Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Stepan Co. (NYSE:SCL)

Q4 2008 Earnings Call

February 11, 2009 2:00 pm ET

Executives

James E. Hurlbutt – Chief Financial Officer

Analysts

George Gasper – Robert Baird

[John Beier – SKA Financial]

Operator

Welcome to Stepan Company’s fourth quarter 2008 conference call. (Operator Instructions) I would now like to turn the conference over to Jim Hurlbutt, Vice President and Chief Financial Officer. Please go ahead sir.

James Hurlbutt

Good afternoon and thank you for joining us. 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.

We are pleased to report record earnings for 2008 that represent the culmination of focus on our core business growth and diversification opportunities combined with a disciplined approach to our cost structure. We are also proud to have delivered to our shareholders in 2009 our 41st consecutive year of increased common stock dividend pay outs despite theses challenging economic times.

At this point, let me walk through our fourth quarter and full year 2008 results. Starting with the top line total net sales for the full year 2008 were $1.6 billion up 20% year-over-year benefiting primarily from higher selling prices, which accounted for 21 percentage points of net sales growth and the positive effect of foreign exchange currency translation, which accounted for one percentage point of the net sales growth.

Both factors were partially off set by a 2% decline in year-over-year sales volume. Total net sales for the fourth quarter were $365 million up 7% year over year. Quarterly sales also benefited primarily from higher selling prices as sales volume declined 7%.

Net income for the full year 2008 increased to a record $37.2 million or $3.52 per diluted share compared to net income of $15.1 million or $1.50 per diluted share in the year ago period. Net income for the fourth quarter was $1.7 million or $0.15 per share compared to net income of $1.6 million or $0.15 per diluted share in the year ago quarter.

Full year 2008, gross profit increased by $28.1 million or 20% year-over-year on improved surfactants segment profitability. Fourth quarter 2008 gross profit declined by $2.7 million or 8% as volume declined 7% and higher priced raw material inventory was consumed.

Turning to operating expenses, for the full year we saw operating expenses rise by $10.3 million or 10% over $3.7 million or 36% of the increase was due to higher provisions for performance based incentive compensation as a result of the record earnings. Higher bad debt charges, pension expense, and the effect of foreign currency translation also contributed to higher level of operating expenses. Operating expenses for the fourth quarter declined $4 million or 15% versus the year ago period.

Excluding deferred compensation expense, the remaining fourth quarter operating expense increases were attributable to higher performance based incentive compensations and bad debt provisions for the quarter. As we discussed last quarter, our full year 2008 operating income includes a $9.9 million pre-tax gain on the sale on the urethane system product line, and an $8.5 million pre-tax gain on the sale of farmland, which was used to acquire an office building in a tax deferred like kind exchange.

The fully effect of our deferred compensation plan on pre-tax income was $4.9 million of expense versus $1 million in the prior year. The accounting for the company's deferred compensation plan results in an expense when the price of Stepan company stock or mutual funds held in the plan rise and income when they decline. The company also recognizes the changes in the value of the mutual funds as an investment income or loss.

Let's move to our view of the performance of our three key business segments. First, we'll look at surfactants, the largest segment of our business. Sales increased 23% for the year to $1.2 billion accounting for 75% of total net sales in 2008.

Volume declined 1% for the year and declined 3% for the fourth quarter. The decline in volume was largely attributable to lower bio-diesel sales volume. Excluding bio-diesel, sales volume was relatively flat for the year.

Improved laundry and cleaning volume in North America was partially offset by lower European volume. Surfactant gross profit increased $30.1 million or 33% for the year. The full year improvement was driven by improved customer and product mix coupled with partial recovery of higher raw material costs and selling prices.

Full year gross profit on sales of higher value added surfactants in the specialty blends agriculture and oil fields markets more than offset weakness in bio-diesel and building product applications. Fourth quarter 2008 surfactant gross profit declined by $1.2 million or 5%, and a 3% decline in volume.

The bio-diesel product line reported a $2.5 million negative gross profit for the quarter due to lower selling prices brought on by falling crude oil and diesel prices. High priced soybean oil inventory, the feedstock for bio-diesel, was consumed during the quarter resulting in the loss.

The remainder of the surfactant savings continued the year long trend of improved customer and product mix and recovery of past margin erosion. During the fourth quarter, Stepan's European subsidiary purchased two small product lines used primarily in fabric softeners from CECA, a subsidiary of Arkema in France. Stepan did not purchase any manufacturing assets. Manufacturer of the products will be transitioned to our [inaudible] France facility over the next three to six months.

