Stepan Company

Greetings and welcome to the Q1 2020 earnings release conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press star followed by the number one on your telephone. If at any time during the conference you need to reach an operator, please press star zero. As a reminder, this conference is being recorded Tuesday, April 21st, 2020. Your speakers for today are Luis Rojo. I would now like to turn the conference over to Mr. Luis Rojo. Please go ahead, sir.

Good morning, and thank you for joining Stepan Company's first quarter 2020 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 for our foreign operations, global and regional economic conditions, and factors detailing 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 and when the earnings releases issue. And we hope that you find the information and perspective helpful. Now with that, I would like to turn the call over to Mr. Quinn Stepan, our chairman, president, and chief executive officer.

Thank you, Luis. Good morning. And thank you all for joining us. Today we are living in a difficult and uncertain world. We are all concerned about our health and the health of those we love. Many people have lost their jobs and are fearful as to how they will support themselves. At Stepan, we are very fortunate that many of the products we sell contribute to the fight against the coronavirus. Our plants are running, and most importantly, We have been able to keep our people employed and healthy. We have supported local first responders including Chicago police and fire stations with free hand sanitizer and disinfecting products. We are grateful to all of our employees for their commitment to make our world healthier. Now, let me provide an overview of our first quarter performance. Given the global pandemic and the impact of the power outage at our Millsdale facility, we actually had a pretty good quarter. First quarter adjusted net income was $24.2 million or $1.04 per diluted share versus $30.6 million or $1.31 per diluted share in the prior year. Including the estimated impact of the Millsdale power outage, For which we have insurance, adjusted net income would have been up versus the prior year. Compact and operating income benefited from strong volumes in the global consumer product end markets driven by higher demand for cleaning and disinfection products as a result of COVID-19. Functional product volumes were down. Mexican operations delivered strong year-over-year earnings growth. Polymer operating income was down due to the power outage of Millsdale and significantly lower thalic and hydride volumes. Global rigid polyol volumes were flat as growth in North America and China was offset by lower demand in Europe due to COVID-19. Our specialty product business results were higher due to improved volume and margins within our medium chain triglyceride product line. driven by strong demand and pantry loading in the infant nutrition market as a result of the COVID-19 outbreak. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of 27.5 cents per share payable on June 15, 2020. At this point, I'd like Luis to walk through a few more details about our first quarter results.

