Greetings and welcome to the Stepan Company Third Quarter 2022 Results. 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, October 19, 2022. I would now like to turn the conference over to Luis Rojo, Vice President and Chief Financial Officer. Please go ahead.

Good morning and thank you for joining Stepan Company's third quarter 2022 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 prospects for our foreign operations, global and regional economic conditions and factors detailed in our Securities and Exchange Commission filing. 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 Investors section of our website. We make these slides available at approximately the same time as when the earnings release is issued and we hope you find the informational perspective helpful. With that, I would like to turn the call over to Mr. Scott Behrens, our President and Chief Executive Officer.

Good morning and thank you for joining us today to discuss our third quarter results. To begin, I will share our third quarter highlights and strategy outlook and Luis will provide additional details on our financial results for the quarter. The third quarter continued to be a challenging operating environment given continued raw material constraints, the energy crisis in Europe, cost inflation, foreign currency exchange impacts from a stronger U.S. dollar and overall global macroeconomic uncertainties. Nonetheless, I am proud of how our team has continued to overcome these challenges by delivering record results for the third quarter. Reported net income reached a record $39.4 million or $1.71 per diluted share, while adjusted net income was a record of $46.3 million or $2.01 per diluted share. Surfactant operating income was $39.0 million compared to $34.5 million in the prior year quarter. Growth was mainly driven by a better product and customer mix, partially offset by an 8% decline in global volume. Our Polymer segment reached a record operating income of $31.9 million compared to $19.8 million in the prior year which represents a 61% increase driven by margin recovery and improved mix. Our Specialty Products segment also had a record quarter, growing operating income to $9.7 million, representing a $7.3 million increase over prior year. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.365 per share, payable on December 15, 2022. And -- this represents a 9% increase in our dividend and Stepan has paid and increased its dividend for 55 consecutive years. During the third quarter of 2022, the company paid $7.5 million of dividends to shareholders and repurchased $5.3 million of company stock. During the first 9 months of 2022, the company paid $22.5 million in dividends and repurchased $22.3 million of company stock. The company still has $127.7 million remaining under our share repurchase program. Looking forward, we believe the operational environment will remain challenging. However, we are confident that we can deliver another record year. At this point, I would like Luis to walk through a few more details about our third quarter results.

Thank you, Scott. My comments will generally follow the slide presentation. Let's start with Slide 4 to recap the quarter. Adjusted net income for the third quarter of 2022 was a record $46.3 million or $2.01 per diluted share versus $36.4 million or $1.57 per diluted share for the third quarter of 2021. Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP measures and this can be found in Appendix 2 of the presentation and Table 2 of the press release. Specifically, the adjusted net income for the third quarter excludes deferred compensation income of $1.1 million compared to last year's income of $1.3 million. It also excludes changes in our environmental reserve of $7.9 million compared to last year's excluded reserve of $0.7 million. The company increased its pretax environmental reserve from $23 million to $33.5 million based on new remediation cost estimate associated with the Maywood New Jersey site. The deferred compensation figures represent the net income related to the company's deferred compensation plan 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 from operational discussion. Slide 5 shows the total company net income bridge for the third quarter compared to the third quarter last year and break down the increase 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, we delivered excellent income growth in all our segments. Corporate and all other expenses which are not allocated to the business segments were up $2.3 million, driven by higher interest expenses and overall inflation. The company effective tax rate was 24% for the first 9…

