NEWMARKET CORP 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This report contains forward-looking statements about future events and expectations within the meaning of the Private Securities Litigation Reform Act of 1995. We have based these forward-looking statements on our current expectations and projections about future results. When we use words in this document such as “anticipates,” “intends,” “plans,” “believes,” “estimates,” “projects,” “expects,” “should,” “could,” “may,” “will,” and similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements we make regarding future prospects of growth in the petroleum additives market, other trends in the petroleum additives market, our ability to maintain or increase our market share, and our future capital expenditure levels. We believe our forward-looking statements are based on reasonable expectations and assumptions, within the bounds of what we know about our business and operations. However, we offer no assurance that actual results will not differ materially from our expectations due to uncertainties and factors that are difficult to predict and beyond our control. Factors that could cause actual results to differ materially from expectations include, but are not limited to, the availability of raw materials and distribution systems; disruptions at production facilities, including single-sourced facilities; hazards common to chemical businesses; the ability to respond effectively to technological changes in our industry; failure to protect our intellectual property rights; sudden or sharp raw material price increases; competition from other manufacturers; current and future governmental regulations; the gain or loss of significant customers; failure to attract and retain a highly-qualified workforce; an information technology system failure or security breach; the occurrence or threat of extraordinary events, including natural disasters, terrorist attacks, and health-related epidemics such as the COVID-19 pandemic; risks related to operating outside of the United States; political, economic, and regulatory factors concerning our products; the impact of substantial indebtedness on our operational and financial flexibility; the impact of fluctuations in foreign exchange rates; resolution of environmental liabilities or legal proceedings; limitation of our insurance coverage; our inability to realize expected benefits from investment in our infrastructure or from recent or future acquisitions, or our inability to successfully integrate recent or future acquisitions into our business; the underperformance of our pension assets resulting in additional cash contributions to our pension plans; and other factors detailed from time to time in the reports that NewMarket files with the SEC, including the risk factors in Item 1A. “Risk Factors” of our 2020 Annual Report, which is available to shareholders upon request. You should keep in mind that any forward-looking statement made by us in this report or elsewhere speaks only as of the date on which we make it. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. We have no duty to, and do not intend to, update or revise the forward-looking statements in this discussion after the date hereof, except as may be required by law. In light of these risks and uncertainties, any forward-looking statement made in this report or elsewhere, might not occur. Overview When comparing the results of the petroleum additives segment for the first nine months of 2021 with the first nine months of 2020, net sales increased 19.9% primarily due to higher lubricant additives product shipments, higher selling prices, and a favorable foreign currency impact. Petroleum additives operating profit was 3.4% lower when comparing the first nine months of 2021 with the first nine months of 2020, reflecting significantly higher raw material costs partially offset by improved product shipments and higher selling prices. During the third quarter of 2021, we increased our quarterly dividend to $2.10 per share, and we repurchased 292,392 shares of our common stock for a total of $99.5 million. Our operations generate cash that is in excess of the needs of the business. We continue to invest in and manage the business for the long-term with the intent of helping our customers succeed in their marketplaces. Our investments continue to be in organizational talent, technology development and processes, and global infrastructure, consisting of technical centers, production capability, and geographic expansion. Impact of the Current Economic Environment and the COVID-19 Pandemic The current economic environment in which we operate is characterized by steadily rising costs, including raw material costs, limitations on certain supply availability, and a challenging supply chain network and transportation system. Because of our active business continuity process and global network, we have substantially managed through these factors during the first nine months of the year and have delivered product to our customers. We do not currently expect the supply chain network disruptions to be long-term in nature, but we cannot predict how the current economic environment may evolve over the coming months. We will continue working with our customers to deliver product, but at the same time, we also expect to be challenged by these ongoing economic factors as we manage our business throughout the rest of the year. 18 Table of Contents In addition, but to a lesser extent than during 2020, petroleum additives operating results for the first nine months of 2021 include an unfavorable impact from the economic uncertainty resulting from the ongoing effects of