Stepan Co (SCL) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Stepan Company First Quarter 2007 Earnings Conference Call. (Operator Instructions.) As a reminder, this conference is being recorded Wednesday, April 25, 2007. I would now like to turn the call over to Mr. Jim Hurlbutt. Go ahead, sir.

Good afternoon, and thank you for joining us. Before I begin, please note that information in this conference 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 first quarter 2007 operating results. Net sales for the first quarter increased 8% to 313 million from 289.6 million for the same period in 2006. The improvement was due to a 9% increase in sales volume during the quarter, which was partially offset by a 1% decline in average selling prices.

Net income for the quarter was 5.7 million, or $0.56 per diluted share, compared with net income of 3 million, or $0.31 per diluted share in the year ago quarter. Gross profit improved by 2.5 million, or 8%, to 34.8 million. Operating income was 10.5 million in the first quarter of 2007, an increase of 70% from the same period in 2006.

Turning to operating expenses, in the first quarter, operating expenses were 24.3 million, down 7% from 26.2 million recorded in the same period last year. The decline was largely due to the recognition of 1.4 million in deferred compensation plan income during the quarter, compared to an expense of 1.7 million in the comparable year ago quarter. As you'll recall, the accounting requirement for the Company's deferred compensation plan results in an expense being recorded when the price of Stepan Company stock or mutual funds held in the plan rise and income being recognized when they decline.

Excluding deferred compensation expense, operating expenses grew by 5%. Marketing expenses increased by $500,000, or 6% in the first quarter of 2007. The growth in marketing expense is primarily due to an increased bad debt provision and higher salary and benefit costs. Research costs were also up 6% as a result of salary and benefit increases.

Now I would like to review the performance of our three segments. First, we'll look at surfactants, which accounted for 75% of the Company's net sales for the first quarter. Net sales for surfactants were up 5%, largely driven by a 10% increase in volume. Surfactant gross profit improved 12% to 22.2 million in the first quarter. The improvement was driven by a strong performance in North America where sales volume rose 12%, primarily as a result of growth in consumer products.

While sales volume of biodiesel grew significantly, gross profit was down, due to higher prices for soybean oil used in the production of biodiesel. Earnings from Europe were higher as a result of improved product mix, although volume was unchanged. Earnings from Latin America were down due to higher raw material costs during the quarter.

Turning to our polymers segment, which represented 22% of first quarter revenue, gross profit was down slightly in the segment to 11.5 million. However, I want to point out that the comparison is impacted by the claim settlement income related to an electrical substation fire included in the first quarter 2006 figure. Taking that out, our polymer earnings would have increased slightly.

Polyol sales and gross profit remained flat in the first quarter. While we saw improved earnings from Europe on the back of a 47% increase in sales volume, this was largely offset by lower earnings from North America where sales volumes declined 2%. Phthalic anhydride gross profit was lower, although this was largely due to the claim settlement income included in the year ago quarter.

And finally, our specialty products segment accounted for 3% of the Company's sales in the first quarter. Gross profit increased by 900,000 in the quarter due to higher pharmaceutical sales volume.

Looking at other income and expenses, net interest expense increased by 12% in the quarter. This was due to higher average debt levels as a result of increased working capital requirements and capital expenditures. The loss from our Philippine joint venture increased slightly in the quarter. While the new Philippine fabric softener plant was generating operating income, it was not enough to offset a loss from a weak product mix of consumer product surfactants.

Turning to the balance sheet, total debt as of March 31, 2007 was 148.9 million, up from 131.2 million at the end of 2006. Our total debt to total capitalization at quarter end was 44.4%, compared to 44.7% in the first quarter of 2006. Capital expenditures were 11.5 million in the quarter, up 26% from the same quarter of last year. Full year capital expenditures are projected to be 42.5 million.

Looking ahead, during 2006 we took steps to improve future profitability. These steps included converting from a defined benefit plan to a defined contribution plan in the U.S. and in the U.K. We also were structuring our food ingredient business in North America and implemented organizational and restructuring changes within our three European sites. We are encouraged by our first quarter results. Our North American surfactant and European polymer groups performed very well. And we continue to expect improvement in both surfactants and polymers profitability for the balance of the year.

