Stepan Co (SCL) 2009 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stepan Company fourth quarter and full year 2009 earnings conference call. During the presentation, all lines will be in a listen-only mode. At the end of the conference, we will have a Q&A session. (Operator Instructions). As a reminder, this conference is being recorded today, Wednesday, February 10th, 2010. I would now like to turn the conference over to Mr. Jim Hurlbutt, Vice President and Chief Financial Officer at Stepan Company. Please go ahead.

Good afternoon and welcome to the Stepan Company fourth quarter and full year 2009 conference call. 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.

Looking out on Stepan's full year 2009 performance, we are proud to report record net income as all three business segments delivered improved levels of profitability. Full year 2009 net income increased 70% year-over-year, with non-GAAP net income up 129%, if we exclude deferred compensation plan expense and gain on assets sold in the prior year. Our success in driving higher levels of profitability was complemented by double-digit increases in quarterly and full year operating income. Earnings before interest, taxes, depreciation and amortization rose 40% to $140 million. Full year cash flow from operations was in excess of $166 million, a significant strengthening of our balance sheet as we reduced outstanding debt and increased cash levels from $17 million last year to $99 million as of year-end 2009. All in all, we reduced our net debt by $121 million in 2009.

We believe the balance of products in our specialty chemicals portfolio is a critical driver in Stepan delivering our record 2009 profitability performance in one of the most challenging economic environments in decades, as both pricing and volumes declined year-over-year, impacting top line revenue. The relative stability of our surfactants used in laundry and personal care products proved valuable during the economic downturn. While we maintained strength in these large laundry and personal care surfactant markets during the economic slowdown, the balance of our portfolio also provides Stepan opportunities for potential growth in demand as the domestic and global economies improve. Our business benefited in 2009 from the positive impact of lower commodity raw material prices, and the successful implementation of our internal Stepan cost efficiency measures.

Looking forward, we are continuing to invest in capacity and organic growth initiatives in markets where we can drive growth. We will proceed with the planned expansion of our polyol plant in Germany to meet anticipated demand growth. In Brazil, we will add equipment at our existing plant to broaden our product offerings in that region. Most importantly, our strategy is allowing us to translate our operational and financial achievements into generating shareholder value. During 2009, we delivered our shareholders Stepan's 42nd annual dividend increase as well as actively repurchasing more than $1.9 million in common stock. These initiatives demonstrate our consistent focus on shareholder value.

At this point, let me walk you through our fourth quarter and full year results. Starting with the top line, total net sales for the fourth quarter were $311 million, down 15% year-over-year. Total net sales for the full year 2009 were $1.3 billion, down 20% versus a year ago. The decline in full year sales was primarily related to lower selling prices, which accounted for 10 percentage points of the decline, and lower sales volume, which accounted for 7 percentage points of the decline, and lastly, lower foreign sales, due to currency translation effect, which accounted for 3 percentage points of the sales decline. The lower selling prices were due to falling commodity raw material costs. If we look at the fourth quarter of 2009, the 15% decline in quarterly sales was broken out as follows. Lower selling prices, accounting for 14 percentage points of the decline, and lower sales vol volume, accounting for 4 percentage points of the decline. The positive impact of foreign currency translation in the fourth quarter offset the declines by 3 percentage points. Overall, volume declined 4% in the fourth quarter and 8% for the full year.

Net income for the fourth quarter was $8.8 million, or $0.80 per diluted share, compared to net income of $1.7 million or $0.15 per diluted share in the year-ago quarter. Net income for the full year 2009 increased to a record $63 million or $5.84 per diluted share, compared to net income of $37.2 million or $3.52 per diluted share a year ago. Our 2009 net income performance gains are even larger when you consider our full year 2008 net income included $11.3 million or $1.06 per diluted share of aftertax gains on the sale of a product line and some land.

Net income for the year and quarter benefited from lower commodity raw material costs, successful cost control initiatives, and a desirable surfactant product mix of laundry and personal care products that performed well during the economic downturn. Fourth quarter and full year net income included $800,000 and $3.1 million respectively in deferred compensation expense, net of investment income or loss, or the equivalent of $0.07 per share in expense during the fourth quarter and $0.29 per share for the full year. A detailed table around the financial effect of the deferred compensation plan has been provided in the earnings release for your reference.

