Stepan Co (SCL) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Co. second quarter 2008 conference call.

(OPERATOR INSTRUCTIONS)

I would now like to turn the conference over to James Hurlbutt, Chief Financial Officer. 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'm pleased to announce that second quarter and first half results were significantly higher than the same periods in 2007. We continue to build momentum established in the first quarter of 2008, which is reflected in the Company's improved sales, net income and earnings per share performance. At this point, let me walk you through our second quarter and first half 2008 operating results.

Starting with net sales, total net sales for the second quarter were $420 million, an increase of 25% year-over-year, benefiting primarily from higher selling prices, which accounted for 21 percentage points of net sales growth, and secondly, the positive effect of foreign exchange currency translation, which accounted for 4 percentage points of net sales growth. Overall sales volume was flat from the prior period. Rising crude oil derivatives and inflationary impacts across most chemical feedstocks led to the higher selling prices. During the quarter, we implemented a series of product line price increases aimed at recapturing the effect of rising raw material prices. These included broad-based price increases across most surfactant and polymer products.

Total net sales for the first half of 2008 were $802 million, an increase of 24% year-over-year, benefiting primarily from higher selling prices, again accounting for 21 percentage points of net sales growth, and as well as the positive effect of foreign exchange currency translation contributing 4% to the increase in net sales. For the first six months, total sales volumes declined by 1%. Net income for the second quarter increased 106% to $9.8 million or $0.93 per diluted share, compared to net income of $4.7 million or $0.47 per diluted share in the year-ago quarter.

The first half 2008 net income increased 78% to $18.5 million or $1.79 per diluted share, compared to net income of $10.4 million or $1.03 per diluted share in the year-ago period. Second quarter and six-month gross profits increased $11.7 million and $22.8 million respectively, both rising 31% year-over-year. In the second quarter, our surfactant polymer segments both recorded improved gross profit. The year-to-date improvement was led by a $21.2 million increase in surfactant gross profit, driven by an improved customer and product mix, as well as the fabric softener margins, which had declined during the prior year.

The second quarter gross margin increased to 11.9% of revenue from a gross margin of 11.3% in the year-ago period. For the six-month period, the gross margin rose to 11.9 compared to 11.2 in the year-ago period. Operating income increased 7.1 in the second quarter or 67%, with six-month year-to-date operating income rising 64% to $34.5. I would point out that the second quarter of 2007 operating income included a $4.2 million net gain on the sale of the product line, and a $3.5 million charge related to goodwill impairment.

Turning to operating expenses. Second quarter operating expenses totaled $32.4 million, up 13% quarter-over-quarter and up 16% in the six-month year-to-date comparison. The major contributors to higher operating expenses across all categories were incentive-based compensation and higher foreign operating expenses due to the weaker U.S. dollar. Summarizing these impacts, the year-over-year incentive-based compensation increased $1.2 million and $2.3 million in the second quarter and six-months year-to-date period. Year-over-year foreign exchange translation effect increased $800,000 and $1.6 million in the second quarter and six-month year-to-date periods. And deferred compensation decreased $500,000 and $2.5 million respectively in the second quarter and six-month periods.

As you will recall, the accounting requirement for the company's fully-funded deferred compensation plan results in an expense being recorded when the price of Stepan Co.'s stock or mutual funds held in the plan rise, and income being recognized when they decline. For reference, Stepan Co.'s common stock share price appreciated $7.39 per share during the quarter. For the second quarter, marketing expenses increased 14% year-over-year to $10.4 million, and administrative costs increased 14% to $13.2 million, and research and development costs 11% to $8.9 million.

