F. Quinn Stepan Jr. - President, Chief Executive Officer Scott Beamer - Vice President, Chief Financial Officer.

Jason Rogers - Great Lakes Review Mike Hunter - Global Hunter Securities Chris Kapsch - BB&T Capital Markets.

Ladies and gentlemen, thank you for standing by. Welcome to the Stepan Company’s Second Quarter 2015 Earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session.

At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press star, zero. As a reminder, this conference is being recorded Wednesday, July 22, 2015.

I would now like to turn the conference over to Scott Beamer, Vice President and Chief Financial Officer. Please go ahead, sir..

Thank you, Cathy. Good morning and thank you for joining Stepan Company’s second quarter 2015 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 the earnings release is issued.

We hope that you find the information and prospectus helpful. With all that being 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. Our second quarter results benefited from earnings momentum in surfactants and polymers partially offset by a decline in specialty products.

Actions taken in 2014 to improve product mix, reduce cost and improve efficiency enabled income growth despite the negative impacts of a strong U.S. dollar. Since our last teleconference, we have taken important steps to improve sulfonation utilization in North America and expand our presence in Brazil.

Scott will talk a little bit more about that later today. Net income was $16.9 million or $0.74 per diluted share versus $1.06 per diluted share in the same quarter last year. Adjusted net income was $20.9 million compared to $20.6 million in the year ago quarter. Net sales decreased 10% to $452.4 million on 1% higher volume.

Surfactant operating income was $24.2 million, up $5 million or 26% versus 2014. Results for the segment benefited from a favorable product mix and improved performance outside the United States, partially offset by negative currency effects from a strong U.S. dollar.

Foreign exchange negatively impacted operating income for surfactants by $2.2 million. All regions, except for Asia, increased earnings from the prior year quarter. Strong volume growth in Europe and Brazil, as well as an increase in consumer product and agricultural sales in North America, contributed to the result.

Polymer operating income was a record $23.4 million, up 27% versus prior year. Growth in operating income for this segment was primarily driven by higher rigid polyol volumes in North America and income growth in coatings, adhesives, sealants and elastomers, or CASE.

Global rigid polyol volumes benefited from enhanced installation standards globally and conversion to metal panels in Europe. Specialty product operating income was $1.5 million, down $2 million or 57% from 2014 due to lower volumes and margins.

Our board of directors declared a quarterly cash dividend on Stepan’s common stock of $0.18 per share, payable on September 15, 2015. At this point, I’d like Scott to walk through Stepan’s second quarter results..

Thank you, Quinn. My comments will generally follow the slide presentation. On Slide No. 3, we note that adjusted net income increased by 1% to $20.9 million or $0.91 per diluted share. Foreign currency translation negatively impacted net income by $1.8 million or $0.08 per diluted share.

Our two largest segments, surfactants and polymers, which accounted for 97% of our total operating income, each delivered $5 million of operating income improvements, increases of 26% and 27% respectively. Since adjusted net income is a non-GAAP measure, we provide a full reconciliation to reported net income, which can be found in Appendix No.

2 of this presentation as well as Table No. 2 of the press release. The only adjusted to reported net income this quarter is for deferred compensation expense, which was $4 million or $0.17 per share compared to $3.8 million or $0.16 of income in the prior year.

Naturally, all employee compensation is reflected in our normal operating net income; however, we also allow employees the opportunity to defer their payouts until some future date, and the future payment changes based on the company’s share price.

When the stock price rises, an expense is incurred, which is what happened this quarter when our shares increased 30% from $42 to $54 per share. Both surfactants and polymers had good quarters despite headwinds from negative currency translation.

In surfactants, the regions outside of North America were particularly strong, while improved North American margins and operational costs more than offset slightly lower volumes. Our polymers business continues to perform well. The global rigid polyol business benefited from higher volumes in installation end markets and improved margins.

As announced recently, we also made progress with a number of key strategic objectives. We signed a long-term surfactant supply agreement with the Sun Products Corporation, which makes private label laundry detergent for large retailers and owns their own brands, including Wisk and All.

