Stepan Company — Q1 2020 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2020; comparisons are with Q1 2019. Stepan makes intermediate chemicals in three segments: Surfactants, Polymers and Specialty Products. The quarter was affected by COVID-19, foreign-exchange movements and production interruptions at its Millsdale, Illinois facility.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $450.0 million | $489.2 million | Down 8% |
| Gross profit | $79.3 million | $84.6 million | Down 6% |
| Gross margin | 17.6% | 17.3% | Up 0.3 percentage points |
| Operating income | $40.0 million | $29.7 million | Up 35% |
| Operating margin | 8.9% | 6.1% | Up 2.8 percentage points |
| Net income attributable to Stepan | $27.5 million | $25.0 million | Up 10% |
| Diluted EPS | $1.18 | $1.07 | Up 10% |
| Adjusted net income, non-GAAP | $24.2 million | $30.6 million | Down 21% |
| Adjusted diluted EPS, non-GAAP | $1.04 | $1.31 | Down 21% |
| Operating cash flow | $(6.5) million | $4.4 million | Lower by $10.9 million |
| Capital expenditures | $33.2 million | $25.7 million | Up $7.5 million |
Cash and cash equivalents were $254.3 million at quarter-end, down $61.0 million from December 31, 2019. Total debt was $222.1 million, including $23.6 million current and $198.6 million long-term. The $350 million revolving credit facility had no borrowings, $4.9 million of letters of credit and $345.1 million available. Current assets were $768.5 million and current liabilities $310.2 million.
Segment sales and operating income were: Surfactants, $327.1 million and $36.2 million; Polymers, $106.5 million and $7.5 million; Specialty Products, $16.4 million and $4.0 million. Year-over-year segment sales declined 6%, 11% and 15%, respectively.
Material changes and drivers
- Consolidated sales fell $39.2 million: lower selling prices reduced sales by $18.0 million, lower volume by $13.0 million, and currency translation by $8.2 million. Lower prices primarily reflected raw-material cost pass-throughs.
- Reported operating income rose despite weaker segment results, mainly because deferred-compensation expense swung favorably by $14.8 million as the company’s share price declined. This comparison is unusual; adjusted net income and adjusted EPS fell 21%.
- Surfactants operating income declined 3%. COVID-related demand lifted cleaning and disinfection product volumes in some markets, but was offset by lower prices, currency and the Millsdale disruption.
- Polymers operating income fell 38%, reflecting lower volume and margins, particularly after the Millsdale interruption reduced phthalic anhydride output and increased maintenance and supply-chain costs. European demand was also affected by deferred or canceled construction projects.
- Specialty Products operating income increased $0.9 million, primarily on improved margins and demand for medium-chain triglycerides used in infant nutrition.
- Comprehensive income attributable to Stepan was a loss of $12.8 million, principally due to $41.2 million of negative foreign-currency translation adjustments.
Cash, outlook, risks and unusual items
Operating cash flow was negative, with working capital using $51.0 million. Receivables increased as consumer-product demand rose late in the quarter; inventory and payables movements also affected cash. Capital spending and the $7.2 million share repurchase contributed to cash use. Management estimated 2020 capital expenditures of $100 million to $120 million and said cash, operating cash flow and committed facilities should fund expected needs.
Management described 2020 as challenging amid the pandemic, but expected Surfactants to benefit from cleaning and disinfection demand and face weaker oilfield demand due to low oil prices. Polymers was expected to be challenged by delayed or canceled construction; North American operations also faced higher raw-material costs from scheduled Illinois River lock closures in the second half. Management expected full-year Specialty Products results to approximate 2019. The filing gives no quantified earnings or revenue guidance and states that COVID-19’s full effect cannot be reasonably estimated.
Millsdale suffered a January power disruption and a February wastewater-treatment issue that halted production and led to force majeure declarations for phthalic anhydride and certain surfactants. All lines were operating before quarter-end. The insurer acknowledged coverage, and the company was pursuing recovery for incremental supply-chain costs and business interruption; the filing does not provide a recovery amount.
Environmental and legal loss estimates were $24.9 million to $43.0 million; $24.9 million was accrued because management considered no amount within the range more likely than another. The company cautioned that actual costs could differ and some site exposures cannot be estimated. Other notable items included a $2.0 million acquisition of renewable-source bio-surfactant assets and $3.9 million of investment losses, primarily related to deferred-compensation and supplemental-plan assets.
Most important facts for investors to verify
- Whether COVID-19-related demand, customer disruptions and operating constraints persist or materially change segment volumes and margins.
- The extent of insurance recovery, if any, for the Millsdale disruption and related production, supply-chain and business-interruption costs.
- Whether the $100 million to $120 million capital expenditure estimate and working-capital demands affect liquidity or debt levels.
- How environmental and legal exposures develop relative to the $24.9 million accrual and $24.9 million to $43.0 million estimated range.
- Underlying operating performance excluding volatile deferred compensation and investment effects; reported operating-income growth did not reflect stronger segment operating income.