Stepan Co (SCL) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2011 earnings 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, Wednesday, July 27, 2011. I would now like to turn the conference over to Jim Hurlbutt, Vice President and CFO. Please go ahead, sir.

Good afternoon, and thank you for joining the Stepan Company second quarter 2011 financial review. Before I begin, please note that information in this conference call contains forward-looking statements which are not historical facts. These statements about 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.

Stepan's second quarter results reflect our successful execution, as we delivered double-digit sales and net income growth versus the year ago period. Sales increased 30% year over year, with net income growth of 22%. The strength of our balance sheet allowed us to make a number of strategic acquisitions, and expansions in recent quarters in key geographies such as Brazil, Singapore, Germany and Poland. These new assets will further enable Stepan to accelerate growth across our key businesses.

During the second quarter, Stepan announced the acquisition of select Lipid Nutrition specialty food ingredient lines from Lipid Nutrition B.V., a part of Loders Croklaand B.V.; which included their Clarinol, Marinol, and PinnoThin product lines. These offerings will be integrated into Stepan's food and health specialties business, which will be renamed Stepan-Lipid Nutrition. We see excellent opportunities for these acquired products on a global basis, as healthy food products outpaced the broader food categories in terms of growth. Manufacturing will be done at Stepan's Maywood, New Jersey plant; as well as at existing outside contract manufacturers for sale in international markets. The Lipid nutrition product lines, combined with our NEOBEE medium-chain triglyceride products, provide us with a unique portfolio of nutritional fats for the food, supplement, and nutrition industries. Overall the acquisition should contribute to earnings this year, and provide longer term synergies with our existing food ingredient business.

In our broader business, higher raw material prices continued to be influential during the quarter. Prior price increases helped drive selling prices and net sales. Overall, we are pleased with our achievements in the first half of 2011, as we leverage our new growth drivers, and aim to deliver full-year earnings growth.

Let me walk you through the second quarter results. Starting with the top line, total net sales for the second quarter were approximately $477 million, up 30% year over year. The rise in second quarter sales was primarily related to higher selling prices, which accounted for 25 percentage points of the growth, combined with a 5 percentage point increase related to foreign exchange translation. Overall, quarterly sales volume grew by less than 1%. A 6% increase in polymer sales volume was largely offset by a 1% decline in surfactant volume. Net income attributable to Stepan Company on a GAAP basis for the second quarter totaled $20.9 million, or $1.87 per diluted share, up 22% versus the year ago quarter. The impact of deferred compensation reduced diluted earnings per share $0.02 in the second quarter. Non-GAAP net income, which excludes approximately $302,000 in pre-tax deferred compensation income, increased 8% year over year to $20.7 million or $1.85 per diluted share. A detailed table outlining the financial effect of the deferred compensation plan, as well as a non-GAAP reconciliation table has been provided in the earnings release for your reference. Second quarter 2011 gross profit increased 10% year over year to $69.6 million. Selling price increase, and improved sales mix led to the improvement.

Moving on to quarterly operating expenses, which rose 5% year over year, administrative general expenses rose by 13% for the quarter and 8% year to date. Our growth initiatives in Singapore, Brazil and Poland contributed to the increase, coupled with the effect of foreign currency translation.

Research expenditures rose 6% for the quarter, due to higher salary expense, which includes new head count in Poland. Marketing expense rose 30% for the quarter, and 13% year to date. Investments' plan to accelerate growth in Singapore, Brazil, Poland and the consolidation of the Philippine operation accounted for nearly half of the growth and marketing expense. Higher travel expense and the effect of foreign currency translation incurred outside the US contributed to the remaining increase.

Turning to our business segments, first we'll look at surfactants, the largest segment of our business, accounting for 72% of company wide sales. Net sales of surfactants totaled $343.8 million for the quarter, an increase of 30% year over year. Sales volume declined 1% for the quarter, due to weaker volumes in consumer products, partially offset by improved sales in agricultural and oil field segments. Oil field volume improvement was driven by increased sales into the enhanced oil recovery applications. Surfactant gross profit rose by $1.5 million, or 3% for the quarter, due to a more favorable sales mix in North America and Europe that was partially offset by lower consumer product sales volume.

Latin America gross profit declined due to higher expenses associated with our Brazilian expansion. Latin America volume grew by 22%. Surfactant earnings should improve as growth from our higher margin functional surfactants offset the weakness in consumer volumes. Surfactant demand for enhanced oil recovery continues to grow. As pilot surfactant floods conclude, we should have a better understanding of the future potential of this market. Our Brazil expansion is now complete, and we believe that we will have an improved contribution from this facility in the third quarter.