the COVID-19 pandemic and the related restrictions on the movement of people, goods and services. The pace and stability of improvement in demand for our products will continue to depend heavily on economic recovery. All of our locations around the world, including our manufacturing and research and development facilities, have continued to operate safely and without interruption during the pandemic, with only a very few government-ordered, short-term exceptions, and we expect them to continue to do so. Our financial position remains strong. We have sufficient access to capital, if needed, and do not anticipate any issues with meeting the covenants for all our debt agreements. Our major capital projects are continuing to progress substantially as planned. As we operate in the chemical industry, we continue to be focused on protecting the health and safety of our employees and have procedures in place at each of our operating facilities to help ensure their well-being. The chemical industry and our products are recognized as essential for transportation of goods and services. Our business continuity planning process focuses our efforts on managing through this challenging time and helping our customers do the same. As we are a global company and can leverage the knowledge and experience of our personnel in facilities across the world, we do not expect to experience negative impacts related to short-term travel and border restrictions. Results of Operations Net Sales Consolidated net sales for the third quarter of 2021 totaled $622.2 million, representing an increase of $109.3 million, or 21.3% from the third quarter of 2020. Consolidated net sales for the first nine months of 2021 totaled $1.8 billion, representing an increase of $296.4 million, or 20.0%, from the first nine months of 2020. The following table shows net sales by segment and product line. Third Quarter Ended September 30, Nine Months Ended September 30, (in millions) 2021 2020 2021 2020 Petroleum additives Lubricant additives $ 527.2 $ 432.9 $ 1,520.5 $ 1,240.1 Fuel additives 91.9 77.4 250.1 236.3 Total 619.1 510.3 1,770.6 1,476.4 All other 3.1 2.6 8.9 6.8 Net sales $ 622.2 $ 512.9 $ 1,779.5 $ 1,483.2 Petroleum Additives Segment The regions in which we operate include North America (the United States and Canada), Latin America (Mexico, Central America, and South America), Asia Pacific, and the EMEAI region. While there is some fluctuation, the percentage of net sales generated in the regions remained fairly consistent when comparing the first nine months of 2021 with the same period in 2020, as well as with the full year in 2020. Petroleum additives net sales for the third quarter of 2021 were $619.1 million compared to $510.3 million for the third quarter of 2020, an increase of 21.3%. Petroleum additives net sales for the first nine months of 2021 were $1.8 billion compared to $1.5 billion for the first nine months of 2020, an increase of 19.9%. For both the third quarter and nine months comparative periods, the increases were across all regions with North America representing around 40% of the increase in both comparative periods. The EMEAI region contributed an approximate 25% increase in the third quarter comparison with the Latin America and Asia Pacific regions each contributing approximately equally for the remaining increase. For the nine month comparison, the Asia Pacific region reflected an approximate 25% increase with the EMEAI and Latin America regions reflecting the remaining increases in petroleum additives net sales. While 2021 results continue to include the economic impact of the COVID-19 pandemic to a lesser extent, the third quarter and nine months 2020 periods include a more significant economic impact from the pandemic. 19 Table of Contents The following table details the approximate components of the increase in petroleum additives net sales between the third quarter and first nine months of 2021 and 2020. (in millions) Third Quarter Nine Months Period ended September 30, 2020 $ 510.3 $ 1,476.4 Lubricant additives shipments 53.7 237.0 Fuel additives shipments 4.3 2.9 Selling prices 46.2 28.2 Foreign currency impact, net 4.6 26.1 Period ended September 30, 2021 $ 619.1 $ 1,770.6 When comparing both the third quarter and the nine months periods of 2021 and 2020, petroleum additives shipments accounted for a $58.0 million increase in net sales for the third quarter comparison and a $239.9 million increase in net sales for the nine month comparison. Selling prices improved during both the third quarter and nine months comparison periods. The impact from selling prices was net of a favorable impact from foreign currency exchange rates in both comparative periods. The United States Dollar weakened against most of the major currencies in which we transact when comparing both the third quarter and nine months of 2021 and 2020 resulting in a favorable impact to petroleum additives net sales for both the third quarter and nine months comparative periods. The favorable impact was predominantly due to changes in the Euro and Chinese Renminbi exchange rates. On a worldwide basis, the volume of product shipments for petroleum additives increased 11.9% when comparing the two third quarter periods and 16.6% when comparing the nine months of 2021 and 2020. For the third quarter comparison, lubricant additives improved across all regions by similar amounts and fuel additives increased across all regions except the EMEAI region. For the nine months comparison, the North America and Asia Pacific regions each contributed approximately one-third of the improvement in lubricant additives shipments, with the EMEAI and Latin America regions