Stepan Co (SCL) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stepan Company's third quarter 2010 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded today, Wednesday, October 20th, 2010.

I would now like to turn the conference over to Mr. Jim Hurlbutt, Vice President and Chief Financial Officer of Stepan Company. Please go ahead, sir.

Good afternoon, and welcome to the Stepan Company third 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.

For the third quarter, Stepan delivered 12% net sales growth while net income declined 2%. Net income was negatively impacted by higher raw material costs and increased transaction costs associated with strategic acquisitions executed during the quarter, as well as increased expenses associated with a union labor dispute, both of which are nonrecurring in nature and are not anticipated to impact fourth quarter earnings results. Third quarter earnings benefited from contributions through earnings from deferred compensation versus a reduction to earnings a year ago, as well as from positive foreign exchange impacts and a nonrecurring gain on the Philippine acquisition, increasing our ownership from 50% to 89%.

The Company has announced price increases aimed at improving margin performance and recovering some of the recent higher raw materials costs. Net sales year-to-date increased 11% to $1.1 billion, while net income year-to-date was $56.9 million, increasing 5% over the year ago period. As we covered in our last call, Stepan made a number of acquisitions during the third quarter, including the purchase of a manufacturing plant located on Singapore's Jurong Island which we will convert to methyl ester production. Stepan Europe's acquisition of Alpha Systems which includes Alpha Systems' plant located in Poland with 25,000 metric tons of polyester polyol capacity and 15,000 tons of polyurethane systems capacity. And lastly, we increased our ownership in our Philippine joint venture from 50% to 89%. 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 also continued to invest in attractive organic growth initiatives, including the planned expansion of our polyol plant in Germany to meet anticipated European demand in 2011 and beyond. We also moved forward on adding equipment to our facility in Brazil which will allow us to leverage our full product offering into the key Latin American and Brazilian markets. 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 online by year end.

These growth initiatives flow from the strength of our balance sheet and cash flow from operations, as well as our ability to find attractive acquisition targets within the current economic environment, all of which complement our organic growth activities and form the foundation of long-term growth drivers for Stepan's global business model. Building on the strength of the third quarter and year-to-date financial performance, I am pleased to announce that on October 19th our Board of Directors approved an increase of the Company's common stock dividend to $0.26 per share. This brings the annual dividend rate to $1.04 per share marking the 43rd annual dividend increase for the Company.

Let me expand on our third quarter 2010 results. Starting with the top line total net sales for the third quarter were $367 million, up 12% year-over-year. Sales for the nine month year-to-date period rose 11% to $1.1 billion. The rise in third quarter sales was primarily related to higher selling prices which accounted for 9 percentage points of the growth, higher sales volume which accounted for 4 percentage points of the growth, and both of which were partially offset by a 1 percentage point decline related to a foreign exchange translation. Overall volume increased 4% in the third quarter versus a year ago.

Net income on a GAAP basis for the third quarter declined 2% to $19.2 million or $1.73 per diluted share compared to GAAP net income of $19.5 million, or $1.80 per diluted share in the year ago quarter. Year-to-date net income rose 5% to $56.9 million. The impact of the deferred compensation plan added $0.13 to diluted earnings per share for the quarter compared to a reduction of $0.24 per diluted share in the year ago quarter. Non-GAAP net income, which includes $2.4 million in deferred compensation income, declined 20% year-over-year to $17.8 million or $1.73 per share during the third quarter. A detailed table around the financial effect of the deferred compensation plan, as well as the non-GAAP reconciliation table, have been provided in the earnings release for your reference.

Third quarter 2010 gross profit declined 15% year-over-year to $58.4 million. Year-to-date gross profit increased 1% to $185.5 million versus the year ago full year. Operating expenses for the third quarter, excluding a nonrecurring gain on acquisition, declined by $8.7 million or 23%, primarily as a result of a $6.7 million decline in deferred compensation expense and an 11% decline in general and administrative due to a reduction in estimated future environmental remediation costs, as well as an 8% decline in marketing expense, primarily due to lower provisions for performance-based compensation and bad debts. These lower areas of spending were partially offset by a 9% increase in research and development, primarily due to consulting expenses related to our European REACH product registration initiative, as well as increased head count to support growth in innovation projects. Excluding the impact of deferred compensation, quarterly operating expenses increased $2 million or 7% versus a year ago.

Turning to a review of the performance of our three key business segments, first we will look at surfactants, the largest segment of our business accounting for 72% of Company-wide sales for the quarter. Net sales of surfactants totaled $264.1 million for the quarter, an increase of 10% year-over-year. Surfactant volume increased 3% during the third quarter and gross profit declined 15% to $38.6 million versus the year ago quarter. Lower surfactant gross profit was due to competitive pricing in Europe, leading to lower margins and due to higher manufacturing costs in North America which included costs associated with the labor dispute in which the Company's Illinois plant was operated by salaried personnel. A new three year labor agreement was subsequently approved on August 19th. A large part of the surfactant volume growth was in Brazil, one of our targeted growth initiatives.

