Stepan Co (SCL) 2015 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company third-quarter 2015 earnings call. During the presentation, all participants will be in a listen-only mode. (Operator Instructions)

As a reminder, this conference is being recorded Wednesday, October 21, 2015. I would now like to turn the conference over to Scott Beamer, Chief Financial Officer. Please go ahead.

Hello and thank you for joining Stepan Company's third-quarter 2015 financial review. Before we begin, please note that information in this conference call contains forward-looking statements which are not historical facts. These statements involve risk and uncertainties that could cause actual results to differ materially, including but not limited to prospects of our foreign operations, global and regional economic conditions, and factors detailed in our Securities and Exchange Commission filings.

Whether you are joining us online or over the phone, we encourage you to review the investor slide presentation, which we have made available at www.stepan.com under the Investor Relations section of our website. We make these slides available at approximately the same time as the earnings release is issued. We hope that you find the information and perspectives helpful.

With all that said, I would like to turn the call over to F. Quinn Stepan, Jr., our President and Chief Executive Officer.

Thank you, Scott, and thank you all for joining us this morning. Our third-quarter results demonstrate that the actions we have taken to improve product mix and asset utilization, reduce costs, and improve efficiency continue to position Stepan for future growth. Despite currency headwinds, we reported higher third-quarter earnings and volume increases in both surfactants and polymers. Net income was $24.9 million or $1.09 per diluted share versus $13.5 million or $0.59 per diluted share in the same quarter last year.

Adjusted net income was $21.1 million compared to $15.6 million. Net sales decreased 10% due to pricing that followed falling commodity prices and the impact of foreign exchange. Volume was up 7%, and unit gross profit improved versus the 2014 third quarter.

Surfactant operating income was $21.8 million, up $10.6 million or 96% versus 2014. Operating income was up in all regions except Asia.

Improved operations, a favorable product mix, and improved asset utilization drove growth in North America. Sun Products anionic surfactant volumes that were previously produced in Pasadena, Texas, have now been absorbed by Stepan's existing sites.

The Pasadena sulfonation capacity has been idled. Stepan did exercise its option to acquire the site. We are evaluating repurposing the site as a lower-cost option for an alkoxylation investment.

Growth in Brazil and Colombia contributed to gains in Latin America. Higher volumes in both consumer and functional surfactant markets drove growth in Europe.

Polymer operating income was a record $24.6 million, up 35% versus the prior year. Polymer adjusted operating income, which excludes certain significant nonrecurring items from the prior year, grew at 13%. Growth in operating income for this segment was primarily driven by higher volume in Europe; an improving mix sold within the coatings, adhesives, sealants, and elastomer -- or CASE -- markets; and improved local currency margins.

Rigid polyol volumes in Europe continued to benefit from enhanced insulation standards and conversion to metal panels. Specialty products operating loss was $300,000, down $3.3 million from 2014 due to lower volumes in margins. Actions taken to restore profitability in this segment are in progress.

We also announced a 5.6% increase in our quarterly cash dividend, which represents the 48th consecutive year of a dividend increase. Our Board of Directors has declared a quarterly cash dividend on Stepan's common stock of $0.19 per share, payable on December 15, 2015.

At this point I would like Scott to walk through Stepan's third-quarter results.

Thank you, Quinn. My comments will generally follow the slide presentation.

On slide number 3 we note that adjusted net income was $21.1 million or $0.92 per diluted share, an increase of 35% versus the prior year. Both our largest segments, surfactants and polymers, delivered significant operating income growth.

Surfactant operating income was $21.8 million, an increase of $10.7 million or 96% versus prior year; while polymer operating income was $24.6 million, an increase of $6.3 million or 35%. Compared to the adjusted third-quarter result of last year, operating income increased $2.9 million or 13%. Since adjusted net income and adjusted operating income are non-GAAP measures, we provide full reconciliations to the reported figures, which can be found in appendix numbers 2 and 3 of the presentation as well as table 2 of the press release.

Specifically regarding adjustments to reported net income, this quarter included deferred compensation income of $3.8 million or $0.17 per diluted share compared to $2.7 million or $0.12 of income in the prior year. Naturally, all employee compensation is reflected in our normal operating net income; however, we also allow employees the opportunity to defer their payout until some future date, and the future payment changes based on the Company's share price.

