Stepan Co (SCL) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stepan company third quarter 2007 earnings. 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, October 31, 2007. And it is now my pleasure to turn the conference over to Mr. Jim Hurlbutt, Vice President of Finance. 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, 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 third quarter 2007 operating results. We'll start with a look at the top line. Total net sales for the third quarter were 338 million, an increase of 12% from approximately 303 million for the same period in 2006. Net sales benefited by a higher selling prices, which contributed 9% growth and foreign exchange impact, which contributed 3% growth during the quarter. Slightly lower sales volume partially offset the above positive factors by less than 1%. Total net sales year-to-date also rose 12% to 988 million supported by improved volume, higher selling prices, and foreign exchange impact, contributing 6 percent, 4% and 2%, respectively. Net income for the quarter was 3.1 million, or $0.31 per diluted share, compared with net income of 6.1 million, or $0.61 per diluted share in the year-ago quarter.

Our performance during the third quarter was negatively impacted by several significant items. First, we recorded a 1.6 million pre-tax or 1 million after-tax increase in deferred compensation expense this quarter. Deferred compensation expense was 900,000 this quarter, compared to income of 700,000 in the year-ago quarter. Mutual fund appreciation accounted for most of the expense during the quarter. The accounting requirement for the company's deferred compensation plan results in expense when the price of Stepan company stock and mutual funds held in the plan rise, and income when they decline.

Second factor affecting the quarter was a 1.4 million pre-tax, or 900,000 after-tax charge associated with the freeze and conversion of the Millsdale, Illinois, plants pension plan and the subsequent replacement with a defined contribution plan. The third item affecting the quarter was a 1.3 million pre-tax, or 800,000 after-tax increase of foreign exchange losses due to the sharp decline in the U.S. dollar versus other currencies. The majority of the loss related to the U.S. dollar denominator receivables held by the company's Canadian subsidiary. In comparison, Stepan recorded a 200,000 foreign exchange gain in the year-ago period. Excluding these three items, our pre-tax income totaled 8.9 million.

Gross profit for the quarter decreased by 3 percent, or 1 million, to 34.9 million. The lower gross profit included the negative impact of the aforementioned pension plan conversion at our Millsdale facility. Operating income was 8.2 million in the third quarter, a decrease of 27% from the same period in 2006. Nine-month year-to-date net income was 13.5 million, or $1.34 per diluted share, up 1.3 million or roughly 11% from the year-ago period.

Turning to operating expenses, third quarter operating expenses were 26.6 million, up 8% from the same period last year. The 24% growth in administrative expenses was primarily due to the 1.6 million increase in deferred compensation expense that I described previously. Excluding the deferred compensation expense from both periods, third quarter operating expenses rose 5% year-over-year. Marketing expenses were essentially unchanged quarter-to-quarter at 8.9 million and research costs rose 1% quarter-to-quarter.

Let's move to a review of the performance of our three key business segments. First we'll look at surfactants, which accounted for 72% of the company's net sales for the third quarter. Net sales of surfactants were up 10% on a 1% increase in volume. Surfactant gross profit declined by 8%, or 1.9 million, to 22 million in the quarter. Improved product mix and volume in North America partially offset the effect of the weaker biodiesel results. Biodiesel gross profit declined by 3.5 million for the quarter, and 6 million for the full year. The high price of soybean oil, the main raw material used in biodiesel production, is continuing to negatively impact margins.

European surfactant earnings improved 15% for the quarter and 16% year-to-date on higher volume. Latin America reported lower earnings for the quarter and year-to-date due to lower margins brought about by outsourcing and delays in recovering higher raw material costs in our selling prices. A new reactor completed during the second quarter is now fully operational and should reduce future outsourcing costs. Our polymer segment represented 26 percent of revenue in the third quarter. Polymers gross profit declined 7%, or $800,000 to 9.9 million due to a sharp decline in phthalic anhydride gross profit caused by unplanned production outages, resulting in lower sales volume and high maintenance and outsourcing costs. We plan to repair or replace additional equipment during the remainder of 2007 and 2008 to further improve plant reliability. Gross profit on sales of polyol rose on significant volume improvement combined with recovery of higher raw material costs in the marketplace.

