Stepan Co (SCL) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company second 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). As a reminder, this conference is being recorded Wednesday, July 28th, 2010. I would now like to turn the conference over to James Hurlbutt, Vice President and Chief Financial Officer. Please go ahead, sir.

Good afternoon and welcome to the Stepan Company second 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.

Building on the success of our record first quarter results, Stepan delivered a solid second quarter performance, including a 14% year-over-year growth in top line revenues, on a 6% improvement in total volume. Both the surfactant and polymer groups posted higher volumes, led by significantly higher volumes of polyol. Year-to-date, net income is up 9%, over a strong 2009 first half. The decline in second quarter 2010 net income versus the year ago is due to lower margins in Europe, and higher global production, administrative and research expenses.

Production costs rose on higher salaries and wages and maintenance expense. The Company continues to invest in growth opportunities, resulting in acquisition expenses and higher research expense. Administrative expenses were higher due to the recent acquisitions in Poland, Singapore, and the Philippines. Research expense rose due to increased headcount in support of our innovation portfolio, and higher regulatory compliance for the European REACH product registration initiative.

As we discussed last quarter, based on the strength of our balance sheet and an attractive interest rate environment, we saw an opportunity to raise some additional capital to meet our strategic growth needs. On June 1st we borrowed $40 million in a new private placement, carrying a 5.88% interest rate. The notes will mature in the years 2016 through 2022 on a straight line amortization. These proceeds were targeted for capital expenditures, general corporate purposes as well as potential acquisitions. While our first priority is organic growth within our core franchise, our strategy also aims to expand our global reach as well as product offerings through acquisitions. Our focus is on opportunities that would be synergistic with our existing business.

Organically, we continued to invest in planned expansion of our polyol plant in Germany to meet anticipated European demand for energy saving insulation in 2011 and beyond. We also moved forward, expanding our existing surfactant facility in Brazil, which will allow us to leverage our full product offering franchise into the Brazilian market. Both of these initiatives are proceeding as planned, with Germany projected to go online in the first quarter of 2011, and the Brazilian expansion targeted to go on in the fourth quarter of this year.

We also made a series of announcements outlining three strategic purchases. First, on July 2nd, Stepan purchased a manufacturing plant located on Singapore's Jurong Island and plans to convert its existing assets into the production of methyl esters. Methyl esters are a core building block of Stepan's surfactant business, and the acquisition of this asset provides a great opportunity to reach our global customer base with methyl esters and value-added derivatives. Our plan is to install a methyl ester fractionation capability on the site in order to supply our customers and our internal surfactants needs globally. We intend to restart the production of the Jurong Island plant by the end of 2011.

Secondly, on July 16th, Stepan announced that its wholly owned subsidiary, Stepan Europe, acquired all of the shares of Alfa Systems. The purchase includes Alfa Systems' new plant, located outside Wroclaw, Poland, which has a 25,000 metric ton capacity for polyester polyol, and a 15,000 metric ton capacity for other polyurethane systems. The plant started up in mid-2009, and specialized in the manufacture of aromatic polyester polyols from recycled polyethylene terephthalate as a raw material. Polyester polyols are the critical component of our polymer business.

The acquisition of Alfa Systems gives us manufacturing capability in eastern Europe, and the ability to economically and effectively serve customers in central and eastern Europe, where we see good long-term opportunities. In addition, the technology to manufacture aromatic polyester polyols from recycled raw materials is new for Stepan. We are excited to add this site with its technology to our global polyester polyol manufacturing network, which will be profitable in 2011.

Thirdly, on July 21st, Stepan Company announced that it increased its ownership in the Company's Philippine joint venture, Stepan Philippines, from 50% to 88.8%. Stepan Philippines operates a surfactant manufacturing plant south of Manila, producing laundry and cleaning products, fabric softeners, and functional surfactants for the Philippines and other Asian markets. We've been working to diversify the product offering produced at the Philippines site, and plan to capitalize on synergies with our Singapore plant when it starts up in late 2011. Overall, we believe our solid organic growth in these targeted acquisitions, which complement our core business, provide a solid foundation for expanding Stepan's global presence in key markets while driving sustainable and attractive margins.