Let's move to a review of the performance of our three key business segments. First, we'll look at surfactants, the largest segment of our business, accounting for 75% of total sales in the first half of the year. Quarterly net sales of surfactants were up 27% and 25% year-over-year. Volume declined 1% in the quarter and 2% in the six-month period as compared to the year ago. Surfactant gross profit increased $9.8 million or 42% to $33.3 million in the quarter, driven by improved product and customer mix, as well as recovery of higher raw material costs and selling prices. For the six-month year-to-date period, surfactant gross profit increased $21.2 million or 46% to $66.8 million. Sales of higher value added surfactants in the distributor markets, agricultural and oil fields contributed to the improved gross profit.

Fabric softener margins recovered from erosion during 2007. The slight decline in volume was due to lower personal care sales volume, due to a customer reformulation to a low-active to a high-active product, the results of lower sales volumes. Commodity laundry and fabric softener volumes improved.

Biodiesel continues to generate a small profit versus a year-ago loss, due to the higher diesel prices and our use of lower-cost tallow and feedstock in conjunction with soybean oil. The improved surfactant segment performance was broad-based geographically, with North America, Latin America and Europe all showing improvements.

Moving now to our polymer segment, which represents 23% of the first half sales. Net sales of polymers were up 21% quarter-over-quarter and 20% year-over-year. Volume grew 5% for the quarter and 4% for the six-month period. Polymer segment gross profit rose $2.5 million in the second quarter, up 20% to $15.1 million on improved margin and higher profits and higher volumes. For the six-month period, polymer gross profit increased $1.6 million or 7% to $25.7 million.

The company's polyol products experienced a 13% increase in volume, and represented most of the polymer segment improvement in profits. Stepan's polyol is used primarily in rigid foam insulation for commercial roofing, the majority of this market being for replacement roofs versus new construction. This market remains strong, in part due to the desire for greater energy savings achieved from increased insulation. Our sales of polyol in Europe have been exceeding the capacity of our plants in Germany. Supplemental product has been supplied from our plants in the U.S. and China. The decision has been made to expand our German plant by 38,000 metric tons. This expansion, coupled with ongoing debottlenecking activities, will bring the German polyol capacity to 86,000 metric tons by 2010.

I would like to point out that we are planning the triannual maintenance turnaround for our phthalic anhydride and polyol facilities at our Millsdale, Illinois plant during the first quarter of 2008, and as such we do expect higher fourth quarter monthly maintenance and outsourcing costs. Longer-term, this maintenance exercise is expected to yield improved reliability in 2009 and beyond.

Finally, our specialty products segment accounted for around 2% of the Company's sales in the second quarter and first half. Net sales for specialty products were up 9% for the quarter and 20% for the first six months of 2008. Specialty products' second quarter gross profit remains unchanged for the quarter, as improved pharmaceutical volume was offset by weaker food ingredients volume.

Turning to other income and expenses, interest expense for the company rose 2% for the quarter and six-month period due to higher average debt levels brought about by increased working capital requirements. The second quarter loss associated with our 50% equity in the Philippine joint venture totaled $600,000, up from an essentially break-even performance in the year-ago period. The combination of production outages and factors around the reliability of raw material supplies for the facility were the primary factors in the higher loss from this facility. Foreign exchange losses also contributed to the weaker Philippine performance. We expect an improved second half performance in our Philippine operations.

Our effective tax rate for the quarter were 32.8%, compared to $37.6 in the year-ago period. The decline in the tax rate was primarily due to the recording of Stepan UK goodwill impairment during the prior year, for which no tax benefit was realized.

Turning to the balance sheet, consolidated debt as of June 30, 2008, was $166.6 million, up by $28.1 million from $138.5 million one year ago. Our total debt to total capitalization at quarter end was 41.8% compared to 41.5% as of the prior year. Capital expenditures were $8.4 million in the second quarter, down 17% from the same quarter last year. This is mainly due to timing of individual projects. We expect our 2008 full-year CapEx to be in the range of $44 million to $52 million.

Looking now to our cash flows during the quarter, operating activities consumed $5.7 million versus a source of $23 million for the prior-year quarter. In the six-month period, operating activities consumed $16.1 million, compared to a $16.9 million source in 2007due to significantly higher working capital requirements. The inflationary impact of crude oil derivatives was the primary cause of higher working capital requirements. Also during the quarter, Stepan paid out $2.2 million of cash dividends to common and preferred shareholders.