Sun has been producing their anionic surfactant needs from their Pasadena, Texas facility. With this supply agreement, Sun has outsourced the product of all of their anionic laundry surfactants to Stepan. Additionally, we purchased select chemical manufacturing assets from the Houston site.

These assets will be relocated to Stepan’s sites as needed and should reduce future capital expenditures. Since we have earned an important piece of North American business without adding assets in the region, our capacity utilization in North America will increase significantly.

Second, the purchase of the surfactant production facility in Bahia, Brazil is similar in that a customer, in this case Procter & Gamble, has sold their surfactant manufacturing site to us, entering a long-term agreement for us to supply surfactants to them.

We were previously capacity constrained in Brazil, but this acquisition will allow us to more fully participate in the large consumer product segment of that country as well as the growing functional end use markets.

We also completed a $100 million debt offering at 3.9%, which will allow us to continue to make investments to execute our strategy and to drive earnings growth. After paying down the debt that is coming due in 2015, the weighted average cost of our long-term debt will be 4.4%. Over 60% of our remaining debt will be at rates lower than 4%. Slide No.

4 shows the total company earnings bridge for the second quarter compared to last year’s second quarter and breaks down the $300,000 increase in adjusted net income. Since this is net income, the figures noted here are after the effect of taxes. Surfactant’s operating income improved by $3.5 million.

Volume was 1%, with Europe and Brazil each delivering volume growth while North America volumes were down slightly. Surfactant margins benefited from operational efficiencies and an improved product mix, mostly from improved performance in household, institutional and industrial.

Consistent with the first quarter, polymers delivered improved earnings, this time by $3.4 million after tax. Specialty products operating income fell by about the same amount as it fell in the first quarter, and was impacted by lower volumes and margins. Demand remained lower in our lipid nutrition business.

Higher raw material costs decreased margin, and the timing of pharmaceutical sales also negatively impacted the quarter. We mentioned last quarter that specialty products operating income decline may continue for the remainder of the year.

Incentive-based compensation was higher for the same reasons that were noted in the first quarter - because we did not pay bonuses in 2014. The all other category mostly represents external consulting fees paid related to our ongoing global efficiency initiative.

The costs are shown here, but the benefits of this initiative are captured within the business segment operating results. The effective tax rate for the first half of 2015 was 30% compared to 27% in the first half. This increase is primarily related to changes in our regional mix of earnings.

In addition, this quarter there was an unfavorable non-recurring tax charge from a settlement of a foreign income tax audit. The former item may continue in the future, while the latter will not. Slide No. 5 focuses solely on surfactants, which recorded $24.2 million of operating income, an increase of $5 million pre-tax or 26% over the prior year.

You will notice that we have combined Asia with North America in this view because our surfactant business in Asia is small.

Our Singapore plant supports the North American business with intermediate product and Asian external results did not change significantly compared to the prior year, so the favorable deviation is entirely related to North America where improved household, institutional and industrial performance more than offset lower performance in laundry and oilfield.

Additionally, North America margins benefited from operational efficiencies and a slightly improved mix. Latin America was higher, mostly driven by Brazil, where both the consumer and functional businesses performed well. In the first half, Latin America made nearly as much money as it made in all of 2014.

Europe is enjoying a strong year despite the headwinds of foreign exchange, specifically through increased sales of specialty surfactants. Turning to polymers on Slide 6, this segment made $23.4 million in the second quarter, an increase of $5 million or 27% versus prior year. Polymer net sales for the second quarter dropped $14.7 million or 10%.

Foreign exchange reduced net sales by $8.7 million and pricing was down, mostly consistent with the falling raw material orthoxylene in our phthalic anhydride business. Sales volume in this segment rose 3%.

Our North American business, excluding phthalic anhydride, improved $5.5 million of operating income, driven by rigid polyol volume growth and improved margins. Our phthalic anhydride business improved by $1.2 million. Europe delivered volume growth but operating income was lower due to the stronger U.S. dollar.

Overall, this business delivered a 27% growth in operating income versus prior year and delivered a 17% operating income as a percent of sales. On Slide No. 7, we reference the expectation for items which are known with some level of certainty and have been provided recently.

