Stepan Co (SCL) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company second quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded Wednesday, July 20th, 2005. I would now like to turn the conference call over to Mr. Jim Hurlbutt, Vice President, Finance, Stepan Company. 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 foreign operations and certain global and regional economic conditions and factors detailed in the Company's Securities and Exchange Commission filings.

I will now take a few minutes to review our operating results. Net sales for the second quarter of 2005 increased 18% to 278.4 million from 236.4 million for the same period in 2004. An increase in sales volume and higher selling prices accounted for the increase in sales. Higher selling prices reflect price increases brought on by rising raw-material costs. Net income increased to 6.2 million, or fixed $0.64 per diluted share for the second quarter compared to 3.8 million or $0.39 per diluted share a year ago. Gross profit improved by 14% to 34.7 million. The increase in raw-material costs also resulted in a last in, first out inventory charge of 1 million after tax for the second quarter compared with a charge of a 0.5 million for the second quarter in 2004. Operating income increased 47% to 10.5 million for the second quarter of 2005 from 7.1 million for the same period in 2004.

Now I would like to highlight the performance in each of our three segments. Beginning with Surfactants, which accounted for approximately 74% of the Company's sales for the second quarter of 2005, Surfactant sales increased 14% from higher selling prices and an increase in volume in North America, Europe, and Latin America. However, Surfactant earnings declined slightly due to higher operating expenses, and a weaker sales mix in North America and lower margins in Europe. Turning to our Polymer segment, which represents 23% of our revenue for the second quarter of 2005, we saw Polymer sales rise 33% in the second quarter due to higher selling prices. Higher margin polyurethane polyol sales volume declined on weaker demand. However, the volume of phthalic anhydride and polyurethane systems improved. For the second quarter, Polymer earnings improved in all product lines due to a recovery of margins previously eroded by higher raw material costs. In addition, a large polyurethane system order was entirely shipped during the second quarter. And finally our Specialty Products group accounted for 3% of the Company's second quarter 2005 sales, increasing by 8% from higher volume of pharmaceutical ingredients. This segment should continue to recover over the balance of 2005.

Turning to expenses, the increase in marketing and research expense was largely due to higher salary, health care and pension expense. Administrative expenses decreased by 18% primarily due to a 1.7 million pre-tax decline in deferred compensation expense. Looking at other income, interest expense increased due to higher average debt levels and a higher short-term interest rates. Regarding our Philippine joint venture, income declined during the second quarter due to an adverse change in lower margin product mix. A new fabric softener reactor currently under construction in the Philippines will benefit earnings during the second half of 2006.

Turning to the balance sheet, total debt at June 30th, 2005 was 133.4 million, up from 112 million at the end of 2004. Our total debt to total capitalization at the quarter end was 44.1%, up from 43% at the same time last year. Capital expenditures were 11.6 million for the second quarter. Year-to-date capital expenditures are 19.8 million and should run slightly higher during the second half of 2005.

Looking ahead, we expect continued improvement in Polymer and Surfactant earnings. Surfactant sales mix is projected to improve and will also benefit from increased sales of biodiesel. High crude oil prices and favorable tax credits have created a market for soybean-based biodiesel produced in existing Stepan manufacturing assets. Surfactant sales grew over the quarter and have been successful in recovering higher raw material and freight costs in North America, though we have met some greater resistance in Europe. But overall we remain confident in our strategy and continue to be optimistic about our full year earnings growth. This concludes my prepared remarks.

At this time, I would like to turn the call over for questions. Operator, please read the instructions for the question portion of today's call.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of John Roberts, Buckingham Research. Please proceed. Your line is now open.

Good afternoon, Jim.

Hi, John.

Could you talk a little bit about the large order shipped during the quarter for polymers and does that mean the third quarter is going to have a decline in that segment?

That segment will see some decline, at least from the polyurethane systems group because that was a nonrecurring volume probably for an annual period. The rest of the business, though, in polymers looks fairly strong for the balance of the year so total polymers is still looking at a improvement in the second half.

And could you characterize the nature of why a year's worth to one customer went one quarter or --

It was a ship -- it was a construction of a ship.

Okay.

And they were going to use a polyurethane system foam to fill cavities within the ship and they wanted to install all the foam in a very short window so we staged all the material to them so they could apply it in a -- in a very tight frame of several weeks' time.

Great. And then secondly, I don't know if you're willing to comment how big your biodiesel related sales are today and what the outlook is over -- just maybe the near term the next several quarters? Is it ramping very quickly right now?

