Stepan Company — Q3 2012 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and nine months ended September 30, 2012, compared with the corresponding 2011 periods. Stepan produces intermediate chemicals in three segments: surfactants, polymers and specialty products. Unless noted otherwise, dollar amounts below are USD millions.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $441.0 | $499.3 | $1,376.5 | $1,398.9 |
| Gross profit | $71.3 | $64.1 | $221.4 | $195.5 |
| Operating income | $33.9 | $33.4 | $104.1 | $97.3 |
| Net income attributable to Stepan | $20.2 | $19.2 | $64.0 | $58.8 |
| Diluted EPS | $1.78 | $1.70 | $5.63 | $5.25 |
Calculated gross margin was 16.2% in Q3 and 16.1% year to date, versus 12.8% and 14.0%, respectively, in 2011. Calculated operating margin was 7.7% in Q3 and 7.6% year to date, compared with 6.7% and 7.0%. Q3 net sales fell 12%, while operating income rose 1% and attributable net income rose 6%. Nine-month sales fell 2%, while operating income increased 7% and attributable net income increased 9%.
- Q3 segment operating income: Surfactants $25.9 (up 12%); polymers $15.0 (up 23%); specialty products $3.8 (up 6%). Segment operating income totals $44.7 before $10.8 of unallocated corporate expenses, resulting in consolidated operating income of $33.9.
- Nine-month segment operating income: Surfactants $90.0 (up 18%); polymers $38.5 (up 15%); specialty products $11.1 (up 7%). Segment operating income totals $139.5 before $35.4 of corporate expenses.
- Cash flow, nine months: Operating cash flow was $78.0, versus $12.6 in 2011. Capital expenditures were $60.9; calculated operating cash flow less capital expenditures was $17.2, versus negative $48.5 in 2011. Cash declined $4.4 to $79.7.
- Debt and liquidity: Total debt was $188.2 at September 30, down from $199.5 at year-end 2011; cash was $79.7 and net debt $108.5. The $125.0 five-year revolving facility had no borrowings and $122.1 available, net of $2.9 in letters of credit. The company reported total debt to debt plus shareholders’ equity of 28.7%, versus 33.0% at year-end.
- Balance sheet and dividends: Current assets were $527.1 and current liabilities $243.5; inventory rose to $155.2 from $111.2 at year-end. Dividends declared were $0.28 per common share in Q3 and $0.84 year to date.
Material changes and management explanation
- Q3 sales declined mainly due to lower average selling prices ($30.3) as raw-material costs fell, currency translation ($14.9), and lower volume ($13.2). Year-to-date, currency translation reduced sales by $37.4 and lower prices by $13.8; 2% higher volume added $28.8.
- Higher margins and improved product mix lifted Q3 gross profit by $7.2 despite lower sales. Year-to-date gross profit rose $26.0, with all three segments contributing.
- Operating expenses rose 22% in Q3 and 20% year to date. Corporate costs, including deferred compensation, legal and intellectual-property expenses, were significant contributors. Q3 deferred-compensation activity was a $1.3 expense versus $2.0 of income a year earlier; year-to-date expense was $6.3 versus $2.7 of income.
- Q3 surfactants sales fell 13%, notably in North America and Europe, but segment operating income improved on margins and mix. Polymer sales fell 8%, while operating income benefited from margins and a large North American urethane-systems sale for aircraft-carrier insulation. Specialty Products sales increased 2% in Q3; nine-month sales increased 47%, primarily reflecting the Lipid Nutrition product lines acquired in 2011.
Outlook, risks and unusual items
- Management expected solid earnings growth for full-year 2012 and reported nine-month net income, excluding deferred compensation, up 16%. It anticipated record full-year earnings in both surfactants and polymers, with surfactants supported by functional and household/industrial sales and continued growth in Brazil. These are management expectations, not guaranteed results.
- Full-year 2012 capital expenditures were estimated at $90–$95 million, including capacity expansions in Germany and Singapore. The Singapore surfactants plant was delayed but expected to begin commercial operations in Q4 2012.
- Management said operating cash, available credit and cash on hand should fund anticipated expenditures, working capital, dividends and other commitments. It also said it expected to remain in compliance with debt covenants through 2012.
- Environmental and legal loss estimates were $9.1–$28.8 million, with $14.9 million accrued. Some sites lacked sufficiently clear information to estimate potential costs; an adverse determination could materially affect cash flows or results in a particular period. Management believed the matters would not materially affect financial position overall.
- Other items to monitor include raw-material and currency volatility, working-capital needs, lower demand in some markets, and the required relocation of the Nanjing, China, manufacturing facility. Accelerated depreciation on the existing Nanjing plant was not considered significant for 2012 and was not expected to materially affect 2012–2013 earnings.
- Management reversed previously accrued compensation for 2012 performance stock awards after concluding profitability targets would not be met. The filing also notes a German plant insurance settlement, with business-interruption income expected to be recognized in Q4.
Important facts for investors to verify
- Whether Q4 demand, product mix and margins support management’s full-year earnings outlook, particularly given Q3 sales-volume declines.
- Progress and costs for the delayed Singapore start-up, planned Germany and Singapore capacity expansions, and Nanjing relocation.
- Inventory growth, working-capital conversion and the sustainability of the improvement in operating cash flow.
- Environmental and legal exposure versus the $14.9 million accrual, including developments at the Maywood, D’Imperio and Wilmington sites.
- Effects of deferred-compensation mark-to-market changes, foreign exchange, raw-material pricing and the German insurance settlement on reported earnings.