Thank you, Quinn. My comments will generally follow the slide presented. Let's start with slide 4 to recap the quarter. Adjusted net income from the first quarter of 2020 was $24.2 million, or $1.04 per diluted share, a 21% decrease versus $30.6 million, or $1.31 per diluted share in the first quarter of 2019. But still in the process of determining all the impacts associated with the Mildred incident. At this time, we believe the impact is at least $10 million on a pre-tax basis. Because adjusted net income is a no-gap measure, we provide full reconciliations to the comparable gap measures. And this can be found in Appendix 2 of the presentation and Table 2 of the press release. Specifically adjusted to report the net income this quarter consists of adjustment for deferred compensation and cash settled SARS income. and some minor restructuring expenses. Adjusted net income for the quarter excludes deferred compensation income of $3.7 million or 15 cents per diluted share compared to deferred compensation expense of $5.1 million or 22 cents per diluted share in the same period last year. The deferred compensation numbers represent the net expense related to the Company's deferred compensation plans as well as cash settled stock appreciation rights for our employees. Because these liabilities change with the movement in the stock price, we exclude this item for our operational discussions. Slide five shows the total company earnings bridge for the first quarter compared to last year's first quarter and breaks down the decrease in adjusted net income. Because this is net income, the figures noted here are on an after-tax basis. We will cover each segment in more detail But to summarize, surfactants and polymers were down while specialty product was up versus the prior year. Corporate expenses and all others were higher during the quarter due to higher acquisition-related expenses for the not-surfactants acquisition, a higher effective tax rate, and forex exchange losses. Favorable net interest expense was related to higher interest income. Company's effective tax rate was 22.5% in the first quarter of 2020 versus 19.5% in the first quarter of 2019. The increase was primarily attributable to lower tax benefits derived from the stock-based compensation awards. We expect the full year 2020 effective tax rate to be in the range of 22 to 25%. Slide six focuses on surfactant segment results for the quarter. to the fact that net sales were $327 million for the quarter, a 6% decrease versus the prior year. Selling prices were down 3%, primarily due to the pass-through of lower raw material costs. Sales volume was down 1% versus the prior year. Higher demand for products sold into our consumer products and markets, driven by increased demand for cleaning and disinfection products as a result of COVID-19, was offset by lower sales volume for our functional product and markets, primarily agriculture and the field. Surfactant operating income decreased $1 million versus the prior year, primarily due to higher costs and low sales associated with our Millsdale plant power outage and the negative impact of foreign currency translation. These items were partially offset by a $4.2 million operating income improvement in Mexico. North America's results decreased primarily driven by higher supply chain expenses and lost sales associated with the power outage incident at the Millsdale plant and lower demand in the agricultural and oilfield end markets. This was partially offset by strong volumes in consumer products, driven by higher demand in cleaning and disinfection products due to COVID-19. Latin America's results were up due to a 4.2 million operating income improvement in Mexico, driven by 17% volume growth and margin expansion. Europe results were basically flat, as higher consumer product demand as a result of COVID-19 was offset by volume reductions by one important customer. Now, turning to polymers on slide seven. Med cells were $106.5 million in the quarter, and 11% decrease versus the prior year. Sales volume decreased 9% in the quarter primarily due to significant reduction in PA volume due to the Millsdale power outage. Global rigid polio volumes were flat. Tailing prices declined 1%. Polymer operating income decreased $4.6 million primarily due to higher cost and volume loss associated with the Millsdale plant power outage. North America polymer results decreased due to higher cost and volume shortfalls associated with the Mildale incident. Rigid polio volumes increased by low single digits. Europe results were basically flat with lower rigid demand at the end of the quarter due to COVID-19. P8 results decreased due to the Mildale incident. Finally, China results improved on volume growth of 16% Our specialty polio business was up with all regions growing operating income year on year. Specialty products sales were $16.4 million for the quarter, a 15% decrease versus the prior year. Sales volume declined 8% for the quarter. Operating income increased $0.9 million versus the prior year. are primarily used to improve volume and margins within our NCT protocol, driven by a strong demand and pantry loading in the infant nutrition market as a result of the COVID-19 outbreak. Turning to slide eight, our balance sheet remains strong. We had negative net debt at quarter end as cash balances of $254 million exceeded total debt of $222 million. Capital spending was $33.2 million versus $25.7 million in the prior year quarter. For the full year, capital expenditures are expected to be on the low side of the range of $100 to $120 million. Moving to slide nine, we believe we have sufficient liquidity levels to operate in this challenging near-term environment. We have $254 million cash on hand, and we have access to a committed $350 million revolving credit agreement. Our debt maturity schedule in 2020 is only $23 million. Beginning on slide 10, Quinn will now update you on our 2020 outlook.