Thank you, Luis. In addition to delivering another record quarter, we continue to advance our strategic priorities in the third quarter. The following two slides capture our strategic priorities and vision for a cleaner, healthier and more energy-efficient world with our customers' preferences in mind. Our diversification strategy into functional products, including agricultural and oilfield chemicals continues to be a key priority for Stepan. Our global agricultural volumes increased double digits in the third quarter of '22. High agricultural commodity prices, coupled with increased planted acreage in 2022, drove a strong season for Crop Protection sales in North America, while elevated and agricultural commodity prices and a favorable currency impact on exports are driving increased planted acreage in Brazil. Oilfield volumes also increased in the third quarter of 2022 despite raw material availability constraints. Demand for our products used in oilfield remains robust as crude oil prices remained elevated at around $90 per barrel. Additionally, we are expecting the raw material constraints in this business to improve over the next few quarters. We continue with the build-out of our KMCO oilfield Demulsifier product line. We remain optimistic about future opportunities in this business as elevated crude prices should encourage increased oil production and the use of production and stimulation chemicals. Our Millsdale plant continues to be one of our key priorities. We are accelerating investments to improve productivity and reliability and to increase capacity through operational excellence initiatives. These investments will continue throughout the year and we expect to see benefits from our efforts and investments starting next year. One of the key priorities at Millsdale is the execution of our low 1,4-dioxane project. Moving to Slide 11. Work continues on our new alkoxylation production facility in Pasadena, Texas. This asset will be a flexible state-of-the-art multi-reactor facility with approximately…

Thank you. That does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.

[Operator Instructions] And our first question comes from the line of Mike Harrison with Seaport Research Partners.

Hi, good morning, Congratulations on a nice quarter.

Thank you, Michael.

Scott, I was hoping that you could talk about price cost dynamics in both the Surfactants business and polymers as we look from Q3 into Q4, are you still seeing higher costs and expecting that maybe we could see some sequential margin headwind? Or are you seeing the costs are moderating a little bit and price cost is turning into a good guide for you? I think that seems to be particularly the case in polymers but maybe you could give us some color again on both of your key segments?

Yes. I would -- from a high level, Mike, what I would say is we've done a good job recovering our margins and covering our inflationary cost to this point. Although we are seeing raw materials somewhat moderating, they still remain highly volatile -- and the other inflationary costs that the business is facing still remains. And those remain in the freight area, utilities and even labor. So I would say we are not at a point where we're done in terms of covering future cost escalations and I think it's going to remain volatile going forward. And I would say it's pretty evenly spread between the surfactants and polymers business. Each are facing similar continued cost pressures.

So Mike, this is Luis in line with what Scott was mentioning, raw materials, if you think about raw material specifically, we are seeing kind of the peak. However, there are still a lot of volatility and some of things are coming down and others are going up. But we believe at least the raw material piece is in a better spot versus the previous quarter. But again, the other inflationary pressures on freight and other elements will continue...

All right. And maybe kind of a related question on how you're seeing the energy availability situation unfold in Europe and with your European operations. Are you planning to continue running all of your plants in the winter? Or could you see that maybe energy availability or demand issues could lead you to idle some of your facilities in Europe?

Good question, Mike. At this point, we do not see a disruption in any of our operations in Europe and are expected to continue to operate throughout the winter. We have worked on contingency plans with alternate sourcing of energy. That gives us a little more confidence if there was a constraint put on industrial use of natural gas or electricity. But as of this point, our anticipation is we're going to operate as normal throughout the winter.

All right, Thank you. And then my last one for now is on the Surfactants business and the margin performance there. I'm just curious if that lower commodity laundry volume number is having a negative impact on your fixed cost absorption? Or is maybe the plant loading factor less of an issue for you guys than it might have been in the past? And also just curious if you're seeing any trading down in this more challenging economic environment for consumers, any trading down to lower value products in surfactants, whether that's on the laundry side or in Personal Care?

No, good questions, Mike. Of course, when you have lower volumes, you have the fixed cost impacting you. But again, we feel very good with the work that we have done in margins in both surfactants and polymers. And remember that we focus first in dollars per pound and the percentage of sales is a consequence of our sales growing significantly higher. But we’re very happy with the year-to-date margins that we have, the 10% in surfactant and 13% in polymers. And of course, you also now that we have some seasonality by quarter. So of course, Q4 is the lowest volume quarter. You see more fixed cost impact and, therefore, lower margins there. But again, our strategy is to continue growing the high growth, high-margin businesses functional, as Scott was mentioning, the strong double-digit growth in ag and oilfield. So those will continue helping our margins despite whatever fixed cost impact that we’re going to have. And I will let Scott talk a little bit more about the dynamics on consumer demand.

