Stepan Co (SCL) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company third quarter 2011 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 Wednesday, October 19, 2011. I would now like to turn the conference over to Mr. Jim Hurlbutt, Vice President and CFO with Stepan Company. Please go ahead, sir.

Good afternoon, and thank you for joining the Stepan Company third 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 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.

Stepan's third quarter and year-to-date results reflect continued improvements across the key financial metrics, including net sales, gross profit, operating income, and net income. Building on the strength of our third quarter and year-to-date financial performance, I am pleased to announce that on October 18, 2011, our Board of Directors approved a 7.6% increase in the Company's quarterly cash dividend on its common stock to $0.28 per share.

This brings the annual dividend rate to $1.12 per share and marks Stepan's 44th consecutive annual dividend increase, highlighting our consistent focus and dedication to returning value to our shareholders. The Board of Directors also declared a quarterly cash dividend on its 5.5% convertible preferred stock at the quarterly dividend rate for an annual rate of 1.375 per share.

Turning to our results, overall, we are executing on our strategic initiatives and remain on track to achieve another record year of earnings. Let me walk through our third quarter results. Starting with the top line, total net sales for the third quarter were approximately $499 million, up 36% year-over-year. Sales volume grew by 4%.

Higher selling prices accounted for 29 percentage points of the growth, and foreign exchange translation added 3 percentage points to the increase. The quarterly sales volume growth of 4% was led by polymer sales volume rising 10% and surfactant sales volumes rising 3%.

Net income attributable to the Stepan Company on a GAAP basis for the third quarter totaled $19.2 million, which is unchanged from the prior year. GAAP earnings per share was $1.70 per diluted share, down 2% versus the year ago.

The impact of deferred compensation reduced GAAP diluted earnings per share by $0.05 in the third quarter. Non-GAAP net income, which excludes approximately $543,000 in pretax deferred compensation income, increased 5% year-over-year to $18.6 million.

Non-GAAP EPS was $1.65 per diluted share, up 3% year-over-year. A detailed table outlining the financial effect of the deferred compensation plan has been provided in the earnings release as table 2 for your reference.

Net income was negatively impacted this quarter by $2 million in other expense as compared to a gain in other income of $2 million in the year-ago period. The third quarter 2011 other expense was comprised of $760,000 of foreign exchange losses, and $1.3 million investment loss related to assets held for the deferred compensation plan.

Both of these items showed gains in the year-ago period. Also, please see table 3 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 2011 period.

Third quarter 2011 gross profit increased 10% year-over-year to $64.1 million. Selling price increases and an improved sales mix drove the improvement.

Turning to operating expenses, which rose 12% year-over-year. Investment for future growth opportunities in Singapore, Brazil, Poland, the Netherlands, and the Philippines have increased total operating expenses by $2.1 million for the quarter and $5.1 million for the year-to-date period.

Administrative, general expense rose by 18% for the quarter and 11% year-to-date. It's important to note that the prior year included a $1.4 million credit for lowered estimated future environmental remediation costs.

Excluding the impact of that year-ago credit, administrative expense rose just over 4% year-over-year. Our recent global expansion activities and foreign currency translation also contributed to the increase.

Research and development expenditures rose 7% for the quarter due to higher salary expense, which includes new head count in Poland. Marketing expense rose 16% for the quarter and 14% year-to-date.

Again, investments in Singapore, Brazil, Poland, and Netherlands and the Philippines have led to the increased personnel supporting the marketing efforts in those regions. Foreign currency translation also contributed to the higher expense.

Looking now to interest expense for the quarter of $2.3 million, which was up 13% versus the year-ago period, largely due to higher debt levels associated with the Company's borrowing of $40 million of private placement debt in 2010 and a 5.88% interest rate. The effective tax rate was 31.9% for the quarter, down from 38.5% a year ago.

The year-to-date effective tax rate was 31.9% compared to 36.2% for the prior year. The decrease was attributable to a non-recurring provision in the prior year related to the purchase of an increased ownership in our Stepan Philippine joint venture, and also contributing to the decrease was the implementation of a holding company structure that will provide a recurring benefit in lowering the tax rate on foreign earnings.