The original expectation was a net improvement of $17 million after tax, or $0.75 per diluted share. We are revising that downward to $14 million or $0.65 per diluted share. The expectation has changed because we have prioritized executing the Sun transaction ahead of a few other projects.

We continue to have opportunities to improve efficiency and will pursue those. The points on Slide 8 list some additional expectations which will be important for growing earnings. Quinn will speak to those in his closing comments, but next I will comment on Slide No. 10, which is Appendix 1.

Capital expenditures for the second quarter were $26 million versus $19 million in the second quarter last year. Year-to-date, we’ve spent $54 million versus $39 million in the first half of 2014. For 2015 as a whole, we continue to expect between $120 million and $140 million as we build our net plant in China and further invest in Poland and Brazil.

Related to our debt, I would like to specify that we will have incremental interest expense moving forward. We have a relatively small portion of debt principal that’s due in the next 12 months, and we are not retiring any debt early, so a large portion of the $100 million is incremental to our balance sheet.

In terms of interest expense, we expect about $3 million more in 2016. The 2014 full-year interest expense is a good proxy as a starting point, so if you add $3 million to the $11 million incurred last year, you arrive at an expectation of about $14 million a year.

Our total debt to capital ratio was 35% at the end of the first quarter and currently stands at 32%. I mentioned earlier why the effective tax rate had increased for the first half. Even with this increase, we continue to expect a full-year effective tax rate of between 28% and 32% for 2015.

Generally speaking, we do expect to improve our earnings in the U.S. in the second half of the year, and this would pressure the rate upward, although still within this range. If the United States R&D tax credit is approved, the 2015 benefit would be $1 million or about 1% on our tax rate.

Now, Quinn would like to make some comments on expectations for the rest of 2015..

Thank you, Scott. After six months, we remain on track to reestablish earnings momentum for the full year. In the second half, polymer income growth should continue and be driven by global energy conservation efforts in rigid polyols and strong results in specialty polyols, including CASE.

Construction projects to add polyol capacity in China and Poland are on schedule, with both expected to start production and improve earnings in 2016. Staffing in China will ramp up in the second half and negatively impact 2015 results.

In surfactants, new commodity laundry volumes in North and Latin America should contribute modestly to income in 2015 as profitability from the new business will be partially offset by higher integration expenses. Bigger benefits are expected in 2016.

Higher functional volumes globally and additional specialty surfactant volumes in Europe, as well as higher contributions from our efficiency program, should continue to favorable impact results. A stronger U.S. dollar should negatively impact the second half by approximately $5 million pre-tax.

Our balance sheet is healthy and future investments will focus on strategic initiatives and improve efficiencies, increase asset utilization, accelerate growth, and deliver shareholder value. This concludes our prepared remarks. At this time, we would like to turn the call over for questions.

Cathy, please review the instructions for the question portion of today’s call.

Cathy?.

[Operator instructions] Our first question comes from the line of Jason Rogers from Great Lakes Review. Please proceed with your question..

Good morning. I wonder if you could talk a little bit more about the Sun deal as far as the size, looking at it in annual revenues, how much an improvement in capacity you realized from the deal, and what your current capacity utilization is..

Jason, we generally don’t specifically talk about customer contracts. The size and the magnitude of this one was important enough that we felt that we should communicate it in an 8-K. From an implementation standpoint, we’re actively working on implementation today.

We will ramp up volumes in August and September, and then the business will be fully integrated as of September. I would tell you that from a volume perspective, Sun is a market leader in the U.S. in the North American business.

They have, I believe, the second-highest laundry share following Procter & Gamble in the marketplace today, so the volume is meaningful. From a sales perspective, this business, as much of our laundry business globally, will be consigned, so the net sales benefit is not significant but the contribution will be meaningful..

Looking at the rest of the year, you have some pretty easy comps on a year-over-year basis; but just looking at the second half compared to the first half, I was wondering if there is any type of seasonality we should be thinking about or just how it looks second half versus first half..

There is a little bit of seasonality associated with our business. Generally speaking, our business tends to drift down in November and December of the year, so the ag business is somewhat seasonal.

