Stepan Co (SCL) 2010 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company first quarter 2010 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)

I would now like to turn the conference call over to James Hurlbutt, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

Good afternoon, and welcome to the Stepan Company first quarter 2010 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.

Overall, I am pleased to report Stepan delivered a solid first quarter 2010 performance, reporting significant profitability growth versus 2009 and record first quarter earnings. Net income increased 36% year-over-year to $20.7 million. Non-GAAP net income, which excludes deferred compensation plan expense, where income jumped 62% year-over-year. Our record first quarter results reflect our success in achieving higher earnings across all three business segments. Improved financial performance was driven by increased volumes, a favorable sales mix, and sustained margin improvement. As we look out on 2010 and beyond, we are encouraged by the signs of stabilization and growth in key segments of our core markets.

In order to leverage international growth opportunities, we are continuing to invest in capacity and organic growth initiatives in markets where we see Stepan maintaining a strategic position, as well as the prospects for sustainable and attractive margins. As we have talked in the past, two key components of this strategy include the planned expansion of our polyol plant in Germany to meet anticipated European demand in 2011 and beyond. And secondly, in Brazil, where we are adding equipment to our existing facility to allow us to leverage our full product offering franchise into the key Latin America and Brazilian markets. Both these initiatives are proceeding as planned, with Germany projected to go online in the first quarter of 2011 and the Brazilian expansion targeted for completion later this year. Building on these organic growth initiatives, we are also actively looking at complimentary bolt-on acquisitions, which can strengthen our market position and accelerate our growth strategy. Let me reiterate what we have said in the past -- our first priority is organic growth within our core franchise. In terms of expanding the product offerings through acquisitions, our focus is on opportunities that would be synergistic with our existing business.

The strength of our balance sheet is excellent right now, as is the interest rate environment. So we see a very good opportunity to raise some additional capital to meet our strategic growth needs. We have agreed to borrow $40 million of new private placement notes to be funded during the second quarter. The notes will mature in the year 2016 through 2022 on a straight line amortization. The Company intends to use those proceeds for capital expenditures, general corporate purposes, as well as possible bolt-on acquisitions.

With that brief overview of our strategy being said, let me now walk through our detailed first quarter 2010 results. Starting with the top line, total net sales for the quarter were $337 million, up 6% year-over-year. The rise in first quarter sales was primarily related to higher sales volume, which accounted for eight percentage points of the growth, higher foreign sales, due to currency translation effect, which accounted for four percentage points of the sales growth. And lastly, both factors were partially offset by lower selling prices, which offset the aforementioned gains by six percentage points. Net income for the first quarter was $20.7 million, or $1.88 per diluted share, up 36% compared to $15.2 million, or $1.43 per diluted share in the year-ago quarter. Non-GAAP net income which excluded $1.3 million in deferred compensation income totaled $19.3 million, or $1.76 per share during the first quarter, up 62% versus the year-ago period. A detailed table around the financial effect of the deferred compensation plan has been provided in the earnings release for your reference.

First quarter 2010 gross profit increased $14.9 million, or 31% year-over-year, on the 6% rise in total sales, with improvements across all three business segments. Operating expenses for the first quarter increased $7.4 million, or 33%, primarily as a result of the increase in deferred compensation expense. Excluding the impact of deferred compensation, quarterly operating expenses increased $3.7 million, or 13% versus a year ago. As we see opportunities to further globalize our business, we planned on increased spending during 2010. Excluding deferred compensation effects, operating expenses are projected to grow by approximately 5% for the full year.

Let's move to a review of the performance of our three business segments. First surfactant, the largest segment of our business accounting for 78% of companywide sales for the quarter. First quarter net sales of surfactant totaled $262.3 million, a rise of 1% year-over-year. Surfactant volume increased 6% for the quarter, as gross profit rose $7.9 million, or 19% versus year-ago. Geographically, the majority of the volume in profit improvement was in North America. Sales volume growth came largely in some of our largest surfactant markets, primarily the consumer laundry and cleaning product categories. A favorable sales mix of higher margin products also contributed to the higher earnings. Unlike North American, European surfactant sales profitability declined slightly due to lower margins. Sales of surfactants to enhanced oil recovery customers continue as planned for 2010. The results of pilot floods this year will determine the extent of larger scale commercial floods in 2011 and thereafter.

