Stepan Company — Q3 2013 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and nine months ended September 30, 2013, compared with the same 2012 periods. Stepan makes intermediate chemicals through its surfactants, polymers and specialty products segments. Amounts below are in millions of dollars except per-share data.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $475.5 | $441.0 | $1,406.5 | $1,376.5 |
| Gross profit | $74.3 | $71.3 | $220.7 | $221.4 |
| Operating income | $31.1 | $33.9 | $95.2 | $104.1 |
| Net income attributable to Stepan | $20.4 | $20.2 | $62.2 | $64.0 |
| Diluted EPS | $0.89 | $0.89 | $2.71 | $2.82 |
| Gross margin | 15.6% | 16.2% | 15.7% | 16.1% |
| Operating margin | 6.5% | 7.7% | 6.8% | 7.6% |
Q3 sales rose 8%, primarily on 9% higher volume, partly offset by lower selling prices as raw-material costs declined. Nine-month sales rose 2%, reflecting 5% volume growth and favorable currency translation, offset by lower average selling prices. Operating income declined 8% in Q3 and 9% year to date; attributable net income was nearly flat in Q3 but down 3% year to date.
Cash flow and liquidity. Nine-month operating cash flow was $81.7 million, versus $78.0 million in 2012. Investing activities used $139.9 million, including $67.1 million of capital expenditures and $68.2 million for the acquisition. Operating cash flow less capital expenditures was approximately negative $53.6 million. Financing activities provided $86.3 million, including $100 million of new borrowings; cash increased $26.2 million to $103.1 million.
At September 30, current assets were $608.9 million and current liabilities $265.9 million (current ratio approximately 2.3). Total debt was $276.8 million, up from $182.4 million at year-end 2012; net debt was $173.7 million, versus $105.5 million. The company reported $122.2 million available on its $125 million revolving credit facility and said it was in compliance with debt covenants. Its new $100 million private-placement loan carries a fixed 3.86% rate, with principal payments beginning in 2019 and final maturity in 2025.
Material changes and operating drivers
- Surfactants: Q3 sales increased 2%, but segment operating income fell 7% to $24.1 million. North American margins were pressured by consumption of higher-cost methyl ester inventory, contractual pricing lags and competition. Singapore operations contributed as commercial production began in late 2012. For nine months, segment operating income fell 11% to $79.7 million.
- Polymers: Q3 sales rose 25% and operating income rose 27% to $19.1 million; nine-month sales rose 11% and operating income rose 13% to $43.4 million. Results benefited from the acquired polyester-resins business and stronger European performance. Q3 and year-to-date results also included a $3.7 million insurance recovery for a 2011 fire-related business interruption.
- Specialty products: Q3 sales rose 10%, but operating income declined amid unfavorable sales mix, higher raw-material costs and expenses, especially for medium-chain triglyceride products. Nine-month operating income also declined.
- Acquisition: On June 1, Stepan acquired Bayer MaterialScience’s North American polyester-resins business for $68.2 million cash. It contributed $13.7 million of Q3 sales and $18.2 million of nine-month sales; its effect on reported earnings through September was immaterial. Management expected it to be slightly accretive to 2013 earnings and saw longer-term growth potential in CASE and polyurethane systems applications.
Outlook, risks and unusual items
- Management said the slow start to 2013 made full-year earnings growth difficult, while remaining optimistic about long-term growth. It expected benefits from the acquisition and capacity expansions in 2014. No specific full-year earnings guidance was provided.
- Management estimated 2013 capital expenditures of $90 million to $100 million, including capacity expansions in Brazil, Germany, Singapore and the United States. It said cash, operating cash flow and committed credit facilities should cover anticipated needs.
- The company expected the remaining adverse impact of high-cost surfactant inventory accumulated for Singapore’s start-up to end after 2013. It anticipated stronger enhanced-oil-recovery surfactant results and continued demand for agricultural surfactants; early Q4 polyol orders were described as strong in North America and Europe.
- Stepan’s China polymer plant in Nanjing had ceased production, and local officials required relocation. The company was sourcing customer needs from inventory, other company plants and toll production, which reduced margins; it recorded dismantling-related charges and accelerated depreciation.
- Environmental and legal loss estimates were $9.8 million to $29.0 million, with $14.8 million accrued. At the Maywood, New Jersey site, a USEPA proposed soil-remediation plan was under review; final required remediation scope and cost were uncertain. The company warned that adverse determinations at certain other sites could materially affect period cash flows and results.
- Other notable items included the $3.7 million insurance recovery and $2.6 million of tax benefits year to date from retroactively extended tax credits. The nine-month effective tax rate was 27.6%, versus 32.1% in 2012. The report cited no material changes to previously disclosed risk factors or market risks.
Important facts for investors to verify
- Whether surfactant margins recover as high-cost inventory is worked through and pricing lags and competitive pressures ease.
- Whether the acquisition delivers expected accretion and growth, and the cost and timing of planned capacity expansions.
- The final remediation requirements and potential liability at Maywood, and developments at other environmental sites.
- China relocation obligations, ongoing sourcing costs and the effect on polymer margins.
- Working-capital needs, capital spending, debt growth and continued compliance with debt covenants.