Stepan Co (SCL) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company's fourth quarter 2006 earnings conference call. During the presentation all participants will be in a listen only mode. Afterward we will conduct a question and answer session. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded Wednesday, February 14, 2007. I would now like to turn the conference over to Jim Hurlbutt, Vice President of Finance, Stepan Company. Please go ahead sir.

Good afternoon and thank you for joining us. Before I begin, please note that information on 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, 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 fourth quarter and full year operating results. Net sales for the fourth quarter of 2006 increased 7% to $288.2 million from $270.1 million for the same period in 2005. The increase was due to a 3% increase in selling prices, coupled with a 2% improvement in sales volume, and a 2% favorable foreign exchange impact.

For the full year 2006, net sales increased 9% to $1.2 billion from $1.1 billion in 2005. Sales were positively impacted by higher selling prices up 7%, volume increases up 1% and foreign exchange impact up 1%.

The net loss for the fourth quarter was $5.5 million or $0.63 per diluted share, compared with a net loss of $400,000 or $0.07 per diluted share, a year ago.

Gross profit declined by $1.3 million or 5%, to $24.3 million. Operating income declined by $8.6 million in the fourth quarter of 2006, from break even for the same period in 2005.

Full year 2006 net income declined by 49% to $6.7 million, or $0.63 per diluted share from $13.2 million or $1.35 per diluted share in 2005. The $2.9 million or 2% improvement in gross profit was more than offset by a $12.5 million increase in operating expenses, leading to a $9.6 million reduction in operating income.

Turning to operating expenses, in the fourth quarter operating expenses increased 29% from $25.6 million to $32.9 million in the same period last year. The increase was primarily within administrative expense.

As announced on January 31, we took a charge of $3 million pretax in the fourth quarter of 2006, results stemming from the settlement of personal injury claims. Also in the fourth quarter the company had a $2.8 million pretax charge for employee severance costs in Europe, and a $1.8 million pretax deferred compensation expense charge due to strong stock market appreciation compared to a $900,000 expense in the same quarter of 2005.

As a reminder, the accounting requirement from the company's deferred compensation plan results in expense when the price of Stepan Company stock, or mutual funds held in the plan, rise, and income when they decline.

Full year operating expenses increased 13%, primarily due to the fourth quarter charges included in administrative expense. Deferred compensation expense increased by $1.6 million for the full year.

Marketing expenses increased by $2 million, or 6%, in 2006. The growth in marketing expense stems from headcount transfers from research and development to marketing. Research remained relatively flat for the year.

Now I would like to highlight the performance in each of our three segments. We begin with surfactants, which accounted for approximately 75% of the company's sales for both the fourth quarter and full year. Surfactant gross profit improved $300,000, 2%, and $4.6 million, or 6%, for the quarter and year respectively. The full year earnings improvement reflected improved product mix in North America, led by increased sales to the functional market and the broad surfactant customer base served through distribution.

These improvements offset lower profitability in the laundry and cleaning product market, as well as higher plant operating costs. Sales volume grew by 1% in the quarter, but was down by less than 1% for the full year, due to the lower laundry and cleaning commodities surfactant volumes. Biodiesel, fabric softener and personal care volumes all increased. Selling price increases kept pace with volatile raw material costs.

European surfactant earnings declined despite higher sales volume, as the prior year results included a gain of $2.3 million on insurance recoveries related to a fire at the UK plant in 2004. Latin America earnings grew for the year on higher sales volume in both Mexico and Brazil.

Biodiesel profit margins remained strong throughout 2006, however biodiesel earnings are forecast to be lower in 2007, due to lower crude oil and higher soybean oil pricing. We continue to explore tallow as an alternative feed stock for production of biodiesel. We are also pursuing additional distribution outlets to reduce some of the inherent risk in this business.

Keep in mind that surfactant results for the fourth quarter of 2005 included $2.1 million of pretax government incentives that we received from the Department of Agriculture for increasing production of biodiesel. This program was discontinued during 2006.

