Stepan Co (SCL) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stepan Company third quarter 2008 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we'll conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As reminder this conference is being recorded, October 22, 2008. I will now like to turn the conference over to James Hurlbutt, Vice President and 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 detail in the Company's Securities and Exchange Commission filings.

I am pleased to report record quarterly and year-to-date earnings, which benefited from profits on the sale of a product line and land. Our strong third quarter financial performance, excluding the asset sales, was driven by our surfactant business and higher level of operating income associated with improved customer and product mix, reduced outsourcing and our success in recapturing margins that have been adversely affected by rising raw material cost. Polyol volume continued to grow due to higher global insulation sales. While Polyol margins declined in the third quarter we have announced Polyol price increases which will take effect in the fourth quarter and should help restore margins for this segment. If we look at our third quarter profitability, excluding the positive nonrecurring gains associated with the sale of product line and the land sale, we continue to see solid earnings momentum in our core business, setting the stage for record full-year 2008 earnings.

At this point let me walk you through our third quarter 2008 operating results. Total net sales for the third quarter were $432 million, up 28% year over year, benefiting primarily from higher selling prices, which accounted for 23 percentage points of net sales growth, increased volume, which accounted for 3% of sales growth, and foreign exchange currency translation, which accounted for two percentage points of net sales growth. Total net sales for the nine months of 2008 were $1.23 billion, up 25% year over year, benefiting primarily from higher selling prices, which accounted for 22 percentage points of net sales growth, and the positive effect of foreign exchange currency translation, which accounted for three percentage points of net sales growth. Total volume was flat year over year. Net income for the third quarter was $17 million, or $1.59 per diluted share, compared to net income of $3.1 million, or $0.31 per diluted share in the year-ago quarter. Net income for the first nine months of 2008 increased to $35.5 million, or $3.39 per diluted share, compared to net income of $13.5 million, or $1.34 per diluted share in the year-ago period.

Please note that the effect of some exceptional items which impacted our third quarter and year-to-date 2008 net income, including our previously-announced sale of certain urethane product lines to Bayer Material Science, which resulted in a pre-tax gain of $9.9 million, or $6.1 million after tax, or $0.57 per diluted share. We will continue to manufacture a full range of polyester polyols and specialty urethane system products for military and aerospace, as well coatings, adhesive sealants and elasimers, which we view as solid growth drivers for Stepan.

Secondly the sale of Company-owned farm land adjacent to our Millsdale, Illinois facility, which resulted in a $8.5 million pre-tax gain, or $5.2 million after ta,x or $0.49 per diluted share. We intend to use these proceeds for the acquisition and renovation of a 60,000 square foot office building near our corporate headquarters. This building will be occupied by current personnel presently working in nearby space, which is coming to the end of its lease term. The two transactions are being completed through a tax deferred like-kind exchange. And lastly, the results were impacted by $2.8 million in deferred compensation plan expense versus just $0.9 million a the year0ago period. As you recall, the accounting requirement for the Company's fully-funded 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. Third quarter gross profit, which excludes the asset sale gains, increased 23% on sales volume growth of 3%, Nine month gross profit increased 2% year over year on flat volume.

Turning to operating expenses, third quarter operating expenses totaled $32.4 million, up 22% quarter over quarter and up 18% in the nine month year-to-date comparison. The major contributors to higher operating expenses across all categories were incentive-based compensation and pension expense. We've also incurred consulting expenses associated with the reengineering of our purchasing function, which is expected to drive broad-based savings company-wide. Also note that in light of the current economic environment, during the third quarter we recorded $700,000 in higher bad debt reserves for potential risk at specific customers.

