Greetings, and welcome to the Stepan Company Fourth Quarter and Full Year 2023 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterward, we will conduct a question-and-answer session. As a reminder, this call is being recorded on Tuesday, February 20, 2024. It is now my pleasure to turn the call over to Mr. Luis Rojo, Vice President, and Chief Financial Officer of Stepan Company. Mr. Rojo, please go ahead.

Good morning and thank you for joining Stepan Company’s fourth quarter and full year 2023 financial review. Before we begin, please note that information this conference call contain forward-looking statements, which are not historical facts. These statements involve risk 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 factor detailing our Security and Exchange Commission filing. In addition, this conference call will include discussions of adjusted net income, adjusted EBITDA and free cash flow, which are noon-GAAP measures. We provide reconciliations to the comparable GAAP measures in the earnings presentation and press release, which we have made available at www.stepan.com under the investor section of our website. Whether you are joining us online or over the phone, we encourage you to review the investor slide presentation. We make these slides available at approximately the same time as when the earnings release is issued, and we hope that you find information and 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 all for joining us today to discuss our fourth quarter and full-year results. To begin, I will share our fourth quarter and full-year highlights. Luis will then provide additional details on our financial results, and I will finish up with comments on our strategic investments, and will also provide brief comments on 2024. For the full-year, adjusted net income was $50.7 million versus a record prior year of $153.5 million. Earnings for the full-year were significantly impacted by an 11% decline in volume due to a slowdown in demand across most end-use markets, including significant customer and channel inventory de-stocking. While we believe the negative impacts of de-stocking are mostly behind us, we continue to experience de-stocking within our agricultural business at the start of 2024. The team did an excellent job controlling our cash expenses. Cash expenses were similar to the prior year due to proactive headcount and discretionary expense controls implemented earlier in the year and lower incentive-based compensation accruals. Additionally, we executed our voluntary early retirement program and other fourth quarter workforce productivity actions that will deliver savings in 2024. In 2023, our cash flow from operations increased to $175 million, representing growth of 9% or $14 million compared to the previous year. The improvement in liquidity was driven by reducing inventory levels while we continued with our significant level of investment in our strategic growth projects. In the fourth quarter, the company reported adjusted net income of $7.5 million versus $13.5 million in the prior year. Volume was up 3% versus prior year, driven by double-digit growth in polymers and 1% up in volume in surfactants. Within surfactants, we delivered strong volume growth in Personal Care from our low 1, 4 Dioxane investments. We also grew volume in the industrial cleaning…

Thank you, Scott. My comments will generally follow the slide presentation. Let's start with slide five to recap the quarter. Fourth quarter adjusted net income was $7.5 million or $0.33 per diluted share versus $13.5 million or $0.59 per diluted share for the fourth quarter of last year. Specifically, the adjusted net income for the fourth quarter excludes deferred compensation expenses and environmental reserve changes. Most items were similar to a prior year for a total of $2.7 million after tax. Finally, we recorded restructuring charges of $6 million after tax. This includes our workforce productivity program as well as non-cash asset and goodwill impairments. The deferred compensation figures represent the net income related to the company deferred compensation plan as well as cash-settled stock appreciation rights for our employees. Because this liability is changed with the movement the stock price, we exclude this item from our operational discussion. Slide six shows the total company net income bridge for the fourth quarter compared to last year's fourth quarter and breaks down the decrease in adjusted net income. Because this is net income, the figures not adhered on an after tax basis. We will cover each segment in more detail, but to summarize, we deliver excellent operating income growth in polymers and lower operating results for surfactants and specialty products. Slide seven focuses on the surfactant segment result for the quarter. Surfactant net sales were $370 million for the quarter and 19% decreased versus the prior year. Selling prices were down 22% primarily due to the fast through of lower raw material costs, unfavorable product mix, and competitive pricing pressures in Latin America. Volume increased 1% year-over-year primarily due to strong double digit growth in personal care from our low 1,4 Dioxane investments. We also grew volume in the industrial cleaning…