Thank you, Luis. Looking forward, we believe 2020 It's going to be a difficult year for our world, our country, our industry, and Stepan Company. However, we believe in the current environment our business is positioned better than most. With empty store shelves around the world due to high demand for disinfection and cleaning products, our surfactant volume in the consumer products market should remain relatively strong short term. Following raw material prices may provide an opportunity for margin improvement. With dramatically lower oil prices, demand for surfactants within the oil field market will be down. We anticipate our agricultural business should approximate last year's results. Overall, we believe our surfactant business should remain relatively recession-resistant. Our polymer business most likely will face a reduction in demand as people defer or cancel reroofing and new construction projects. We believe in the long-term prospects of this business remains attractive and energy conservation efforts and more stringent building codes should increase demand. Our specialty products business should continue to benefit from medium chain triglyceride demand in the infant nutrition market. Our flavor and pharmaceutical product sales should be stable for the year. After a good start to the year, we are positioned to continue to deliver critical products to our customer base. However, our business is not without risk. The continued health of individuals throughout the supply chain, raw material suppliers, logistics providers, Customers as well as our own employees is critical for sustained performance. We believe M&A represents an important tool as a means to deliver meaningful EPS and EBITDA growth over the next few years. Given the strength of our balance sheet, we will look to identify and pursue acquisition opportunities to fill gaps in our product portfolio and to add new platform chemistries. During the first quarter of 2020, Stepan acquired the NatSurfact business, a rhamnolipid-based line of biosurfactants from Logos Technologies. Biosurfactants produced via fermentation from renewable resources offer opportunities in several strategic end-use markets, including agricultural, personal care, and household cleaning. With our strong balance sheet and available liquidity, We believe we are well positioned to operate in the challenging near-term environment. I want to close by thanking all Stepan employees for their effort and hard work to help us fight this pandemic. Additionally, we want to thank our customers, our suppliers, government agencies, and the local communities in which we operate for all their support during this unprecedented time. We continue to be optimistic about our collective future and remain confident in the resiliency of people and the strength of the human spirit. We will get through this together. This concludes our prepared remarks. At this time, we would like to turn the call over for questions. Pasha, please review the instructions for the question portion of today's call.

As a reminder to register for a question, press star followed by the number one. Again, that's star one. Your first question is from the line of Vincent Anderson.

Thanks. Good morning, everyone. Good morning, Vincent. Good morning. So just briefly on agriculture, I was curious how much of the weakness in the quarter could you attribute to some delays in spring planting that we've seen start to abate here more recently? And, you know, following on that, has the business improved more recently?

What I would say is that there was a high level of inventory coming into within the agricultural sector of our business coming into the season. So I don't know that we've seen significant delays in planting necessarily as we've seen a drawdown of existing inventories. We do anticipate the balance of this year in North America that we would kind of be on plan or equal to budget. and we're going to offset the decrease in the first quarter in North America with global growth.

That's helpful. Thank you. And then just quickly on the numbers in Mexico, you know, how much of the improvement would you attribute to normalizing your operating conditions there versus an uptick in maybe COVID-related demand? and at that current run rate of improvement, you know, what would that $4.2 million that you highlighted in one queue look like in this quarter?

Yeah, being said, this is Luis. I will say half and half is due. Remember that last year we had the incident in a Caratex, so of course the 17% volume growth is also driven by that low base. but I would say half and half is the split.

And I guess I would further add that the most of the improvement that we've seen is not COVID related. We are on plan with the volume that we put in our budget for the year. So we feel good about that. We did use that site to supply small amounts back to the United States during our Millsdale outage. But our Mexican volume is on plan. And we do anticipate and we are adding additional buy-a-side capabilities in Mexico. So we do see that as being an opportunity for the second half of the year, primarily supporting the U.S., but we also have new registrations that will allow us to sell that product line in Mexico.

Great, thanks. If I could just ask one more quick one on NatSurfact. Is that commercial scale already? And then can you just talk about... It's not, okay.

No, it is. We bought primarily what we bought is process technology and patented process, specifically patented process technology. So that'll accelerate our R&D program in that space.

Okay, and just out of curiosity, you know, what specifically about this portfolio interested you, just kind of given historically fermentation-based chemistries have kind of struggled to maintain profitability?

Yeah, there's a significant pull that's beginning in the market for bio-based natural surfactants. So, this is, we have a number of products historically in our line. that are derivatives from coconut oil or palm oil. But we see this as kind of the new frontier for surfactants. Generally speaking, they tend to cost a little bit more than petroleum-based surfactants, particularly with oil today at minus $37 a barrel. But we do think it's a long-term play, and our customers, particularly the large consumer product companies, are looking for bio-based products to formulate with. That's great, thank you.

