Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 annual periods included in the accompanying consolidated financial statements.
Presentation of Information
The discussion that follows includes a comparison of the Company’s results of operations and liquidity and capital resources for the fiscal years ended December 31, 2021 and 2022. For a discussion of changes from the fiscal year ended December 31, 2020 to the fiscal year ended December 31, 2021, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021 (filed February 25, 2022).
Overview
The Company produces and sells intermediate chemicals that are used in a wide variety of applications worldwide. The overall business is comprised of three reportable segments:
Surfactants - Surfactants, which accounted for 68 percent of the Company’s consolidated net sales in 2022, are principal ingredients in consumer and industrial cleaning and disinfection 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, disinfectants, 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:
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On September 23, 2022, the Company completed the purchase of PerformanX Specialty Chemicals, LLC’s surfactant business and associated assets. Included in the transaction were intellectual property, customer relationships, inventory and working capital. This acquisition enhanced the Company’s specialty alkoxylates portfolio and provides market diversification opportunities. This acquisition is also expected to deliver additional baseload volumes for the Company’s Pasadena, Texas alkoxylation facility that is scheduled to start up in the first half of 2024. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
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In February 2021, the Company completed the purchase of a fermentation plant, located in Lake Providence, Louisiana. The Company believes this plant complements the rhamnolipid-based bio-surfactant technology the Company acquired from Logos Technologies in March 2020. Fermentation is a new platform technology for the Company and the Company is focusing efforts to further develop, integrate, produce and commercialize these unique surfactants moving forward. Bio-surfactants, produced via fermentation, are attractive due to their biodegradability, low toxicity, and in some cases, unique antimicrobial properties. These bio-surfactants offer synergies in several strategic end use markets including oilfield, agriculture, personal care and household, industrial and institutional cleaning. The acquisition of this industrial scale fermentation plant is a step in the Company’s bio-surfactant commercialization efforts. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
Polymers - Polymers, which accounted for 28 percent of consolidated net sales in 2022, 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 products). 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 are manufactured at the Company’s Elwood, Illinois (Millsdale), and Wilmington, North Carolina sites. Phthalic anhydride is manufactured at the Company’s Elwood, Illinois (Millsdale) site and specialty polyols are manufactured at the Company’s Columbus, Georgia, site. In Europe, polyurethane polyols are manufactured at the Company’s subsidiaries in Germany and Vlissingen, Netherlands 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. Recent significant events include:
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In January 2021, the Company completed the purchase of INVISTA’s aromatic polyester polyol business and associated assets. Included in the transaction were two manufacturing sites, one in Wilmington, North Carolina and the other in Vlissingen, Netherlands along with intellectual property, customer relationships, inventory and working capital. This acquisition expanded the Company’s manufacturing capabilities in both the United States and Europe and enhanced the Company’s business continuity capabilities for the polymer market. The Company believes that the available spare capacity, combined with
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debottlenecking opportunities in both plants, allows Stepan to support future market growth in a capital efficient way. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
Specialty Products – Specialty products, which accounted for four percent of consolidated net sales in 2022, 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, by third-party contractors.
Deferred Compensation Plans
The accounting for the Company’s deferred compensation plans can cause period-to-period fluctuations in Company income and expenses. Compensation expense is recognized when the value of Company common stock and mutual fund investment assets held for the plans increase, and compensation income is recognized when the value 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 deferred compensation obligations) and the income statement line items in which the effects of the activities were recorded are displayed in the following tables:
Income (Expense)
For the YearEnded December 31,
Deferred Compensation (Administrative expenses) $ 9.4 $ (6.9 ) $ 16.3 (1)
Investment Income (Other, net) 1.7 2.8 (1.1 )
Pretax Income Effect $ 3.1 $ (2.0 ) $ 5.1
Income (Expense)
For the YearEnded December 31,
Deferred Compensation (Administrative expenses) $ (6.9 ) $ (10.0 ) $ 3.1 (1)
Investment Income (Other, net) 2.8 1.6 1.2
Realized/Unrealized Gains on Investments (Other, net) 2.1 3.1 (1.0 )
Pretax Income Effect $ (2.0 ) $ (5.3 ) $ 3.3
(1)
See the Segment Results – Corporate Expenses sections of this MD&A for details regarding the period-over-period changes in deferred compensation.
Below are the year-end Company common stock market prices used in the computation of deferred compensation income and expense:
December 31
22
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 year-over-year comparisons of financial statement items (i.e., because foreign exchange rates fluctuate, similar year-over-year 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 year-over-year changes in consolidated net sales and various income statement line items for 2022 compared to 2021 and 2021 compared to 2020:
For the YearEnded December 31, Decrease Dueto Foreign
(In millions) 2022 2021 Increase CurrencyTranslation
For the YearEnded December 31, Increase Dueto Foreign
(In millions) 2021 2020 Increase(Decrease) CurrencyTranslation
Results of Operations
2022 Compared with 2021
Summary
Net income attributable to the Company in 2022 increased seven percent to $147.2 million, or $6.38 per diluted share, from $137.8 million, or $5.92 per diluted share in 2021. Adjusted net income increased seven percent to $153.5 million, or $6.65 per diluted share, from $143.5 million, or $6.16 per diluted share in 2021 (see the “Reconciliation of Non-GAAP Adjusted Net Income and Diluted Earnings per Share” section of this MD&A for a reconciliation of reported net income attributable to the Company and reported earnings per diluted share to non-GAAP adjusted net income and adjusted earnings per diluted share). Below is a summary discussion of the major factors leading to the year-over-year changes in net sales, expenses and income in 2022 compared to 2021. A detailed discussion of segment operating performance for 2022, compared to 2021, follows the summary.
Consolidated net sales increased $427.3 million, or 18 percent, between years. Higher average selling prices positively impacted the year-over-year change in net sales by $676.2 million. The increase in average selling prices was mainly attributable to the pass through of higher raw material, logistics and input costs as well as more favorable product and customer mix. Consolidated sales volume decreased seven percent and negatively impacted the year-over-year change in net sales by $153.5 million. Sales volume in the Surfactant, Polymer and Specialty Products segments decreased six, seven and four percent, respectively. Foreign currency translation negatively impacted the year-over-year change in net sales by $95.4 million due to a stronger U.S. dollar against the majority of currencies where the Company has foreign operations.
Operating income in 2022 increased $36.5 million, or 21 percent, versus operating income in 2021. Polymer and Specialty Products operating income increased $9.3 million and $15.7 million, respectively, year-over-year. Surfactant operating income decreased $3.3 million year-over-year. Corporate expenses, including deferred compensation and business restructuring/asset disposition expenses, decreased $14.8 million year-over-year. Most of this decrease was attributable to a $16.3 million decrease in deferred compensation expenses, a $3.0 million decrease in business restructuring/asset disposition expenses and lower acquisition-related and consulting expenses. These lower expenses were partially offset by $9.5 million of higher environmental remediation reserve expenses and higher incentive-based compensation expenses. The higher environmental reserve expenses primarily reflect revised remediation cost estimates for the Company’s Maywood, New Jersey site due to U.S. Environmental Protection Agency (USEPA) work plan approvals and the receipt of third-party contractor bids during the third quarter of 2022. Foreign currency translation had a $7.2 million negative impact on operating income in 2022 versus the prior year.
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Operating expenses (including deferred compensation, business restructuring/asset disposition expenses and goodwill impairment) decreased $5.3 million, or two percent, year-over-year. Changes in the individual income statement line items that comprise the Company’s operating expenses were as follows:
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Selling expenses decreased $0.2 million between years.
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Administrative expenses increased $9.3 million, or 10 percent, year-over-year primarily due to higher environmental remediation reserve ($9.5 million) and incentive-based compensation expenses, partially offset by lower acquisition-related and consulting expenses.
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Research, development and technical service (R&D) expenses increased $3.9 million, or six percent, year-over-year primarily due to higher salaries and incentive-based compensation expenses.
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Deferred compensation expense decreased $16.3 million, year-over-year, primarily due to a $17.83 per share decrease in the market price of Company common stock during 2022 versus a $4.97 per share increase in the market price of Company common stock during 2021. A decrease in the value of mutual fund investment options selected by some plan participants also contributed to the lower expense year-over-year. See the Overview and Segment Results - Corporate Expenses sections of this MD&A for further details.
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Business restructuring/asset disposition expenses were $0.3 million in 2022 versus $3.4 million in 2021. The 2022 expenses consist of $0.3 million of decommissioning costs associated with the Company’s Canadian plant closure. The 2021 expenses include a $2.7 million loss on the sale of the Company's corporate headquarters building and $0.7 million of decommissioning costs associated with the Company’s Canadian plant closure. See Note 22, Business Restructuring, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
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Goodwill impairment expenses were $1.0 million in 2022 versus no impairment expense recognition in the prior year. See Note 4, Goodwill and Other Intangible Assets, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
Net interest expense in 2022 increased $4.1 million, or 71%, versus the prior year. This increase was primarily attributable to higher outstanding debt balances in 2022 versus 2021.
Other, net was $8.8 million of expense in 2022 versus $7.5 million of income in 2021. The Company recognized $6.4 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 2022 compared to $5.2 million of income in 2021. The Company also recognized $2.9 million of foreign exchange losses in 2022 versus $0.5 million of foreign exchange gains in 2021. In addition, the Company recognized $0.5 million of income related to net periodic pension and other retirement obligations in 2022 versus $0.9 million of income in 2021. The Company also recognized $1.0 million of income related to the dissolution of its China joint venture in 2021.
The Company’s effective tax rate was 22.0 percent in 2022 compared to 20.1 percent in 2021. The increase was primarily attributable to a non-recurring favorable tax benefit recognized in 2021, related to the anticipated utilization of a foreign tax credit attribute, for years prior to 2021. See Note 9, Income Taxes, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for a reconciliation of the statutory U.S. federal income tax rate to the effective tax rate.
Segment Results
(In thousands) For the YearEnded December 31,
Net Sales 2022 2021 Increase PercentChange
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(In thousands) For the YearEnded December 31,
Operating Income 2022 2021 Increase(Decrease) PercentChange
Business Restructuring and Asset Disposition 308 3,353 (3,045 ) -91
Surfactants
Surfactant 2022 net sales increased $320.0 million, or 20 percent, versus 2021 net sales. Higher average selling prices positively impacted the change in net sales by $469.5 million. The higher average selling prices were primarily due to the pass-through of higher raw material, logistics and input costs along with improved product and customer mix. Sales volume declined six percent and negatively impacted the change in net sales by $100.9 million. Foreign currency translation had a $48.6 million unfavorable impact on the year-over-year change in net sales. A year-over-year comparison of net sales by region follows:
For the YearEnded December 31,
(In thousands) 2022 2021 Increase(Decrease) PercentChange
Net sales for North American Surfactant operations increased $195.1 million, or 22 percent, between years. Higher average selling prices positively impacted the change in net sales by $244.6 million. The higher average selling prices were primarily due to the pass-through of higher raw material, logistics and input costs along with more favorable product and customer mix. Sales volume declined five percent and negatively impacted the year-over-year change in net sales by $47.8 million. Lower sales volume into the consumer products end markets, principally commodity laundry and personal care products, accounted for most of this decline and was largely due to raw material availability issues, customer inventory destocking efforts and previously anticipated lost volume at one customer that chose to invest in internal production as part of the transition to low 1,4 dioxane products. Partially offsetting the above was higher demand for products sold into the functional products end markets and higher demand from the Company’s Tier 2/3 customers. Foreign currency translation negatively impacted 2022 net sales by $1.7 million.
Net sales for European Surfactant operations increased $60.9 million, or 21 percent, year-over-year. Higher average selling prices positively impacted the change in net sales by $115.5 million. The higher average selling prices were primarily due to the pass-through of higher raw material costs and improved product and customer mix. Foreign currency translation and a four percent decline in sales volume negatively impacted the year-over-year change in net sales by $42.2 million and $12.4 million, respectively. A stronger U.S. dollar relative to the European euro and British pound sterling led to the unfavorable foreign currency translation effect. The lower sales volume was primarily due to lower demand for commodity laundry products sold within the consumer products business partially offset by higher demand for products sold into the functional products and institutional cleaning end markets.
Net sales for Latin American Surfactant operations increased $64.2 million, or 21 percent, between years primarily due to higher average selling prices that positively impacted the change in net sales by $84.6 million. The higher average selling prices were primarily due to the pass-through of higher raw material costs and improved product and customer mix. Sales volume declined seven percent and negatively impacted the change in net sales by $22.2 million. The decline in sales volume was primarily due to lower demand for commodity laundry products within the consumer products business partially offset by higher demand for products sold into the functional products and institutional cleaning end markets. Foreign currency translation positively impacted the change in net sales by $1.8 million.
