Stepan Company (SCL) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, October 24, 2012. And I like to turn the conference over to Mr. Jim Hurlbutt, Vice President and Chief Financial Officer. Please go ahead sir.

Good afternoon, and thank you for joining the Stepan Company's Third Quarter 2012 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. That being said, I would now like to turn the call over to F. Quinn Stepan Jr., President and Chief Executive Officer of Stepan Company. Quinn?

Thank you, Jim, and thank you all for joining us today. Stepan’s third quarter and year-to-date results reflect our ability to deliver sustained profit growth in a weakening economy while preparing the company for future growth. New geographies and a more attractive product mix, as well as our ability to manage commodity raw material volatility in our base business is driving results. Specifically, net income rose 6% in the third quarter and increased 9% year-to-date versus last year. Net income excluding deferred compensation expense grew by 11% for the quarter and 16% for the first 9 months. All 3 business segments delivered improved earnings despite a 3% decline in volume, brought about by the weaker commodities, surfactant and polymer sales. Building on the strength of our balance sheet and current results, I am pleased to announce that our Board of Directors approved a 14% increase in the company’s quarterly cash dividend on common shares to $0.32 per share. This brings the annual dividend rate to $1.28 per share and marks Stepan’s 45th consecutive annual dividend increase, highlighting our commitment to return value to our shareholders. The Board of Directors also declared a 2-for-1 stock split on its common shares in the form of a 100% stock dividend, payable December 14, 2012, to stock holders of record on November 30,2012. Concurrent with payment of the 100% stock dividend, the adjusted quarterly cash dividend rate on the common stock will be $0.16 per share or $0.64 per share, annually. With the improved performance of the company and appreciation in the common shares over the last 5 years, we believe there is an opportunity today to improve the marketability and liquidity of Stepan shares by splitting the stock. The company’s preferred stock, which is convertible into approximately 1.1 shares of common stock, will be convertible at a rate of approximately 2.28 shares of common stock after the 2-for-1 split. The Board of Directors also declared a quarterly cash dividend on its 5.5% convertible preferred stock, at the quarterly dividend rate of approximately $0.34 per share or an annual rate of $1.375 per share. Dividends remain a key part of our philosophy of providing value to our shareholders. Overall, our year-to-date results position Stepan to deliver significant earnings growth in 2012 and set a solid foundation for long-term growth. At this point I would like Jim to walk through Stepan's third quarter results.