Looking forward, overall we're pleased with our progress in the second quarter. Looking ahead to the second half, we expect slightly higher maintenance and outsourcing costs in the fourth quarter, and while we remain concerned about the state of the current economic environment, we believe our improved profitability is sustainable. Our business is increasingly diverse, with a broader product line and a greater number of end-use markets, contributing to our improved performance. While household cleaning products hold up reasonably well during recessionary periods, we're pleased that our improvement is being positively impacted by growth in rigid foam insulation, agricultural products and oil field products.

We would like to thank the Stepan team worldwide for their contribution to our strong second quarter results, and we believe Stepan remains on track and well-positioned to perform for future.

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.

(OPERATOR INSTRUCTIONS)

Our first question comes from the line of Daniel Rizzo with Sidoti & Co. Please proceed with your question.

Thank you. Hi, Jim.

Hi.

I understand you said a lot of - some of the margin gains were because of better product mix. Are you still cutting internal costs as well?

Yes, we have. We implemented some cost-saving efforts at our Maywood, New Jersey plant last year. Then we continued to pursue - we implemented a Six Sigma project to take costs out of the system on a companywide basis, as well as we implemented a purchasing initiative, which is - you know, we anticipate savings down the road. We have yet to see significant savings at a relatively early stage. But we still put cost savings high on the priority list for improving the overall profitability of the company.

Okay. So there is a long ways to go with things you think you can achieve?

We still see a lot of opportunity. Yes.

Okay. And has there been a pullback in the cost of the raw materials for biodiesels? I know oil -- I'm talking the last few weeks with the pullback of the price of oil and gas.

Well, we certainly have seen, you know, the selling price of crude oil coming down, but I think we have yet to see any significant decline yet in soybean oil. I would expect that it would come down some, but it's not moving in perfect tandem with crude oil because so much is used in the food industry.

Okay. And --

And we're still using a significant amount tallow in our biodiesel blend, which is significantly lower cost than soybean oil. Unfortunately, we can't run tallow all winter because of the temperatures being too low, and it doesn't hold up as well in cold weather as soybean oil, but for the summer months and well into the fall, we will be using a fairly high percentage of lower-priced tallow to be able to put a biodiesel out on the market where we can make some improved profitability, which has declined over the last year.

And when would you start using tallow, in March or something like that?

Yes, the springtime.

And finally, the - Roman Hoss's book by Dow Chemical, I guess a month or so ago now, is that something that's going to affect you guys negatively? I thought Roman Hoss was a customer?

We're not aware of any -- we're not anticipating or expecting any significant impact for the company from that acquisition.

Okay. Thanks, Jim.

Okay. Thanks, Dan.

Our next question comes from the line of George Gaspar with Robert Baird. Please proceed with your question.

Good afternoon, Jim.

Hi, George.

First - the first question on just the raw material costs outlook relative to the second quarter, can you give us any color on what you might be experiencing on a relative basis?

Well, before crude had started to back off, everybody had been going out with price increase announcements July 1. So as we sit here today, we're still being faced with increased costs versus the second quarter, which we in turn have attempted to get pushed through in our July 1 price increases as well. So if we see a backing off as a result of crude, it's probably won't - we won't feel a significant impact for another month or two.

I see. Okay. And then on the surfactant area, you mentioned one of the volume opportunities were oil fields. Is that still coming from the few projects that you have on secondary treatment, or is there something starting to materialize on an ongoing opportunity basis?