As a reminder, in order to register for a question, please press star 1. Your next question is from the line of Mike Harrison.

Hi, good morning. Good morning, Mike. I was wondering if you could help us understand the Millsdale outage, kind of what the impact was from an operating income perspective in both the surfactants business and the polymers business, if you could.

You know, what I would say is we believe the cost in the first quarter were at least $10 million. That cost to date would be equally split more or less between the surfactants and the polymer business. We may have some additional expenses in Q2. and those would be more directly applicable to the polymer business. We have been shipping some material from Europe back to the United States and some of that volume is still in transit.

All right, thank you. And then I was also just wondering in terms of that outage, and the surfactants business, were you able to meet this increasing demand that's been associated with COVID and with the increase in demand for consumer cleaning and disinfecting applications? Are you kind of, were you 100% able to deliver on surfactant demand and are you fully back to being able to be 100% fulfilling those orders now?

And I would first say that our team at the Millsdale plant did a fabulous job restoring production at the site. And in addition to that, we had a lot of support from the other plants in our network in North America. So we actually lost a small amount of business in our surfactant line during this period. So, our inventories were generally low as we were coming out of that period, so we weren't able to ship everything that customers ordered, but pretty close, pretty close in our surfactant line. Not true for We did have some back orders in the Polyol marketplace that we're shipping in March and April. But I would say for the most part we've been able to ship all of the COVID-19 related demand. And maybe if I could just expand on that a little bit. As you see some of the large consumer product companies when they start and have started making their Earnings Announcements, they're talking about potentially an increase in demand for cleaning products on a sustained basis. We have sufficient anionic capacity, so is our sulfonation product line in North America to support that. In our amphoteric product line, which are batch reactors, they tend to be used a little bit more in hand washing. We're snug, I would say, in that area. but have some incremental capacity that we could bring to the market to bear. And from a biocidal quaternary perspective, we have sufficient capacity to support growth in the market or significant more growth in the market. But in that case, raw materials are a significant concern. And so raw materials are limiting our ability to capture some increased demand in that space today. And we're trying to work with our suppliers across three or four different key product lines in that space to bring additional volume to the marketplace.

All right, that actually is kind of a question that I wanted to get to is maybe understanding In terms of some of these applications that you're serving, can you walk through areas where you're seeing demand well ahead of normal? I assume things like hand soap or other hand washing types of products and disinfecting wipes. That's off the charts right now. Can you just maybe help us understand where we are relative to normal and also maybe talk a little bit about the margin profile of some of those products compared to Detergents, which I think of as being lower margin, and maybe some of the functional surfactants, which I think of as being some of your highest margin products.

Yeah, so, and I started to break it down a little bit. So, let's start with the biocidal quaternaries first. So, again, I mentioned those are, for example, are used in Clorox wipes, are used in Lysol, and other hard surface cleaning products. in the marketplace today. Those products tend to be more profitable than some of the other materials in our range. There are three companies in the United States that have those products registered with the US EPA. And again, so I would say when we sell additional volume, it tends to be accretive to our business. Sales in the first quarter for those products were up 18-19% for the first quarter, with most of that increased demand occurring in the month of March. So that's one example. And then we talked about amphoterics, generally, mean oxides and betanes specifically. Those tend to be more commodity products. That volume globally was up a little bit, but still low single digits. And then alcohol sulfates, which are kind of companion products used in many of the hand soaps, that was up over a magnitude of about 10%. And I would say Our ability to respond to the amine oxides and the betaine product lines, again, that's where I said we're tight, but we have opportunities to squeeze a little bit more capacity or throughput from our assets.