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Net sales for Asian Surfactant operations decreased $0.3 million year-over-year. A 20 percent decline in sales volume and the unfavorable impact of foreign currency translation negatively impacted the change in net sales by $14.0 million and $6.5 million, respectively. The decline in sales volume primarily reflects lower demand for commodity laundry products sold within the consumer products business, partially attributable to lost market share at one major customer, and lower demand from our distribution partners. A stronger U.S. dollar relative to the Philippine peso accounted for most of the unfavorable foreign currency translation effect. Higher average selling prices positively impacted the year-over-year change in net sales by $20.2 million and primarily reflected the pass-through of higher raw material costs.
Surfactant operating income for 2022 decreased $3.3 million, or two percent, versus operating income reported in 2021. Gross profit increased $3.8 million, or one percent, and operating expenses increased $7.1 million, or seven percent. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:
For the YearEnded December 31,
(In thousands) 2022 2021 Increase(Decrease) PercentChange
Gross Profit and Operating Income
Gross profit for North American Surfactant operations increased $5.4 million, or three percent, year-over-year. Higher average unit margins positively impacted the year-over-year change in gross profit by $14.4 million. The higher average unit margins were mostly attributable to more favorable product and customer mix that was partially offset by higher raw material, manufacturing and transportation costs, which were not fully recovered in the market, and higher expenses associated with the Company’s transition to low 1,4 dioxane capabilities. A five percent decline in sales volume negatively impacted the change in gross profit by $8.9 million. Foreign currency translation negatively impacted the change in gross profit by $0.1 million.
Gross profit for European Surfactant operations increased $3.1 million, or eight percent, year-over-year. Higher average unit margins positively impacted the year-over-year change in gross profit by $9.4 million. The higher average unit margins primarily reflect a more favorable product and customer mix. The unfavorable impact of foreign currency translation and a four percent decline in sales volume negatively impacted the year-over-year change in gross profit by $4.7 million and $1.6 million, respectively. A stronger U.S. dollar relative to the European euro and British pound sterling led to the unfavorable foreign currency translation effect.
Gross profit for Latin American Surfactant operations decreased $1.3 million, or two percent, primarily due to a seven percent decline in sales volume that negatively impacted the year-over-year change in gross profit by $4.1 million. Higher average unit margins and the favorable impact of foreign currency translation positively impacted the year-over-year change in gross profit by $2.4 million and $0.4 million, respectively. The higher unit margins primarily reflect a more favorable customer and product mix.
Gross profit for Asian Surfactant operations decreased $3.4 million, or 30 percent, year-over-year. A 20 percent decline in sales volume and lower unit margins negatively impacted the change in gross profit by $2.2 million and $1.4 million, respectively. Foreign currency translation positively impacted the change in gross profit by $0.2 million.
Operating expenses for the Surfactant segment increased $7.1 million, or seven percent, year-over-year. Most of this increase was attributable to higher incentive-based compensation and travel-related expenses, a goodwill impairment charge at the Company’s Philippines subsidiary and higher bad debt provision expense.
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Polymers
Polymer 2022 net sales increased $75.6 million, or 11 percent, versus net sales in 2021. Higher average selling prices favorably impacted the year-over-year change in net sales by $169.6 million. The higher average selling prices were mainly due to the pass through of higher raw material, logistics and input costs along with margin recovery. A seven percent decrease in sales volume and the unfavorable impact of foreign currency translation negatively impacted the year-over-year change in net sales by $49.2 million and $44.8 million, respectively. A year-over-year comparison of net sales by region follows:
For the YearEnded December 31,
(In thousands) 2022 2021 Increase(Decrease) PercentChange
Net sales for North American Polymer operations increased $72.9 million, or 20 percent, primarily due to higher average selling prices that positively impacted the change in net sales by $99.1 million. The higher average selling prices were mainly due to the pass-through of higher raw material, logistics and input costs along with margin recovery. Sales volume declined seven percent and negatively impacted the change in net sales by $26.2 million. Sales volume of polyols used in rigid foam applications decreased three percent year-over-year. Sales volume within the phthalic anhydride and specialty polyols businesses decreased 19 percent and 15 percent, respectively. The year-over-year decline in sales volume reflects customer inventory destocking, lower construction-related activities and general economic concerns. In addition, sales volume in 2022 was impacted by a January 2022 power outage at the Company’s Elwood, Illinois (Millsdale) plant site that negatively impacted Polymer production. The production disruption resulted in the declaration of force majeure for select products. Production resumed in February 2022 and the force majeure was lifted in April 2022. The Company was able to mitigate a portion of this production disruption by supplying customers from its Wilmington, North Carolina site, which was acquired a part of the acquisition of INVISTA's aromatic polyester polyol business in 2021.
Net sales for European Polymer operations increased $5.3 million, or two percent, year-over-year. Higher average selling prices favorably impacted the change in net sales by $67.4 million. The higher average selling prices were mainly due to the pass-through of higher raw material costs. The unfavorable impact of foreign currency translation and a six percent decline in sales volume negatively impacted the change in net sales by $43.2 million and $18.9 million, respectively. A stronger U.S dollar relative to the Polish zloty and British pound sterling led to the unfavorable foreign currency translation impact. The decline in sales volume reflects lower construction-related activities, customer inventory destocking and the effects of general economic concerns.
Net sales for Asian and Other Polymer operations decreased $2.6 million, or six percent, primarily due to an eight percent decline in sales volume and the unfavorable impact of foreign currency translation. These two factors negatively impacted the year-over-year change in net sales by $3.9 million and $1.6 million, respectively. The decline in sales volume was primarily attributable to suppressed demand resulting from COVID lockdowns and restrictions in China. Higher average selling prices positively impacted the year-over-year change in net sales by $2.9 million.
Polymer operating income for 2022 increased $9.3 million, or 13 percent, versus operating income for 2021. Gross profit increased $9.7 million, or nine percent, and operating expenses were up $0.4 million, or one percent, year-over-year. Year-over-year comparisons of gross profit by region and total segment operating expenses and operating income follow:
For the YearEnded December 31,
(In thousands) 2022 2021 Increase(Decrease) PercentChange
Gross Profit and Operating Income
Gross profit for North American Polymer operations increased $10.2 million, or 19 percent, primarily due to higher average unit margins. The higher average unit margins favorably impacted the year-over-year change in gross profit by $14.0 million. The higher
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average unit margins primarily reflect year-over-year margin recovery. Sales volume declined seven percent and negatively impacted the year-over-year change in gross profit by $3.8 million.
Gross profit for European Polymer operations increased $0.4 million, or one percent, primarily due to higher average unit margins that favorably impacted the change in gross profit by $9.4 million. The higher average unit margins primarily reflect year-over-year margin recovery. The unfavorable impact of foreign currency translation and a six percent decline in sales volume negatively impacted the change in gross profit by $6.1 million and $2.9 million, respectively.
Gross profit for Asia and Other Polymer operations declined $0.8 million, or 16 percent, due to an eight percent decline in sales volume, lower average unit margins and the negative impact of the foreign currency translation. These items negatively impacted the year-over-year change in gross profit by $0.4 million, $0.2 million and $0.2 million, respectively.
Operating expenses for the Polymers segment increased $0.4 million, or one percent, year-over-year mainly due to higher incentive-based compensation and travel-related expenses.
Specialty Products
Specialty Products net sales in 2022 increased $31.7 million, or 45 percent versus net sales in 2021. This increase reflects higher average selling prices that were partially offset by a four percent decline in sales volume. Gross profit and operating income increased $15.1 million and $15.7 million, respectively. The year-over-year improvements in gross profit and operating income were mostly attributable to improved margins and customer mix within the medium chain triglycerides (MCTs) product line.
Corporate Expenses
Corporate expenses, which include deferred compensation, business restructuring/asset disposition and other operating expenses that are not allocated to the reportable segments, decreased $14.8 million between years. Corporate expenses were $68.2 million in 2022 versus $83.0 million in the prior year. This decrease was primarily attributable to $9.4 million of deferred compensation income recognized in 2022 versus $6.9 million of deferred compensation expense recognized in 2021. Also contributing to the reduction in corporate expenses were lower year-over-year acquisition-related expenses, consulting expenses and the non-recurrence of a $2.7 million loss incurred on the sale of a corporate headquarter building in 2021. Partially offsetting the decreases above were higher year-over-year environmental remediation reserve ($10.2 million) and incentive-based compensation expenses. The higher environmental reserve expenses were primarily due to revised remediation cost estimates associated with the Company’s Maywood, New Jersey site.
Deferred compensation expense decreased $16.3 million between years. This decrease was primarily due to a $17.83 per share decrease in the market price of the Company’s common stock during 2022 compared to a $4.97 per share increase during 2021. A decrease in the value of mutual fund investment options selected by some plan participants also contributed to the lower expense year-over-year. The following table presents the period-end Company common stock prices used in the computation of deferred compensation income/expense in 2022 and 2021:
December 31
Liquidity and Capital Resources
Overview
Historically, the Company’s principal sources of liquidity have included cash flows from operating activities, available cash and cash equivalents and the proceeds from debt issuance and borrowings under credit facilities. The Company’s principal uses of cash have included funding operating activities, capital investments and acquisitions. The Company’s generation of cash from operations, cash on hand, committed credit facilities and ability to access capital markets are expected to meet the Company’s short-term and long-term cash requirements for working capital, capital expenditures, debt maturities, contributions to pension plans, dividend distributions to stockholders, share repurchases and other needs.
For 2022, cash generated from operating activities was a cash source of $160.8 million versus a source of $72.1 million in 2021. For 2022, investing cash outflows were $308.1 million versus cash outflows of $376.8 million in 2021. Financing activities were a cash source of $166.2 million in 2022 versus a source of $117.3 million in 2021. Cash and cash equivalents increased by $14.6 million compared to December 31, 2021, inclusive of $4.3 million of unfavorable foreign exchange rate impacts.
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As of December 31, 2022, the Company’s cash and cash equivalents totaled $173.8 million. Cash in U.S. demand deposit accounts and money market funds totaled $11.8 million and $64.9 million, respectively. The Company’s non-U.S. subsidiaries held $97.1 million of cash outside the United States as of December 31, 2022.
Operating Activities
Net income in 2022 increased by $9.3 million versus the comparable period in 2021. Working capital was a cash use of $75.7 million in 2022 versus a cash use of $140.5 million in 2021.
Accounts receivable were a cash use of $26.2 million in 2022 compared to a use of $104.2 million in 2021. Inventories were a cash use of $99.4 million in 2022 versus a use of $79.3 million in 2021. Accounts payable and accrued liabilities were a cash source of $54.2 million in 2022 compared to a source of $44.4 million in 2021.
Working capital in 2022 was a lower use of cash versus the prior year primarily due to the changes noted in the preceding paragraph. The major driver of the year-over-year decrease was accounts receivable. The lower accounts receivable cash usage reflects lower sales volume, particularly in the second half of the year, due to a slow down in customer demand across most end use markets and customer inventory destocking. It is management’s opinion that the Company’s liquidity is sufficient to provide for potential increases in working capital requirements during 2023.
Investing Activities
Cash used for investing activities decreased $68.7 million year-over-year. This decrease primarily reflects the Company’s 2021 acquisition of INVISTA’s aromatic polyester polyol business and associated assets for $183.7 million, net of cash received. Cash used for capital expenditures was $301.6 million in 2022 versus $194.5 million in 2021. The higher capital spending in 2022 was largely attributable to the alkoxylation plant the Company is building at its Pasadena, Texas site and equipment upgrades to meet new regulatory limits on 1,4 Dioxane in the United States.
For 2023, the Company estimates that total capital expenditures will range from $240.0 million to $270.0 million. This projected spending includes the new alkoxylation plant that is being built in Pasadena, Texas, equipment upgrades to meet new regulatory limits on 1,4 Dioxane in the United States, growth initiatives, infrastructure, and optimization spending in the United States and Mexico.
Financing Activities
Cash flow from financing activities was a source of $166.2 million in 2022 versus a source of $117.3 million in 2021. The year-over-year change is primarily due to a higher level of borrowings under the Company’s revolving credit facility and a $98.8 million delayed draw term loan borrowing during 2022, partially offset by lower cash proceeds received from the issuance of senior unsecured notes in 2022 versus 2021.
