Business context and reporting period
Stepan Company’s unaudited Form 10-Q covers the three months ended March 31, 2015, compared with the first quarter of 2014. The company manufactures intermediate chemicals through Surfactants, Polymers and Specialty Products. Surfactants generated 72% of quarterly sales, Polymers 24% and Specialty Products 4%.
Financial performance
Amounts are in millions of dollars except per-share data. Balance-sheet comparisons are with December 31, 2014.
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Net sales | $460.5 | $477.4 |
| Gross profit | $76.4 | $63.0 |
| Operating income | $35.2 | $22.5 |
| Net income attributable to Stepan | $21.3 | $13.0 |
| Diluted EPS | $0.93 | $0.57 |
| Operating cash flow | $33.9 | $(9.0) |
| Capital expenditures | $28.3 | $20.5 |
Gross margin was approximately 16.6% versus 13.2%; operating margin was approximately 7.6% versus 4.7%. Declared dividends were $0.18 per share, up from $0.17.
Sales declined 4%, while operating income rose 56% and attributable net income increased 63%. Foreign-currency translation reduced the sales comparison by $29.7 million and the operating-income increase by $3.1 million. Management attributed improved profitability principally to stronger Surfactants performance, including recovery from unusually difficult North American winter conditions in Q1 2014.
- Surfactants: Sales fell 2% to $330.6 million, but segment operating income rose 84% to $33.8 million. Higher margins and improved results across regions outweighed currency headwinds.
- Polymers: Sales fell 8% to $109.4 million; operating income rose 37% to $14.8 million, including a $2.9 million product-line sale gain. Volume increased 5%, while lower selling prices and currency translation reduced reported sales.
- Specialty Products: Sales declined 9% to $20.5 million and operating income fell 44% to $2.2 million, reflecting lower prices and volume and higher unit overhead.
Administrative expenses increased $4.9 million, including higher deferred-compensation and consulting expense, and a $0.6 million increase in environmental remediation expense. The effective tax rate rose to 30.3% from 28.1%.
Cash, debt and liquidity
Cash and cash equivalents were $97.3 million at March 31, up from $85.2 million at year-end. Operating cash flow was $33.9 million; investing activities used $25.1 million and financing provided $8.1 million. Capital expenditures exceeded operating cash flow by approximately $5.6 million. The company attributed the year-over-year cash-flow improvement mainly to higher earnings and lower working-capital use.
Total debt was $283.7 million, versus $273.9 million at year-end; cash-adjusted net debt was $186.4 million, down from $188.7 million. The $125 million revolving facility had $30.0 million drawn, $3.0 million of letters of credit and $92.0 million available. Management said the company was compliant with its debt covenants and expected cash, operations and credit facilities to fund planned needs.
Outlook, risks and unusual items
- Management said the company was on track to re-establish earnings momentum in 2015. It expected benefit from improved Polymers income, a better Surfactants mix, efficiency efforts and lower petroleum-based raw-material costs; no specific full-year earnings guidance was provided.
- 2015 capital expenditures were estimated at $120–$140 million, including capacity expansions in the United States, China and Brazil. Management expected to close the Brazilian surfactant-facility acquisition in Q2 2015. A new Nanjing, China, plant was projected to be operational in the first half of 2016.
- Management identified underutilized North American anionic capacity as both an opportunity and vulnerability. Other sensitivities include foreign exchange, raw-material prices, segment demand and customer inventory levels.
- In January, Stepan sold its specialty polyurethane systems product line to J6 Polymers for $3.3 million cash and recognized a $2.9 million pretax gain. The filing states J6 is wholly owned and operated by members of the immediate family of a former Stepan executive, who is a J6 managing member.
- Environmental and legal loss exposure was estimated at $22.1–$41.4 million; $22.1 million was accrued. Some sites’ potential costs could not be estimated, and adverse determinations could materially affect results or cash flows in a period. Customer-claim liabilities were $4.0 million.
- Foreign-currency translation drove a $25.2 million reduction in other comprehensive income, contributing to a comprehensive loss attributable to Stepan of $3.2 million despite positive net income.
Management reported no material changes to the risk factors or market risks disclosed in the 2014 Form 10-K, and stated that disclosure controls were effective at quarter-end.
Important facts for investors to verify
- Whether the Q1 earnings improvement persists after excluding the $2.9 million sale gain and accounting for the unusually weak Q1 2014 comparison.
- How currency movements, raw-material prices, selling prices and demand affect sales and margins across segments.
- Progress and funding needs for the Brazil acquisition, China plant and planned $120–$140 million capital program.
- Available borrowing capacity and covenant headroom as debt and investment requirements change.
- Developments in environmental matters, particularly Maywood remediation, unclaimed-property examination and customer claims.
- Terms and governance surrounding the J6 product-line transaction and the expected transition-period production arrangement.