When the stock price falls, income is generated. Since the future liability only changes consistently with changes in the share price, we exclude this item from our operational discussion. We show our figures with this income effect pulled out of the numbers so you have a clearer view of our operating performance.

The third quarter of 2014 results also included $2.7 million of environmental reserve expense associated with our Maywood, New Jersey, site. That quarter also included $2.1 million of expense for a phthalic anhydride customer that filed for bankruptcy.

Both surfactants and polymers had very good quarters and continued to overcome headwinds from negative foreign currency translation. In surfactants, improved performance in North America, Latin America, and Europe drove operating income growth for the quarter. Polymers had a record quarter of operating income, primarily as a result of volume and margin growth in rigid polyols.

As we announced in July and discussed in last quarter's conference call, we signed a long-term supply agreement with the Sun Products Corporation. And we have noted here that the transition has gone very well. Sun is one of the leading laundry detergent producers in the US, and we now supply all of their anionic surfactant needs from within our existing supply chain -- significantly improving our asset utilization in North America. As Quinn mentioned, their former site in Pasadena, Texas, has been idled.

Slide number 4 shows the total Company earnings bridge for the third quarter compared to last year's third quarter and breaks down the $5.5 million increase in adjusted net income. Since this is net income, the figures noted here are after the effect of taxes.

We will cover each segment in more detail shortly, but both surfactants and polymers contributed strong operating income growth, while specialty products struggled in the quarter. Incentive-based compensation was higher, since we did not pay bonuses last year.

Interest expense is higher after the $100 million private placement borrowing, which we executed and announced in July. The all/other category mostly represents external consulting fees paid related to our ongoing global efficiency initiative, which began during the third quarter of last year. The benefits of this initiative are captured within the business segment operating results.

The effective tax rate for the first nine months of 2015 was 28% compared to 27% for the same period last year. This increase is primarily related to a settlement of a foreign income tax audit, which was recorded in the second quarter and was mentioned at that time.

Slide number 5 focuses solely on surfactants, which recorded $21.8 million of operating income, an increase of $10.7 million or 96% over the prior year. North American volumes were up 6%, primarily as a result of higher consumer products sales, including the additional business from Sun.

You will notice that we have combined Asia and North America in this view. Based on our surfactant business in Asia being small, our Singapore plant supports the North American business with intermediate products. And Asia's external results did not change significantly compared to the prior year.

North America benefited from the impact of earnings leverage of higher volumes, operating efficiencies, and a more favorable mix. The new supply contract with Sun increased capacity utilization. Specifically, mix improves, as we grew our earnings in agriculture, distribution and household, institutional, and industrial end markets. This improvement was more than offset by lower performance in our oilfield business, which was again negatively impacted by lower crude oil prices.

Latin America was higher as consumer and functional businesses grew in Brazil and Colombia. Despite inflation and currency devaluation, through nine months Latin America has doubled its earnings compared to the same period last year. Europe's strong performance in 2015 continued despite the headwinds of foreign exchange, with third-quarter results up $1.9 million. Higher volumes in both consumer and functional surfactant markets contributed to this increase. Year to date European operating income increased $4.5 million or 67% compared to prior year.

Turning to polymers on page 6, the segment delivered improved earnings to $24.6 million, which is a record for any quarter. Volumes were 4% higher, primarily from the global rigid polyol business. Specialty polyols also grew.

Regionally, North America and Europe both performed higher than last year. North American polyols improved by $2 million, driven by better performance in both rigid and CASE. Europe benefited from higher rigid polyol volumes despite the negative foreign-exchange impact.

Phthalic anhydride results, excluding the 2014 customer bankruptcy, were down slightly despite higher demand. Specialty products operating income declined $3.3 million and was again impacted by lower margins and volumes. The decline in volumes was primarily due to order timing differences by food and flavoring product customers. Overall our lipid nutrition business continues to perform below expectations.

The points on slide 7 update the progress we have made in meeting the expectations which we believed were important to deliver 2015 earnings growth. In the first nine months of the year, polymers indeed delivered income growth of $15.3 million over prior-year. After eliminating the bankruptcy charge that was mentioned, the increase was $11.9 million or 23%.