Moving on to our polymer segment, representing nearly 19% of sales, polymer first quarter net sales totaled $63.1 million, an increase of 30% year-over-year. Volume increased 25% for the quarter versus the year-ago. The surge in volume was primarily a result of higher sales of polyol used in rigid insulation foam for new commercial roof construction, as well as replacement roofing. Polymer gross profit grew $4.5 million, or 67% for the quarter. The profit improvement was driven by higher sales of polyol and phthalic anhydride in North America. As we discussed last quarter, we anticipated a modest recovery in the phthalic anhydride market from both the merchant market as well as increased internal in the manufacturer of our polyol product. As we expected, phthalic anhydride rose 25% from the depressed year-ago levels. Phthalic anhydride is used as a plasticizer in the automotive, housing, boating and recreational vehicle markets. PA profitability was also up versus the year-ago quarter due to lower raw material costs.

Finally, we look at our specialty products segment, which accounted for approximately 3% of sales. For the first quarter specialty products net sales totaled $11.6 million, up 18% year-over-year. Volume increased 29% for the first quarter, as gross profit rose $2.5 million, doubling when compared to the year-ago period. The surge in gross profit was primarily attributable to higher volumes and improved product mix on higher margin products, and lower raw material costs. Overall, across our three business segments, in 2010 we announced a range of price increases aimed at recouping recently rising raw material costs.

Turning to interest expense, we saw a decline of $600,000, or 32% for the quarter, due to lower average debt levels. For quarter ending March 31, 2010, the US dollar weakened against nearly all the foreign currencies in the locations where the Company does business. Consequently, reported net sales, expense and income amounts for the first quarter were higher than they would have been had the foreign currency exchange rates remained constant with the rates for the same period of 2009. Please see table three in our earnings release for a summary of the effects of foreign currency translation on net sales in the key income line items. The effective tax rate for the quarter was 34.6% versus 34.8% a year ago. Recently passed healthcare legislation and related tax law changes had no current impact on the Company's tax provision.

Turning to the balance sheet, total debt as of March 31st was $103.1 million, down $1 million in sequential quarterly comparison and down $29 million versus the year-ago quarter, representing a 22% reduction in total debt. As of March 31, net debt representing total debt minus cash was $27.7 million, up $22.1 million for the quarter, due to higher working capital levels, driven by the improved sales volumes. Net debt versus the year ago period was down $97.6 million, representing a 78% reduction. Our total debt to total capitalization at quarter end was 25.3% compared to 37.9% a year ago. The issue of net debt to capitalization of March 31, 2010 was 8.3% compared to 36.7% a year ago. Capital expenditures were $13 million for the quarter, down 17% from the year-ago quarter. Looking forward, we expect our 2010 full year capital expenditures to be in the range of $65 million to $75 million with the higher year-over-year levels of spending driven primarily by our planned expansions in Germany and Brazil.

As of March 31st, the Company had accounts receivable day sales outstanding of 45.6 days compared to 46.4 days a year ago. Cash flow from operating activities for the first three months of 2010 was a net use of $3.3 million compared to a source of $15.3 million for the same period in 2009, despite a net income increase of $5.5 million year-over-year. For the first quarter of 2010, working capital consumed $33.6 million, due mainly to higher accounts receivable inventories driven by the increased sales volumes. In contrast, for the first quarter of 2009, working capital consumed only $11 million, as the Company experienced lower sales, along with lower raw material costs. As a result of these factors, Stepan's total cash decreased $23.1 million for the first quarter from $98.5 million to $75.4 million. During the quarter, Stepan repurchased 73,000 shares in the open market at a cost of $3.7 million. Stepan had approximately 306,000 shares remaining and available under its share repurchase authorization as of March 31st, 2010. In terms of returning value to our shareholders through cash dividend distributions, in the first quarter of 2010, Stepan paid out a total of $2.6 million in dividend -- cash dividends -- to its common and preferred shareholders.

Before I open the call to questions, let me provide some perspective on Stepan's view of 2010. We believe our core markets provide opportunities for additional profit growth. We are presently adding the capabilities to our surfactant plant in Brazil and expanding our polyol plant in Germany. These and other investments should create the opportunity for us 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.

(Operator Instructions) Our first question comes from the line of Daniel Rizzo with Sidoti & Company. Please go ahead.

Hi, Jim.

Hi, Dan.

With the polyols, what's the breakdown between replacement roofs versus commercial in terms of percentage?

Typically it runs about 70%, or say two-thirds replacement and one third new.

