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 six months of 2022 with the first six months of 2021, net sales increased 20.0% primarily due to higher selling prices, as well as a small increase in product shipments, which were partially offset by an unfavorable foreign currency impact. Petroleum additives operating profit was 5.8% higher when comparing the first six months of 2022 with the first six months of 2021, reflecting the same drivers of higher selling prices and increased product shipments that favorably impacted net sales, partially offset by significantly higher raw material costs and higher operating and conversion costs. During the first six months of 2022, we repurchased 289,737 shares of our common stock for a total of $92.8 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, a challenging transportation system, and an equally challenging global supply chain network. Because of our active business continuity process and global network, we have continued to substantially manage through these factors during the first six months of the year. 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 has not had a material impact on our financial results for the first six 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 second quarter of 2022 totaled $723.6 million, representing an increase of $132.9 million, or 22.5% from the second quarter of 2021. Consolidated net sales for the first six months of 2022 totaled $1.4 billion, representing an increase of $228.9 million, or 19.8%, from the first six months of 2021. The following table shows net sales by segment and product line. Second Quarter Ended June 30, Six Months Ended June 30, (in millions) 2022 2021 2022 2021 Petroleum additives Lubricant additives $ 623.0 $ 498.8 $ 1,193.0 $ 993.3 Fuel additives 98.0 87.8 188.3 158.2 Total 721.0 586.6 1,381.3 1,151.5 All other 2.6 4.1 4.9 5.8 Net sales $ 723.6 $ 590.7 $ 1,386.2 $ 1,157.3 Petroleum Additives Segment The regions in which we operate include North America, Latin 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 six months of 2022 with the same period in 2021, as well as with the full year in 2021. Petroleum additives net sales for the second quarter of 2022 were $721.0 million compared to $586.6 for the second quarter of 2021, an increase of 22.9%. Petroleum additives net sales for the first six months of 2022 were $1.4 billion compared to $1.2 billion for the first six months of 2021, an increase of 20.0%. For both the second quarter and six months comparative periods, the increases were across all regions. For both comparative periods, North America represented around 50% of the increase and EMEAI represented about 25%. For the second quarter comparison, Asia Pacific represented about 15% of the increase and Latin America contributed around 10%. For the six months comparative periods, Latin America represented approximately 15% of the increase and Asia Pacific contributed around 10%. The following table details the approximate components of the increase in petroleum additives net sales between the second quarter and first six months of 2022 and 2021. (in millions) Second Quarter Six Months Period ended June 30, 2021 $ 586.6 $ 1,151.5 Lubricant additives shipments 21.7 21.3 Fuel additives shipments (10.8) (8.0) Selling prices 135.0 237.1 Foreign currency impact, net (11.5) (20.6) Period ended June 30, 2022 $ 721.0 $ 1,381.3 When comparing both the second quarter and the first six months periods of 2022 and 2021, higher selling prices was the predominant factor in the increase in petroleum additives net sales. Higher lubricant additives shipments, partially offset by lower fuel additive shipments, also had a favorable impact on petroleum additives net sales, but to a much lesser extent than 17 Table of Contents selling prices. The favorable impact from improved selling prices and the net higher shipments was partially offset by an unfavorable impact from foreign currency exchange rates for both the second quarter and six months comparative periods. The United States Dollar strengthened against all of the major currencies in which we transact when comparing both the second quarter and first six months periods of 2022 and 2021, resulting in an unfavorable impact to petroleum additives net sales for the comparative periods. The unfavorable impacts for both the second quarter and six months comparison was predominantly due to changes in the Euro and Japanese Yen exchange rates. On a worldwide basis, the volume of product shipments for petroleum additives increased 2.6% when comparing the two second quarter periods and 2.5% when comparing the first six months of 2022 and 2021. The worldwide increase in petroleum additives shipments for both the second quarter and six months comparative periods included higher lubricant additives shipments, partially offset by lower fuel additives shipments. The increase in lubricant additives shipments when comparing the 2022 second quarter with the 2021 second quarter was across all regions except Latin America with most of the increase from the EMEAI region. The lubricant additives increase in shipments for the first six months 2022 and first six months 2021 comparison was across all regions except Asia Pacific with most of the increase in the North America and EMEAI regions. The decrease in fuel additives shipments for the second quarter comparison was across all regions except North America, which experienced an increase in fuel additives shipments. The six months comparison for fuel additives shipments reflected decreases in the EMEAI and Asia Pacific regions which were partially offset by increases in the North America and Latin America regions. 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 second quarter and six months ended June 30, 2022 and June 30, 2021. Second Quarter Ended June 30, Six Months Ended June 30, (in millions) 2022 2021 2022 2021 Petroleum additives $ 91.2 $ 74.2 $ 178.1 $ 168.3 All other $ (0.3) $ 0.0 $ (0.2) $ (0.7) Petroleum Additives Segment Petroleum additives segment gross profit increased $17.1 million and operating profit increased $17.0 million when comparing the second quarter of 2022 to the second quarter of 2021. For the first six months of 2022 compared to the first six months of 2021, gross profit increased $9.5 million and operating profit increased $9.8 million. Cost of goods sold as a percentage of net sales was 78.2% for the second quarter of 2022, 76.1% for the second quarter of 2021, 77.4% for the first six months of 2022 and 73.8% for the first six months of 2021. The operating profit margin was 12.7% for both the second quarter of 2022 and second quarter of 2021, 12.9% for the first six months of 2022, and 14.6% for the first six months of 2021. For the rolling four quarters ended June 30, 2022, the operating profit margin for petroleum additives was 11.3%. When comparing both the second quarter and first six months of 2022 and 2021, both gross profit and operating profit included the impact of significantly higher selling prices, along with a favorable impact from higher shipments. These favorable components were partially offset by significantly higher raw material costs, as well as a smaller unfavorable impact from operating and conversion costs. 