Now let's move to a review of the performance of our three key business segments. First we'll look at Surfactant. The largest segment of our business accounting for 75% of total net sales in the first nine months of the year is up 27% year over year. Volume declined 1% in the nine-month period as compared to the year ago. Surfactant gross profit increased by $10.9 million, or 46%, to $32.3 million in the quarter, driven by improved product and customer mix coupled with recovery of higher raw material costs and selling prices. For nine-month year-to-date Surfactant gross profit increased $31.3 million, or 46%, to $99 million. We continue to see strength in sales of higher value-added surfactants in the distributor, agricultural and oil field markets. Fabric softener margins showed a nice recovery over 2007 levels and biodiesel profitability improved as we migrated our feed sack formulation from the traditional soybean oil to lower cost tallow. With regards to the decline in the price of crude oil, it is yet to translate into lower raw material cost for Stepan. However, we currently expect to see some initial positive impact from lower raw material pricing sometime in the coming quarter.

Moving now to our Polymer segment, which represented 23% of total sales in the first nine months of the year, quarterly net sales or polymers were up 20% year over year. Volume grew 5% quarter over quarter and 4% in the nine month period as compared to the year ago. Polymer segment gross profit declined $1.1 million in the third quarter, down 11% to 8.9 million, while nine month Polymer gross profit increased $0.5 million, or 2%, to $34.6 million. The Company polyol product experienced a 15% increase in volume, though higher raw material cost and added shipping cost associated with the supplemental supply for the European market with product from our global manufacturing facilities negatively impacted margins and gross profit. Recent debottlenecking errors in Germany elevated production capacity near the current demand levels. European polyol demand continues to benefit from consumers looking for energy-saving insulation materials, as well as energy-efficient regulatory standards in the European region. Expansion of the Wesseling German facility has plans for a two-phase process, which will provide additional long-term capacity beyond the current debottlenecking production gains.

While recessionary economic factors led to lower sales volumes of phthalic anhydride, or PA, to the merchant market due to lower demand from sectors, such as automotive, recreational vehicles and boating industries, we did experience higher internal demand within Stepan for PA from our growing polyol product line, which provides some offset. PA sales volume was down 15% year to date. I would point out that while we -- that we will be conducting our trianial maintenance turnaround for our phthalic anhydride and and polyol manufacturing facilities at Millsdale, Illinois during the fourth quarter. As such, we do expect slightly-higher fourth quarter maintenance and outsourcing costs in our Polymer segment. Longer term this maintenance exercise is expected to yield improved reliability in 2009 and beyond. Finally, our Specialty Product segment, which accounted for 3% of the Company sales in the first nine months of 2008, up 21% year over year. Specialty Product third quarter gross profit declined 29% for the quarter and 10% for the nine-month period, impacted by lower volume and higher margin pharmaceutical and food ingredient products.

Looking at other income and expenses, interest expense rose 2% for the quarter and nine-month period, due to higher average debt level brought about by increased working capital requirements. Included in other net income and expense we recorded a loss of $1.5 million for the quarter associated with neutral fund investments held for the deferred compensation plan, which is partially offset by quarterly foreign exchange gains of $900,000. Our effective tax rate for the quarter and year to date were 30.2% and 31.3% respectively compared to 32% and 33.1% in the respective year-ago periods. The decline in the rate was primarily due to the favorable impact of increased foreign generated income taxable at lower rates than here in the US.

Turning to the balance sheet, consolidated debt as of September 30, 2008 was $149.6 million, up from $139.1 million in the year-ago period. Our total debt to total capitalization at quarter end was 38.3% compared to 40.8% in the third quarter of 2007. Capital expenditures were $16.6 million in the third quarter, up 117% from the same quarter last year. Third quarter 2008 CapEx included the $6.4 million for the new office building. On a full-year basis we expect our 2008 CapEx budget projection to be in the $50 million to $55 million range including the office building.

Dividend increase. We are pleased to announce that yesterday the board of directors approved a 4.8% increase in the Company's quarterly cash dividend to $0.22 per share. This brings the annual dividend rate to $0.88 per share and marks the 41st consecutive year in which the dividend on its common stock has been increased. We've also previously announced the strategic joint venture with Nalco Holding Company to globally market custom engineered chemical solutions for maximizing the production of crude oil and gas from existing fields. Our Enhanced Oil Recovery, or EOR Technologies, operate under the Tiorco brand with Nalco providing extensive reach in the global markets, as well as its EO polymer and reservoir expertise. Stepan runs the JV, its global surfactant technology and manufacturing capabilities. The joint venture is equally owned by Stepan and Alco.

