Stepan Company — Q1 2019 Form 10-Q
Business context and period. This unaudited quarterly report covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018. Stepan produces intermediate chemicals through Surfactants, Polymers and Specialty Products. Amounts below are in U.S. dollars; comparative 2018 figures reflect the retrospective FIFO accounting change.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $489.2 million | $499.3 million | Down 2% |
| Gross profit / margin | $84.6 million / 17.3% | $91.2 million / 18.3% | Down 7% |
| Operating income / margin | $29.7 million / 6.1% | $41.3 million / 8.3% | Down 28% |
| Net income attributable to Stepan | $25.0 million | $32.0 million | Down 22% |
| Diluted EPS | $1.07 | $1.37 | Down 22% |
| Operating cash flow | $4.4 million | $1.0 million | Up $3.5 million |
| Capital expenditures | $25.7 million | $27.4 million | Down $1.6 million |
Sales volume rose 3%, contributing $15.8 million; foreign currency translation reduced sales by $16.2 million, and lower selling prices reduced sales by $9.8 million, primarily reflecting lower raw-material costs. Other income was $3.1 million, including $2.4 million of realized and unrealized investment gains. Net interest expense fell to $1.9 million from $3.2 million. The effective tax rate was 19.5%, versus 18.7%.
Segments: Surfactants sales were $349.7 million, down 3%, and operating income was $37.2 million, down 10%. Polymers sales were $120.2 million, down 1%, and operating income was $12.1 million, down 30%. Specialty Products sales rose 5% to $19.3 million; operating income improved to $3.1 million from a $0.4 million loss, largely on higher volume and favorable order timing.
Liquidity, debt and balance sheet
- Cash and equivalents were $269.5 million at March 31, down $30.7 million from year-end. Current assets were $808.1 million and current liabilities $295.4 million.
- Total debt was $271.9 million, including $32.8 million current maturities; net debt was $2.4 million, compared with net cash of $24.1 million at December 31, 2018.
- The $350 million revolving facility had no borrowings and $344.7 million available, net of letters of credit. Management said liquidity was sufficient and expected cash, operating cash flow and committed facilities to fund planned needs. The company reported compliance with its debt covenants.
- Operating activities provided $4.4 million, while investing and financing activities used $23.7 million and $10.8 million, respectively. Working capital was a $46.8 million cash use, including $42.3 million from accounts payable and accrued liabilities.
Material changes and unusual items
- Effective January 1, 2019, Stepan changed U.S. inventory accounting from LIFO to FIFO and retrospectively adjusted prior periods. The change increased Q1 2019 net income by $1.1 million versus what LIFO would have produced, or about $0.05 per diluted share; 2018 net income increased by $1.2 million, or about $0.06 per diluted share.
- Deferred compensation expense rose $5.9 million to $7.5 million, primarily due to the increase in Stepan’s stock price. Management’s non-GAAP adjusted net income was $30.6 million, or $1.31 per diluted share, down from $33.6 million, or $1.44, in Q1 2018. This measure excludes specified compensation and restructuring items and is not a substitute for GAAP results.
- A January equipment failure at the Ecatepec, Mexico plant contributed to a $2.3 million site operating loss; the company was pursuing insurance recovery for equipment damage, incremental supply-chain costs and business interruption.
- Net sales were affected by the stronger U.S. dollar. Segment pressure also reflected reduced margins, German plant shutdown-related effects, and the nonrecurrence of a $2.1 million class-action settlement recorded in Polymers in Q1 2018.
- Adoption of the new lease standard resulted in $42.4 million of operating lease assets and liabilities at adoption; operating lease liabilities totaled $40.3 million at quarter-end. Adoption did not affect retained earnings, earnings or cash flows.
Outlook, risks and contingencies
- No quantified earnings or sales guidance was provided. Management expected Surfactants to benefit from diversification, new technologies and efficiency improvements; anticipated Polymers volume growth and incremental margin improvement for the full year; and expected Specialty Products’ margins and restructuring efforts to contribute in the second half.
- 2019 capital expenditures were estimated at $110 million to $130 million, including U.S., German and Mexican infrastructure and optimization spending. Decommissioning costs for the German and Canadian sites were expected to continue during 2019.
- Environmental and legal losses were estimated at $23.4 million to $44.7 million; $23.4 million was accrued. Management noted that actual costs could differ and that certain sites’ potential costs could not be estimated; adverse outcomes could materially affect cash flows or results in a period.
- Disclosed risk factors include plant disruptions, raw-material and energy price or supply volatility, competition, foreign exchange, economic downturns, capital project execution, environmental and legal matters, and debt covenant or capital-market risks. Management reported no material changes to previously disclosed risk factors or market risks.
Important facts for investors to verify
- Track whether segment margins recover, particularly in Polymers and Surfactants, and distinguish underlying performance from currency, pricing and inventory-accounting effects.
- Monitor insurance recovery and operational normalization following the Ecatepec failure.
- Compare GAAP earnings with management’s adjusted results, including the recurring volatility from stock-price-linked compensation and investment gains.
- Assess cash conversion, working-capital needs, planned capital spending, and whether net debt and covenant headroom remain manageable.
- Follow environmental remediation estimates and restructuring/decommissioning costs, which may change as projects and investigations progress.