Let's move to a review of the performance of our 3 key business segments. Surfactants, the largest segment of our business, accounting for 72% of Company-wide sales. Net sales of surfactants totaled $361.9 million for the quarter, an increase of 37% year-over-year.

Sales volume rose 3% for the quarter, primarily due to strength in Latin America and Asia. North American volume declined slightly on continued weakness in demand from consumer product applications which offset growth in biodiesel and functional surfactants that are used in agricultural and oilfield applications.

Oilfield volume improvement included increased sales into enhanced oil recovery applications. Surfactant gross profit rose by $3.6 million, or 9% for the quarter, due to a more favorable sales mix in North America that offset the impact of weaker consumer product sales volume. Our Brazilian expansion also contributed to the higher gross profit, as sales volume there grew by 20%.

Moving on to our polymer segment, representing roughly 24% of sales, polymer net sales totaled $120.1 million for the quarter, an increase of 31% year-over-year. Volume increased 10% for the quarter versus the year-ago. Polymer gross profit rose 15% versus a year ago to $17.2 million.

The improvement was largely related to a 16% increase in polyol volume, coupled with our ongoing efforts to recover higher raw material costs through higher selling prices. Polyol sales volume increased 16% versus the year-ago quarter.

Stepan's polyols are primarily used in rigid foam insulation, particularly for new and replacement commercial flat roof building insulation. Our insulation business is primarily commercial in nature and not linked to residential construction. We are also seeing growing demand for our polyol product in metal insulation -- metal panel insulation and adhesive applications.

The sold-out demand for polyol at our German plant required imports from our Illinois plant due to delay in the new German capacity caused by a fire. The higher cost of supplying polyol from the US to Europe adversely impacted the polymer segment gross profit by $1.8 million.

Repairs to the German plant should be completed during November. The potential benefit of any recovery under business interruption insurance will not be recorded until a settlement is recovered.

Lastly, we look at our specialty products segment which accounted for approximately 4% of sales. For the third quarter, specialty products net sales totaled $17.4 million, up 60% as compared to the year-ago. Specialty products quarterly gross profit increased 5% year-over-year to $5.3 million, driven by higher sales volume associated with our acquisition of the Lipid Nutrition product line in June of this year.

Turning to the balance sheet, total debt as of September 30, 2011 was $186.6 million, down $4.2 million in the sequential quarterly comparison and down $5 million year-to-date. As of September 30, net debt representing total debt minus cash was $154.2 million, up $73.8 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, as well as the $13.6 million Lipid Nutrition product line acquisition.

Our total debt to capital -- debt to capitalization rate at the quarter-end was 31.8% compared to 34.2% a year ago. The ratio of net debt to capitalization at quarter-end was 27.8% compared to 16.3% a year ago.

Capital expenditures were $$20.6 million for the quarter and $61 million year-to-date. Looking forward, we continue to expect our 2011 full-year capital expenditures to be within the range of $90 million to $100 million, including capacity expansions in Singapore and Germany, and including the $12.2 million purchase of the Millsdale warehouse, which was recorded earlier this year within financing activity.

For the third quarter, cash flow from operations was $33.9 million compared to a source of $33.2 million for the same quarter in 2010. During the third quarter, Stepan repurchased 5,000 shares in the open market.

Stepan has approximately 214,000 shares remaining under its treasury share repurchase authorization as of September 30, 2011. In the third quarter, 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 financial guidance. Our growth initiatives remain on track to deliver increased earnings in 2012. We expect surfactant earnings to improve in 2011, 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 delivered improved results in the third quarter. The recent fall in commodity prices should improve margins in the fourth quarter.

Global polyol volume continues to benefit from recommendations to use higher insulation levels to reduce energy consumption, as well as other new applications for our polyol. Our polyol supply chain costs will decrease in 2012 as we begin to utilize our expanded capacity in Germany.

Specialty product earnings will benefit from our Lipid Nutrition product line acquisition. In 2011, we have the opportunity to achieve our fourth consecutive record income year, despite the economy and the higher expenses associated with our growth initiatives in Brazil, Singapore, Poland, and the Netherlands.

