Item 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign currency exchange rate risk
We have foreign-based operations, primarily in Europe, South America and Asia, which accounted for approximately 24 percent of our net sales in the first six months of 2025. We have designated the local currency as the functional currency of our significant operations outside of the U.S. The primary currencies for which we have exchange rate exposure are the U.S. dollar versus the euro, the Japanese yen, the pound sterling, the Brazilian real, and the Chinese renminbi. In addition, certain of our domestic operations have sales to foreign customers. In the conduct of our foreign operations, we also make inter-company sales. All of this exposes us to the effect of changes in foreign currency exchange rates. Our earnings are therefore subject to change due to fluctuations in foreign currency exchange rates when the earnings in foreign currencies are translated into U.S. dollars. In some cases, to minimize the effects of such fluctuations, we use foreign exchange forward contracts to hedge firm and highly anticipated foreign currency cash flows. Our largest exposures are to the Brazilian real, the Chinese renminbi and the euro. A hypothetical 10 percent adverse change, excluding the impact of any hedging instruments, in the average Brazilian real, Chinese renminbi and euro to U.S. dollar exchange rates during the six months ended June 30, 2025, would have decreased our net sales and income before income taxes by approximately $7.8 million or one percent, and $2.7 million or two percent, respectively. Comparatively, a hypothetical 10 percent adverse change, excluding the impact of any hedging instruments, in the average Brazilian real, Chinese renminbi and euro to U.S. dollar exchange rates during the six months ended June 30, 2024, would have decreased our net sales and income before income taxes by approximately $8.4 million or one percent, and $2.9 million or one percent, respectively.
Interest rate risk
During the third quarter of 2024, we entered into a floating-to-fixed interest rate swap to convert a notional amount of $200.0 million of the variable, Secured Overnight Financing Rate ("SOFR") based interest component of our debt to a fixed rate. In accordance with the terms of this instrument, we receive floating rate interest payments based upon one-month U.S. dollar SOFR, which was 4.32 percent as of June 30, 2025, and in return are obligated to pay interest at a fixed rate of 3.84 percent until August 2026. The fair value of the interest rate swap was an asset (liability) of $(0.2) million and $0.6 million at June 30, 2025 and December 31, 2024, respectively.
As of June 30, 2025, approximately $485 million of our borrowings, adjusted for our $200.0 million floating-to-fixed interest rate swap, included a variable interest rate component. The weighted average interest rate associated with our variable interest rate borrowings was 5.69 percent for the period ended June 30, 2025. A hypothetical 100 basis point increase in the variable interest rate component of our borrowings for the six months ended June 30, 2025, would have increased our annual interest expense by approximately $4.8 million or seven percent. Comparatively, a 100 basis point increase in the variable interest rate component of our borrowings for the six months ended June 30, 2024, would have increased our annual interest expense by approximately $8.5 million or 10 percent.
Commodity price risk
A portion of our manufacturing costs includes purchased raw materials, which are commodities whose prices fluctuate as market supply and demand fundamentals change. Accordingly, product margins and the level of our profitability tend to fluctuate with the changes in these commodity prices.
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Crude tall oil price risk
Our results of operations are directly affected by the cost of our raw materials, particularly CTO, which, excluding CTO resales, represented 7 percent and 16 percent of our condensed consolidated cost of sales for the six months ended June 30, 2025 and 2024, respectively. Raw material CTO spend was approximately $8 million and $18 million during the three and six months ended June 30, 2025. Comparatively, total raw material CTO spend was approximately $55 million and $111 million during the three and six months ended June 30, 2024. Pricing for CTO is driven by the limited supply of the product and competing demands for its use, both of which drive pressure on its price. Our gross profit and margins have been and could continue to be adversely affected by increases in the cost of CTO if we are unable to pass the increases on to our customers. Based on average pricing during the three and six months ended June 30, 2025, a hypothetical unhedged, unfavorable 10 percent increase in the market price for CTO would have increased our cost of sales by approximately $0.8 million (zero percent) and $1.8 million (zero percent), respectively, which we may not have been able to pass on to our customers. Comparatively, based on average pricing during the three and six months ended June 30, 2024, a hypothetical unhedged, unfavorable 10 percent increase in the market price for CTO would have increased our cost of sales by approximately $5.5 (two percent) and $11.1 million (two percent), respectively. The repositioning of the Performance Chemicals reportable segment and the termination of the long-term CTO supply contract have significantly reduced the company's volume requirements and exposure to CTO beginning in 2025.
Natural gas price risk
Natural gas, both direct and indirect, is our largest form of energy costs constituting approximately four percent of our cost of goods sold for the six months ended June 30, 2025. Increases in natural gas costs, unless passed on to our customers, would adversely affect our results of operations. If natural gas prices increase significantly, our business or results of operations may be adversely affected. We enter into certain derivative financial instruments to mitigate expected fluctuations in market prices and the volatility to earnings and cash flow resulting from changes to the pricing of natural gas purchases. Refer to Note 8 for more information on our natural gas price risk hedging program. For the three and six months ended June 30, 2025, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $0.7 million (28 basis points) and $1.6 million (39 basis points). Comparatively, for the three and six months ended June 30, 2024, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $0.9 million (33 basis points) and $1.9 million (36 basis points). As of June 30, 2025, we had 1.8 million mmBTUS (millions of British Thermal Units) in open natural gas derivative contracts, designated as cash flow hedges. As of June 30, 2025, open natural gas derivative contracts hedge a portion of forecasted transactions until September 2026. The fair value of the open natural gas derivative contracts was a net asset (liability) of $(0.5) million and $0.3 million as of June 30, 2025 and December 31, 2024, respectively.
Other market risks
Information about our other remaining market risks for the period ended June 30, 2025, does not differ materially from that discussed under Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk of our 2024 Annual Report.
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