Stepan Co (SCL) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded Tuesday, April 25, 2017. I would now like to turn the conference over to Scott Beamer, VP, Chief Financial Officer. Please go ahead, sir.

Hello, and thank you for joining Stepan Company's First Quarter 2017 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 risks 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 other factors outlined in our Security and Exchange Commission filings.

Whether you're 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 when the earnings release is issued, and we hope that you find the information and perspectives helpful.

Now with that, I'd like to turn the call over to F. Quinn Stepan Jr., our Chairman, President and Chief Executive Officer.

Thank you, Scott. Good morning, and thank you all for joining our call today. Following a record year in 2016, the company had a good start to 2017 by delivering record quarterly reported and adjusted net income results. Reported net income was $31.9 million, up 14% versus last year. Adjusted net income was $31.7 million, 7% higher than last year. Adjusted net income, as a percent of net sales, was 6.8%. The strong quarter was driven by record Surfactant operating income, which benefited from structurally lower manufacturing costs related to previous actions taken to close plants in Canada and Brazil. Strong Surfactant results were partially offset by a slight decrease in Polymer operating income, which was attributable to higher costs associated with the new production facility in China and raw materials.

Global Rigid Polyol volume was up 13%. Specialty Products were lower -- results were lower due to order timing differences within our pharmaceutical and flavor business. First quarter results benefited from a lower effective tax rate, which was partly attributable to tax benefits from stock-based compensation awards.

Our balance sheet remains strong, and as the company's net debt to total capitalization ratio was 15% at quarter-end despite seasonal cash deployment. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.205 per share, payable on June 15 2017.

At this point, I would like Scott to walk through a few more details about our first quarter results.

Thank you, Quinn. My comments will generally follow the slide presentation, and I'd like to start on Slide 4 to recap the quarter.

As Quinn stated, adjusted net income was $31.7 million, and this was our highest-ever earnings for any quarter. Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP figures, and these can be found in Appendix 2 of the presentation and Table 2 of our press release.

Specifically, regarding adjustments to reported net income, this quarter included deferred compensation income of $800,000 or $0.03 per diluted share compared to deferred compensation expense of $1.8 million or $0.08 per diluted share in the same period last year.

Naturally, all employee compensation expenses are reflected in our normal operating income. However, we allow employees the opportunity to defer their incentive payout until some future date and the future payment change is based on the company share price. When the stock price declines, income is generated. Because the future liability of employee compensation only changes consistently with changes in the stock price, we exclude this item from our operational discussion.

The first quarter of 2017 results also included business restructuring charge related to the closure of our Canadian plant. This was related to decommissioning at the site and was in line with the expectation we mentioned on last quarter's call. We expect that an additional $900,000 of decommissioning expense in 2017.

Let's move to Slide 5, which shows the total company earnings bridge for the first quarter compared to last year's first quarter and breaks down the $1 million increase in adjusted net income.

Because this is net income, the figures noted here are after the effective taxes. We'll cover each segment in more detail, but Surfactants was up, while Polymers and Specialty Products were down versus the prior year.

The all other category primarily represents lower environmental remediation cost as compared to the first quarter of 2016. Our effective tax rate was 28% for the first quarter of 2017 compared to 31% in the first quarter last year.

The decrease was attributable to tax benefits derived from the stock-based compensation awards. In addition, the first quarter of 2016 had an unfavorable tax settlement related to a foreign income tax audit that did not recur in 2017.

We continue to believe that our 2017 full year effective tax rate should be between 28% and 30%.

Our discussion on Slide #6 focuses solely on the results of the Surfactant segment in the first quarter. Surfactant sales were $322.6 million, up 4% from the same quarter a year ago. Prices were 12% higher due to pass-through of higher raw material cost.

Sales volumes were down 7% versus the prior year, mainly due to lower North American and Europe fee and consumer product and agricultural volumes.

The negative translation impact of a stronger U.S. dollar lowered sales by about 1%. The segment delivered a record $38.2 million of operating income, a 3% increase over the first quarter of 2016.

In the bridge, we show North America and Asia in the same category because our Surfactant business in Asia is relatively small and much of the Surfactant production in the region is used to support business in the U.S.

North America was positively impacted by lower manufacturing cost as a result of the Canadian plant shutdown. A decline in SG&A cost due to lower incentive-based compensation expenses and continued strong performance in the segment niche Gypsum business. This increase was partially offset by lower consumer product sales volume and a slow start to the agricultural season as compared to the same period last year.

