Apr 12, 2008
Executives
James E. Hurlbutt – Vice President and Chief Financial Officer
Analysts
George Gaspar - Robert W. Baird [Beverly McNeer - Grayson White]
Operator
Welcome to the fourth quarter 2007 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Jim Hurlbutt, Vice President and Chief Financial Officer.
James E. Hurlbutt
Before I begin, please note that the 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.
I am pleased to report that Stepan made significant progress against the company’s financial and operational objectives in 2007. Most importantly we continue to focus on driving higher levels of profitability as well as returning value to our shareholders.
Our success in both of these areas was clear. On the profitability front, Stepan increased full-year 2007 net income by 127% year-over-year to $15.1 million, supported by double-digit sales growth across all business groups.
At this point let me turn now to walking through our fourth quarter and full year 2007 operating results. We’ll start with a look at the top line.
Total net sales for the fourth quarter were $342 million, an increase of 19% from the $288 million in sales reported for the same period in 2006. Net sales benefited from higher selling prices, accounting for 14% net sales growth.
Also the positive effect of foreign exchange translation which accounted for 4% of net sales growth, and finally improved volume which accounted for 1% of the increase in sales. Total net sales for the full year rose 13% to $1.333 billion supported by higher volume accounting for 5% of the sales growth, higher selling prices accounting for 5% of the sales growth and finally the positive effect of foreign exchange translation which accounted for 3% of the net sales growth.
Net income for the fourth quarter was $1.6 million or $0.15 per diluted share, compared with a net loss of $5.5 million or $0.63 per diluted share in the year-ago quarter. Fourth quarter gross profits increased by $9.1 million, up 38% year-over-year, supported by improvements in all three business areas.
Gross margin jumped roughly 140 basis points to 9.8% of revenue from gross margin of 8.4% in the year-ago period. Full year gross profit rose 12% year-over-year with gross profit margins of 10.6%, in line with the 10.7% 2006 full year margin.
Operating income was $5.8 million in the fourth quarter as compared to an operating loss of $8.6 million in the fourth quarter of 2006. Full year 2007 operating income rose 121% year-over-year to $35.1 million.
As I mentioned earlier, full year net income increased 127% to $15.1 million or $1.50 per diluted share, up from $6.7 million or $0.63 per diluted share in the year ago period. Turning to operating expenses, fourth quarter operating expenses totaled $27.5 million down 16% as compared to the same period last year.
The decline in operating expenses was primarily due to the absences of $6.2 million in legal settlement expense and severance costs incurred in the prior year period. Additionally, deferred compensation expense declined by $1 million year-over-year.
As you will recall the accounting requirement for the company’s deferred compensation plan resulted in an expense being reported when the price of Stepan Company stock or the mutual funds held in the plan rise and income being recognized when they decline. Excluding exceptional legal, severance and deferred compensation impacts from both periods, fourth quarter operating expenses increased 8% due to higher wage expense, benefit costs and the effect of foreign currency translation.
Fourth quarter marketing expenses increased 8% year-over-year to $9.2 million. Administrative costs declined 39% to $10.4 million primarily related to the absence of a $6.2 million legal settlement and severance costs for the prior period.
Research costs rose 9% year-over-year to $7.9 million. Full year operating expenses declined by 3% or $2.9 million.
Excluding a $1.4 million decline in deferred compensation expense and the aforementioned $6.2 million in legal settlement and severance costs, operating expenses grew by $4.7 million or 5% driven by higher wage and benefit costs as well as the effect of foreign currency translation. While we are on the topic of foreign currency effects, Stepan’s foreign exchange impact for the year, the decline of the U.S.
dollar particularly against the Canadian dollar resulted in foreign exchange losses and foreign translation gains producing a net expense of $1.8 million versus $300,000 of income a year ago. The majority of the loss related to U.S.
dollar denominated receivables held by the company’s Canadian subsidiary. Let’s now move to a review of the performance of our three business segments.
First we’ll look at surfactants which accounted for 74% of the company’s net sales for the fourth quarter and full year period. Net sales of surfactants were up 18% quarter-over-quarter and 11% year-over-year.
Fourth quarter volume decreased by 1% while full year volume grew 4% as compared to the respective prior year period. Surfactant gross profit grew by $7.2 million or 43% to $23.9 million in the quarter driven by the improved product and customer mix which contributed to higher margins.