Turning to polymer segment, which represents 25% of sales, polymer net sales totaled $91.8 million for the quarter, an increase of 22% year-over-year. Volume increased 8% for the quarter versus the year ago. The growth in volume was due to continuing recovery of polyol sales volume used in rigid foam insulation markets, particularly in Europe. Phthalic anhydride volume declined 7% due to the continuing weak demand in the housing, boating and recreational vehicle industries. Polymer gross profit declined 24% year-over-year to $15 million. Higher raw material costs led to lower gross profits in North America and Europe. Competitive pressure and lagging price increase agreements did not allow for margin recovery in our polymer products.

Finally, we look at specialty products segment which accounted for 3% of sales. For the third quarter specialty product net sales totaled $10.9 million, up 1% year-over-year. Specialty products gross profit rose 1% to $5 million as volume was unchanged versus a year ago.

Looking now to interest expense which rose $500,000 or 33% for the quarter due to higher interest costs associated with the Company's borrowing of $40 million of private placement debt at a 5.88% interest rate during the second quarter. For the quarter, the Stepan Philippine income is reflected as equity income through July 19th, at which time Stepan Company increased its ownership from 50% to 89%. Income subsequent to July 19th is included in consolidated income as part of operating income. Stepan recorded other income of $2 million during the third quarter related to foreign exchange gain of $1 million and a gain of approximately $1 million from the investment income based on assets held for the deferred compensation plan Please see table three in our earnings release for a summary of the effects of foreign currency translation on net sales in key income line items for the third quarter and year-to-date periods.

Our effective tax rate for the quarter was 38.5% compared to 35.6% for the year-ago period. The higher tax rate was due to a higher mix of income generated in the US, taxable at higher rates than foreign earned income, coupled with higher provisions related to the purchase of the additional 39% interest in our Philippine joint venture.

Turning to the balance sheet, total debt as of September 30th, 2010 was $177.5 million, up $27.8 million in the sequential quarterly comparison, and up $73.4 million versus 2009. Debt and cash increased year-to-date primarily related to the Company securing the $40 million additional private placement debt in the second quarter. As of September 30th, net debt, representing total debt minus cash, was $66.5 million, up from $5.6 million at year-end 2009. The year-to-date increase in net debt was due to higher working capital requirements related to improved sales volumes and higher selling prices attributable to higher raw material costs. Cash expended on acquisitions during the third quarter totaled $24.5 million. Our total debt to capitalization at quarter end was 34.2% compared to 28.5% a year ago. The ratio of net debt to capitalization at September 30th, 2010 was 16.3% compared to 11.9% a year ago.

Capital expenditures were $37.3 million for the quarter, up 400% from the third quarter of 2009 due to ongoing expansions in Brazil, Germany, and Singapore. Looking forward we expect our full 2010 capital expenditures to be in the range of $75 million to $80 million.

Looking now to our cash flows during the third quarter, we generated $33.2 million in cash flow from operating activity, down 1.9% from the same quarter in 2009. During the third quarter, Stepan repurchased 20,000 common shares in the open market at a cost of $1.2 million. Stepan had approximately 285,000 shares remaining under its treasury share repurchase authorization as of September 30th, 2010.

Before I open the call to questions, let me provide some perspective on Stepan's forward-looking guidance for the full year 2010. Based on the strength of our year-to-date results, we have the opportunity to achieve another record full-year earnings despite the downward pressure on margins in Europe, higher spending on acquisition-related activities, and higher research costs focused on innovation for organic growth. The fourth quarter will benefit from lower manufacturing costs attributable to the absence of the nonrecurring third quarter labor dispute expenses and lower acquisition-related spending. In addition, we have announced price increases for the fourth quarter, attempting to recover some of the third quarter margin erosion. Despite the continued slow economic recovery we look forward to volume growth in 2011 due to our surfactant expansion in Brazil, our polyol expansion in Germany and the acquisition in Poland. We also look for further growth from higher value-added surfactant specialties.

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). And our first question comes from Daniel Rizzo with Sidoti & Co. Please proceed with your question.

Hi Jim. You indicated that there was some cost in the quarter from consultants you hired for REACH compliance in Europe. I was wondering if those costs were going to continue?

They're going to continue for several more quarters and then they should start to come down gradually. It is a multi-year project to compile the data, toxicity data for submission for the REACH regulatory requirements. So it won't come down quickly but it will eventually decline over the next three or four quarters.

Do you know how much that costs you in the quarter?

In the quarter, it was probably close to $1 million, maybe a little less than $1 million pretax.

In regards to the strike that ended in August, how much did that cost in the quarter?

The expense, including the direct spending and some outsourcing costs, it was probably close to $2.5 million.

Okay. And then just finally, would the CapEx expansion, the capacity expansions in Latin America and Europe, where are you with those projects?