Thanks, Quinn. And I will start my review with a look at the top line. Total net sales for the third quarter were approximately $441 million, down 12% versus the year-ago quarter. The decline in third quarter sales was primarily related to lower selling prices, which accounted for a 6-percentage-point decline in sales. The decline in selling prices was brought on by lower commodity raw material costs. Lower volumes which accounted for a 3-percentage-point decline in sales and then foreign exchange translation, which contributed a 3-percentage-point decline in third quarter sales largely due to the weakening of the euro versus the dollar. Net income attributable to Stepan Company on a GAAP basis for the third quarter totaled $20.2 million, up 6% from the prior year. GAAP EPS was $1.78 per diluted share, up 5% versus the year ago quarter. The impact of deferred compensation reduced GAAP-diluted earnings per share by $0.04 in the third quarter of 2012. Third quarter non-GAAP net income which excludes approximately $600,000 of deferred compensation expense increased 11% to $20.6 million versus the year-ago quarter. Non-GAAP EPS was $1.82 per diluted share, up 10% from the year-ago quarter. 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. 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. Third quarter 2012 gross profit increased 11% year-over-year to $71.3 million. Third quarter operating expenses rose $6.7 million or 22% versus the year-ago quarter. Excluding deferred compensation plan expense, operating expenses rose 20%. The higher level of administrative and general expense relates primarily to our planned head count additions to support global growth initiatives in Singapore and Brazil, as well as routine wage increases. Looking now to net interest expense for the quarter of $2.7 million, which reflects in the increase of 19% versus the year-ago period, largely due to the $60 million private placement loan which was completed in the fourth quarter of 2011 in order to secure liquidity for growth opportunities. Let's move now to a review the performance of our 3 key business segments. First, we'll look at Surfactants, the largest segment of our business accounting for 71% of company-wide sales. Net sales of Surfactants totaled $313.1 million for the quarter, a decrease of 13% versus the year-ago quarter. Gross profit grew by 9% to $46.1 million, overcoming a 2% decline in volume. The volume decline was primarily among commodity Surfactants, due to lower usage levels, competitive pressures and the weak economy. Higher value-added Surfactants used in household and industrial cleaning products as well as agricultural products posted higher sales volumes. The improved product mix, declining raw material cost and profit growth in Brazil contributed to the improved Surfactant earnings. Moving on to our Polymer segment, representing roughly 25% of the sales. Net sales totaled $110.2 million for the quarter, a decrease of 8% versus the year-ago quarter. Polymer gross profit increased by 19% to $20.5 million, overcoming a 4% decline in sales volume on improved product mix and lower raw material costs. The favorable product mix included a urethane systems order sold to insulate an aircraft carrier. Volumes declined in both phthalic anhydride and polyol all due to the slowing economy as demand weakened as the quarter progressed. Stepan’s Polyol, used primarily in rigid foam roof insulation, experienced a 3% decline in volume but posted slightly higher profits. Given lower anticipated demand the company reduced its phthalic anhydride manufacturing capacity by shutting down its oldest, fully depreciated reactor. The remaining capacity is more than adequate to meet projected sales demand as well as the company’s internal needs as a raw material in the production of polyol. Finally, we look at our Specialty Products segment, which accounted for approximately 4% of sales. For the third quarter, Specialty Products net sales totaled $17.7 million, up 2% versus the year-ago quarter. Specialty Products' third quarter 2012 gross profit increased 6% versus the year-ago quarter to $5.6 million, benefiting from a favorable mix of higher-margin nutrition supplements. Moving now to the balance sheet. Total debt as of September 30, 2012, was $188.2 million down $7.1 million in the sequential quarterly comparison and up $1.6 million versus the year-ago. As of September 30, 2012, net debt representing total debt minus cash was $108.5 million down $17.3 million in the sequential quarter due to lower working capital requirements. Net debt was down $45.7 million from the same quarter a year-ago. Our total debt to total capitalization as of September 30, 2012, was 28.7% compared to 31.8% for the year-ago quarter. The ratio of net debt to capitalization as of September 30, 2012, was 18.8% compared to 27.8% for the year-ago quarter. As of September 30, 2012, inventories net of LIFO reserves totaled 155.2 million, an increase of 17.3 million versus the sequential quarterly comparison. Compared to 1 year earlier, inventories were up by 18 million, primarily due to the addition of Singapore inventories during 2012. Capital expenditures were $20.1 million for the third quarter of 2012. Looking forward, we project full year capital expenditures to be within the range of $90 million to $95 million. Turning to cash flows. Third quarter cash flow from operations was a source of $41.3 million compared to a source to $33.9 million for the same quarter of 2011, due partially to lower working capital demands in 2012. During the third quarter, Stepan purchased 5,000 shares of common stock in the open market and had approximately 152,000 shares remaining under its treasury share repurchase authorization as of September 30, 2012. In the third quarter, Stepan paid out a total of $3.1 million in cash dividends to its common and preferred shareholders. Before we open the call to questions, Quinn would like to provide some perspective on Stepan’s forward looking outlook.

Thank you, Jim. We expect to deliver solid earnings growth in 2012. Net income excluding deferred compensation is up 16% for the first 9 months. While the economy has created a more challenging environment, we remain committed to our strategy to globalize our business and to improve our products mix to deliver future earnings growth. Our Surfactant business is more recession resistant and should deliver record full-year earnings on greater functional and household and industrial sales. Brazil will continue to deliver earnings growth. Our Polymer business should also deliver record earnings despite the slowing economy. This concludes our prepared remarks. At this time we would like to turn the call over for questions. Nikki, please review the instructions for the question portion of today's call.