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 we have our first question from the line of Daniel Rizzo with Sidoti & Company. Please proceed with your question.

Hi, Jim, how are you?

Hi, Dan.

The enhanced oil recovery, you said that sales were improving. Do you have a dollar amount on how much sales you got from that in the quarter?

You know, I should, and I don't have it right in front of me, Dan. Let me get that. It's up from the second quarter, but it's still I would say -- the progress has been similar to what I stated last quarter. It's moving slower than we had hoped. There are still -- our pilots are in place. We know we've got a commercial flood. The rate of commercial adaptation, though, is certainly still slower than we would have hoped at this point in time.

You still just have that 1 commercial flood, and that's it?

Yes, and then about a half a dozen pilot projects ongoing as we speak. So it's still, we've said before, it's -- we're going to do a little bit better than breakeven on the project this year between our costs of the joint venture and our sales into that space -- the gross profit on our sales in that space. We hope to make a little bit of money on the business next year, and we hope still to see some significant opportunity develop by 2013.

So, is there a definitive timeframe with these pilot programs? Does the decision have to be made by now? Or is it kind of like a feel your way through-type process?

Well, it's a little of both. What we're seeing is they are getting the results back and then deciding whether they want to go to a commercial scale or pilot more fields in the immediate area or tweak the formulation. And so, it's been a mixed bag of what the pace of adoption is going to be. We're getting positive results from field work. It's not always maybe the same, as high a result of yield improvement as they are initially hoping. And so, they may look for alternative solutions to try and restimulate that field to a higher level, by possibly even going back and pushing more surfactant through the same pilot field. So, we're getting a mixed bag of results at this point. But, I think the guys that are very much interested in this are committed to trying to make it successful.

Okay, and then with the Brazilian plant that's now online. I know things are improving. Is that profitable at this point? Is it accretive to earnings?

Yes -- no, it's accretive to earnings, and we should see more improvement next year, because as you know, we got off to a slow start. But the third quarter results are more indicative of what the Brazilian operation can deliver.

Okay, and then raw material costs -- they've been rising for most of the year. But it just seems like some of the indicators are suggesting that prices have fallen in the past couple of months. Are you seeing that at all?

Again, it's been a mixed bag. Clearly, there's a significant decline that's been occurring very recently in quite a few of the [feed stocks] we utilize. Surprisingly, though, some have not been coming down very fast and [ortho xylene], one of the products we use in our polyol group is 1 of those one's that has not been falling yet. We think that's about to change, and that's going to come down, too. But, yes, they didn't come down as fast as crude oil came down. But now suddenly, there seems to be both the earlier drop in crude combined with what would appear to be softness in demand is causing the commodity guys to start cutting their price. It's good news/bad news. I hope it's not an indicator that the overall economy -- global economy is slowing down. But from our selfish perspective, we're happy to see the raw material pricing reductions, and we would hope that at this point, we don't see any indications that would turn on us very quickly going into 2012. Because of the size of some of the reductions we're seeing, that should carry over into lower raw material costs into 2012 as well.

So, price hikes by you is probably not going to be necessary going forward?

Did you say price increase?

Price hike -- your own price hikes?

No, no, we'll be under pressure to give price reductions.

Okay. That's what I figured.

The challenge now is how much -- how much of that can we put in our pocket?

Got you. Alright. Thanks, Jim.

Sure, Dan.

Our next question comes from the line of John Roberts with Buckingham Research. Please proceed with your question.

Good afternoon, Jim.

Hi, John.

Is the weakness in the consumer surfactant volume in North America still Proctor & Gamble having lost [in] consumer share? And therefore have taken more business in-house for them since they've got the capacity?