The Company purchases shares of its common stock in the open market or from its U.S. pension plan from time to time to fund its own benefit plans and to mitigate the dilutive effect of new shares issued under its compensation plans. The Company may, from time to time, seek to purchase additional amounts of its outstanding equity and/or retire 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. During the twelve months ended December 31, 2022, the Company purchased 251,120 shares of its common stock on the open market at a total cost of $24.9 million. At December 31, 2022, the Company had $125.1 million remaining under the share repurchase program authorized by its Board of Directors.
Debt and Credit Facilities
Consolidated balance sheet debt increased from $363.6 million on December 31, 2021 to $587.1 million on December 31, 2022, primarily due to higher domestic debt, which includes borrowings from the Company’s revolving credit agreement and new senior unsecured notes issued during the first quarter of 2022. Net debt (which is defined as total debt minus cash – See the “Reconciliation of Non-GAAP Net Debt” section of this MD&A) increased by $209.0 million in 2022, from $204.4 million on December 31, 2021 to $413.4 million on December 31, 2022. This change was due to a debt increase of $223.6 million partially offset by a cash increase of $14.6 million. The cash increase primarily reflects the new debt borrowings and cash from operations, largely offset by scheduled debt repayments, capital expenditures, dividends, share repurchases and the previously announced third quarter 2022 acquisition of the PerformanX Specialty Chemicals surfactant business.
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As of December 31, 2022, the ratio of total debt to total debt plus shareholders’ equity was 33.5 percent compared to 25.3 percent at December 31, 2021. As of December 31, 2022, the ratio of net debt to net debt plus shareholders’ equity was 26.2 percent versus 16.0 percent as of December 31, 2021. On December 31, 2022, the Company’s debt included $397.9 million of senior unsecured notes, with maturities ranging from 2023 through 2032, that were issued to insurance companies in private placement transactions pursuant to note purchase agreements, a $98.8 million delayed-draw term loan borrowed pursuant to the Company’s credit agreement, $90.5 million of short-term loans borrowed under the Company’s revolving credit facility and no foreign credit line borrowings. The proceeds from the senior unsecured note issuances have been the Company’s primary source of long-term debt financing and are supplemented by borrowings under revolving and other bank credit facilities to meet short and medium-term liquidity needs.
On March 1, 2022, pursuant to a note purchase and master note agreement dated as of June 10, 2021 (the NYL note purchase agreement), the Company issued and sold $25.0 million in aggregate principal amount of its 2.83% Senior Notes, Series 2022-A, due March 1, 2032 (the Series 2022-A Notes). In addition, on March 1, 2022, pursuant to a note purchase and private shelf agreement dated as of June 10, 2021 (the Prudential note purchase agreement), the Company issued and sold $50.0 million in aggregate principal amount of its 2.83% Senior Notes, Series 2022-B, due March 1, 2032 (the Series 2022-B Notes). The Series 2022-A Notes and the Series 2022-B Notes bear interest at a fixed rate of 2.83%, with interest to be paid semi-annually and with equal annual principal payments beginning on March 1, 2026 and continuing through final maturity on March 1, 2032. The proceeds of the issuance of the Series 2022-A Notes and the Series 2022-B Notes are being used primarily for capital expenditures, to pay down existing debt and for working capital and other general corporate purposes. The NYL note purchase agreement and the Prudential note purchase agreement require the maintenance of certain financial ratios and covenants that are substantially similar to the Company’s existing long-term debt and provide for customary events of default.
On June 24, 2022, the Company entered into a credit agreement with a syndicate of banks. The credit agreement provides for credit facilities in an initial aggregate principal amount of $450.0 million, consisting of (a) a $350.0 million multi-currency revolving credit facility and (b) a $100.0 million delayed-draw term loan credit facility, each of which matures on June 24, 2027. This credit agreement replaced the Company’s prior $350.0 million revolving 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 December 31, 2022, the Company had outstanding letters of credit totaling $10.9 million and $189.2 million of outstanding borrowings under the credit agreement, inclusive of a $98.8 million delayed-draw term loan, with $249.8 million remaining available.
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 expenditures and acquisitions. At December 31, 2022, the Company’s foreign subsidiaries had no outstanding debt.
The Company is subject to covenants under its 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 shares. As of December 31, 2022, testing for these agreements was based on the Company’s consolidated financial statements. Under the most restrictive of these debt covenants:
3. The Company is required to maintain net worth of at least $750.0 million.
The Company believes it was in compliance with the covenants under its material debt agreements as of December 31, 2022.
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Material Cash Requirements
At December 31, 2022, the Company’s material cash requirements included the following contractual obligations (including estimated payments by period):
Payments Due by Period
(In thousands) Total Less than1 year 1-3 years 3 – 5 years More than5 years
(1)
Excludes unamortized debt issuance costs of $0.7 million.
(2)
Interest payments on debt obligations represent interest on all Company debt at December 31, 2022. Future interest rates may change, and, therefore, actual interest payments could differ from those disclosed in the above table.
(3)
The majority of operating lease obligations consist of railcar and real estate leases.
(4)
Purchase obligations consist of raw material, utility and telecommunication service purchases made in the normal course of business.
(5)
The “Other” category comprises deferred revenues that represent commitments to deliver products, expected 2023 required contributions to the Company’s funded defined benefit pension plans, estimated payments related to the Company’s unfunded defined benefit supplemental executive and outside director pension plans, estimated payments (undiscounted) related to the Company’s asset retirement obligations, environmental remediation payments for which amounts and periods can be reasonably estimated and income tax liabilities for which payments and periods can be reasonably estimated.
The above table does not include $43.2 million of other non-current liabilities recorded on the balance sheet at December 31, 2022, as summarized in Note 15, Other Non-Current Liabilities, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K). The significant non-current liabilities excluded from the table are defined benefit pension, deferred compensation, environmental and legal liabilities and unrecognized tax benefits for which payment periods cannot be reasonably determined. In addition, deferred income tax liabilities are excluded from the table due to the uncertainty of their timing.
During the periods covered by this Form 10-K, the Company was not party to any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, cash requirements or capital resources.
Pension Plans
The Company sponsors a number of defined benefit pension plans, the most significant of which cover employees in the Company’s U.S. and U.K. locations. The U.S. and U.K. plans are frozen, and service benefit accruals are no longer being made. The overfunded status (pretax) of the Company’s U.S and U.K. defined benefit pension plans was $8.2 million at December 31, 2022, versus overfunded status (pretax) of $7.9 million at December 31, 2021. See Note 13, Postretirement Benefit Plans, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
The Company contributed $0.8 million to its U.S. and U.K. defined benefit plans in 2022. In 2023, the Company expects to contribute a total of $0.5 million to the U.K. defined benefit plan. As a result of pension funding relief included in the Highway and Transportation Funding Act of 2014, the Company has no 2023 contribution requirement to the U.S. qualified defined benefit plans. The company expects to contribute $0.3 million in 2023 to the unfunded non-qualified U.S. pension plans.
Letters of Credit
The Company maintains standby letters of credit under its workers’ compensation insurance agreements and for other purposes as needed. The insurance letters of credit are renewed annually and amended to the amounts required by the insurance agreements. As of December 31, 2022, the Company had a total of $10.9 million of outstanding standby letters of credit.
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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 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. During 2022, the Company’s expenditures for capital projects related to environmental matters were $11.8 million. Expenditures for capital projects related to environmental matters are capitalized and depreciated over their estimated useful lives, which are typically 10 years to 15 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 approximately $37.2 million for 2022, $34.9 million for 2021 and $35.4 million for 2020.
Over the years, the Company has received requests for information related to or has been named by the government as a potentially responsible party 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 these sites. See the Critical Accounting Policies section that follows for a discussion of the Company’s environmental liabilities accounting policy. After partial remediation payments at certain sites, the Company has estimated a range of possible environmental and legal losses from $32.6 million to $56.4 million at December 31, 2022, compared to $23.1 million to $41.7 million at December 31, 2021. Within the range of possible environmental losses, management has currently concluded that no single amount is more likely to occur than any other amounts in the range and, thus, has accrued at the lower end of the range. The Company’s environmental and legal accruals totaled $32.6 million at December 31, 2022 as compared to $23.1 million at December 31, 2021. This increase primarily reflects revised environmental cost estimates for the Company’s Maywood, New Jersey site due to USEPA work plan approvals and the receipt of third party contractor bids during the third quarter of 2022. Remediation work has commenced at a portion of the Maywood site and the Company anticipates increased cash spending to occur in 2023. Because the liabilities accrued are estimates, actual amounts could differ materially from the amounts reported. During 2022, cash expenditures related to environmental remediation and certain other legal matters approximated $2.3 million compared to $3.5 million expensed in 2021.
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 on the Company’s present knowledge with respect to its involvement at these sites and 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.
See Item 3. Legal Proceedings, in this Form 10-K and Note 16, Contingencies, in the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for a summary of the significant environmental proceedings related to certain environmental sites.
Outlook
Management believes the macro environment in 2023 will continue to be challenged by elevated inflation and high interest rates which could negatively impact consumer demand and construction-related activity, thereby impacting the Company’s Surfactant and Polymer segments. Additionally, management believes higher overall cost inflation, higher depreciation and pre-start up expenses associated with the Company’s new Pasadena facility, will challenge the Company’s ability to deliver earnings growth in 2023. The Company is seeking to partially offset these 2023 headwinds with productivity improvements, pricing increases where possible, and furthering its efforts to improve product and customer mix. The Company remains committed to executing its long-term growth strategy.
Climate Change Legislation
Based on currently available information, the Company does not believe that existing or pending climate change legislation or regulation is reasonably likely to have a material effect on the Company’s financial position, results of operations or cash flows.
Critical Accounting Policies
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (generally accepted accounting principles or GAAP). Preparation of financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets,
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liabilities, income and expenses at the date of the financial statements and to provide disclosures of contingent assets, liabilities and related amounts of revenues and expenses during the reporting period. The following is a summary of the accounting policies the Company believes are the most important to aid in understanding its financial results:
Environmental Liabilities
It is the Company’s accounting policy to record environmental 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 a range of possible costs is a better estimate than any other amount, the minimum amount in the range is accrued. Estimating the possible costs of remediation requires making assumptions related to the nature and extent of contamination and the methods and resulting costs of remediation. Some of the factors on which the Company bases its estimates include information provided by decisions rendered by State and Federal environmental regulatory agencies, information provided by feasibility studies, and remedial action plans developed.
Estimates for environmental liabilities are subject to potentially significant fluctuations as new facts emerge related to the various sites where the Company is exposed to liability for the remediation of environmental contamination. See the Environmental and Legal Matters section of this MD&A for discussion of the Company’s recorded liabilities and range of cost estimates.
Recent Accounting Pronouncements
See Note 1, Summary of Significant Accounting Policies, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for information on recent accounting pronouncements which affect the Company.
Non-GAAP Reconciliations
The Company believes that certain non-GAAP measures, when presented in conjunction with comparable GAAP measures, are useful for evaluating the Company’s performance and financial condition. 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 as substitutes for or superior to, measures of financial performance prepared in accordance with GAAP. The Company’s definitions of these adjusted measures may differ from similarly titled measures used by other entities.
Reconciliations of Non-GAAP Adjusted Net Income and Dilutive Earnings per Share
Management uses the non-GAAP adjusted net income metric to evaluate the Company’s operating performance. Management excludes the items listed in the table below because they are non-operational items. The cumulative tax effect was calculated using the statutory tax rates for the jurisdictions in which the transactions occurred.
Twelve Months Ended December 31
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Reconciliations of Non-GAAP Net Debt
Management uses the non-GAAP net debt metric to show a more complete picture of the Company’s overall liquidity, financial flexibility and leverage level.
December 31
Current Maturities of Long-Term Debt as Reported $ 132.1 $ 40.7
Long-Term Debt as Reported $ 455.0 $ 322.9
Less Cash and Cash Equivalents as Reported $ (173.8 ) $ (159.2 )
Net Debt/Net Debt plus Equity 26 % 16 %
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
Because Company operates globally, its cash flows and operating results are subject to movements in foreign currency exchange rates. Except for the financial transactions, balances and forward contracts referred to below, most of the Company’s foreign subsidiaries’ financial instruments are denominated in their respective functional currencies.