It tends to be strong in the first and second quarters, so there is somewhat seasonality in our functional surfactant business and in our polymer business. The consumer products business, so laundry, personal care, tends to be a little bit more stable throughout the year..

Finally, the--sorry, go ahead?.

I was just going to add, Jason, I think if you look at historical seasonality, that would be a proxy for this year’s seasonality as well, so the factors that Quinn mentioned, those have been factors for some period of time for our businesses and are likely to continue..

Finally, the $14 million in expected earnings improvement, how should we think about that looking at the second half, Q3 versus Q4?.

So we said--I mean, there is some improvement from 3 to 4, so we said it’s the 14 and a third of that was in the first quarter. It was small in the second quarter, so there’s sort of the majority of the remainder in the third and fourth, and I would say that is an improvement.

The fourth will be higher than the third, but we’ll intentionally not be much more specific than that, but model in the fourth being higher than the third..

Thank you very much..

Ladies and gentlemen, as a reminder, to register for a question, please press the one followed by the four on your telephone. Our next question comes from the line of Mike Harrison with Global Hunter Securities. Please proceed with your question. .

Hi, good morning. Quinn, I was hoping that you could maybe give a little bit more color on what’s going on in some of your specialty surfactant markets, particularly in North America.

Obviously you noted the oilfield was a little bit weak, and I would expect that that’s probably approaching the bottom at this point; but can you talk about what you’re seeing in terms of trends there as well as in the ag business? It seems like maybe the ag business was holding up a little bit better than maybe we would have expected, given the weakness in commodity prices..

So I believe your question relates to the functional surfactant business rather than our specialty products business. So from a functional surfactant perspective, oilfield is down significantly. We talked previously about our enhanced oil recovery business.

Our perspective for the year has not changed significantly since the first quarter call, where we do have one commercial flood going and four pilots that are ongoing today, so we don’t anticipate significant commercial activity until the oil price goes above $65 a barrel. So that’s our EOR business, oilfield business.

Our other traditional oilfield business for production and for drilling, we have a relatively small share in that business.

We do anticipate that there could be some upside in our business in second half of 2015 as companies have some time to explore new technologies and the adoption of new technologies, because the price of oil is down and they’re not as busy.

So we do have some new opportunities in that market that we are pursuing today, so we think there could be a little upside in terms of our projection for the year. Then from an ag perspective, better than 2014, not as good as 2013. The lower crop prices have continued to put pressure on the business.

Our internal efficiency effort has enabled us to improve the profitability and small volume growths in that area in 2015, and we would anticipate that would continue for the balance of the year..

All right, and can you talk about your expectations for pricing as the year progresses in surfactants? It looks like it was down, I believe, around 4% year-on-year.

Is that kind of where we would expect it to trend for the rest of the year, or is there still more to go given what raw materials have done?.

I think from an overall perspective, we would--we don’t see significant changes in pricing from Q2 going into Q3 and Q4.

We would hope that an improved product mix over a period of time would enable us to improve our overall margins due to greater functional surfactant sales, improvement of oil, improvement of market demand in the agricultural market. But fundamentally, I don’t see a significant change in margins Q2 going into Q3 and Q4..

All right..

Maybe just one more comment - because of the consigned nature of the new laundry business, that could slightly improve the percent margin but not necessarily improve our unit margin, which we talk about in our business as well..

Okay.

Then just looking at the cost savings and the reduction in your expectation there, I understand your comment was that you were focused on landing the Sun deal and the Sun transaction, so was that really a function of more capital priorities and you wanted to focus on putting capital towards that rather than towards some of these cost savings projects, or was it more an issue where you’re having challenges kind of walking and chewing gum at the same time, where it’s just tough to be working on this transaction and be working on other things at the same time?.

We can walk and chew gum at the same time, but given the size and the magnitude of the Sun transaction, it is requiring significant activities from all parts of our organization, from the supply chain, the logistics organization, from a manufacturing perspective.