Surfactant selling prices were increased to recover higher petroleum and natural oil costs. Fourth quarter volume declined by 1% on lower bio-diesel volume while geographically North America, Latin America and Europe all posted improvements.
Full year surfactant gross profit grew 13% of $10.4 million driven by a 4% increase in volume. Strength during the year came from the recovery of escalating raw material costs and selling prices as well as improved product mix including increased contributions from higher margin specialty blends and agricultural products.
It is important to note that the higher farm crop prices we have seen stimulated agricultural product demand which is expected to remain strong for 2008. Volume gains were largely in North America in laundry and cleaning products, ag products and specialty blends.
European surfactant sales grew at a 5% rate primarily due to increased sales of fabric softener. This broad based improvement more than offset lower bio-diesel profitability and profit margins.
In Latin America we saw a volume decline slightly. European surfactant sales volume grew at a rate of 5% due primarily to increased sales of fabric softener.
Our polymer segment represented 24% of revenue in the fourth quarter and 24% of revenue for all of 2007. Net sales of polymers were up 20% quarter-over-quarter and 22% year-over-year.
Polymer volume grew 13% in the quarter and 9% for the year based on higher polyol sales volumes in both North America and Europe. Fourth quarter polymer gross profit grew by $1.7 million or 22%.
Rising energy costs and positive changes in the regulatory standards for the environment are driving higher demand for roofing insulation. Stepan’s polyol products are primarily used for the replacement roof market versus new construction.
Phthalic anhydride gross profit improved quarter-over-quarter on a higher sales volume as PA production returned to normal operating rates. For the full year period polymer gross profit grew by $2.7 million or 7%.
Polyol volume grew in Europe and North America. Market conditions in Europe improved significantly on higher demand for polyol and commercial roof insulation.
Phthalic anhydride volume and profitability declined in large part due to production outages during the third quarter resulting in outsourcing costs and lower sales volume. The PA plant is back online and the operating schedule has returned to normal.
Tri-annual maintenance turnaround is planned for 2008 which will further improve reliability in 2009 and beyond. Supporting our outlook for growth in the Chinese market, a research and pilot facility has been constructed in China to support development of that market.
To date sales volume in China grew by 1% as we continue to pursue initiatives focused on further penetrating this important market. Finally our specialty products segment accounted for around 2% of the company’s sales in the fourth quarter and full year.
Net sales of specialty products were up 22% quarter-over-quarter and 17% year-over-year. Specialty products fourth quarter gross profit grew by $300,000 or 33% year-over-year.
For the full year, 2007 gross profit grew by $2.2 million or 32% year-over-year. Quarterly and full year results for the group were largely driven by higher sales volumes in both pharmaceutical and food ingredient markets.
Looking at other income and expenses. Interest expense for the year rose 10% due to higher average debt levels and short term interest rates.
The fourth quarter loss from our 50% equity in the Philippine joint venture declined falling to just $200,000 from $400,000 in the year ago period. Rising fabric softener sales volume was the primary driver while the larger volume commodity laundry products continue to post losses.
The other net portion of our income statement is largely attributable to the previously explained foreign exchange losses caused by the sharp decline in the value of the U.S. dollar.
Turning to the balance sheet, total debt as of December 31 was $128 million down from $131.2 million at the end of 2006. Our total debt to total capitalization at year-end was 38.3% compared to 42% in the fourth quarter of 2006.
Capital expenditures were $10.5 million in the fourth quarter, down 33% from the same quarter last year. On a full year basis capital expenditures totaled $39.8 million below our 2007 projection of $42.5 million and below the full year 2006 CapEx of $46 million.
2008 capital expenditures should approximate $40 million. Looking ahead, overall we concluded 2007 with improved operating results across all three core businesses.
These improvements reflect the benefit of our investments in capacity additions as well as the success of our corporate restructuring activities implemented over the course of the past 15 months. While we cannot dismiss the potential influence of the general economic factors that might influence the broader economy in 2008, we currently see opportunities to capitalize on existing plant capacity and drive additional profit growth in 2008.
At this time I would like to turn the call over for questions.
Operator
(Operator Instructions) And our first question comes from the line of George Gaspar - Robert W. Baird.
George Gaspar - Robert W. Baird
Could you relate a little bit more on where you are with some of the capacity levels within the company considering now the CapEx that was spent in ’07? For example, where are you in South America, in the U.S.
if you take an overview of the U.S., and in the Far East, Philippines, and China, can you give us any incremental percentages there?