In the area of enhanced oral recovery, our joint venture with Nalco continues to move forward with a series of pilot field tests for improved oil recovery yields. While oil prices dropped notably in the fourth quarter, these pilot tests are focused on supporting long-term oil recovery yields. While we do not expect any contribution to profits in 2009, we do believe theirs is a strong need for yield for our EOR technology that will generate future profitability.

Turning to the polymer segment, full year sales increased 12% to $359 million representing 22% of total sales. Fourth quarter net sales of polymers declined 12%. Polymer volume declined 2% for the year and slipped 22% quarter-over-quarter due to a lower sales volume of [falican] hydride used in the end use markets of automotive, boating, and housing.

Polymer gross profit for the full year 2008 declined by $1.6 million or 4%. Fourth quarter polymer gross profits declined by $2.1 million or 22%. Higher raw material costs, higher freight, and maintenance costs related to a fourth quarter scheduled maintenance shutdown caused the lower earnings.

Our more profitable polyal product within this segment saw gross profit grow by 2% on volume growth of 10% for the full year. Fourth quarter polyal volume and gross profit declined by 6%. The majority of the polyal is sold into the commercial flat roof insulation market and the growth was driven by energy efficiency and the strength of replacement roofs on commercial buildings versus the residential construction market.

Fourth quarter polyal sales line declined as the global recession worsened and customers delayed purchases in anticipation of lower announced pricing for January of 2009 as raw material feedstock prices declined rapidly. While recessionary economic factors led to lower sales of PA, PA sales represent less than 5% of total company sales.

PA profitability declined due to lower sales volume and the higher maintenance costs. The previously announced expansion of our Wessling, Germany polyal facility, which will provide additional long-term capacity beyond the current [inaudible] production gains is put on an extended timeline to achieve cost savings from falling input costs. We still believe the additional capacity will be needed in 2010 and beyond.

Finally, turning to our specialty product segments, sales rose 27%, year-over-year with the segment sales accounting for 3% of the company’s total net sales for the year. Specialty products full year gross profit rose to $9.1 million, up 2% for the year.

Turning to other income and expenses, interest expense declined 15% for the quarter and 2% for the year, due to lower interest rates offsetting the affect of higher average debt levels, higher working capital requirements due to rising raw material costs during 2008, which started the decline during the fourth quarter.

The loss associated with our 50% equity stake in the Philippine joint venture totaled $2.3 million versus a loss of $0.4 million a year ago. The primary factors negatively impacting the joint ventures results were significantly higher foreign exchange losses and bad debt provisions as compared to foreign exchange gains in the prior year. The year-over-year operating loss declined on improved volume and margins.

Moving on to other net income and expense, we recorded a loss of $2.1 million for the quarter and $4.7 million for the year associated with mutual fund investments held for our deferred compensation plans. Partially offsetting this expense is foreign exchange gains of $500,000 for the quarter and $1.1 million for the year attributable to the strengthening of the U.S. dollar.

Our effective tax rate for the full year was 32.1% compared to 36.6% in the prior year. The decline in our tax rate was primarily attributable to the recording in 2007 of U.K. goodwill impairment for which no tax benefit was realized.

Looking at the balance sheet, consolidated debt as of December 31, 2008, was $143 million up from $128 million in the year ago period. Our total debt to total capitalization at the year-end was 40.7% compared to 38.3% a year ago.

Capital expenditures were $14.2 million in the fourth quarter, up 35% from the same quarter last year. This was mainly due to capital associated with the previously discussed maintenance shutdown in the polymer segment. Full year capital expenditures totaled $49.8 million in line with our projected range. Looking forward, we expect our 2009 full year capital expenditures to be in the range of $45 to $50 million.

Turning to cash flows, for the year Stepan generated total cash from operating activities of $29.1 million down 38% year-over-year due to higher working capital requirements in 2008 caused by rapidly escalating raw material prices. We expect lower levels of working capital in 2009 due to falling commodity prices.

At December 31, 2008, the company had trade day sales outstanding of 47.3 days compared to 46.8 one year earlier with comparable customer payments continuing thus far in 2009. Bad debt provisions were higher in 2008 and we are vigilant on customer credit as the recession worsens.

In terms of returning value to our shareholders, in 2008 Stepan paid out a total of $8.9 million in cash dividends to its common and convertible preferred stockholders. Yesterday the board of directors also authorized the company to repurchase up to 500,000 shares of its outstanding common stock or the equivalent in Stepan preferred stock.

