Stepan Company (SCL) Q4 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Fourth Quarter and Full Year 2016 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we'll conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded on Wednesday, February 22, 2017. I would now like to turn the conference over to Scott Beamer, Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Terra. Hello everyone and thank you for joining Stepan Company's fourth quarter and full year 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 of our foreign operations, global and regional economic conditions and factors detailed in our Securities 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 as when the earnings release is issued and we hope that you find the information and prospectus helpful. With that said, I'd like to turn the call over to F. Quinn Stepan Jr., our Chairman, President and Chief Executive Officer.

Thank you, Scott. Good morning, and thank you all for joining our call today. 2016 was a good year for Stepan Company. The company delivered record reported and adjusted net income results for the full year 2016. Reported net income was $86.2 million, up 13% versus last year. Adjusted net income was $98.2 million, 24% higher than 2015. Adjusted net income as a percent of sales was 5.6%. The strong year was driven by enhanced internal efficiencies, increased asset utilization and higher global rigid polymer volumes. Our internal efficiency program DRIVE contributed $15 million in pretax cash cost-out improvements. Through active employee engagement, we use the process to reduce cost. We've also used DRIVE to improve our raw material margins and to increase capacity of our production assets. We have an active pipeline of DRIVE opportunities for 2017. Surfactants delivered income growth on improved utilization of new laundry supply contract and it slightly improved product mix, which was offset by certain nonrecurring cost. Polymer results benefited from increased rigid polyol volumes due to global energy conservation efforts and new customer volumes. Specialty products benefited from restored lipid nutrition profitability. Our balance sheet continues to remain strong as we reduce net debt from 22% at the end of 2015 to 13% at the end of 2016. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.205 per share payable on March 15, 2017. At this point I'd like Scott to walk through a few more details about our fourth quarter and full year results.