James E. Hurlbutt
Let’s do it in two pieces because the two segments really are quite different in terms of capacity utilization. If we look at surfactants most of our capacity in Europe is pretty well utilized.
In the Philippines it is pretty full up in terms of sulfination. We have excess fabric softener capacity in the Philippines.
In Europe we don’t have much fabric softener capacity so that is fairly utilized. The major capacity available for the surfactant group today is in the traditional sulfination side for detergent type products and most of that capacity would be right here in the U.S., particularly in Illinois.
So it is centrally located and easily to attach for supporting opportunities throughout all of North America. In Brazil we have capacity left on the sulfination unit.
We have added a multi-purpose reactor. That still has capacity available for diversifying the product line.
But in the big picture in terms of available capacity the biggest available opportunity is still in North America, particularly here in the U.S. in the traditional core products.
Quite honestly we could be close to, based on our projections within the next 12-18 months we might be getting closer to a higher level of utilization even here in North America. In terms of the polyol group we have a pretty well sold out situation in Europe where we are actually bringing product over from our Illinois plant to supplement the European demand right now.
At some point we will have to make a decision whether to expand Europe. We have done some de-bottlenecking and would expect to expand that plant at some time.
We’re just not sure if it is a 12 month off or 18 month off decision. But eventually we will need to expand that plant because it is not overly economical shipping from the U.S.
Our Chinese plant is still only running at less than 50% so there is enormous opportunity to tap that capacity for polyol in China.
George Gaspar - Robert W. Baird
In terms of trying to match up on the CapEx that you are talking about for 2008 at $40 million, where is the emphasis going to be on that expenditure? Can you relate that?
James E. Hurlbutt
We are, as I said, tapped out on softener so the first and foremost on our list is to get another fabric softener reactor here in the U.S. in the ground and then we have referred to the fact we have a tri-annual turnaround of our PA plant in the polymer group and in addition to our turnaround we are going to make some improvements to that facility.
Some of it is not capacity related. Some of it is safety and environmental and some of it is liability.
So there will be a fair amount of money going into the polyol group to support the PA plant which as you know the PA product, phthalic anhydride is a significant portion of our polyol molecule so it is very vertically integrated to our business and we want to make sure that plant is operating very reliably. That commodity has tightened up recently and hopefully there will be some opportunity to improve margins in the underlying phthalic anhydride market as well.
George Gaspar - Robert W. Baird
We are now getting close to the middle of the first quarter, are you sensing that you can improve upon the first quarter of last year in terms of your performance.
James E. Hurlbutt
You know everyone is afraid of the “R” word and we quite honestly have not seen signs of softening in our business. In fact we are seeing just the opposite.
Things are looking pretty promising. We are pleased to see the Colgate and Proctor are seeing the same things.
We are optimistic. Obviously everyone is very concerned should a significant downturn occur in the whole economic conditions in the United States particularly with Europe.
We’re seeing broad based strength in Europe and North America so we are just pinching ourselves and hoping we don’t see any slow down because right now our business is performing very well.
Operator
Our next question comes from the line of Beverly [McNeer - Grayson White].
[Beverly McNeer - Grayson White]
I just want to touch a little bit more on the capacity and are there any plans for closing facilities that are not performing well?
James E. Hurlbutt
We have talked in the past and really studied each site independently to try and determine how best to optimize that site, which precipitated the sale of one of the product lines in our New Jersey site so we could do some consolidation and reduction in workforce at that site. At this point in time we have not concluded it would be a benefit to any actual sites being taken out of service.
At this point the answer is no, but we do continue to study that for the most optimum configuration.
[Beverly McNeer - Grayson White]
Do you see any opportunities either for some acquisitions or just product line acquisitions? What is happening in the market now?
James E. Hurlbutt
Yes, in fact we have a team that spends quite a bit of time on that looking for opportunities either to buy and/or to sell to optimize our product portfolio. No, we feel very good with our own operating results improving.
We are in a better position to gain more traction, looking for product line additions. Ideally bolt on’s that don’t require additional production facilities that could be dropped into our plants.
[Beverly McNeer - Grayson White]
Are there things out there?