So it would be fair to say that then -- some of the delays in replacing roofs during the recession can't be delayed any longer. Correct?

Eventually you see pent-up demand, as people have patched roofs and delayed it too long, eventually you start seeing a diminishing return and damage to the building structure. So, yes, usually you get a little bit of added bang after pent-up demand builds up from a recessionary environment.

So, there is a chance that the strong -- the 30% growth is somewhat sustainable?

For the year, yes. We're looking at the overall broad polyol business. We're looking at targeting double-digit growth anyways just from the sheer insulation and energy saving aspects of it. There probably was some pent-up demand coming into this year. There may have been a little bit of restocking in the first quarter. There is some seasonality as people come out of the winter months and can get at roof replacements.

But year-over-year, since last year was so bad, no, that's not unrealistic to see. Our expectations are that that would not be an unrealistic target for the full year -- year-over-year improvement in volume.

Okay, and I think before the recession, that Europe was looking at a key growth area for polyol demand. Is that still the case?

Yes, because they have a lot of tougher energy standards going into effect. We've seen increased demand. A lot of our market shares in Western Europe were targeting Eastern Europe, where, insulation is becoming more of a hot button -- they lagged Western Europe in terms of standards for insulation. And we've also been penetrating the -- I think we referred to it before -- the metal panel business -- where we had not participated. Most of our foam was going into just the rigid foam board that lays flat across the roof with a waterproof membrane going over them. So we're optimistic that we will gain market in the metal panel segment.

Okay.

We are gaining market share today as we speak -- in that segment.

All right, thanks, Jim.

Thanks, Dan.

(Operator Instructions) Our next question comes from the line of Michael [Gorkid] with Scotia Capital. Please proceed with your question.

Hi, Jim. My question is on the surfactant and gross margins. Looking back historically from 2004 to '08, they were roughly, say, 9% to 10%. Then obviously following the big decline in commodities prices, they are now almost double that at 19%. What do you see as a long run gross margin target for this business, and how much are customers pushing back on pricing?

If you go back even further, you would see that we probably had margins not too far off where we are back in the late '90s. So, one, we don't feel that they are totally out of line with a more normalized market. And then we're not seeing significant pushback from a customer standpoint. Obviously they were constantly evaluating raw material declines over the past 12 months. But I think they understand that the market's changed and we're not seeing extremely difficult or challenging conditions in the marketplace today.

So is that fair to say that you think that the fair long-term margin is the current level? Or somewhere in between?

Well, hopefully more towards the current level than the prior -- our expectation for this year is we're looking out -- we're not anticipating -- within surfactants alone, we've seen some slippage in Europe, primarily in the UK, but we've seen some improvements in margins in North America. Our goal overall is to maintain or improve that margin level within surfactants.

And then I guess in the early part of the decade, several customers took volumes in-house. I'm presuming that was to save costs. Given the current return on capital of 20% plus in 2009 and it looks like around 30% for the quarter, are customers looking at taking volume in-house or do you see the threat of additional competition, or what's on the horizon there?

There's probably more barrier to entry today than in years gone by with all the regulatory hurdles. We're not seeing significant new entrants into the -- certainly the North American market. Could that change? Of course it could, especially a global player who may not have a big market share in North America. But we're not seeing any current indications of that.

In terms of capacity, in-house capacity at some of our customers, they seem to be fairly well balanced. We have no current indications of anybody taking further business in-house that would affect our relationship and volumes with them. Right now, it looks like a fairly stable market environment. We don't see -- in fact, most brand companies are probably less interested in producing the chemicals themselves. They are more interested in focusing on growing their brands.

And just on the margin point, is there any structural change in the industry competitively or otherwise that you could point to from the 2004 to '08 period versus now going forward, that would enable you to keep this margin -- or that will prevent pushback, other than the decline on commodity prices?

Well, it certainly helps coming out of a recession that there's going to be less available capacity out there, so the temptation for somebody to cut pricing to gain market share presumably will be less as available capacity gets further utilized. In North America, probably Stepan -- within the core surfactants, using cleaning compounds -- Stepan probably has the most excess capacity so we're certainly not going to give away that capacity. So we feel comfortable where we are on margins.

