Stepan Company — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Stepan produces intermediate chemicals in three segments: Surfactants, Polymers and Specialty Products. Figures below are in U.S. dollars; financial statement amounts are unaudited.
Key financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $451.6 million | $508.0 million | $1,413.8 million | $1,527.2 million |
| Gross profit | $77.4 million | $83.6 million | $255.0 million | $264.8 million |
| Operating income | $28.0 million | $27.1 million | $98.8 million | $113.8 million |
| Net income attributable to Stepan | $25.9 million | $21.8 million | $81.1 million | $87.2 million |
| Diluted EPS | $1.11 | $0.93 | $3.48 | $3.74 |
| Approx. gross margin | 17.1% | 16.5% | 18.0% | 17.3% |
| Approx. operating margin | 6.2% | 5.3% | 7.0% | 7.5% |
Q3 adjusted net income, a non-GAAP measure, was $27.9 million ($1.20 diluted EPS), versus $26.4 million ($1.13) a year earlier. Nine-month adjusted net income was $93.7 million ($4.02 diluted EPS), versus $92.2 million ($3.95). Management presents these measures as supplemental, not substitutes for GAAP results.
Cash flow, debt and liquidity
- For the first nine months, operating cash flow was $132.6 million, compared with $96.2 million in 2018. Capital expenditures were $70.8 million; investing cash outflow was $68.5 million and financing cash outflow was $74.4 million.
- Cash was $286.0 million at September 30, 2019, down from $300.2 million at year-end 2018. Total debt declined to $231.9 million from $276.1 million, leaving reported net cash of $54.1 million, compared with $24.1 million at year-end.
- The $350 million revolving facility had no borrowings and $345.0 million available, after $5.0 million of letters of credit. The company reported compliance with its debt covenants.
- Cash dividends paid in the nine-month period were $16.9 million; share repurchases cost $13.2 million. Capital spending for full-year 2019 was estimated at $110–$130 million.
Material changes and operating performance
- Q3 sales declined 11% year over year. Lower sales volume reduced revenue by $29.1 million, lower selling prices by $20.1 million, and foreign currency translation by $7.2 million. Lower selling prices primarily reflected the pass-through of lower raw-material costs.
- Q3 operating income rose 3% despite lower gross profit, helped by lower corporate, deferred-compensation and restructuring expenses. Surfactants operating income fell 32% to $19.7 million; Polymers rose 21% to $23.3 million; Specialty Products fell 15% to $2.3 million.
- For nine months, sales fell 7% and operating income fell 13%. Surfactants operating income declined 15% to $88.9 million, while Polymers increased 2% to $58.1 million and Specialty Products increased to $11.4 million from $6.5 million.
- Comparative 2018 figures were retrospectively adjusted after the company changed U.S. inventory accounting from LIFO to FIFO. The change increased December 2018 inventory by $31.4 million and retained earnings by $23.7 million. On a hypothetical LIFO basis, 2019 nine-month diluted EPS would have been $3.58 rather than reported FIFO EPS of $3.48.
Outlook, risks and unusual items
- Management said its Surfactants strategy and cost-reduction efforts were intended to support margins in a challenging environment; it expected Polymers to deliver full-year volume growth and incremental margin improvement, and Specialty Products results to improve versus 2018. No specific earnings or revenue guidance was provided.
- The Ecatepec, Mexico facility’s January equipment failure contributed to Surfactants operating losses during the first nine months. The plant was fully operational by the filing date; the insurer acknowledged coverage and the company was pursuing recovery.
- The company estimated environmental and legal losses of $23.9–$45.6 million and accrued $23.9 million, the low end of the range. Management cautioned that adverse determinations could materially affect cash flows or results in a particular period; certain site costs could not be estimated.
- Other notable items included $3.3 million of environmental remediation expense, a $0.6 million gain on an asset sale, and costs from restructuring and facility decommissioning. The company prepaid $17.1 million of senior notes in June and recorded a $1.2 million make-whole payment and related debt-cost expense.
- Principal risks include raw-material and energy cost volatility, weaker customer demand, manufacturing or transportation disruptions, currency movements, competition, environmental regulation and litigation, and covenant or capital-market risks. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether Surfactants volume, margins and end-market demand stabilize, particularly in North America and Asia, and whether the Ecatepec insurance recovery is realized.
- Progress toward the stated full-year capital expenditure range and the expected Polymers and Specialty Products performance.
- Changes in environmental remediation estimates and the potential exposure beyond the $23.9 million accrual.
- The sustainability of reported and adjusted earnings, including the effects of deferred compensation, tax credits, restructuring and inventory accounting.
- Cash generation, debt repayment, share repurchases and dividend capacity under the company’s covenants.