Moving on to our polymer segment, representing roughly 25% of sales, polymer net sales totaled $120.9 million for the quarter, an increase of 33% year over year. Volume increased 6% for the quarter, versus a year ago. Polymer gross profits surged 37% to $20.6 million, compared to $15 million a year ago. The improvement was largely due to the 12% increase in polyol volume, coupled with improved margins, particularly in Europe, which had experienced margin erosion over the last year as commodity raw material costs escalated. The improvement in our polymer business is in line with our expectations. The sold out demand for our polyol at our German plant will continue to require imports from our Illinois plant for the balance of the year, due to a delay in the start of the new German capacity. Our Polymer plant in Poland should see improved volume over the balance of the year as we begin fulfilling new customer demand.

External sales of pthalic anhydride declined by 10%, while profitability improved on higher margins. The lower pthalic anhydride volume relates to recurring weakness in polyester resins used in automotive, boating, and the construction industries. However, internal consumption of pthalic anhydride in our polyol products increased on the growth in our polyol volumes. Polyol sales volume increased 12% versus the year ago quarter. Stepan's polyols are primarily used in new and replacement commercial flat roof insulation, and we anticipate continued strong demand for polyol used in the replacement roofs and metal panel applications, driven by energy savings. It is important to note our insulation business is primarily commercial in nature, not linked to residential construction.

Finally, we looked at our specialty product segment, which accounted for 3% of sales. For the second quarter, specialty products net sales totaled $12.4 million, up 12% as compared to a year ago. Specialty products quarterly gross profit declined 4% year over year to $4.4 million. The decrease was primarily due to lower margins in our food ingredient business, precipitated by higher raw material costs and competitive pressure on selling prices. Specialty products sales volume rose 8%. Specialty product earnings will benefit from the recently announced Lipid Nutrition product line acquisition, which I discussed earlier.

Looking now to interest expense for the quarter, which was $2.2 million, which rose 45% versus the year ago, largely due to higher interest costs associated with the Company's borrowing of $40 million of private replacement debt in 2010, carrying a 5.88% interest rate. Please see table 3 in our earnings release for a summary of the effects of foreign currency translation on net sales, and key income line items for the second quarter of 2011. Our effective tax rate for the quarter was 33%, compared to 35.3% for the year ago period. The decrease was primarily attributable to the implementation of a holding company structure that will provide a recurring benefit in lowering the effective tax rate in foreign earnings.

Turning to the balance sheet, total debt as of June 30, 2011 was $190.8 million, up $5.1 million in the sequential quarterly comparison, and up $41 million versus June 30, 2010. The increase in debt versus the year ago was primarily attributable to financing recent plant expansions in Brazil and Germany, as well as acquisitions in Singapore and Poland, coupled with higher working capital requirements. As of June 30th, net debt, representing total debt minus cash, was $165.2 million, up $84.8 million since year end 2010. Our year-to-date increase in net debt was primarily due to the inflationary impact of higher commodity raw material costs on inventory and receivables. The second quarter increase also included the $13.6 million Lipid Nutrition product line acquisition, which included $5 million of inventory. Our total debt to total capitalization at quarter end was 32.2% compared to 32.1% a year ago. The ratio of net debt to total capitalization at quarter end was 29.2% compared to 9.2% a year ago. Capital expenditures were $17.9 million for the quarter, and $40.4 million a year ago. Looking forward, we expect our 2011 full year capital expenditures to be within the range of $90 million to $100 million, including the expansions in Singapore and Germany. During the second quarter, Stepan repurchased 16,000 shares in the open market at a cost of $1 million. Stepan currently has approximately 235,000 shares remaining and available under its treasury share repurchase authorization.

In terms of returning value to our shareholders through cash dividend distributions in the second quarter of 2011, Stepan paid out a total of $2.8 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 projections. Our growth initiatives are on track to deliver future earnings in 2012. Surfactant earnings will improve this year, as growth from our higher margin functional surfactants offset the weakness in consumer volumes. Surfactant demand for enhanced oil recovery continues to grow.

Our Brazil expansion is complete, and we will have improved contribution in the third quarter. The significant improvement in our polymer business this year is in line with our expectations. The sold out demand for polyol at our German plant will continue to require imports from our Illinois plants for the balance of the year, due to the delay in the expansion of the German capacity.

Our polymer plant in Poland should see improved volume over the balance of the year, as we begin to fulfill new customer requirements. Specialty product earnings will benefit from our recently announced Lipid Nutrition product line acquisition. While 2011 will have some planned higher costs associated with our global growth initiatives, we have the opportunity to deliver full year earnings growth.