Fourth quarter 2009 gross profit increased $18.9 million or 61% year-over-year. Full year 2009 gross profit increased by $63.6 million or 37% year-over-year, with improvements across all three business segments. Operating expenses for the fourth quarter increased by $12.4 million or 53% and rose $29.4 million or 30% as compared to the year ago periods, primarily as a result of the increase in deferred compensation expense. Excluding the impact of deferred compensation and one-time gains related to the sale of product lines or land, quarterly operating expenses increased $6.4 million or 27% for the quarter, and increased $4.2 million or 4% for the full year. For the full year, cost containment efforts helped offset higher performance based compensation expense.

Let's move now to a review of the performance of our three business segments. First we'll look at surfactants, the largest segment of our business, which accounts for 76% of Company-wide sales in 2009. Fourth quarter net sales of surfactants totaled $234.5 million, a decline of 17% year-over-year, while full year surfactant sales declined 19% to $972.6 million. Surfactant sales volume declined 5% for the quarter and 7% for the full year. Within our largest surfactant market -- consumer, laundry, and personal care -- demand proved resilient during the economic downturn with minimal impact on volume, which were actually slightly ahead of last year. Most of the decline in our surfactant volume was attributable to lower biodiesel sales as the economics of biodiesel remain unattractive due to the high feedstock cost and lower diesel selling prices. Sales of surfactant products for use in enhanced oil recovery picked up in the fourth quarter as we began sales to our first commercial oil field flood. We remain optimistic about this market opportunity as a potential growth driver as global demand for crude oil grows.

Surfactant gross profit increased $15.5 million or 68% for the fourth quarter, and $48.3 million or 40% for the year. Gross profit improvement continued to be driven by lower commodity raw material costs, purchasing lead cost reduction initiatives, including freight and logistical savings, as well as a more favorable product mix. For the full year ending December 31st, 2009, the US dollar strengthened against nearly all the foreign currencies in locations where the Company does business. Consequently, net sales expense and income amounts were lower than they would have been had the foreign currency rates remained constant with the same rates for the prior year. Please see the table three in our earnings release for a summary of the effects of foreign currency translation on net sales in key income items.

Moving on to our polymer segment, which represents 20% of total 2009 sales. Polymer fourth quarter net sales totaled $65.6 million, a decrease of 8% year-over-year, while full year 2009 sales fell 27% to $260.8 million versus a year ago. Volume increased 3% for the quarter versus the year-ago period and declined 16% for the full year. The decline in full year volume was primarily as a result of lower sales of polyol used in rigid insulation foam for flat roof commercial construction. The recession significantly slowed sales of new as well as replacement and retrofit construction roofing.

Polymer gross profit grew $2.6 million or 35% for the fourth quarter, and $9.7 million or 23% for the year. Polyol products generated most of the improvement on lower raw material cost as well as cost reduction efforts. As I mentioned, we have restarted our planned capacity expansion in Germany, and if needed, we will supplement European material with polyol from available capacity in our US plant. Phthalic anhydride volumes declined in the quarter and full year periods, primarily due to lower demand in automotive, housing, boating, and recreational vehicle end use markets. We look for modest recovery in phthalic anhydride in 2010, both from the merchant market and increased internal use in the manufacture of our polyol.

Finally, we look at our specialty product segment, which accounted for 4% of the Company's 2009 sales. For the fourth quarter, specialty products net sales totaled $10.8 million, a decline of 2% year-over-year, while full year sales increased 3% to $43 million. Volume increased 24% for the fourth quarter, and 9% for the full year. Specialty gross profit increased $1.8 million or 89% for the fourth quarter as compared to the year-ago period, and increased $7 million or 70% for the full year. The surge in gross profit was primarily attributable to lower raw material costs, improved product mix, and higher food ingredient volumes.

In early 2010, we have already announced a range of price increases aimed at recouping recent increases in raw material costs and precluding margin erosion. We expect the pricing of crude oil and the related raw materials we consume to remain volatile.