Now let me walk through our detailed 2010 second quarter results. Starting with the top line, total net sales for the second quarter were $367 million, up 14% year-over-year. The rise in second quarter sales was primarily related to higher sales volume, which accounted for 6 percentage points of the growth, and higher selling prices, which accounted for 8 percentage points of the growth. The higher selling prices were due to rising commodity feed stock prices.

Net income for the second quarter declined 13% to $17 million, or $1.53 per diluted share, compared to net income of $19.6 million or $1.83 per diluted share in the year-ago period. Year-to-date net income rose 9% to $37.7 million. Non-GAAP net income, which excludes $3.4 million in deferred compensation expense, declined 14% year-over-year to $19.2 million, or $1.72 per share during the second quarter. A detailed table around the financial effect of the deferred compensation plan, as well as a non-GAAP reconciliation table have been provided in the earnings release for your reference.

Second quarter gross profit declined $2.2 million, or 3% year-over-year. Operating expenses for the second quarter declined $800,000, or 2%, primarily as a result of a 49% decline in deferred compensation expense, partially offset by a 12% increase in research and development expense, and an 11% increase in general administrative expenses. The increase in research expense was due to increased headcount in support of our innovation portfolio and the higher regulatory compliance for the European REACH expenses. Excluding the impact of deferred compensation, quarterly operating expenses increased $1.9 million or 7%, versus a year ago.

Turning 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 72% of Company-wide sales for the quarter. Net sales of surfactants totaled $264.6 million for the quarter, a rise of 11% year-over-year, surfactant volume increased 4% for the second quarter, and gross profits declined by $1.7 million or 4% versus the year-ago quarter. The lower segment gross profit was due to higher production costs in North America, combined with lower net margins in Europe related to higher raw material costs. Geographically, volume improved in North America and Europe. Sales volume growth came in the consumer laundry and cleaning product categories, as well as functional surfactants used in housing, oilfield and agricultural products.

Turning to our polymers segment, representing roughly 25% of sales, polymer net sales totaled $90 million for the quarter, an increase of 28% year-over-year. Volume increased 16% for the quarter versus the year ago. The growth in volume was primarily due to improved volume in rigid insulation foam for commercial flat roof construction as well as replacement and retrofit roofing. Polymer gross profit declined $400,000, or 3% year-over-year. The decline in gross profit was due to higher raw material costs, a competitive environment, and foreign currency translation. Phthalic anhydride volume rose 10%, driving improved profitability. Demand of phthalic anhydride based on saturated polyester resins in the automotive and housing industries improved from last year's recessionary conditions.

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 million, down 5% year-over-year. Specialty products gross profit declined $200,000 or 4%, primarily attributable to slightly lower volume in pharmaceutical applications. We expect full year results for specialty products to be higher than 2009, based on improved volume, margin and product mix.

Turning to interest expense, we saw a decline of $100,000 or 5% for the quarter, due to lower average debt levels as well as lower interest rates. For the quarter, the net loss related to our joint ventures was $800,000, as our Philippine joint venture reported a small profit for the quarter, and our TIORCO enhanced oil recovery joint venture added $900,000 of expense. For the quarter ending June 30th, the impact of foreign currency translation on Company profits was negligible. Please see the table three in our earnings release for the summary of the effects of foreign currency translation on net sales in key income line items for the first half of 2010. Our effective tax rate for the quarter was 35.3%, compared to 36.1% for the year-ago period. The decrease in the effective tax rate was primarily attributable to an increase in the domestic production activities deduction.

Moving now to the balance sheet. Total debt as of June 30th, 2010, was $144.9 million, up $41.8 million for the quarter, primarily related to the Company securing $40 million of new private placement long-term debt. As of June 30th, net debt, representing total debt minus cash, was $31 million, up $26.3 million since last year-end. The increase in net debt reflects higher working capital requirements, driven by increased sales revenues. The ratio of net debt to capitalization at June 30th was 9.2%, compared to 21% a year ago.

