Business context and reporting period
Stepan Company’s unaudited Form 10-Q covers the three months ended March 31, 2013, compared with the first quarter of 2012. The company makes intermediate chemicals in three segments: surfactants, polymers and specialty products. Financial amounts below are in millions of dollars unless otherwise stated.
Financial performance and condition
| Metric | Q1 2013 | Q1 2012 / prior date |
|---|---|---|
| Net sales | $456.5 | $465.3 |
| Gross profit / margin | $72.7 / 15.9% | $76.8 / 16.5% |
| Operating income / margin | $28.3 / 6.2% | $35.4 / 7.6% |
| Net income attributable to Stepan | $19.0 | $22.3 |
| Diluted EPS | $0.83 | $0.98 |
| Operating cash flow | $(9.9) | $4.7 |
| Capital expenditures | $21.0 | $21.3 |
| Cash and cash equivalents | $54.8 | $76.9 at Dec. 31, 2012 |
| Total debt | $193.9 | $182.4 at Dec. 31, 2012 |
- Sales declined 1.9%; operating income fell 20% and diluted EPS declined 15%. Lower sales prices, weaker unit margins and higher operating expenses pressured results.
- Segment sales and operating income were: surfactants $340.0 and $29.7; polymers $96.0 and $10.8; specialty products $20.6 and $2.8. Segment operating income totals exclude $15.0 of unallocated corporate expenses.
- Operating cash flow was negative as receivables used $31.8 and inventories used $16.5; payables and accrued liabilities provided $5.5. Investing activities used $22.9, while financing activities provided $11.3. Cash decreased $22.1 for the quarter.
- Current assets were $543.0 and current liabilities $252.2. The $125.0 committed revolving facility had $119.5 available after borrowings and letters of credit. Management said liquidity was sufficient for expected needs.
- Net debt was $139.1, up from $105.5 at year-end. Debt-to-debt-plus-equity was 28.2%, versus 27.5%. The company reported compliance with its debt covenants.
- Quarterly dividends declared were $0.16 per common share, compared with $0.14 a year earlier. Share and per-share figures reflect the December 2012 two-for-one stock split.
Material changes and management commentary
- Consolidated sales volume grew 3%, but lower average selling prices reduced sales by about $21.3; currency translation reduced sales by $0.3. Surfactants volume rose 5%, while polymers volume fell 7% and specialty products volume fell 3%.
- Surfactants operating income fell 10%, chiefly from lower unit margins as selling prices declined faster than costs of previously purchased inventory. Polymer operating income fell 8%, largely on lower volume; specialty products operating income declined 27% on lower volume and higher raw material costs.
- Operating expenses rose $3.0, including a $1.4 increase in deferred compensation expense associated with the rise in Stepan’s share price. The effective tax rate fell to 24.8% from 31.7%, helped by retroactively extended tax credits; the company recorded $1.8 of related tax benefits.
- Management expects surfactant margins to improve as the year progresses and polymer volume to improve in Q2. April polymer price increases were intended to recover higher raw material costs. The company said lower Q1 results would make full-year earnings growth challenging; it gave no quantified earnings guidance.
- For 2013, capital expenditures were estimated at $110–$115, including capacity expansions. Management expected cash, operations and credit facilities to fund planned commitments for the foreseeable future.
Outlook, risks, contingencies and unusual items
- In April 2013, Stepan agreed to acquire Bayer MaterialScience’s North American Polyester Resins business, with annual sales of approximately $64 and a 21,000-ton Columbus, Georgia facility. Financial terms were not disclosed; closing was expected in June, subject to customary conditions. Management expected the deal to be slightly accretive to 2013 earnings and said financing was available.
- Officials in Nanjing require relocation of the China polymer facility. The company planned a replacement facility expected to be operational in 2015, with a period of interruption and inventory or third-party supply that could reduce profits. It assumed the existing facility would be vacated in June 2013; accelerated depreciation had no significant Q1 profit effect.
- Environmental and legal loss estimates ranged from $10.2 to $29.0; accrued liabilities were $15.3. The company said certain site exposures cannot be estimated and adverse determinations could materially affect cash flows or results in a period, while it did not expect the matters collectively to materially affect financial position.
- Foreign currency translation reduced other comprehensive income by $4.4 in Q1, versus a positive $8.5 in Q1 2012. The filing reported no material change in market risks or risk factors from the 2012 Form 10-K.
Important facts for investors to verify
- Whether surfactant unit margins recover as management expected, and whether commodity-price changes continue to affect selling prices and inventory costs.
- Progress on the Bayer acquisition, including final purchase price, closing, funding and contribution to 2013 earnings.
- China relocation timing, required investment, customer supply arrangements and the profit impact of the shutdown and new facility.
- Working-capital requirements and cash generation, given negative Q1 operating cash flow and increased net debt.
- Developments at environmental and legal sites, particularly where remediation costs remain indeterminate.
- Whether the company remains compliant with debt covenants and has sufficient liquidity for its capital spending and other commitments.