So Mike, I would say the trading down in -- from premium to mid or economy tiers. I think that started well earlier this year and even late last year. I think what's different now is the sustained inflation that the consumers are facing, it's actually starting to show demand softness across the board. Stepping we're agnostic to whether we participate in all segments of consumer products, whether it be premium economy or mid-tier. So we're agnostic there. But I think now we're seeing the overall softness in demand from the consumer.

And fair to say that, that’s primarily Europe and emerging market trend rather than something you’re seeing in North America?

Yes. Yes, as it follows the other industries, the first signs of softness happened in the emerging markets and Europe with the energy crisis and interest rates rises, definitely, Europe is going to be in that board as well. North America to this point has held up much better than the other region.

All right. Thanks very much. I'll turn it back for now.

And our next question comes from the line of Vincent Anderson with Stifel. Please proceed.

Yes, good morning. Scott, Luis... So I just wanted to dig in on the acquisition a little bit. I'm trying to understand how the alcohol ethoxylates kind of fits your portfolio. Would these like -- would these represent an intermediate product between your existing formulations that are mostly told -- or is this just a brand-new derivative family that would generally be sold as is? And then second, were these products already 1,4-dioxane compliant? Or is that something that you're bringing to this company?

Yes. Great question, Vincent. First, the alcohol ethoxylates product line that we’re acquiring or have acquired from PerformanX. That is a standard product line that exists in the industry today and quite honestly, is in Stepan’s product portfolio and has been for 20 years. What it’s really doing is bringing new customers and new markets to Stepan, that is a great diversification opportunity for our ethoxylate business and provides, I believe, material opportunities for pull-through products within other Stepan’s other product lines, including cationic and maybe even biocides into these new end-use markets. So that was really the driver. The chemistry is a standard chemistry line that we have in our product portfolio today. And can you remind me your second question?

1,4-dioxane.

So 1,4-dioxane is really primarily generated from the sulfonation process that's in our commodity anionic product line used in laundry. These non-ionic that are not sulfinative have much, much lower, almost negligible levels of 1,4-dioxane and not really of concern as it relates to the new regulations that are showing up next year.

Okay, perfect. And then just on the topic of 1,4-dioxane you have your investments there to reduce its levels in your relevant products but we were reading about some switching to alpha olefin sulfonates as an alternative to just not even deal with the lower 1,4-dioxane concentration. Is that an opportunity within your portfolio to also push that as an alternative? Or would that be considered trading down? Or you really are focused on other end markets with your AOS capacity?

No. So Stepan is a one-stop shop for sulfonation chemistries, whether it be either sulfate, sulfonic acids alpha olefin sulfonates. We've been practicing and producing these and selling to the market for multiple decades. So we are agnostic to the customer base in terms of what is their best solution for their company's needs -- either sulfates do provide the best cost performance in some consumer cleaning and liquid cleansing applications. So customers that are formulating based on strong consumer performance benefits want to stay in either sulfates, Others that may be looking to avoid a lot of reformulation or I should say, cost-related issues with the new 1,4-dioxane regulations are looking to switch away to alternative anionics. And we're working with those customers on changing their formulations to ALS or lauryl sulfate or sulphonic acid. So we're agnostic and it remains an opportunity for our ALS franchise as well as customers look to find their own custom solution for the 1,4-dioxane regulation.

Great. That's very helpful. And just one more quick one from me on selling that we don't normally talk about. But MCT has had another nice quarter. You've mentioned in the past that you wanted to build out some of your raw material availability to improve output of those products. Is that still a strategy? And how much volume upside is there from those assets?