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 questions.

(Operator instructions) Our first question comes from the line of Daniel Rizzo with Sidoti & Co. Please proceed with your question.

Hey Jim.

Hey Dan.

With the plant -- you're shipping polymers from Illinois to Germany, is there a reason why you are not doing it from Poland to Germany?

Well the Poland plant is rapidly filling up, with a different polyol than the polyol product made in Germany. We don't have duplicate capability in Poland to meet the polyol requirements currently coming out of Germany. So, we are going to ship those from Illinois, and fill the new demand for this other flavor of polyol from the Poland plant. We actually expect the Poland plant to be fairly full within the next 12 months, and the demand coming off Germany is going to have to be supported. But we hope that the German additional capacity is up before year end, and that will de-bottleneck the whole pipeline.

Okay. And then, with enhanced oil recovery it seems like things are progressing. How many commercial contracts do you have now?

We are working with over a dozen people. Mostly in the pilot flood stage still, as they try to prove the efficacy of the yield improvement they are looking for. We have had 2 that have gone to larger scale commercial floods, and we are still optimistic that in the next year or 2, we'll see some more significant volumes. Today the volumes are relatively small. But the profitability of this is still a significant opportunity for us that we are going after.

Okay and then just with the acquisition you did for the Lipid business, how much did you acquire in terms of sales?

It's a small little niche business, probably about $20 million in sales revenue, currently. But, this is a much higher margin business than surfactants or polymers, being a specialty food business. So, it should have a nice potential to contribute this year and should be accretive to earnings this year.

Alright. Thanks Jim.

Okay. Thanks Dan.

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

Hi Jim.

Hi Beverly.

I was wondering if you could talk a little more about the polymer sales, and really the product that is in such demand in Germany. What is the situation, though, for demand of the rigid insulation in the United States?

It is very strong. We are seeing the same phenomena in North America as we are in Europe. We still believe that this business can generate 10% or better volume growth for the foreseeable future. Really, a couple of things driving it, it's the combination of pent-up roof replacements -- clearly during the recession people were deferring all deferrable expenditures. So, there is clearly a pent-up demand for roof replacement in North America and Europe. Obviously, in the northern climates where you get ice, there is an obsolescence on a flat roof, 15 to 20 years. We do believe there is pent-up demand; it seems to be corroborated by the coatings manufacturers. But in our case we are getting a little of the added benefit of, when they go to replace the roof they are looking for energy savings and they can choose to use more insulation than was on the roof originally. We believe we are getting the double benefit of a pent-up demand, and the increasing desire to save money on energy consumption by putting better -- more insulation down on the roof.

I can certainly relate to that. Our building just put on a new roof last year --

I hope they used Stepan foam.

I don't know what they used, per se, but I'll tell you we had no insulation and now we have 3 inches, maybe more of something up there.

Good.

So, now your facility in Illinois has enough capacity to meet the US demand as well as ship overseas?

We are going to push our Illinois plant to its limit to try and accommodate that. Current forecast levels, we don't see us losing any sales volume as a result of the delay in bringing up the German expansion. We think we are going to be able to accommodate all sales needs by shipping from the US, although, at a several million dollar freight disadvantage.

You keep talking about new growth drivers for the business. Clearly over the last 3 years the Company has sort of taken off. I was wondering if you could elaborate again on where the direction of the Company is going? Because things have changed. I was wondering if you could remind us where you plan to take the Company going forward? Is this a sustainable growth pattern? Because we had a little bit from biofuels and that kind of petered out and now, clearly things are different. But maybe if you could just elaborate again on that?

Just briefly on the biodiesels, we are selling a couple of biodiesels today. It's an opportunistic play. That market was strong for a couple years and then died. We will participate in that market opportunistically. The growth driver for the surfactant business now that we've got the franchise producing pretty good returns that can support growth is really twofold within surfactants; we have a large merchant market share in North America. The opportunities for growth for us is to take that franchise into global markets that we think are attractive. For example, Brazil is 1 where we are really pushing hard because it is a very large country, diverse surfactant markets, not tied just to the more commodity laundry market but also a large specialty surfactant and Ag surfactant marketplace. And it's converting to more surfactant usage as they migrate from bar soaps to powders to liquid laundry. There is a certain evolution there conducive to surfactant consumption.

So, would you say they are behind the times in that marketplace?