also improving. Fuel additives shipments for the nine months comparison improved across all regions, except for the EMEAI region. Similar to the discussion on net sales above, the volume of product shipments in the third quarter and nine months of 2020 include the impact from unusually low shipments due to the COVID-19 pandemic. All Other The “All other” category includes the operations of the antiknock compounds business and certain contracted manufacturing and services. Segment Operating Profit NewMarket evaluates the performance of the petroleum additives business based on segment operating profit. NewMarket Services Corporation expenses are charged to NewMarket and each subsidiary pursuant to services agreements between the companies. Depreciation on segment property, plant, and equipment, as well as amortization of segment intangible assets and lease right-of-use assets, is included in segment operating profit. The following table reports segment operating profit for the third quarter and nine months ended September 30, 2021 and September 30, 2020. Third Quarter Ended September 30, Nine Months Ended September 30, (in millions) 2021 2020 2021 2020 Petroleum additives $ 72.1 $ 102.2 $ 240.4 $ 248.9 All other $ (0.1) $ 2.0 $ (0.8) $ 2.0 Petroleum Additives Segment The petroleum additives segment operating profit decreased $30.1 million when comparing the third quarter of 2021 to the third quarter of 2020 and $8.5 million when comparing the first nine months of 2021 to the first nine months of 2020. Both comparative periods included the impact of the same factors that affected gross profit (see discussion below). 20 Table of Contents The operating profit margin was 11.7% for the third quarter of 2021 as compared to 20.0% for the third quarter of 2020 and was 13.6% for the first nine months of 2021 as compared to 16.9% for the first nine months of 2020. For the rolling four quarters ended September 30, 2021, the operating profit margin for petroleum additives was 14.1%. Increasing costs during 2021, including primarily raw material costs, are having a negative impact on our operating profit margins. While we have made some progress in adjusting our selling prices, our costs have continued to rise. Operating profit margins remain a priority, and while they will fluctuate from quarter to quarter due to multiple factors, we believe the fundamentals of our business and industry as a whole are unchanged. Petroleum additives gross profit decreased $25.9 million when comparing the two third quarter periods and was substantially unchanged when comparing the first nine months of 2021 and 2020 . Cost of goods sold as a percentage of net sales was 77.7% for the third quarter of 2021, increasing from 67.9% for the third quarter of 2020, and 75.2% for the first nine months of 2021, increasing from 70.2% for the first nine months of 2020. When comparing the third quarters of 2021 and 2020, the decrease in gross profit primarily resulted from significantly higher raw material costs, as well as a small unfavorable impact from conversion costs, which were partially offset by improved selling prices and product shipments. The same unfavorable effect from higher raw material costs impacted the nine months comparison, but was offset primarily by improved product shipments and improved selling prices. Petroleum additives selling, general, and administrative expenses (SG&A) for the third quarter of 2021 were $1.9 million higher as compared to the third quarter of 2020, and $3.7 million higher when comparing the first nine months of 2021 to the same 2020 period. SG&A as a percentage of net sales was 4.9% for the third quarter of 2021, 5.6% for the third quarter of 2020, 5.2% for the first nine months of 2021, and 6.0% for the first nine months of 2020. Our SG&A costs are primarily personnel-related and include salaries, benefits, and other costs associated with our workforce, including travel expenses. While personnel-related costs fluctuate from period to period, there were no significant changes in the drivers of these costs when comparing the periods. Our investment in petroleum additives research, development, and testing (R&D) increased $2.3 million when comparing the third quarter of 2021 with the third quarter of 2020 and $5.1 million when comparing the first nine months periods of 2021 and 2020. As a percentage of net sales, R&D was 5.7% for the third quarter of 2021, 6.5% for the third quarter of 2020, 6.1% for the first nine months of 2021, and 6.9% for the first nine months of 2020. Our R&D investments reflect our efforts to support the development of solutions that meet our customers' needs, meet new and evolving standards, and support our expansion into new product areas. Our approach to R&D investments, as it is with SG&A, is one of purposeful spending on programs to support our current product base and to ensure that we develop products to support our customers' programs in the future. R&D investments include personnel-related costs, as well as costs for internal and external testing of our products. The following discussion references certain captions on the Consolidated Statements of Income. Interest and Financing Expenses Interest and financing expenses were $9.3 million for the third quarter of 2021, $6.5 million for the third quarter of 2020, $24.6 million for the first nine months of 2021 and $20.6 million for the first nine months of 2020. The increase for both the third quarter and the nine months comparison resulted primarily from higher outstanding debt during the 2021 periods. A slightly lower average interest rate resulted in a small favorable impact for the third quarter comparison, while a higher average