The Company uses forward contracts to mitigate the exposure of certain foreign currency transactions and balances to fluctuating exchange rates. At December 31, 2022, the Company had forward contracts with an aggregated notional amount of $56.7 million. Except for the Company’s subsidiaries in Argentina, Brazil, China and Colombia, foreign currency exposures are substantially hedged by forward contracts. The fair value of all forward contracts as of December 31, 2022, was a net liability of $0.01 million. As of December 31, 2022, the potential reduction in the Company’s earnings resulting from the impact of hypothetical adverse changes in exchange rates on the fair value of its outstanding foreign currency contracts of 10 percent for all currencies would have been $5.0 million.
Interest Rates
The Company’s debt was comprised of $397.9 million fixed-rate borrowings and $189.2 million variable-rate borrowings as of December 31, 2022. A hypothetical 10 percent average change to short-term interest rates would result in less than a $0.5 million (assuming the same debt level as December 31, 2022) increase or decrease to interest expense for 2023.
The fair value of the Company’s long term fixed-rate debt, including current maturities, was estimated to be $351.8 million as of December 31, 2022, which was approximately $46.8 million above the carrying value. Market risk was estimated as the potential increase to the fair value that would result from a hypothetical 10 percent decrease in the Company’s weighted average long-term borrowing rates at December 31, 2022, or $6.1 million.
Commodity Price Risk
Certain raw materials used in the manufacture of the Company’s products are subject to price volatility caused by weather, petroleum price fluctuations, general economic demand and other unpredictable factors. Increased raw material costs are recovered from customers as quickly as the marketplace allows; however, certain contractual arrangements allow for price changes only on a quarterly basis, and competitive pressures sometimes prevent the recovery of cost increases from customers, particularly in periods where there is excess industry capacity. As a result, for some product lines or market segments it may take time to recover raw material price increases. Periodically, firm purchase commitments are entered into which fix the price of a specific commodity that will be delivered at a future time. Forward purchase contracts are used to aid in managing the Company’s natural gas costs. At December 31, 2022, the Company had open forward contracts for the purchase of 1.6 million dekatherms of natural gas at a cost of $9.4 million. Because the Company has agreed to fixed prices for the noted quantity of natural gas, a hypothetical 10 percent fluctuation in the price of natural gas would cause the Company’s actual natural gas cost to be $0.9 million higher or lower than the cost at market price.
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Item 8. Financial Statements and Supplementary Data
The following statements and data are included in this item:
Report of Independent Registered Public Accounting Firm (PCAOB ID Number 34) 36
Notes to Consolidated Financial Statements 45
Report of Independent Registered Public Accounting Firm
To the shareholders and Board of Directors of Stepan Company
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Stepan Company and subsidiaries (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2023, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is matter arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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Contingencies — Refer to Note 16 to the financial statements
Critical Audit Matter Description
The Company is involved in several property sites where the Company may be exposed to liabilities for the remediation of environmental contamination. Environmental loss contingencies are evaluated based on the likelihood of the Company incurring a liability and whether a loss or range of losses is reasonably estimable. The likelihood and amount of a loss or range of losses are estimated based on currently available information and assumptions related to the nature and extent of contamination and the methods and resulting costs of remediation. Past estimates for environmental liabilities are subject to adjustment as new facts emerge during the investigatory and remediation processes.
Given the subjectivity of estimating the likelihood of a loss, the range of potential loss, and the amount of liability to recognize, performing audit procedures to evaluate whether environmental loss contingencies were appropriately recorded and disclosed as of December 31, 2022, required especially challenging, subjective, and complex auditor judgment and an increased extent of effort.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the environmental loss contingencies included the following, among others:
•
We tested the effectiveness of internal controls related to the Company’s development of the estimated environmental loss contingencies, including the assumptions related to the nature and extent of contamination and the methods and resulting costs of remediation.
•
We inquired of Company legal counsel and external legal counsel to understand developments in environmental matters.
•
We evaluated written responses received from external legal counsel as it relates to the environmental loss contingencies.
•
We inquired of the Company’s third-party environmental specialists to understand developments in the Maywood environmental matters.
•
We searched data on the U.S. Environmental Protection Agency website to identify any additional information relevant to the specific property sites.
•
We read Board of Directors meeting minutes to identify any additional information relevant to the specific property sites.
•
We evaluated whether the assumptions related to the nature and extent of contamination and the methods and resulting costs of remediation used by the Company to determine the estimated losses or ranges of losses were reasonable by comparing those assumptions to decisions rendered by state and Federal environmental regulatory agencies, information provided by feasibility studies and remedial action plans developed for the Maywood site.
•
If the Company’s reasonable estimate of loss for a remediation site is a range, we evaluated whether the amount of the liability recognized by the Company within that range was reasonable based on the facts and circumstances specific to the remediation site.
•
We evaluated the Company’s environmental contingencies disclosures for consistency with our knowledge of the Company’s environmental matters.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Chicago, Illinois
February 28, 2023
We have served as the Company’s auditor since 2002.
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Stepan Company
Consolidated Statements of Income
For the years ended December 31, 2022, 2021 and 2020
Operating Expenses:
Goodwill impairment (Note 4) (978 ) — —
Other Income (Expense):
Net Income Attributable to Noncontrolling Interest (Note 1) — (91 ) (886 )
Net Income Per Common Share Attributable to Stepan Company (Note 18):
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Stepan Company
Consolidated Statements of Comprehensive Income
For the years ended December 31, 2022, 2021 and 2020
Other Comprehensive Income:
Defined benefit pension plans:
Cash flow hedges:
Cash flow hedge activity 8,357 — —
Reclassifications to income in period (9 ) (9 ) (9 )
Net cash flow hedge activity (Note 19) 8,348 (9 ) (9 )
Comprehensive Income Attributable to Noncontrolling Interest — (122 ) (959 )
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Stepan Company
Consolidated Balance Sheets
December 31, 2022 and 2021
Assets
Current Assets:
Property, Plant and Equipment:
Liabilities and Equity
Current Liabilities:
Current maturities of long-term debt (Note 6) $ 132,111 $ 40,718
Non-current operating lease liability (Note 7) 50,559 56,668
Commitments and Contingencies (Note 16)
Equity (Note 10):
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Stepan Company
Consolidated Statements of Cash Flows
For the years ended December 31, 2022, 2021 and 2020
Cash Flows From Operating Activities
Goodwill impairment (Note 4) 978 — —
Changes in assets and liabilities, excluding effects of acquisitions:
Cash Flows From Investing Activities
Proceeds from asset disposition — 4,149 —
Cash Flows From Financing Activities
Revolving debt and bank overdrafts, net (Note 6) 186,551 2,861 —
Effect of Exchange Rate Changes on Cash (4,318 ) (3,391 ) 3,307
Supplemental Cash Flow Information
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Stepan Company
Consolidated Statements of Equity
For the year ended December 31, 2020
STEPAN COMPANY STOCKHOLDERS
Other comprehensive income (638 ) — — — (711 ) — 73
Cash dividends paid:
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Stepan Company
Consolidated Statements of Equity
For the year ended December 31, 2021
STEPAN COMPANY STOCKHOLDERS
Cash dividends paid:
(1)
Reflects the derecognition of noncontrolling interest due to the dissolution of the China joint venture. See Note 1, Summary of Significant Accounting Policies, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K).
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Stepan Company
Consolidated Statements of Equity
For the year ended December 31, 2022
STEPAN COMPANY STOCKHOLDERS
Other comprehensive income (14,276 ) — — — (14,276 ) —
Cash dividends paid:
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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Notes to Consolidated Financial Statements
For the years ended December 31, 2022, 2021 and 2020
1. Summary of Significant Accounting Policies
Nature of Operations
Stepan Company’s (the Company) operations consist predominantly of the production and sale of specialty and intermediate chemicals, which are sold to other manufacturers for use in a variety of end products. Principal markets for all products are manufacturers of cleaning and washing compounds (including detergents, shampoos, fabric softeners, toothpastes and household cleaners), paints, cosmetics, food, beverages, nutritional supplements, agricultural products, plastics, furniture, automotive equipment, insulation and refrigeration.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires Company management to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses at the date of the financial statements and to provide disclosures of contingent assets, liabilities and related amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries in which the Company exercises controlling influence. The equity method is used to account for investments in which the Company exercises significant but noncontrolling influence. Intercompany balances and transactions are eliminated in consolidation.
Prior to the fourth quarter of 2021, the Company had an 80 percent ownership interest in the Nanjing Stepan Jinling Chemical Limited Liability Company (a joint venture) and exercised controlling influence over the entity. As a result, the China joint venture results were included in the Company’s consolidated financial statements. The partner’s interest in the joint venture’s net income was reported in the net income attributable to noncontrolling interest line of the consolidated statements of income and its interest in the net assets of the joint venture was reported in the noncontrolling interest line (a component of equity separate from Company equity) of the consolidated balance sheets. The joint venture was dissolved during the fourth quarter of 2021.
Business Combinations
The Company makes acquisitions from time to time. When such acquisitions occur, the Company applies the accounting guidance per FASB ASC Topic 805, Business Combinations (ASC 805), to determine whether the acquisition should be treated as an asset acquisition or a business combination. When the acquisition meets the criteria of a business combination the Company recognizes the identifiable assets acquired and liabilities assumed at their estimated fair values as of the date of the acquisition. The Company recognizes goodwill for any portion of the purchase price that exceeds the sum of the net fair value of all the assets purchased in the acquisition and the liabilities assumed. Considerable estimates, complex judgments and assumptions are typically required to arrive at the fair value of elements acquired in a business combination, inclusive of discount rates, customer attrition rates, royalty rates, economic lives, and estimated future cash flows expected to be generated from the assets acquired. These items are typically most relevant to the fair valuation of identifiable intangible assets and property, plant and equipment.
In some instances, the purchase price allocation of an acquisition is not complete by the end of a reporting period. This situation most typically arises when an acquisition is complex and/or completed very close to the end of a reporting period and all necessary information is not available by the end of the reporting period in which the acquisition occurs. In these instances, the Company reports provisional amounts for any incomplete items and makes subsequent adjustments as necessary information becomes available or determines that additional information is not obtainable. Any subsequent adjustments could have a material impact on the Company’s financial position or results of operations as they could impact the initial fair values assigned to intangible assets and property, plant and equipment and/or their estimated economic lives. ASC 805 requires purchase price allocations to be finalized within one year from the acquisition date.
Cash and Cash Equivalents
The Company considers all highly liquid investments with purchased maturities of three months or less to be cash equivalents.
At December 31, 2022, the Company’s cash and cash equivalents totaled $173,750,000 including $64,851,000 in money market funds each rated AAAm by Standard and Poor’s, Aaa-mf by Moody’s and AAAmmf by Fitch. Cash in U.S. demand deposit accounts
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and certificates of deposit totaled $11,811,000 and cash of the Company’s non-U.S. subsidiaries held outside the U.S. totaled $97,088,000 as of December 31, 2022. At December 31, 2021, the Company’s cash and cash equivalents totaled $159,186,000 including $46,689,000 in money market funds, each of which was rated AAAm by Standard and Poor’s, Aaa-mf by Moody’s and AAAmmf by Fitch. Cash in U.S. demand deposit accounts totaled $25,253,000 and cash of the Company’s non-U.S. subsidiaries held outside the U.S. totaled $87,244,000 as of December 31, 2021.
Receivables and Credit Risk/Losses
Receivables are stated net of allowances for doubtful accounts and other allowances and primarily include trade receivables from customers, as well as nontrade receivables from suppliers, governmental tax agencies and others.
The Company is exposed to both credit risk and losses on accounts receivable balances. The Company’s credit risk and loss exposure predominately relates to the sale of products to its customers. When extending credit to customers the Company evaluates a customer’s credit worthiness based on a combination of qualitative and quantitative factors, inclusive of, but not limited to, a customer’s credit rating from external providers, financial condition and past payment experience. The Company performs credit reviews on all customers at inception and on a scheduled basis thereafter dependent on customer risk and the level of credit extended. Payment terms extended are short term in duration, typically ranging from 30 to 60 days. The majority of the Company’s sales are made to large companies that are able to weather periodic changes in economic conditions. This risk of losses is further mitigated by the Company’s diverse customer base, which is dispersed over various geographic regions and industrial sectors. No single customer comprised more than 10 percent of the Company’s consolidated net sales in 2022, 2021 or 2020.