[Operator instructions] And our first question is coming from the line of Beverly Machtinger with Grace & White.

I was wondering if you could update us a little bit about your plans for India and China?

Specifically from a China perspective, we have a Polymer plant in China today that the Chinese Government is strongly requesting we relocate that. So we are in the process of -- we have a contract for land use rights today. We’ll be moving that site beginning in 2013. As we move the plant, we’ll expand our capacity from 20,000 tons to 50,000 tons and are enthusiastic about the long-term prospects for our Polyol business in China. We have limited activity going on from a surfactant perspective and still working out a business case to develop our future plans there. From an Indian perspective, we have some land in India. And again there too, we are looking for, to develop our business plans a little more specifically.

Okay. As far as the China facility, do you actually have sales in that country? Is there actual business going on? Are you importing product in there like the surfactants?

We have a manufacturing facility today that’s owned through a joint venture. Stepan owns 80% of the joint venture. We have Jinling Petrochemical owns 20% of the joint venture today. So we have sales in China today for our polymer products and we are developing -- we have limited sales from a Surfactants perspective. Overall we probably have a little less than $20 million of sales in China today.

Okay, great. And is there -- I mean, what’s the demand situation like? Is it a market you have to develop or is it a market that is yearning for your product?

It is a market that is still in the developmental phase today. China has existing insulation requirements for buildings that are not fully embraced by the country today. And so as the government enforces and encourages adherence to the existing regulations in China for building construction, our business will grow.

Okay, great. Then I was wondering if you could talk about the Polymer business in general. I know you said there’s weakness in demand from that, but I was wondering if you could be more specific geographically. Is the U.S. business weak? Is it just Europe that’s weak? Or this is just a general global malaise?

I would say we are more concerned about the health of the business in Europe today than in the U.S. In the third quarter both the business in Europe and the business in the U.S. were down, but I guess we have more confidence that the U.S. business will return to a growth position than we have in Europe today. We are concerned about the European economy. Those comments relate primarily to our flex-based lamination which is traditionally flat or low sloping roofs. We are seeing increased market share for Stepan in terms of the metal panel or vertical panels versus horizontal applications within construction. So we think we can offset some of the decline in the European market with new market penetration in the metal panel business.

Okay. And lastly I was wondering if you could just talk a little bit more about the Surfactant switch to the higher value-added products? This has been an ongoing process for you guys and I was wondering if you are at -- I don't want to say a plateau. But is there still a lot more room to grow the value-added business? Or are you now more in a steady state between percent commodity versus percent value-added?

Fundamentally I believe we have a lot of room to grow in the functional markets for our Surfactant products. The ag business is growing on a global basis and I believe our market share in that continues to improve and there are opportunities for us -- specific short-term opportunities for us to grow into that segment. In addition to that, I think everyone is familiar with the Renaissance of the oil field market here in the United States. So that is providing opportunities for us short-term. And we also have -- we are optimistic about the long-term prospects for our enhanced oil recovery business.

[Operator instructions] Our next question is coming from the line of Jason Rodgers with Great Lakes Review.

Looking at the aircraft carrier business, is that pretty much complete now or is there any leftover?

It’s virtually complete for this aircraft carrier. There may be small residual sales in the fourth quarter, but essentially it’s all done.

Okay. And then looking at just -- your expectations in the fourth quarter and heading into 2013 with volume growth and pricing as well as raw material costs?

That’s a fairly involved question. As we look at the volume growth, we believe our Surfactant business will grow in 2013 and we believe we’ll continue to have opportunities in the functional markets as I just mentioned. We do believe our business will continue to grow outside the United States and specifically we remain enthusiastic about Brazil. From a margin perspective we are seeing falling commodity prices in our Surfactant business today. So we do believe that we can at least maintain our margins as we go forward in 2013 and maybe some opportunities to enhance margins and we’ll be looking at that as time moves forward. In our Polymer business, we are seeing an increase in raw materials, primarily tied to petroleum. So we are seeing those move up and we do believe in North America we can maintain our margins. In Europe we are seeing a decrease in our margins for our Polymer products there.