Thanks, Luis. I will focus my comments on our cost and cash management initiatives and on the progress of our major capital investments and strategic priorities. Despite continued pressure from general cost inflation and higher expenses related to our major growth investments in Pasadena and low 1,4 Dioxane investments, our cash expenses remain flat year-over-year. Throughout the year, we took proactive actions to control costs and also successfully executed a significant productivity program that led to a 9% increase in cash generated from operations. As you may recall from our October earnings call, we anticipate returning the positive free cash flow generation this year, now that we are approaching the end of our heavy investment phase. The cost reduction activities initiated last year, along with additional productivity and cost out programs underway in 2024, which is centered around improved operational performance across our manufacturing network, are expected to deliver $50 million in pre-tax savings in 2024. Moving to slide 12, construction on our new alkoxylation production facility in Pasadena, Texas is approximately 80% complete, but we expect the plant to start up in the third quarter of 2024. The underlining alkoxylation business that supports the Pasadena investment continued its volume growth during 2023 and at a very attractive unit margin, despite the continued destocking activity happening within the agricultural chemicals market. As you know, we have increased North American capability and capacity to produce ether sulfates that meet new regulatory limits on 1,4 Dioxane. Recently installed assets in our no-dale facility are now mechanically completed. New contracted low 1,4 Dioxane volumes have already started shipping from the site and should grow as we reach full installed capacity during the first quarter of 2024. Stepan now has the largest installed low 1,4 Dioxane production capacity serving the North American merchant market,…

[Operator Instructions] Our first question comes from Mike Harrison with Seaport Research Partners. Your line is now open.

Hi, good morning.

Good morning, Mike.

Good morning, Mike.

So, I wanted to start out with a couple questions on surfactants. You mentioned a lot of the volume growth there was related to recent low 1,4 dioxane investment. Can you just maybe give a little bit more color on where those assets are in their ramp? What the customer response has been? And I guess if you can talk at all about what the margins or returns have looked like there compared to your expectations?

Sure. Yes, so, Mike, over the last 18 to 24 months, we've gone on a heavy investment phase for 1,4 dioxane capability. We did install new assets at both our Winder Georgia facility and two separate production units at our Millsdale facility. All three of those assets are now up and operational with the last asset at Millsdale, which is going through final commissioning and startup this quarter. But volumes have sequentially been ramping up as we brought each of those three independent assets up over the last 12 months or so. In terms of margins, I think it's [indiscernible].

Mike, I don't know if you were waiting for other context on volume growth in surfactants. So, Personal care grew strong double digits due to the low 1.4-dioxane investment that Scott was mentioning. We had a strong double-digit growth in Latin America as well in surfactants. We grew with our distribution partners high single digits -- mid to high single digits. We grew in institutional cleaning as well. So, the plus 1% that you see in surfactants is coming from a lot of places with good growth, but unfortunately, of course, offset by the de-stocking in Ag. So, if you exclude the destocking in Ag, surfactants grew 5% , which is a pretty robust number.

All right, thanks. That's very helpful. And maybe a little bit more detail on what you're seeing in Latin America. Obviously, the Ag business is dragging there, but I think you mentioned some pricing pressure, some share loss related to imported products. Just curious if you can talk about any actions you're taking and kind of what the path to better earnings in Latin America surfactants might look like?

Yes, sure, Mike. Yes, you're absolutely correct, as we've shared on prior calls. With the supply chains disruptions in the second half of 2022, and customers were looking for security of supply, they -- I think, enticed in imports in early in 2023, which caused some of our margin and share issues. But I'm happy to report we are recovering our share in the marketplace, and margins should continue to gradually improve going forward.

Mike, one thing that happened in 2023, and that's why margins are depressing in Latin America, is a competitive situation, but also carrying a high cost raw material. So actually, we just flushed out the last high cost material in January, but that was a big drag for the region in 2023, and that should improve in 2024.

All right, perfect. And then, I guess, switching over to the comments you made on the Millsdale facility and the power disruption and operational issues you have there. I think it'd be helpful if there's any way for you to quantify the impacts there. But I guess my broader question is, I thought we had gone through some improvements at Millsdale to reduce the potential impact of power disruption. So maybe just an update on where we are in terms of improving resiliency there?