Because the first quarter we were -- we had been in this business in the past part of the economics being driven by agricultural department had a subsidy for producers of biodiesel from either soy or ethanol. That economics required you to increase your volumes and therefore once you couldn't increase your volumes anymore, you were out of the game. The excise tax credits that had subsequently been enacted create an economic opportunity with a longer time frame. The state of Illinois has got an excise tax credit and the Federal Government's got an excise tax credit with -- the hope is that they will extend the federal excise tax credit from the current two-year legislation to an additional five. That being the case, we have approximately 70 million pounds at capacity and we hope to ship every pound we can produce. Right now the customers are taking every pound we can produce.

Because of the limited window that this opportunity may have, you wouldn't consider adding capacity because you might get stuck with it I guess at the end of the program.

We're studying that internally. The big guys, ADM and Kargo have both announced expansions, so obviously given the somewhat artificial economics meaning, it's driven by tax credits to make it cheaper than diesel or to put a profit in between straight diesel and biodiesel. If the -- if the tax credits are enacted, we would certainly look at the costs of expanding -- and whether we feel comfortable with the risk reward ratio.

Okay. Thank you.

Thank you. Our next question comes from the line of George Gaspar from Robert W. Baird. Please proceed, your line is now open.

Good afternoon, Jim.

Hi, George.

A question on China. Can you give us a little detail now of when you started generating sales and what your capacity's going to be and how do you -- how are you going to account for the sales there on a percentage ownership basis? Can you share that with us?

Sure. The plant was dedicated last month. It's up and running, producing product. We've been sampling customers in China. We were running a little tight on capacity in North America so we actually did place some orders for some material from that Chinese plant. So we're pretty optimistic, of course there's a time -- time lag involved in getting product approvals for existing and prospective customers' plants. So exactly how quickly we will ramp up the volume, still a little bit of uncertainty, but we didn't put in an extremely large plant. It's roughly -- I believe it was a 30,000 ton plant, with the intention being we're right adjacent to the raw-material supplier. Our partner is the raw-material supplier at the phthalic anhydride plant. Our intention would be if the market dictates, we'd be able to put in additional reactors right in line with the one we've already put in. The percentage ownership is 55% equity ownership in the joint venture with some -- some benefit to the earnings sharing based on our technology being used for the product, but it is a 50 -- we did go with a majority-owned situation to -- partly just to ensure that we would have control over the future of the business.

Okay. And in terms of the reporting process, then, if you control 55%, are you going to be reporting all the sales that are generated within the facility?

The only downside to the majority ownership is it does require consolidation, so we will -- all of the plant assets that that will be in our consolidated balance sheet and the income will be in our income statement and then a minority interest will be recorded on the income statement to reflect their share.

I see. And then you didn't get any sales volume out of there in the second quarter, did you?

No.

Okay. So that's going to take a gradual ramp up. The Brazil situation. You indicated that you -- your Surfactant volume was up there and I assume that's because of the facility that you took over, you had some contract volumes to deliver. What's the magnitude of your opportunity with the Unilever plant purchase and what kind of volume can you get out of there?

Well, it's -- the plant itself today is entirely being used to supply -- we -- in addition of acquiring the plant from Unilever on a long-term lease with an option to buy we acquired a supply contract to Unilever to supply them for the 10-year period. They will take roughly half of the capacity of that plant. And I am trying to remember the capacity. I think it's in the vicinity of 100 million pound capacity plant. So if they take half, that leaves us half to go use in other markets in Brazil. What we're looking at, though, is trying to focus on -- not focus on straight commodities in Brazil, but can we get into the ag and some of the other specialty markets by adding a reactor to that site. So -- you know, the base business in there is -- it's going to make a little bit of money but it's not going to be a significant contributor to overall earnings, but the next step is we want to get a reactor in there, a multipurpose reactor, potentially, that could make a broad array -- array of products. We are quite honestly we are moving slowly because of the volatility that Brazil -- people have experienced in investing in Brazil. We want to be very cautious and take some small steps and make sure we are confident in the results we can achieve.

Right. And then any comments on Europe as far as how you're polyol margins look in the German facility and then how you size up this UK situation where a competitor has now closed a plant, which I assume was done in the second quarter and does that detail an opportunity right here in the third quarter for you?

We certainly are expecting improvement. We saw a surge in volume in June related to the UK site as customers really finalized arrangements to get supplied from either Stepan as Huntsman exited the UK market or made arrangements to be supplied by Huntsman or others from the continent of Europe. And clearly there is a freight disadvantage but I don't know if anyone in the continent is going to eat some of that freight differential to keep the business, but we see significant improvement coming for the UK. Now, that being said, we could -- we've got a fair amount of room to go to get to an acceptable level of earnings in the UK but we do believe we turned the page towards getting back into a profitable operation in the UK by the third-quarter results. It's actually helping our German operation, too. I think there's been a little bit of tightening up of supply in the continent as well as a result of Huntsman's departure from their shutting down their plant in the UK. So a little bit of tightening in the continent has allowed us to get a little more volume out of our German Surfactant plant and then that coupled with our polyol operation in Germany. We're covering the overheads of a bigger operation and we expect that to be profitable as well in the second half.