Yes. In some respects, in terms of the evolution of the surfactant market, yes, it's more where the US was in the 50s than -- and even Europe has been continuing evolve from powders to liquid. But global growth is a critical avenue for Stepan with a large market share. In North America, we have to reach for the growth opportunities outside North America to replicate our surfactant franchise elsewhere, which is clearly 1 of the goals. And then we do look for internal growth through extensions of our product lines and the enhanced oil recovery being the 1 we are very focused on right now. But here are other areas we'll continue to focus on to broaden that surfactant offering into areas where we don't have a large market share, or where there is a new market forming, such as enhanced oil recovery.

Polymers is his clearly going to be led by our insulation foam, but the growth beyond that -- we are certainly looking at expanding into coatings, adhesives and sealants, flexible foams, and also selling more heavily into the European systems market. The people we used to compete with in the systems market are now willing to buy polyols from us in their formulations. There is a broadening of that market in addition to our continuing efforts to take advantage of the significant growth opportunities in the rigid foam insulation market.

Okay great. Great. Thanks. That kind of explains where you're going. I appreciate that.

Sure, thanks Beverly.

Next question from the line of Jeff Hershey from Columbia Management. Please proceed with your question

Hey Jim, how are you?

Hey Jeff.

With a German plant expansion, can you refresh my memory about what the capacity is of the plan? When exactly do you think it will start up, and when will it begin to contribute to profitability?

We had a small fire in that facility that delayed the start -- well we had started without the small fire. We've got to replace some of the infrastructure, not the new reactor, that was undamaged. So, we anticipate probably October and November would be the earliest that capacity will come on. It was between I think it is 30 metric tons to 40 metric tons of capacity, I'm drawing a blank whether it is 30 or 40 right now. So, it's significant, it almost doubles our capacity out of the German facility. Once we get that up and running we should have adequate capacity for, hopefully, at least a couple more years.

Okay. Then on the Brazil expansion, can you just quantify the impact on overall surfactant gross profit margins from the expansion in terms of what the negative impact was this quarter?

Let's see. There was roughly $2 million of pre-tax expenses in the quarter. So, net about, say, $1.5 million. So, not significant, but we hope to reverse that and make it contributing in the third and fourth quarter.

Okay. Finally, maybe spend a minute or so on the surfactant business on the consumer side. Volumes have been pretty weak there for a couple of quarters. Do you think there is demand construction going on with the price increases that you put through, or do you sense any share loss? Maybe provide an update there.

Clearly, we think the raw material pricing has driven reduced consumption and/or reduction in the active ingredient used in the bottles. So, there is a combination of both probably going on, and we expect it to be that it is driven by the high pricing today. Going forward, normally in a cycle like this, you are only going to take actives out until the consumer gets upset with the performance of the product. So, we think we are probably going to see it leveling out now. Hopefully, we'll see increased volumes. There is always the demand shift. As Proctor goes after market share, most of their requirements are met internally from their own capacity. So that, they would be dipping into the merchant market that we sell into, when they recover market shares. There could be some of that going on, because we do know that Proctor lost market share during the recession.

Perfect. Thanks.

Our next question comes from the line of Gregory Macosko with Lord Abbett.

Yes. Thank you. I missed 1 point you talked about -- you are working with the customers on pilot demand. Was it in the oil field area? Or where was that? Would you explain?

That's enhanced oil recovery. We have been working hard with -- formed a joint venture with Nalco called TIORCO, we've been working for several years now to grow that market. It's a technology that's been around for quite some time, and with the increased price of crude oil, we have a lot more interest from oil field operators to inject surfactants into a water flood oil field, an older oil field that is now using water to push the oil through. If you add a surfactant, you can literally scrub more oil out of an older oil field. These pilot floods are being done by operators, typically, who have a water flood field. Then they can move to the next step and incur more expense up front, adding the surfactant, but we are seeing enough increased oil yield from the surfactant to stimulate their interest.

In terms of this particular situation, how many customers do you have in that area and what is the potential there?

Today, like I said, we are working with about 12 companies in pilot or semi-commercial floods. Frankly, our own internal estimates is that is just a small, small fraction of the potential of this market if people see the demonstrated benefits of the surfactant and the higher yield coming out of the ground, we think the potential is very large. Obviously, that potential is going to be -- 1 of the key assumptions is the price of crude oil. Certainly at these prices, there should be strong interest for enhanced oil recovery. Currently the global demand for oil is such that we don't anticipate a significant drop in price of crude oil. So, we think there is a significant potential out there.

In terms of the profitability or I assume that this is, at this point, a loss.

It's about break even. We'll probably make a little bit of money at this business this year. We're incurring significant costs through our joint venture with Nalco. Then, we sell direct to the customers the surfactant. Today we are about break even. By year end, we would probably be slightly profitable on this business. Again, it's a developmental project in our minds. We hope it has significant upside potential. We would have liked to have seen it move along a little faster than it has over the last year or 2. We still think that there is significant upside potential. We are clearly not alone. There are other surfactant providers are going after this market. We know certainly that Rhodia and Cagnes are interested in servicing this business.