This repurchase authorization replaces 300,000 share authorization approved in 2004 of which the remaining unutilized repurchase authorization of 111,000 shares is canceled. Stepan will repurchase shares from time-to-time for cash in open market or private transactions in accordance with the applicable securities and stock exchange rules.

The repurchase authorization represents approximately 4.6% of the company’s total shares of common stock outstanding. The timing and amount of repurchases will be determined by the company’s management based on their evaluation of market conditions and share price.

Turning to 2009, before you open the call up for questions, let me provide some perspective on Stepan’s outlook for 2009. Based on our present day expectations around the current global economical slowdown in 2009, we believe we will see an affect in our sales volume, particularly in the polymer group.

As is a significant portion of our surfactant sales are tied to consumer spending on laundry and personal wash products, we feel Stepan remains well positioned in some attractive and defensive from a recession prospective customer segments. These segments have historically proven more recessional resistant than the broader economy. Our surfactant business will continue to focus on profit growth in higher margin segments, innovative product opportunities and cost reduction opportunities.

While 2009 appears to be full of uncertainty, we believe it is also full of opportunity. We will continue to stay close to our customers within our core markets while we focus on innovation and cost reduction opportunities. This concludes my prepared remarks.

At this time, I would like to turn the call over for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from George Gasper – Robert Baird

George Gasper – Robert Baird

A question on the bio-diesel outlook in terms of your cost structure looking forward versus what you experienced in 4Q and last year, and also what you’re dealing with on the sales price side, what do you see the variances are here looking forward versus the past year?

James Hurlbutt

Are you talking specifically about bio-diesel now?

George Gasper – Robert Baird

Yes

George Gasper – Robert Baird

Just for everybody to understand, bio-diesel is a very small part of our business. We opportunistically took advantage of some assets we had to make the product. We actually made money in the first three quarters last year based on margin spread coupled with including more tallow-based feed stock in lieu of higher priced soybean oil. Unfortunately, in the fourth quarter when the world when topsy-turvy on crude oil, we were holding higher priced raw material inventory so the fourth quarter pretty much wiped out whatever profits we had made and then some for the year.

Today, we don’t see significant improvement, we see modest improvement in the bio-diesel margins, but I would not expect a full year profit on bio-diesel. Our priority would be to use those assets preferentially for higher value-added products to the extent we can. There may be opportunities on-the-spot basis to jump in and make higher margins during the year, which we would do, but we certainly don’t have a long-term view unless legislation comes out of Washington that would change the picture that bio-diesel margins are going to return to the levels they were at over the prior two or three years.

George Gasper – Robert Baird

And then on the CapEx outlook, you mentioned that you’re looking at about $45 to $50 million CapEx range for '09, which was pretty similar. I mean you had close to 50 for this past year. What are you going to be doing on this CapEx side specific projects versus last year, and it kind of surprises me a little bit it's that aggressive considering the economy and everything. Just kind of interested to know what you're planning on doing, and based on your cash flow projection or my thoughts on cash flow versus what you had this last year, how will you be increasing your credit financing to accomplish this?

James Hurlbutt

Well, on the last point, no, we certainly hope that we would by the end of the year see lower debt levels so we would finance this from internal cash from operations and a reduced investment and working capital, because we have seen a significant reduction in working capital due to the falling crude oil, and resulting raw material costs, so our plan is to not increase debt during the year, but to fund from within from operations.

The CapEx issue as to whether we would hold back if the economy continues to deteriorate. Yes, we would try and look at ways to defer and slow down the rate of spend. We're off to what we think is a relatively good start in 2009 so it would be premature for us to hold back on base spending that is necessary to really keep our plants in good shape.

The only two expansion opportunities that are in that budget are the approved expansion in Brazil of a neutralizer to expand our product portfolio in Brazil, which is something we've been needing to do for quite some time to penetrate that market, so, we're pretty excited about the opportunity in Brazil, and do not want to delay that neutralizer.

While we have slowed down the German polyal project, we have not discontinued it. We still believe that in 2010 and 2011 at some point we will definitely need that capacity so. We've slowed down the rate of spend. We've bought long lead time equipment, and then we’ll take a delay in the project to go back and try and reduce the cost of the project because certainly steel prices and other inputs for that plant have been falling in price. So we think there's an opportunity not only to delay it to conserve cash, but to actually get an all in cost that will be lower than first projected.

