F. Quinn Stepan, Jr. - President & CEO Scott Beamer - CFO.

Daniel Rizzo - Sidoti & Company Jason Rogers - Great Lakes Review Christopher Meeker - Franklin Templeton.

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company’s Second Quarter 2014 Results Call. 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, the call is being recorded, Wednesday, July 23, 2014.

I’d now like to turn the call over to Scott Beamer. Please proceed..

Thank you, James. Good morning and thank you everyone for joining the Stepan Company’s second quarter 2014 financial review. Before we begin, please note that information in this conference call contains forward-looking statements, which are not historical facts.

These statements involve risks and uncertainties that could cause actual results to differ materially including, but not limited to prospects for our foreign operations, global and regional economic conditions and factors 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. As we started doing last quarter, we’ll plan to post the slide presentation at the same time we issue our earnings release.

We hope that you find the information and perspectives helpful. With all of that said, I’d like to turn the call over to F. Quinn Stepan, Jr., our President and Chief Executive Officer..

Thank you, Scott, and thank you all for joining us this morning. Despite facing challenges in the second quarter, we matched prior year earnings. Operating earnings were hampered by continued weakness in North American Surfactants offset by good growth in our Polymer business.

Net income for the second quarter was $24.4 million, up 7% from last year’s $22.7 million. Net income excluding deferred compensation was $20.6 million, essentially flat with prior year results of $20.4 million.

In the second quarter, our Surfactant business in North America experienced an 11% volume decrease and is expected to continue challenges for the rest of 2014. Stepan’s Polymer business experienced good growth with Polymer sales volume increasing 22% and operating income up 36%.

Our balance sheet continues to be solid and we will continue to pursue further investments and opportunities to improve efficiency, accelerate our earnings growth and deliver greater returns to our shareholders.

Last week we announced an agreement to acquire a second sulfonation site in Brazil, which is synergistic with our existing plant and provides an opportunity to serve the growing northeast of Brazil. Our Board of Directors has declared a quarterly cash dividend on Stepan’s common stock of $0.17 per share payable on September 15, 2014.

In the fourth quarter of 2013, we increased our quarterly cash dividend by 6% marking the 46th consecutive year that we have paid increasing dividends to our shareholders. At this point, I would like Scott to walk through Stepan’s second quarter results..

Thanks, Quinn. Total net sales for the second quarter were $504 million, up 6% versus prior year. The selling price increases mostly from our Surfactant business accounted for 7% of this change. These increases are mostly from contractual changes to selling prices, which correspond to changes in our raw material costs.

In other words, when our raw material cost increase in some cases we’re able to pass the increase along. Total volume was down 2% with global Surfactants down 8%.

Consistent with the prior quarter, we chose not to participate in the biodiesel market because it was not economically advantageous to do so and this accounted for 2% of the Surfactants decline. You will notice this item is not shown separately on the earnings bridge because the impact to net income was negligible.

However, earnings were impacted by the remaining 6% volume decline in Surfactants, most of which is from North America. Specifically, two of our customers brought volume in-house to use more of their internal surfacting capacity and this accounted for 2% out of the 6% decline.

One item is new for this quarter, so it will remain a difficult comparable until this time next year. The other item was mentioned in last quarter’s call and will remain a difficult comparable for the remainder of this year.

Similar to other information that has been issued by other sources, we have noted that the agricultural market was weaker than expected. Consistent with this, Surfactant sales for agricultural applications fell and this accounted for most of the remaining decline.

Primarily, there was a carryover impact of severe first quarter weather in North America, which led to reduced customer demand and higher customer inventory levels. Also, Brazil’s agricultural market was impacted by drought conditions from earlier this year.

While the Surfactant volumes were challenged, we had strong growth in our Polymer segment of 22% for the quarter or 15% excluding the extra two months of the Columbus-Georgia acquisition. Since we closed this acquisition on June 1, 2013, the volumes and earnings from this acquisition will have prior year comparables going forward.

Overall, in Polymers, our rigid foam business continued to benefit from the macro trend of greater use of insulation and this helped drive fairly significant growth in North America and Europe.

Europe also continued to benefit from market growth in insulated metal panels which are used in vertical applications or walls of structures in addition to flat or low slope roof application which makes up a majority of our business. Our C.A.S.E business which is coatings, adhesives, sealants and elastomers continued to grow.

