Stepan Company — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results; dollar amounts below are in millions unless noted.
Business context and results
Stepan makes intermediate chemicals through Surfactants, Polymers and Specialty Products. Surfactants generated 67% of first-half sales, Polymers 28%, and Specialty Products 5%.
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $495.1 | $454.6 | $963.4 | $900.5 |
| Gross profit | $90.0 | $92.9 | $182.1 | $186.4 |
| Operating income | $39.0 | $42.9 | $85.0 | $87.5 |
| Net income attributable to Stepan | $27.9 | $28.5 | $59.8 | $56.4 |
| Diluted EPS | $1.19 | $1.24 | $2.56 | $2.46 |
| Operating cash flow | Not separately provided | Not separately provided | $60.9 | $76.3 |
Q2 gross margin was approximately 18.2% versus 20.4% a year earlier; operating margin was 7.9% versus 9.4%. For the first half, gross margin was approximately 18.9% versus 20.7%, and operating margin 8.8% versus 9.7%. Declining margins reflect cost and mix pressures despite higher sales.
Material changes and financial position
- Q2 sales rose 9%, but consolidated volume fell 4%; higher selling prices added $62.5 million to the year-over-year sales change, largely reflecting raw-material cost pass-through, while lower volume reduced it by $17.9 million. Foreign exchange reduced sales by $4.1 million.
- Q2 segment operating income increased in Surfactants ($31.0 million, up 14%) and Specialty Products ($5.4 million, up 204%), but fell in Polymers ($21.3 million, down 31%). Polymer results were pressured by higher raw-material costs and lower volume.
- First-half sales increased 7%, while volume declined 4%. Operating income fell 3%; Polymer operating income declined 20%, partly offset by gains in Surfactants and Specialty Products. First-half net income rose 6%, supported in part by lower interest expense, investment gains and a lower effective tax rate.
- First-half operating cash flow was $60.9 million, down from $76.3 million. Capital expenditures were $38.3 million; investing cash outflow was $44.9 million. Cash declined $1.9 million to $223.8 million.
- At June 30, current assets were $733.4 million and current liabilities $274.4 million (current ratio approximately 2.7). Total debt was $304.4 million, down from $317.0 million at year-end; net debt was $80.6 million. The $125 million revolving facility had no borrowings and $119.9 million available, after letters of credit.
- Dividends declared were $0.21 per share in Q2, compared with $0.19 in Q2 2016. First-half declared dividends were $0.41 per share, versus $0.38.
Outlook, risks and unusual items
- Management said it remained optimistic after record first-half net income and expected earnings for 2017 to grow. It cited diversification and efficiency improvements, a strong global rigid-polyol market, and expected partial recovery of higher raw-material costs and lower manufacturing costs in the second half. North American competitive activity was expected to persist. No specific earnings guidance amount was provided.
- Management estimated 2017 capital expenditures of $95 million to $105 million, including capacity expansions in the United States, Brazil and Germany, and said cash, operating cash flow and committed facilities should fund foreseeable needs.
- The company agreed to acquire a BASF surfactants facility and related business in Ecatepec, Mexico, with completion expected in Q4 2017 subject to approvals and closing conditions. It was not expected to materially affect 2017 results. The facility has more than 50,000 metric tons of capacity.
- Restructuring costs included $0.6 million in Q2 and $1.4 million in the first half, principally for decommissioning the closed Longford Mills, Canada facility; Q2 also included a Singapore workforce reduction. Total Longford Mills restructuring expense was expected to be about $4.5 million.
- Environmental and legal loss exposure was estimated at $25.0 million to $45.8 million; the accrued liability was $25.0 million. Management considered the accrual adequate, but adverse outcomes at certain sites could materially affect cash flows or results in a period. The company also disclosed a USEPA prefiling notice seeking a $178,600 penalty for alleged pesticide-law violations; the final penalty could not be estimated.
- Key risks include raw-material and energy-cost volatility, demand and competitive pressures, plant disruptions, foreign exchange, acquisition execution, environmental and legal matters, and debt-covenant compliance. Management reported covenant compliance at June 30 and expected compliance through 2017.
- Deferred-compensation expense is affected by changes in the company’s share price and plan investments, causing period-to-period earnings variability. Q2 expense rose $2.6 million year over year; the company also recorded investment gains in other income.
Important facts for investors to verify
- Whether second-half price recovery and lower manufacturing costs offset Polymer margin pressure and volume weakness.
- Whether cash conversion improves after the first-half working-capital use, especially the increase in receivables and decrease in accounts payable and accrued liabilities.
- Progress, purchase terms, regulatory approval and expected returns for the planned BASF Mexico acquisition, as well as execution of the stated capital program.
- Potential changes in environmental and legal exposures, including the USEPA matter and remediation estimates that may change as investigations and designs progress.
- How much reported earnings are affected by raw-material pass-through timing, deferred compensation, investment gains and stock-based tax benefits; adjusted earnings are non-GAAP measures.