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Stepan Company (NYSE:SCL)

Q4 2013 Earnings Conference Call

February 19, 2014 14:00 ET

Executives

F. Quinn Stepan, Jr. - President and Chief Executive Officer

Scott Beamer - Vice President and Chief Financial Officer

Analysts

Daniel Rizzo - Sidoti & Company

Jason Rogers - Great Lakes Review

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Stepan Company’s Fourth Quarter and Full Year 2013 Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, February 19, 2014.

I would now like to turn the conference over to Scott Beamer, Vice President and CFO. Please go ahead, sir.

Scott Beamer - Vice President and Chief Financial Officer

Thanks Mike. Good afternoon and thanks everyone for joining us today for Stepan’s fourth quarter and full year 2013 earnings conference call.

Before I begin, I’d like to mention that the conference call contains some 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 factors detailed in the company’s Securities and Exchange Commission’s filings.

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

F. Quinn Stepan, Jr. - President and Chief Executive Officer

Thank you, Scott and thank you all for joining us today. The fourth quarter and full year 2013 net income was disappointing to us despite being the second best year in company history. Net income was $10.7 million in the quarter and $72.8 million for the full year. Earnings, excluding deferred compensation and restructuring expenses, were $14.3 million and $77.3 million respectively. Full year earnings from operations were down 8.8%. Net sales were $1.9 billion, up 4% as all three operating segments delivered improved sales. Recent large investments in both surfactants and polymers contributed to our profitability in 2013 and should deliver income gains in the fourth quarter – should deliver income gains in 2014.

The fourth quarter was highlighted by net sales growth of 11% with strong volume growth within our Ace business and our strategic initiatives in Brazil, Singapore and Columbus. The fourth quarter and year were not without challenges as net income declined due to higher raw material, maintenance and transportation costs. Despite these challenges in 2013, we remain optimistic about our future and our ability to deliver growth. In the fourth quarter, the company approved a plan to consolidate a portion of its North American surfactant manufacturing operations to reduce future cost and improve asset utilization. Specifically, we shut down sulfonation production at our Canadian manufacturing site, which will result in the elimination of an estimated 20 positions. Production of effective products currently manufactured in Canada will be moved to U.S. plants.

The restructuring actions are expected to be completed in the third quarter of 2014. Additionally, the company reduced the useful life of the manufacturing assets in the affected areas of the Canadian plant. This change will add about $1.8 million of depreciation expense in the first half of 2014. The savings are expected to begin in the second half of 2014 with an annual run rate of approximately $2.5 million per year beginning in 2015.

Overall, our balance sheet remains strong and we intend to make additional investments that will improve our efficiency, drive our earnings growth and deliver value to our shareholders. Our Board of Directors declared a quarterly cash dividend on its common stock of $0.17 per share payable on March 14, 2014. In 2013 Stepan paid out total cash dividend distributions of $14.5 million and in the fourth quarter increased its quarterly cash dividend by 6% marking the 46th consecutive year of paying increased dividend.

At this point, I would like Scott to walk through Stepan’s fourth quarter and full year results.

Scott Beamer - Vice President and Chief Financial Officer

Thanks Quinn. Total net sales for the fourth quarter were $474.3 million, which was up 11% versus prior year due to higher volumes across all the businesses. Selling prices were flat versus the prior year. For the full year net sales were $1.88 billion, up 4% versus prior year. Volumes were up 7% while selling prices decreased by 3%. Since deferred compensation expense is generally a non-operating item which is driven by changes in our share price, we typically speak about net income excluding deferred compensation expense. Additionally in the fourth quarter we took the pretax restructuring charge for the items that Quinn mentioned of about $1 million pretax or $700,000 after tax. So we exclude both of those items, we get a more comparable view. Fourth quarter net income excluding deferred compensation expense and restructuring expense was $14.3 million versus $18 million in the prior year.

A detailed table outlining the financial effect of the deferred compensation plan has been provided as normal in the earnings release as Table 2 for your reference. With regard to the restructuring action approved in the fourth quarter the $1 million pretax charges related to one-time severance expenses, most of the severance payments are expected to be made in the third quarter of 2014. In addition to the restructuring cost the company reduced the useful life of the manufacturing assets in the affected areas and recognized $300,000 of additional depreciation in fourth quarter cost of sales and as required by the accounting rules. This change will add about $1.8 million of depreciation expense in the first half of 2014.

While the impact of foreign currency on our net income is negligible, we provide Table 3 in our earnings release which shows the summary of the effects of foreign currency translation on sales and key income statement line items. Fourth quarter gross profit declined 13% versus prior year to $60.9 million and full year gross profit declined 3% to $281.7 million and we will speak about more details of that when we get into the segment review. Fourth quarter operating expenses excluding deferred compensation expense declined by $1.5 million or 4% primarily from the reduced performance-based compensation expense related to our lower performance year for the year.

Full year operating expense include – excluding deferred compensation increased by $9.4 million or 6%. This increase is primarily from spending to drive strategic initiatives such as additional R&D resources, evaluating acquisitions, filing patents and trademarks and external innovation cost.

Next net interest expense for the quarter was $2.9 million, which reflects an increase of $638,000 versus last year. This is specifically due to the higher average debt levels resulting from the private placement at a 3.86% rate which was used to fund the second quarter acquisition of the North American polyester resins business from Bayer MaterialScience.

The full year effective tax rate was 24% in 2013 compared to 31% in 2012. The decrease was partially attributable to a favorable IRS ruling published in the fourth quarter 2013 that allowed the company to exclude certain biodiesel excise credits from income and that was retroactive to January 1, 2010 and that resulted in the large benefit that you have seen in the fourth quarter. The decrease in the overall annual rate was also attributable to the federal research and development tax credit which was extended retroactively back to January 1, 2012 when the American Taxpayer Relief Act of 2012 was signed in the law in 2013. So that entire affect was in 2013. Also contributing to the effective tax rate decline was a greater percentage of consolidated income being earned outside the U.S. where the effective tax rates are generally lower.

Looking ahead to 2014 we project our ongoing tax rate to be between 28% and 30% which is just slightly changed from what we said in our third quarter conference call. Now let’s move to a review of the performance of our three (key) business segments. First we’ll look at Surfactants which is our largest segment and accounts for about 70% of our company’s sales.

Net sales of surfactants totaled $327.7 million for the quarter, an increase of 6% versus prior year. Full year surfactant sales, was 1% to $1.32 billion. Surfactant sales volumes increased 9% for the quarter and 6% for the full year, all regions delivered growth for the full year. U.S. consumer product and general surfactant volumes were each up 2%. European consumer product volumes were up 3%. Higher value-added surfactants used in agricultural products delivered strong volumes growth while surfactants used in oilfields declined in 2013.

Regionally recent capacity expansions in Brazil and Singapore delivered anticipated growth. Surfactant gross profit declined $10.9 million or 21% for the quarter and declined $17.7 million or 9% for the full year. North American operations were responsible for most of the quarterly and full year decline. For the quarter, North American results were negatively impacted by higher material cost, maintenance and transportation cost.

On a full year basis, North American results were also negatively impacted by higher cost raw material inventory built to support our Singapore plant start-up and contractual timing differences between changes in raw material cost selling price and non-recurring cost to secure a strategic raw material for specialty surfactant growth. All regions outside the U.S. delivered higher gross profit for the full year.

Moving on to our Polymer segment, which represents about 25% of our sales. Net sales totaled $128.4 million, an increase of 25% from prior year. Full year polymer sales increased 14% to $483.4 million. Excluding the impact of the acquisition polymer sales increased 11% and 14% for the quarter and full year respectively. Polymer sales volume increased 19% for the quarter and (8%) for the full year. Excluding the acquisition from Bayer the increases were 10% and 3% respectively.

For the full year despite continued general economic headwinds, European polyol volumes grew by 16%, in large part due to new business and market growth in metal panels and case. North American polyol used in rigid foam installation was flat. Phthalic anhydride sold into the merchant market experienced a volume decline of 6% while internal consumption increased. About 40% of total phthalic anhydride production is consumed internally. Polymer gross profit increased $1.2 million or 7% for the quarter and increased $9.0 million or 13% for the full year.