Today most of our improved volume going into the oil field industry is primarily in foamers for - you know, downwell foam for improving recovery; [biosize] for preventing plugging and corrosion inhibitors in the wells, and then fracturing additives. So today, the improvement has really been in the more traditional oil field service markets. We still continue to pursue the enhanced oil recovery field, where you are actually using the surfactant in the waterflood of a field to generate a stimulation of production, increasing yield size. Targets of anywhere from 10 to 25% more oil coming out of the ground. That business is still yet to see much commercial success from a standpoint of large - any large sourcing of a volume of new business. Now, there are a lot of field tests, pilot floods going on, that are expected to result in full floods in the next six to 12 months, so depending on the outcome of the pilot floods, if they're happy with the results, we would expect to start seeing improved volume.

Okay, and then just from the general point of view, your general sales to the patch, are you getting any significant percentage increase relative to what you have seen before?

Today it's a very small part of Stepan's business, but it's been growing. So yes, we're seeing significant improvement interest and demand for those products.

Okay. And then back on to fabric softener, can you describe your conditioning the markets in Mexico, South America, and then the Philippines and China area? How are the Philippine and China operations coming along on a volume-comparison basis?

Well, let me circle back to North America. North America, fabric softener volume is doing very well and we're bumping up against our capacity - our production capacity in North America and in Mexico combined, on a combined basis. We have a fair amount of fabric softener capacity in Mexico. So that business is in good shape and with the improved margins we experienced this year versus last year, we're very pleased with the performance of the fabric softener. The fabric softener plant that was put into the Philippines is progressing along fairly well. They should be starting to bump up against the capacity of that plant by next year, so on that basis, the fabric softener plants in the Philippines, which is currently profitable, will be making a nice profit next year.

Some of the problems we're having in the Philippines that are precluding us from delivering an operating profit is on the traditional sulfonation side for the detergent products, where we have had, you know, a succession of production outages due to logistical reasons of not having raw materials on hand, having manufacturing problems with the facilities due to equipment failures. So you have a whole host of issues in the Philippines to deal with. We do believe that the product mix in the current margins that we have, a volume of business we have under contract, should allow for that facility to be profitable once we solve some of the current, hopefully, shorter-term problems. But the product mix and pricing is different from the most recent two years, and should allow us to get thing back to a profit point.

So, the real issue is more on the sulfonation side. The fabric softener is on track, too, what we had hoped to accomplish at that site. And you mentioned China, we currently don't have a softener capability in China. We just have the polyol plant in China.

I think that I miscued a little bit, I found the China request from you, I was kind of looking just at your total business.

Where it's headed.

Over how do you operations there?

It's still coming up slower than we would like in terms of total takeaway from that plant. We're probably running that plant, it's a 30,000-metric ton plant, and today we're probably only selling 25% of that capacity. Fortunately, we are sold out in Europe, so we have started to divert some of the Chinese capacity to Europe. I mean the volume growth is progressing, and they still feel very optimistic that we will sell that plant out, but it's certainly going to take several more years to get it sold out. It did turn profitable; we've had several straight months now on profitability on the Chinese Operations, so it's encouraging. So, it's encouraging.

I see. Okay. Thank you.

Thanks, George. (OPERATOR INSTRUCTIONS) We have a follow-up question from the line of George Gaspar with Robert Baird. Please proceed with your question.

Okay, Jim on South America, does the agricultural area - this is the area that you expanded into, as I recall, in the last year or two? And you can correct me or highlight, I thought you maybe made an honest acquisition to - of a product line to help penetrate that area. How do you see the Brazil or South American market in general, and what opportunity skills do you have going there that you can take advantage of?

Well, we got into a situation that was primarily taking over the Unilever plant and base loading it with their - in in our contract with Unilever. Our goal was then to broaden and diversify the product line. We have added the multi-purpose reactor down there, which today has been diverted on - you know, primarily into the agricultural markets in Brazil. So we have taken - been successful in getting access into niche markets in Brazil, for particularly egg products. Longer-term, we have a lot of opportunity in Brazil. We're not sure as to how the timing will play out, but we would still look to add neutralization capabilities so we can broaden the product portfolio from the base, sulfonic acid-type detergent product to a more robust surfactant portfolio. And we don't have fabric softener capability today in Brazil, and while that may be not short - real near-term, it's something that we're actively exploring, based on several customers' potential demand for that region of the world. But between the time we negotiate anything with a customer and build a plant, that would probably be 12 to 18 months away. Those are not, you know, short-term construction projects.