Thank you, Quinn. My comments will generally follow the slide presentation and I'd like to start with Slide Number 5, which recaps the quarter. First, we show the items we are including as adjustments to reported net income and fundamentally we believe this should be a very short list. We have a normal deferred compensation expense or income, in this case expense, and we took a restructuring charge of a net impact of $4 million after-tax. The first piece was related to severance and decommissioning at our Canadian plant, which was previously announced as a closure. There was an asset write-down related to an investment in Louisiana and there was an asset write-down related to our plant in Bahia in Brazil. These totaled $4 million on an after-tax basis. Then to discuss the underlying business, we've also highlighted a few more significant nonrecurring items. The fourth quarter was impacted negatively by these items of about $8.9 million on a pretax basis, $5.5 million was related to product claim commitments in Europe and $3.4 million was for environmental remediation in the United States. On an after-tax basis, the unfavorable impact was $6.1 million or $0.26 per diluted share. Of the nonrecurring items, $8.3 million was reported within the surfactant segment and $600,000 was reported within polymers. Adjusted net income was $12.3 million or $0.52 per diluted share compared to $17 million or $0.74 per diluted share in the fourth quarter of last year. Surfactants reported operating income was $14.6 million compared to $24.3 in the prior-year quarter. The decrease was primarily due to $8.3 million of the nonrecurring items as well as $600,000 of accelerated depreciation related to our Canadian plant. Raw material costs were also higher and volumes were slightly lower. We discussed last quarter that we expected a negative year-over-year effect of LIFO and this was indeed the case of certain vegetable based raw material cost were higher this year than last year. Polymers operating income was $16.5 million compared to $18.1 million in the prior-year quarter. The decrease was mainly due to scheduled maintenance shutdown in our Phthalic Anhydride line at Millsdale in Illinois and operating cost in our new plant in China. Operating income of the specialty products segment increased $3.3 million over prior year to $4.2 million due to improved results within our lipid nutrition business. Since adjusted net income is a non-GAAP measure, we provide full reconciliations to the reported figures and these can be found in Appendix 2 of this presentation and Table 2 of the press release. Related to the adjustments, deferred compensation expense was $2.7 million or $0.11 per diluted share, which is consistent with the figures reported at the same period last year. Naturally all employee compensation expenses are reflected in our normal operating income. However, we allow employees the opportunity to defer their incentive payouts until some future date and the future payment changes based on the company's share price. When the stock price increases, expense is generated. Since the future liability of employee compensation changes only due to the change in share price, we exclude this item from our operational discussion. Let's move to Slide number 6, which shows the total company earnings bridge for the fourth quarter compared to last year's fourth quarter and breaks down the $4.7 million decrease in adjusted net income. Since this is net income, the figures noted here are after the effective taxes. We'll cover each segment in a little more detail shortly, but surfactant was down versus the prior year, primarily due to the nonrecurring items than the year-over-year effect of LIFO. Polymers excluding the Phthalic Anhydride business was up and specialty products was up $2.1 million. The all other category represents primarily the favorable impact of us having no consulting fees paid to external parties in the fourth quarter of 2016 related to our ongoing global efficiency initiative. This initiative is now internally managed and the related benefits are captured within each business segment's operating results. Our effective tax rate for all of 2016 was 24% and this benefited from the early adoption of an accounting standard related to stock options, which is titled ASU Number 2016-09. This lowered the reported rate by about 200 basis points. The 26% baseline rate in 2016 was positively impacted by certain significant expenses in the U.S. such as the deferred compensation and some restructuring expenses. While assuming those will not recur in 2017 and considering some expected earnings growth within the United States, we believe our 2017 tax rate should be between 28% and 30% and that's the items shown in Appendix 1 under future assumptions. Slide number 7 focuses solely on the results of the surfactant business for the fourth quarter. Surfactant sales were $282.5 million down slightly from the same quarter a year ago. Prices were slightly higher, which favorably impacted sales by 2%. Currency translation negatively impacted sales by 2%, while volumes were down 1% versus the prior year quarter. Segment operating income was $14.6 million, a decrease of $9.7 million versus the fourth quarter of 2015. Segment operating income excluding the cash received from a customer contract termination fee related to our thank you Bahia, Brazil site with $10.4 million. In the bridge, we show North America and Asia in the same category because our surfactant business in Asia is relatively small and much of the surfactant production in the region is used to support business in the U.S. North America was negatively impacted by lower margins on higher raw material costs, lower consumer product volumes and accelerated depreciation, which was expected. As noted in the previous earnings call, we expected a swing in LIFO from the fourth quarter of 2015 results compared to the fourth quarter of 2016 to be negative by at least $4 million and this indeed occurred. These items were partially offset by favorable product mix within our functional products. Latin America was down due to lower sales volumes, partially offset by improved mix. During the quarter, we closed on our acquisition of Tebras and PBC and this is expected to expand and diversify our customer base in Brazil and should provide us with an opportunity to attract new customers to Stefan's broader surfactants products offerings. Following a record year in 2015, Europe results were down slightly on more challenging comps and were negatively impacted by unfavorable foreign currency translation from the U.K. The nonrecurring cost of $8.3 million represent the items mentioned previously at product claim commitments in Europe and remediation costs in the United States. If we turn to the polymers segment on Slide 8, we see that sales were $116.3 million up $2.5 million from the same quarter a year ago. Prices were slightly lower, which decreased sales by 2%, foreign currency lowered sales and volumes were up by 6%. Operating income was $16.5 million compared to $18.1 million in the same quarter last year. Global rigid polyol volumes continued their growth trends and were 14% higher over the prior year quarter due to strong market demand from increased insulation standards and growth in construction. Our specialty reactor in Poland began production late in the third quarter 2016. In China, the results were negatively impacted by higher operating costs. Phthalic Anhydride results decreased year-over-year due to the scheduled maintenance shutdown during the quarter as reflected in the PA business on the bridge. The nonrecurring cost of $600,000 represent remediation costs in the U.S. We'll take a moment on the following slide and recap 2016 as a full year. Adjusted net income was a record $98.2 million or $4.25 per diluted share. The 24% increase from $79.4 million or $3.46 per diluted share in 2015. Surfactant operating income was $99.8 million compared to $104 million in the prior year, not a record, but a good year. The decrease was due to nonoperational accelerated depreciation in Canada of $4.5 million and the nonrecurring cost related to the product claim commitments of $7.4 million as well as the remediation cost of $2.8 million in the U.S. These were partially offset by improved performance in North America laundry and our drive program contributions. Polymers delivered its seventh consecutive record year. Operating income increased to $96.8 million from $80.9 million in the prior year, mainly due to volume growth in the global rigid polyol business and improvements from our internal efficiency program. Specialty product operating income was $10.7 million or $6.3 million versus $4.4 million reported in 2015 due to improved lipid nutrition results and actions taken in the fourth quarter of 2015 to lower cost, enhance our supply chain efficiencies and we also benefited from higher MCT volumes. Slide number 10 shows the total company earnings bridge for the full year 2016 compared to 2015. Like the quarterly bridge, the figures here are noted after the effective taxes. On Slide number 11, we outlined some improvement areas of progress we made during 2016. We continue to deliver savings from restructuring actions that began in 2013 and '14 such as exiting the enhanced oil recovery joint venture. We also restored profitability to the lipid nutrition business and we transitioned [consolation] production from Canada to other sites in our North American supply chain. We continue to optimize our operations and we delivered about $15 million of improved operating income through our DRIVE initiative. Our new laundry volume significantly improved the asset utilization in our sulfonation assets in North America. Global rigid polyol volumes grew as a result of demand from higher installation standards and growth in construction. We added new products and gained new customers in Latin America, particularly as a result of the Tebras PBC acquisition, which closed during the quarter. Improving shareholder value remains a fundamental objective. Adjusted EPS grew from $3.46 per diluted share to a record $4.25. Meanwhile our balance sheet also remained strong. We now have less than $100 million of debt, net debt and the net debt ratio declined to 13% from 26% at the end of 2014. In 2016 we also increased our cash dividends for the 49th consecutive year, continuing to place us in a very select group of companies. Now Quinn will cover Slide 13 to address our path to further increasing shareholder value going forward.