Okay. And then looking at -- I think the release talked about costs related to the delay in the startup for the Singapore plant. What were those costs? Can you quantify them?

Well, we’ve got the operating costs of the plant site so even though we were not producing during the quarter we’ve got incremental costs every quarter of the magnitude of $1 million-plus per quarter. Hope to have -- we have started up the plant this week. We hope we’ll be operating it smoothly during the quarter and absorbing that cost. But yes, it’s been an additional cost of operating a new site during the year.

Okay. And then any new developments for the enhanced oil recovery and the renewable feed stocks?

Yes. Starting off with enhanced oil recovery. We are involved in today approximately 30 different projects for enhanced oil recovery. They are moving through the pipeline. Progress -- the timeframe in which they move through the pipeline is a little bit slower than we anticipated. But we are encouraged by the amount of activity in the market. We do not see it as a significant opportunity for 2013 but we do see benefits in 2014 and '15. So again we are still very bullish about it, still resourcing it with our joint venture partner significantly and we are planning on being successful in resourcing it accordingly. With regard to Elevance, we remain enthusiastic about the technology, but more importantly we have started to introduce that to the marketplace in the month of September. And so our customers actually have the new technology for certain segments or target applications in their hands today and will have a better feel over the next 2 or 3 months as they test it themselves.

Just to clarify on the Elevance, the commercialization of those products will be a multiyear thing. The customers will be formulating and testing. So we won’t see any incremental contribution from those formulations for at least another year or 2.

Okay. And just finally, just some line items. Jim, do you have the accounts receivable and accounts payable balances?

Yes, I do. Receivables at September 30 were $265 million, inventories were $155 million and that is net of our LIFO reserve and then payables were $144.6 million.

And the receivable and payable balances should decrease as the year moves forward due to the price deflation that we have seen particularly in our Surfactant business.

Okay. And Jim, did you say the cash flow from our operations was 43.3? Did I hear that right?

41.3.

[Operator Instructions] Our next question is coming from the line of Kevin Hocevar with North Coast Research.

Could you elaborate on -- in the press release you talked about competitive pressures in the surfactant business. Could you elaborate a bit on what those competitive pressures are?

Primarily pricing.

Okay. So mainly just pricing?

Yes. Pricing on a global basis, in particular as the economy slows down you can see increased price competition from people as they try to hang on to a piece of the pie.

Okay. And when -- I missed the very beginning of the call, so I don’t know if you commented on this, but could you mention, with the aircraft business, how much of a benefit this was during the quarter in terms of a revenue or volume standpoint?

It was helpful and we benefited that from both a revenue and a gross profit perspective and we will not comment specifically on the value of that.

Okay. And in terms of the EOR business, I believe the flood you were supplying started in 2009 and I believe it was supposed to go on for 3 years. So is that flood coming to an end or has it been extended? Just wondering if you could comment on that?

The customer is looking at extending that currently. A final decision will be made before the end of the year. It’s ongoing today.

Okay. And finally, it looks like you’ve had some price announcements here over the past couple of months here. Just wondering how those are sticking and if you’re getting all the pricing that you’ve asked for?

Most of them were in polymers and we’re not aware that they are -- as far as we know at this point, they are sticking.

I think there has been a little bit of margin deterioration in Europe, but for the most part I think we are pleased with where our margins are.

Mr. Hurlbutt, there are no further questions at this time. I will now turn the call back to you, sir.

I’d like to thank everyone for joining Jim and I on today’s call as well as the entire Stepan team for their dedication and more importantly delivering higher profitability and long-term growth for you, our shareholders. We look forward to reporting back to you on our fourth quarter and full year 2012 results call. Thank you. Have a good day.

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