Functional surfactant volumes have been higher, despite the well-known challenges in agricultural and oilfield end markets. Lower prices for agricultural commodities have led to these significant changes by large crop protection companies. They have announced lower 2015 earnings forecasts, staff reductions, and other cost-cutting measures.

Overall we continue to believe in the long-term favorable macro trends in the agricultural end markets. As for enhanced oil recovery, Quinn will provide an update on that business later.

In surfactants the seamless transition of new supply of the Sun business that began in early August has led to improved asset utilization in North America. The new laundry volumes in North America and Latin America have contributed to -- modestly to income in 2015 as profitability from the new business has been partially offset by integration expenses. Greater benefits are expected in 2016.

As mentioned previously, we continue to see improved operational cost savings from the investments that were made to our infrastructure in 2014. The stronger US dollar has negatively impacted operating earnings by $10.2 million through nine months. This is likely to continue in the last quarter, albeit possibly to a lesser degree, because the US dollar began to more significantly strengthen in the early fourth quarter of last year.

Our balance sheet is healthy, and future investments will focus on strategic initiatives that will improve efficiencies, increase asset utilization, accelerate growth, and deliver shareholder value. Turning to slide 9, which is appendix one: capital expenditures for the third quarter were $36 million versus $23 million in the third quarter last year. Year to date we've spent $90 million on CapEx. Even with the recent acquisition of the assets from Sun, we're revising our full-year projection downward slightly to between $110 million and $120 million.

Regarding our debt, I noted in last quarter's conference call that we have incremental interest expense moving forward from July of 2015, and that's indeed the case. As noted, we have a relatively small portion of debt principle that is due in the next 12 months. And we're not planning to retire any debt early, so a large portion of the $100 million is incremental to our balance sheet.

In terms of interest expense we continue to expect about $3 million in additional interest expense annually, starting in July of this year, for a new annual total of about $14.5 million. For the full year we expect an effective tax rate of between 26% and 29%. If the R&D tax credit in the US is passed in 2015, it would lower our rate by about 1% and would likely place us toward the lower end of that range.

Now Quinn would like to make some comments on expectations for the rest of 2015.

Thank you, Scott. After nine months we are positioned to deliver earnings growth for the full year: surfactant earnings should continue to benefit from new laundry detergent volumes in North and Latin America, continued diversification of our business in Europe, as well as contributions from our efficiency program and improved operations overall. Given the current and forecasted price of petroleum, Stepan Company and Nalco Company have decided to dissolve their TIORCO enhanced oil recovery joint venture. Both Stepan and Nalco will continue to participate in enhanced oil recovery but will do so with groups integrated into their respective organizations. Stepan Company expects to take a charge during the fourth quarter between $3 million and $4 million to restructure its enhanced oil recovery efforts.

We expect polymer income growth to continue, driven by higher polyol volumes used in rigid insulation and metal panels. In the fourth quarter planned maintenance activity in our North American phthalic anhydride plant will negatively impact earnings.

Construction projects to add polyol capacity in China, Poland, and the United States are progressing well. In China, plant commissioning expenses will begin in the fourth quarter. 2016 volumes will be less than anticipated due to reduced demand associated with the current construction environment in China.

External resources used to improve our effectiveness and efficiency will end in the fourth quarter. Rate of returns, net of fees, will be realized in 2016. Overall we believe we have restored earnings momentum in 2015 as we continue to position the Company for further earnings growth in 2016.

This concludes our prepared remarks. At this time we would like to turn the call over for questions. Scott, please review the instructions for the question portion of today's call.

(Operator Instructions) Eugene Fedotoff, KeyBanc Capital Markets.

Good morning, guys. Thanks for taking my questions. I was wondering if you can talk about just underlying volume growth in surfactants in North America, excluding Sun deal -- if volumes were up or down in the quarter, year-over-year base?

The volumes were up, excluding Sun. They were up a little bit, not a lot. And I don't have that exact percent for you right now. But we can look at that and hopefully have that number at the end of the call -- or the question portion of today's call.

Okay. That's fine. And would you be able to provide utilization rates or approximate utilization rates for North American laundry business now, with the Sun deal in place?

So the Sun deal impacted only our anionic sulfonation capacity utilization. I would tell you that we still have some excess capacity in our network.