Looking at interest expense, which declined $800,000 or 38% for the quarter, and fell $3.2 million or 34% for the year, this was entirely due to lower average debt levels. For the full year, the net loss related to our joint ventures increased $1 million or 38%. As planned, the TIORCO enhanced oil recovery joint venture incurred startup losses of $2.5 million in 2009, compared to $400,000 in 2008. The Philippine joint venture posted a lower loss of $1.2 million in 2009 versus a $2.3 million loss in the prior year. Other income for the full year 2009 improved year-over-year, primarily on assets held for our deferred compensation plan.

Our effective tax rate for the year rose to 35% compared to 32.1% a year ago. The increase in the effective tax rate was primarily attributable to a greater percentage of consolidated income being generated in the United States, where the effective tax rate is higher than our foreign tax jurisdictions.

Moving now to the balance sheet. Total debt as of December 31st, 2009 was $104.1 million, down $6.2 million for the quarter and down $38.9 million for the year, representing a 27% reduction in total debt for 2009. As of December 31st, net debt, representing total debt minus cash, was just $5.6 million, down $31.8 million for the quarter, a decrease of 85%. For the year, net debt decreased by $120.7 million or 96%. The lower net debt levels were attributable to improved earnings coupled with lower working capital requirements. Working capital excluding cash declined due to the lower raw material costs brought about by the decline in crude and natural oil prices. Our total debt to total capitalization at the year-end was 26.5% compared to 40.7% a year ago. The ratio of net debt to capitalization at December 31st, 2009 was 1.9%, compared to 37.8% a year ago. Capital expenditures were $42.6 million for the year, down 14% from the prior year. Fourth quarter CapEx totaled $11.7 million, down 18% versus the year-ago period. Looking forward, we expect our 2010 full year capital expenditures to be in the range of $65 million to $75 million. The higher 2010 capital expenditures are due to the expansions planned for Germany and Brazil.

Looking now to our cash flows. During the fourth quarter, we generated $46.5 million in cash flow from operating activities, up 80% from the same quarter in 2008. Cash flow from operating activities for the year totaled $166.4 million, up 472% versus the year ago. The cash flow increases were driven by improved earnings as well as the lower working capital requirements. As a result of these factors, Stepan's total cash increased by $25.6 million for the fourth quarter, and $90.2 million year-to-date to $98.5 million.

During the fourth quarter, Stepan repurchased 12,000 shares in the open market at a cost of $743,000. In 2009, we purchased a total of 50,000 shares, leaving approximately 400,000 shares remaining and available under our repurchase authorization as of December 31st. Finally, in terms of returning value to our shareholders in the fourth quarter of 2009, Stepan paid out a total of $2.6 million in cash dividends to its common and preferred shareholders.

Before I open the call to questions, let me provide some perspective on Stepan's forward-looking financial guidance for 2010. Given consensus expectations for a slow economic recovery, we are focused on global market share growth and penetrating new end use markets. We are committed to driving organic growth in our business and believe that our growth initiatives will create the opportunity to sustain our earnings momentum.

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.

Thank you. (Operator Instructions). Our first question is from the line of Daniel Rizzo with Sidoti & Company. Please proceed with your question.

Hi, Jim.

Hey, Dan.

I noticed just that your initiative costs and marketing costs were a little higher in the fourth quarter than the previous year, a bit higher. What was that from? Is that something that's going to happen going forward?

Not probably to that extent. The largest portion of that was because of the very strong year, our accruals needed for our bonus, profit sharing, and long-term stock incentive awards were a little higher than normal in the fourth quarter and certainly higher for the full year than prior years by quite a bit. So would not -- we certainly hope we have a great year next year but -- and if that's the case, then they would be that high. On a normalized basis, they probably would not be quite that high.

Okay. Are you seeing -- go ahead.

Go ahead.

Please, you.

We probably had a little bit higher work in terms of some consulting and legal work that we were trying to get done for the year. That probably also drove the costs up a little bit. For the full year, when you exclude deferred comp we were able to deliver only a 4% increase.

Okay. And you mentioned that you had your first commercial sale of enhanced oil recovery. Is EOR proceeding according to plan? Is there more commercial sales coming in the near future? A little more color on that?