Overall, North America and Europe polyol volumes increased 19% and 16%, respectively. The impact of foreign currency on sales was an increase of 1% while the impact to net income was negligible. Even so, we provide Table 3 in our earnings release which shows the summary of the effects of foreign currency translation on sales and key income line items.

Now with the volume covered in some detail, I’d like to review the remaining drivers of our net income by referring to the bridge shown on Slide 4 of the quarterly presentation. Prior to doing so, I will mention that the bridge reports net income excluding deferred compensation.

That’s because deferred compensation expense is generally a non-operating item which is driven primarily by changes in our share price and we feel it focuses the discussion more sharply to operating items when we exclude deferred compensation from the figures.

In total, second quarter net income excluding deferred comp expense or income was $20.6 million, which is essentially flat compared to the $20.4 million we earned in the prior year. The negative item in global surfactant volume and mix shows the negative earnings impact of the items mentioned above in the surfactant volume discussion.

North America maintenance costs increased $1.1 million on an after tax basis versus prior year, as we had an unusually high level of activity primarily from projects to address the issues we faced with the harsh winter weather in the first quarter.

This work continued into the second quarter and as a result, more of the typical maintenance work was reprioritized until later in the quarter and into the second half of the year.

As a result, in the second half of the year, we expect maintenance costs to continue to run unfavorable to the prior year but to a lesser degree than those incurred in the second quarter. The Canadian accelerated depreciation is the same item that we spoke about in the last two quarters.

As a reminder, it relates to the fourth quarter restructuring reserve for the closure of sulfonation production at our Longford Mills plant in Canada. This production generally serves the consumer products and distribution markets and this is the final quarter for this item.

We stated in the fourth quarter of 2013 that the savings from this initiative will begin in the second half of 2014 with a full annual run rate of approximately $2.5 million per year beginning in 2015. The total of the first three items on the bridge is a negative $4.8 million after tax or approximately 6.8 million before tax.

At a macro level, this accounts for the change in Surfactants operating income shown on Slide 5. Continuing with the bridge, Europe and North America polyols, excluding the acquisition, delivered $1.7 million on an after tax basis which has improved from a positive $400,000 last quarter.

The primary drivers were the volume increases we reviewed earlier in the call. We benefited as the effective tax rate improved for the quarter and on a year-to-date basis. For the first half of 2014, the effective tax rate was 27%, slightly below the 28% for the first half of 2013.

This decrease was primarily as a result of greater percentage of our consolidated income being earned outside the U.S. where effective tax rates are generally lower. First quarter 2013 had a catch-up benefit related to 2012 research and development and biodiesel credits which were not reenacted until 2013.

2013 was the time when companies could recognize the catch-up and the current year impact in their financial statements. Overall, the change in country mix more than offset the catch-up items which did not recur.

For the full year, we expect our effective tax rate to be between 26% and 28% which is revised lower than the projection we communicated in the first quarter conference call. Finally, as we did in the prior quarter, we reduced bonuses and other variable compensation items to reflect our results not meeting our internal objectives.

Additionally, I will provide some overall comments on the performance of our segments. As mentioned, Surfactants were impacted by two consumer product customers bringing Surfactant volumes in-house and from the weaker than expected agricultural market.

However, we continued to make progress on our strategic objectives as sales to higher margin, non-consumer products such as products sold into the household, industrial and institutional markets and sales to our distributors increased slightly. Enhanced oil recovery sales also increased.

Polymer results benefited from the macroeconomic trends that have been highlighted as well as strong execution on the overall strategy and the integration of the Columbus acquisition where we remain on track to deliver the targets we stated. Finally, we have our specialty products segment which represented about 4% of our company sales.

Here the sales volume was flat versus the prior quarter while operating income declined by 600,000 primarily as a result of timing on pharmaceutical orders. Overall, you may have noticed that once again we added to our disclosures, this time by adding tables showing gross profit and operating income by segment in our earnings release.

We hope you find value in the improved visibility into our segments. Now moving to the balance sheet. Total debt was $271 million as of June 30. This is the same as the total debt at the end of the year as there were no scheduled debt repayments in the first half of the year.

Beginning a few quarters ago, we began providing some additional transparency to our working capital components directly in the earnings release.

Here you’ll see that net receivables generally changed consistent with our increased sales while inventories and accounts payable changed consistent with our increased input costs and the typical slightly higher activity levels in the second quarter. There were no significant underlying changes to terms or operations in these areas.

We also report net debt, which is total debt minus cash on hand. Net debt was up about $24 million versus March. Since total debt essentially did not change, the increase was primarily a result of increased working capital attributable to the reasons mentioned previously.

