Business context and reporting period
Stepan Company’s unaudited Form 10-Q covers the three months ended March 31, 2012, compared with the first quarter of 2011. The company makes intermediate chemicals across surfactants, polymers and specialty products. In March, it acquired the remaining 11.2% of Stepan Philippines, bringing ownership to 100%.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 or comparison |
|---|---|---|
| Net sales | $465.3 million | $422.6 million; up 10% |
| Gross profit and margin | $76.8 million; 16.5% | $61.8 million; 14.6% |
| Operating income and margin | $35.4 million; 7.6% | $29.9 million; 7.1% |
| Net income attributable to Stepan | $22.3 million | $18.8 million; up 19% |
| Diluted EPS | $1.97 | $1.68 |
| Operating cash flow | $4.7 million | $(25.4) million |
| Capital expenditures | $21.3 million | $22.5 million |
| Cash and total debt at March 31 | $64.6 million cash; $201.0 million debt | Net debt was $136.3 million, up $20.9 million since year-end |
Sales benefited from approximately $29.9 million of higher average selling prices and $17.9 million of increased volume; currency translation reduced the increase by $5.1 million. Segment operating income rose in surfactants ($33.0 million versus $28.2 million), polymers ($11.8 million versus $6.4 million) and specialty products ($3.9 million versus $3.3 million). Consolidated operating income is lower than segment totals because corporate expenses were $13.2 million, up from $7.9 million.
Cash from operations improved substantially year over year, but receivables and inventories together used $46.6 million in the quarter. Current assets were $514.7 million and current liabilities $247.6 million. The $60 million revolving facility had no borrowings and $57.3 million available after letters of credit. The company reported compliance with debt covenants.
Material changes, outlook and risks
- Operating expenses increased 30%; the $3.9 million year-over-year swing in deferred compensation was a major factor. Excluding it, operating expenses increased 17%, reflecting staffing and growth spending, including in Brazil, Singapore and the Netherlands.
- Management said all three segments achieved record first-quarter profits and cited the strong quarter as support for its global expansion and higher-value-product strategy. It said the company has an opportunity to deliver significant earnings growth in 2012, but provided no quantified earnings guidance.
- Management estimated 2012 capital spending of $100–$110 million, including capacity expansions in Germany and Singapore. Commercial production at the Singapore methyl esters plant was expected to begin in Q2 2012. A three-week North American polymer-plant maintenance shutdown was also planned for Q2.
- China officials informed the company that its Nanjing manufacturing facility must relocate; the company intended to build a replacement facility expected to operate in 2014. Accelerated depreciation was not expected to materially affect 2012 or 2013 earnings.
- Environmental and legal losses were estimated at $9.3–$29.0 million, with $15.1 million accrued. Some site exposures could not be estimated; management said adverse determinations could materially affect cash flows and results in a period.
- Other notable factors include higher raw-material and working-capital needs, foreign-exchange effects, deferred-compensation expense volatility, and a 31.7% effective tax rate versus 30.7%, primarily due to expiration of the U.S. research and development credit. A potential business-interruption insurance recovery relating to prior German plant damage had not been finalized and was not recorded.
Important facts for investors to verify
- Whether improved margins and segment performance continue after Q1, especially in Asia surfactants and following planned Q2 maintenance.
- Execution and returns on the $100–$110 million capital program, including Singapore and Germany expansions and the Nanjing relocation.
- Working-capital trends and cash conversion, given the quarter’s inventory and receivables cash use and lower cash balance.
- Environmental remediation estimates, accrued liabilities and unresolved site exposures.
- Debt, covenant headroom and the company’s ability to fund investment, dividends and other commitments while net debt rises.