring charges totaled $0.5 million in the third quarter of 2019 versus $1.7 million in the third quarter of 2018. The 2019 restructuring charges were comprised of ongoing decommissioning costs associated with the Company’s manufacturing facility in Canada ($0.3 million) and decommissioning expenses associated with the Company’s 2018 sulfonation shutdown in Germany ($0.2 million). The 2018 restructuring charges were comprised of asset and spare part write-downs related to the Company ceasing Surfactant operations in Germany ($1.4 million) and Canadian decommissioning costs ($0.3 million). See Note 17, Business Restructuring, for additional details.

Net interest expense for the third quarter of 2019 decreased $1.4 million versus the prior year quarter. This decrease was primarily due to higher U.S. interest income earned on U.S. cash balances, resulting from the repatriation of $100.0 million to the United States in 2018, and lower interest expense resulting from scheduled debt repayments and the Company’s voluntary prepayment of its 5.88% Senior Notes in the second quarter of 2019.

Other, net was $0.9 million of income for the third quarter of 2019 compared to $0.3 million of income for the same period of 2018. The Company incurred $0.2 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 2019 compared to $0.8 million of income in last year’s third quarter. The Company also reported foreign exchange gains of $0.4 million in the third quarter of 2019 versus $0.3 million of foreign exchange losses in the third quarter of 2018. Net periodic pension costs were $0.4 million lower in the third quarter of 2019 versus the prior year quarter. In addition, the Company reported a $0.6 million gain on the sale of an asset in the third quarter of 2019.

The Company’s effective tax rate was 5.7 percent for the third quarter of 2019 compared to 11.9 percent for the third quarter of 2018. The quarter-over-quarter decrease was primarily attributable to: (i) current quarter incremental U.S. tax credits identified as part of a research and development tax credit study, and (ii) the non-recurrence of unfavorable tax consequences resulting from the repatriation of $100.0 million to the United States in 2018. These items were substantially offset by other non-recurring favorable tax benefits recognized in the third quarter of 2018.

Segment Results

(Dollars in thousands)

(Dollars in thousands)

(1) The 2018 segment and total operating income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Surfactants

Surfactant net sales for the third quarter of 2019 decreased $47.2 million, or 14 percent, versus net sales for the third quarter of 2018. The unfavorable impact of lower sales volume, lower average selling prices and foreign currency translation negatively impacted the quarter-over-quarter change in net sales by $29.2 million, $13.2 million and $4.8 million, respectively. A quarter-over-quarter comparison of net sales by region follows:

(Dollars in thousands)

Net sales for North American operations decreased $26.3 million, or 13 percent, between quarters. An eight percent decline in sales volume and lower average selling prices negatively impacted the quarter-over-quarter change in net sales by $16.9 million and $9.3 million, respectively. The decline in sales volume was mostly due to lower commodity demand in the personal care and laundry and cleaning end markets and lower demand in the functional products end market. The lower functional products demand reflects wet weather in the U.S. farm belt that negatively impacted the Company’s agricultural business. Selling prices decreased five percent mostly due to the pass through of lower raw material costs to customers. Foreign currency translation negatively impacted the quarter-over-quarter change in net sales by $0.1 million.

Net sales for European operations decreased $10.9 million, or 16 percent, between quarters. A 14 percent decline in sales volume and unfavorable foreign currency translation negatively impacted the quarter-over-quarter change in net sales by $9.4 million and $2.8 million, respectively. The lower sales volume was principally due to the Company ceasing Surfactant production at its German plant site during the fourth quarter of 2018. A stronger U.S. dollar relative to the European euro and British pound sterling led to the foreign currency translation effect. Slightly higher average selling prices favorably impacted the change in net sales by $1.3 million.

Net sales for Latin American operations decreased $6.6 million, or 11 percent, primarily due to lower average selling prices, the negative impact of foreign currency translation and a two percent decline in sales volume. These items accounted for $3.2 million, $2.2 million and $1.2 million, respectively, of the quarter-over-quarter change in net sales. The lower average selling prices reflect the pass through of lower raw material costs to customers and slightly less favorable product mix. The quarter-over-quarter strengthening of the U.S. dollar against the Columbian and Mexican pesos and the Brazilian real generated the unfavorable foreign currency effect. The lower sales volume mostly reflects the residual impact of a sulfonation equipment failure at the Company’s Ecatepec, Mexico site during the first quarter of 2019 partially offset by higher agricultural demand in the region.