For the nine-month year-to-date period polymer gross profit grew 3 percent, or 1 million. The year-to-date improvement reflects significant polyol volume growth. The majority of the company's polyol is sold into the rigid foam insulation market used largely in flat roof commercial construction, which has not experienced the slow down occurring in residential construction.

And finally, our specialty products segment accounted for just under 3% of the company's sales in the quarter. Gross profit grew by 1.1 million or 52% year-over-year. For the nine-month year-to-date period, gross profit grew by 1.9 million, or 30% -- 32% year-over-year, largely driven by higher sales volumes in both pharmaceutical and food ingredient markets.

Looking at other income and expenses, interest expense rose a modest 3% in the quarter due to higher average debt levels and interest rates. The third quarter loss from our equity in the Philippine joint venture decreased slightly. Fabric softner volume is increasing and efforts to improve the product mix in order to restore profitability are progressing. The other net line on the income statement is largely attributable to the previously explained foreign exchange losses caused by the sharp decline in the value of the U.S. dollar.

Turning to the balance sheet, total debt as of September 30th, 2007, was 139.1 million, up from 131.2 million at the end of 2006. Our total debt to total capitalization at the quarter end was 40.8%, compared to 43.8% in the third quarter of 2006. Capital expenditures were 7.6 million in the quarter, down 18% compared to the same quarter last year. Full-year capital expenditures are projected to be 38 to 40 million.

I'm also pleased to report that subsequent to the end of the third quarter, our board of directors approved an increase in our quarterly cash dividend paid to our common shareholders. The 2.4% increase in our common stock dividend brings the annual dividend rate to $0.84 per share. Notably, this remarks the 40th consecutive year in which Stepan's quarterly rate on its common stock has been increased since the company first initiated a cash dividend policy in 1967. These increases also reflect our long-term commitment to returning value to our stockholders.

Looking ahead, overall we continue to see good opportunities globally for our surfactant, polymer, and specialty products businesses. In line with that outlook we expect results from operations in both the fourth quarter and full year of 2007 to exceed our prior year results. Surfactants volume and margin improvement are expected to overcome the projected decline in fourth quarter biodiesel profitability versus the year-ago quarter. Our polymers business is expected to overcome the phthalic anhydride production problems and should exceed its year-ago performance driven by a higher global polyol volume. As 2007 comes to a close we expect that both surfactant and polymer segments will deliver further earnings improvement in 2008.

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.

Absolutely. Thank you. (OPERATOR INSTRUCTIONS) And our first question is from the line of George Gaspar with George W. Baird.

It's Robert Baird. Good afternoon.

Hi, George.

Question -- on the polyol, what's -- where's the emphasis here in the favorable outlook? Can you give us some color on the markets that you're penetrating in better form here?

Yes, the biggest improvement has been volume in Europe where we've seen significant volume gains, market share gain. And profitability has been -- we recover -- we were having trouble recovering higher raw material costs in Europe and so we've made some improvement there in getting the pricing up to recover those high costs. So we've seen significant improvement in Europe. Demand in Europe seems to be accelerating faster than in the U.S. in part due to higher energy -- or tightening energy standards, building code standards in Europe. Because the more insulation they put on -- in the roof of these buildings the less energy consumption that occurs. So there's a regulatory issue as well as just the economic benefit of saving energy going forward with more insulation on the roof of a building.

So it's a very positive trend for us. And it looks, our expectations that obviously commercial construction may slow down following the slowdown in residential, but there's enough work going on we still feel pretty comfortable that next year should be fairly strong.

Okay. Alright. And second question on raw material costs, in general, considering where oil is tracking lately, how do you view raw material costs going forward here in 4Q with your more positive outlook? How does that fit into the equation?