Let me give you the numbers, and then Scott can also expand on the situation in Millsdale. At the end, Mike, this is a small number vis-a-vis the EBITDA of this company, so we're projecting probably around $5 million of EBITDA impact in Q1. Again, we are still understanding all the details, doing the final fixes, some extra totaling expenses, so we don't have a precise number now, but it's going to be roughly $5 million EBITDA impact in Q1.

Yes, Mike, in terms of your correct, in terms of this has been a focused area of investment over the last couple of years to improve the operational reliability in the winter months. And I can say the site, based on our prior investments over the last two years, fared much better with these power disruptions in the month of January. As I mentioned in my earlier comments, the PA Polyol assets were more impacted than the broader site was, and we have obviously more work and more investment to do to fix the areas within the PA Polyol that were disrupted, but overall, I think we're pretty pleased with the improved resiliency we've been able to do through investments over the last couple of years.

And we are working now in partnership with our external power supplier, because that's the driver of this situation, so we need to improve resiliency on that side as well. And I forgot to mention, I think Scott talked a lot about PA, so the majority of the $5 million will be in the Polymers business.

All right, very helpful. And then that last question for me is more of a high-level question. Just on the 2024 outlook, you call out a number of positive drivers and talk about EBITDA improvements to come, which I think we all understand that. But maybe just a little bit of additional detail or color about how we should think about the cadence of earnings in 2024? It seems like maybe at some point there should be a meaningful step up or positive inflection point. Just curious if you can maybe help us understand what the timing looks like on that potential inflection?

Great question, Mike. And as we mentioned in our prepared remarks, we are still expecting destocking in Ag to continue in the first half, and we're expecting a revamp of the Ag business in the second half. And so that's one of our key drivers. Second, I will say, the $50 million productivity program already kicking, but you are going to have a gradual ramp up of that program, so you should expect to deliver more savings in the second half than in the first half. And the third thing that I will say, of course, Pasadena is one of our key building blocks for the second half and for 2025. Still, starting off the plant is not going to be all positive at the beginning. You need to spend some money. But those are the three big building blocks that we see. And of course, I mean, you know that we have a seasonality effect on the polymers business, where typically Q2 and Q3 are stronger with all the construction activities. So that skew there means that it will be done in more in the second half.

And Mike, I would also just point out the underlying core business outside of those specific initiatives that we just went through, has demonstrated sequential growth in Q4. So distribution, I&I, polymers, that will continue to -- should continue to incrementally grow through the quarters going forward. But really, the second half of the year is when our new assets come online in Pasadena. And as we said, that's when the Ag destocking is supposed to subside.

All right, very helpful. Thanks very much.

Thank you. One moment for our next question. Our next question comes from Vincent Anderson with Stifel. Your line is now open.

Yes, thanks. Good morning, everyone. I wanted to follow up on a couple of Mike's questions. I think first and foremost, I was hoping to get some more context on agriculture, but really more your confidence in a second half recovery, given we're still seeing a lot of pressure in Brazil on both the safrinha corn acres and then just overall farmer financial positions?

Yes. So, Vincent, the good news is the macro trend is there. And if you've been reading some of the downstream agricultural companies, the demand in the field remains. So this truly is the destocking activity that we're going through right now. I think, and again, what we've had read and talked to with our customers, the second half is when we should start to see the improved volumes. Now, the rate of that ramp up and the geographical cadence of how that happens, I do think you're right, Brazil could be probably the slowest to recover and work through that destocking, but our Ag business is global in nature. North America, Europe, and Asia are all important for us. So we have good anticipation that we'll start to see those volumes recover in the second half.

And this is a 100% in line with the feedback that we're getting from our customers. I mean, this is a 100% in line with their focus.

Okay. It's good to know. I just called out Brazil because I think you pointed to that as a specific area of pressure recently, but no, that all tracks. And then kind of going back to the Latin American business, I think you kind of framed it as imports were incentivized by supply chain disruptions, but if I recall, those were Chinese imports that can be tough to compete with once they kind of get a toehold in. So are you comfortable with where you're running those assets from a margin perspective right now? Or if the imports don't play nice, let's say, is there more room for you to compete being a domestic supplier? Or is this something that you're going to have to continue to monitor pretty closely?