Latin America was down slightly due to lower consumer product sales volumes, which were partially offset by slightly accretive contributions from the Tebras/PBC acquisition.

Europe results were down due to lower consumer product demand and a slow start to the agriculture season in that region.

Now turning to Polymers on Slide 7. Net sales were 122.6 -- $126.6 million, up 11% from the same quarter a year ago. A 4% increase in selling prices was related to higher raw material costs. Volumes were up 8% in the quarter, primarily due to continued growth in polyols used in rigid foam insulation and insulated panels, while the negative impact of foreign currency translation lowered sales by 1%.

Operating income was $21.4 million compared to $22.2 million in the same quarter last year. The decrease over prior year was primarily due to higher cost associated with the new production facility in China and higher raw material cost.

Global Rigid Polyol volumes were 13% higher than the prior year due to strong market demand from increased insulation standards and growth in construction. The operating income impact of the higher sales volumes was offset by increased raw material cost.

Global specialty polyol volumes were up 21%. Income was down slightly due to higher manufacturing cost in Poland and margin pressures from higher raw material cost. In China, the results were negatively impacted by higher plant operating cost, which were partially offset by higher export shipments.

Phthalic Anhydride results increased over prior year due to favorable production yields, despite lower sales volume. Our balance sheet remains strong. Our net debt to total capitalization ratio has declined from 26% at the end of 2014 to 15% today. Some deployment of cash in Q1 is typical, and we continue to expect our financial strength to enable growth going forward.

Now, Quinn will cover Slide 9 to address our path to further increasing shareholder value going forward.

Thank you, Scott. After a record first quarter, we remain optimistic about the balance of the year. As previously explained, our path to increase shareholder value consists of three steps: improved asset utilization; support global polyol growth driven by energy conservation; and diversify through innovation, new products, new end markets and geographic expansion.

We expect our focus strategy to positively impact 2017 and position us well for the future. Increased asset utilization is taking place across several product lines. The transfer of production from our Canadian site to our Millsdale site is complete and delivered $1.7 million in savings for the quarter. Although reported results will be negatively impacted by an additional $900,000 of decommissioning expense in the remainder of 2017, we expect that these onetime cash costs will be more than offset by additional related savings of $4.6 million during the remainder of the year.

During the quarter, we consolidated Brazilian continuous sulfonation production into our Vespasiano plant, after shutting down the plant in Bahia. Although savings were minimal in the first quarter, we expect to save $1.6 million during the last three quarters of the year.

We will continue to examine our asset base for opportunities to improve -- to further optimize and improve our production capacity and more efficiently serve our customers around the world. Our capital expenditure plan is aligned with our strategy to support global polyol growth driven by energy conservation efforts in United States and Europe. Projects to enhance production at our Millsdale, United States, and Wesseling, Germany plants are underway.

Rigid Polyol volumes was up 13% in the first quarter. Our new specialty polyol reactor in Poland which began production in the third quarter of last year is contributing anticipated growth. A new specialty polyol reactor in Columbus, Georgia, should start later this year.

Our strategic plan also supports the production, supports product and end market diversification. We are committed to deliver volume growth within targeted geographic regions, CASE polyols, functional surfactants in Tier 2 and Tier 3 consumer product customers. Functional surfactants are below expectations due to lower commodity crop prices. We are making inroads in hydraulic fracking, with new surfactants as the oil markets slowly recovers. Our acquisition of Tebras/PBC is ahead of plan.

Finally, our internal operation -- efficiency program, DRIVE is an important component of our strategy. It helps support our long-term plans. This process helps the company reduce costs, improve our raw material margins and increase the capacity of our production units. We are targeting to deliver $15 million of pretax cash cost out this year.

After a record first quarter, we remain optimistic about the balance of the year, although we expect raw material cost to rise, which may pressure margins. Our path to increase shareholder value should advance in 2017, we believe earnings for the year should grow.

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

(Operator Instructions) And our first question comes from the line of David Stratton, Great Lakes Review.

When we look at the China facility, just to start out, can you kind of breakout the time line at which you think that when those costs are going to fall off? And is it a combination of costs from the facility, or is there some market aspect in there that you could kind of break out what's dragging results?