Not, not entirely. For us, it's more across the spectrum. And part of it, we have confirmed is less active surfactant ingredient in the product on the shelf at the retail level. So, there's been a reduction in the amount of surfactants that some companies have put into their products. So it's a little broader than just the dynamics of Proctor. We don't sell -- a lot of what we sell to Proctor are specialties. Now, their commodity needs, they meet largely through their internal production capacities. So, it's less of a concern for us. Obviously, if they retake market share, it may come out of the merchant market, which we supply, too. So, that's bad for us, and we know that they had lost market share during the recession and are fighting to gain it back. But at this point, we don't see a significant contraction due to what we call backward integration into the assets of Proctor. It's more of an across-the-board contraction that we're seeing in the demand for surfactants and consumer products.

Now, I'm unaware of any reports of performance issues in the detergents? I don't see that Consumer Reports or some consumer group has talked about the quality or performance of soaps, the laundry detergents, et cetera, being poorer. Have the customers successfully done this reformulation? So this is business that will never come back?

We're hoping that's not true. We hope that as costs come down that the brand companies will want to make sure they are competing effectively with the premium brands out there. So we do have, we are aware that some people in the fight to take share from Proctor's Tide had actually been increasing active ingredients. So, we would hope others may follow suit and do the same. But it's hard for -- I guess it's hard for the consumer to see if it's a small reduction. If you're only reducing the amount of surfactant actives by a small percentage, probably not too noticeable to the consumer. But obviously that directly impacts us.

Lastly, is there a small segment of the market that's taken a lot of surfactant out or almost all of the detergent market has taken a small surfactant --?

No, no, no, certainly has not been across the board, but we're aware of at least 2 or 3 where we know they have taken down actives.

Okay. So it's a couple of the low-- just a few of the low-end products that have done it?

Yes, and our own internal feeling is that the performance is going to -- has always ends up being more important to the brand than the raw material savings, and they will get the actives back up to protect their brand performance.

Okay, thank you.

Sure.

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

Good afternoon, Jim.

Hi, Greg.

Wondered if you could run through a couple of the balance sheet items if you've got those available. Like receivable balance, inventory payables, cash?

I certainly could. Obviously, it's been a big use of cash during the year, and that we expect to see some relief on in the fourth quarter partly due to these -- a little bit due to the seasonality of our business falling in the fourth quarter, but also due to the declining feed stock prices will help reduce our working capital. But at the end of September, our consolidated receivables are $291 million.

Okay.

Versus a year ago, $199 million. Our inventories are $137 million versus $96 million at the end of 2010. And did you want the payables?

Yes, payables, if you have them.

Payables are $152 million versus $115 million at the end of last year.

Okay. Your cash balance, I think it was $26 million -- about $26 million at the end of June. Do you have that as well?

I do. $32.4 million at the end of September.

Alright. And you commented about the tax rate with the new holding company structure. Is a rate around 32% going forward something that we can expect?

That's a good run rate for us. It should be around that 32% going forward.

And that's 2012 and beyond hopefully?

Yes, yes.

Okay.

Unless Washington does something.

Yes, right, you can count on that. We just don't know what. On the capital spending side, you commented that $90 million to $100 million is the expectation for this year. Any reason to expect that to change dramatically, either up or down for 2012?

No, we have enough projects on our plate right now that we are certainly anticipating the possibility of spending another $100 million next year. That may be a combination of CapEx and acquisition opportunities. We don't know for sure yet. Yes, we're trying to temper people's expectations that we're not going to drop back to a repair and replace capital spend level which might only be $50 million. But that's unlikely, given the number of projects we have.

And you mentioned acquisitions. Can you talk about the effort there in terms of what you're seeing in terms of pricing? Or what direction you may want to go into?

I can't comment on anything specifically, but we have been for several years now actively interested in pursuing all opportunities for growth. Whether first goal is organic growth through innovation and better asset utilization and then global growth through expanding our presence around the globe. So, acquisitions really comes in third, but it's something we've been actively pursuing the last couple of years for things that would fit nicely and be synergistic with our business.

Unfortunately, yes, multiples did not come down coming out of the recession. We had hoped there would be more opportunities at more attractive multiples, but a lot of the deals were getting done at 7 to 8 times EBITDA which is still a fairly hefty price within the chemical industry. So, we've been really pursuing smaller opportunities at this point, but we still have our eyes out looking for opportunities.

Okay.