Okay. And then one on this closing of the Huntsman. What percentage of the market did that represent?

Well, in the UK they -- I don't have exact percentage but a rough number would be -- I think we had probably a little more than 50% of the market share and they probably had the majority of the rest.

I see.

Now, that being said, I caution they are not leaving the European market. They've shut a plant down in the UK and they're free to compete in the UK with product produced in -- in France and other plants on the continent.

I got you.

But again that's not a reliable supply chain and that's why we see a lot of the business moving in our direction.

Okay. Thank you.

You're welcome.

Thank you. [Operator Instructions] One moment please for our next question. Our next question comes from the line of Beverly [Matchsinger] from Grace and White. Please proceed.

Hi, Jim. Most of my questions have been answered, but I just have a couple follow-ups on the other questioners. The UK situation, now that that plant is closed, are you going to try and raise the prices and do you think that you could actually get them through to the customers?

Well, yes, absolutely. We have raised prices. We actually were trying to get prices up even before Huntsman announced their shutdown because of the raw material situation increases over the last 18 months dictated that we had to get our prices up to get our margins back. This certainly helped and we've gotten margins up in the second quarter and we certainly hope to continue to get the margins up a little more. Yeah, it's definitely helping.

And, also -- let me think what my other question -- oh, the biodiesel business. Is that more -- where does that stand in the profitability range versus all the other products that are coming out of that -- those facilities where you're making --

Yeah. It's not as profitable as a specialty chemical because you're really looking at a commodity chemical. You're simply taking soy bean oil and converting it into a fuel by reacting it with methanol and removing the glycerin. So in large part it's a commodity, but the margins are pretty good for that type of business today. It's -- for us, it was a low cost -- there's no barrier to entry. We had existing equipment easily adaptable to making it and we had the methanol capability and handling equipment already in our plant for other product lines. So -- and we already do glycerin removal and stripping, so it was a fairly easy business for us to get into. The margins will obviously be vulnerable to the fluctuations in crude oil and soy bean oil prices. With crude at these prices there should be plenty of room for margin because the -- you're really sharing the margin between Stepan and the blender who mixes it with diesel and ultimately sells it to the truck-stop or fuel distributor. So today the margins are good. But they are a commodity-type margin.

Can you --

The attractiveness, though, is -- we're already up to 70 million pounds and as I said we would certainly entertain if economically justifiable a further expansion.

Okay. And can you give us just some idea what's happening right now with raw material pricing? I mean are you getting any kind of sense that you're at the peak and maybe -- you know, I mean everybody knows that the crude is just going through the roof, but what sense do you get as far as what's going on out there?

Well, you put me on the hot spot, aren't you? I wish I knew. Six months ago I thought I told you that I thought we had seen the worst. We're seeing things flattening out right -- I mean in the last four weeks I would say we're seeing signs that things have at least flattened even with these near-term gyrations in crude oil. Part of the difficulty we had last year was not directly crude-oil related. There was some alcohol plant shutdowns or outages in Europe and China was thirsting for diethylene glycol. So we see that seems to be back in balance now. There are some alcohol plants going up in China and I believe another part of southeast Asia. So all our gurus tell us that things should start to soften later this year or next year, but I sure can't predict crude. I'm so wrong on crude oil, I wouldn't know. We had -- our collective judgment including some knowledgeable people in our Company thought we'd be down to $40 crude by now and --

You and the rest of the world.

We're all wet, aren't we.

Yeah. Okay. Great. Thanks a lot, Jim.

Thanks, Beverly.

Thank you. Our next question comes from the line of Steven [Weiss], Mid-flow Capital Investment. Please proceed, your line is now open.

Thank you very much. Congratulations on a great quarter and improving your profit, Jim, I applaud you.

Thank you.

A couple questions. Regarding commodity prices obviously crude oil is what it is. A lot of your competitors have been looking at these challenges in the market and putting in some new initiatives to reduce the raw material and commodity prices by opening better lines of communication to the supplier base to overall reduce their total landed cost throughout their supply chain by looking at the supply chain as a whole. What are you guys doing to improve or reduce your raw material and commodity costs by looking at your supply chain as a whole and overall seeing where there's areas of improvement.