Turning to the polymer segment, which represented 23% of our revenue in the fourth quarter and full year 2006, polymer gross profit declined by $1.2 million, 13%, for the quarter, and was unchanged for the year. Sales volume grew by 6% in the fourth quarter and 7% for the full year. The lower fourth quarter earnings occurred in North America as polymers had to work off higher priced raw material inventory as costs declined sharply, resulting in temporary margin compression on sales of polyol and phthalic anhydride.

Prior year polymer earnings included significant non-recurring profit contribution of a large polyurethane system sale during the second quarter of 2005.

European polyol earnings improved in the fourth quarter on higher volume, but full year results were less than last year due to lower margins resulting from high raw material costs. Sales of polyol in China continue to grow but full year results posted a loss due to escalating raw material costs. During the fourth quarter the polyol business in China attained a slight profit. We expect additional volume growth in China will lead to a profitable year in 2007.

And finally our specialty products segment accounted for 2% of the company's sales in the fourth quarter and for the full year. Gross profit decreased by $500,000 in the fourth quarter and $1.2 million during the year, due to lower food ingredient margins stemming from competition for market share and higher raw material costs. Sales volume grew by 23% and 16% for the quarter and full year respectively.

Looking at other income, interest expense increased by 14% in 2006 due to higher average debt levels and interest rates. Higher raw material costs, due mainly to the high cost of crude oil, continue to elevate our working capital requirements, resulting in the higher average debt levels.

Our relatively low annual effective tax rate of 12% reflects the benefit of $1.6 million of U.S. income tax credits generated throughout the year for the production of biorenewable fuels or biodiesel. The favorable effect of a change in tax law in Mexico on deferred tax liabilities reduced the tax provision by $600,000 in the fourth quarter, also improving the company's tax provision.

Turning to the balance sheet, total debt as of December 31, 2006, was $131.2 million, up from $125.7 million at the end of 2005. Our total debt to total capitalization at the quarter end was 42%, down from 43% in the fourth quarter of 2005. Capital expenditures were $45.9 million in 2006, compared to $41.5 million in 2005.

Looking ahead, during 2007 we expect improved earnings from operations. We are focused on commercializing our newest polyol, growing our global fabric softener franchise, larger scale commercialization of sulfonated methyl esters for the surfactant marketplace, and securing long term value in our biodiesel business. Recent lower crude oil prices will adversely affect biodiesel margins, but should help our core operating segments through lower raw material costs.

This concludes my prepared remarks. At this time I'd like to turn the call over for questions. Operator, please review the instructions for the question portion of today's call.

Certainly. [OPERATOR INSTRUCTIONS] One moment please for our first question. [OPERATOR INSTRUCTIONS] We do have a question coming from the line of Beverly Machtinger with Grace and White. Please proceed.

Hi Jim. I have a couple of questions. One, the situation in China, right now it's just polyol business there. Are there any plans to expand operations there for surfactants? Is there a need, is there -- I mean how can we perhaps get a better return on that facility?

Well we still have high hopes for the polymer business in China, it's a rapidly expanding market for insulation foam as they try and improve their energy efficiency. They burn a lot of coal and it's created a lot of pollution problems. So there are increased desires to get energy improvements in China.

As far as surfactants, there's a fairly strong surfactant base in the country. If we were to go in with surfactants we'd be looking at niche markets. We currently built a fabric softener plant in the Philippines that was just opened last year.

How is that doing?

It's doing well, we expect it to be sold out before the end of the year with existing customer contracts and commitments. That would be something that would be down the road, a potential for China, is would there be a need, some day, for us to put a fabric softener plant in China. But I think that's still out in the future some distance.

Our plan for the polyol is still to continue to grow that market and significantly grow it to the point where it is profitable.

What percent of capacity is being utilized there now? Like, you fully -.

No, we're only using, oh, roughly a third of the capacity in China, of that facility. There's plenty of room to take on more business.

