Stepan Co (SCL) 2003 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stepan fourth-quarter and year-end earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded Wednesday, February 11, 2004. I would now like to turn the conference over to James Hurlbutt, Vice President and Corporate Controller for Stepan. Please go ahead, sir.

Good afternoon and thank you for joining us. Before I begin, please note that information in this conference call contains forward-looking statements which are not historical facts. These statements involve risks and uncertainties that could cause actual results to differ materially including, but not limited to, prospects for our German developing operations and certain global and regional economic conditions and factors detailed in the company's Securities and Exchange Commission filing.

I will now take a few moments to review our operating results. Net sales for the fourth quarter of 2003 rose by 9 percent to 201.3 million from 185.2 million reported one year ago. Excluding the effects of foreign currency translation, sales increased 9 million or 5 percent. Most of the increase was due to higher selling prices, which reflected higher raw material costs.

During the fourth quarter, sales volumes increased 1 percent compared to the prior-year quarter. We reported a net loss of 3.4 million or a loss of 41 cents per diluted share, compared with net income of 2.4 million or 25 cents per diluted share in last year's fourth quarter. There are a number of onetime charges and expenses that impacted both our fourth-quarter and full-year results. Rather than repeat myself, I will go through these in detail in just a few minutes.

For the full year, net sales increased 5 percent to $784.9 million from $748.5 million in 2002. The increase in sales was primarily due to two factors, higher selling prices resulting from higher raw material costs and the translation effect of foreign sales against a weaker U.S. dollar. For the year, sales volume was down 1 percent.

Net income for 2003 was $4.9 million or 45 cents per diluted share, compared with $20.2 million or $2.05 per diluted share for the full-year 2002. This decrease was due to decreased earnings in our core surfactants business as well as several onetime charges and expenses.

Now I would like to highlight the performance in each of our three segments, starting with surfactants, which accounted for approximately 79 percent of the company's sales for the full-year 2003. Surfactant earnings were down 44 percent and accounted for the majority of the decline in annual operating income.

As we talked about on earlier calls in 2003, our North American surfactant volume, which declined 5 percent for the year, was down due to two customers taking business into their own internal production facilities rather than outsourcing the products, as they had in the past. I will address the steps we are taking to replace this lost business during my outlook for 2004. The weak results in surfactants were also impacted by higher raw material prices and higher energy costs. During the year European earnings declined due to lower margins in the UK and lower sales volume in Germany.

Turning to our polymers segment, which represents 18 percent of our revenue in 2003, polymer earnings were slightly lower for the year. Polyurethane polyol volume was up 7 percent in the U.S. and 26 percent in Europe; however higher raw material costs caused operating income to decline. The phthalic anhydride earnings improved modestly on improved margins, even though volume declined by 5 percent.

And finally, specialty products, which accounted for 3 percent of the company's full-year sales, experienced a 22 percent decline in earnings due to reduced pharmaceutical demand at one larger specialty customer who had unusually large volume in the prior year as they increased their supply chain.

Turning to expenses, for the year operating expenses were up 6 percent compared with 2002. The strength of the euro and the British pound contributed to a 6 percent increase in marketing expenses in 2003. Other impacts on operating expenses for the year included a 20 (technical difficulty) a 2.1 million pretax cash charge for environmental remediation costs at a Stepan-owned facility, as well as a site formerly owned by the company.

Another charge was deferred compensation noncash expense, which was higher in 2003 at $2 million compared to $200,000 in 2002 as a result of appreciation in our stock and mutual funds held for our deferred compensation plans.

The third component of the operating expenses was a noncash asset impairment charge of $1.4 million for assets that were mostly idled and impaired at our Millsdale plant, which is located in Joliet, Illinois. We took this charge in the fourth quarter of 2003. Of note, this was only a very small portion of the plant's total production capacity.

A fourth item for the year was severance costs, which were $900,000 pretax resulting from a workforce reduction of 5 percent of our employees. This came through downsizing and through attrition.