The Company maintains allowances for potential credit losses. With the adoption of ASU No. 2016-13, Financial Instruments – Credit Losses, the Company assesses the likelihood of default based on various factors, including the length of time receivables are past due, historical experience, current economic conditions and forward-looking economic forecasts. The Company also evaluates expected losses based on portfolios of data inclusive of geographical areas, specific end market uses of its products, etc. Although the Company’s historical credit loss experience has not been significant, its exposure to credit losses may increase if customers are adversely affected by economic challenges and/or uncertainty due to domestic or global recessions, disruptions due to pandemics, or other adverse global/regional events and customer specific factors. Specific customer allowances are recorded when a review of customer creditworthiness and current economic conditions indicate that collection is doubtful. General allowances are also maintained based on historical averages and trade receivable levels and incorporate existing economic conditions and forecast assumptions, when warranted. The Company reviews its reserves for credit losses on a quarterly basis. The Company also maintains other customer allowances that occur in the normal course of business.
The following is an analysis of the allowance for doubtful accounts and other accounts receivable allowances for the years ended December 31, 2022, 2021 and 2020:
Accounts written off, net of recoveries (431 ) (919 ) (56 )
Inventories
Inventories are valued at cost, which is not in excess of net realizable value, and include material, labor and plant overhead costs. Currently, the first in, first out (FIFO) method is used to determine the cost of the Company’s inventory.
Property, Plant and Equipment
Depreciation of property, plant and equipment is provided on a straight-line basis over the estimated useful lives of the assets. Lives used for calculating depreciation are generally 30 years for buildings and 15 years for building improvements. For assets classified as machinery and equipment, lives generally used for calculating depreciation expense range from 10 to 15 years for manufacturing equipment, five to 10 years for furniture and fixtures, three to five years for vehicles and three to 10 years for computer equipment and software. The manufacturing of chemicals is capital intensive and a large majority of the assets included within machinery and equipment represent manufacturing equipment. Major renewals and betterments are capitalized in the property accounts, while maintenance and repairs ($82,110,000, $75,351,000, and $69,234,000 in 2022, 2021 and 2020, respectively), which do not renew or extend the life of the respective assets, are charged to operations as incurred. Land is not depreciated. The cost of property retired or sold, and the related accumulated depreciation, are removed from the accounts and any resulting gain or loss is reflected in income. Long-lived assets are reviewed for impairment when conditions exist that indicate the carrying amount of the assets may not be fully
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recoverable. Such conditions could include significant adverse changes in the business environment, significant declines in forecasted operations or an approved plan to discontinue an asset or an asset group before the end of its useful life.
Included in the computer equipment and software component of machinery and equipment are costs related to the acquisition and development of internal-use software. Capitalized costs for internal-use software include external direct costs of materials and services consumed in obtaining and developing the software. For development projects where major internal resources are committed, payroll and payroll-related costs incurred during the application development phase of the project are also capitalized. The capitalized costs are amortized over the useful lives of the software, which are generally three to 10 years. Costs incurred in the preliminary project phase are expensed. Deferred implementation costs for hosted cloud computing service arrangements are stated at historical cost and amortized on a straight-line basis over the term of the hosting arrangement.
Interest charges on borrowings applicable to major construction projects are capitalized.
Deferred Compensation
The Company sponsors deferred compensation plans that allow management employees to defer receipt of their annual cash incentive compensation and performance shares and outside directors to defer receipt of their fees and stock awards until retirement, departure from the Company or as elected by the participant. The plans allow for the deferred compensation to grow or decline based on the results of investment options chosen by the participants. The investment options include Company common stock and a limited selection of mutual funds. The Company funds the obligations associated with these plans by purchasing investment assets that match the investment choices made by the plan participants. A sufficient number of shares of treasury stock are maintained on hand to cover the equivalent number of shares that result from participants electing the Company common stock investment option. As a result, the Company must periodically purchase its common shares in the open market or in private transactions. Upon retirement or departure from the Company or at the elected time, participants receive cash amounts equivalent to the payment date value of the investment choices they have made or shares of Company common stock equal to the number of share equivalents held in the accounts.
Some plan distributions may be made in cash or Company common stock at the option of the participant. Other plan distributions can only be made in Company common stock. For deferred compensation obligations that may be settled in cash, the Company must record appreciation in the market value of the investment choices made by participants as additional compensation expense. Conversely, declines in the value of Company stock or the mutual funds result in a reduction of compensation expense since such declines reduce the cash obligation of the Company as of the date of the financial statements. These market price movements may result in significant period-to-period fluctuations in the Company’s income. The increases or decreases in compensation expenses attributable to market price movements are reported in the operating expenses section of the consolidated statements of income. Because the obligations that must be settled only in Company common stock are treated as equity instruments, fluctuations in the market price of the underlying Company stock do not affect earnings.
At December 31, 2022 and December 31, 2021, the Company’s deferred compensation liability was $43,005,000 and $61,219,000, respectively. In 2022 and 2021, approximately 47 percent of deferred compensation liability represented deferred compensation tied to the performance of the Company’s common stock. The remainder of the deferred compensation liability was tied to the chosen mutual fund investment assets. A $1.00 increase in the market price of the Company’s common stock will result in approximately $189,000 of additional compensation expense. A $1.00 reduction in the market price of the common stock will reduce compensation expense by a like amount. The expense or income associated with the mutual fund component will generally fluctuate in line with the overall percentage increase or decrease of the U.S. stock markets.
The mutual fund assets related to the deferred compensation plans are recorded on the Company’s balance sheet at cost when acquired and adjusted to their market values at the end of each reporting period. As allowed by generally accepted accounting principles, the Company elected the fair value option for recording the mutual fund investment assets. Therefore, market value changes for the mutual fund investment assets are recorded in the income statement in the same periods that the offsetting changes in the deferred compensation liabilities are recorded. Dividends, capital gains distributed by the mutual funds and realized and unrealized gains and losses related to mutual fund shares are recognized as investment income or loss in the other, net line of the consolidated statements of income.
Fair Value Measurements
GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Furthermore, GAAP establishes a framework, in the form of a three-level hierarchy, for measuring fair value that prioritizes the inputs to valuation techniques used to measure fair value. The following describes the hierarchy levels:
Level 1 - quoted prices in active markets for identical assets and liabilities.
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Level 2 - inputs other than quoted prices included within Level 1 that are directly or indirectly observable for the asset or liability, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3 - unobservable inputs which reflect the entity’s own assumptions about the assumptions market participants use in pricing the assets and liabilities.
The Company applies the fair value measurement provisions of GAAP to any of its financial assets and liabilities that are carried at fair value on the consolidated balance sheets (see Note 2, Fair Value Measurements, of the notes to the Company’s consolidated financial statements included in Item 8 of this Form 10-K), its outstanding debt for disclosure purposes (see Note 2, Fair Value Measurements, of the notes to the Company’s consolidated financial statements included in Item 8 of this Form 10-K) and its pension plan assets (see Note 13, Postretirement Benefit Plans, of the notes to the Company’s consolidated financial statements included in Item 8 of this Form 10-K).
The Company also applies fair value measurements to nonfinancial assets and liabilities recorded in conjunction with business combinations and as part of impairment reviews for goodwill and other long-lived assets.
Revenue Recognition
The Company’s contracts typically have a single performance obligation that is satisfied at the time product is shipped and control passes to the customer. For a small portion of the business, performance obligations are deemed satisfied when product is delivered to a customer location. For arrangements where the Company consigns product to a customer location, revenue is recognized when the customer uses the inventory. The Company accounts for shipping and handling as activities to fulfill a promise to transfer a good. As such, shipping and handling fees billed to customers in a sales transaction are recorded in Net Sales and shipping and handling costs incurred are recorded in Cost of Sales. Volume and cash discounts due customers are estimated and recorded in the same period as the sales to which the discounts relate and are reported as reductions of revenue in the consolidated statements of income. See Note 21, Revenue from Contracts with Customers, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for more details.
Cost of Sales
Cost of sales is comprised of raw material costs (including inbound freight expense to deliver the raw materials), manufacturing plant labor expenses and various manufacturing overhead expenses, such as utilities, maintenance, operating supplies, amortization and manufacturing asset depreciation expenses. Cost of sales also includes outbound shipping and handling expenses, inter-plant transfer costs, warehouse expenses and rail car rental expenses.
Operating Expenses
Selling expenses are comprised of salaries and related fringe benefit expenses for marketing and sales personnel and operating costs, such as outside agent commissions, automobile rental and travel-related expenses, which support the sales and marketing functions. Bad debt charges and any depreciation expenses related to marketing assets (e.g., computers) are also classified as selling expenses.
Administrative expenses are comprised of salaries and related fringe benefit expenses and operating costs for the Company’s various administrative functions, which include information services, finance, legal, and human resources. The majority of environmental remediation expenses are also classified as administrative expense.
The Company’s research and development costs are expensed as incurred. These expenses are aimed at the discovery of new knowledge with the intent that such effort will be useful in developing and commercializing a new product or in bringing about a significant improvement to an existing product or process. Total research and development expenses were $40,902,000, $38,778,000, and $35,999,000 in 2022, 2021 and 2020, respectively. The remainder of research, development and technical service expenses reflected on the consolidated statements of income relate to technical services, which include routine product testing, quality control and sales service support.
Compensation expenses or income related to the Company’s deferred compensation plans is presented in the deferred compensation expense line in the Consolidated Statements of Income. For more details, see Note 12, Deferred Compensation, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K).
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Environmental Expenditures
Environmental expenditures that relate to current operations are typically recorded in cost of sales. Expenditures that mitigate or prevent environmental contamination and that benefit future operations are capitalized as assets and depreciated on a straight-line basis over the estimated useful lives of the assets, which are typically 10 years.
Estimated future expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are recorded as liabilities, with the corresponding charge typically recorded in administrative expenses, 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 amount in the range is accrued. Estimating the possible costs of remediation requires making assumptions related to the nature and extent of contamination and the methods and resulting costs of remediation. Some of the factors on which the Company bases its estimates include information provided by feasibility studies, potentially responsible party negotiations and the development of remedial action plans. Legal costs related to environmental matters are expensed as incurred. See Note 16, Contingencies, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for environmental contingencies details.
Goodwill and Other Intangible Assets
The Company’s intangible assets include patents, agreements not to compete, trademarks, customer lists and relationships, technological and manufacturing know-how, supply contracts and goodwill, all of which were acquired as part of business or product line acquisitions. Intangible assets other than goodwill are determined to have either finite or indefinite useful lives. The Company currently has no indefinite-life intangible assets other than goodwill. The values for intangible assets with finite lives are amortized over the useful lives of the assets. Currently, the useful lives for the Company’s finite-lived intangible assets are as follows: patents – 15 years; non-compete agreements – three years; trademarks – eight to 11 years; customer relationships – ten to 20 years and know-how – seven to 20 years. In addition, finite-life intangible assets are tested for impairment when events or changes in circumstances indicate that the carrying value of an intangible asset may not be recoverable. Goodwill is not amortized but is tested for impairment at least annually, or more frequently, if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit to which goodwill relates below the reporting unit’s carrying value. See Note 4, Goodwill and Other Intangibles, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for detailed information about goodwill and other intangible assets.
Income Taxes
Income taxes are accounted for under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
Deferred tax assets are recognized to the extent that the Company believes these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
Uncertain tax positions are recorded in accordance with ASC 740, Income Taxes, on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying Consolidated Statements of Income. Accrued interest and penalties are included within the related tax liability line in the Consolidated Balance Sheet. See Note 9, Income Taxes, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for more information about the Company’s income taxes.
Translation of Foreign Currencies
For the Company’s consolidated foreign subsidiaries whose functional currency is the local foreign currency, assets and liabilities are translated into U.S. dollars at exchange rates in effect at year end and revenues and expenses are translated at average exchange rates for the year. Any resulting translation adjustments are included in the consolidated balance sheets in the accumulated other comprehensive loss line of stockholders’ equity. Gains or losses on foreign currency transactions are reflected in the other, net caption
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of the consolidated statements of income. The Company has four foreign subsidiaries whose functional currencies are the U.S. dollar. For these subsidiaries, nonmonetary assets and liabilities are translated at historical rates, monetary assets and liabilities are translated at exchange rates in effect at year end, revenues and expenses are translated at average exchange rates for the year and translation gains and losses are included in the other, net caption of the consolidated statements of income.