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. Nonetheless, we continue to be challenged by the ongoing inflationary environment and continue to experience a lag between when price increases go into effect and when margin recovery is realized. This lag will continue until raw material costs and other operating costs, including higher costs resulting from the worldwide supply chain disruptions, stabilize. 18 Table of Contents In this uncertain economic environment of continuing increasing costs, operating profit margins are a priority for us. Margin recovery and cost control will remain 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 second quarter of 2022 were substantially unchanged from the second quarter of 2021 and were $0.4 million lower when comparing the first six months of 2022 and first six months of 2021. SG&A as a percentage of net sales was 4.2% for the second quarter of 2022, 5.2% for the second quarter of 2021, 4.5% for the first six months of 2022 and 5.4% for the first six 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 second quarter periods, as well as the first six months periods of 2022 and 2021. As a percentage of net sales, R&D was 4.9% for the second quarter of 2022, 6.1% for the second quarter of 2021, 5.2% for the first six months of 2022, and 6.2% for the first six 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 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 $7.1 million for the second quarter of 2022, $8.9 million for the second quarter of 2021, $16.5 million for the first six months of 2022, and $15.2 million for the first six months of 2021. The decrease for the second quarter comparison resulted from a lower average interest rate, as well as lower average outstanding debt. A decrease in capitalized interest during the 2022 period partially offset the impact of the lower average rate and lower outstanding debt. The increase for the six months comparison resulted primarily from higher outstanding debt during the 2022 period, along with higher amortization and fees, as well as lower capitalized interest. A lower average interest rate partially offset these unfavorable impacts. Other Income (Expense), Net Other income (expense), net was income of $9.1 million for the second quarter of 2022, $5.2 million for the second quarter of 2021, $16.3 million for the first six months of 2022, and 12.4 million for the first six months of 2021. The amounts for both the 2022 and 2021 second quarter and first six months 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 first six months of 2022 period also included investment income of $1.4 million, as well as a loss on marketable securities of $3.0 million. Income Tax Expense Income tax expense was $19.1 million for the second quarter of 2022 and $15.1 million for the second quarter of 2021. The effective tax rate was 22.4% for the second quarter of 2022 and 22.5% for the second quarter of 2021. Income tax expense increased $4.2 million due to higher income before income tax expense with the remaining $0.2 million of the difference caused by the slightly lower effective tax rate. Income tax expense was $33.3 million for the first six months of 2022 and $34.8 million for the first six months of 2021. The effective tax rate was 20.9% for the first six months of 2022 and 22.2% for the first six months of 2021. Income tax expense increased $0.6 million due to higher income before income tax expense with the remaining $2.1 million of the difference caused by the lower effective tax rate. While there were a number of factors impacting the change in the effective tax rate between the second quarter of 2022 and the second quarter of 2021, the overall change was small. The decrease in the effective tax rate for the six months comparison was primarily driven by the impact of research and development expense capitalization in 2022 on the foreign derived intangible income deduction. 19 Table of Contents Cash Flows, Financial Condition, and Liquidity Cash and cash equivalents at June 30, 2022 were $79.5 million, which was a decrease of $3.8 million since December 31, 2021. Cash and cash equivalents held by our foreign subsidiaries amounted to $77.1 million at June 30, 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 six months of 2022 were $24.4 million, adjusted for the use of $114.7 million to fund higher working capital requirements. The $114.7 million used for working capital excluded an 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 2022, we sold all of our marketable securities. The increase in accounts receivable balances when comparing June 30, 2022 with the end of 2021 was primarily the result of higher sales prices along with a smaller impact from increased shipment volumes. 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 $714.3 million at June 30, 2022 and $663.1 million at December 31, 2021. The current ratio was 2.60 to 1 at June 30, 2022 and 1.91 to 1 at December 31, 2021. Cash Flows – Investing Activities Cash provided from investing activities totaled $344.3 million during the first six months of 2022 primarily representing the proceeds from the sale of marketable securities of $372.8 million. Capital expenditures for the first six months of 2022 were $27.8 million. We currently expect that our total capital spending during 2022 will be in the $55 million to $65 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 six months of 2022 amounted to $371.7 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), $90.8 million for repurchases of our common stock, and cash dividends of $42.9 million. We also borrowed an additional $121.0 million on the revolving credit facility. Debt Our long-term debt was $911.3 million at June 30, 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 8 for additional information on the 2.70% 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. 20 Table of Contents 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 June 30, 2022, the Leverage Ratio was 2.61 under the revolving credit facility. At June 30, 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 55.8% at June 30, 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. 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.