Lastly, a higher legal expense charge of $800,000 due to protecting intellectual property and patents. While doing this is for the most part a cost of doing business, the expenses for the year were higher than usual. We do not believe that this will be a long-term trend.

Net interest expense increased 9 percent due to higher proportion of fixed-rate debt. This was due to the same reasons interest expense was up in the earlier periods this year. In 2002 we secured more long-term fixed-rate debt to lock in lower interest rates for the long term, although at a higher cost than current short-term interest rates.

Turning to other income, income from the Philippine joint venture declined due to a less favorable sales mix. This trend is expected to continue into 2004. Additionally we recognized other income of 1.4 million primarily from foreign exchange gains in Europe on U.S. dollar-denominated liabilities.

Turning to the balance sheet, total debt on December 31, 2003, was 115.7 million, down from 116.5 million at September 30, 2003, and $117.7 million at December 31, 2002. Capital expenditures were $32.9 million for the year. This came in slightly below our capital expenditure projection of 34 to $36 million.

Our long-term debt to total capitalization at the end of the quarter was 36.2 percent, down from 37.8 percent at September 30, 2003, and 39.6 percent at December 31, 2002.

As a result of the fourth-quarter loss, we are currently not in compliance with certain covenants in our U.S. loan agreements. We are continuing discussions with our lenders to obtain an amendment or waiver to cure the noncompliance. We expect to conclude these negotiations prior to filing our form 10-K for 2003 during March this year.

For the future prospects, (technical difficulty) we look forward. We realize the cost-cutting efforts that we undertook, while necessary to better prepare for the future, are not a substitute for growth. We are focused on getting back on a growth trajectory and are taking the following steps to do that.

First, increasing our efforts to align ourselves with our customers in their R&D endeavors. R&D spending is projected to increase by 8.8 percent in 2004. We are looking to replace the surfactant volume that was lost to the two customers that expanded their internal capabilities. Initiatives to grow our share of the fabric softener market have been successful, but additional opportunities have taken longer to commercialize than previously expected.

Our focus on higher value-added surfactants for agricultural, emulsion, polymerization, and oilfield markets have been successful in 2003 and are an important growth area for 2004. Personal care specialties including new products for soap bars is also an important target market for 2004. Soap bars is a market we have little marketshare in today.

Third we are also pursuing polymer growth opportunities. Polyurethane polyol for the flexible foam market has been developed for use in automotive and furniture cushions. The polyurethane systems business has commercialized an insulation foam that is a water-based reaction free of all those ozone depleting chemicals.

The company had set a target of 25 percent of sales dollars from innovative products commercialized over the prior five years. The 2003 result was 29 percent. The company had also targeted 10 percent of sales from higher value-added products. The 2003 result was 11.2 percent. While such targets may in part be replacement of existing business, they command significant attention with the management group in setting objectives for employees who are in a position to execute on these opportunities.

This concludes my prepared remarks. At this time, I would like to turn the call over for questions.

(OPERATOR INSTRUCTIONS) Beverly Machtinger (ph) of Grace & White.

I have a question; I guess it's a pretty much economic question, what is going on in the marketplace I know you lost those two big customers. What is happening out there that customers are trying to bring business back in-house? Is it more economical for them to do that? Also it seems that they are doing it and increasing their own capacity; so what happened along the way that made this switch from outsourcing?

Clearly Wal-Mart has been forced; both private-label producers and branded producers to try and take as much cost out of their systems as they can. In Proctor's case, they have been a large producer internally and outsource primarily new product launches to fill their peaks and valleys, or products that they would prefer not to bring in-house for their own logistical reasons, or to take advantage of freight savings from regional suppliers. But as they keep trying to economize, they have been trying to maximize the internal capacities of their own facilities. That is true really in some of the private-label area as well.

The core business that is being internalized is what we call sulfonation. It is not a significantly proprietary technology for just the base laundry detergent product line. When you move outside of that product line, we don't see people moving towards internal production. Particularly fabric softeners as well.

It's a more difficult manufacturing process. Fewer people want to get into that game. So what we're seeing is the commodity laundry detergent business where they are squeezing every penny out of the supply chain, that is the market that is being affected by the backward integrations of the facilities at either branded or private-label production houses.