So, is that one of the reasons why it's not yet profitable? You're not getting the efficiencies or the business out of there, vs. the overhead costs?

That's the major reason. The volatility in raw material costs has made it difficult to manage the margin is we've had the same problem in Europe and North America with polyols but they've pushed price increases through and got the margins up and now we just need to get the volume up.

Okay. The Surfact - the bio-diesel business; are you just - you mentioned you wanted to get better long-term value out of that business. Can you just expand on what you mean by that?

Well, I think, as we've spoken in the past, there are tax incentives due to expire in 2008. We certainly see a lot of interest now, including President Bush, to create less dependence on foreign oil. And the natural outcome of that would be a mandatory use percentage in the U.S.

So, we have not made a decision to expand our capacity in bio-diesel because we'd like to see the landscape, you know, some of the uncertainty, going forward in this business, to be resolved. Soybean oil prices have gone up, even while crude oil was coming down, compressing our margins in bio-diesel.

And so, we look at alternative feed stocks as one solution, moving to a tallow instead of a soybean oil. And most of our business has been traditionally sold on the spot market. We'd like to line up some long-term relationships in the distribution side of the business-.

Okay.

-to tie up a greater percentage, the output of our plant with long-term contracts. All of this aimed at, you know, taking some of the volatility out of the business and securing it as a viable business for the long-term.

You know, I had a question in general about the - when you have, you know, when your major raw material is crude oil and, obviously, the price is up one day and down the next and we're seeing a lot of that going on now and the cyclical side of it going down.

You know, we were talking here in the office; why is it, though, that you can't - I mean, can you not pass along the pricing easily to the end users, to your end users, when the prices are going up? Or even, I think, in your press release about, with the polyol, now you have a high - a higher cost inventory and you're getting margin compression. What - I guess I'm not clear on the dynamics of pricing in those businesses.

It's been a challenge. You know, the competition doesn't always respond. They might move slower than we would to raise prices, so it's a competitive landscape.

A lot of our business in surfactants, you know, we do quote with some quarterly pricing. So, we honor those quarterly commitments. We try and tie up some of our suppliers with quarterly pricing, but we're less successful in that area.

So, yes, it's just a constant challenge to push those price increases through. I think we've been relatively successful last year in surfactants.

Polymers was more of an unusual situation. It was so volatile; one of the suppliers had shut - had a planned shutdown and so we built inventory to make sure we didn't run out. And right at the time we built inventory, the pricing fell dramatically, with much more volatility than we've seen in many years.

So, you actually didn't have business for the inventory - you weren't already contracted for the inventory you were building?

We had probably two months or more supply on hand when the raw material price fell. We had to absorb the majority of that decline.

So, that was more of an unusual situation?

That was more of a one-off because we don't normally - we would try and stick to less than one month's inventory.

Okay. And then, what else is the company doing to perhaps consolidate or, you know, some of the locations? Because, you know, clearly, you're not achieving the goals that, you know, Quinn the Senior had said, you know, 10 years ago. And, it seems that every year there's another little issue that kind of prevents you from getting to that next step.

Well, you're absolutely right. Certainly, the fourth quarter we had several setbacks. Hopefully, the majority of them non-recurring, but, in terms of going forward, the European severance is one item that we think is a step in the right direction of restructuring Europe to make it more profitable, going forward.

We have done a modification of our food specialty business. We did reduce some headcount in that area last year. We're trying to improve the profitability there. We have announced price increases in the food ingredient specialty business to restore those margins that we lost last year.

And, you're correct; we do look, now, more aggressively, at opportunities to - if there are opportunities to change the mix of business in our plants. We're looking at that and we have several projects going on.

And, we would even, you know, look at shutting down parts of a plant if it's not efficient anymore. I mean, we're actively looking at those opportunities.

Okay, great. That's it for me.

Thanks, Beverly.

[OPERATOR INSTRUCTIONS].

It seems we have no further questions at this time.

Okay, then I just want to thank everybody for participating in today's call. Thank you.

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.