Before I open the call to questions let me provide our prospectus on the economic environment, as well as our outlook for record 2008 earnings. Overall we believe we've been taking steps which should help Stepan navigate the economic downturn, including implementing price increases to recover higher raw material prices and as a significant portion of our significance -- of our surfactant sales are tied to consumer spending on laundry and personal wash products we feel Stepan is better positioned from a recession perspective. These segments have historically proven more recession proof than the broader economy. We continue to see strong demand for our polyol used in flat roof foam insulation. Energy savings and higher energy standards are expected to continue to drive the demand for polyol. We've only recently started to see some announced decreases in raw material costs. We expect to see more of the favorable impact of raw material reductions in 2009. We believe the total Company results for the fourth quarter should be stronger than last year and contribute to record results for 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.

(OPERATOR INSTRUCTIONS) We do have a question from the line of George Gaspar from Robert Baird. Please proceed with your question.

Yes, good afternoon, Jim.

Hi, George.

A question on the -- in terms of product development on the oil field side. Is there any update that you can give us for the past quarter and what the price prospects might be there?

We are seeing pilot activity where we do have orders for pilot floods in 2009. Some of the pilot work that's been done this year with small scale pilots have been reconfirmed that enhance oil recovery technology works in the right field with the right chemistry generates high yields of oil. We still expect that market to develop. People have asked about the impact to lower crude oil. Most of the people pursuing enhanced recovery had a longer-term view. I don't think many people feel that crude is not going to be more expensive over the long haul, so even at the current prices enhanced oil recovery is very attractive. So in terms of impact on financial results for 2009, probably not a significant contributor in 2009, but with continued success in pilot floods we would expect it to have a more material contribution in earnings in 2010.

Okay. And then just an overview on expansion domestically and internationally, both on the surfactant side and polyol side at this point. Can you highlight if you're making additions at this point in time and when they might be effective?

As we previously announced we are going ahead with an expansion in Germany that will roughly double the capacity of the German polyol unit. That probably will -- because of construction lead times that is -- would not add capacity until at this point probably mid 2010 at the earliest. And then in terms of surfactants we've added fabric softener capacity here in the US in Winder, Georgia, and brought that online this year. We have no -- we added a multipurpose reactor in Brazil last year. We have no current plans for further expansions pending the outcome of what enhanced oil recovery might bring. We would like to use up our North American sulfination capacity for EOR should that opportunity continue to develop. In terms of global footprint, the only site we are actively looking at is India, but we are still studying that market and have not made a firm commitment to any assets on the ground in India.

Great, okay. And then lastly, the polyol -- the insulation aspect of the market can you describe where the strength is geographically on that?

Well, Europe has been a pleasant surprise. The increased energy standards in Europe plus I think the global desire to improve -- everyone's desire to improve their green footprint is certainly helping, but the volume of growth has been in Europe primarily but we're seeing strong volumes still in North America. So despite all of the concerns about construction downturns -- even though most of ours is in commercial construction, that could slow down, as well -- but what we're seeing is the fact that when you do go replace a roof, which approximately 70% of our material goes into replacement roofs, the tendancy is to increase the thickness of the foam on the roof.. So even with fewer roof replacements but a higher depth of insulation foam we would stand the benefit over the short term, which is still what we're hearing from our customers and still what we believe is in store in the near term.

Great. Okay. All right, I'll take -- I'll stand back and see if there are other questions then come back.

Okay. Thanks, George.

(OPERATOR INSTRUCTIONS) We have a question from Daniel Rizzo from Sidoti & Company. Please proceed with your question.

Hi Jim.

Hey, Dan.

With the price increase that you just initiated in polyols are there going to be further price increases in either segment, or in any of the segments, I should say?