We continue to work on securing long-term value from our biodiesel business initiative, however, the higher price of soybean oil used in making biodiesel continues to pressure our profit margins in this area and remains a concern. Nonetheless, we expect that improvements in other parts of our business will outweigh the pressure on biodiesel earnings. With higher volumes, improved product mix and margin improvement on some product lines, we remain confident in our expectations for full year earnings improvement over 2006.

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

Gladly, sir. (Operator Instructions.) And the first question comes from the line of Laurence Alexander.

Hi, there. This is Martha Shelton, actually, on behalf of Laurence Alexander. How are you, sir?

Very good. How are you?

Doing well, thank you. Just a question for you regarding your biodiesel business. Looking--it sounds like the outlook for your margins in the balance of 2007--it's not too favorable, or how would you characterize your outlook for margins?

Well, it's certainly down from the past two years. Those that have been following the biodiesel business probably are aware of the shift in crop acreage from planting corn, which is being driven by the ethanol market, versus planting soybean, which feeds into the biodiesel market. So about a 10% increase in acreage went over to corn this year, which has driven speculative pricing into the soybean oil market and driven our raw material costs up. Obviously, as crude oil has risen recently, that's helped the margins a little bit. But there is still a fair amount of uncertainty where soybean oil prices are going to level out at.

Okay. And would you comment on perhaps your ability to change the sourcing of soybeans to reduce costs?

Well, we've had an active program on working towards a tallow feed stock that we would use, particularly during the summer months. It's a little less conducive to use in the winter because it's a little harder to work with and doesn't quite perform as well in the winter months because of the cold temperatures. But there are producers out there working on tallow. We have a process for tallow and we hope to be implementing that. But we have yet to modify our manufacturing equipment to utilize tallow.

So we're still uncertain whether we're going to get a benefit out of tallow in 2007, or whether there will be a 2008 benefit.

Okay. Thank you very much.

Thank you.

And our next question comes from the line of Beverly Machtinger.

Hi, Jim. A follow-up on the biodiesel question. Can you perhaps talk a little bit about the demand right now for biodiesel? And also, when you talk about going to tallow, what kind of differential would that be as far as margins? I mean, is it really significant enough that you should be pushing ahead with that, or is it going to be so minor that it's really just an alternative source?

Well, today there's still probably about a $0.10 a pound spread between soybean oil and tallow that we would use in our formulations. So it would certainly help. The uncertainty though is will that spread last. As more and more people move tallow into the biodiesel markets, will that increase demand on tallow drive prices up. We think there will still be a spread, but will it--historically, it's been even larger than $0.10. So that spread may narrow.

But in terms of making the business healthier and improve the margins, yes, it would certainly give us several cents more per pound margin, hopefully in the long-term, but certainly in the near term.

Also, I think in the past you've talked about expanding capacity for the biodiesel. Given that the margins are really being squeezed now, what is the Company's plan for that?

I think we indicated in the past we did have plans we were working on. And as margins contracted due to this rise in soybean oil prices, we've taken a little more of a wait and see approach. The current economics are largely based on the $1 a gallon excise tax credits that biodiesel blenders get. That is legislated through 2008. We would expect that to be extended beyond 2008.

But more importantly, we would like to see a mandatory use percentage, which is the way most of Europe operates in the biodiesel market. That would certainly stimulate demand for biodiesel and make the longer term investment more secure. To invest in the expansion today at today's margins is not particularly attractive unless we can see some long-term relief in Congress that would solidify the demand going beyond 2008.

You don't break out what percent is biodiesel. But with the declining margin picture you're describing, how much of a squeeze is this on the overall picture? And is it even worthwhile staying in the biodiesel sector at this time?

Well, it's positive cash. It's generating positive margins, positive cash flow today. As we've explained in the past, the fortunate position for Stepan is we didn't build a grassroots biodiesel plant. So these assets are usable for other products within our product portfolio. So we still believe the biodiesel market is going to be profitable, so we--the equipment that right now is producing biodiesel, is staying in the biodiesel market.

But we do have that flexibility that if Congress doesn't act and the business is not profitable, we would put those assets to other use.

So then, the downside risk from an asset perspective is pretty minimal.

We think it's very minimal. We actually switch--during the winter months when business slows down, we actually did use one of those reactors for surfactant products. So it is very much a multi-purpose reactor.