The most significant driver was the strong volume growth in Europe and the Columbus, Georgia acquisition also contributed marginally to 2013 earnings as expected. In Quinn’s outlook section he will comment on 2014 expectations for this acquisition. The positive margin improvements were partially offset by one-time cost related to the Chinese government-mandated plant relocation.

Finally, for Specialty Products, the segment which represents about 5% of our company’s sales, here the sales increased 33% to $18.2 million for the quarter. Full year segment sales, was 8% to $80.3 million. Specialty products gross profit increased 58% to $1.6 million for the quarter driven by higher food and flavoring product sales volumes. Full year gross profit declined 1% to $300,000. Specialty products volume increased 26% for the quarter and 2% for the year.

Now moving ahead to the balance sheet. Total debt was $270.6 million as of December 31, 2013 down $6.2 million essentially due to scheduled debt repayment. Total debt was up $88.2 million year-over-year largely driven by the $100 million private placement completed in June to fund the second quarter acquisition which has been mentioned. As of December 31, 2013 inventories totaled $172.4 million, an increase of 10.4 from prior year. And the largest driver was an additional $7.3 million at the new Columbus, Georgia plant.

We also report net debt which is total debt minus cash on hand. As shown in the earnings release that ratio of net debt to total capital was 19.9% on December 31 compared to 18% for the prior year. Our total debt to capital ratio total debt now was 32.8% compared to 27.5%. Capital expenditures were $92.9 million for the full year. And looking forward we expect full year 2014 capital expenditures to be within the range of $115 million and $125 million, including capacity expansions in the U.S. and Brazil. This increase is consistent with our general objective to use cash from operations to fund investments for future growth. Regarding cash flows for the full year we generated $150.3 million in cash from operations compared to $109 million in the prior year. In the earnings release we have provided some additional transparency on some key working capital components.

Net receivables inventories and accounts payable generally changed consistently with the increased volumes in our business. There were no significant changes to terms. We’ve a relatively small share repurchase program. For the full year of 2013 we repurchased 42,000 common shares in the open market for a total of $2.3 million. We made no share repurchases in the fourth quarter.

Before we open the call to questions Quinn will provide some perspective on Stepan’s forward-looking outlook.

F. Quinn Stepan, Jr. - President and Chief Executive Officer

Thank you, Scott. As we look to the full year 2014 we are experiencing a slow start to the year with severe weather impacting customer locations as well as our own facilities in North America. Even with this 2014 income should rebound as many of the events that held us back in 2013 are now behind us.

In particular surfactant earnings will be down in the first quarter mostly due to the extreme weather and higher maintenance expenses. Earnings will improve as the year progresses driven by greater agricultural sales, continued consumer product growth in Brazil, projected demand and enhanced oil recovery and gains from operational efficiencies. This surfactant business will also benefit from the absence of approximately $9 million in non-reoccurring items including costs related to the Singapore plant start-up and securing a strategic raw material for specialty surfactant growth. Generally speaking, there should be minimal deterioration of base margins. 2013 margins excluding one-time items should serve as a good predictor of 2014 margins. Any deterioration in baseline margins couldn’t be mostly offset by expanded sales into the more profitable markets for functional surfactants and case polyols.

Polymer should experience continued growth from polyol used in energy saving, rigid foam installation. Improving economies in the U.S. and Europe as well as further conversion of metal panel and case customers should contributed to volume growth in 2014. The North American polyester resin business acquired from Bayer is fully integrated and is positioned to deliver between $6 million and $8 million operating income in 2014.

The $2 million cost to close our Chinese joint venture plan and the establishment of an Interim supply chain will not reoccur. We plan to build a new plant in China to participate what we expect will become the largest polyol market in the world. Overall, the health of our balance sheet remains strong and will facilitate investments in growth and efficiency opportunities. And that will deliver value to you, our shareholders.

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

Question-and-Answer Session

Operator

Absolutely, thank you. (Operator Instructions) And we have one question from the line of Daniel Rizzo with Sidoti & Company. Please proceed. Your line is now open.

Daniel Rizzo - Sidoti & Company

Good afternoon guys.

