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, sharp, or prolonged 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, wars, 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 future acquisitions, or our inability to successfully integrate 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 2021 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 three months of 2022 with the first three months of 2021, net sales increased 16.9% primarily due to higher selling prices, as well as higher product shipments, which were partially offset by an unfavorable foreign currency impact. Petroleum additives operating profit was 7.6% lower when comparing the first three months of 2022 with the first three months of 2021, reflecting significantly higher raw material costs, as well as higher operating costs, partially offset by higher selling prices and improved product shipments. During the first three months of 2022, we repurchased 115,796 shares of our common stock for a total of $37.3 million. We also redeemed our 4.10% senior notes and sold all of our marketable securities. Our operations generate cash that is in excess of the needs of the business. We continue to invest in and manage our business for the long-term with the goal 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 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 continued to substantially manage through these factors during the first three 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 or how long the supply chain network disruptions may last. 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. 16 Table of Contents In addition to the general inflationary environment in which we operate, the Russia-Ukraine war has introduced additional challenges to our business. While this conflict did not have a material impact on our financial results for the first three months of 2022, numerous countries have imposed sanctions against Russia. We are complying with these sanctions and are evaluating this evolving situation to assess its impact on our business. Despite the challenging economic environment, 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. The chemical industry and our products are 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. Results of Operations Net Sales Consolidated net sales for the first three months of 2022 totaled $662.6 million, representing an increase of $95.9 million, or 16.9%, from the first three months of 2021. The following table shows net sales by segment and product line. Three Months Ended March 31, (in millions) 2022 2021 Petroleum additives Lubricant additives $ 570.0 $ 494.6 Fuel additives 90.3 70.3 Total 660.3 564.9 All other 2.3 1.7 Net sales $ 662.6 $ 566.6 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 three months of 2022 with the same period in 2021, as well as with the full year in 2021. Petroleum additives net sales for the first three months of 2022 were $660.3 million compared to $564.9 million for the first three months of 2021, an increase of 16.9%. The increase was across all regions with North America representing around 60% of the increase, both the EMEAI and Latin America regions representing about 20%, and net sales for the Asia Pacific region nearly unchanged when comparing the three months periods of 2022 and 2021. The following table details the approximate components of the increase in petroleum additives net sales between the first three months of 2022 and 2021. (in millions) Three Months Period ended March 31, 2021 $ 564.9 Lubricant additives shipments (0.4) Fuel additives shipments 2.6 Selling prices 102.3 Foreign currency impact, net (9.1) Period ended March 31, 2022 $ 660.3 When comparing the first three months periods of 2022 and 2021, petroleum additives shipments accounted for a $2.2 million increase in net sales. Selling prices improved during the first three months of 2022 over the same period in 2021 contributing a favorable impact to net sales of $102.3 million. The favorable impact from shipments and improved selling prices was partially offset by an unfavorable impact from foreign currency exchange rates. The United States Dollar strengthened against most of the major currencies in which we transact when comparing the first three months of 2022 and 2021 resulting in an unfavorable impact to petroleum additives net sales for the three months comparative periods. The unfavorable impact was predominantly due to changes in the Euro and Japanese Yen exchange rates. 17 Table of Contents On a worldwide basis, the volume of product shipments for petroleum additives increased 2.3% when comparing the first three months of 2022 and 2021. The increases in product shipments for both lubricant additives and fuel additives was across all regions except for the Asia Pacific Region, which experienced decreases in both product lines. North America contributed most of the increase in product shipments for both lubricant additives and fuel additives. While there was an increase in lubricant additives product shipments on a global basis, due to the mix of products sold within the product line, lubricant additives had a small unfavorable impact on net sales as shown in the table above. 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 three months ended March 31, 2022 and March 31, 2021. Three Months Ended March 31, (in millions) 2022 2021 Petroleum additives $ 86.9 $ 94.1 All other $ 0.1 $ (0.7) Petroleum Additives Segment Petroleum additives segment gross profit decreased $7.6 million and operating profit decreased $7.2 million when comparing the first three months of 2022 to the first three months of 2021. Cost of goods sold as a percentage of net sales was 76.6% for the first three months of 2022 and 71.3% for the first three months of 2021. The operating profit margin was 13.2% for the first three months of 2022 as compared to 16.7% for the first three months of 2021. For the rolling four quarters ended March 31, 2022, the operating profit margin for petroleum additives was 11.2%. When comparing the first three months of 2022 and 2021, both gross profit and operating profit included the impact of significantly higher raw material costs, as well as an unfavorable impact from conversion costs. These were partially offset by the impact of improved selling prices and product shipments as discussed above, as well as a favorable foreign currency transaction and translation impact. Throughout most of 2021, we experienced declining operating margins due mainly to the prolonged period of escalating raw material costs. While raw material costs, along with other operating costs, have continued to increase in 2022, we have been able to make adjustments to selling prices to offset some of the raw material and operating cost increases. We continue to experience a lag between when price increases go into effect and when margin recovery begins. This lag will continue until raw material costs and other operating costs, including higher costs resulting from the worldwide supply chain disruptions, stabilize. In this uncertain economic environment of continuing increasing costs, operating profit margins remain a priority for us. Margin recovery and cost control will be priorities throughout this year with the goal of returning to our historical profit margin range. While operating margins 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 selling, general, and administrative expenses (SG&A) for the first three months of 2022 were $0.5 million lower as compared to the first three months of 2021. SG&A as a percentage of net sales was 4.7% for the first three months of 2022 and 5.6% for the first three months of 2021. Our SG&A costs are primarily personnel-related and include salaries, benefits, and other costs associated with our workforce, including travel-related 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) was substantially unchanged when comparing the first three months periods of 2022 and 2021. As a percentage of net sales, R&D was 5.5% for the first three months of 2022, and 6.4% for the first three months of 2021. 