As shown in the release, the ratio of net debt to total capitalization at June 30 was 20.3% which has not significantly changed from the 23.5% at March 31. Capital expenditures were $19 million for the quarter versus $21 million for the same quarter last year.

Looking forward, we expect full year 2014 capital expenditures to be within the range of $100 million to $110 million including capacity expansions in strategically important areas. This is consistent with the range we provided in the previous call. We also have a share repurchase program.

For the first half of the year, we purchased approximately 90,000 shares on the open market at a total value of about $5 million. Before we open the call to questions, Quinn will provide some perspective on our forward-looking outlook..

Thank you, Scott. As previously noted in the prior earnings call, lower first quarter earnings will make it difficult to exceed 2013 operating earnings. North American Surfactants will continue to face challenges for the rest of 2014 with lower consumer product volumes and slightly higher maintenance costs.

The North American agricultural market is not anticipated to reach 2013 levels in the second half. However, we expect the Brazilian agricultural market to recover. Contributions from new enhanced oil recovery projects should deliver between $3 million and $5 million in additional operating income versus last year.

We anticipate continued earnings growth from our 2013 acquisition from Bayer and recent capacity expansions in Brazil, Europe and Singapore. Closing on the announced acquisition in Brazil would not materially impact 2014 results. It does have synergies with our existing site and would positively impact 2015.

Polymer should continue to deliver strong global volume growth, improving economies in the U.S. and Europe and greater use of insulation should both contribute to full year Polymer growth.

The North American polyester resin business in Columbus-Georgia purchased from Bayer is fully integrated and is expected to deliver between $6 million and $8 million of operating income in 2014 which is $4 million to $6 million higher than prior year. We expect the loss in China to be less than last year.

We continue to supply material for this growing market from other Stepan facilities and local toll manufacturers. In this quarter, we signed an engineering procurement and construction contract to build our Chinese polyol plant which is expected to be operational in 2016.

We launched a formal program utilizing internal and external resources to improve the efficiency and profitability and plan to communicate targets later this year. Overall, we have a healthy balance sheet and will continue to pursue investments that will accelerate our growth. This concludes our prepared remarks.

At this time, we would like to turn the call over for questions. James, please review the instructions for the question portion of today’s call..

Thank you. (Operator Instructions). Our first question is from Daniel Rizzo from Sidoti & Company. Please proceed..

Good morning..

Good morning, Dan..

Good morning, Dan..

The Surfactant customers that are now doing their surfactants in-house, I assume that’s kind of a permanent loss at this point?.

At this point, we would say it is a permanent loss..

Fair enough. And how much – sorry, go ahead..

If we take a look at that, due to the kind of reformulations, greater use of enzymes, the trading down from premium brands to economy brands, that has led to a decline in the use of surfactant in the wash load, and as result of that internal capacity at those customers has freed up and so they are moving some of that volume that they previously outsourced from us into their internal capabilities.

So at this point in time, we would believe that’s a permanent loss. And to quantify that, it was probably one-third of our decrease that we highlighted in our surfactant bridge..

Okay..

That’s approximately $1 million after tax..

That’s 1 million after tax and you can think about that as being a similar number going out into the next couple of quarters as well.

So that negative – and just to frame it, that negative on the bridge, the 3 million of surfactant volume and mix, as Quinn said, this piece is about a third of that and was the biggest part of that which was a surprise to us.

We don’t expect there to be problems ongoing in ag but the piece on the two consumer product customers that’s going to be a continuing challenge in the next few quarters..

Then you guys have excess capacity now, I guess, at least domestically with the surfactants that was formally serving those customers..

In terms of our anionic product line, today we have excess capacity. That is correct..

Okay. All right, thank you guys..

Our next question is from the line of Jason Rogers from Great Lakes Review. Please proceed..

Good morning..

Good morning, Jason..

Good morning, Jason..

Wondered if you could talk about the loss of the customers in that consumer area, what’s the risk that you may see other customers bringing their own operations in-house as well as any risk for other industries to do the same?.

What we’re talking about is just kind of the anionic and the sulfonation piece of our business today. The remaining anionic business that we have in the laundry segment we have under long-term contracts. So we think the additional risk going forward in North America is minimal.

So relative to other industries, our industries generally don’t have the economies of scale that would allow them to install or build sulfonation equipment to that.

