Business context and reporting period
Stepan Company filed this unaudited Form 10-Q for the quarter ended June 30, 2016. It produces intermediate chemicals through three segments: Surfactants, Polymers and Specialty Products. Figures below are in U.S. dollars; income statement and cash-flow amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $454.6 | $452.4 | $900.5 | $912.9 |
| Gross profit | $92.9 | $79.5 | $186.4 | $156.0 |
| Operating income | $42.9 | $28.6 | $87.5 | $63.8 |
| Net income attributable to Stepan | $27.9 | $16.9 | $55.5 | $38.2 |
| Diluted EPS | $1.21 | $0.74 | $2.42 | $1.67 |
Gross margin was approximately 20.4% in Q2 (17.6% prior year) and 20.7% in the first half (17.1%). Operating margin was approximately 9.4% in Q2 (6.3%) and 9.7% in the first half (7.0%).
Q2 net sales were nearly flat year over year: 12% higher volume was largely offset by lower selling prices ($40.4 million adverse effect) and foreign currency translation ($10.5 million adverse effect). First-half sales declined 1%; 12% higher volume was offset by lower prices ($90.0 million) and currency translation ($28.5 million). Lower raw-material costs contributed to price declines and improved margins.
Segment operating income increased in Q2: Surfactants $27.2 million, up 12%; Polymers $31.0 million, up 32%; Specialty Products $1.8 million, up 17%. For the first half, segment operating income was $64.5 million for Surfactants, $53.2 million for Polymers and $4.1 million for Specialty Products. Polymers led the year-over-year improvement, supported by volume growth and lower raw-material costs.
For the six months, operating cash flow was $75.4 million, versus $78.3 million a year earlier. Capital expenditures were $40.7 million; investing cash use was $44.2 million and financing cash use was $18.9 million. Cash increased $14.3 million to $190.4 million. Working capital absorbed cash, notably receivables ($33.6 million) and inventories ($8.7 million), reflecting higher sales quantities, increased inventory and slower receivables turnover.
At June 30, cash was $190.4 million and total debt was $321.4 million, down from $331.4 million at year-end 2015. Net debt was $130.9 million, versus $155.2 million at year-end. The $125 million revolving credit facility had no borrowings; $120.1 million was available after letters of credit. Current assets were $679.3 million and current liabilities $242.3 million. The company reported compliance with debt covenants.
Material changes, outlook and risks
- Management reported record first-half results and said it remained optimistic for the balance of 2016. It expected earnings growth for the year, continued benefits from laundry and rigid-polyol volumes and efficiency initiatives, with higher raw-material costs expected to slightly reduce margins. A planned 30-day shutdown at the German plant, Canadian closure-related depreciation and lower construction activity in China were expected to weigh on the second half.
- Capital spending for 2016 was estimated at $110 million to $120 million, including capacity expansions in the United States, Brazil and Poland. Management said cash, operations and committed facilities should fund anticipated needs.
- The Longford Mills, Canada, facility was planned to close by year-end, with approximately 30 jobs affected and production transferred to other North American sites. The company recorded $1.1 million in employee termination costs, estimated another $3.0 million of closure costs, and expected about $2.6 million of additional depreciation in the second half.
- Environmental and legal losses were estimated at $21.7 million to $42.4 million; the recorded liability was $21.7 million. The company said some site exposures could not be estimated and adverse determinations could materially affect results or cash flows in a period.
- On July 20, 2016, Stepan announced agreements to acquire a Brazilian commercial business and sulfonation facility, subject to customary conditions and projected to close in Q4 2016. Combined annual sales were approximately $32 million; the deal was expected to have minimal impact on 2016 results.
- Deferred-compensation expense is tied partly to company share and investment values and can fluctuate. Q2 expense was $2.4 million versus $6.6 million; first-half expense was $5.2 million versus $8.2 million. Management’s adjusted net income and adjusted EPS are non-GAAP measures: Q2 $30.1 million and $1.31, versus $20.9 million and $0.91; first half $59.6 million and $2.60, versus $41.3 million and $1.80.
- TIORCO, the enhanced-oil-recovery joint venture, was dissolved; its prior-year losses did not recur in 2016. Foreign exchange remained a factor. Management described Brexit’s expected impact as minimal, while continuing to monitor developments.
Important facts for investors to verify
- Whether volume growth and improved margins can persist as raw-material costs, selling prices and foreign exchange change.
- Cash conversion and working-capital trends, particularly receivables and inventory, alongside planned capital spending.
- Actual Canadian closure and German shutdown costs, and whether expected efficiency savings offset these and other second-half pressures.
- Updates to environmental and legal reserves, including potentially unquantifiable site exposures.
- Closing conditions, integration and financial contribution of the announced Brazilian acquisitions.
- How much reported earnings growth reflects ongoing operations versus deferred-compensation movements and other adjustments; compare non-GAAP measures with GAAP results.