Stock-Based Compensation
The Company grants stock options, stock awards (including performance-based stock awards) and SARs to certain employees under its incentive compensation plans. The Company calculates the fair values of stock options, stock awards and SARs on the date such instruments are granted. The fair values of the stock options and stock awards are then recognized as compensation expense over the vesting periods of the instruments. The Company’s SARs granted prior to 2015 are cash-settled, and SARs granted in 2015 and later are stock-settled. The cash-settled SARs are accounted for as liabilities that must be re-measured at fair value at the end of each reporting period. Compensation expense for each reporting period is calculated as the period-to-period change (or portion of the change, depending on the proportion of the vesting period that has been completed at the reporting date) in the fair value of the cash-settled SARs. Compensation expense for the stock-settled SARs is calculated in the same way as compensation expense for stock options. See Note 11, Stock-based Compensation, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for detailed information about the Company’s stock-based compensation.
Earnings Per Share
Basic earnings per share amounts are computed as net income attributable to the Company divided by the weighted-average number of common shares outstanding. Diluted earnings per share amounts are based on the weighted-average number of common shares outstanding plus the weighted-average of net common shares (under the treasury stock method) that would be outstanding assuming the exercise of outstanding stock options and stock-settled SARs, the vesting of unvested stock awards that have no performance or market condition and the issuance of contingent performance stock awards. See Note 18, Earnings Per Share, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for detailed information about the Company’s earnings per share calculations.
Comprehensive Income and Accumulated Other Comprehensive Income
Comprehensive income includes net income and all other non-owner changes in equity that are not reported in net income. Comprehensive income is disclosed in the consolidated statements of comprehensive income. Accumulated other comprehensive income (AOCI) is reported as a component of stockholders’ equity in the Company’s consolidated balance sheets. See Note 19, Accumulated Other Comprehensive Income (Loss), of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for detailed information regarding changes in the Company’s AOCI and reclassifications out of AOCI to income.
Segment Reporting
The Company reports financial and descriptive information about its reportable operating segments. Operating segments are components of the Company that have separate financial information that is regularly evaluated by the chief operating decision maker to assess segment performance and allocate resources. The Company discloses segment revenue, operating income, assets, capital expenditures and depreciation and amortization expenses. Enterprise-wide financial information about the geographic locations in which the Company earns revenues and holds assets is also disclosed. See Note 17, Segment Reporting, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for detailed information about the Company’s segment reporting.
Derivative Instruments
Derivative instruments are recognized in the consolidated balance sheets as either assets or liabilities measured at fair value. For derivative instruments that are not designated as hedging instruments, changes in the fair values of the derivative instruments are recognized currently in earnings. For derivative instruments designated as hedging instruments, depending on the nature of the hedge, changes in the fair values of the derivative instruments are either offset in earnings against changes in the fair values of the hedged items or recognized in AOCI until the hedged transaction is recognized in earnings. At the time a hedging relationship is designated, the Company establishes the method it will use for assessing the effectiveness of the hedge and the measurement approach for determining the ineffective aspect of the hedge. Company policy prohibits the use of derivative instruments for trading or speculative purposes. See Note 3, Derivative Instruments, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for further information regarding the Company’s use of derivatives.
At December 31, 2022, the Company held open forward contracts for the purchase of 1.6 million dekatherms of natural gas in 2023 at a cost of $9,381,000. The Company uses forward contracts to minimize its exposure to volatile natural gas prices. Because the
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Company anticipates taking delivery of the natural gas for use in its operations, the forward contracts qualify for the normal purchase exception provided under U.S. GAAP for derivative instruments. The Company has elected the exception for such contracts. As a result, the forward contracts are not accounted for as derivative instruments. The cost of natural gas is charged to expense at the time the natural gas is delivered and used.
Recent Accounting Pronouncements
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848) Facilitation of the Effect of Reference Rate Reform on Financial Reporting. This update provides optional guidance for a limited period of time to ease the burden of implementing the usage of new reference rates. The amendments apply to contract modifications that replace a reference rate affected by reference rate reform and contemporaneous modifications of other contract terms related to the replacement of the reference rate. If elected, the optional expedients to contract modifications must be applied consistently for all eligible contracts or eligible transactions. The original timeframe for electing optional expedients to contract modifications was between March 12, 2020 and December 31, 2022. In December 2022, the FASB issued ASU No. 2022-06 deferring the sunset date of Topic 848 from December 31, 2022, to December 31, 2024. The guidance should be applied prospectively. Other than electing select expedients associated with an interest rate swap, the Company has not currently utilized any of the optional expedients of exceptions available under this ASU. The Company will continue to assess whether this ASU is applicable throughout the effective period.
In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers which improves the accounting for acquired revenue contracts with customers in a business combination by addressing current inconsistencies in the recognition of acquired contract liabilities as well as payment terms and their effect on subsequent revenue recognized by the acquirer. Under current GAAP, an acquirer generally recognizes assets acquired and liabilities assumed in a business combination, including contract assets and contract liabilities arising from revenue contracts with customers and other similar contracts that are accounted for in accordance with ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) at fair value on the acquisition date. This amendment requires acquiring entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The amendments in this update are effective for fiscal years beginning after December 31, 2022 and should be applied prospectively. The Company is prepared to implement the guidance of ASU No. 2021-08 when it becomes applicable.
2. Fair Value Measurements
The following were the financial instruments held by the Company at December 31, 2022 and 2021, and the methods and assumptions used to estimate the instruments’ fair values:
Cash and cash equivalents
Carrying value approximated fair value because of the short maturity of the instruments. Fair value of cash and cash equivalents is a Level 1 measurement.
Derivative assets and liabilities
Derivative assets and liabilities include the foreign currency exchange and interest rate swap contracts discussed in Note 3, Derivative Instruments, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K). Fair value and carrying value were the same because the contracts were recorded at fair value. The fair values of the foreign currency contracts were calculated as the difference between the applicable forward foreign exchange rates at the reporting date and the contracted foreign exchange rates multiplied by the contracted notional amounts. The fair value of the interest rate swaps was calculated as the difference between the contracted swap rate and the floating interest rate multiplied by the present value of the notional amount of the contract. The Company’s fair value measurements for derivative assets and liabilities fall within Level 2 of the fair value hierarchy.
See the table that follows the financial instrument descriptions for the reported fair values of derivative assets and liabilities.
Long-term investments
Long-term investments include the mutual fund assets the Company held to fund a portion of its deferred compensation liabilities and all of its non-qualified supplemental executive defined contribution obligations. See the defined contribution plans section of Note 13, Postretirement Benefit Plans, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K). Fair value and carrying value were the same because the mutual fund assets were recorded at fair value in accordance with the FASB’s fair value option guidance. Fair values for the mutual funds were calculated using the published market price per unit at the reporting date multiplied by the number of units held at the reporting date and therefore its fair value measurements for mutual fund assets fall within Level 1 of the fair value hierarchy.
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See the table that follows the financial instrument descriptions for the reported fair value of long-term investments.
Debt obligations
The fair value of debt with original maturities greater than one year comprised the combined present values of scheduled principal and interest payments for each of the various loans, individually discounted at rates equivalent to those which could be obtained by the Company for new debt issues with durations equal to the average life to maturity of each loan. The fair values of the remaining Company debt obligations approximated their carrying values due to the short-term nature of the debt. The Company’s fair value measurements for debt fall in level 2 of the fair value hierarchy.
At December 31, 2022 and 2021, the fair values and related carrying values of debt, including current maturities, were as follows (the fair value and carrying value amounts are presented without regard to unamortized debt issuance costs of $686,000 and $710,000 as of December 31, 2022 and 2021, respectively):
December 31
The following tables present financial assets and liabilities, excluding cash and cash equivalents, measured on a recurring basis at fair value as of December 31, 2022 and 2021, and the level within the fair value hierarchy in which the fair value measurement falls:
(In thousands) December 31,2022 Level 1 Level 2 Level 3
Derivative assets:
Foreign currency contracts 513 — 513 —
Derivative liabilities:
Foreign currency contracts $ 525 $ — $ 525 $ —
(In thousands) December 31,2021 Level 1 Level 2 Level 3
Derivative assets:
Foreign currency contracts 436 — 436 —
Derivative liabilities:
Foreign currency contracts $ 338 $ — $ 338 $ —
3. Derivative Instruments
The Company is exposed to certain risks relating to its ongoing business operations. The primary risk managed by the use of derivative instruments is foreign currency exchange risk. The Company holds forward foreign currency exchange contracts that are not designated as any type of accounting hedge as defined by U.S. generally accepted accounting principles. The Company uses these contracts to manage its exposure to exchange rate fluctuations on certain Company subsidiary cash, accounts receivable, accounts payable and other obligation balances that are denominated in currencies other than the entities’ functional currencies. The forward foreign exchange contracts are recognized on the balance sheet as either an asset or a liability measured at fair value. Gains and losses arising from recording the foreign exchange contracts at fair value are reported in earnings as offsets to the losses and gains reported in earnings arising from the re-measurement of the receivable and payable balances into the applicable functional currencies. At December 31, 2022 and 2021, the Company had open forward foreign currency exchange contracts, all with durations of one to six months, to buy or sell foreign currencies with a U.S. dollar equivalent of $56,746,000 and $51,542,000, respectively.
The Company is currently exposed to volatility in short-term interest rates and has mitigated certain portions of that risk by using an interest rate swap. The interest rate swap is recognized on the balance sheet as either an asset or a liability measured at fair value. At December 31, 2022, the Company held an interest rate swap contract with a notional value of $100,000,000 that was designated as a cash flow hedge. Period-to-period changes in the fair value of the interest rate swap are initially recognized as gains or losses in other
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comprehensive income. As the interest rate swap contract is settled, the corresponding gain or loss is reclassified out of accumulated other comprehensive income (AOCI) into earnings. The maturity date of the current interest swap contract is March 10, 2027 which is closely aligned with the June 24, 2027 maturity of the Company’s revolving credit facility.
The fair values of the derivative instruments held by the Company on December 31, 2022, and December 31, 2021, are disclosed in Note 2, Fair Value Measurements, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K). Derivative instrument gains and losses for the years ended December 31, 2022, 2021 and 2020, were immaterial. For amounts reclassified out of AOCI into earnings for the years ended December 31, 2022, 2021 and 2020, see Note 19, Accumulated Other Comprehensive Income (Loss), of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K).
4.Goodwill and Other Intangible Assets
The changes in the carrying value of goodwill for the years ended December 31, 2022 and 2021, were as follows:
SurfactantsSegment PolymerSegment Specialty ProductsSegment Total
Balance as of January 1
Goodwill measurement period adjustment (1) — 940 — — — — — 940
Goodwill impairment (978 ) — — — — — (978 ) —
Balance as of December 31
(1)
See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for information regarding the goodwill acquired in a business combination.
The Company typically tests its goodwill balances for impairment in the second quarter of each calendar year. Testing is completed more frequently when triggering events or changes in circumstances indicate it is more likely than not that the fair value of a reporting unit to which goodwill relates has declined below its carrying value. During the second quarter of 2022 the Company completed its annual goodwill impairment testing and concluded that the goodwill related to its Philippines reporting unit was impaired. The Philippines reporting unit is part of the Company’s Surfactant segment. Goodwill impairment was recognized as a result of the reporting unit’s fair value declining below its carrying value. The Company estimates the fair value of each of its reporting units based on the average of market and income-based computations. The Philippines impairment primarily resulted from lost market share at one major customer combined with higher unit overhead costs. The Company recorded a non-cash charge of $978,000 in the Consolidated Statements of Income for the year ended December 31, 2022. The impairment charge equaled the entire balance of the Philippines’ goodwill. The Company concluded that there was no goodwill impairment at any of its other reporting units based on its quantitative testing completed during the second quarter of 2022 and its qualitative assessment at the year end.
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The following table presents the components of other intangible assets, all of which have finite lives, as of December 31, 2022 and 2021. The year-over-year changes in gross carrying values mainly resulted from the acquisition that took place in 2022 and the effects of foreign currency translation.
Gross Carrying Value AccumulatedAmortization
December 31 December 31
Other Intangible Assets:
(1)
Know-how includes intellectual property rights covering proprietary information, written formulae, trade secrets or secret processes, inventions and developmental products (whether patentable or not), discoveries, improvements, compositions, manufacturing processes, manuals, specifications and technical data.
(2)
The 2021 balances include intangible assets acquired as part of the Company’s acquisition of INVISTA’s aromatic polyester polyol business and associated assets in January 2021 and the Company’s fermentation plant acquisition in February 2021. The 2022 balances include intangible assets acquired as part of the Company’s PerformanX acquisition in September 2022. See Note 20, Acquisitions, of the notes to the Company’s consolidated financial statements (included in Item 8 of this Form 10-K) for additional details.
