STEPAN CO quarterly report, Q2 FY2023

Business context and reporting period

Stepan Company manufactures intermediate chemicals through its Surfactants, Polymers and Specialty Products segments. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2023; comparisons are with the corresponding 2022 periods. Amounts below are in U.S. dollars unless stated otherwise.

Financial results and key metrics

• Q2 adjusted net income, a non-GAAP measure, was $12.1 million, or $0.53 per diluted share, versus $53.0 million, or $2.30, a year earlier. First-half adjusted net income was $28.5 million, or $1.24 per diluted share, versus $93.7 million, or $4.05.
• Q2 sales fell 23%; volume declined 19%, reducing sales by $143.9 million, and lower average selling prices reduced sales by $32.2 million. First-half sales fell 14%; a 17% volume decline reduced sales by $239.7 million, partly offset by $52.2 million of higher average selling prices.
• All three segments reported lower Q2 sales and operating income. Surfactants sales declined 19% and operating income 69%; Polymers sales declined 31% and operating income 52%; Specialty Products sales declined 14% and operating income 62%.
• First-half operating cash flow was $35.8 million, versus $38.2 million. Capital expenditures were $159.9 million, versus $129.5 million, implying cash flow after capital expenditures of negative $124.1 million. Cash and equivalents were $133.9 million at June 30, down from $173.8 million at year-end.
• Total debt was $682.6 million, up from $587.1 million at December 31, 2022; net debt was $548.7 million, versus $413.3 million. Net debt to net debt plus equity increased to 31.1% from 26.2%. The credit agreement had $294.0 million of borrowings, $11.3 million of letters of credit and $142.2 million available.
• Interest expense was $3.9 million in Q2 and $6.7 million in the first half. The current portion of long-term debt was $244.4 million. Management reported compliance with debt covenants.

Material changes versus prior periods

• Profitability contracted sharply as lower demand and customer and channel destocking reduced volumes, while lower unit margins reflected product mix, competitive pressure and carryover of higher-cost inventory. Reduced construction activity also weighed on Polymers.
• Q2 operating income fell 77%; first-half operating income fell 72%. Higher corporate costs contributed, including deferred compensation expense of $0.7 million in Q2 versus $3.4 million of income in Q2 2022, and $2.2 million of expense for the first half versus $10.9 million of income in the prior-year period.
• Net interest expense increased year over year, primarily due to higher borrowings and interest rates. Other, net shifted to income of $2.4 million in Q2 and $4.0 million in the first half, largely reflecting investment results compared with losses in 2022.
• Operating cash flow was supported by inventory reduction and collections, but offset by a $116.5 million cash use from accounts payable and accrued liabilities. Capital spending rose mainly due to the Pasadena alkoxylation project.
• No goodwill impairment was recorded in Q2 2023; the comparable 2022 period included a $1.0 million non-cash impairment for the Philippines Surfactants reporting unit.

Outlook, risks and unusual items

• Management expects second-half 2023 sales volume and margins to improve incrementally from the first half, citing gradual recovery in rigid polyols, new contracted Surfactants business and sequentially lower raw-material costs. These are expectations, not quantified earnings guidance.
• Management projected 2023 capital expenditures of $240–250 million, with spending expected to be significantly lower in the second half. The Pasadena alkoxylation facility was expected to start up in mid-2024; U.S. 1,4-dioxane regulatory equipment upgrades were substantially complete at June 30.
• Management said cash on hand, operating cash flow and committed facilities should fund anticipated needs for the foreseeable future, and described liquidity as sufficient for potential 2023 working-capital increases. It also cited ongoing cost-control and cash-management initiatives.
• Environmental and legal losses were estimated at $24.0–48.0 million; $24.0 million was accrued because no amount within the range was considered more likely. The reserve declined from $32.6 million at year-end, primarily due to remediation payments. Actual costs may differ, and certain sites cannot yet be reliably estimated. A possible natural-resource-damages claim relating to the Wilmington site remains unresolved.
• Key disclosed risks include weaker demand, customer reformulation, raw-material and energy price or supply volatility, manufacturing disruptions, competition, regulation and environmental obligations, foreign-exchange exposure, litigation, capital-project execution, IT and cybersecurity issues, access to capital, and debt-covenant compliance.

Important facts for investors to verify

1. Whether the expected second-half recovery in rigid polyols and Surfactants volumes and margins materializes amid continued destocking and competitive pressure.
2. Progress, costs and timing for the Pasadena facility and other capital projects, against the $240–250 million 2023 capex projection.
3. Debt maturities, borrowing needs, interest expense, covenant headroom and the availability of the revolving credit facility.
4. Whether cash generation improves after elevated capital expenditures and environmental remediation payments.
5. Changes in environmental reserves, especially the Maywood and Wilmington matters and the unresolved natural-resource-damages claim.