interest rate resulted in a small unfavorable impact for the nine months comparison. Higher capitalized interest during the 2021 periods partially offset the average debt impact. Other Income (Expense), Net Other income (expense), net was income of $7.4 million for the third quarter of 2021, $25.3 million for the third quarter of 2020, $19.8 million for the first nine months of 2021 and $39.3 million for the first nine months of 2020. The amounts for both of the 2021 and 2020 periods primarily reflect the components of net periodic benefit cost (income), except for service cost, from defined benefit pension and postretirement plans. See Note 4 for further information on total periodic benefit cost (income). Both of the 2020 periods also included a gain of $16.5 million related to the sale of a non-operating parcel of real estate and both of the 2021 periods included the gains and losses on marketable securities. Income Tax Expense Income tax expense was $9.1 million for the third quarter of 2021 and $21.8 million for the third quarter of 2020. The effective income tax rate was 14.9% for the third quarter of 2021 and 18.6% for the third quarter of 2020. Income tax expense decreased $10.5 million due to lower income before income tax expense and $2.2 million resulting from the lower effective income tax rate. 21 Table of Contents Income tax expense was $43.9 million for the first nine months of 2021 and $51.3 million for the first nine months of 2020. The effective tax rate was 20.2% for the first nine months of 2021 and 20.1% for the first nine months of 2020. Income tax expense decreased $7.5 million due to lower income before income tax expense with the remainder of the difference caused by the slightly higher effective tax rate. The decrease in the tax rate for the third quarter comparison period is primarily driven by the impact from our foreign operations. Cash Flows, Financial Condition, and Liquidity Cash and cash equivalents at September 30, 2021 were $59.6 million, which was a decrease of $65.6 million since December 31, 2020. Cash and cash equivalents held by our foreign subsidiaries amounted to $57.8 million at September 30, 2021 and $97.3 million at December 31, 2020. Periodically, we repatriate cash from our foreign subsidiaries to the United States through intercompany dividends and loans. We do not anticipate significant tax consequences from future distributions of foreign earnings. A portion of our foreign cash balances is associated with earnings that we have asserted are indefinitely reinvested. We plan to use these indefinitely reinvested earnings to support growth outside of the United States through funding of operating expenses, research and development expenses, capital expenditures, and other cash needs of our foreign subsidiaries. We expect that cash from operations, together with borrowing available under our revolving credit facility, will continue to be sufficient to cover our operating needs and planned capital expenditures for at least the next twelve months. Cash Flows – Operating Activities Cash flows provided from operating activities for the first nine months of 2021 were $145.0 million, adjusted for the use of $98.4 million to fund higher working capital requirements. The $98.4 million used for working capital excluded a favorable foreign currency impact to the components of working capital on the balance sheet. The most significant changes in working capital included increases in accounts receivable, inventory, and accounts payable. The increase in accounts receivable balances when comparing September 30, 2021 with the end of 2020 was primarily the result of increased shipment volumes along with higher sales prices. The increase in inventory was primarily in response to higher forecasted demand in some regions, as well as increased raw material costs. The increase in accounts payable reflected higher raw material costs, increased purchases of raw materials to meet customer demand, and normal fluctuations across the regions due to timing. Including cash and cash equivalents, as well as the impact of changes in foreign currency exchange rates on the balance sheet, we had total working capital of $975.5 million at September 30, 2021 and $585.6 million at December 31, 2020. The current ratio was 3.49 to 1 at September 30, 2021 and 2.87 to 1 at December 31, 2020. Cash Flows – Investing Activities Cash used in investing activities totaled $445.6 million during the first nine months of 2021 and represented the purchases (net of proceeds from sales and maturities) of marketable securities of $381.5 million and capital expenditures of $64.0 million. We currently expect that our total capital spending during 2021 will be in the $75 million to $85 million range and will include several improvements to our manufacturing and R&D infrastructure around the world. We expect to continue to finance capital spending through cash on hand and cash provided from operations, together with borrowing available under our revolving credit facility. Cash Flows – Financing Activities Cash provided from financing activities during the first nine months of 2021 amounted to $235.7 million. These cash flows included $395.1 million of proceeds from the issuance of our $400 million 2.70% senior notes, which were subsequently mostly invested in marketable securities. Cash flows from financing activities also included $91.7 million for repurchase of our common stock and cash dividend payments of $64.1 million. Debt Our long-term debt was $991.9 million at September 30, 2021 compared to $598.8 million at December 31, 2020. On March 18, 2021, we issued $400 million aggregate principal amount of 2.70% senior notes due 2031 at an issue price of 98.763%. We intend to use the net proceeds from the offering for the repayment or redemption of our 4.10% senior notes and for general corporate purposes. We incurred financing costs in 2021 of approximately $4 million related to the 2.70% senior notes, which are being amortized over the term of the notes. 