Okay. And, I guess, switching gears and talking about polyols, it seems like pricing pressures are increasing there. Can you comment on the competitive landscape and capacity increases by the competitors -- how that impacts your business, including some of the expansions that you are doing in Europe, and North America, and China?

I guess I would disagree with your initial statement, though. We do see increased competitive activity in that space, but the margins are actually up in 2015 versus 2014.

So with regard to the capacity expansions, we are increasing capacity to service the CASE market in both our Columbus, Georgia, facility and in our Brzeg Dolny Polish facility. So those projects are a little earlier on in terms of the anticipated startup. We would look at the Polish site starting up in kind of mid-2016, and the Columbus site kind of toward the end of 2016, potentially the early 2017.

So those projects are progressing well and kind of are on track at this point in time. Those products are primarily targeted for our liquid CASE products, and target customers have been established. And we believe that they will start up per the business plan and increase the utilization as time marches on.

With regard to China, the plant will be mechanically complete in 2015 and will be going through commissioning activities beginning this fourth quarter and into the first quarter of next year. So we're a little concerned at this point about the startup volumes in China, given the current state of the Chinese economy. So we are looking at the potential to utilize that plant to support planned maintenance shutdown in Germany in 2016 and also potentially to supply some markets outside of China to increase utilization. Those plans for non-Chinese activity are being developed as we speak.

As far as the polyols margins or polymers margins -- do you think they are sustainable at the current level, adjusted, maybe, for seasonality going into fourth quarter? Or do you think that margins will decline?

There could be -- I think the European current -- the margins are sustainable. And we will continue to look at the North American margins. There could be some decrease in North America as -- into 2016. Minimal decreases, but --.

Okay. And just the last question before I get back in the queue: any update on guidance -- the $0.65 improvement in 2015 versus 2014 in the EPS? Does that still impact -- any update on this number?

Yes, Eugene. It is intact. We said of the $0.65, about a third of it impacted Q1. We said it was smaller in Q2. So that would leave about half of that benefit for quarters three and four. And just seasonally that would imply about 30% or so of that $0.65 into Q3 and the other 20% into Q4.

So if you are taking last year's adjusted net income numbers and adding an impact [of] that $0.65, I'd use about a third of that for Q3 -- which I think our results show we delivered that increment in addition to other items that we delivered. And then the fourth quarter is about a 20% or about $0.13 a share or so compared to the -- that you would add potentially to a prior-year number.

Overall, yes, we are on track.

Got it. Thank you.

(Operator Instructions) Michael Harrison, Seaport Global Securities.

Quinn, I was hoping you could talk about the specialty business a little bit. I know you called out the timing issues, which -- that was an issue last quarter as well. But you also mentioned higher raw material costs, and I know that we've been dealing with a little bit of competitive dynamics on the pricing side. So do you think that we could see the raw material versus pricing situation improve over time? And are you considering any actions right now to improve the cost structure of that business?

So we are taking steps to improve the cost structure of the business. Don't want to comment on that directly at this point in time.

From a raw material perspective, we have been working on changing our supplier base. And we do anticipate that with -- the changes that we've made in our supplier base will help margins, primarily in our MCT line in the beginning of the fourth-quarter 2015 and carry over into 2016.

So I think the competitive dynamics overall are difficult with some integrated -- backward-integrating competition. But we have taken steps to improve the situation, again, in the fourth quarter -- beginning in the fourth quarter of this year. But we'll continue to look at other opportunities to improve the profitability of this business. And we do anticipate progress in 2016.

And as you look at the functional surfactants business, I know you mentioned that oilfield continues to be weak and probably will be as long as oil is below $65 a barrel -- I was a little bit surprised to hear that ag was an area of strength. Are we seeing new products being introduced there, and kind of a secular-driven growth there? Or are you actually seeing improvement in the underlying markets?

Let me make a comment about oilfield. So Stepan Company's oilfield activities are -- they fall into two camps. One is a traditional oilfield business that is tied primarily to production but also has some surfactants that are being used in exploration. So that business has been negatively impacted by the drop in oil.