Net sales for Asian operations declined $3.4 million, or 22 percent, primarily due to lower sales volume and lower average selling prices. These items unfavorably impacted the quarter-over-quarter change in net sales by $2.3 million and $1.4 million, respectively. Sales volume declined 15 percent mostly due to lower demand in the commodity laundry and cleaning end markets. Foreign currency translation favorably impacted the quarter-over-quarter change in net sales by $0.3 million.

Surfactant operating income for the third quarter of 2019 decreased $9.2 million, or 32 percent, versus operating income for the third quarter of 2018. Gross profit declined $9.5 million and operating expenses were down slightly quarter-over-quarter. Quarter-over-quarter comparisons of gross profit by region and total segment operating expenses and operating income follow:

(Dollars in thousands)

31

(1) The 2018 North America gross profit and the total surfactants segment operating income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Gross profit for North American operations decreased 28 percent, or $9.9 million, quarter-over-quarter primarily due to lower unit margins and an eight percent decline in sales volume. These two items negatively impacted the quarter-over-quarter change in gross profit by $6.9 million and $3.0 million, respectively. The lower unit margins were primarily attributable to higher inventory costs associated with the Company’s internal Asia-U.S. supply chain. Most of the sales volume decrease was attributable to lower demand for commodity products sold into the personal care and laundry and cleaning end markets and lower demand in the functional products end market.

Gross profit for European operations increased 11 percent, or $0.9 million, between quarters primarily due to lower overhead costs and higher unit margins resulting from the Company ceasing Surfactant production at its German plant site during the fourth quarter of 2018. Higher unit margins favorably impacted gross profit quarter over quarter by $2.3 million. A 14 percent decline in sales volume, mostly attributable to the exit from sulfonation in Germany, and the unfavorable impact of foreign currency translation negatively impacted the current year quarter by $1.0 million and $0.4 million, respectively.

Gross profit for Latin American operations decreased $2.4 million, or 33 percent, quarter-over-quarter. Lower unit margins, the unfavorable impact of foreign currency translation and a two percent decline in sales volume negatively impacted gross profit quarter-over-quarter by $2.1 million, $0.2 million and $0.1 million, respectively. The lower unit margins primarily reflect competitive market pressures, the non-recurrence of a 2018 favorable $0.6 million equipment reimbursement in Brazil and the residual impact of the equipment failure in Ecatepec, Mexico.

Gross profit for Asia operations increased 79 percent, or $2.1 million, between quarters largely due to higher unit margins that were partially offset by lower sales volume. The higher unit margins reflect a more favorable product mix and higher margins on products supplied to the United States. Sales volume decreased 15 percent primarily due to lower demand in the commodity laundry and cleaning end markets.

Operating expenses for the Surfactants segment decreased $0.3 million, or one percent, quarter-over-quarter.

Polymers

Polymers net sales for the third quarter of 2019 decreased $6.6 million, or five percent, versus net sales for the same period of 2018. A three percent increase in sales volume positively impacted the quarter-over-quarter change in net sales by $4.5 million. The unfavorable impact of lower average selling prices and foreign currency translation negatively impacted the quarter-over-quarter change in net sales by $8.8 million and $2.3 million, respectively. A quarter-over-quarter comparison of net sales by region follows:

(Dollars in thousands)

Net sales for North American operations declined $3.3 million, or four percent, primarily due to lower average selling prices partially offset by slightly favorable volume growth. The lower selling prices negatively impacted net sales quarter-over-quarter by $3.7 million while sales volume growth positively impacted the quarter by $0.4 million. The lower selling prices are largely a reflection of lower raw material costs. Sales volume of polyols used in rigid foam applications increased five percent during the third quarter of 2019 but was mostly offset by lower phthalic anhydride and specialty polyols sales volume.

Net sales for European operations declined $5.9 million or 13 percent. The unfavorable impact of lower average selling prices and foreign currency translation negatively impacted the quarter-over-quarter change in net sales by $3.6 million and $1.9 million, respectively. A one percent decline in sales volume negatively impacted net sales quarter-over-quarter by $0.4 million. A stronger U.S. dollar relative to the Polish zloty led to the foreign currency translation effect.

