Stepan Company — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2016. Financial statements are unaudited. Stepan makes intermediate chemicals through Surfactants, Polymers and Specialty Products; Surfactants represented about 67% of year-to-date sales.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $445.0m | $444.0m | $1,345.5m | $1,356.9m |
| Gross profit | $83.4m | $77.6m | $269.8m | $233.6m |
| Operating income | $28.7m | $38.8m | $116.3m | $102.6m |
| Net income attributable to Stepan | $20.4m | $24.9m | $75.9m | $63.1m |
| Diluted EPS | $0.89 | $1.09 | $3.31 | $2.76 |
Gross margin was approximately 18.7% in Q3 versus 17.5% a year earlier, and 20.1% for the first nine months versus 17.2%. Operating margin was approximately 6.5% in Q3 versus 8.7%, and 8.6% year to date versus 7.6%.
Management’s non-GAAP adjusted net income was $24.5m, or $1.06 diluted EPS, for Q3 (up 16% and 15%, respectively); year-to-date adjusted net income was $84.1m, or $3.66 per diluted share (up 35% and 34%). Adjustments principally reflect deferred compensation, with restructuring and other specified items also adjusted in the year-to-date comparison. These measures supplement, and do not replace, GAAP results.
Cash flow, balance sheet and liquidity
- Operating cash flow for the first nine months was $117.7m, compared with $123.5m in 2015. Capital expenditures were $69.8m versus $90.3m.
- Cash and equivalents were $207.0m at September 30, 2016, versus $176.1m at December 31, 2015. Working capital absorbed cash, chiefly through higher receivables and inventories.
- Total debt was $326.1m, down from $331.4m at year-end; net debt was $119.1m versus $155.2m. The $125m revolving facility had no borrowings and $120.1m available after letters of credit.
- Management said operating cash, available credit and cash on hand should fund anticipated capital expenditures, working capital, dividends and other planned commitments for the foreseeable future. The company reported compliance with its debt covenants.
- Dividends declared were $0.19 per share for Q3 and $0.57 year to date, compared with $0.18 and $0.54, respectively, in 2015.
Changes versus prior periods
- Q3 sales were nearly flat, but operating income fell 26% and GAAP diluted EPS fell 18%. Segment operating income rose $4.1m, but a $14.3m unfavorable year-over-year swing in deferred compensation more than offset that improvement.
- Year-to-date sales declined 1%, while operating income increased 13% and diluted EPS increased 20%. Higher volumes across all segments supported profit growth; lower selling prices, mainly reflecting lower raw-material costs, and foreign currency translation reduced reported sales.
- For Q3, Polymers operating income rose 10% and Specialty Products moved from a loss to profit; Surfactants operating income declined 5%. Year to date, all three segments improved operating income.
- Year-to-date comparisons include no 2016 TIORCO joint-venture loss, versus a $3.9m loss in 2015. The 2015 period also included a $2.9m gain on sale of a product line.
Outlook, management commentary and risks
- Management anticipated fourth-quarter headwinds from higher raw-material costs versus Q4 2015, a scheduled phthalic anhydride maintenance shutdown, and accelerated depreciation related to the Canadian plant closure. It expected the base business to benefit from higher polyol volumes, increased asset utilization and efficiencies, and said it was positioned for continued growth in 2017. No specific earnings guidance was provided.
- Management estimated 2016 capital expenditures of $110m–$120m, including capacity expansions in the United States, Brazil and Poland. The Longford Mills, Canada, closure was planned by year-end 2016; about 30 employees were affected. Approximately $3m of additional consolidation and decommissioning expenses were expected in Q4 2016 and 2017. Accelerated depreciation was $3.2m year to date, with about $1.3m additional expense expected in Q4.
- In October 2016, after quarter-end, the company completed a Brazilian acquisition for approximately $24.6m, including $2.8m placed in escrow. The acquired businesses had approximately $32m in annual sales and 25,000 metric tons of sulfonation capacity; management expected minimal impact on 2016 results.
- Environmental and legal loss estimates were $21.4m–$42.4m; the accrued liability was $21.4m. The company stated that costs at certain sites could not be estimated and that adverse determinations could materially affect cash flows or results in a period, while it did not expect the matters overall to materially affect financial position.
- Deferred compensation is sensitive to Stepan’s share price and investment values, causing earnings volatility. Q3 deferred compensation was $7.4m expense versus $6.9m income in Q3 2015. Management said Brexit’s impact had been insignificant to date and expected its overall effect to be minimal, while continuing to monitor developments.
Important facts for investors to verify
- Whether Q3’s GAAP earnings decline is primarily timing and market-value volatility in deferred compensation, and how adjusted results reconcile to GAAP.
- Whether working-capital investment, especially receivables and inventories, converts to cash, and whether capital spending stays within the stated range.
- Progress and costs of the Canadian closure, Q4 maintenance shutdowns, and the anticipated 2017 operating benefits.
- Integration, final purchase-price allocation and performance of the October Brazil acquisition.
- Changes in environmental and legal exposures, including matters for which the company says potential costs cannot currently be estimated.