Thank you, Scott. After record results in 2016, we are positioned for further growth in 2017. Despite nonoperational and nonrecurring items that negatively impacted the fourth quarter of 2016, our base business remained strong. Our path to increase shareholder value consists of three steps; the focus of our plan is to improve asset utilization, support global polyol growth driven by energy conservation and diversify through innovation, new products, new end markets and geographic expansion. Our DRIVE program provides the fundamental support for our journey by delivering cost out initiatives and improving our internal efficiencies. Our focused strategy should positively impact 2017 and position us well for the future. More specifically asset utilization will increase across several product lines as a transfer of production from our Longford Mills Canadian site to Millsdale is complete. Although we expect to incur an additional $1,700,000 of decommissioning expense in 2017, we expect that these one-time cash cost will be offset by related savings of approximately $4 million. In addition, due to key customer in Brazil exiting the powdered laundry market, we negotiated a contract termination fee. This enabled us to recover our cost, shutdown the Bahia Brazil site and consolidate production into our existing plant in Vespasiano, Brazil. We wrote down cost associated with the potential nonionic investment in Louisiana. We now plan to build nonionic surfactant capabilities in the Pasadena Texas site that we acquired from the Sun Products Corporation. Building in Pasadena will significantly reduce future required investment. Finally, we will continue to consider other potential opportunities to further optimize our production capacity throughout the world. Our capital expenditure plan is in aligned with our strategy to support global polyol growth in conjunction with energy conservation efforts in the United States and Europe. Projects to enhance production at our Wessling Germany and Millsdale United States plants are underway. Our new specialty polyol reactor in Poland began production in the third quarter of 2016 providing an opportunity for growth in 2017. A new specialty polyol reactor in Columbus Georgia, should start late this year. Our strategic plan also supports product and end market diversification. We are committed to deliver volume growth within certain targeted geographic regions for rigid polyols, case polyols, functional surfactants in Tier 2 and Tier 3 customers within the consumer product segment. Finally, our internal efficiency program DRIVE is an important component of our strategy to help support our long-term plans. This process should help the company reduce costs, improve our raw material margins and increase the capacity of our production assets. Our markets provide challenges and opportunities. We feel we're well-positioned to capture opportunities for you our shareholders. This concludes our prepared remarks. At this time, we would like to turn the call over for questions. Tara, please review the instructions for the question portion of today's call.