It's certainly going slower than originally anticipated, but we're seeing a lot of interest. And as crude keeps moving back up and conditions about when we come out of the recession, is there going to be more demand placed on crude and push price up even further. So we are seeing a lot of interest. The flood we've got ongoing now is with one customer is a commercial flood, not just a pilot. So I think there's gaining recognition in the industry, the technology works, and that we certainly expect to see continued interest going forward. Do we have a significant amount of new commercial floods already planned for 2010? No, we're going to be supplying this one large flood for several years.

Okay. All right. Thanks, Jim.

Thanks, Dan.

Thank you. Our next question is from the line of Beverly Machtinger of Grace and White, Inc. Please proceed with your question.

Hi, Jim.

Hey, Beverly.

How's everything out there?

Good. Buy some stock, will you?

Couple questions here. I was wondering if you could explain the European regulatory cost, what that was about?

Europe has been in the process for several years of adopting what they call their REACH initiative for registration of chemicals. So all chemicals used commercially in Europe are going through a registration process where the manufacturers have to -- what they're doing is forming consortiums to share data on the chemicals. And so they have to submit that to the government for registration, and so the required data includes studies of toxicity and other environmental factors regarding the chemicals. So it's a tedious and expensive process. There is some benefit in this process, as there are people who are smaller players in the market who don't want to incur that cost. So they'll be leaving the market or selling that -- their business to other people, so there is going to be some consolidation as a result. But we expect several million dollars of costs associated with complying with REACH for the next several years.

So this is not a one-time thing, this will be -- ?

This will be an ongoing cost to register our products in Europe, and it's not unique. It's the whole chemical industry is going through the same process.

Okay. And then I was wondering if you could talk a little bit more about the polyol business, because I got the impression from the press release that the fourth quarter there was a little bit of a pickup in demand. And I was wondering if that was due to real demand increasing or whether or not it was just people refilling their inventories?

We saw a pickup in demand and probably the main growth we saw was in Europe. In part, we believe we're gaining market share in Europe. In North America, it's still fairly slow in this winter weather. Heavier winter weather of late will even slow it down further. We anticipate a pickup in the spring is probably the earliest we would see a strong recovery in North America. But we do hope to gain some additional product applications in North America during 2010 for our polyol, moving beyond just flat roof insulation, but also into metal panel construction applications. So if we can diversify the product offering or end use applications, we think we'll be able to grow that market, despite the weakness in the economy.

Okay. But in Germany, you're expanding capacity. So there is more real demand there for the product?

The volume never fell off in Europe to anywhere near the extent it did in North America, and so we're projecting to be sold out within 12 months and need that capacity by the time that plant comes up. As I said, if we need to, we will supply them. We have excess capacity in North America, so we will supply from North America in the meantime, should the need arise.

Also, you mentioned the organic growth you were talking about, not just gaining market share, but entering new end user markets. And other than the oil recovery option, what other markets are you actually looking at?

Well, it's -- the metal panel is certainly one end use application of our polyol that we're trying to penetrate. In Brazil, the equipment modifications we're making down there will allow us to offer our fuller -- we have a very broad surfactant product portfolio in North America. But in Latin America, it's a much narrower product offering. So we really want to take our full product offering franchise in North America and get it into the marketplace in Latin America, and Brazil is one of the big targets for us right now to make that happen.

Okay. So in Brazil, that's really the surfactant business?

That's the surfactant business, absolutely. In Germany, polyol expansion is the polymer group.

I know when you went into the biodiesel, you had capacity that you were able to flip into biodiesel business. And I was wondering how much capacity now do you have tied up with biodiesel, or have you shifted some of that back to your regular surfactant business?

We are using it for some of our regular surfactant business and we are looking at alternatives for other products that can go into that facility. We will opportunistically make biodiesel, should the margins improve. There is still a government mandate. I don't know how effectively it's going to be enforced. But by -- at the end of the day, there's a very large amount of excess biodiesel capacity out there, chasing too few pounds. So near term, we don't view it as very attractive business and we would put it to use in traditional surfactant products wherever and whenever we have the best opportunity. We are using it today for part of our surfactant business.