The supply of the fatty acid used to make MCTs has loosened up a bit. Global supply chains are operating a little more freely. But I would not say that there’s a significant opportunity from here in terms of continued profit expansion that we’ve seen over the last 4 months or last 4 quarters, I should say. Margins are probably close to being at their peak. I think we’ve done a really good job with our customer optimization and getting fatty acids into our manufacturing facilities in a time where they were constrained.

And Vincent, this is Luis -- an additional perspective is, as Scott was mentioning, probably were on the peak on the margin side but we continue looking for opportunity to grow volume and we have extra capacity right now in our facility in Maywood -- so as fatty acid become more available, our focus for the next few quarters will continue to grow as a business, get new customers and continue growing volume.

Understood. If I remember correctly, these are mostly coconut oil or palm kernel oil fatty acid derivatives.

Yes.

Okay. Thanks, guys.

[Operator Instructions] And our next question comes from the line of David Silver with CL King. Please proceed.

Yes. Hi, good morning. I guess my first question would be regarding the Surfactant segment and you talked about the price cost balance earlier. I was wondering if you could maybe just help me parse through the lower sales volume. So in other words, for the last few quarters, you've been clear about the divergent trends, let's say, in the personal care side of your surfactants business versus institutional or commercial which has been healthier. And I'm just wondering when -- if you could maybe just talk about that a little bit and how far along do you think we are in the personal care side bottoming out post pandemic? If we -- maybe we could just start there.

Yes. David, if I understand your question as it relates to our personal care volumes, one thing I would say is we've had significant raw material constraints affecting our personal care volumes, specifically in our Amphoterics product lines. And that was, quite honestly, industry-wide in terms of a critical raw material that was short to the industry. So that's helped exasperate some of the divergence that you're referring to. In terms of the post-covid demand in personal care as it relates to the increased use of hand wash factoring the peak of the pandemic, that has pretty much stabilized and is not in any declining or significant increasing trajectory. So that's kind of more stable. So I'd say most of the impact of divergence you're seeing has really just been with some isolated supply chain constraints on raw materials that has really impacted the volumes.

And then, thank you for that -- and then also on Surfactant, I was just hoping to get an update, let's say, year-to-date on your Tier 2, Tier 3 customer strategy? Do you have a figure for accounts that it maybe this quarter or year-to-date? And then if you might be able to comment on how that's affected the margins. In other words, smaller volumes but maybe with the greater service component, structurally higher margins. I mean, when we look at the third quarter segment results there, what would you say the impact of that strategy to date might be?

Yes, definitely contributing to the continued success. It's a core element of our strategic growth priorities going forward. I think in our earnings slide deck, you'll see that there's over 100 new customers that were gained in the third quarter. And yes, the smaller volume tends to be higher margin business and that's been a core foundation of our growth strategy going forward.

Okay. And this one is for Luis and we just have to do with the trend on interest expense. So sequentially, I see your debt levels are rising. I think we know that interest rates, at least in this country are rising -- just wondering why there was a modest sequential decline in interest expense and maybe if you could kind of help us on where that interest expense line might go in the next quarter or two is maybe another rate hike or two is in the offing. That would be great. Thank you.

Great question, David. And yes, you are right. We're going to see our interest net on a yearly basis, of course, going up. We have clear guidance that it's going to be around $11 million this year versus last year was roughly around $6 million. So you clearly see the effect of all the new debt that we acquired. However, remember that we acquired significant new debt at fixed interest rates that were well below 3%. So I think we believe we're in a very good spot. And actually, what we're seeing recently is, of course, with the interest rate increases, we're generating more interest income of our cash. So that is actually helping. And by the way, we're generating now interest income that are higher than what we are paying on the debt. So we're generating 3 and 3.5 in interest rates for the interest income piece. So that is actually healthy. But in February, I will give you -- I will provide clear guidance as always, on what would be our interest net forecast for 2023. Of course, it should go higher than the $11 million that that we have in 2022. I will give you but nothing dramatic and we will give you guys the exact numbers when we meet in February.