Aggregate amortization expense for the years ended December 31, 2022, 2021 and 2020, was $6,835,000, $7,292,000, and $3,621,000, respectively. The Company typically recognizes amortization expense within the Cost of Sales line item on the income statement. Estimated amortization expense for identifiable intangibles assets for each of the five succeeding fiscal years is as follows:
(In thousands)
5. Inventories
The composition of inventories was as follows:
December 31
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6. Debt
At December 31, 2022 and 2021, debt was comprised of the following:
(In thousands) MaturityDates December 31,2022 December 31,2021
Senior unsecured notes
Debt of foreign subsidiaries
Unsecured bank debt, foreign currency 2023 — 2,861
The Company’s long-term debt financing is currently comprised of certain senior unsecured notes issued to insurance companies in private placement transactions, totaling $397,890,000 as of December 31, 2022. These notes are denominated in U.S. dollars and have fixed interest rates ranging from 2.30 percent to 4.86 percent. The notes had original maturities of seven to 12 years with mandatory principal payments beginning four, five and six years after issuance. The Company will be required to make principal payments on the currently outstanding notes from 2023 to 2032.
On March 1, 2022, pursuant to a note purchase and master note agreement dated as of June 10, 2021 (the NYL note purchase agreement), the Company issued and sold $25,000,000 in aggregate principal amount of its 2.83% Senior Notes, Series 2022-A, due March 1, 2032 (the Series 2022-A Notes). In addition, on March 1, 2022, pursuant to a note purchase and private shelf agreement dated as of June 10, 2021 (the Prudential note purchase agreement), the Company issued and sold $50,000,000 in aggregate principal amount of its 2.83% Senior Notes, Series 2022-B, due March 1, 2032 (the Series 2022-B Notes). The Series 2022-A Notes and the Series 2022-B Notes bear interest at a fixed rate of 2.83%, with interest to be paid semi-annually and with equal annual principal payments beginning on March 1, 2026 and continuing through final maturity on March 1, 2032. The proceeds of the issuance of the Series 2022-A Notes and the Series 2022-B Notes are being used primarily for capital expenditures, to pay down existing debt and for other corporate purposes. The NYL note purchase agreement and the Prudential note purchase agreement require the maintenance of certain financial ratios and covenants that are substantially similar to the Company’s existing long-term debt and provide for customary events of default.
On June 24, 2022, the Company entered into a credit agreement with a syndicate of banks. The credit agreement provides for credit facilities in an initial aggregate principal amount of $450,000,000, consisting of (a) a $350,000,000 multi-currency revolving credit facility and (b) a $100,000,000 delayed draw term loan credit facility, each of which matures on June 24, 2027. This credit agreement replaced the Company’s prior $350,000,000 revolving credit agreement. The Company maintains import letters of credit, and standby letters of credit under its workers’ compensation insurance agreements and for other purposes, as needed from time to time, which are issued under the revolving credit agreement. As of December 31, 2022, the Company had outstanding letters of credit totaling $10,870,000 and $189,250,000 of outstanding borrowings under the credit agreement, inclusive of a $98,750,000 delayed-draw term loan. There was $249,880,000 available under the credit agreement as of December 31, 2022.
Loans under the credit agreement may be incurred, at the discretion of the Company, with terms to maturity of one month, three months or six months. The Company may choose from two interest rate options: (1) Adjusted Term Secured Overnight Financing
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Rate (SOFR) applicable to USD loans and relevant benchmark rates applicable to EUR, GBP and CAD loans plus spreads ranging from 1.125 percent to 1.750 percent, depending on the Company’s net leverage ratio, or (2) the prime rate plus 0.125 percent to 0.750 percent, depending on the Company’s net leverage ratio. The credit agreement requires the Company to pay a commitment fee ranging from 0.125 percent to 0.250 percent per annum, which also depends on the Company’s net leverage ratio. The credit agreement requires the maintenance of certain financial ratios and compliance with certain other covenants that are similar to the Company’s existing debt agreements, including net worth, interest coverage, leverage financial covenants and limitations on restricted payments, indebtedness and liens.
The Company’s foreign subsidiaries had no debt at December 31, 2022.
The Company’s material debt agreements contain provisions which, among other covenants, require maintenance of certain financial ratios and place limitations on additional debt, investments and payment of dividends. Based on the loan agreement provisions that place limitations on dividend payments, unrestricted retained earnings (i.e., retained earnings available for dividend distribution) were $224,189,000 and $468,095,000 at December 31, 2022 and 2021, respectively.
Debt at December 31, 2022, matures as follows: $132,111,000 in 2023; $53,572,000 in 2024; $69,108,000 in 2025; $66,786,000 in 2026; $135,535,000 in 2027 and $130,714,000 after 2027. Debt maturing in 2023 includes $41,608,000 of scheduled repayments under long-term debt agreements. The Company’s foreign subsidiaries routinely have short-term working capital loans. These short-term loan agreements could be supplemented, if necessary, by the Company’s $350,000,000 revolving credit facility entered into on June 24, 2022.
Net interest expense for the years ended December 31, 2022, 2021 and 2020, comprised the following:
7. Leases
The Company’s operating leases are primarily comprised of real estate, railcar, storage tank, warehouse, auto, trailer and manufacturing/office equipment leases. Real estate and railcars comprise approximately 62 percent and 24 percent, respectively, of the Company’s consolidated right of use (ROU) asset balance. Except for real estate, typical lease terms range from one to ten years. Real estate lease terms typically range from one to fifty years. The Company’s four principal real estate leases consist of the office lease for the corporate headquarters in Northbrook, Illinois and land leases in the Philippines, Singapore and Lake Providence, Louisiana. As of December 31, 2022, the Company had railcars, equipment and storage tank leases valued at approximately $8,229,000, that had not commenced. These leases will commence during the first three quarters of 2023 with lease terms ranging 1 year to 10 years.
As most of the Company’s leases do not provide an implicit borrowing rate, the Company uses its incremental borrowing rate (IBR) based on the information available at the commencement date in determining the present value of lease payments. IBRs were specifically determined for the United States, Philippines, Singapore, Brazil and China, typically for five-year increments. The U.S. IBR was used for all other countries as the leases in these countries are not material. The total value of leases that reside in the five countries identified above represents approximately 97 percent of the Company’s consolidated ROU asset balance. Lease cost is recognized in both the Cost of Sales and Operating Expenses sections of the Consolidated Statements of Income.
(In thousands) Year ended December 31, 2022 Year ended December 31, 2021
Lease Cost
Other Information
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flow from operating leases $ 15,963 $ 14,885
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The following table outlines maturities of lease liabilities as of December 31, 2022:
(In thousands)
Undiscounted Cash Flows:
Total Undiscounted Cash Flows $ 75,092
Less: Imputed interest (11,481 )
Current operating lease liabilities (1) 13,052
Non-current operating lease liabilities 50,559
Total lease liabilities $ 63,611
(1)
This item is included in Accrued liabilities line on the Company’s Consolidated Balance Sheet.
Weighted-average remaining lease term-operating leases 10 Years
Weighted-average discount rate-operating leases 3.2%
8. Other, Net
Other, net in the Consolidated Statements of Income included the following for the years ended December 31, 2022, 2021 and 2020:
Foreign exchange gains (losses) $ (2,871 ) $ 501 $ 1,367
Realized and unrealized gains (losses) on investments (8,188 ) 2,289 3,143
Gain on dissolution of the China joint venture — 972 —
9. Income Taxes
The provisions for taxes on income and the related income before taxes for the years ended December 31, 2022, 2021 and 2020, were as follows:
Taxes on Income
Federal
State
Foreign
Income before Taxes
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The variations between the effective and statutory U.S. federal income tax rates are summarized as follows:
(In thousands) Amount % Amount % Amount %
(1)
Includes cost of global intangible low-taxed income (GILTI) in 2022, 2021 and 2020 plus other taxes paid or withheld on cash repatriated from foreign countries in 2021 and 2020. For 2022, includes Subpart F activity. For 2021, includes the benefit of separate limitation loss foreign tax credit attributes, related to prior years, that were utilized in 2021.
(2)
For 2022, amount resulted from a higher federal research credit and lower GILTI. For 2021, amount resulted from a higher federal research credit, higher foreign-derived intangible income (FDII), and lower GILTI.
(3)
For 2022, the increase was partially due to certain pilot model design and engineering costs.
At December 31, 2022 and 2021, the tax effects of significant temporary differences representing deferred tax assets and liabilities were as follows:
Deferred Tax Assets:
Non-U.S. subsidiaries net operating loss carryforwards 3,634 1,494
Deferred Tax Liabilities:
Unrealized foreign exchange loss (3,603 ) (2,908 )
Valuation Allowance $ (836 ) $ (862 )
Reconciliation to Consolidated Balance Sheet:
Non-current deferred tax assets (in other non-current assets) 46,684 20,944
Non-current deferred tax liabilities (10,179 ) (12,491 )
Earnings generated by a foreign subsidiary are presumed to ultimately be transferred to the parent company. Therefore, the establishment of deferred taxes may be required with respect to the excess of the investment value for financial reporting over the tax basis of investments in those foreign subsidiaries (also referred to as book-over-tax outside basis differences). A company may overcome this presumption and forgo recording a deferred tax liability in its financial statements if it can assert that management has
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the intent and ability to indefinitely reinvest the earnings of its foreign subsidiaries. Pursuant to the 2017 U.S. Tax Cuts and Jobs Act (Tax Act), the Company’s foreign earnings have been subject to U.S. federal taxes. The Company now has the ability to repatriate to the U.S. parent the cash associated with these foreign earnings with little additional U.S. federal taxes. This cash may, however, be subject to foreign income and/or local country taxes if repatriated to the United States. In addition, repatriation of some foreign cash balances may be further restricted by local laws. As such, the Company intends to limit its distributions to earnings previously taxed in the U.S. or earnings that would qualify for the 100 percent dividends received deduction provided for in the Tax Act as long as such distributions would not result in any significant foreign taxes. In 2022, the Company did not repatriate any cash to the U.S. parent company. In 2021, the Company repatriated $15,340,000 between May and December from its Brazilian, Colombian, and Mexican subsidiaries. The Company did not incur any incremental taxes as a result of this repatriation. In anticipation of the Company’s acquisition of INVISTA’s aromatic polyester polyol business and associated assets, the Company’s Philippines entities declared a cash dividend of approximately $20,700,000 to the U.S. parent in December 2020. The Company recorded $2,384,000 of additional income tax expense in 2020 as a result of the expected repatriation. The Company’s U.S. parent received the cash in 2021. The effect of the adjustment on the 2020 effective tax rate was an increase of approximately 1.4 percent.
The Company evaluated its indefinite reinvestment assertion with regards to certain accumulated foreign earnings as of December 31, 2022. The Company does not consider the undistributed earnings of its Canadian subsidiary to be indefinitely reinvested in foreign operations to the extent of the subsidiary’s paid-up capital (PUC) as determined under Canadian tax law which is used to determine tax-free distributions for Canadian tax purposes. The Company also does not consider the undistributed earnings of one of its Dutch subsidiaries, and one of its Singapore subsidiaries to be indefinitely reinvested in foreign operations. A distribution from any of these subsidiaries should not result in any significant foreign taxes to the extent of the distribution limitations discussed above and therefore, the Company has not recognized a deferred tax liability for these undistributed earnings as of December 31, 2022. In 2021, the Company dissolved its China joint venture that prior to dissolution had not been considered indefinitely reinvested. The dissolution resulted in $142,000 of additional income tax expense in 2021. The Company considers the undistributed earnings of its remaining foreign subsidiaries to be indefinitely reinvested in foreign operations. At this time, the determination of deferred tax liabilities on this amount is not practicable.
The Company had non-U.S. tax loss carryforwards of $10,754,000 (pretax) as of December 31, 2022, and $3,351,000 as of December 31, 2021, that are available for use by the Company between 2023 and 2032. The Company had tax credit carryforwards of $8,183,000 as of December 31, 2022, and $2,829,000 as of December 31, 2021, that are available for use by the Company between 2023 and 2042. The Company had non-U.S. capital loss carryforwards of $595,000 as of December 31, 2022, and $638,000 as of December 31, 2021. The Company’s capital loss carryforwards do not expire.
As of December 31, 2022, and 2021, the Company had valuation allowances of $836,000 and $862,000, respectively, which were attributable to deferred tax assets in Canada, India, the Philippines and Singapore. The realization of deferred tax assets is dependent on the generation of sufficient taxable income in the appropriate tax jurisdictions. The Company believes that it is more likely than not that the related deferred tax assets will not be realized.