George Gasper – Robert Baird

On that project cost that you're talking about, domestic versus international, in the projected CapEx area this year versus last year, what will the variance be?

James Hurlbutt

It's probably running at about the rate of 30% in North America, I'm sorry, 60% in North America, 40% outside, with the outside portion being largely Europe, except for the expansion in Brazil.

George Gasper – Robert Baird

Okay, and would that parallel last year's percentage comparison?

James Hurlbutt

Yes, it's not too dissimilar because last year there no major projects. We completed a winder Georgia fabric softener expansion, but there were no major capacity expansion projects last year.

Operator

Our next question comes from [John Beier – SKA Financial].

[John Beier – SKA Financial]

You had indicated in your release here that falling volume, that were some deferrals of I guess of orders as people anticipated, or companies anticipated, lower pricing, and I was wondering if you have seen some stabilization there, and if their ordering trends have kind of gotten back to what you would say would be quote, unquote "normal".

James Hurlbutt

We've seen resurgence in volume in January versus the November and December levels. We're cautiously optimistic that, yes, that the falling commodity raw material prices in the fourth quarter that led us to announce price decreases and as did all our competitors. Precipitated some movement of volume into January now, I guess it's a little premature to say what the recession has in store for the balance of the year, but we're pretty optimistic by what we see in terms of volume so far this year.

[John Beier – SKA Financial]

And are you still seeing pressures on pricing that are going to kind of push you in the direction of having to lower those offerings again.

James Hurlbutt

So far the industry has been relatively disciplined about not letting margins erode at this point, and that is certainly one of our number one goals this year because there's probably minimal up side on volume growth this year. We certainly do not expect volume growth and we're cautious that it could be down slightly in 2009, so hanging onto margins is going to of paramount importance to us this year, as raw materials decline. And we would expect that there will be some further declines over the year, but not to the magnitude of what happened after crude oil plummeted from $140 down to the $40 range.

[John Beier – SKA Financial]

In answering a previous question you had said that you hoped that your overall debt levels would be down by the end of the year, do you have any kind of target number there, or can you quantify that to some extent?

James Hurlbutt

Well, I think our target would be certainly at least in the $10 million range of reduction and hopefully we could beat that, depending on what this economy has in store for all of us.

[John Beier – SKA Financial]

Also along the lines of debt you had indicated there were some bad debt issues out there, are those issues stabilizing also, and can you quantify that at all?

James Hurlbutt

Yes. Well in the year I think our bad debt provision was up about $2 million last year, which is significant for us. I mean that's much larger. We have very low bad debt experience and so we had, in particular, out of that number there was really three bankruptcies that accounted for a significant part of that increase in the bad debt provision.

[John Beier – SKA Financial]

Is that $2 million total that you have right now?

James Hurlbutt

Increased our provision last year by, but on our overall broad customer base, we're not seeing a significant problem yet. Now, we hope the economy continues to churn along and that the customer's liquidity continues to improve. I think the lower working capital is going to help, certainly helping us. I think it's going to help our customers as well, so if they can withstand the recession, hopefully their liquidity is going to continue to improve and we won't see increased problems.

But it's something very high on our watch list. We've got very vigilant credit procedures in place right now to try and minimize that exposure. Historically, our business has had very low bad debt provisions and exposures.

[John Beier – SKA Financial]

Two other quick questions then I'll get out of the way, are you see any pressures on the demand for your energy efficient products? I know that most of the re-roofing thing is something that if you got a bad roof you got to get it fixed, but are you seeing any slowdown in the demand in that area?

James Hurlbutt

Well, we did in November and December, and it's hard to get a firm handle on how much of that was due to customers holding off on reordering until the prices dropped on January 1 as opposed to their underlying business slowing down. And we do slow down normally in the winter months because less of that work occurs in the winter months.

Our customers are not indicating that they expect a significant fall off this year in demand. I mean, significant I would say maybe up to 10% decline but not like the commodity chemical guys that are down 30, 40%. We're not hearing of those type of expectations, so hopefully the energy efficiency and the need to replace a roof will hold true this year and continue to drive consumption of our product.

[John Beier – SKA Financial]

One last question and I'll get out of the way here. With regards to your oil field projects, I would think that given the considerable matter of the oil production in this country is from stripper wells, there's ten barrels a day and less, that there would be a much more greater interest in enhanced oil recovery for these older fields. And I'm wondering if the drop in oil prices has increased your inquiries or interest in that, given the fact that so many of these independents are scaling back their exploration budgets and so forth.