Scott Beamer

Good afternoon, Dan.

Daniel Rizzo - Sidoti & Company

Could you just provide a little color on specifically what the maintenance costs were that they were elevated last quarter and are kind of hampering things in the beginning of the first quarter here is that something that’s, I don’t know it’s like a yearly maintenance thing or is that something that was unique to this timeframe?

F. Quinn Stepan, Jr.

We have been spending a significant amount of money kind of on base maintenance capital of our facilities over the last several years and reinvesting in our core manufacturing operations. Although we had planned to do some significant work at our Anaheim facility in mid-2014, we had some mechanical issues with our sulfur burner at our Anaheim facility that caused significant down time, higher maintenance costs in the fourth quarter and significant outsourcing from – in terms of additional transportation costs from our Millsdale facility in the fourth quarter and has got into the first quarter of 2014 as well. So, that one specific item probably contributed at least to $1.5 million of down term in 2013 and is carried over a little bit into 2014 as well.

Daniel Rizzo - Sidoti & Company

But should be gone by the end of the first quarter, correct?

F. Quinn Stepan, Jr.

It should be gone. We will probably experience, the plant is up in running today, but we will go down for additional maintenance, planned schedule maintenance to replace the burner actually probably in the second quarter maybe early third quarter. So there will be some outsourcing cost, but mostly behind us in the first quarter.

Daniel Rizzo - Sidoti & Company

Okay. And then you mentioned that you did a capacity expansion in Brazil I think with surfactants, is that complete or you – would you have enough capacity there now because I think you were – I mean you are more demand than you can meet before, is that still case?

F. Quinn Stepan, Jr.

We are planning an adding a second neutralizer to our site in Vespasiano which is outside Belo Horizonte, Brazil and it’s a significant capital project. That project itself will not be online until the first – end of the first quarter 2015. So we have opportunities to sell little bit more incremental capacity down in the region until we expand that site.

Daniel Rizzo - Sidoti & Company

Okay. Alright, thank you guys.

F. Quinn Stepan, Jr.

Thank you, Dan.

Operator

(Operator Instructions) And we have another question coming from the line of Jason Rogers with Great Lakes Review. Please proceed. Your line is now open.

Jason Rogers - Great Lakes Review

Hi, good afternoon.

Scott Beamer

Hi, Jason.

F. Quinn Stepan, Jr.

Hi, Jason.

Jason Rogers - Great Lakes Review

Just wanted to get your thoughts on the oil market for 2014 what you’re expecting out of the enhanced oil recovery business?

F. Quinn Stepan, Jr.

We continued to be optimistic about the enhanced oil recovery market recognizing that some of the development activities have been much longer than we anticipated. We are seeing some increased competition within our customer base for other opportunities they maybe seeing in the fracking market. But having said that, we are currently active in 5 to 7 pilots and/or commercial floods in 2014 we are anticipating based on projects that have started or committed to be started that we will as the year unfolds improve our profitability $3 million to $5 million over 2013.

Jason Rogers - Great Lakes Review

And then, you have mentioned $1.5 million in maintenance costs for the surfactant business is that in addition to the $9 million of costs that you flushed out as non-recurring or is that included in the $9 million.

F. Quinn Stepan, Jr.

That’s an addition too.

Jason Rogers - Great Lakes Review

And looking at that $9 million, how is that spread out over the last fourth quarter, is it petty much evenly spread or is it more concentrated in certain quarters.

F. Quinn Stepan, Jr.

Yes, I would say the first half of that was probably 50% or 70%, 70% very little in the third quarter and then 30% in the fourth quarter.

Jason Rogers - Great Lakes Review

Thank you, very much.

Operator

And Mr. Beamer, there are no further questions at this time. I will turn the call back over to you.

F. Quinn Stepan, Jr. - President and Chief Executive Officer

Okay. I would like to thank everyone for joining Scott and I on the call today as well as the entire Stepan team for their continued dedication to serving our customers worldwide and their valuable contributions that allow us to generate value for you, our shareholders. We look forward to reporting back to you on our first quarter 2014 results call. Have a great day. Thank you.

Operator

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

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