Okay, great. And then just last question. I mean, this is something I just have noticed in the headlines over the last week or 2. But water levels, this is in the U.S. logistics but the water levels on the Mississippi are such that barge and vehicle vessel traffic is being disrupted. So thinking about Millsdale and maybe some of your other -- or maybe your flow of raw materials -- is that creating unusual issues for you? Are you kind of diverting to different modes of transport as a result? Or is that just -- is that something you're able to manage without too much difficulty, thank you.

Yes. We -- yes, great question. And yes, we've been operating our plants on the Illinois River, the is Plaines River for 50 years and we have very robust contingency plans in our sourcing and planning groups work with very closely with our raw material suppliers to ensure alternate modes are available into the Chicago area. So not an impactful...

Yes. No major impact.

No major impact to our...

But you're right, David, that has been -- that has been an issue but no major impact for us.

Okay, great. Thank you very much. Appreciate it.

And I do have a follow-up question from the line of Mike Harrison with Seaport Research Partners. Please proceed.

Just a few more for me. In terms of this $8 million fourth quarter impact related to some planned maintenance, how much of that is going to hit the polymers business? And how much of it impacts Surfactants?

Good question, Mike. Actually, I want to make a clarification that $8 million is after tax, just make sure that everybody understands that it's roughly $10 million to $11 million on a pretax basis and around 70% of that will hit polymers and 30% will hit surfactants...

Okay. And have you seen any customers pulling forward any volumes in Q3 in anticipation of that Q4 outage? Or were the order patterns generally pretty steady?

Yes. We work with our customers well in advance. Our shutdowns are planned 6 to 12 months in advance. So the supply chain has already been executed against the shutdown.

Okay. And then I guess, maybe hoping for a little bit more color on what exactly you guys are doing at that Millsdale site. You mentioned some operational excellence initiatives. But are some of these actions intended to help improve reliability. And I know if we look back over the last couple of years, we've had some power outages that have affected production out of that plant.

Yes. Great insight, Mike. And yes, we are investing heavily in improving the reliability of the infrastructure at that -- at our Millsdale site. So we've had multiple projects ongoing since Q2 to replace substrate substations, MCCs and we feel really good that the projects are going to significantly improve our reliability and we're ready for the upcoming winter.

And then, I guess, as it relates to the low 1,4-dioxane transition costs that are associated with this $8 million impact. What do those costs entail? And are they onetime in nature? Or are there going to be additional costs that we see you guys incur at some point in 2023...

Mike, I will say a good chunk will be onetime. But of course, as we mentioned in our prepared remarks, the transition for low 1,4-dioxane is going to go through 2023. This is not a 1-day switch. So we need to go through the transition and after we execute all of these, of course, we're not going to incur in some of those one-timers.

Okay. But it sounds like maybe as we're thinking about 2023 that we should consider that there's still some headwinds associated with these transition costs.

Yes, a little bit. I mean, it's not going to be major. And I'm looking forward also to the meeting in February, we can provide a little bit more guidance about how we see the years and what are some of the key elements that we see going forward. But yes, you're going to expect some additional expenses there but nothing major.

Okay. And then the last one I had is on polymers. I was just hoping you could give a little bit more detail on what you're seeing in terms of demand trends as we're getting into Q4. Obviously, the 10% volume decline in Q3 suggests that you're definitely seeing some things getting worse. Curious if some of that is customer inventory destocking that might be a little bit more temporary but anything you can share on near-term demand in the construction-related portions of polymers would be appreciated.

