Stepan Company — FY 2018 Form 10-K
Business context and period. This is the annual report for the fiscal year ended December 31, 2018, rather than a standalone Q4 filing. Stepan produces specialty and intermediate chemicals for manufacturers. Its three reportable segments are Surfactants, Polymers and Specialty Products; respectively, they represented 70%, 26% and 4% of 2018 net sales. No customer accounted for more than 10% of consolidated revenue.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $1,993.9 million | $1,925.0 million |
| Gross profit / gross margin | $341.5 million / 17.1% | $338.5 million / 17.6% |
| Operating income / operating margin | $151.4 million / 7.6% | $147.2 million / 7.6% |
| Net income attributable to Stepan | $112.8 million | $91.6 million |
| Diluted EPS | $4.83 | $3.92 |
| Cash from operating activities | $171.1 million | $198.9 million |
| Capital expenditures | $86.6 million | $78.6 million |
- Revenue rose 4%; higher volume contributed $64.7 million, higher selling prices $4.1 million and currency translation $0.1 million. Total volume increased 3%.
- Operating income increased 3%, while gross margin contracted about 0.4 percentage points. Management attributed most of the operating-income improvement to a $7.1 million favorable year-over-year swing in deferred compensation.
- Segment operating income was $137.5 million for Surfactants, $64.5 million for Polymers and $11.7 million for Specialty Products. Versus 2017, Surfactants rose 14%, Polymers fell 22%, and Specialty Products rose 17%.
- The effective tax rate was 19.4%, versus 34.3% in 2017. The comparison benefited from the lower U.S. statutory rate and the non-recurrence of the 2017 tax-reform charge; 2018 also included tax effects from foreign-cash repatriation and tax accounting-method changes.
- Operating cash flow declined $27.7 million, mainly as working capital shifted to a $39.2 million cash use, including higher inventories and lower cash provided by accounts payable and accrued liabilities. Cash less capital expenditures was approximately $84.5 million, compared with $120.3 million in 2017.
- Year-end cash was $300.2 million; total debt was $276.1 million, giving reported net cash of $24.1 million. Working capital was $463.9 million and the current ratio was 2.4. The $350 million revolving facility had no borrowings and $345.3 million available, net of letters of credit.
- Dividends paid were $20.9 million, or $0.93 per share. The company repurchased $15.5 million of shares during 2018.
Fourth-quarter data
Unaudited Q4 2018 net sales were $466.7 million, down from $473.8 million in Q4 2017. Operating income was $39.4 million versus $31.4 million, and net income attributable to Stepan was $26.9 million versus $9.9 million. Q4 diluted EPS was $1.16 versus $0.42.
Material changes and unusual items
- Surfactants sales rose 7% and operating income rose 14%, supported by volume growth and stronger North American unit margins. The March 2018 Ecatepec, Mexico acquisition added capacity and business; it was slightly accretive to Latin American gross profit, while integration and startup costs weighed on margins.
- Polymers sales fell 4% and operating income fell 22%. Lower sales volume and unit margins were driven by competitive pressure in North America and lower European volume, including customer inventory builds and delayed construction activity.
- Stepan approved a shutdown of German Surfactants operations in 2018, recording $1.4 million of asset and spare-part write-downs. Decommissioning costs were expected to continue into 2019. Canadian plant decommissioning also continued.
- In March 2018, the company acquired BASF’s Ecatepec facility and part of its Mexican surfactants business for a final purchase price of $22.9 million. Management said the acquisition had minimal impact on 2018 results.
- Foreign-currency translation reduced other comprehensive income by $38.0 million in 2018. The company repatriated approximately $100 million of foreign cash and recorded $1.8 million of related additional tax expense.
Outlook, risks and contingencies
- Management expected Surfactants to benefit from functional-product diversification, new technologies, efficiencies and broader sales; Polymers to deliver full-year volume growth and incremental margin improvement versus 2018; and Specialty Products to improve year over year.
- 2019 capital expenditures were estimated at $120–$140 million, including U.S., Mexico and Brazil infrastructure and optimization projects. Management stated that cash, operating cash flow and committed facilities should fund planned needs.
- Key risks include raw-material and energy-price volatility and limits on passing costs through; competition and weaker margins, particularly in Polymers; production interruptions, transportation disruption and project cost overruns; currency and international tax exposure; and environmental, chemical-registration, product-liability and cybersecurity risks.
- Environmental and legal losses were estimated at $23.4–$44.7 million; $23.4 million was accrued. Certain site costs remain difficult to estimate. The Maywood groundwater remedy had no final EPA Record of Decision at filing, and the Wilmington agreement could require contributions without a stated ultimate cap.
- Debt agreements include leverage, interest-coverage and net-worth covenants, as well as limits on additional debt, dividends and share repurchases. The company reported compliance at year-end. Environmental compliance costs included $5.4 million of capital expenditures and approximately $28.3 million of recurring operating costs in 2018.
- Management and Deloitte reported effective disclosure controls and internal control over financial reporting; Deloitte issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether Polymers’ volume and margin trends improve as management projected, and whether Surfactants’ gains persist after acquisition and restructuring costs.
- The drivers of lower operating cash flow and whether working capital normalizes; compare subsequent cash conversion with reported earnings.
- Progress, remaining costs and expected savings from the German shutdown and ongoing Canadian decommissioning.
- Actual 2019 capital spending, debt maturities and covenant headroom, including the impact of lease-accounting adoption and the expected addition of approximately $42 million of lease assets and liabilities.
- Updates to environmental reserves and site exposure, especially Maywood groundwater and the uncapped potential contribution obligation at Wilmington.
- The durability of the lower tax rate, including repatriation, foreign earnings and tax-rule effects; reported 2018 earnings also benefited from the non-recurrence of the 2017 tax-reform charge.