Capital expenditures for the quarter were $15 million. Looking forward, we expect our 2010 full year capital expenditures to be in the range of $75 million to $80 million, with the higher levels of spending driven primarily by our planned expansions in Germany, Brazil, and Singapore. During the second quarter, Stepan had no open market share repurchases of Treasury stocks. Stepan had approximately 305,000 shares remaining and available under its Treasury share repurchase authorization as of June 30th, 2010. In terms of returning value to our shareholders through cash dividend distributions, in the second quarter, Stepan paid out a total of $2.6 million in cash dividend to its common and preferred shareholders.

Before I open the call to questions, let me provide some perspective on Stepan's forward-looking performance. Overall, we are optimistic on Stepan's outlook for 2010. Our strong first half volume gains were generated by improved market demand and greater penetration of new end use markets. We expect these opportunities for growth will continue for the balance of this year and into 2011. We anticipate some continued pressure on margins in Europe, in both surfactants and polymers and higher operating expenses as we commit more resources to research and integration of our recent acquisitions. These acquisitions will allow for further growth in 2011 and beyond.

This concludes my prepared remarks. At this time, I'd 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). One moment, please, for our first question. And our first question comes from Daniel Rizzo with Sidoti & Company. Please go ahead.

Hi, Jim.

Hey, Dan.

Volumes were up fairly strongly in the quarter. Are you seeing any slowdown yet going into the third quarter, back half of the year?

No, we're not. No, things seem pretty steady in terms of what's been going on the last two quarters, in terms of volume, and actually we're pretty comfortable that it looks like -- we typically do have a slower fourth quarter but right now we're not seeing any indications of a slowdown in the third quarter. People are worried about a double dip recession, but we're not seeing any volume weakness.

Even with the commercial roofing insulation?

No, I mean, that's been very strong in the second quarter, and it's continuing strong right now.

Okay. In terms of raw material costs, I know they're rising. Are you going to have any more price hikes to offset them or do you think they've stabilized?

We put price increases out July 1st in both surfactants and polymers to try and stay on top of it. We've been pretty successful in maintaining unit margins in North America in all of our product lines. Most of the weakness margin-wise is limited to Europe, and that's a combination of competitive pressure, and trying to make sure we fill up our new polyol capacity that's coming online, both through the German expansion and the recent Poland acquisition.

Now, with the Poland acquisition, the German expansion, are you going to have excess capacity in that region?

Initially, but as we speak today, we are sold out in Europe. We are supplementing Europe with polyol from North America. So we're pretty excited that with the opportunity to diversify the polyol product, that we're picking up an additional product line as part of the acquisition. We have not used recycled PET in our formulations in the past, so we're going to broaden our product line as well as meet the continuing growth for polyol in insulation products in Europe and so this gives us a better foothold in eastern Europe and a broader product line.

Last question --

We will certainly have available capacity for at least for another year or two before we would be sold out in Europe.

So you're not planning on any additional capacity expansions beyond what you have planned for the rest of the year?

Well, we have a debottlenecking available scenario for the German plant. So even though we're doubling the capacity today, there is a further opportunity to debottleneck that site down the road, should we need more capacity.

All right. Thanks, Jim.

Sure, Dan. Thanks.

Thank you. (Operator Instructions). Our next question comes from Justin Speer with Invesco. Please go ahead.

Good afternoon, gentlemen. Thanks for the call. Just a couple of questions. Can you walk through the math on the productive capacity that you're adding and how to think about the timing of it all, just so we can have it for model purposes.

Let's do it by surfactants first. In Brazil, we're adding about 35 metric tons of capacity, which is a little more than doubling our current capacity, roughly. I'm sorry, that's not correct. It's about a 50% increase in our capacity in Brazil. The Singapore site currently was built as a biodiesel facility. We're going to completely convert it to a methyl ester facility for surfactants and that will be approximately a 50 metric ton facility for methyl esters and methyl ester derivatives and then the German expansion is approximately 40 metric tons in addition to the existing 48 metric ton capacity, and Poland's going to provide approximately 40 metric tons of polyol capacity as well.