Well, you have to recall that going into the fourth quarter we were still recovering from higher raw material costs and price increases handed to us effective October 1st. The impact of crude coming down has not -- had not yet been reflected in our raw material cost. So, yes, we've got price increases through in the fourth quarter. First quarter, boy, it's going to be a volatile situation because raw materials now do look like they'll be heading down so I wouldn't expect price increases going forward. The question is how much of the raw material savings do we keep versus share with our customers and that will be the challenge.

Okay, and that'll be decided,obviously, as you go along?

Yes. It's been so volatile with crude bouncing all over the place, but we have seen announced price reductions in some of the commodity-type products for November and December.

Okay. And with the current capacity you have, not what you're building, what percentage are you operating at right now?

You really have to separate the segments. In polymers, particularly polyol, we have a little bit of capacity left in North America. We're probably at about 85% to 90%. We're sold out in Europe. We're importing from the US and China, and then China is probably running at about 30% of capacity, so we have room in China to grow into that market. Unfortunately the European market grew much faster than the Chinese market where we have excess capacity. In terms of surfactants we're pretty tight across most our platforms except for sulfination and primarily right here in Illinois. So the opportunity in EOR is really targeted to mesh nicely with available capacity right here in Illinois, which we're probably in the 75% to 80% of capacity.

Okay. I know the people with long-term views will still use EOR, but have you seen any potential customers possibly not having the financing, not having the ability to buy surfactant, given what's going on with some -- and maybe some of the small oil companies? Is it --

We have not seen that yet. Now will the volume of interest wane over time, I don't know. In our traditional core business of polymers and surfactants we're really seeing no disruption. Quite surprisingly we're seeing no disruption from the tightness in the credit markets. Our customers are ordering. They're paying their bills on time. Our suppliers are supplying. We're seeing minimum disruption, and so from that perspective, no, we're not seeing people coming back and saying we just can't go forward with this because of cash.

Okay. All right, thanks, Jim.

Sure, Dan.

We have another question from the line of George Gaspar. Please proceed with your question.

Yes. One question on the earnings. If you were to back out, Jim, the extraordinaries on land sale and the product sale and crank through the cost structure on the incentive side, what would your number be for earnings versus last third quarter?

Well, we gave you the after tax on the two asset sales totaling $1.06. Off the top of my head the -- you're talking about the higher pension incentive based compensation accrual? That would probably easily get to another $0.20 per share.

Okay. All right. And of course that is generally a flow through -- that particular item is a normal flow through on a quarter-to-quarter basis?

Yes, it's operating income. It's a charge to operations.

Okay. And then on the raw material side, based on the decline in price how far out have you bought raw material at potentially higher prices, or maybe you haven't. Can you just give us a little bit of thought on where the Company is on its raw material cost going forward?

The vast majority our raws are bought on spot pricing or we'll get a quarterly quotation from suppliers. So we're not out too long. We're going to have to consume some higher price raws in the fourth quarter., that's why I indicated we're not expecting to see a significant benefit from any raw material reductions in the fourth quarter. We'll probably see more of that in the first quarter and into 2009 as we consume our existing higher raw material cost.

Great.

What was the -- you had a second part to that question.

Well, the -- just basically just thinking about the oil and gas aspect of what's happened on the raw material decline side and how far out you've hedged and you pretty well have answered that.

On the energy side we do have some contracts on natural gas, so we have bought on natural gas and natural gas has plummeted, too, so we are over the market on natural gas should the current spot -- forward prices stick, but we don't think we're out -- it's a big exposure for us and if natural gas comes back, we'll still be close to market.

Okay. And then on your indication of some relief on your field prices moving upward, doing some adjustment, are you effectively able to get these sales price increases through at this point in time considering what's happened in the economy? And is the market such that you feel that they can be implemented and stick?

I think our customer base, for the large part, is pretty well informed about what our raw material costs have been doing for the last 18 months. So, yes, I think the customer base understands and quite honestly, as we've indicated, with a significant portion of our volume in surfactants in laundry and cleaning compounds these aren't areas that are -- where people cut back consumption dramatically so we're not seeing push back in terms of customer volume coming down or problems with their financing. So unless there's going to be a delayed reaction we're very pleased with the limited impact we're seeing right now from the economic downturn.