It's a significant risk factor. I think related to that question are the risks of what's going to happen in 2008 as far as potential recessionary environment. We've been dealing with the higher raw material costs. And we are really into our third year of escalating raw material costs. And really in the last 18 months I think we've been highly successful in recapturing those, and we would certainly -- we were -- we will just keep pounding away to recover those higher raw material costs in the marketplace. Yes, it's a challenging -- it's been a challenging market. We expect it to continue to be a challenging market but we've been in -- we've really been insistent upon getting those costs recovered.

And now, on the raw material side of your total business what -- can you break down what oil makes up versus other natural gas or whatever? Can you give us a little bit on that?

Yes, you mean crude oil derivatives?

Yes, crude oil -- crude oil.

I don't have a perfect answer, but I would say certainly it's in the -- the 60 to 70% of our feed stocks are ultimately coming from crude oil derivatives.

So -- do you have a hedging program.

Only indirectly in that we've got some products where we can have an immediate pass-through and we are work to go try and get more of our contracts on an immediate pass-through basis so that the pricing is based on a price plus whatever raw material costs are. And then indirectly, in our biodiesel program was -- hopefully when times are bad on the surfactant side we would be making more money on the biodiesel side. That's been a little bit of rough regain than we thought because we did not envision the soybean and most of the oils -- coconut oil, palm oil -- going up as fast as they have in the last 24 months, particularly in the last 12 months and it's -- those raw materials have more than doubled in price.

Okay, that was going to be my third question here and I will get back in queue. It was on the biodiesel area. With these results slipping up, I know that I think you were looking at expansion and maybe received some monies from the state of Illinois to possibly review that possibility? Correct me on this if I'm wrong, but where do you stand on looking at the biodiesel market considering the expansion going on in the industry and are you -- have you got it on hold or where are you?

No, we definitely have any expansion programs on hold and I think as I had mentioned last quarter we did formally notify the state of Illinois that we would -- we would not be taking their grant offer because we were going to -- we were holding off on moving forward with an expansion project. It's been a very dynamic year in biodiesel. There are an awful lot of plants that have been built, several of which have already been shut down pending improved economics for sale of biodiesel. Now, there's proposals in con -- Congress to extend the credits associated with biodiesel. So, that should solidify it as a -- as a business going forward. And if the margins can improve a little bit we should be able to participate in this market.

The margins have improved slightly in recent weeks and months as the crude oil prices shot up but I don't know -- we have not been able to identify the -- how much correlation soybean and palm and coconut are now going to have to crude oil. It used to be quite a bit different than crude but now they seem to be moving more and more in line with crude. So that's the challenge. That being said we don't have an immediate plan to expand our facilities for biodiesel. We took advantage of some underutilized equipment when we first got into this business, which is fortuitous, given that some other people have large investments that are struggling. We also are pursuing an alternative strategy. We believe we can make a feedstock for our fabric softner business potentially utilizing this equipment. So if the economics of biodiesel don't improve, we do have a contingent plan we are pursuing to get greater return from those assets by making an intermediate that we currently purchase, we outsource today.

I see. Okay. Thank you. I'll get back in queue.

Okay. Thanks, George.

And our next question is from the line of Beverly Matchinger with Grace and White.

Hi, Jim.

Hi, Beverly.

Just -- while talking about the biodiesel I was wondering if you can just give us some idea of the comparison and margins from your regular surfactant business to the margins you were getting in the biodiesel. Is biodiesel more than your regular surfactant business or comparable, or where did it stand since now you are telling us margins are being squeezed there?

Well, I mean today's margins are very, very low -- well below our average surfactant margin. We had two very good years in '06 and '07; I mean '05 and '06. Where margins were probably comparable to our commodity surfactant margins and it was a nice shot in the arm. Now today, there is certainly probably less than half of what our commodity surfactant margins would be and they've been quite volatile.

Is it profitable?