James E. Hurlbutt

It's a mixed result. We have people who, as you point out, a good portion, at least in the continental US market, is older wells. A lot of those older wells have already gone to waterflood technology, meaning they've already got injection wells pushing water through their formations. If they have those wells, then the economics of adding surfactants is probably still attractive.

If they have to make the capital investment in the wells, I think we're seeing less interest in doing that at today's prices of oil. If oil comes back up, there'd probably be more active consideration of injection wells, but given the vast number of waterfloods out there, we still think it's economically viable for people, even at today's prices.

[John Beier – SKA Financial]

And are these pilot projects with the traditional sand reservoir-type fields, or is there any application of your product to either coal bed or some of the shale gas plays?

James E. Hurlbutt

Yes. We're trying to formulate for all of those types of fields. I mean the whole reason for forming the joint venture with Nalco was to put together a team with the professional expertise to go in and offer the solutions to the various geological formations that somebody's trying to extract more oil out of, as well as natural gas. There are applications for natural gas fields.

[John Beier – SKA Financial]

How long are those pilot projects anticipated? I mean are you looking at 3, 6, 12-month type or longer?

James E. Hurlbutt

All of that range. Some people go in and do short tests to see if they can see any difference. Realistically, you probably need a longer three to six-month period to get any high degree of confidence in the results.

[John Beier – SKA Financial]

I'm sure it depends on the –

James E. Hurlbutt

In the geology, correct, and now I'm out of my field.

Operator

Your next question comes from George Gasper – Robert Baird.

George Gasper – Robert Baird

Jim, just pursue a little bit on the pricing side in terms of your product pricing versus raw material pricing. How do you sense the quarter that you're in here on a relative basis with raw material pricing coming down versus what you're managing to get? If you were to look at that in, say, for the nine months beginning April going forward, do you think there's a decent potential for you to keep a lesser pricing decline than the raw material pricing decline that may be in the market to you going forward?

James E. Hurlbutt

We're certainly trying to make sure we protect our margins, and if it's a segment of our business where there's a basis and we can justify improving the margins, we're certainly going to try and do that. We feel there's probably more upside in terms of overall profit improvement in the first half of the year than as the year unfolds. And if the economy continues to slide, we'll discipline on pricing dissipate and will margins be vulnerable?

That's very speculative at this point because we just don't know where this economy's going. But we feel pretty good about where our margins are right now and we hope we can hang on to that for at least the first half of the year.

George Gasper – Robert Baird

On the fabric softener side, as you're looking across the plain this year, is there any increases in your capacity that will take place, international versus domestic, and is there any specific area that you're concentrating on trying to expand that capacity?

James E. Hurlbutt

Well, we were getting very tight on softener capacity and we added a reactor in Winder, Georgia, which in effect, freed up capacity in our Matamoras, Mexico plants. So now, we do have a little elbow room in Mexico and in the U.S. because of shuffling of the production utilization.

As far as remaining other capacity, we still have plenty of room on our Philippine fabric softener reactor for expansion, and that's one of the areas we really see an opportunity for improvement in the Philippines, because we don't have a profitable operation there today. Filling out that softener reactor would go a long way to improving the profitability.

And as I think I've mentioned in the past, the Asian consumption of softener per capita is much lower than in Europe and North America, so we still think that's a growing market. We want to sell out that reactor. Before we would consider a further Asian softener reactor, we want to fill up the capacity in the Philippines.

George Gasper – Robert Baird

Anything going in Brazil?

James E. Hurlbutt

No. Not yet. This multipurpose reactor we completed last year is really almost sold out and mostly on agriculture and functional products. So, there certainly may be an opportunity down the road to diversify into softeners.

George Gasper – Robert Baird

And then one last question, on acquisition opportunity, based on the economic fallout and the negative valuation that has come about, do you see any opportunities to make acquisitions that would align you in your field or are you just going to –

James E. Hurlbutt

We have an active program on to go try and identify opportunities because, yes, it's very clear to us that valuation multiples that had gotten very high two, three years ago, are coming down to a much more reasonable position. And some companies who just flat out have too much debt may be looking to get rid of some product lines, and we'd be very interested in those opportunities and we intend to pursue them this year.

Operator

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

James E. Hurlbutt

That concludes my prepared remarks. Thank you all very much for participating today. Bye-bye.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Stepan Co. Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts