Stepan Company — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Stepan manufactures intermediate chemicals across Surfactants, Polymers and Specialty Products. Amounts below are in millions unless stated; 2018 comparisons reflect retrospective FIFO accounting adjustments.
Financial performance
| Metric | Q2 2019 | Q2 2018 | H1 2019 | H1 2018 |
|---|---|---|---|---|
| Net sales | $473.0 | $519.9 | $962.2 | $1,019.2 |
| Gross profit | $93.0 | $90.0 | $177.6 | $181.2 |
| Gross margin | 19.7% | 17.3% | 18.4% | 17.8% |
| Operating income | $41.1 | $45.4 | $70.8 | $86.7 |
| Operating margin | 8.7% | 8.7% | 7.4% | 8.5% |
| Net income attributable to Stepan | $30.2 | $33.5 | $55.2 | $65.4 |
| Diluted EPS | $1.30 | $1.44 | $2.37 | $2.80 |
- Q2: Sales fell 9% year over year, while GAAP net income declined 10%. Management-reported adjusted net income rose 9% to $35.1 million, or $1.50 per diluted share, excluding specified items.
- H1: Sales fell 6%, operating income 18%, and GAAP net income 16%. Adjusted net income was $65.8 million, or $2.82 per diluted share, essentially level with the prior year.
- H1 operating cash flow was $78.8 million, versus $53.8 million. Capital expenditures were $45.1 million; investing cash use was $43.1 million and financing cash use was $61.4 million. Cash decreased $24.9 million to $275.3 million.
- At June 30, current assets were $806.8 million and current liabilities $299.5 million. Total debt was $232.6 million; cash exceeded debt by $42.7 million (company-defined net debt of negative $42.7 million). The $350 million revolving facility had no borrowings and $344.8 million available, net of letters of credit.
Changes and operating drivers
- Lower sales reflected weaker volumes, lower selling prices largely passed through from lower raw-material costs, and adverse foreign exchange. In Q2 these reduced sales by approximately $24.2 million, $12.9 million and $9.8 million, respectively. H1 effects were $8.8 million, $22.2 million and $26.0 million.
- Surfactants, the largest segment, had Q2 sales down 12% and operating income down 6%; H1 sales fell 7% and operating income 8%. Drivers included weaker demand, the German sulfonation exit, foreign exchange, and the Ecatepec, Mexico equipment failure. Ecatepec was fully operational by late Q2; the insurer acknowledged coverage and Stepan was pursuing recovery.
- Polymers Q2 operating income rose 12% on better North American and Asia margins, but H1 operating income fell 7%, partly because a $2.1 million settlement benefit recorded in H1 2018 did not recur. Specialty Products operating income improved in both periods, although revenue declined; management cited improved food and nutrition margins and order timing.
- H1 operating income was pressured by $9.2 million higher deferred-compensation expense, which fluctuates with Stepan’s share price, and $2.9 million of environmental remediation expense. Q2 also included a $1.2 million early-debt-repayment charge; restructuring expense was $1.2 million for H1.
Outlook, liquidity and risks
- Management expects Surfactants’ diversification, customer focus and cost actions to support margin improvement despite a challenging environment. It expects Polymers to deliver full-year volume growth and incremental margin improvement, and Specialty Products results to improve year over year. No numerical earnings guidance was provided.
- Management estimated 2019 capital expenditures of $110–$130 million and said cash, operating cash flow and committed facilities should fund anticipated needs for the foreseeable future. The company stated it was in compliance with debt covenants.
- Environmental and legal losses were estimated at $23.9–$45.0 million; $23.9 million was accrued. Some site remediation exposures cannot be estimated, and adverse determinations could materially affect results or cash flows. Maywood, New Jersey, is a significant remediation matter.
- Other disclosed risks include raw-material and energy cost or supply volatility, production interruptions, demand and competitive pressures, foreign exchange, environmental and regulatory compliance, litigation, capital-project execution, and debt-covenant or capital-market risks.
Material accounting and other items
- Effective January 1, 2019, Stepan changed U.S. inventory accounting from LIFO to FIFO and retrospectively adjusted prior periods. The change increased December 2018 retained earnings by $23.7 million. For H1 2019, FIFO reported net income was $1.5 million lower than it would have been under LIFO.
- Adoption of lease accounting brought $42.4 million of right-of-use assets and related liabilities onto the balance sheet at adoption; June 30 operating lease liabilities were $38.7 million. The filing says adoption did not affect earnings or cash flows.
- In June, Stepan prepaid $17.1 million of 5.88% senior notes, paying a $1.2 million make-whole amount. H1 debt declined from $276.1 million to $232.6 million.
- On July 10, 2019, the company paid a $612,718 civil penalty under an EPA consent order concerning alleged FIFRA violations involving three biocide products sold by a distributor.
Important facts for investors to verify
- Whether Surfactants’ volume and margin trends improve, particularly in Asia and North America, and whether Ecatepec insurance recovery is realized.
- Whether management’s segment outlook and $110–$130 million 2019 capital-spending estimate remain achievable.
- How deferred-compensation volatility and environmental remediation costs affect reported versus adjusted earnings and cash flow.
- Whether environmental exposure exceeds the $23.9 million accrual, including developments at Maywood and other sites with unquantified costs.
- Whether the LIFO-to-FIFO accounting change and other non-GAAP adjustments are appropriately considered when comparing periods.