Net sales for Asia and Other operations increased $2.7 million, or 33 percent, quarter-over-quarter primarily due to a 50 percent increase in sales volume. The increase in sales volume positively impacted the quarter-over-quarter change in net sales by $4.1 million. The unfavorable impact of lower average selling prices and foreign currency translation negatively impacted the quarter by $1.1 million and $0.3 million, respectively.

Polymer operating income for the third quarter of 2019 increased $4.0 million, or 21 percent, from operating income for the third quarter of 2018. Gross profit increased $3.4 million, or 13 percent, quarter-over-quarter. Operating expenses declined $0.6 million quarter-over-quarter. Quarter-over-quarter comparisons of gross profit by region and total segment operating expenses and operating income follow:

(Dollars in thousands)

(1) The 2018 North America gross profit and total operating income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Gross profit for North American operations increased $1.6 million, or eight percent, quarter-over-quarter due to improved unit margins and slightly higher sales volume. The margin improvement reflects favorable product mix, which benefited from five percent sales volume growth of polyols used in rigid foam applications, partially offset by lower phthalic anhydride and specialty polyols volumes.

Gross profit for European operations was flat between quarters. Higher average unit margins positively impacted quarter-over-quarter gross profit by $0.4 million but were largely offset by the unfavorable impact of foreign currency translation.

Gross profit for Asia and Other operations improved $1.8 million quarter-over-quarter primarily due to improved unit margins and sales volume growth of 50 percent.

Specialty Products

Net sales for the third quarter of 2019 decreased $2.7 million, or 14 percent, versus net sales for the third quarter of 2018. This decrease was primarily related to lower volume and lower average selling prices. Gross profit decreased $0.5 million and operating income decreased $0.4 million quarter-over-quarter primarily due to lower sales volume and unfavorable order timing differences within the Company’s pharmaceutical business. These items were partially offset by improved margins within the food and nutritional business.

Corporate Expenses

Corporate expenses, which include deferred compensation, business restructuring and other operating expenses that are not allocated to the reportable segments, decreased $6.4 million between quarters. Corporate expenses were $17.2 million in the third quarter of 2019 versus $23.6 million in 2018. The decrease was primarily attributable to lower deferred compensation expense ($2.6 million), business restructuring expense ($1.3 million) and non-recurring 2018 employee separation costs.

The $2.6 million decrease in quarter-over-quarter deferred compensation expense was primarily due to a $5.15 per share increase in the market price of Company common stock in the third quarter of 2019 compared to a $9.00 per share increase for the third quarter of 2018. The following table presents the quarter-end Company common stock market prices used in the computation of deferred compensation expenses for the three months ended September 30, 2019 and 2018:

33

Nine Months Ended September 30, 2019 and 2018

Summary

Net income attributable to the Company for the first nine months of 2019 decreased seven percent to $81.1 million, or $3.48 per diluted share, from $87.2 million, or $3.74 per diluted share, for the first nine months of 2018. Adjusted net income increased two percent to $93.7 million, or $4.02 per diluted share, from $92.2 million, or $3.95 per diluted share, in 2018 (see the “Reconciliation of Non-GAAP Adjusted Net Income and Diluted Earnings per Share” section of this MD&A for reconciliations between reported net income attributable to the Company and related earnings per diluted share and non-GAAP adjusted net income and related earnings per diluted share). Below is a summary discussion of the major factors leading to the year-over-year changes in net sales, profits and expenses. A detailed discussion of segment operating performance for the first nine months of 2019 compared to the first nine months of 2018 follows the summary.