Okay. That's perfect. Also on the margin side, can you walk me through maybe what were some of the one-off charges that you were talking about? I think you mentioned some maybe acquisition-related costs.

We had a fair amount of travel, consulting, due diligence type costs in the quarter to support investigating and then pulling the trigger on those. And I would say all in, we were probably in the $600,000 to $700,000 range for direct acquisition related costs.

That would be on the administrative side?

I would not -- pardon me?

That would be on the administrative line?

Yes, that was almost all entirely administrative. Now, we still have an appetite for acquisitions, so we are continuing to investigate additional opportunities. So I wouldn't want you to imply that those costs will be a one-off and completely go away, because we intend to continue to pursue some opportunities.

Okay. Is there a certain leverage level that you guys are comfortable getting to as you kind of think about the acquisition pipeline, low interest rates here, and think about maybe a macro environment that some are maybe seeing softening a little bit in terms of the growth trajectory? I don't know if you can speak to that?

Well, sure. If you go back historically, we were more leveraged in a 35% to 40% of debt to total capitalization. And we certainly aren't -- we don't get very comfortable going beyond that level unless it was something extremely attractive. Today, we're well below that kind of percentage and feel we've got plenty of room to navigate some additional opportunities.

In terms of those opportunities, and in terms of your evaluation of those opportunities, how do you go about doing that in your due diligence and what kind of maybe metrics from an economic standpoint do you guys think about as you pencil these deals?

Well, I think we look at the traditional metrics. We look at the DCF, return on discounted cash flow, return on investment model, as well as comparative EBITDA multiples for like, similar acquisitions going on in the industry.

What kind of discount rate do you use? Just curious.

We have risk factors that we associate with the project and determine, if it's a fairly low risk, we would look for a minimum 15% DCF. If it's higher risk, then the threshold goes up, and depending on region of the world, we'll apply risk factors and be looking for something north of 20% to 25%.

That's smart. What kind of opportunities are you seeing right now in the marketplace? In terms of maybe geographies or maybe product opportunities.

Well, we're primarily interested in either expanding our global footprint where it fits our strategy. Today, our strategy is primarily focused in surfactants, South America, primarily Brazil, and then expanding our presence in Asia. Within polymers, I think now with our additional footprint in Europe, our desire would be if there was a product portfolio expansion, that would be of interest. We're already in China, so I don't know if we have a significant global additional appetite today for polymers, but certainly something that broadens our product offering would be of significant interest. And then we're also looking at things for our specialty products group, which has become a very small revenue piece of our Company, but it's a disproportionate part of our income now and we're committed to having a food grade plant in our New Jersey site, and it would be attractive to add some additional product offerings out of that site.

Perfect. And I don't want to take up too much time, but one last question and I'm going to hop off. Just on the competitive pressures you mentioned in Europe, maybe could you speak to that a little further? Thank you again for the time.

We have a little more time lag trying to -- a lot of the contracts in Europe are quarterly, where we have to play catch-up on margins. And that we hope to accomplish in this next quarter. But the more important factor is in the polymer group, I think we're trying to make sure we were building the volume to fill up the capacity that we expect to have coming online with our Poland acquisition and now the expansion of our German plant. In the surfactant side, we have a little -- we have a major market share in North America in surfactants, so we have a little more ability to lead pricing. We do not have that ability in Europe. There's a multitude of competitors and available capacity. There's much more excess capacity in Europe, so we have less pricing power in Europe in surfactants and considerably more in North America.

Thank you for your time. Appreciate it.

No problem. Sure, thank you.

Thank you. Mr. Hurlbutt, there appears to be no further questions in the queue. I'll turn the conference back to you. Please continue with your presentation and/or closing remarks.

I just want to thank everybody for participating in today's call and look forward to speaking next quarter. Thank you very much.

Thank you. Ladies and gentlemen, that concludes our conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a good day.