Thank you. [Operator instructions] And our first question comes from the line of David Stratton with Great Lakes Review. Please proceed.

Good morning. Thanks for taking the question.

Hi David.

If you look at raw material costs and your LIFO expenses, how is that going to play out going forward into 2017?

At this point, I would say that we anticipate that we're probably going to get some inflation on the petroleum-based raw materials. We are anticipating that we'll get a decrease in [veg] space raw materials toward the second half of the year. So, at this point time, we would probably anticipate that it would not be a significant factor for the year.

Okay. And then regarding the nonrecurring items, could you give a little more detail on what exactly was going on, especially with the product claims in Europe and is that expected to go forward? I know you have listed it as nonrecurring, but it looked like they kind of hit a little bit throughout the year of 2016. So just little more information around that please.

Maybe I'll take the second part. No, they didn't hit throughout the year. These were one-time, there was a small piece that hit in the third quarter that we didn't call out because it was I think $1 million or less. So, we do want to convey that this is not an item that we expect to repeat. These are not the types of items that we expect to repeat. So, the quarter was impacted. So, we've called those out, but we don't expect these types of items to repeat going forward.

And I would just indicate that we're also in conversations with our insurance company and we believe that while we continue to work with them throughout the year and we're hopeful that we'll get some insurance coverage for this claim.

And so what will that I guess when you think about insurance covering some of this claim, what does that do? Will that be hitting in the first, second quarter or second half of next year?

We don't have a specific update on that at this point in time. My assumption is it will take, at the earliest it would be the second half of the year, may spill into 2018.

Thank you. I'll get back in queue.

Thank you.

Thank you.

Thank you. And our next question comes from the line of Michael Harrison with Seaport Global Securities. Please proceed.

Good morning. This is Jacob on for Mike. Could you guys talk about where your surfactant capacity utilization in North America was at the start of last year and how it compares going into -- starting 2017?

I don't know that I want to give specific numbers today, but I would say that the utilization over the last year and a half to two years has improved by approximately 20%. We still have excess capacity available within our network.

All right and then another question on pricing, could you give a little more color on how pricing in both surfactants and the polymer business are playing out in regards to the raw materials that you mentioned in the earlier question?

With regard to pricing, we do have and particularly within our surfactant business, we have many contracts that are tied to increases and decreases to raw material costs. Having said that there is a large part of our business that is not tied to raw material contracts as well and so at this point in time, we are in the market place for our surfactant products with some price increases effective for the April 1. We've targeted and have announced some price increases for April 1 and then for petroleum-based products within our polymer business, we've recently announced some prices that are effective for March 15.

Okay. And then one more in terms of plant related cost either the shut downs that you mentioned or start-up activities, could you provide some more color on how that will play out over 2017?

Yes. So, 2016 was a big year for shutdown costs with the German TUV costs impacting both our surfactant and our polymer businesses and as well as a large maintenance shutdown of our Phthalic Anhydride plant in the United States. So, in 2017, we would anticipate significantly lower shutdown cost across our networks.

Okay. Thank you.

Thank you.

Thank you. [Operator instructions] And we have no further questions at this time.

Okay. Thank you very much for joining us on today's call. We appreciate your ownership in Stepan Company. We look forward to reporting positive performance to you in our first quarter call in April. Thank you very much have a great day.

Thank you, 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.