But overall, we have some new technology going into that market. And so we believe that there's opportunities for Stepan to grow in the traditional oilfield business despite the current price of oil. The enhanced oil recovery business is more difficult. And when we talk about that large opportunity from a volume and profit perspective, we believe that $65 a barrel is required for commercial -- new commercial floods in that area.

As we go forward into 2016, we do have -- I'll say eight active opportunities. Most of them are pilot floods that people are continuing to look at to position themselves for -- as the price of oil recovers. So that is the opportunity -- the EOR opportunity that we've restructured with TIORCO. And then our oilfield EOR business will be combined with our traditional oilfield business. And we'll be looking at that and lower our costs overall to participate in the EOR business.

So we remain optimistic about our traditional oilfield business and our ability to grow in that space. With regard to the agricultural market, most -- you know, the time frame for implementation of new technology in that case can be 3 to 4 years. So we have many opportunities in the pipeline, based on new technology or blends of existing technology, that have been specifically formulated to provide benefits for our agricultural product customers that are working their way through the pipeline.

So the growth that we anticipate in the agricultural market is coming from much of those activities that occurred three or four years ago. In addition to that, we continue to see great interest in our green agricultural solvents. And specifically, part of our reason for growth in Europe in 2015 has been the expansion of sales of those product lines.

Right. And then the last question for me is just on the return profile of the polymers plant in China -- you mentioned being concerned about where the startup volumes are and working to get Germany -- you know, take some volume out of Germany when there's going to be some downtime there. But are you confident that over time you can still get the returns you were hoping for? Or is it really contingent on how tightly we are enforcing some of the energy efficiency building codes in China?

Certainly in order to generate the return over a 10- or a 20-year period, we're going to need the Chinese government to enforce their existing building codes. So at this point in time, we believe that they will do that over a period of time.

So when you look at return on investment, you obviously need volume and margin in the first couple of years. So I would say at this point in time, we are a little bit concerned about the overall return, given the short-term current softness in the Chinese economy. Long-term we're confident that we will generate the operating income on an annual basis that we had targeted in that site, although the return may be lower, given the softness in 2016 and 2017, potentially.

All right. Thank you very much.

David Stratton, Great Lakes Review.

Most of my questions have been answered, but I was wondering if you can just quantify the expenses you see in the phthalic anhydride plant maintenance and the China commissioning expenses for the next quarter?

They are both just slightly under $1 million for the quarter.

Thank you so much.

Eugene Fedotoff, KeyBanc Capital Markets.

Thanks. Just got a few follow-ups. Can you provide an update on the efficiency program? I believe the expectations were $8 million this year, but then you had some delays there because of the Sun deal. Can you give us an update -- where you stand on that program, and what the benefits are both for this year and maybe expectations for next year?

I would say that we are essentially in line with our initial forecast of -- $8 million is a pretty good estimate at this point in time, net of fees. As we look into 2016 we are not planning -- as I said in my comments, we are not planning on continuing that arrangement.

So we would anticipate that we would see a net improvement in profitability order of magnitude of $3 million to $4 million. And then we may have some incremental benefits from the projects that we are currently working on. But at this point in time I would model $3 million to $4 million improvement.

Great. Thanks. And now just a question on palltran oil. It seems like there's some shortages, and prices have been significantly higher over the last couple of months. Is that impacting your business? Is that a concern at all?

I'd say the short answer is it's not having a significant impact on our business.

Okay. Great. Thanks.

(Operator Instructions)

And I'll step back in here to fill in a little bit about the volume -- I think it was Eugene's question from earlier, volume excluding Sun. Nearly flat or down slightly the rest of the business. Personal care was mostly flat, up slightly; with oilfield and EOR both being down from a volume perspective. So broad strokes, I think that answers Eugene's question regarding -- yes, Sun had an impact on our volume, a significant impact for the quarter.

In North America.

In North America, which is the primary portion of the surfactants business -- but yes, in North America. We've talked about the comments in the other regions.

And there are no further questions registered at this time.

Okay. I'd like to thank everyone for joining Scott and me on today's call as well as the entire Stepan team for their continued dedication to serving our customers worldwide. We look forward to reporting continued positive performance to you on our fourth-quarter 2015 call. Have a great day.

Ladies and gentlemen, that concludes the call for today. We thank you for your participation and ask you to please disconnect your line.