Okay. And then in terms of the impact, there was -- in your release you made a comment about maybe trying to get some sales opportunity in the quarter from possibly lower inventory levels incurred in the third quarter, maybe something to do with the seasonal weather/hurricane situation. Exactly what did that hurricane situation impact the Company on? Can you describe that at all?

Sure, sure. just to back up, after the -- most of the plants on the gulf coast went down on a planned preventive basis, and when -- after the hurricane didn't really do much damage to the plants they were ready to come up, but they were -- the electrical supply was down in a large part of the area and they had one or two delays coming back up. As a result a lot of their commodity feed stocks went on forced [mijure]. From our standpoint we did a lot of juggling. We have a plant in Canada that was able to get ethylenoxide from Dow's Canadian plant so we were able to juggle and logistically provide most of our customers' needs with minimal disruption. That being said, inventory levels, probably, were depleted to a fairly low level, both in our tanks and in our customers' tanks and certainly our suppliers' tanks. From the standpoint if we are truly heading into a recession the first thing people do to conserve cash is bring their inventory levels down. I don't think they're going to have much ability to do that in the fourth quarter or first quarter of next year. I think that's already happened for the most part.

Okay. All right, thank you.

Sure, George. Thank you.

And we have a question from the line of Steve Schwartz from First Analysis. Please proceed with your question.

Hi Jim.

Hi, Steve.

Can you talk a little more about the supply and demand situation in Europe? In the release you mentioned debottlenecking helped you get close to demand levels. I think earlier in the call you mentioned the expansion would be done in 2010. so it looks like the segment had a margin hit because of the import -- importing material. What do you see over the next couple quarters, especially considering there's a slowdown going in Europe? Do you think your margins will continue to be impacted for, say, the next two or three quarters?

Well, we don't anticipate bringing much material from China or North American into Europe. We believe they're going to be able to meet their -- and there is some seasonality in the polyol business. Construction slows down, so irregardless of whatever recession impacts are there would be normally be some seasonality. So we think we're going to be able to meet all of our sales requirements from local production, so that would help improve margins in the fourth quarter and first quarter of next year, coupled with we did have price increases. We expect to see improved margins. How quickly demand starts to move up in Europe will dictate whether or not we'll have further outsourcing next year. Our expectation is that by the second half of next year we probably will have to start bringing some material into Europe from either North America or China, and so we could have a little bit of an outsourcing premiums (inaudible).

Did your regional sales managers know when taking these orders that you guys might be paying a little bit more to get the material, or is -- was there a strategic reason for taking the business or were they just trying to book as many orders as possible? Do you have --

Well, we have available capacity at other plants to we hate to turn down an order and cause any inconvenience for our customer base if we've capacity in our system. And on a cash basis we weren't losing money we were making money, it just wasn't as much because we had the higher freight cost. So strategically, for our long-term relationship with our customers it absolutely makes sense. We want to make sure we're base loaded for the expansion in Europe in 2010. So yes, all things considered, these were all weighted into the decision to continue to supply from our other locations.

Okay, sounds good. Thanks, Jim.

Sure. Thank you.

And we have another question from the line of George Gaspar. Please proceed with your question.

Yes, Jim, one follow up on the currency translation outlook. Considering comparisons in currency around the world at this present time do you see any factors -- how would you see the factors plus and minus for the Company in the fourth quarter?

We'll have -- at least right now it's probably one of the most volatile times I think most of us have ever seen in the foreign currency markets, but right now we would probably expect to see net foreign exchange gain on foreign currency gains. In terms of translating our profits back from foreign locations I'd say that'll incur a hit, but I don't think net-net the combined effect would be a negative on the fourth quarter.

I see. Okay. All right, thank you.

Sure.

And we have no other questions at this time.

Okay. Well, thank you very much for participating in today's call. Good 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 lines.