As of December 31, 2022, 2021 and 2020, unrecognized tax benefits totaled $10,682,000, $7,292,000 and $4,735,000, respectively. The amount of unrecognized tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future periods, net of the federal benefit on state issues, was approximately $10,172,000, $6,973,000 and $4,545,000 at December 31, 2022, 2021 and 2020, respectively. The Company does not believe that the amount of unrecognized tax benefits related to its current uncertain tax positions will change significantly over the next 12 months.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits as income tax expense. In 2022, the Company recognized net interest and penalty expense of $202,000 compared to $260,000 of net interest and penalty expense in 2021 and $31,000 of net interest and penalty expense in 2020. At December 31, 2022 the liability for interest and penalties was $543,000 compared to $340,000 at December 31, 2021.
The Company files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. The Company is not subject to U.S. federal income tax examinations by tax authorities for years before 2016. Some foreign jurisdictions and various U.S. states jurisdictions may be subject to examination back to 2015.
During 2021, the Internal Revenue Service started its audit of the 2016-2019 tax years and expanded the years under audit to 2016-2020 in 2022. As of December 31, 2022, this audit was still open, and the Company had not been notified of any significant proposed adjustments.
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Below are reconciliations of the January 1 and December 31 balances of unrecognized tax benefits for 2022, 2021 and 2020:
Unrecognized tax benefits, opening balance $ 7,292 $ 4,735 $ 3,273
Gross increases – tax positions in prior period 2,188 938 190
Gross increases – current period tax positions 1,617 1,662 1,288
Settlements (454 ) — —
Foreign currency translation 74 (14 ) 15
Lapse of statute of limitations (35 ) (29 ) (31 )
Unrecognized tax benefits, ending balance $ 10,682 $ 7,292 $ 4,735
10. Stockholders’ Equity
At December 31, 2022 and 2021, treasury stock consisted of 4,605,858 and 4,340,729 shares of common stock, respectively. During 2022, 251,120 shares of Company common stock were purchased in the open market. In addition, 20,347 shares were surrendered to the Company in connection with the settlement of employees’ minimum statutory withholding taxes related to performance stock awards, exercised SARs and deferred compensation distributions. Also, 6,338 shares of treasury stock were distributed to participants under the Company’s deferred compensation plans.
11. Stock-based Compensation
On December 31, 2022, the Company had outstanding stock options, stock awards and SARs awarded under its 2011 Incentive Compensation Plan (2011 Plan) and stock awards and SARs awarded under its 2022 Equity Incentive Compensation Plan (2022 Plan). Equity incentive awards are currently granted to Company executives and other key employees. In addition, stock awards are currently granted to non-employee directors of the Company. As of April 26, 2022, no additional stock options, stock awards or SARs may be granted under the 2011 Plan. As of the effective date of the 2022 Plan, 500,000 shares of the Company’s common stock, plus the number of shares that remained available for awards under the 2011 Plan as of April 26, 2022, were available for equity awards under the 2022 Plan. At December 31, 2022, there were 810,080 shares available for grant under the 2022 Plan.
Compensation expense recorded in the consolidated statements of income for all plans was $13,851,000, $11,716,000, and $10,080,000 for the years ended December 31, 2022, 2021 and 2020, respectively. The increase in stock-based compensation in 2022 versus 2021 was primarily attributable to the accelerated vesting of certain equity grants for the Company’s former Chief Executive Officer, who retired on April 25, 2022. In addition, management’s assessment that higher performance targets for certain grants would be achieved led to the increase of compensation expenses for performance awards.
The total income tax benefit recognized in the income statement for share-based compensation arrangements was $3,537,000, $2,867,000, and $2,390,000 for the years ended December 31, 2022, 2021 and 2020, respectively.
Stock Options
Under all plans, stock option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. The market price is defined and calculated as the average of the opening and closing prices for Company common stock on the grant date as reported in the New York Stock Exchange – Composite Transactions. Stock option awards granted prior to 2017 generally cliff vested after two years. Starting in 2017, stock options have a three-year graded vesting feature, with one-third of the awards vesting each year. The Company has elected the straight-line method of expense attribution for the stock options with graded vesting feature. These options have a 10-year contractual term. The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model incorporating the weighted-average assumptions noted in the following table. Expected volatility is based on the historical volatility of the Company’s common stock. The Company also uses historical data to estimate the expected term of options granted. The risk-free rate is the U.S. Treasury note rate that corresponds to the expected option term at the date of grant. The following are the weighted-average assumptions used to calculate the grant-date fair values of stock option awards granted in the years ended December 31, 2022, 2021 and 2020:
For the Years Ended December 31
Expected term 6.0 years 7.3 years 7.3 years
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A summary of stock option activity for the year ended December 31, 2022 is presented below:
Options
The weighted-average grant-date fair values of options awarded during the years ended December 31, 2022, 2021 and 2020, were $32.21, $36.49, and $25.90, respectively. The total intrinsic values of options exercised during the years ended December 31, 2022, 2021, and 2020 were $475,000, $1,287,000, and $2,534,000, respectively.
As of December 31, 2022, the total unrecognized compensation cost for unvested stock options was $692,000. That cost is expected to be recognized over a weighted-average period of 1.2 years.
Cash received from stock option exercises under the Company’s stock option plans for the years ended December 31, 2022, 2021, and 2020 was $782,000, $1,369,000, and $2,926,000, respectively. The actual tax benefit realized for the tax deductions from stock option exercises totaled $36,000, $172,000, and $339,000 for the years ended December 31, 2022, 2021 and 2020, respectively.
Stock Awards
In 2020, 2021, and 2022, the Company granted stock awards under the 2011 Plan and, starting in April 2022, the Company also granted stock awards under the 2022 Plan. Most Company stock awards are granted in the form of performance awards. The performance stock awards vest only upon the Company’s achievement of certain levels of financial performance by the end of specified measurement periods as approved by the Board of Directors. The number of shares of the Company’s common stock ultimately distributed, if any, is contingent upon the Company’s actual financial performance attained by the end of the measurement period relative to the targets approved by the Board of Directors. The fair value of performance stock awards equals the grant-date market price of the Company’s common stock, discounted for the estimated amount of dividends that would not be received during the measurement period. Compensation expense is recorded each reporting period based on the probable number of awards that will ultimately vest given the projected level of financial performance. If at the end of the measurement period the performance objectives are not met, no compensation cost is recognized and any compensation expense recorded in prior periods is reversed. Under the 2011 Plan, the Company periodically granted stock awards that have no performance conditions associated with their vesting. Under the 2022 Plan, stock awards that have no performance conditions may be routinely granted to eligible employees. These stock awards vest after the period of service established for the given grant. In addition, the Company grants stock awards that have no performance conditions associated with their vesting to non-employee directors of the Company.
A summary of stock award activity for the year ended December 31, 2022, is presented below:
Shares Weighted-AverageGrant DateFair Value
Stock Awards
Forfeited/Modified due to change of assumptions 5,613 86.94
The weighted-average grant-date fair values of stock awards granted during the years ended December 31, 2022, 2021 and 2020, were $106.78, $119.76, and $98.46, respectively. As of December 31, 2022, under the current Company assumption as to the number of shares of the Company’s common stock underlying stock awards that will vest at the measurement periods ended December 31, 2023
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and 2024, there was $6,144,000 of unrecognized compensation cost for unvested stock awards. That cost is expected to be recognized over a period of 1.7 years.
SARs
At December 31, 2022, the Company had both cash-settled and Company stock-settled SARs outstanding. SARs granted prior to 2015 are cash-settled, and SARs granted in 2015 and later are stock-settled. SARs granted prior to 2017 cliff vested after two years. Starting in 2017, SARs have a three-year graded vesting feature, with one-third of the awards vesting each year. The Company has elected the straight-line method of expense attribution for the SARs with graded vesting feature. All SARs expire ten years from the grant date. Upon the exercise of a SARs award, a participant receives cash (for cash-settled SARs) or Company common stock (for stock-settled SARs). For cash-settled SARs, an amount equals the excess of the fair market value of a total number of shares/SARs exercised at the date of exercise over the fair market value of a total number of shares/SARs exercised at the date of grant (the exercise price). For stock-settled SARs, the number of shares equals the excess of the fair market value of a total number of shares/SARs exercised at the date of exercise over the fair market value of a total number of shares/SARs exercised at the date of grant (the exercise price) divided by the fair market value of a share of Company common stock at the date of exercise. Cash-settled SARs are accounted for as liabilities that must be re-measured at fair value at the end of every reporting period until settlement. Compensation expense for each reporting period is based on the period-to-period change (or portion of the change, depending on the proportion of the vesting period that has been completed at the reporting date) in the fair value of the SARs. Compensation expense for stock-settled SARs is based on the grant-date value of the awards allocated over the proportion of the vesting period that has been completed at the reporting date. Because stock-settled SARs are considered equity instruments, they are not re-measured at fair value at the end of each reporting period.
The following is a summary of SARs activity for the year ended December 31, 2022:
SARs
The weighted-average grant-date fair values of SARs granted during the years 2022, 2021 and 2020 were $34.76, $36.49, and $25.88, respectively. The fair value for each SARs award was estimated using the Black-Scholes valuation model incorporating the same assumptions as noted for stock options.
As of December 31, 2022, and 2021, the liability for cash-settled SARs recorded on the consolidated balance sheet (non-current liabilities) was $747,000 and $1,502,000, respectively. At December 31, 2022, there was $5,211,000 of total unrecognized compensation cost related to all unvested SARs. That cost is to be recognized over a weighted-average period of 1.8 years.
In general, it is the Company’s policy to issue new shares of its common stock upon the exercise of stock options and stock-settled SARs or the vesting of stock awards.
12. Deferred Compensation
The Company sponsors deferred compensation plans that allow management employees to defer receipt of their annual cash incentive compensation and performance shares and outside directors to defer receipt of their fees and stock awards until retirement, departure from the Company or as otherwise elected. Compensation expense and the related deferred compensation obligation are recorded when the underlying compensation is earned. Over time, the deferred obligation may increase or decrease based on the performance results of investment options chosen by the plan participants. The investment options include the Company’s common stock and a limited selection of mutual funds. The Company maintains sufficient shares of treasury stock to cover the equivalent number of shares that result from participants elections of the Company common stock investment option. As a result, the Company periodically purchases shares of its common stock in the open market or in private transactions. The Company purchases shares of the applicable mutual funds to fund the portion of its deferred compensation liabilities tied to such investments.
Some plan distributions may be made in cash or Company common stock at the option of the participant. Other plan distributions can only be made in Company common stock. For deferred compensation obligations that may be settled in cash or shares of Company’s
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common stock at the option of the participant, the Company must record appreciation in the market values of the investment choices made by participants as additional compensation expense. Conversely, declines in the market values of the investment choices reduce compensation expense. Increases and decreases of compensation expense that result from fluctuations in the underlying investments are recorded as part of operating expenses in the consolidated statements of income. The obligations that must be settled only in shares of the Company’s common stock are treated as equity instruments; therefore, fluctuations in the market price of the underlying shares of the Company’s common stock do not affect earnings.
The additional compensation expense or income resulting from the changes in the market values and earnings of the selected investment options was $9,393,000 income in 2022, and $6,895,000 expense and in 2021 and $9,988,000 expense in 2020. The main factors in the decrease of the 2022 deferred compensation expense versus 2021 deferred compensation expense was a decrease in the value of the mutual fund investment assets as well as a $17.83 per share decrease in the market price of the Company’s common stock in 2022 versus a $4.97 per share increase in the market price of the Company’s common stock in 2021. The Company’s deferred compensation liability was $43,005,000and $61,219,000 at December 31, 2022 and 2021, respectively.
13. Postretirement Benefit Plans
Defined Benefit Plans
The Company sponsors various funded qualified and unfunded non-qualified defined benefit pension plans, the most significant of which cover employees in the U.S. and U.K. locations. The various U.S. defined benefit pension plans were amended during the years 2005-2008 to freeze the plans by stopping the accrual of service benefits. The U.K. defined benefit pension plan was frozen in 2006. Benefits earned through the freeze dates are available to participants when they retire, in accordance with the terms of the plans. The Company established defined contribution plans to replace the frozen defined benefit pension plans.
Obligations and Funded Status at December 31
United States United Kingdom
Change in benefit obligation
Foreign exchange impact — — (2,322 ) (238 )
United States United Kingdom
Change in plan assets
Foreign exchange impact — — (2,735 ) (290 )