James E. Hurlbutt
Certainly, quite a bit, in our polymer group we are really fairly narrowly focused to polyols, or at least most of our volume is in polyol for rigid insulation foam. Our phthalic anhydride is part of that molecule and we still have a balance in the merchant market but beyond that we have not penetrated significantly into other applications of the coating adhesives and sealants or reflectable foam markets.
We very much would like to continue to expand into those fields where we feel we have a lot of technology and potentially could hopefully acquire some technology as well.
[Beverly McNeer - Grayson White]
Can you just give us a little bit of an update on the bio-diesel situation and what the company’s plans are for that now that we’ve had that nice little spike from it, but what does the future look like now for bio-diesel?
James E. Hurlbutt
Quite a bit of uncertainty, in the legislation extending the excise tax credits it was extended and there is a targeted use percentage in the United States in that legislation. That being said the margins for the products have not recovered.
The rapid rise of soy bean oil prices as well as tallow and the other oils that you can make bio-diesel from ran up to the point where the margins really are very nominal. So at this point what we are doing is we pursued converting one of the reactors successfully in December to be able to use it both for bio-diesel and for a fabric softener intermediate that we currently outsource.
So we are getting greater value utilizing that reactor for our fabric softener intermedia. We are really looking now for some longer term partners who are interested in contracting for the long haul on bio-diesel volume so we can not be quite as dependent on the spot market and the fluctuation in margins that result.
There are some incentives by some municipalities and some companies to use more bio-diesel to improve their green movement internally. So as we talk to those people we are trying to look for a longer term relationship where we could share some of the risk on the volatility on the margin.
So we do not expect to expand that plant in the near future under the current economic environment for bio-diesel.
Operator
We have a follow-up question from the line of George Gaspar - Robert W. Baird.
George Gaspar - Robert W. Baird
Jim, is there any update that you can transport here on the polymer testing? I believe that you have been involved in a couple of secondary oil spill projects?
James E. Hurlbutt
Well, ours is really a surfactant for use in the enhanced soy recovery project. I guess there is a co-polymer that can be used with our surfactant.
But it is still very early. The technology was developed over 30 years ago.
We have participated in projects. We are still trying to get into some floods in North America.
We have reached out to some other groups that have technology in this area to see if we can accelerate the penetration of this market but unfortunately it is quite slow. It is a very decentralized market now because a lot of the older oil wells are no longer owned by the major multi-nationals.
When those properties become small they sell them off and so there are literally thousands of independent producers out there who suddenly are making a lot of money with the high price of crude and may not be particularly interested in rushing to spend more money to improve their yield in their field. We still think there is a significant opportunity there because the technology works but the market penetration is going to be the tougher nut here.
So we’re still on it but we don’t have any near term results to report.
George Gaspar - Robert W. Baird
Considering where oil and gas prices are now in this quarter on average versus where you were in the first quarter of this past year, have you pretty well adjusted out your costs in terms of getting over that cost and in terms of pricing of product so that you can still get the same or better margins as you are seeing the first quarter here?
James E. Hurlbutt
We feel over the last four or five quarters we have had to just keep pounding away to recover the raw materials but I think we feel pretty comfortable now that in most product lines have been able to recover the overall effect and then hopefully start to build some recovery into our margins. We added another price increase January 1 across the board in many of our product lines.
If things were to stabilize I think we are at a point now where we feel and continue to see some tightening in the demands for phthalic anhydride commodity surfactants in North America. We could probably see some further improvements.
George Gaspar - Robert W. Baird
And the product marketing availability is that how you see the market on materials you are producing for the basic chemical materials for the construction market. How do you see that, still tapering at this point?
James E. Hurlbutt
Well that is our one soft spot. Fortunately that is not a large segment for us but we sell into the gypsum board market and some paint additives and that is soft.
Fortunately it is a small enough portion of our business that it didn’t have a significant impact on ’07’s results. So, we have some products though that despite the downturn events they have some proprietary advantages for the paint market that we would hope to gain market share despite a down market.
We’re hoping that we can still grow that business despite the housing downturn.
George Gaspar - Robert W. Baird
Do you have any stock repurchase agreements in place currently that are still open? Or have you pretty much fulfilled whatever you have been approved on in the past?
James E. Hurlbutt
We have a small authorization left. We don’t have an active plan to acquire shares other than a need for benefit plans or operating our stock option plan but we are not actively in the market today repurchasing shares.
Operator
There are no further questions at this time.
James E. Hurlbutt
I’ll take this opportunity to thank you all for participating in today’s call. Thank you.