Yes.

Okay, and in terms of -- it sounds like Europe is moving along pretty good for your product lines, and do you see - and it sounded on your commentary on the shipping out of China potentially for the European market, do you see the European market hanging in there pretty good? I mean there has been some parts of it that -- recently, we've hearing other levels of activity because of economics and that things are softening up. How do you see your market there?

We're hearing the same broad-based information that Europe might be starting to slow down; however, we're not experiencing that in our markets. Just the opposite; with the increased demand for energy savings we're seeing, you know, the business gaining momentum still, and we did just recommend and the Board approved the expansion of our German polyol plant, so we will now take it up from 42,000 metric tons to 86,000 metric tons through further debottlenecking of the existing plant, coupled with 38,000 new reactors for polyols in Europe. We see the European demand as fairly broad-based improvement. It's improved - tougher and more stringent energy standards for building, plus a very short-term payback on energy savings for the person putting more foam into his building, and then coupled greater interest coming out of Eastern Europe for insulation products. So we're feeling fairly confident about the polyol business in Europe at this point.

Your German expansion, what is the timeframe on including -

That would be - it would be over a 12-month completion, so we would not expect to see capacity from the new reactor until 2010. We're in debottlenecking on the old reactor; that hopefully will add another 6,000 to 8,000 metric tons over the next four to six months.

I see. Okay, and then kind of expenditure is this involving going from 42 to 86?

It's close to a $20 million project that will - the spend will spread over - just a little bit in, you know, in '08, the majority in '09.

I see. Okay. All right. And then in the United States, you mentioned North America very strong on the overall fabric softener, general surfactant market. Is there any particular precise area within that market that is really showing extra strength for you? Is it the fabric softener aspect of it?

Fabric softener's been very strong, and that has been a push by us strategically over the last more than five years to take a major position and market share in fabric softeners. So, yes, we're pleased with the progress on fabric softeners. And then the robust farm economy is certainly helping the egg business and all of the companies selling herbicides, pesticides and fertilizer - anyone using a surfactant to help with the delivery of their product to their crops is benefiting from that, so we're certainly not seeing any signs that the far - you know, the whole issue of where is the farmer going to shake out once the fight over food versus fuel on the biodiesel, and that's all on the basis of size. But right now the farmers are certainly in a boom time and have money in their pocket to buy fertilizer and farm equipment.

Right.

It's a plus.

Okay, and then on this biodiesel market, you have pretty much decided, I would assume here from past conversations and comments on a quarterly basis, that you're going to hold at where you are in the biodiesel market, that you're not going to do a further expansion on it?

That's correct. I mean the margins have - you know, we made nice profit on that business for two or three years before the price of soybean all went up and the margins deteriorated. So today, we're viewing it more as an opportunistic opportunity. If we can use those assets and make more money on surfactants or other products, intermediates for surfactants, we'll divert those assets for that use.

Okay, and then lastly on your stock performance, which is outstanding, is there any chance that you would look to split the stock along the way to increase the share count to get a little more flexibility in the trading activity in there?

Well, we have discussed that. But quite honestly, the trading volume has improved quite a bit over the past year, so we're not seeing an imminent pressure to try and improve liquidity in the marketplace. Today, no, we don't have any near-term intention to look at a stock split, depending on - obviously, I don't want to say never, because I don't know what the stock price will be down the road, but as long as the liquidity in the marketplace remains robust, there may not be a need.

Okay. Thank you.

Okay, thank you, George.

We have no further questions at this time. I'll turn the call back to you.

Okay, I would like to thank everyone for participating in today's phone call. Thank you very much. Goodbye.

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.