Stepan Company — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Stepan produces intermediate chemicals through its Surfactants, Polymers and Specialty Products segments. Amounts below are in U.S. dollars; financial statement figures are rounded to millions unless stated otherwise.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $508.0m | $487.8m | $1,527.2m | $1,451.2m |
| Gross profit | $84.1m | $75.6m | $263.0m | $257.7m |
| Operating income | $27.7m | $30.4m | $112.0m | $115.8m |
| Net income attributable to Stepan | $22.2m | $21.9m | $85.8m | $81.7m |
| Diluted EPS | $0.95 | $0.94 | $3.68 | $3.50 |
| Gross margin | 16.6% | 15.5% | 17.2% | 17.8% |
| Operating margin | 5.5% | 6.2% | 7.3% | 8.0% |
Q3 sales rose 4%, principally on 6% higher volume, with foreign currency translation reducing the increase by $10.7m. Nine-month sales rose 5%, reflecting volume, pricing and currency effects. Effective tax rates declined to 12.2% for Q3 and 18.6% year to date, from 25.4% and 26.2%, respectively; management attributed the decrease mainly to the lower U.S. corporate tax rate, partly offset by tax-reform effects and other items.
Segment results
- Surfactants: Q3 sales increased 8% to $346.9m and operating income rose 38% to $31.2m. For nine months, sales grew 9% and operating income 15% to $105.7m. North American results benefited from volume and mix; Latin American margins were pressured by acquisition integration and start-up costs.
- Polymers: Q3 sales declined 4% to $141.6m and operating income fell 18% to $17.4m. Nine-month sales declined 3% and operating income fell 16% to $53.8m, reflecting lower volume and margins, including raw-material costs not fully passed through to customers.
- Specialty Products: Q3 sales rose 5% to $19.5m and operating income increased to $2.7m, partly due to order timing and product mix. Nine-month sales and operating income declined 4% and 15%, respectively.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $96.2m, down from $124.7m. Working capital absorbed cash, including $34.8m from receivables and $21.6m from inventories; management linked inventory growth to the Mexico acquisition and planned inventory builds.
- Investing cash outflow was $82.7m, including $62.9m of capital expenditures and $21.5m paid for the Ecatepec, Mexico acquisition. Financing cash outflow was $34.1m, including $15.2m of dividends and $13.5m of share repurchases. Cash declined $24.9m to $274.0m.
- At September 30, total debt was $286.2m, versus $290.8m at year-end 2017; cash exceeded debt by approximately $12.2m. Current assets were $815.0m and current liabilities $326.9m.
- The company had no borrowings on its $350m revolving credit facility and $345.0m available after letters of credit. Management said cash on hand, operating cash flow and committed facilities should fund anticipated needs; it reported compliance with debt covenants.
Changes, outlook and notable items
- Despite higher Q3 revenue and gross profit, operating income declined 9%, as segment gains were outweighed by higher corporate costs, deferred compensation expense and restructuring charges. Reported Q3 attributable net income rose about 1%; management’s non-GAAP adjusted net income rose 21% to $26.0m. For nine months, reported attributable net income increased 5% and adjusted net income increased 7% to $90.1m.
- Management remained optimistic about full-year earnings growth, citing Surfactants’ diversification, efficiency and customer reach; continued insulation-market support for Polymers despite margin challenges; and expected improvement in full-year Specialty Products results. No quantified earnings guidance was provided. 2018 capital expenditures were estimated at $90m–$100m.
- In Q3, the company approved closing its German Surfactants operations, recording $1.4m of asset and spare-parts write-downs; decommissioning costs are expected through 2019. The Ecatepec acquisition’s purchase-price allocation remained preliminary, with final inventory settlement anticipated in Q4; the acquired business was expected to have minimal 2018 results impact.
- Management planned to repatriate approximately $100m of foreign cash in Q4. The company recorded a $1.9m Q3 tax expense related to repatriation, partly offset by favorable tax-accounting adjustments. Tax Act accounting remained incomplete for certain items, including GILTI and executive compensation, with completion expected in Q4.
- Environmental and legal losses were estimated at $24.0m–$45.5m; $24.0m was accrued. The company said certain other site exposures could not be estimated, and adverse determinations could materially affect cash flows or results for a period, although management did not expect the matters in aggregate to materially affect financial position.
- Other risks highlighted include raw-material and energy cost volatility, production interruptions, competition, foreign exchange and international risks, acquisition integration, debt covenant limits, litigation, environmental compliance and changing tax rules. The company reported effective disclosure controls and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether Surfactants’ growth and margin gains can persist, and whether the German closure delivers savings after decommissioning costs.
- Whether Polymers can recover margins as raw-material costs and customer pricing change, and whether volume trends improve.
- How working-capital demands, capital spending and the planned foreign-cash repatriation affect cash balances and net debt.
- Final Ecatepec acquisition accounting and integration performance; the filing says its purchase-price allocation was preliminary.
- Developments in environmental and legal exposures, including the unquantified sites, and completion of remaining Tax Act accounting items.