Consolidated net sales decreased $113.4 million, or seven percent, between years. The unfavorable impact of lower average selling prices, lower sales volume and foreign currency translation negatively impacted net sales by $41.5 million, $38.7 million and $33.2 million, respectively. The decrease in average selling prices was primarily due to the pass through of lower raw material costs. Consolidated sales volume decreased three percent year-over-year. Sales volume in the Surfactant segment decreased four percent while sales volume in the Polymer and Specialty Product segments increased four percent each. Approximately 45 percent of the decline in Surfactant volume was due to the Company’s exit from its sulfonation business in Germany during the fourth quarter of 2018. The unfavorable foreign currency translation effect reflected a stronger U.S. dollar against the majority of currencies where the Company has foreign operations

Operating income for the first nine months of 2019 declined $15.0 million, or 13 percent, from operating income reported for the first nine months of 2018. Most of this decline was related to lower year-over-year gross profit and higher deferred compensation expense. These two items negatively impacted the year-over-year change in operating income by $9.8 million and $6.5 million, respectively. Foreign currency translation had a $2.5 million unfavorable effect on year-over-year consolidated operating income. From a segment perspective, Polymer and Specialty Product operating income increased $1.3 million and $4.8 million, respectively. Surfactant operating income declined by $15.5 million.

Operating expenses (including deferred compensation and business restructuring expenses) increased $5.3 million, or three percent, between years. Changes in the individual income statement line items that comprise the Company’s operating expenses were as follows:

• Selling expenses decreased $0.6 million, or one percent, year-over-year.
• Administrative expenses increased $1.1 million, or two percent, year-over-year primarily due to $3.3 million of environmental remediation expenses incurred in 2019. The majority of these costs relate to the Company’s Maywood, New Jersey site. Non-recurring employee separation costs incurred in 2018 partially offset the above.
• R&D expenses declined $1.1 million, or three percent, year-over-year.
• Deferred compensation expense increased $6.5 million year-over-year primarily due to a $23.06 per share increase in the market price of Company common stock during the first nine months of 2019 compared to an $8.04 share increase in the first nine months of 2018. See the Overview and Segment Results-Corporate Expenses sections of this MD&A for further details.
• Business restructuring expenses were $1.6 million in the first nine months of 2019 compared to $2.3 million in the first nine months of 2018. The 2019 restructuring charges were primarily comprised of severance and office shutdown expenses related to the Specialty Product segment restructuring ($0.5 million), ongoing decommissioning costs associated with the Company’s manufacturing facility in Canada that ceased operations in the fourth quarter of 2016 ($0.8 million), and decommissioning expenses associated with the Company’s 2018 sulfonation shutdown in Germany ($0.6 million). The 2018 restructuring charges were comprised of asset and spare part write-downs related to the Company ceasing Surfactant operations in Germany ($1.4 million) and decommissioning costs associated with the Canadian plant closure ($0.9 million). See Note 17, Business Restructuring, for additional details.

Net interest expense for the first nine months of 2019 declined $3.6 million versus the first nine months of 2018. This decrease was primarily due to higher U.S. interest income earned on U.S. cash balances, resulting from the repatriation of $100.0 million to the United States in 2018, and lower interest expense resulting from scheduled debt repayments and the Company’s voluntary prepayment of its 5.88% Senior Notes in the second quarter of 2019.

Other, net was $4.3 million of income for the first nine months of 2019 compared to $2.0 million of income for the first nine months of 2018. The Company recognized $3.1 million of investment income (including realized and unrealized gains and losses) for the Company’s deferred compensation and supplemental defined contribution mutual fund assets in the first nine months of 2019 compared to $1.6 million of income in the first nine months of 2018. In addition, the Company reported foreign exchange gains of $0.3 million in 2019 versus $0.9 million of gains in the first nine months of 2018. The Company also reported $0.7 million of lower net periodic pension cost expense in the first nine months of 2019 versus the prior year. The Company also reported a $0.6 million gain on the sale of an asset in 2019.

The Company’s effective tax rate was 17.3 percent for the first nine months of 2019 compared to 18.7 percent for the first nine months of 2018. The year-over-year decrease was primarily attributable to: (i) current year incremental U.S. tax credits identified as part of a research and development tax credit study, and; (ii) the non-recurrence of unfavorable tax consequences resulting from the repatriation of $100.0 million to the United States in 2018. These items were substantially offset by other non-recurring favorable tax benefits recognized in the first nine months of 2018.