No. I think we feel pretty good, Vincent. As Luis mentioned, with that inventory hangover in the first half of last year, we were chewing through high-cost raw materials, which really impacted margins as we competed in the domestic market down there. But all things equal, our customers prefer to buy from local supply. And when raw material valuations are matching where market pricing is, I think we're going to win that game. And I think our Q4, where we reported double-digit volume growth is demonstrating that. But we expect that to continue quite frankly. But yes, margins can always improve. We're not happy or pleased with where the margins are currently at in Q4, but we expect those to continue to improve as we go forward.

All right, excellent. Good to hear. And then I've just got two really quick ones. You mentioned the biocide business being a little bit of a headwind. Does that just continue de-stocking, or is there maybe some customer concentration on that portfolio that's creating one-off headwind?

Yes, it was really customer concentration and just rolling off some of the COVID types of activity and business that came off in Q4 of 2022.

Okay. Thanks. And then last one is just anything remarkable to report on the annual Polyols negotiations this year?

No, nothing new to report now. Nothing new to report now, Vincent. You know it's a very competitive business. We are good margin stewards in the marketplace, and we will continue protecting volumes of margins.

All right. That's all from me. Thanks, guys.

Thank you. One moment for our next question. Our next question comes from David Silver with CL King and Associates. Your line is now open.

Yes. Hi. Good morning. Thank you.

Good morning David.

Morning. A couple of things. I don't think this was asked. If it has been, I apologize. But during the quarter you called out or in your remarks and in the release, growth on the Rigid Polyols side was called out and double-digit growth all regions, et cetera. And I'm just wondering if you could go back and maybe kind of speak to that just a little bit. In other words, in my opinion, I mean, that's more construction and durable goods related like industries that have not necessarily been the strongest lately. And I believe you called out North America and Europe where maybe the UK has just indicated they're in a technical recession and the German market hasn't been especially robust. So you called out the volume growth. You called out higher margins, I believe, or per unit margins. So what is in your opinion driving that growth? Is this a share gain situation or what type of drivers should we be thinking about for that portion of your polymers business?

Good question, David. What I would say is remember that destocking for this particular business started in Q4, 2022. So what you have, you have the effect of not destocking impact and that's why you see the 12% in rigid polyols. There are still a lot of growth opportunities for the market, for the market with all the construction activity that needs to happen and with all the re-roofing that needs to happen in the U.S. If you look at the pipeline and the backlog of projects on re-roofing in North America, it's still pretty strong and that should provide market growth for the next three to five years. So there is still -- this is not like we're in a peak and we're good. This is just a reflection of not destocking and what we believe and what our customers are also saying is re-roofing and construction activity, there is still plenty of opportunities with energy conservation with all of that this industry should be healthy for the next few years.

Okay, great. I was hoping to change the subject to your CapEx budget for fiscal year 2024. So the midpoint of your range is almost exactly half of what was spent in 2023. If I was just to take the midpoint of maybe 130, I was hoping you could maybe talk about that in terms of how much of that is what you might consider sustaining and then more to the point for the non-sustaining for the discretionary portion of the 130 million or so. Could you just highlight where the discretionary CapEx is being directed? So in other words, I'm guessing 1,4 Dioxane and anything remaining with Pasadena is in there, but also wondering, does rigid polyols need some incremental capacity there or where else should we be looking for where the discretionary portion of your CapEx budget for 2024 is being directed? Thank you.

Yes, Dave, this is Scott. Yes, no, you're spot on. The 130 million is inclusive of us finishing the last final touches on the Pasadena and the 1,4 Dioxane investments, definitely the minority portion of that 130 million. In terms of other discretionary spends, I would call them incremental opportunities where we may be modifying reactor sets to produce or execute on customer-specific opportunities or certain product line extensions. I would not characterize anything in that 130 outside of Pasadena and 1,4 Dioxane as significant discretionary spend. And it's important for us to get these new assets fully up and running and start generating returns against them. So consider the pause in 2024 for any new major incremental capital discretionary projects, and I'll leave it at that.