Would you talk about Singapore? You didn't -- you talked to Brazil and some of the other, but Singapore, in terms of that expansion?

That's a longer-term project. What we are doing there is building a methyl ester fractionation column to replace 1 we currently have in Illinois. And that will provide methyl esters, which we derivatized from tropical oils, and they're an ingredient in lots of our surfactant products. We'll be shipping those intermediates back to Illinois, and our other plants in Europe and South America are going to help develop a broader product portfolio offering in those regions of the world. So, the initial play is largely to derivatize tropical oils into methyl esters that we have existing know-how in processing technology. Using that Singapore plant is a stepping stone into other surfactant chemistries to start serving primarily the Southeast Asia region of the world. So initially, it is not going to contribute, -- it won't contribute much until next year, and even then, it will probably just be a few million dollars savings on our methyl ester cost structure. Sales volume growth will probably be more likely to see some added benefit in 2013.

Okay. Thank you very much.

Sure.

Our next question comes from the line of Greg Halter with Great Lakes Review. Please proceed with your question.

Hi Jim, good afternoon.

Good afternoon.

Looking at your capital spending, which has been accelerated here for some of these moves, you have indicated $90 million to $100 million this year. Just wondering, if you could elaborate on how you see that playing out over 2012 and beyond? Will it remain at such a high level? Or do you see some of that pulling back?

Well, first let me clarify. The base capital to keep all of our plants running is probably now closer to the $40 million number. So, in an ongoing spend level, you are going to need $40 million to keep your current operations up and running. We do see 2012 will most likely be in that $100 million range, provided some of the opportunities we are investigating today come to fruition and receive board approval. We are looking at several growth opportunities, continued growth opportunities in Brazil, additional chemistry opportunities in Europe. Then, we are still looking for are forward to relocating our China polyol plant in Nanjing to a new plant there site there, as the government is relocating everybody within the chemical zone we are in. So, we do see a fair amount of potential capital expenditures over and above that $40 million repair and replace spend annually, at least through 2013.

Okay. And relative to the German situation -- and obviously, you had the fire with some delays there, and the importation from your plant here in the US. Did you comment on what kind of cost that has been or was in the quarter?

It was late in the quarter, so it really didn't significantly effect the second quarter. But it certainly is going to add, at least, $2 million of freight and logistics costs to the second half, depending upon the actual time in which we bring up the unit in Germany.

Okay. That was the $2 million you discussed with about $1.5 million after tax?

I think that was in reference to the higher costs in Singapore -- I mean in Brazil. We incurred higher costs. (multiple speakers.) That would be a second half -- first half, second quarter event of higher costs. So, we do expect -- I probably didn't adequately clarify that. We do expect significant improvement in the profitability of Brazil in the second half as a result of not having the $2 million nonrecurring expenses, as well as having the gross profit on the increased volume coming out of that site. So, this swing could hopefully be quite a bit more than just the $2 million. First half-second half.

And relative to your balance sheet, I know you gave some data on current assets and liabilities. Would you have available a couple of key items, like receivables, inventory and payables?

Sure. You mean, the actual balances at quarter end?

Yes. If you've got those.

The consolidated -- hold on, I've got them right here. It's material -- the increase in working capital is clearly material. At the end of June 30, consolidated accounts receivable was $295 million, up from $200 million at year end, last year. Inventories are $159 million up from $96 million at the end of 2010. And then the offsetting benefit of payables is up $174 million from $115 million. We are going at total working capital of $180 million at the end of last year to $280 million, or $100 million.

Okay.

So, part of the increase -- or decrease in the -- you know, we have been carrying a significant cash balance. A lot of that has been consumed over the last 6 months as we have had to invest that in working capital; most of that due to inflation, but part of it is due to the expansion, or acquisitions too.

Okay. Relative to your recent acquisition, where you mentioned the sales of about $20 million annually with higher margins, what kind of growth expectations do you have for that business? Is this a 10% grower, a 20% grower, a 2% grower?

Because it's in the nutritional category, we are hoping for double digit, 10% or better growth. Certainly more and more interests, particularly in the older population for most of the end use applications of these products.

Okay. And that is what I had. Thanks very much.

Okay. Thanks Greg.

Mr. Hurlbutt, there are no further questions at this time. I'll turn the call back to you. Please continue with your presentation or closing remarks.

I have no other presentation and I just want to thank everybody for participating in today's call. Thank you very much.

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