Okay. And then finally, in the phthalic anhydride markets, I know that's a lot of the auto and the things that have been -- markets that have been pretty weak. What can you tell us about what's going on, or what do you see in those markets? Are things starting to turn around or bottom out? Are you seeing any pickup there, in general?

No, very slow -- we're anticipating a very slow recovery in those markets. Our strategy for many years now has been to divert our capacity from phthalic anhydride into our polyol business and grow our polyol business so that we're using as much as we can in a captive end use. But we still have a significant portion available for the merchant market and no, we're not seeing significant improvement in the merchant market yet.

Okay. That's it. Thank you.

Thanks, Beverly.

Thank you. (Operator Instructions). Our next question is from the line of Mike Harrison with First Analysis. Please proceed with your question.

Hi, good afternoon.

Good afternoon.

I had a couple questions for you on the enhanced oil recovery business. This oilfield flood that you started up last quarter, was this a North American customer? And then it also sounds like you would classify this as a relatively large project compared to other projects that you're looking at, is that right?

Yes, because in recent -- most of the work we had done shipping to customers in the last year to 18 months have been pilot floods. So they are putting sample quantities into a field, pulling core samples to see what effect it's having on the oilfield, whereas this is a commercial flood where they're going to inject for -- a planned three year injection into a fairly large field. If they're happy with those results, they would also expand it to other fields. So we're pretty excited about it.

And I guess can you give us a sense of the timing of a project like that from the design stages through startup and then ongoing recovery?

Well, in this particular case, they're planning on a steady flood over a three-year period and then they'll see how the results played out for them. This is not entirely new technology. It was used back in the 1980s, and I think the trend is moving towards a steady flood over a protracted period of time. In earlier floods, people would do a massive injection all at once and then try and see how much recovery they had over the ensuing six to 12 months -- whereas now, the technology, the preferred approach on most oilfields is to do a continuous flood, combining the water surfactant and the polymer and trying to get an improved result over a protracted period of time.

Is the revenue from a project like that, is it front end loaded for you or when do you get into the sweet spot in terms of revenue over that three-year timeframe?

The one we're working on now is fairly straight line. We'll be shipping in fairly even quantities over the three-year period.

And can you give us any sense of what kind of revenue impact we could see during 2010?

Yes. It's still relatively small relative to our total sales. We're looking in the $20 million range.

Okay. Longer term, conventional wisdom has been that enhanced oil recovery makes the most sense when oil prices are sustained at higher than $80 a barrel. First of all, is that still a good rule of thumb to use? And I guess given where oil prices have been recently in the mid-70s range, what is the interest level that you're seeing for that offering as you look over the next year or two?

Well, we're still seeing interest. I think the -- when you refer to an $80 threshold, I think you have to differentiate between people who already have a water flood operation in progress, which is a significant portion of the older fields in North America. If they already have injection wells for water, their capital cost for converting to a surfactant polymer flood is not that significant, and $80 would not be a barrier -- I mean, they would be willing to do it at well below $80 a barrel. $80 is probably more of a target if somebody is going to have to incur a lot of upfront capital cost to drill injection wells.

Got it. And then I had a question, just looking broadly at your commentary on raw material volatility that you expect going forward. Do you think it's going to be a situation where you see inflation accompanied by a pickup in demand broadly, or could you be stuck in a position where you see higher raw material costs while demand stays weaker, maybe even falls off and you're in a more challenging environment?

We don't have a crystal ball. We're anticipating the former, that the inflationary pressures on raw material costs will be driven by people coming out of the recession and driving demand up. That's what we view as the more likely scenario.

All right. Thanks very much.

Thank you.

Thank you. Our next question is from the line of John Bayer with SKA Financial Services. Please proceed with your question.

I wanted to ask a little bit, you did address that you're seeing some stability or you've been raising some prices here recently and seems to be some stability in sales volumes. And I was just wondering in a big picture here if you're seeing that across the board and what your overall utilization rates of your plants are to where if you do see a pickup in demand, you'd be able to meet that improved demand?

