Stepan Company — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Financial statements are unaudited. Stepan produces intermediate chemicals through surfactants, polymers and specialty products segments.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $477.0 million | $366.5 million | $899.6 million | $703.5 million |
| Gross profit | $69.6 million | $63.5 million | $131.4 million | $127.0 million |
| Operating income | $34.1 million | $29.8 million | $63.9 million | $63.4 million |
| Net income attributable to Stepan | $20.9 million | $17.0 million | $39.6 million | $37.7 million |
| Diluted EPS | $1.87 | $1.53 | $3.55 | $3.41 |
| Operating margin | 7.1% | 8.1% | 7.1% | 9.0% |
Sales rose 30% in Q2 and 28% in the first half. Management attributed most of the growth to higher selling prices reflecting higher raw-material costs; currency translation also contributed. Sales volume was nearly flat in Q2 and up 2% in the first half. Gross profit increased in dollars, but gross margin narrowed as input-cost increases and lagging price recovery weighed on profitability.
Q2 segment operating income was $24.7 million for surfactants (down 8% year over year), $15.1 million for polymers (up 43%), and $3.5 million for specialty products (down 8%). First-half segment operating income was $52.9 million for surfactants (down 6%), $21.4 million for polymers (up 25%), and $6.7 million for specialty products (down 16%). Surfactants faced lower consumer-product volumes and Brazil expansion start-up costs; specialty products were pressured by food-ingredient input costs and limited pricing flexibility. Polymer results improved across regions.
Cash flow, debt and liquidity
First-half operating cash flow was a use of $21.3 million, compared with a source of $13.0 million in 2010. Working capital consumed cash, notably receivables ($83.9 million) and inventories ($55.1 million), partly offset by a $55.2 million source from accounts payable and accrued liabilities. Management linked the working-capital increase to higher raw-material costs, sales and inventory levels.
Investing cash outflow was $54.5 million, including $40.4 million of capital expenditures and $13.6 million for the Lipid Nutrition product-line acquisition. Financing cash outflow was $10.7 million. Cash declined to $25.6 million from $111.2 million at year-end 2010.
Total debt was $190.8 million, slightly below $191.6 million at year-end; net debt rose to $165.2 million from $80.4 million as cash declined. Current maturities were $35.8 million and long-term debt was $155.0 million. Under the $60 million U.S. revolving facility, $50.5 million remained available after borrowings and letters of credit. The company reported compliance with debt covenants and expected cash, operating flows and committed credit facilities to fund anticipated needs.
Material changes, outlook and risks
- Acquisition: On June 23, Stepan paid $13.6 million cash for three Lipid Nutrition product lines, to be integrated into specialty products. No acquired-business results were included in the quarter or half-year statements because of the late closing date.
- Investment and outlook: Management estimated 2011 capital spending of $85–90 million, net of an expected $3.9 million insurance recovery. Singapore plant completion was expected in Q2 2012. Management said growth initiatives were on track to deliver future earnings in 2012 and that 2011 offered an opportunity for full-year earnings growth, while noting planned higher growth-related costs.
- Operations: Surfactant earnings were expected to improve during 2011 as higher-margin functional products offset weakness in consumer volumes; Brazil expansion was complete and expected to contribute better in Q3. German polyol capacity expansion was delayed following a fire in related infrastructure; imports from Illinois were expected to continue for the rest of 2011. Management expected insurance to cover repair costs and other potential losses.
- Contingencies: Environmental and legal loss estimates ranged from $9.4 million to $29.2 million; accrued liabilities were $15.2 million. Management considered the accrual adequate but noted actual costs could differ and adverse determinations could materially affect cash flows and results in a period. The Poland soil remediation was completed in Q2 at an immaterial cost above the purchase-price holdback.
- Other factors: Foreign currency translation increased reported sales and profits. Deferred-compensation accounting caused period-to-period expense variability. The filing reported no material changes to previously disclosed risk factors or market risks.
Key facts for investors to verify
- Whether price increases keep pace with raw-material inflation and restore gross margins.
- Whether working-capital needs and operating cash flow improve after the significant first-half cash use.
- Progress and costs for Brazil and German capacity projects, including the timing and extent of insurance recovery.
- Realization of the Lipid Nutrition acquisition’s earnings contribution and expected synergies.
- Developments at environmental sites and whether the recorded $15.2 million liability remains adequate.