For us it is profitable. But it -- we would, we are seeing several cents-per-pound improvement this quarter so we are hoping that if the shake-out of producers continues that there might be -- we might be able to get back to some acceptable margins. Long-term it's -- it would be hard to envision it exceeding our commodity surfactant margins over the long term.

Okay. And then on a --

Which is why I alluded to the fact that we have looked at alternative uses for those assets.

Right. Also I was wondering if you could talk a little bit about the surfactant business in general and why you saw volume weakness in the third quarter.

That was primarily the biodiesel business slowing down. Most of the rest of our surfactant business had a fairly strong -- strong quarter.

Okay, and then the last question I have has to do with the -- the shutting of the pension plans at this specific plant. Are you doing this on a plant-by-plant basis, or is that -- ?

We are almost done.

Okay.

I should have clarified that. Yes, you're absolutely right. As I previously indicated, we terminated -- or froze -- the salary plan last year and that was the largest piece of our defined benefit plan participation that we've frozen and converted to a defined contribution. And we were able to take care of two of the hourly contracts. We had to go back and do the hourly plans at the plant locations when their collective bargaining agreements came up. So we've converted the two in New Jersey and Winder, Georgia, last year, and then our largest plant, Millsdale here in Illinois, we just got done in June. So we have a very small plan left in Anaheim, California, but it's a very small number of people, so there should be no financial -- significant financial impact.

Okay, so then this --

This should be -- this should be the last of it. We've got everybody now pretty well converted to defined contribution plans.

Okay. Great. I guess that's it for the moment. Thanks.

Okay, thanks, Beverly.

Our next question is from John Roberts with Buckingham Research. Please go ahead.

Hi, Jim.

Hi, John.

I guess maybe just a comment first, but I think if you had told us a year or two ago that oil would be at $90-plus a barrel we would never guess the biodiesel business would be unattractive.

That was our supposition as well. We never thought that soybean oil -- well, the farmers are doing very well. The soybean oil crushers are doing pretty good. But the guys putting in the biodiesel aren't getting a fair shake of the profit split.

I don't know if you saw it today, but International Flavors and Fragrances reported and their functional fragrance business in North America, which is the consumer-related fragrance -- consumer-product fragrances was down 14% in sales and they cited the fabric care market as the source of that decline. Given -- they have a relatively high share, I assume, in fragrances in fabric care. And I would assume you've got a fairly high share of surfactantces in fabric care and it seems like very different trends.

Yes, that's very surprising to me. I don't think we are quite as exposed but that, I don't know what their -- how their end market segments are split but, no, we are not seeing -- we are obviously concerned about a recession but we are not seeing that type of impact yet.

They attributed it to product transition that customers were doing and said this was inventory workdown at customers in advance of some new product introductions. I -- it sounds like you didn't see that at all?

We are not seeing it, no.

Okay. Thank you.

I mean there's certainly people moving to put more green claims on their products and so if there are -- there are reformulations that we're -- I'm aware of that are going on but not to the extent that they are causing a significant contraction in fabric care, if they are specifically referring to -- to laundry. I don't know if they sell much into new fabric care for things going into the housing industry, but --

Well -- well, I -- I just guess congratulations, I guess, for doing much better. The -- my presumption is, and I've heard this before from other people, that when raw material costs are going up for your customers -- the consumer product companies, the detergent companies, et cetera -- that they actually slow down new product introductions because they are under expense pressure to offset raw material costs and one of the things that they try to hold steady is new product launch costs, which tends to be significant. Are you seeing that effect at all, that -- that products are staying on the market longer without being reformulated?

I would say we are still seeing people, because the other angle on all of that is to reformulate to a lower cost formulation. I -- I -- so I can't say that I would agree that they are not reformulating. I think they might be reformulating for different reasons and that is to reduce the cost of their product.

Alright. Thank you. Okay.

And, Mr. Hurlbutt, we have no further questions at this time.

Okay, well, I thank you all for participating in today's call. Thank you very much.

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