So P&G, they were always doing some of this, as it was?

When you look at the laundry detergent business, probably -- I don't have the exact number in front of me -- but over about half of the production capacity is within the soapers themselves, the large; the Lever, Proctor, Colgate. They produce their own.

Then you have the merchant market making up the rest. We play primarily in the merchant market, and then secondarily by supplying the soapers for additional needs they may have. We don't see the merchant market customers moving towards internal production. We just see the guys that are fighting it out on the shelf directly in the brands or private-label's squeezing cost out of their products.

I see. Okay, also with the rising raw material costs and energy costs, I'm not sure I understand why you are unable to pass some of these costs on to your customers. It is not a secret that everything is costing more. I don't understand why you can't have a surcharge or something like that, that you have to eat up all of these costs?

We had price increases last year. Because of the competitive landscape we are in, sometimes it takes a month or a quarter to get the price increase pushed through. Then in the meantime we are absorbing lower, weaker margins. We are going to try and be more proactive on that front, and we do have price increases planned, some announced, for April 1.

This year is going to be another challenging year on that front, because with crude oil rising and then the high demand in China for some of the feedstock chemicals in the oil derivatives area, we do expect continued pressure on raw material pricing. We are trying to be much more proactive in getting prices increased. Because of some of the margin deterioration in the prior year, we are going to try and recover some of the margin as well through these price increases. So, yes, there is an opportunity out there, and we are (indiscernible) to try and recover that.

Also, then, in the press release where you talked about opportunities to expand business, what is slowing it down? Do you not have a big enough sales force to get out there and pound the pavement? Or are the customers resistant to new products? What is slowing down some of these opportunities from developing?

I think we have an adequate sales force out there. I think the backward integration issue is taking large quantities, large volumes out of our plants, where the other merchant business that we are growing, which we have grown and continue to grow, is in smaller quantities. So it is hard to make up the volume quickly in our overall, the rest of our base business.

But we had a good year in several of the segments that we had been targeting last year, and that was the emulsion polymerization and the agricultural chemicals had a very good year last year. Oil field is something that was virtually a very small market for us; and with increased drilling, increased interest in enhanced oil recovery, we certainly see that as having some potential, particularly if crude oil continues to remain at these levels.

So the specialty, as we call them functional or industrial, markets where you're not dealing with the commodity laundry detergent market, are areas that we are actively pursuing and have grown. Those are also businesses where we are trying to use our more global footprint to provide consistent feedstocks to these customers around the world, particularly in agricultural chemicals, where they want to standardize their formulations.

Also what are your capital spending plans for 2004?

We intend to cut them back as much as possible. We want to make sure that we have flexibility going forward for whatever other opportunities may come forward. And obviously with earnings being down that means EBITDA is down and free cash flow is a little bit lower than we like. But we also feel we can maintain capital spending in the 25 to $30 million range, which would free up additional free cash flow. We would like to pay some debt down along the way as well.

So we are comfortable that in terms of liquidity we are in good shape. We've got good borrowing capacity. We don't want to rule out acquisition opportunities, so down the road we want to keep the balance sheet healthy. If the right acquisition opportunity comes along we don't want to be unable to pursue it.

Okay; and then I guess since you obviously did evaluate your asset needs, is there any likelihood that you might be closing down any other facilities or parts of facilities in 2004?

I think I commented briefly on this last quarter. The volume that we have lost is primarily in our Millsdale, Joliet, Illinois, site. Our satellite plants are running at a relatively high rate of capacity. There might be a little bit of softness in our Anaheim facility.

But it is the core plant, and we are not going to shut the core plant down. It is our bread and butter facility. So today as we sit here I would say we do not have plans. We will certainly evaluate all options and make sure that we are making the best decision in terms of capacity utilization.

Okay, great. I will leave it open for someone else.

(OPERATOR INSTRUCTIONS) At this time, Mr. Hurlbutt, there are no further questions.

If there's no further questions, I just thank everybody for listening in today and we will talk to you again soon. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.