Okay. Thank you for that. Luis, I did want to ask about the debt structure, and if you could just remind me of the total debt that you have at the end of the year here north of half a billion. If you could just remind me how much of that would you consider variable in terms of either fixed rate or something that's been locked in with derivatives where your interest costs are highly predictable? And then what is the balance that might be subject to fluctuations in short-term base rates or indices? Thanks.

Good question, David. Look, as you saw, $654 million in gross debt, $524 million in net debt when you include the 130 that we have from cash. And if you think about our debt, the majority is fixed, and it's -- I would say, 65%, 70% of that, and we fixed a lot of debt during COVID at a very attractive interest rate, so below 3%, and we also did some derivative for $100 million also hedging below 3%. So the majority is fixed at a very attractive rate.

Okay, great. And then last one, if I could. But I was hoping to just get a tiny bit more color on the workplace productivity programs that are the biggest part, I guess, of the $50 million cost reduction program. So I guess there were some a start to it here, but you do have kind of a growing global network here. And I'm just kind of scratching my head, and I'm wondering if you could qualitatively maybe just point out one or two areas where you see the most opportunity to get from where you are now to the $50 million, I guess, run rate in cost reductions over the next year or two? Thank you.

Good question, David. Look, the majority of the $50 million comes from the operational side, right? For example, logistics, the team is doing a great job on reducing our logistic cost, and of course the market is in favor of that, so our logistic cost is going down 25%, 30%, a procurement savings on raw materials, improving the operations in the whole supply chain in our plans to reduce inefficiencies that we have. So 70% -- roughly 70% of the $50 million is on the operation side, and then only 30% is the workforce productivity that we already executed. This was already the programs that we announced last year with the early retirement program, and some reductions in force, so that's the other 30%.

Okay. Thank you very much. I'll get back in queue. Appreciate it.

Thank you. [Operator Instructions] One moment for our next question. Our next question comes from Dave Storms with Stonegate. Your line is now open.

Good morning.

Good morning.

Just wondering if I could ask about kind of what you're seeing upstream from a raw material standpoint, both from a cost and sourcing lens and how you expect that might change over these next coming quarters?

Good question, Dave. And look, when you think about raw material prices and pricing, I think we're in a pretty good position. As you saw Q4, despite our sales down 15%, our cost of goods sold is down 17%, so we basically almost hold a gross margin flatish $66, $67 million despite the 15% drop in sales. You see oil now relatively stable in the 70 to 80 range, and what we have seen is our raw material prices have stabilized. There are a few pockets where they are still coming down a little bit, but the 80 for the 20 is stable, and this is why we are catching up on the margin side.

Yes. I would just say overall capacity in the chemical industry is much looser than it was 12 months ago, 18 months ago, right? There's greater optionality and opportunity to really work on your raw material costs in the current environment.

Very helpful. Thank you. And then just also, what's the customer acquisition environment looking like? It sounds like you defend your market share pretty well and continue to defend your market share pretty well. Is there potential to expand into more clients, either Tier 1s through 3s?

Yes, so that's obviously a big part of our growth strategy within the surfactant business, is to continue to service and sell more Tier 2 and Tier 3 customers. Even last year in the challenging market we had financially, we grew our net customers within surfactants by over 500 new customers. Those are around the world that truly value our technical service, our formulation expertise, and our broad product line. And that continues in a difficult challenging market. So we're very excited that our sales and R&D teams continue to do a great job bringing new customers into the company.

That's perfect. And then just one more quick clarifying question. Luis, I think you mentioned earlier that you were through most of the high-cost inventory. Was that specific to surfactants inventory, or did that include polymer and specialty?

Yes, it's both. It's the three businesses.

Perfect. Very helpful. Thank you very much for taking my questions.

Thank you, Dave.

Thank you. I'm showing no further questions at this time. I would now like to turn it back to Scott Behrens for closing remarks.

Thank you very much for joining us on today's call. We appreciate your interest and ownership Stepan Company, and please have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.