Okay. Switching to a different topic, I was wondering if you could tell us when some of these restructuring situations will actually bring some benefits to the bottom line. I think the European and you just alluded to the North American--I'm trying to look at where I made the note. Yes. The food ingredient business in North America. And clearly, the company is kind of doing what they have to do to restructure. But when are we going to start seeing some of the benefits of this to the bottom line?

Well, the food ingredient activities were implemented last year. So in terms of salary savings that will be in this year's results. Europe, which was a larger undertaking with a target of 1.5 million savings per year, we should see a partial savings this year, maybe half that amount. And then, the full year amount should be realized next year.

The other issue on the pension plans, we will see savings on the pension plans, but more in the long-term in terms of it kind of capped our costs and then we see a savings being generated in another three or four years. More importantly, the defined contribution plan switch avoids a lot of volatility currently associated with defined benefit pension plans. So that will be a longer term benefit, but it will also take some volatility out. We won't be as exposed to sudden fluctuations in pension cost.

Okay. Are you sort of finished with the restructuring plans? Are we going to see any more charges this year or is this an ongoing process or you pretty much have the [plants taking the charges] and now it's just implementation?

The--for Europe, I think we're done. We have lots of initiatives on the table that we are looking at. And so, I would not want to say we're completely done with any future activities that we may be pursuing. So we are looking at improving the profitability of this business and we're looking under every block and cranny we can. We're looking at product lines, we're looking at plant sites. So it would be very premature to say that we will not be doing any further activity.

Management is committed to the profitability of this business. It's got to go up and that's what we're committed to doing. And if we have to take further action, that's the plan.

Okay. And then, one last thing on the polymer business. It seems to be pretty sluggish this year. I was wondering how much of this weakness can you relate to perhaps the lousy housing market or new home production and things like that? Or is there any way for you to break it out?

Well, it's kind of a mixed bag. In Europe, our volume is up significantly. Due to higher energy standards, people are using more material in Europe. And despite any economic sluggishness, volume improved dramatically in Europe, particularly in the United Kingdom, where they have ramped up energy standards. So energy conservation is going to be probably a bigger factor than the housing slowdown.

In the U.S., most of our volume goes into commercial flat roof construction - warehouses, office complexes--of that nature. So we're not expecting a significant slowdown due to the housing downturn in the U.S. But I can't--I wish I knew where the North American economy was headed. But we're not seeing a significant volume slowdown. We were down 2% in the first quarter in the U.S. compared to last year. And we--for the full year we hope to have improved volume. So, no, we're not directly seeing a correlation to the housing slowdown.

Okay. And then, lastly--I know I said that before, but I'll say it again. I was wondering how much of your business--or if you even know this--is really commodity based at this point versus premium or value-added product?

Well, sure. I'll throw out a rough number. But certainly, 30 to 40% by volume is probably more on the commodities side. And that's the area we've been focused on changing over the last four or five years and driving that number down and getting more diversification in products. We've been very--pushing very hard in the--like for example, in the polymer foam area where we go into gypsum board and concrete and oilfield drilling compounds, enhanced oil recovery - putting surfactants into oilfields to increase the recovery of oil. The push has been to diversify into the higher value-added products.

Okay. The reason I ask is that your margins have just in the past five years really not shown much improvement. And I don't have to tell you the last five years have been--not stellar. And yet, one would think that as you shift away from the commodity to the higher--these higher premium products that we would have seen that. And so, I guess my question is then why aren't we seeing that?

Well, I think the biggest reason is that the--we've actually lost volume in the commodities side as well. So the loss of volume has given us excess capacity. So we're covering our overhead with fewer pounds than we were five years ago, and that's driving our margin down.

We still have efforts underway to try and consume that excess. And this is primarily in North America where we have excess what we would call commodity surfactant volume. But we still have efforts underway to--we're exploring multiple opportunities to try and better utilize those assets. If we were running those assets at or near capacity, the--our overall gross profit margin would be much improved.

Okay. Would there be any likelihood of shutting down North American facilities?

As I alluded to before, we have been looking at and will continue to look at that. Obviously, we're not in a position to announce anything at this time. But we will continue to study whether that's a viable option for us.

Okay. Great, Jim. Thanks so much.

Okay. Thanks, Beverly.

(Operator Instructions.) Mr. Hurlbutt, there are no further questions at this time. I'll now turn the call back to you. Please continue with your presentation or closing remarks.

I just want to thank everybody for participating in today's call. And we'll be speaking in the future. Thank you very much. Bye-bye.

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