So for the most part, all the personal care, the agricultural accounts are all buying on the merchant market with the exception of some of the large consumer companies that have both the laundry and a personal care business may supply some personal care SKUs today.

But at this point in time, we will see the risk being minimal for the balance of our business going forward for the foreseeable future. There are opportunities that exist to increase that and today I would say we are pursuing one or two of those, but they’re not in our projections at this point in time going forward..

And how long do you believe this situation of excess capacity will exist or when will it improve in your opinion?.

Certainly from a North American perspective, again it’s anionic capabilities that we’re talking about only, so there is excess capacity in the marketplace. So we have an issue before us.

Ideally, we would like to fill it up with enhanced oil recovery opportunities but if that does not materialize in the North American market, we’re going to have to take some action. We talked about increasing our effectiveness and efficiency. That’s one of the opportunities that we’re looking at.

We have taken a small step in terms of shutting down some sulfonation capacity in our Longford Mills Canadian facility and we’ll continue to look at our network as appropriate..

And finally just wanted to get an update on that new cleaning product with the Elevance partnership..

We’re still very excited. We have supplied over 900 samples to the marketplace today. I think we have had 16,000 hits on our MICRO website as of this point, so there is a fair amount of customer interest. We have sold very small drum quantities to date with a couple of customers talking about moving to bulk quantities in 2014.

So we’re optimistic that it’s going to be a very successful product for us long term, but at this point in time it’s not a significant part of our 2014 forecast but we look forward to volumes beginning to build in 2015..

Thank you..

Thank you, Jason..

(Operator Instructions). Our next question is from the line of Chris Meeker from Franklin Templeton. Please proceed..

Good morning, guys..

Hi, Chris..

Could you remind us again how much North America represents of the total Surfactant business?.

North America is about 55% of our Surfactants business globally..

Okay.

And to go back to kind of the excess capacity questions, what I’m trying to kind of work through here in my head is, in terms of the capacity you have, you’ve got excess capacity it sounds like at some of the customer sites and maybe that’s been soaked up by these two customers bringing the volume in-house, but it seems like there could be risk that there are other customers out there that could bring volume in-house.

You have excess capacity in your plants from the volume that you’ve lost and then you also have kind of the excess capacity sitting around because you’re no longer participating in the biodiesel market.

Is that kind of the right way to frame the situation in front of us?.

Partially. One, the biodiesel assets are a different type of assets and they’re distinct from sulfonation assets.

So biodiesel in our case in North America, we have primarily batch reactors that are multipurpose reactors that are underutilized today but can be used in the future for other surfactant or polymer opportunities, and we’re looking at trying to fill those things with other Stepan technologies.

So I think there’s an answer for the biodiesel assets going forward.

Relative to our customers having excess sulfonation capacity, for the most part today with the two moves that the customers that we referred to have contemplated, our customer networks will be filled with their current demands and there is limited opportunities for other customers – other customers aren’t – they have limited opportunities to move in-house today without building additional facilities.

So to date, there are no plans for those customers that are buying from the merchant market to build their own capacities. And today, generally consumer product companies would prefer to outsource rather than spend their money on capital projects to backward integrate. They would prefer to invest and to grow their market through acquisitions.

So they will try to take advantage of existing assets as they have in place. So again, I think the risk of losing additional volume is to backward integration is minimal.

Having said that, we have significant excess capacity in our marketplace today and again we’re strategically taking a look at that in terms of what we want to do with that going forward..

What does the utilization look like today on that North American capacity compared to a couple of years ago when the margins were more high single digits or even double digits a couple years back?.

I would say we have lost – over the last 10 years we’ve probably lost 20% in terms of capacity utilization in North America and we’re short of capacity in Brazil and that’s why we’ve made the acquisition there and we’re a little bit long in capacity in Europe as well, I would say at this moment..

Okay. And then just a last question, could you just help us understand the significance of the new sulfonation plant that you bought down in Brazil? You mentioned that it’s synergistic to the one that you have down there already.

What exactly does that do for you?.

I would like to defer that question to the next quarter until after we actually close on the acquisition, if I could..

Okay. Thanks, guys..

Thank you, Chris..

(Operator Instructions). There are no further questions from the phone lines at this time..

Okay. I’d like to thank everyone for joining Scott and me on the call today as well as the entire Stepan team for their commitment to serving our customers worldwide and their valuable contributions that allow us to generate a value for you, our shareholders. We look forward to reporting results on our third quarter in our next call. 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. Thank you..