(In thousands)

(In thousands)

(1) The 2018 segment and total operating income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Segment Results

Surfactants

Surfactant net sales for the first nine months of 2019 decreased $100.0 million, or nine percent, versus net sales for the first nine months of 2018. The unfavorable impact of lower sales volume, lower average selling prices and foreign currency translation negatively impacted the year-over-year change in net sales by $47.6 million, $30.8 million and $21.6 million, respectively. Sales volume declined four percent versus prior year. A year-over-year comparison of net sales by region follows:

(In thousands)

35

Net sales for North American operations decreased $58.7 million, or nine percent, year-over-year. A five percent decline in sales volume, lower average selling prices and the unfavorable impact of foreign currency translation negatively impacted the year-over-year change in net sales by $30.3 million, $27.7 million and $0.7 million, respectively. The decline in sales volume was mostly due to lower commodity demand in the personal care end market, lower demand in the functional products end market and lower sales volume to our distribution partners. Selling prices decreased five percent mostly due to the pass through of lower raw material costs to customers. The foreign currency impact reflected a stronger U.S. dollar relative to the Canadian dollar.

Net sales for European operations decreased $29.5 million, or 14 percent, primarily due to a nine percent decrease in sales volume and the unfavorable effects of foreign currency translation. These items negatively impacted the year-over-year change in net sales by $19.4 million and $11.6 million, respectively. The lower sales volume was principally due to the Company ceasing Surfactant production at its German site during the fourth quarter of 2018. A stronger U.S. dollar relative to the British pound sterling and European euro led to the foreign currency translation effect. Slightly higher average selling prices favorably impacted the year-over-year change in net sales by $1.5 million.

Net sales for Latin American operations were essentially flat year-over-year. A three percent increase in sales volume and higher average selling prices positively impacted the year-over-year change in net sales by $5.2 million and $4.1 million, respectively. These items were offset by foreign currency translation which negatively impacted the year-over-year change in net sales by $9.4 million. The higher sales volume was mostly attributable to higher demand in the laundry and cleaning and agricultural end markets. The higher average selling prices were partially due to one-time benefits related to a VAT tax recovery in Brazil. The year-over-year strengthening of the U.S. dollar against the Columbian and Mexican pesos and Brazilian real generated the unfavorable foreign currency effect.

Net sales for Asian operations decreased $11.7 million, or 23 percent, primarily due to a 13 percent decline in sales volume and lower average selling prices. These items accounted for $6.3 million and $5.6 million, respectively, of the year-over-year change in net sales. The decline in sales volume was largely due to lower commodity demand in the laundry and cleaning end markets and lower sales volume to our distribution partners. The lower selling prices were mostly due to the pass through of lower raw material costs to customers. The favorable effects of foreign currency translation positively impacted the net sales change by $0.2 million.

Surfactant operating income for the first nine months of 2019 decreased $15.5 million, or 15 percent, versus operating income for the first nine months of 2018. Gross profit declined $15.4 million, or nine percent, versus prior year and operating expenses were essentially flat. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

(In thousands)

(1) The 2018 North America gross profit and total operating income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Gross profit for North American operations decreased $13.1 million, or 11 percent, year-over-year primarily due to lower unit margins and a five percent decline in sales volume. These items negatively impacted the change in gross profit by $7.3 million and $5.7 million, respectively. The lower unit margins were mostly attributable to higher one-time inventory costs associated with the Company’s internal Asia-U.S. supply chain. The decline in sales volume was mostly due to lower commodity demand in the personal care end markets, lower demand in the functional products end market and lower sales volume to our distribution partners.

Gross profit for European operations increased $2.2 million, or nine percent, primarily due to lower overhead costs and higher unit margins resulting from the Company ceasing Surfactant production at its German plant site during the fourth quarter of 2018.

Higher unit margins favorably impacted the year-over-year change in gross profit by $6.0 million. A nine percent decline in sales volume and the unfavorable effect of foreign currency translation negatively impacted the current year by $2.2 million and $1.6 million, respectively. The lower sales volume is primarily attributable to the Company’s exit from sulfonation in Germany during the fourth quarter of 2018.

Gross profit for Latin American operations decreased $3.5 million, or 19 percent, primarily due to lower unit margins and the unfavorable impact of foreign currency translation. These items negatively impacted the change in year-over-year gross profit by $2.7 million and $1.4 million, respectively. The lower unit margins primarily reflect competitive market pressures and the residual impact of the Ecatepec equipment failure in Mexico. Sales volume growth of three percent positively impacted current year gross profit by $0.6 million.