Well, we are--We have actually started making product in Brazil and then we will have to go through the product approval because some of the first requirements for that is, is with our existing major customer down there, Unilver. We will be seeking product approval over the next few weeks and then hopefully, we will be shipping commercial quantities during the beginning of 2011. Then as far as Germany, that expansion should be completed by the end of the year, we should have available commercial quantities by first quarter as well in Germany for polyol products.

So then your CapEx would probably be coming down next year then?

Yes, absolutely. There are quite a few other requests for infrastructure improvements but we certainly would not expect CapEx to be in that $75 million to $80 million range we are hitting this year. It should come down.

Thanks, Jim.

Thank you. (Operator Instructions). Our next question comes from Gregory Macosko of Lord Abbett. Please proceed with your question.

Yes, thank you. You spoke about R&D and I know it's up 9%. I realize some of that is for the REACH registration. But you added head count. Can you talk a little bit about what your plans there are, or what you are expecting? You also mentioned, I think, relative to 2011 that those costs will be higher. So besides the REACH project what's in process for R&D?

Well, what's driving the expansion in head count is we are trying to expand our capabilities for some of the innovation projects. I think we have discussed in the past that we have a significant effort, and enhanced oil recovery. We did a joint venture with NALCO forming this TIORCO joint venture. But in addition to the lab costs and support we get from the TIORCO joint venture, we have our own R&D group working on surfactants for enhanced oil recovery. So it is the innovation projects where we are trying to staff up to meet the needs of projects that are ongoing that we hope will have commercial success in the future. For many years we have been trying to divert more of our R&D capabilities from tech service support and ongoing support of existing customers and redirected towards a higher percentage of new, new innovative type products that will be new commercial successes for the Company.

If I might ask, are you still involved in the biodiesel, is that still in process?

We have put much of the assets that were used to produce biodiesel into alternative service primarily because the economics of biodiesel today are so awful. The anticipated recovery in the biodiesel that many had expected from the government mandate of the utilization of bio-renewable fuels has not helped the business gain any strength in terms of margin. So, we are actually sitting on the sideline. We still have a few customers but it is really insignificant today. Unless there's a major change in the biodiesel economics, we're going to try and deploy those assets in traditional surfactant products.

So those are easily converted over to--?

It is a multi-purpose reactor. We had actually converted an existing reactor into biodiesel service, so now we'll convert it to other manufacturing capabilities.

I see. And then with regard to the Stepan Philippines operation and the TIORCO JV, those are both similar operations to your existing fully owned assets, and those just are in joint ventures in two different locations?

The Stepan Philippines was a 50-50 joint venture to make surfactants primarily for the Philippines and Southeast Asian markets. Our partner happened to be a raw materials supplier so they were right next door. We have increased our ownership to 89%. We have good reason to believe, we continue to grow our footprint, in economic success over there. We hope to be--We added fabric softener capabilities to that site several years ago, and we're optimistic we could be sold out by some point next year and be potentially even looking to add capacity at that site. So that's just a core surfactant plant for us with traditional sulfonation capability for laundry, and then we added fabric softener. So we have a dryer so we can take the sulfonated product through our dryer and offer it in dry form.

The TIORCO is really the joint venture with Nalco, totally focused on one end-use industry and that's enhanced oil recovery. They're interested in selling their water treatment and polymer chemicals into that space and we are interested in selling surfactants into that space. So we joined forces to share the costs of a significant investment and outlay of operation and geologists and Ph.D. chemical engineers. As crude oil continues to head up, we are optimistic, that will continue to gain some strength for us. It has been a slow project. We view it as a long term project with significant upside but it's the pace at which it is moving is slower than we would like. A lot of pilot injections of our product into oil fields. People looking for long-term results. And we are still seeing increased sales volume into that but we would sure love to see it break out in a bigger way in the near future. But the TIORCO joint venture is really targeting one segment, the enhanced oil recovery market.

Okay. But with regard to that then you are just manufacturing at your existing operations and selling it to the joint venture?

We either sell to the joint venture or we sell directly to the customer and pay the joint venture a commission.

Right, I understand. Okay, fine. So that's really sort of a marketing and product development operation then?

Very much so.

And then finally with regard, you mentioned Singapore expansion, what is that?

We recently acquired a former biodiesel plant from Peter Cremer that was located in Singapore. They had shut it down due to the poor economics in biodiesel. Those assets can be redeployed to make methyl esters. We are adding a fractionation column to that site which will give us the capability of making methyl esters. We currently make methyl esters in a fairly significant way in Illinois. This is going to give us a lower cost supply chain because the oils for making methyl esters all come from that part of the world. So instead of shipping oil we will send methyl esters to the US and it'll give us a cost effective position for sending methyl esters into Europe and South America and helping our operations there broaden and diversity their product offering into further derivatives of methyl esters. And then we view the footprint as attractive for gaining entree into Asia.

I see. Okay. Very good. Thank you.

Thank you. (Operator Instructions). Mr. Hurlbutt, I will now turn the conference back to you for closing remarks. Please go ahead

Okay. If there's no further questions, I just want to thank everybody for participating in today's call and look forward to talking to you again. Thank you very much. Bye bye.

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