And we're not limited to 1 segment. It could be in any segment -- surfactants, polymers, or our little specialty group that we did acquire -- that Lipid Nutrition product line this year.

In the press release, you mentioned there were some transition costs on the acquisition, but you didn't specifically call those out. Was that anything that was meaningful in terms of millions of dollars? And are those behind you?

Oh, no, it's not millions of dollars. It's -- we only picked up about $300,000 of gross profit contribution from the Lipid Nutrition product line acquisition in the quarter. And there was certainly several hundred thousands of dollars of transition expenses absorbed in the quarter, but it was nothing in the millions of dollars range, no.

Are those done now?

Hopefully more. Yes, there may be a little bit left in the fourth quarter, but not significant.

Okay, okay. And relative to the other expansion projects that you have going on, can you bring us up to date on where those stand?

Yes, just to reiterate, so the German polyol expansion that incurred the fire last June, that should be up and running again. We are targeting mid-November. So, that will -- we'll be able to discontinue shipping from Illinois to cover the shortfall in capacity at the existing German reactor. We have 2 reactors in Germany now. 1 -- the second 1 will be started back up in November.

And then the Singapore operation should be probably second quarter of next year, and that is just the fractionation capability we've discussed in the past. We want to add other chemistries to that site, but the first goal is to get our methyl ester fractionation column up and running, supplying methyl esters to our other Stepan locations, particularly Illinois. And also being able to give those intermediate feed stocks to our European and Latin American operations so they can broaden their product portfolio. And then beyond that, we would want to add other chemistries to the Singapore site. Initially, it's a strategic play on supplying methyl esters since they come from all the coconut and palm oils in that region anyway. So, it was a good logistics move, but it gives us a nice facility in Singapore for future growth whether it's a multipurpose reactor for ag products or potentially an additional reactor for fabric softeners. Those are all being evaluated as we speak.

Okay.

And Brazil, I didn't touch on, but that's because it's relatively -- it's complete and operational now and producing product. Again, Brazil is an area where we would look to expand further in the not too distant future because we are confident in the demand curve in Brazil. And we'll probably want to broaden our product offerings in Brazil as well. We don't have a fabric softener reactor down there, and that may be something we'll be needing in the not too distant future.

Okay. Looking at your operating expenses, they were down on a quarter-over-quarter basis from the second quarter, about flat with the first quarter. What should we look at or think about for the fourth quarter in terms of direction?

Well, there's certainly -- since a significant portion of the increase year-over-year is attributable to building out people resources in these additional regions of the world, I would not anticipate them going down significantly in the fourth quarter. I think something comparable to the third quarter is reasonable.

Okay.

But these are permanent additions to the structure of the Company to support our growth opportunities.

Alright. And one last one, regarding the expansions and so forth. I don't know if you mentioned either the Netherlands or Poland or the Philippines. Anything there?

Well, there's -- the only expansion in the Philippines has been about a $3 million to $4 million CapEx for a debottlenecking to broaden the fabric softener offering from that site and increase the throughput at that site on the existing reactor. That should be pretty well completed by the first quarter of next year and delivering increased capacity at about the same timeframe.

Okay.

Poland was an acquisition. There has been no expansion of Poland at this point in time. But the good news is I think we've got a significant improved volume going through that site as we are making a polyol for an adhesive application at that site that's consuming about 50% of the plant capacity. And then the existing business at the site is -- we're still probably going to have 30% or 40% capacity at the site. So, there's -- it would be premature to look at expansion at the Poland site.

And Netherlands is simply a product line. So, the only thing we have there is a sales and marketing office. So, those products are being [toll] produced by the same toll producers that Lotus [Croakland] whom we bought the business from used. As well as moving more and more of the CLA product line into our Maywood, New Jersey site, where we were also making CLA for Lotus Croakland before we bought the product line. So, we are going to be able to make more and more of that internally and be long-term hopefully less reliant and have the cost savings of making it in-house versus the toll arrangement.

Great. Thanks very much.

Thanks, Greg.

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

Okay. Well, I have no closing remarks other than to thank you all for participating in today's call and look forward to talking to you soon. Thank you very much.

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