Gross profit for Asian operations decreased $1.0 million, or eight percent, largely due to a 13 percent decline in sales volume that negatively impacted the year-over-year change in gross profit by $1.6 million. The decline in sales volume was largely due to lower commodity demand in the laundry & cleaning end markets and lower sales volume to our distribution partners. Higher unit margins positively impacted the year-over-year change in gross profit by $0.6 million.

Operating expenses for the Surfactant segment were flat year-over-year.

Polymers

Polymer net sales for the first nine months of 2019 decreased $8.5 million, or two percent, versus net sales for the same period of 2018. A four percent increase in sales volume positively impacted the year-over-year change in net sales by $16.3 million. The unfavorable impact of lower average selling prices and foreign currency translation negatively impacted the year-over-year change in net sales by $13.7 million and $11.1 million, respectively. A year-over-year comparison of net sales by region follows:

(Dollars in thousands)

Net sales for North American operations declined $6.0 million, or two percent, primarily due to lower average selling prices partially offset by slightly favorable volume growth. The lower average selling prices negatively impacted the change in net sales by $7.1 million. Slightly higher sales volume increased net sales year-over-year by $1.1 million. Sales volume of polyols used in rigid foam applications increased 11 percent during the first nine months of 2019 but was mostly offset by lower phthalic anhydride and specialty polyols sales volume.

Net sales for European operations decreased $6.6 million, or five percent. Sales volume growth of six percent increased net sales year-over-year by $7.7 million. The unfavorable impact of foreign currency translation and lower average selling prices decreased net sales year-over-year by $9.6 million and $4.7 million, respectively. A stronger U.S. dollar relative to the Polish zloty led to the foreign currency translation effect.

Net sales for Asia and Other operations increased $4.0 million, or 17 percent, year-over-year primarily due to a 27 percent increase in sales volume. The increase in sales volume positively impacted the year-over-year change in net sales by $6.5 million. The unfavorable impact of foreign currency translation and lower average selling prices negatively impacted the change in net sales by $1.6 million and $0.9 million, respectively.

Polymer operating income for the first nine months of 2019 increased $1.3 million, or two percent, from operating income for the first nine months of 2018. Gross profit increased $0.5 million, or one percent during the first nine months of 2019 versus prior year. Operating expenses declined $0.8 million, or four percent, year-over-year. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

(In thousands)

(1) The 2018 North America gross profit and total operating income line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Gross profit for North American operations declined $2.1 million, or four percent, year-over-year due to slightly lower unit margins that were primarily driven by the consumption of higher priced 2018 year-end inventories carried to guard against winter supply disruptions and the non-recurrence of a $2.1 million class action settlement received in the first quarter of 2018. Slightly higher sales volume positively impacted year-over-year gross profit by $0.3 million. Sales volume of polyols used in rigid foam applications increased 11 percent during the first nine months of 2019 but was mostly offset by lower phthalic anhydride and specialty polyols sales volume.

Gross profit for European operations declined $0.9 million, or five percent, year-over-year. Sales volume growth of six percent positively impacted the year-over-year change in gross profit by $1.1 million. The unfavorable impact of foreign currency translation and lower unit margins negatively impacted year-over-year gross profit by $1.3 million and $0.7 million, respectively.

Gross profit for Asia and Other operations improved $3.5 million due to higher unit margins and 27 percent sales volume growth during the first nine months of 2019.

Specialty Products

Net sales for the first nine months of 2019 declined $4.9 million, or eight percent, versus net sales for the same period of 2018. Sales volume increased four percent but the increase was offset by a decrease in average selling prices. Gross profit increased $4.1 million and operating income increased $4.8 million year-over-year due to improved sales volume and margins within the food and nutritional business and order timing differences within the Company’s pharmaceutical and flavor businesses.