22 Table of Contents See Note 9 for additional information on the 2.70% senior notes, 4.10% senior notes, 3.78% senior notes, and revolving credit facility, including the unused portion of our revolving credit facility. All of our senior notes and the revolving credit facility contain covenants, representations, and events of default that management considers typical of credit arrangements of this nature. The covenants under the 3.78% senior notes include negative covenants, certain financial covenants, and events of default which are substantially similar to the covenants and events of default in our revolving credit facility. The revolving credit facility contains financial covenants that require NewMarket to maintain a consolidated Leverage Ratio (as defined in the agreement) of no more than 3.75 to 1.00, except during an Increased Leverage Period (as defined in the agreement) at the end of each quarter. At September 30, 2021, the Leverage Ratio was 2.66 under the revolving credit facility. At September 30, 2021, we were in compliance with all covenants under the 4.10% senior notes, 3.78% senior notes, 2.70% senior notes, and revolving credit facility. As a percentage of total capitalization (total long-term debt and shareholders’ equity), our total long-term debt percentage increased from 44.1% at December 31, 2020 to 56.2% at September 30, 2021. The change in the percentage resulted primarily from the issuance of the 2.70% senior notes, partially offset by the increase in shareholders' equity. The change in shareholders’ equity primarily reflects our earnings offset by dividend payments, the repurchases of our common stock, and the impact of foreign currency translation adjustments along with the changes in the funded position of our defined benefit plans. Generally, we repay any outstanding long-term debt with cash from operations or refinancing activities. Critical Accounting Policies and Estimates This Form 10-Q and our 2020 Annual Report include discussions of our accounting policies, as well as methods and estimates used in the preparation of our financial statements. We also provided a discussion of Critical Accounting Policies and Estimates in our 2020 Annual Report. There have been no significant changes in our critical accounting policies and estimates from those reported in our 2020 Annual Report. Recent Accounting Pronouncements There are no new significant recent accounting pronouncements which may materially impact our financial statements. Outlook Our stated goal is to provide a 10% compounded return per year for our shareholders over any five-year period (defined by earnings per share growth plus dividend yield), although we may not necessarily achieve a 10% return each year. We continue to have confidence in our customer-focused strategy and approach to the market. We believe the fundamentals of how we run our business - a long-term view, safety-first culture, customer-focused solutions, technology-driven product offerings, and world-class supply chain capability - will continue to be beneficial for all of our stakeholders over the long term. We expect our petroleum additives segment will continue to experience impacts to its operating performance due to the current economic environment. Our global business will see varying effects on demand that will differ by region based on our product portfolio and geographic coverage. The global market for our products should continue to stabilize as government restrictions on the movement of people, goods, and services are lifted, as modern transportation and machinery cannot function without our products. We expect that the petroleum additives market will grow in the 1% to 2% range annually for the foreseeable future. We plan to exceed that growth rate over the long-term. Over the past several years we have made significant investments in our business as the industry fundamentals remain positive. These investments have been and will continue to be in organizational talent, technology development and processes, and global infrastructure, consisting of technical centers, production capability, and geographic expansion. We intend to utilize these investments to improve our ability to deliver the solutions that our customers value, expand our global reach, and enhance our operating results. We will continue to invest in our capabilities to provide even better value, service, technology, and customer solutions. Our business generates significant amounts of cash beyond its operational needs. We regularly review our many internal opportunities to utilize excess cash from technological, geographic, production capability, and product line perspectives. We believe our capital spending is creating the capability we need to grow and support our customers worldwide, and our research and development investments are positioning us well to provide added value to our customers. Our primary focus in the acquisition area remains on the petroleum additives industry. It is our view that this industry segment will provide the greatest opportunity for solid returns on our investments while minimizing risk. We remain focused on this strategy and will evaluate 23 Table of Contents any future opportunities. We will continue to evaluate all alternative uses of cash to enhance shareholder value, including stock repurchases and dividends.