Business context and reporting period
Stepan Company filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. It produces intermediate chemicals through three segments: Surfactants, Polymers and Specialty Products. Surfactants represented about 70% of first-half sales.
Financial performance and position
- Second quarter: Net sales were $519.9 million, up 5% year over year. Net income attributable to Stepan was $32.9 million, up 18%; diluted EPS was $1.41 versus $1.19. Adjusted net income, a non-GAAP measure, rose 4% to $32.1 million, and adjusted diluted EPS was $1.38 versus $1.32.
- First half: Net sales were $1,019.2 million, up 6%. Net income attributable to Stepan was $63.6 million, up 6%; diluted EPS was $2.73 versus $2.56. Adjusted net income increased 2% to $64.1 million, and adjusted diluted EPS was $2.75 versus $2.68.
- Margins: Q2 gross margin was approximately 17.2% versus 18.2% a year earlier, while operating margin increased to 8.6% from 7.9% and net margin to 6.3% from 5.6%. First-half gross margin was approximately 17.5% versus 18.9%; operating margin was 8.3% versus 8.9%.
- Segments: Q2 Surfactants sales rose 8% and operating income rose 10%; Polymers sales were essentially flat while operating income fell 9%; Specialty Products sales declined 10% and operating income fell 22%. For the first half, Surfactants operating income increased 7%, while Polymers declined 15% and Specialty Products declined 42%.
- Cash flow: First-half operating cash flow was $53.8 million, down from $60.9 million. Capital expenditures were $43.7 million versus $38.3 million; investing cash outflow totaled $63.4 million, including $21.5 million for the Ecatepec acquisition. Financing cash outflow was $27.1 million, including $10.2 million of dividends paid and $12.0 million of share repurchases.
- Liquidity and debt: Cash was $256.7 million at June 30, down $42.2 million from year-end. Total debt was $286.8 million, down from $290.8 million; net debt was $30.1 million versus net cash of $8.1 million at year-end. The company had no borrowings under its $350 million revolving facility and $344.7 million available after letters of credit.
- Other metrics: The quarterly dividend declared was $0.23 per share, compared with $0.21. Q2 comprehensive loss attributable to Stepan was $1.3 million, principally reflecting foreign currency translation losses; first-half comprehensive income attributable to Stepan was $38.9 million.
Material changes versus the prior comparable period
- Q2 sales growth primarily reflected higher volume, especially in Surfactants, partly offset by lower average selling prices. First-half sales growth also benefited from favorable currency translation and higher selling prices.
- Q2 operating income increased $5.6 million, largely because deferred-compensation expense shifted to income, improving the year-over-year comparison by about $5.9 million. Segment operating income was nearly unchanged in aggregate: Surfactants gains were offset by declines in Polymers and Specialty Products.
- First-half operating income decreased $1.0 million. Surfactants improvement was more than offset by lower Polymers and Specialty Products results. Higher raw-material costs and weaker margins pressured Polymers; Ecatepec integration and start-up costs weighed on Latin American Surfactants margins.
- The effective tax rate fell to 22.5% for Q2 from 24.7%, and to 20.6% for the first half from 26.5%, mainly reflecting the lower U.S. federal tax rate.
- The company acquired BASF Mexicana’s Ecatepec production facility and part of its surfactants business for $21.5 million in March 2018. The purchase-price allocation remained preliminary, and management expected minimal impact on 2018 results.
Outlook, risks and contingencies
- Management expected Surfactants to build on its strong first half. It cited potential second-half volume opportunities in Polymers despite North American margin challenges, and expected full-year Specialty Products results to improve versus the prior year. Management remained optimistic about the remainder of 2018.
- Estimated 2018 capital expenditures were $90 million to $100 million. Management expected operating cash flow, available credit and cash on hand to fund planned capital spending, working capital, dividends and other commitments.
- Key risks include raw-material, energy and transportation cost volatility; production disruptions; competition and demand changes; foreign exchange and international risks; acquisition integration; environmental regulation and remediation; debt-covenant compliance; and litigation. The company reported compliance with debt covenants at June 30.
- Environmental and legal loss exposure was estimated at $23.8 million to $45.2 million, with $23.8 million accrued. Certain sites have unresolved remediation uncertainty; management said adverse determinations could materially affect cash flows or results in a period.
- Accounting for several Tax Cuts and Jobs Act provisions remained incomplete, including GILTI, executive compensation deductibility and cost recovery. Adoption of the new revenue standard did not materially affect results. The company was assessing the impact of the upcoming lease-accounting standard.
- Foreign-currency translation reduced first-half other comprehensive income by $26.2 million. Management stated there were no material changes to the market risks or risk factors disclosed in the 2017 Form 10-K.
Important facts for investors to verify
- Whether Surfactants volume and margin momentum continues, and whether Ecatepec integration costs subside.
- Whether Polymers’ North American margins recover amid elevated raw-material costs and competitive pricing, and whether its volume outlook improves.
- Whether Specialty Products’ expected full-year improvement materializes given first-half earnings declines and order timing effects.
- Cash conversion, working-capital requirements, capital spending against the $90–$100 million estimate, and the movement from net cash to net debt.
- Final Ecatepec acquisition valuation and any additional environmental or legal obligations beyond the recorded accrual.
- Final measurement of Tax Act impacts and the balance-sheet effect of lease-accounting adoption.