Stepan Company — 2017 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2017. The filing is an annual report, not a standalone fourth-quarter filing. Stepan manufactures specialty and intermediate chemicals, reported in Surfactants, Polymers and Specialty Products. Surfactants represented 68% of 2017 sales; Polymers 28%; Specialty Products 4%.
Financial performance
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $1,925.0 million | $1,766.2 million | Up 9% |
| Gross profit | $338.3 million | $338.5 million | Approximately flat |
| Operating income | $146.2 million | $126.2 million | Up 16% |
| Income before taxes | $139.2 million | $113.8 million | Up 22% |
| Net income attributable to Stepan | $91.6 million | $86.2 million | Up 6% |
| Diluted EPS | $3.92 | $3.73 | Up 5% |
| Operating cash flow | $198.9 million | $212.2 million | Down $13.3 million |
| Capital expenditures | $78.6 million | $103.1 million | Down $24.5 million |
Gross margin was approximately 17.6% versus 19.2%; operating margin improved to 7.6% from 7.1%, while net margin was 4.8% versus 4.9%. Operating cash flow less capital expenditures was approximately $120.3 million, a derived measure.
- Surfactants: Sales rose 10% to $1,297.6 million; segment operating income increased 20% to $120.0 million. Higher selling prices, favorable mix, lower costs after the Canada plant closure, and Brazilian acquisitions supported results; segment volume fell 2%.
- Polymers: Sales rose 10% to $546.6 million, but operating income declined 14% to $82.8 million. North American margin pressure and lower volume weighed on performance.
- Specialty Products: Sales fell 6% to $80.8 million and operating income declined 7% to $10.0 million, mainly due to weaker demand and lower volume.
Fourth-quarter 2017 sales were $473.8 million versus $420.6 million in fourth-quarter 2016. Operating income was $30.8 million versus $9.9 million; net income attributable to Stepan was $9.9 million versus $8.4 million, and diluted EPS was $0.42 versus $0.36. The year-over-year comparison reflects, among other items, a favorable $4.7 million reversal of a prior-year customer-claim reserve in 2017 and the 2017 tax-reform charge.
Liquidity, debt and capital allocation
- Year-end cash and equivalents were $298.9 million; total debt was $290.8 million, implying net cash of approximately $8.1 million. Debt declined from $317.0 million in 2016.
- Working capital was $468.5 million and the current ratio was 2.5. Management said available cash, operating cash flow and committed credit facilities should fund expected needs for the foreseeable future.
- On January 30, 2018, the company replaced its $125 million revolving facility with a $350 million, five-year multi-currency facility maturing in 2023. The company reported compliance with debt covenants at year-end.
- 2017 dividends were $0.86 per share, up from $0.78; the company reported 50 consecutive years of dividend increases. It repurchased $6.0 million of shares during 2017.
- Management forecast 2018 capital expenditures of $105 million to $115 million. Environmental and legal losses were estimated at $24.2 million to $45.4 million, with $24.2 million accrued.
Material changes, outlook and notable items
- Sales growth was predominantly price-driven: higher average selling prices added $174.5 million, while a 1% consolidated volume decline reduced sales by $25.5 million. Foreign currency translation added $9.9 million.
- The effective tax rate increased to 34.3% from 24.3%. The Tax Cuts and Jobs Act resulted in a net 2017 tax expense of $14.9 million: a $19.4 million provisional transition-tax expense, partly offset by a $4.5 million benefit from the lower U.S. corporate tax rate. Management said its tax accounting remained subject to adjustment as analysis continued.
- Reported adjusted net income, a non-GAAP measure, was $108.7 million, or $4.65 per diluted share, versus $98.2 million, or $4.25, in 2016. The company cautions that this measure supplements, and does not replace, GAAP results.
- Management expected Surfactants to benefit from diversification into functional products, new technologies, broader customer reach and stabilizing commodity volumes. It expected North American Polymer lost share and margin pressure to remain a challenge in 2018, while the lower U.S. corporate tax rate should be beneficial.
- The company agreed to acquire a BASF surfactants facility and related business in Ecatepec, Mexico; completion was expected in 2018 subject to closing conditions and regulatory consents. This was an agreement, not a completed acquisition at filing.
- Restructuring included Fieldsboro, New Jersey costs and accelerated depreciation, as well as continuing decommissioning costs from the closed Canadian facility. One of two 2016 customer claims remained open; the other was settled in 2017, with the remaining reserve reversed.
- Key risks include chemical manufacturing accidents or shutdowns, volatile raw-material and energy costs, competitive pricing and customer reformulations, foreign-exchange exposure, regulatory and environmental liabilities, debt covenant constraints, and IT or cyber disruption. The company reported no customer exceeding 10% of consolidated sales.
- Environmental matters include the Maywood, New Jersey site, where the groundwater remedy had not yet received a final EPA decision, and the Wilmington, Massachusetts site, where future contribution obligations have no stated ultimate cap. A $131,440 EPA civil penalty for alleged FIFRA violations was paid in January 2018.
- The CEO was also Chairman; the CFO position was held on an interim basis by the Corporate Controller from January 2018 pending a permanent replacement. Deloitte issued unqualified audit opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether volume and margins stabilize, particularly in North American Polymers, and whether Surfactants’ pricing and mix gains persist.
- The final tax-reform accounting, transition-tax payment schedule and ongoing effects of the new U.S. tax rules.
- Completion, terms and expected contribution of the BASF Mexico transaction, and delivery of the $105–$115 million capital program.
- Resolution and potential cost range of environmental matters, including Maywood groundwater and the uncapped Wilmington contribution obligation; monitor the remaining customer claim.
- Debt maturities, covenant headroom, dividend restrictions and whether cash balances held abroad are practically available for U.S. needs.