Yes. I think as we all read what’s happening in Europe, specifically in the construction markets, there is a slowdown happening. Projects are being put on hold or canceled which is really what’s driven our volume decline in polymers in Q3. And then the continued kind of lockdowns in China have also significantly impacted demand. Where is it look sequentially quarter-over-quarter into Q4, we’re kind of expecting a lot of the same for Q4. And I think the overall hope is that there’s maybe a two or three quarter, call it, a hiatus and expecting growth and recovery in the construction markets in Europe in the second half of next year. I think that’s kind of a general consensus right now across what we’re hearing in the market.

And as you know, Mike, I mean, at the end, insulation played a critical role in what needs to be achieved in the world which is to reduce energy consumption. So of course, people preserve cash in this environment and people put on hold some of the projects. But if you need to replace your roof, you need to replace it, right? And you can hold out for one, two, three quarters but you cannot hold forever. So we believe this is a transitory theme. And if you look at North America, despite all the challenges, a region in North America year-to-date is growing volume, single low single digits but it's still growing. So the impact that we saw in Q3 is mainly Europe and Asia.

All right. That's very helpful. Thanks.

And our next question comes from the line of David Storms with Stonegate. Please proceed.

Good morning, gentlemen. Thanks for taking my call. You actually just touched on it with the demand weakening in Europe and the Chinese markets. I know the North American markets seem to still have pretty strong demand. Are there any indicators that you're keeping an eye on to forecast if or when any of this demand weakness does spread to the North American markets?

Yes. We're obviously staying very close to our customers and watching and hearing what they're saying about the installation contractors [indiscernible]. I think everyone's been talking about the backlog of orders and projects. And in the first sign of weakness that we will see is when we hear that those back orders are starting to decline. So at this point in time, as Luis mentioned, our growth -- our rigid North American volumes continue to grow in the small single digits. And I think we can anticipate that Q4 should be very similar. But too early to tell.

Thanks. And one more, if I could. You mentioned earlier that labor is an inflationary pressure expected to continue along with freight and utilities. But the labor market in the U.S. remains as strong as it is, do you anticipate this to becoming an outsized expense relative to those freight and utilities expenses or just kind of maintaining as it has that.

No. What I would say is, of course, as a normal chemical company, we don't have a lot of labor in our site. And -- but the situation is that we're coming from years where salary inflation was -- in the U.S. was roughly in the 3%, we could see a little bit more pressure on those numbers in the short term. So that's kind of the difference. And when you think about developing markets in Europe, it could be higher single-digit type of number. So that's kind of the new thing on the labor piece. However, labor for us is not the biggest impact for us, it's about raw materials, freight and utilities.

Okay. Thank you very much.

And I have a follow-up question from the line of Vincent Anderson from Stifel. Please proceed.

Yes, thanks. Just hopefully a quick one. I meant to ask the customer that took its 1,4-dioxane compliance internal. Was that a customer that was kind of core to your investment case into the low 1,4-dioxane capacity? Or are those customers more secure? And then I just have a quick follow-up on that.

Yes. So you know with the level of investment that we've made for 1,4-dioxane, we obviously had early and off in conversations with our customer base, both existing and new to get ready for the type of capacity and capability we put in. So core to Stepan, yes but definitely within our plans and our forecast.

Okay, that makes sense. And then just to understand maybe the commercialization of that product, assuming I'm guessing it's a little bit more overcapacity; so to speak, than you need for Day 1 compliance. Is most of this being addressed with the purification step post reaction that you could maybe bypass -- or are you managing this on the front end. And so when the plant changes over, you're just making low 1,4 product regardless and it's up to our team to find a home for it at an accretive margin?

We have the flexibility and the design of the process that we've implemented. We have the flexibility to operate the units as we see fit. I'll leave it at that.

No, it's perfect. I appreciate it. That's all for me, I promise.

And there are no other questions. I'll turn the call back to you, Scott for closing remarks.

Thank you, Kathy. And thank you all for joining us on today's call. We appreciate your interest and ownership in Stepan Company. Have a great day.

Thank you. That does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.