All right. And then maybe a last question on the polymers business. Just in terms of construction activity, You mentioned the slowing that you saw during Q1 in Europe. You know, it seems like Europe is kind of two weeks ahead of where North America is. So just maybe comment on how you saw construction activity trending in Europe and maybe what you're seeing in North America, I guess, in March and thus far in April.

saw a significant decrease in activity in Q1, particularly in March in Europe. Significant decrease. We see that as a possibility coming in the U.S., potentially in kind of May-June type timeframe, probably June. What we are also seeing in that space, some of the schools are pulling forward some of their re-roofing projects that had been previously approved and why the kids are not in the classrooms. We're looking forward to pulling some of the projects forward. So we think Probably late May or June we may see a decrease in activity in that space in North America.

All right. Thanks very much.

Thank you, Mike.

As a reminder, to register for a question, press star followed by the number one on your telephone. Again, that's star one. Your next question is from the line of David Silver.

Good morning, David. Can you hear me here? Yes, we can.

Okay, sorry. So I'm going to apologize in advance. I had to join the call a little bit late, so I may be asking you to repeat yourself. But first question, I just wanted to review the cash flow in the first quarter. So Not so much year over year, but sequentially. And I just wanted to clarify that. But by my calculation, the net use of cash in the first quarter was $90 million, 9-0. And I was just wondering if you could break that down. How much is kind of normal working capital buildup, let's say, versus some incremental expenses or other items that that are not purely working capital related. And, you know, just in general, maybe compared to the last couple of first quarters, how does the draw this year for working capital and other uses compare? Thank you.

Yeah, David, this is Luis. What I would say is that consumption, cash consumption in Q1 is typical for us, right? I mean, we have a lot of working capital usage in Q1. bonus payments in Q1, et cetera. So at the end, what we saw in Q1 was very similar to the other years. There are probably a couple of factors that were a little bit higher. CapEx was higher, as we mentioned, $33 million versus last year, 25. And we did share buybacks for $7 million in the quarter. So those are the two particular numbers that are a little bit different versus other Q1s. But in general, we always have a cash consumption or, you know, cash consumption in Q1 in all those.

Sure. Okay. Great. Second question would be about your Mexican facility. My sense is that the improvement in financial results this quarter was a little bit greater than maybe I anticipated or that was indicated or expected from your end. I was just wondering, you mentioned the 17% volume increase. On a scale of zero to 100%, where do you think Ecotech facility was operating during the quarter? and when do you think it would be back to 100%? In other words, incremental improvement above what we saw in the second quarter.

Let me answer that question a couple different ways. One, I would say in terms of existing capacity, we're probably in the 80% range. We do have a project to de-bottleneck that site that we are working on and we'll have additional capacity available probably toward the end of this year, the Q1 of next year. So we have an expansion project on. But the other thing, there's a short-term issue right now in terms of COVID-19. The Mexican government has limited and is restricting people over 60 years old to their quarters, if you will. They're sheltering in place. So we are short some employees in our current Mexican facilities. We are having management work with our union employees to run the units today, and we're hiring some temporary employees on site. But so there is a limit to how much we can push those sites until the pandemic eases and we can return a significant amount of our workforce back to the site.

Okay. I have a couple of questions, I guess. about just the broader market. So I apologize, this might be a little garbled. But first question would be related to offshore competition. So in other words, I guess, you know, economic growth and demand for, you know, a lot of your products has declined globally. And I wonder if, you know, that translates into more opportunistic exporting out of Asia or wherever. I'm just wondering if you could comment on that. Maybe the dollar's a little stronger as well. I mean, how do you view that potential threat to either your demand or the pricing for your major products? And then separately, I was wondering if you could comment on your – if you could follow up or add some color to your comments about potential threats. Raw Material Cost Savings. And the reason I mention that is, you know, I'm certainly aware of where oil traded yesterday, but my impression is the U.S. petrochemical market is not so much tied to oil these days, but really to natural gas, you know, based ethylene and ethylene oxide, ethylene glycol, and things like that. and I'm just wondering, you know, for your main facilities that might be supplied out of the U.S. Gulf or wherever, I mean, do you see a meaningful, you know, raw material cost benefit or is the potential a little bit more, I don't know, incremental? So offshore competition and the potential for raw material cost savings. You could add some color there. I'd appreciate it. Thank you.