Sure, sure. I think if you look at the overall surfactant business, we're probably operating in the -- across the whole platform, at around the 75% of capacity range. Now, that -- you have to stratify that a little bit, because in some commodity categories, we may have a little bit more available capacity, and in some of the specialties that are reactor specific we may have no excess capacity. In general, we would be able to absorb an uptick without a capacity constraint, for certainly what we would anticipate for foreseeable future in surfactants, except for Brazil, where we're a small player down there, trying to grow, and we do need to expand our capacity to get the full product range.

In terms of the polyol business, it's two different answers. In North America we certainly have available capacity, probably 25% to 30% capacity available for the market recovery. In Europe, we're still fairly tight. We're probably close to 90% or better capacity utilization in Europe on polyol, so that is why we want to be ready, because we anticipate growth in eastern Europe. And in 12 months we would like to make sure we have that new reactor in place, and we have a lot of confidence we'll be filling that reactor up fairly quickly.

Okay. That leads into, since your net debt situation is so much better, then I would imagine that cash utilization would probably go towards those plant expansions where you need them, like in Brazil and so forth. Is that a fair assessment?

Our first priority for -- yes, we have an excellent balance sheet right now, and it gives us a lot of flexibility, but our first priority is to organic growth. So we do want to -- we don't want to hamper our growth opportunities with our core franchise. In terms of expanding the product offerings through acquisitions, I mean, we're actively looking for opportunities that would be synergistic with our existing business and accretive to earnings, hopefully from day one. So yes, we have a balance sheet that's giving us the flexibility to go look at opportunities besides just organic growth. But the organic growth will get our first -- is our first priority.

Well, and in reference to a previous question about the regulatory cost and so forth, you mentioned that some of the small players may be dropping out or whatever. Is that opening up some activity and possible acquisitions there?

Yes. We think there will be some more opportunities. We actually bought some small product lines in the past in Europe because people anticipated these regulations coming and wanted to exit some of the bioside product lines that we picked up in Europe. It was a small acquisition, but it is typical of the small players saying we're not going to incur this regulatory cost for such a small operation. That doesn't make sense. So there has been some consolidation, we expect there will be further consolidation, particularly among smaller players.

The EOR seems to be a very popular topic, so I'm going to throw one in here too. That is, actually in addition to traditional enhanced oil recovery, a lot of talk lately about the issues around fracking the nonconventional shale plays. I was wondering how much involvement you might have supplying product to the service companies that are involved in the actual fracking injection.

That has been an important -- we've been in that business for many years, independent of enhanced oil recovery. We sell into the oilfield markets and have for quite some time. And that is a very attractive market to us, specialty area, and yes, I mean, we're providing oilfield chemicals and -- so, yes, it's important.

So are you seeing -- I guess I'll refine it a little bit here and say because of the increased activity in those plays throughout the US, and I would imagine that we'll start seeing that happening more internationally too, are you seeing a significant percentage increase in sales towards those type of projects?

To date, I wouldn't -- we've seen steady increased business in oilfield. Can I tell you it's directly related to the increased activity, particularly around, say, the new techniques for getting at natural gas? No, I don't know that for a fact. I mean, I'd have to check into it a little more and see if I could find some more information for you. That's a hot area right now because they're doing angular drilling and going much deeper.

The multi-stage fracking aspect.

Right, and pulling gas out of places they never could get it out.

Right. One last question and I'll get out in case somebody else is in here. The water floods, are these projects, I know you said there's some pilots and one commercial water flood going on -- the fields that are being worked over here, would the viscosity of the oils be -- are they a lower weight? A stickier stuff? Or are they more the conventional one, higher API weight oils? When you tell me there's three -- ?

It tends to be heavier. I'm not an oil and gas expert, but if -- I don't know how familiar you are. The traditional pumping only gets 30% of the oil out of a typical field.

Right.

Because the remaining oil tends to be stickier.

The heavier stuff like Venezuelan crude that's 14 API, whatever --

You're talking higher quality.

You're lucky to get 10%.

Yes, I mean absolutely it's going to help with that. That's the whole property is to -- it's literally putting a detergent in to loosen oil off the geological formation.

Okay. I'll step out.

Okay. Thank you.

Thank you. There are no further questions at this time. Mr. Hurlbutt, I will turn the conference back over to you.

Okay. Well, thank you everybody for participating in today's call and we'll talk next quarter. Thank you very much.

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