I don't believe the costs from the facility are going to decrease. We have a volume or market opportunity to change a situation. The market is developing slower than we anticipated. So we anticipate a slightly greater loss in 2017 than we had in 2016 as a result of the higher depreciation expense that we're experiencing this year. No significant recovery in 2017.

All right. And then when we look at the agricultural markets, can you break out how much of your Surfactant business goes to the agricultural markets and just kind of maybe update us on what you're seeing there. And what's driving the downturn globally?

The piece I would point you to David about the functional -- the agricultural piece is reported within our functional surfactants, which we have a pie chart. And if you do the math on that, you'll see that the functional surfactants are between 200 million and 300 million in total as a company. And we have said that agriculture is the biggest piece of that. So that will help dimensionalize the business for you in terms of the outlook, I'll let Quinn make a couple of comments.

Yes. So I would say, generally speaking in North America and Europe, the low crop prices have put a damper on market growth for 2017, at least in the first half of 2017. Our customers are anticipating a stronger back end of the year. And typically that would support the 2018 season to a great degree. So we also have seen a significant consolidation in that space as well. So as we look at the consolidation that's occurring in the marketplace, there are going to be opportunities and vulnerabilities for that matter for suppliers on either side of those transactions. So we still feel very good about our agricultural business. We're excited about the R&D investments that we've made in that space over the last 5 years and many new products in which, where a Surfactant is helping provide significant benefits to the active that's going to be delivered in the marketplace. We'll be rolling out in the marketplace, over the next 18 to 24 months. We're going to be a big part of some of the new introductions.

(Operator Instructions) Our next question comes from the line of Jacob Schowalter, Seaport Global Securities.

I'm asking a question for Mike today. In polymers, you guys posted the 8% volume growth against one of the highest comps of the year. Do you expect that increase -- to increase as the year goes on? Or can you comment on the growth outlook from there?

I'm not going to comment specifically on the growth projections. We do anticipate volume to continue to grow for the balance of the year. And we -- as we mentioned, we do believe that there's going to be some margin pressure -- continuing margin pressure in that space. In the second quarter, and we are optimistic that we'll be able to make some progress on our margin in the second half of the year.

Okay. And then in the Surfactants business, the volume declined 7%. Could you break out how that -- what that look like in the different geographies like North America, Europe and Latin America? And then any sense on when it might stabilize in those geographies? It seems like with the manufacturing rationalization, you guys could see a lot of operating leverage once that recovers. So any color on that would be great?

Yes, I would say, the volume decline was mostly associated with our commodity consumer products business split relatively evenly between North America and Europe. And also our Latam business was down slightly in terms of commodity Tier 1 Consumer Product volume. We are forecasting that, that volume will stabilize in the second half of the year and continuing to -- would grow relative to last year's performance in the second half slightly.

All right. And then on the pricing side in Surfactants, can you talk about the traction you're getting there? And kind of the softer volume growth environment in the first half of the year, and then where you see pricing going?

Pricing relatively stable for the year in terms of an overall perspective. I would say, our commodity margins were down in the first half. So we anticipate some improvement in commodity, anionic margins into the second half of the year. But net-net, the following commodity margins will be offset by improved product mix. So we're anticipating our margins overall would be relatively flat.

(Operator Instructions) Our next question is a follow-up question from the line of David Stratton, Great Lakes Review.

I was wondering if you could -- you highlighted new surfactants in the oil fracking realm. I was just wondering if you could break out what you're seeing there? And if there's anything that's fundamentally changing that might be attractive or positive for the future?

We have established a new laboratory for oil field surfactants down in Houston. So in the market, we're working very closely with our customers. And we are slightly modifying traditional surfactants to provide performance benefits at the direction of our customers. So for the most part, it's not new breakthrough technology, but modification of it. Existing chassis, if you will, that we have production capabilities for within our surfactant network.

All right. And then I guess, lastly, when you look at your raw material imports, you have given us color on where you saw those going previously. Has there been any changes that you see throughout the remainder of the year that in any direction of the raw material inputs?

We're certainly seeing petroleum derivatives continue to kind of have some upward price pressure. We are beginning to see some downward pressure on some natural-based palm oil or coconut-based feedstocks recently. So we are encouraged by the downward movement in naturals at this point.

(Operator Instructions) Our next question comes from the line of Curt Siegmeyer with KeyBanc Capital Markets.