Corporate Expenses

Corporate expenses, which include deferred compensation, business restructuring and other operating expenses that are not allocated to the reportable segments, increased $5.7 million between years. Corporate expenses were $59.7 million in the first nine months of 2019 versus $54.0 million in the first nine months of 2018. This increase was primarily attributable to higher deferred compensation expense ($6.5 million) and environmental remediation expense ($3.3 million). These items were partially offset by a decrease in business restructuring expenses ($0.7 million), the non-recurrence of 2018 employee separation costs ($2.1 million) and the non-recurrence of prior year costs associated with the Company’s 2018 first quarter acquisition in Mexico.

Deferred compensation expense increased $6.5 million between years. This increase was primarily due to a $23.06 per share increase in the market price of the Company’s common stock in the first nine months of 2019 compared to an $8.04 per share increase in the first nine months of 2018. The following table presents the period-end Company common stock market prices used in the computation of deferred compensation expenses for the nine months ended September, 2019 and 2018:

38

LIQUIDITY AND CAPITAL RESOURCES

Overview

For the nine months ended September 30, 2019, operating activities were a cash source of $132.7 million versus a source of $96.2 million for the comparable period in 2018. For the current year period, investing cash outflows totaled $68.5 million, as compared to an outflow of $82.7 million in the prior year period, and financing activities were a use of $74.4 million, as compared to a use of $34.1 million in the prior year. Cash and cash equivalents decreased by $14.2 million compared to December 31, 2018, inclusive of a $3.9 million unfavorable exchange rate impact.

At September 30, 2019, the Company’s cash and cash equivalents totaled $286.0 million, of which $162.6 million was held within the United States. The U.S. cash was held in money market funds, deposit accounts and a certificate of deposit totaling $74.0 million, $73.6 million and $15.0 million, respectively. The Company’s non-U.S. subsidiaries held $123.4 million of cash outside the United States as of September 30, 2019.

Operating Activity

Net income decreased by $6.1 million versus the comparable period in 2018. Working capital was a use of $22.2 million versus a use of $64.4 million for the comparable to prior year period.

Year-to-date accounts receivable were a use of $9.0 million compared to a use of $34.8 million for the comparable period in 2018. Inventories were a source of $25.9 million in 2019 versus a use of $23.4 million in 2018. Accounts payable and accrued liabilities were a use of $35.3 million in 2019 compared to a use of $6.9 million for the same period in 2018.

Working capital requirements were lower year-to-date, compared to the same period in 2018, due to the changes noted above. The 2019 accounts receivable lower cash usage primarily reflects lower sales quantities. The current year inventory source of cash reflects lower quantities and prices. The current year accounts payable and accrued liabilities cash usage reflects lower quantities purchased and prices. It is management’s opinion that the Company’s liquidity is sufficient to provide for potential increases in working capital requirements during 2019.

Investing Activity

Cash used for investing activities decreased by $14.2 million year-over-year. In the first nine months of 2018, the Company paid $21.5 million in cash to acquire BASF’s production facility in Ecatepec, Mexico and a portion of the related surfactants business. Cash used for capital expenditures was $70.8 million in the first nine months of 2019 versus $62.9 million in the comparable prior year period.

For 2019, the Company estimates that total capital expenditures will range from $110 million to $130 million, inclusive of infrastructure and optimization spending in the United States, Germany and Mexico.

Financing Activity

Cash used for financing activities was $74.4 million in 2019 versus $34.1 million in 2018. The majority of this increase in cash usage relates to the voluntary prepayment of the outstanding principal balance of the Company’s 5.88 percent Senior Notes in the second quarter of 2019 and scheduled principal payments on the Company’s 3.86 percent Notes that were incurred for the first time in 2019.

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 benefit plans. The Company may, from time to time, seek to retire or purchase additional amounts of its outstanding equity and/or 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. In the nine months ended September 30, 2019, the Company purchased 144,457 shares of its common stock at a total cost of $13.2 million, on the open market. As of September 30, 2019, there were 349,830 shares remaining under the current share repurchase authorization.

Debt and Credit Facilities

Consolidated balance sheet debt decreased to $231.9 million as of September 30, 2019 from $276.1 million at December 31, 2018. Net debt (which is defined as total debt minus cash – see the Reconciliation of Non-GAAP Net Debt section of this MD&A) decreased by $30.0 million for the first nine months of 2019, from a negative $24.1 million to a negative $54.1 million, primarily due to current year debt repayments.