Well, we do have a couple areas where we've been fortunate to have some progress. For example, with our phthalic anhydride business, we sell that now and have for some time but it's certainly -- certainly has protected us. We sell that on a price plus ortho, so if the toll fee or margin is 5, 6, 7, 8, $0.09, we sell it at that price plus the cost of the ortho. So we've tried to neutralize Stepan from the impact of the fluctuations in orthoxylene. In some of our other businesses we have done some strategic purchasing. We had an excellent diethylene -- long-term diethylene glycol contract that took us through -- basically through the last month. So we had very favorable diethylene glycol pricing for part of -- not all of our -- part of our contracts. And not all over the world, but -- so we have done some of that to try and mitigate as much as we can the volatility of raw material costs.

How are you -- obviously quality's been real important in metric in Stepan's growth over the last 10, 15 years, how do you guys qualify your suppliers to make sure they live up to your standards and provide you with the right raw materials and commodities when you need them, so you can provide those products to your customers?

Well, we have a routine audits of our suppliers and we have certificates of analysis of all product coming in. Quite honestly, that has not been a -- you know, most of our -- the vast majority of our raw materials come from fairly large chemical producers who adhere to fairly stringent standards themselves. So this has not been a significant issue for us in recent years.

Okay. Well, congratulations on a great quarter and good luck down the road.

Great, thank you.

Thank you. Our next question comes from the line of George Gasper, Robert W. Baird. Please proceed with the follow-up question.

Yes. Jim, on your gross margin, your gross profit situation. And looking at overall margins, the bottom line. How can you -- what can you see in terms of Stepan improving into some historical range? Where do you see yourself and where do you think you can go?

Well, I think I've said in the past, our focus is how do we continue to grow the specialty and functional products at as fast a rate as we can and get capture Surfactant margins into higher value-added end-use applications and a lot of our efforts and a lot of our R&D activities are focused on supporting those markets, as opposed to continuing to support commodity margins in laundry and cleaning. Laundry and cleaning is very important to us. We sell a lot of -- an enormous array of products into laundry and cleaning, but we still want to focus on the higher margin products and devote our R&D resources to developing those markets.

Okay.

And I think I've mentioned that we've had some inroads in the emulsion polymerization markets. We've expanded our participation in the agricultural chemical markets, so I mean Surfactants as a laundry detergent is one thing. Surfactants for the hundreds of other end-use markets is another and we're looking at all those end-use markets.

Okay. And that -- just to expand a little bit on R&D. Is there anything in R&D that -- on a relatively near-term basis that could come out here and start to contribute to an earnings stream for you -- or a revenue stream for you?

Well, as an adjunct to the biodiesel we've looked at alternative feedstocks to -- biodiesel again is driven by artificial economics of tax incentives. Could we find a feedstock that would feed biodiesel as a stand-alone business that would have economically independent of tax subsidies and we have spent a little time on that. We continue to pursue flexible foams. As I mentioned our polymer -- or polyol goes primarily into the rigid foam insulation market. The flexible foam market is enormous and we have -- we have some sales going into the flexible foam market but a very, very small portion of the -- of the market share. And that's furniture foam and auto -- automobile seating and that type of flexible foam. We think we have some performance and cost attributes that are very attractive. I can't say that it's going to be near term. Near term I guess would mean the next couple of quarters. But we do feel it's got some potential in 2006 and beyond.

Okay. And then your comments or the Company's comments in the release of the second half and your comments leading into the call. The third quarter is -- has historically been a pretty good quarter for Stepan. Does it suggest that you can duplicate second-quarter performance in the third quarter?

We're pretty comfortable that the third quarter is looking pretty good. We typically -- certainly for the last four or five years, have seen a fair amount of softness in the fourth quarter as people slow down their plants and bring their inventories down and shut down -- do turn-arounds over the holidays. But the third quarter -- you know, we're pretty bullish right now in the third quarter in terms of some of the opportunities we have got going on. And the biodiesel volumes should be significantly larger in the second half than the first half, so that gives us some optimism that we have a little better chance of getting through the third and fourth quarter with some solid legs and we traditionally have come in the fourth quarter.

And then a comment on the interim quarter business. Is there any chance that the Company could maybe change their thought process a little bit and give an interim update inside the quarter now and then just to give some guidance as to how the business is going, or is the --

Well, we -- we can certainly entertain the thought.

Yeah. I think it would be great if we could hear a little bit more than -- it's great to be able to visit on the conference call on a quarterly basis but if the Company would look at the possibility of issuing a little bit more update on what you're actually doing and how you are progressing in terms of getting things up and running and what your outlook is, that would be great.

We will -- we will kick it around and I'll get back to you.

Thank you.

Thank you. Mr. Hurlbutt. There seem to be no further questions at this time. I'd like to turn the conference call over back to you. Mes continue with your presentation or closing remarks.

And no closing remarks. I just want to thank everybody for joining us and participating in our call today. 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. Have a great day and thank you again for participating. One moment, please, sir