Business context and reporting period
Stepan Company’s unaudited Form 10-Q covers the three months ended March 31, 2016, compared with the first quarter of 2015. The company produces intermediate chemicals in three reportable segments: Surfactants, Polymers and Specialty Products.
Financial performance
Amounts are in millions of U.S. dollars, except per-share data and where noted.
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $445.9 | $460.5 | Down 3% |
| Gross profit | $93.5 | $76.4 | Up 22% |
| Operating income | $44.6 | $35.2 | Up 27% |
| Net income attributable to Stepan | $27.7 | $21.3 | Up 30% |
| Diluted EPS | $1.21 | $0.93 | Up 30% |
| Operating cash flow | $(2.1) | $33.9 | Down $36.0 |
Gross margin was approximately 21.0%, versus 16.6%; operating margin was approximately 10.0%, versus 7.6%. Reported diluted EPS was $1.21. Management’s non-GAAP adjusted EPS was $1.29, compared with $0.90 in Q1 2015; adjusted net income was $29.5 million versus $20.4 million. The company cautions that these non-GAAP measures supplement, and do not replace, GAAP results.
Segment results
| Segment | Sales, Q1 2016 | Sales change | Operating income, Q1 2016 | Operating income change |
|---|---|---|---|---|
| Surfactants | $310.0 | Down 6% | $37.2 | Up 10% |
| Polymers | $113.9 | Up 4% | $22.2 | Up 50% |
| Specialty Products | $22.0 | Up 7% | $2.3 | Up 4% |
Liquidity, debt and cash flow
Cash and cash equivalents were $145.7 million at March 31, down from $176.1 million at year-end 2015. Current assets were $639.1 million and current liabilities $221.3 million. Total debt was $327.9 million; net debt was $182.2 million, up from $155.2 million at year-end. The company reported a 35.5% ratio of debt to debt plus shareholders’ equity, compared with 37.2% at year-end.
Operating cash outflow was $2.1 million, primarily reflecting a $56.7 million working-capital use, including increased receivables and inventories and lower payables and accrued liabilities. Investing outflow was $22.5 million, including $19.3 million of capital expenditures. Financing outflow was $8.6 million, including $4.2 million of dividends. A committed $125 million revolving credit facility had no borrowings and $120.1 million available after letters of credit. The company said cash, operating flows and committed credit facilities should fund anticipated requirements.
Changes, outlook and notable items
- Consolidated sales volume rose 12%, contributing $53.0 million to sales; lower selling prices reduced sales by $49.6 million and foreign currency translation reduced them by $18.0 million. Lower prices primarily reflected lower raw-material costs.
- All segments improved operating income. Polymers benefited from higher volumes and lower raw-material costs; Surfactants benefited from higher volume and improved North American and Asian results.
- Q1 2015 included a $2.9 million gain on a product-line sale; Q1 2016 did not. The prior-year quarter also included a $1.2 million share of TIORCO joint-venture losses; no such loss was recorded in 2016 following the venture’s dissolution. Stepan funded $2.9 million of final TIORCO cash requirements in Q1 2016 and expects no further significant costs.
- The effective tax rate rose to 31.7% from 30.3%, primarily due to an unfavorable nonrecurring settlement related to a foreign tax audit. Stock-based compensation expense increased to $2.4 million from $0.8 million; deferred compensation expense rose to $2.7 million from $1.6 million.
- Management remained optimistic about the balance of 2016 and expected full-year earnings to grow, supported by laundry and rigid-polyol volumes and the internal efficiency program. No specific earnings target was provided. Raw-material costs were expected to rise and potentially compress margins. Expected headwinds included a planned 30-day German plant shutdown, Canadian ethoxylation decommissioning costs and lower demand from reduced construction activity in China.
- 2016 capital expenditures were estimated at $115 million to $135 million, including capacity expansions in the United States, China, Brazil and Poland. Commissioning began at the Nanjing plant in Q1; customer qualification was underway, with full operation anticipated by the end of Q2.
- Environmental and legal losses were estimated at $21.8 million to $42.4 million, with $21.8 million accrued. Management considered the accrual adequate, but noted that adverse determinations at certain sites with unquantifiable exposures could materially affect cash flows and results in a period.
Investor facts to verify
- Whether higher sales volumes can be sustained and offset the effects of lower prices and foreign exchange.
- Whether receivables collection, inventory and working-capital needs normalize after the Q1 cash outflow.
- Whether rising raw-material costs, the German shutdown, Canadian decommissioning and China construction weakness affect margins and the full-year earnings outlook.
- Progress, customer qualification and start-up costs for the Nanjing plant, and execution of the planned capital program.
- Changes in environmental and legal exposure versus the $21.8 million accrual and the disclosed $21.8 million–$42.4 million loss range.
- Debt covenant compliance and available liquidity; management reported compliance at March 31 and expected compliance throughout 2016.