As of September 30, 2019, the ratio of total debt to total debt plus shareholders’ equity was 21 percent compared to 25 percent at December 31, 2018. As of September 30, 2019, the ratio of net debt to net debt plus shareholders’ equity was a negative 7 percent, compared to a negative 3 percent at December 31, 2018.

On January 30, 2018, the Company entered into a five year committed $350 million multi-currency revolving credit facility with a syndicate of banks that matures on January 30, 2023. This revolving credit facility replaced the Company’s prior $125 million 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, 2019, the Company had outstanding letters of credit totaling $5.0 million under the revolving credit agreement and no borrowings, with $345.0 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 expenditure programs and acquisitions. At September 30, 2019, the Company’s foreign subsidiaries had outstanding debt of $0.6 million.

The Company has 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 treasury shares. As of September 30, 2019, testing for these agreements was based on the Company’s consolidated financial statements. 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 $325.0 million.

4. The Company is permitted to pay dividends and purchase treasury shares after December 31, 2017, in amounts of up to $100.0 million plus 100 percent of net income and cash proceeds of stock option exercises, measured cumulatively beginning December 31, 2017. The maximum amount of dividends that could have been paid within this limitation is disclosed as unrestricted retained earnings in Note 15 to the condensed consolidated financial statements.

The Company believes it was in compliance with all of its loan agreements as of September 30, 2019.

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. For the nine months ended September 30, 2019 and 2018, the Company’s expenditures for capital projects related to the environment were $1.3 million and $3.1 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 $22.8 million and $21.1 million for the nine months ended September 30, 2019 and 2018, respectively.

Over the years, the Company has received requests for information related to or has been named by the government as a PRP 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 the 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. Some of the factors on which the Company bases its estimates include information provided by feasibility studies, PRP negotiations and the development of remedial action plans. After partial remediation payments at certain sites, the Company has estimated a range of possible environmental and legal losses of $23.9 million to $45.6 million at September 30, 2019, compared to $23.4 million to $44.7 million at December 31, 2018. Within the range of possible environmental losses, management currently concluded that no single amount is more likely to occur than any other amounts in the ranges and, thus, has accrued at the lower end of the ranges; that accrual totaled $23.9 million at September 30, 2019 and $23.4 million at December 31, 2018. Because the liabilities accrued are estimates, actual amounts could differ materially from the amounts reported. Cash expenditures related to legal and environmental matters were $2.8 million for the nine months ended September 30, 2019, compared to $1.0 million for the same period in 2018. The majority of the 2019 cash expenditures relate to environmental remediation costs at the Company’s Maywood, New Jersey site.

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 9, Contingencies, to the condensed consolidated financial statements for a summary of the environmental proceedings related to certain environmental sites.

OUTLOOK

Management believes its Surfactant strategy, inclusive of its focus on end market diversification, Tier 2 and Tier 3 customers and cost out activities will continue to contribute to margin improvement despite the challenging current environment. Management believes Polymers will continue to benefit from the growing market for insulation material and remains optimistic the business will deliver full year volume growth and incremental margin improvement versus the prior year. Management believes full year Specialty Products results will improve versus the prior year.

CRITICAL ACCOUNTING POLICIES

There have been no changes to the critical accounting policies disclosed in the Company’s 2018 Annual Report on Form 10-K.

RECONCILIATION OF NON-GAAP ADJUSTED NET INCOME AND EARNINGS PER SHARE

(In millions, except per share amounts)

(1) The 2018 amounts for the noted line items have been retrospectively changed from the amounts originally reported as a result of the Company’s first quarter 2019 change in method of accounting for U.S. inventory valuation from LIFO to FIFO.

Management believes that certain non-GAAP measures, when presented in conjunction with comparable GAAP measures, are useful for evaluating the Company’s operating performance and provide better clarity on the impact of non-operational items. 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 a substitute for or superior to, measures of financial performance prepared in accordance with GAAP. The cumulative tax effect was calculated using the statutory tax rates for the jurisdictions in which the noted transactions occurred.

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. This adjusted measure should be considered supplemental to and not a substitute for financial information prepared in accordance with GAAP. The Company's definition of this adjusted measure may differ from similarly titled measures used by other entities.

(In millions)

43

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, 2019. 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, 2019, 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, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.