So from an offshore competitor perspective, let me first deal with our polymer business because that's pretty straightforward. We see limited competition in the polyol area coming from overseas. There's sufficient capacity in the United States today. and so we don't see a lot of imports into the United States. From a thalic and hydride perspective, molten thalic and hydride is used by the majority of our customers. Molten thalic and hydride is not imported into the United States. There are some bags or super sacks that come into the United States. So there is some offshore competition in thalic and hydride. From a surfactants perspective, surfactants generally have a fair amount of water associated with it and the commodity range of our products generally don't travel fairly well. The profitability of them would be offset by the incremental freight and so generally there's not a significant a lot of competition in the commodities surfactant line and when you get into the specialties lines, various lines, You can see import competition, but in the biocide area, for example, that we've talked about, there are U.S. EPA registrations that are required to sell the active ingredient and are required for people to have registered formulations to actually use the products as well. So there tends not to be a lot of import competitions in that space. In terms of You're correct that most of the U.S. chemical industry is based on natural gas versus oil, but the two do move together a little bit. It's too early to tell whether there's going to be margin improvement, but the prices for our polymer raw materials decrease. Key to raw materials decrease 50%. So there will be... impact on sales at a minimum as we go forward. And I think there's more opportunity within our surfactants business for margin enhancement. I think there's a little bit of a vulnerability relative to our polymer business because we were planning for the Illinois River closure that we've talked about. And so we had high inventories of high-priced raw materials. So We're working through those today, but I think short-term, that's more of a vulnerability than an opportunity for us. Okay.

Is it okay if I ask one more here? Is that all right? Sure. I had a question, and I apologize. I'm going to ask you to put your product manager hat on a little bit. I was looking on a couple of government websites, and in particular, I was looking at List N from the EPA, which includes more than 30 of your products that are approved for use against coronavirus. And I was just wondering, I mean, I was looking at the list, more than 30 of your products are listed, all of them are quats or Quaternary Compounds, but also on the list there were some non-Quaternary products, isopropyl alcohol, hydrogen peroxide, which I'm assuming are lower priced alternatives. Could you maybe discuss in this current environment how your Quaternaries compete against The other approved products that are based on perhaps lower cost base antiviral disinfectants, is there kind of a way to think about that? Or is it, I don't know, all in the formulation and it's too hard to kind of separate it apart?

It's in the formulation, but it's also in the surfaces that you treat. So bleach is a very effective disinfectant. It's very effective against coronavirus, probably more effective than biocidal quaternaries from a technical perspective, depending on the surface that you're cleaning, depending on the surface that you're trying to treat. So our products are generally used in hard surface cleaning. that will not be damaged by bleach. So that's where the strength of our product line rests. And again, we're in Clorox wipes, we're in Lysol, so products that tend to be a little more gentle to surfaces. But generally, when you're talking about fighting a virus, you want to use a range of active ingredients to fight them as well. So beyond that, you're going to get in over my head.

Over my head too. But no, I apologize. I know there was a ton of detail on those lists that I kind of skipped over. But okay. Thanks very much. I appreciate it. Thank you.

As a reminder, if you would like to register for a question, please press star followed by the number one on your telephone. Again, that's star one. At this time, sir, there are no further questions.

Okay. Thank you all very much for joining us on today's call. We appreciate your interest in ownership in Stepan Companies. We look forward to reporting to you on our second quarter call. Be safe. Stay healthy. Thank you very much.

Thank you, ladies and gentlemen, for participating in today's conference call. We exit you now. Please disconnect your lines.