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 18 Table of Contents 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, Net Interest and financing expenses were $9.4 million for the first three months of 2022 and $6.3 million for the first three months of 2021. The increase resulted primarily from higher outstanding debt during the 2022 period, along with higher amortization and fees, as well as lower capitalized interest when comparing the first three months of 2022 and the first three months of 2021. A lower average interest rate partially offset these unfavorable impacts. Other Income (Expense), Net Other income (expense), net was income of $7.2 million for both the first three months of 2022 and 2021. The amounts for both the 2022 and 2021 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). The 2022 period also included investment income of $1.1 million, as well as a loss on marketable securities of $3.0 million. Income Tax Expense Income tax expense was $14.2 million for the first three months of 2022 and $19.7 million for the first three months of 2021. The effective tax rate was 19.3% for the first three months of 2022 and 22.0% for the first three months of 2021. Income tax expense decreased $3.5 million due to lower income before income tax expense with the remaining $2.0 million of the difference caused by the lower effective tax rate. The decrease in the effective tax rate for the first three months comparison was primarily driven by the impact of research and development expense capitalization in 2022 on the foreign derived intangible income deduction and the impact of having less projected United States interest expense in 2022 as compared to 2021 on the calculation of the allowable global intangible low-taxed income foreign tax credits. Cash Flows, Financial Condition, and Liquidity Cash and cash equivalents at March 31, 2022 were $84.6 million, which was an increase of $1.2 million since December 31, 2021. Cash and cash equivalents held by our foreign subsidiaries amounted to $81.5 million at March 31, 2022 and $81.1 million at December 31, 2021. 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 both a short-term and long-term horizon. Cash Flows – Operating Activities Cash flows provided from operating activities for the first three months of 2022 were $6.8 million, adjusted for the use of $67.0 million to fund higher working capital requirements. The $67.0 million used for working capital excluded a small unfavorable foreign currency impact to the components of working capital on the balance sheet. The most significant changes in working capital included a decrease in marketable securities, as well as increases in accounts receivable, inventory, and accounts payable. During the first three months of 2022, we sold all of our marketable securities. See Note 6 for further information. The increase in accounts receivable balances when comparing March 31, 2022 with the end of 2021 was primarily the result of increased shipment volumes along with higher sales prices. The increase in inventory was primarily caused by higher raw material costs, as well as an increase in quantities to meet customer demand. The increase in accounts payable reflected higher raw material and operating costs 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 $702.6 million at March 31, 2022 and $663.1 million at December 31, 2021. The current ratio was 2.71 to 1 at March 31, 2022 and 1.91 to 1 at December 31, 2021. 19 Table of Contents Cash Flows – Investing Activities Cash provided from investing activities totaled $359.4 million during the first three months of 2022 primarily representing the proceeds from the sale of marketable securities of $372.8 million. See Note 6 for further information. Capital expenditures for the first three months of 2022 were $12.6 million. We currently expect that our total capital spending during 2022 will be in the $65 million to $75 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 used in financing activities during the first three months of 2022 amounted to $365.8 million. These cash flows included $350.0 million for the redemption of the 4.10% senior notes along with $7.1 million of costs related to the redemption (see Debt discussion below), $37.3 million for repurchases of our common stock, and cash dividends of $21.6 million. We also borrowed an additional $51.0 million on the revolving credit facility. Debt Our long-term debt was $841.1 million at March 31, 2022 compared to $1.1 billion at December 31, 2021. On March 15, 2022, we redeemed the 4.10% senior notes at a redemption price of 100% of the principal amount of $350 million plus the accrued and unpaid interest on the notes and the applicable premium as outlined in the Indenture dated December 20, 2012. The 4.10% senior notes were due December 2022. We recognized a loss of $7.5 million on the early extinguishment including cash paid of $7.1 million for the premium on the early redemption and a write-off of $0.4 million of unamortized deferred financing costs. See Note 9 for additional information on the 2.70% senior notes, 3.78% senior notes, 4.10% 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 March 31, 2022, the Leverage Ratio was 2.57 under the revolving credit facility. At March 31, 2022, we were in compliance with all covenants under the 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 decreased from 59.9% at December 31, 2021 to 52.5% at March 31, 2022. The change in the percentage resulted primarily from the repayment of the 4.10% senior notes, partially offset by the increase in outstanding revolving credit facility borrowings and the decrease 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 2021 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 2021 Annual Report. There have been no significant changes in our critical accounting policies and estimates from those reported in our 2021 Annual Report. Recent Accounting Pronouncements There are no new significant recent accounting pronouncements which may materially impact our financial statements. 20 Table of Contents 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 to experience impacts to its operating performance due to the current economic environment, as we continue to see challenges with the global supply network, inflationary trends, and raw material price escalation and volatility. 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 any future opportunities. We will continue to evaluate all alternative uses of cash to enhance shareholder value, including stock repurchases and dividends.