I don't think there's a significant amount of available capacity throughout, so to your first point, unless somebody were to come in and decide to expand or build a plant, we're not -- we would expect the available capacity continue to tighten up and in particular, for Stepan, that's one of the motivations that's behind pursuing the [enhance or a] recovery business because it's basically a brand-new market potential for surfactants, which not only would fill capacity that we have currently, but if that market truly does develop, we would be prepared to expand into it for that market.

Okay, thank you.

Thanks, Michael.

(Operator Instructions) Our next question comes from the line of Beverly Machtinger with Grace and White. Please proceed with your question.

Hi, Jim. I know you touched a little bit on the oil recovery market. I was wondering if you could give us a little more detailed update on what's going on there and give us some timeframe of when we might see some real business coming out of there.

Sure. It's going to be probably longer time line. It's not a near-term homerun. We're not even sure how big of a homerun it potentially could be. We would expect to break even overall -- if you look at it that way for 2010 -- in terms of our significant investment in research capabilities and our TIORCO joint venture. Those expenses are largely going to be offset by sales this year. So as a break-even in 2010, our goal is that the results of pilot floods in 2010 are positive. And the one commercial float that's ongoing is successful. So that we get more adopters of the technology.

Certainly the rise in oil price -- crude oil -- is certainly going to continue to stimulate interest, but they have to see the results from the field before they are going to continue to expand injection. So I would hope we get a pretty good -- some pretty good feedback -- over the next 12 months that would indicate that there would be a significant increase in interest and sales into the OR market. But it's still a developmental project, partly an R&D project, but we're still very excited about it. It's just going to be a longer-term project.

Also, did biodiesel have any impact this quarter?

We had very few sales of biodiesel in the quarter, which I think was the case last year first quarter. Once they lifted the excise tax credit, the market -- which was already the margins had already dropped off to unacceptable levels -- the margins really cratered and I don't -- there's very little production of biodiesel going on in North America and for that matter, all over the world -- there's shutdown biodiesel plants. So we have been busy putting those assets to work in other surfactant product lines, which we will continue to do.

Our own internal feeling is unless there's some significant change, regulatory change coming out of Washington is that the biodiesel market is not going to recover to a margin level that we would be interested in participating in. Even substituting lower cost [hallow] for the feedstock in lieu of soybean oil -- higher priced soybean oil -- it still is not an attractive market.

So these assets, does this contribute -- like before you said you had excess capacity in the North American market -- are you referring to these assets per se?

Not, not specifically to these assets. These are batch reactors, which can be converted to use in other product lines relatively easily to -- in our methyl ester -- total methyl ester plant form processing natural oils. Where the sulfonation equipment of the reaction of sulfur trioxide with either [linerac] or benzoyl or alcohol -- those sulfonation assets is where we have the most of our excess capacity available for growing the business, as well as going after the [enhanthor] recovery market.

Could you also perhaps talk a little bit about the difference between what's going on in the European market for surfactants versus what's going on in the North American market. I guess I was a little surprised when you said how the European market was laggered.

We've always had a difference in Europe versus the US. The European surfactant market has got more excess capacity than North America. A lot of regional producers in almost every country within Europe, compounded by vertically integrated producers. So people who make alcohol and [linor-alco-benzene] also produce surfactants downstream. So they have a vested interest in keeping their commodity plants running to cover overhead. So they are really pushing -- they will push surfactants out in the marketplace more aggressively than we see in North America.

More price competition?

Price competition.

Okay, do they play--

Primarily due to -- and it's primarily due to the excess capacity situation. So it's a more aggressive pricing market. And it has been. This isn't unique to this year. It's traditionally been that way for many years.

I see. And then finally, can you talk a little bit -- I know it's a very small part of the business -- but the specialty market, specialty products. One, what's going on there that all of a sudden there's a big kick-up.

What we've been very, very pleased to see our brand product Neobee, a multi-chain triglyceride that goes into food additives, is doing very well in terms of more end uses of it. People are putting into more products. A lot of it has gone into baby formula, sports bar, sports drinks, and so we're pleased to see that it's getting a greater following as an alternative oil. And the pricing has been solid and the margins there, too, have been falling based on raw material costs. So it's been a nice shot in the arm for us.

In addition, we've seen improved volume in one of our -- it's an eye care surfactant that goes into contact lens solutions and eye drops and that business has improved recently. So it's been a nice positive. And we're looking for continued growth in that area.

Okay, great. Thanks.

Mr. Hurlbutt, we have no more questions at this time. I'll turn the call back to you.

Okay. I just want to thank everybody for joining in today's 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 line.