Just a follow-up on the raw material impact. How should we think about the soft of the cadence of the impact over the rest of the year. Is this something that the majority will fall in 2Q? Or should we expect some of that pressure to kind of persist into the second half?

From a petroleum base, I believe that we would anticipate some upward pressure throughout the balance of the year. From a natural base, we believe that we're going to see meaningful relief in the second half of the year. So...

I would just add to that, Curt. In the Polyols business, 90% of our raw materials are petroleum based in our Polyols business in our Global Polymers segment. So that's a segment that has experienced some significant increases in the quarter. We announced the price increase in Q1 that has not been supported yet in the marketplace. We're more optimistic as the year goes on with the ability of us to be able to capture some price in the market consistent with the significant raw material pressures that we're facing there.

Got you. And then could you just update us on your capital deployment priorities?

Yes, I think that as you know, we'll continue -- I mean, in terms of our capital priorities for 2017, #1 priority is to continue to support the polymer growth both in the United States and Europe, specifically for our Rigid Polyol insulation business. We also have plant expansions that we completed in Poland for specialties and that we are -- should complete and startup in kind of the second half of the year in terms of our Columbus Storage Facility. So those are the largest key investments that we are making to grow our business and our capital priorities for 2017. From a Surfactants perspective, we're adding additional multipurpose reactor capabilities in Brazil to support our agricultural business and potentially fabric softeners down in that marketplace. And then we'll continue to look at investments to help us optimize our overall production capabilities across our network, and hopefully, be able to take some additional costs out of the network.

Yes. So -- thank you, Quinn. Good summary in terms of primarily CapEx. And Curt, I'd just broaden that a bit if that's where your interest lies. We've talked about CapEx being expected to be between $100 million and $120 million for the full year. We continue to expect to pay dividends that's been in the range of about $17 million. And you know our dividend for share and you know how many shares we have outstanding. And from a debt perspective, we'll pay down debt as it comes due according to the schedule and not prior to that. So hopefully, all of that together gives you a fair picture of what all we expect, overall cash and then specifically, the cash deployment priorities to be for us this year.

Our next question comes from the line of Mike Sison with KeyBanc.

I wanted to revisit Polymers a little bit given the volume growth there was impressive. If you can continue to generate the volume growth in the remaining quarters, what type of earnings growth should follow through if you're successful with the price increases for the full year?

We don't give specific projections for the company nor for the individual business units. But I would say that the volume growth was mostly offset by margin compression in the first quarter of the year. So we need to be able to improve our margins to demonstrate growth for the year.

Right. So if you think about the 200 or so basis point squeeze in 1Q, we should expect that's the delta to make up. And then what type of incremental leverage or contribution margin would you get on volume growth you think once you catch up on that margin squeeze?

Well, we...

We understand the question.

And we have said, Mike, a couple of times [ unverified text ] here. Last year, we had I think it was 7 straight years of record earnings for the Polymers business. And so far, we did not grow earnings in the first quarter. That's -- yes, I guess, I would add to that, that there is a dynamic in the marketplace, which we have found challenging at this point in terms of our pricing and what has been supported in the marketplace. So that's a bit of, again, as Quinn mentioned, we're more optimistic as the year goes on, but it's really difficult to determine right now, the level of earnings that, that would come from that we could fill -- adding to the earnings in terms of our volumes.

And just to make a comment. In 2016, we had peak margin levels associated with that business. So we're not sure that we're going to be able to pull a return back to that level. So I mean, we're working hard on our costs, and also, on opportunities in the market to improve our margins, but it remains a target for us to do that, but it could be difficult.

Right. Okay. And then, I mean, if you think about that business it's generally good volume growth, you've got very good margins there and the balance sheet's in good shape. Are there acquisitions that you can maybe continue to add on to this segment and can further grow it given how well it's done in the last couple of years?

We -- as we said and as you've noticed, we have a very healthy balance sheet. And we would like to be able to use that ability to leverage that balance sheet to make acquisitions to accelerate our growth in the areas that we've targeted, which includes Rigid Polyols, CASE polyols, functional surfactants in Tier 2 and Tier 3 consumer product accounts. So we are underleveraged. We'd like to use that capacity to make bolt-on acquisitions that will accelerate our growth in those areas.

And we are showing no further questions at this time.

Okay. Thank you very much for joining us on today's call. We appreciate your attendance, and we appreciate your ownership in Stepan Company. We look forward to reporting continued positive performance to you on our second quarter call. Have a great day.

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