We’re going to source these materials from four different sites in North America, so realigning in some of our assets at those sites, integrating significant number of new rail cars into the supply chain, getting all of those things completed in a short period of time has required significant resources across the organization, including resources from our sales and marketing organization.

So it has--we’ve appropriately prioritized that activity. .

And does the $0.65 of EPS improvement, does that include the impact of higher year-on-year incentive comp, or is that a headwind against the $0.65?.

No, that would be a headwind beyond that or outside of that, Mike..

Okay, thank you very much..

Thank you, Mike..

Ladies and gentlemen, to register for a question, please press the one followed by the four. Our next question comes from the line of Chris Kapsch with BB&T Capital Markets. Please proceed with your question..

Yes, good morning. I had some follow-up questions surrounding the Sun deal. Just want to try to understand a little bit more.

Just curious if prior to this transaction, were they 100% captive? In other words, is there any share shift involved with you now being effectively the sole source for these materials to Sun?.

We had previously supplied prior to midyear 2014. We had previously supplied some volume to them, a relatively small share versus what we’re picking up today. So effectively, there’s no share shift; it’s Sun rationalizing their facility and choosing to outsource it today..

Got you, and then just want to understand the consignment terminology.

Is this effectively--I mean, you’re effectively tolling their chemicals, toll manufacturing?.

Yes, typically in the sulfonation market in the laundry segment in particular, Stepan and others have toll manufactured, where the large consumer product companies would consign the primary raw material and Stepan would supply the minor raw materials and the sulfonation service. .

I see, okay.

And then just in terms of the effect, once this is sort of--this transition is complete, is the contribution, the margin contribution greater from the additional Sun business or the benefits associated with having your assets more fully utilized? Just order of magnitude, which is contributing more to the incremental margins?.

I’ll try to address that, Chris, again without giving too many specifics about a particular customer contract.

We know that we’re dealing with the commodity laundry piece of our surfactants business, which is the lower returning business within the consumer products surfactants, and it will improve that aspect both--I’ll say both from the deal and also from a volume leverage perspective of there’s a significant piece of business, as Quinn mentioned, going through our four existing sites in North America today.

So I’m going to say the answer is both, and I’m going to intentionally not specify which is greater than the other, but it’s probably pretty balanced overall..

Got you, okay. Then finally, as you’re going to be servicing this business out of your existing assets but you’re also purchasing select assets, just wondering what the idea is with redeploying those select assets, over what time, what geography might you be putting those to work. Thank you..

So, we have an option to acquire the site. We are looking at whether we can repurpose that site for some other use. We’ll look at that closely over the next 60 days, but beyond that, assuming we do not exercise that option, we’ll have a four-month period to remove any and all the equipment at that site.

It would be our intention to put most of that equipment in inventory or to repurpose it, for example storage tanks, at other Stepan sites in North America..

Okay, thank you..

We do have a follow-up question from the line of Mike Harrison with Global Hunter Securities. Please proceed with your question..

Just looking at the polymers segment here, you didn’t really mention raw materials as a tailwind there, but I know in the prior quarter we had some higher cost inventory that you were selling out of, particularly in the PA business.

So how much margin contribution did you get in this quarter from lower raws, and how much of it was really more sustainable performance from the rigid foam side and from the CASE side?.

Certainly from the phthalic anhydride business, we had high cost orthoxylene inventory coming into the year, which negatively impacted the first quarter.

We were able to work that through our system, as we communicated in our first quarter conference call that we would anticipate the phthalic anhydride business would perform better as the year progressed, and we did see that occur.

Relative to our polyol business, both our rigid business and our specialty business, our first half results did benefit from falling raw material prices. We are seeing some downward pressure on that business, on those margins as the year progresses, so we would anticipate the margins compressing a little bit in that area as the year progresses..

And then Scott, I was hoping maybe you could give us a little more color on the capital structure of the company following this recent bond issue, and maybe talk about the rationale for doing such a large issue so far ahead of some of your debt coming due..

It’s really, Mike, around I think a couple of points. We had the capacity to do it. We felt like the rate environment continued to be at historically low levels, and we have increased our demands in terms of our capital spending. We’re spending today on depreciation and amortization about $65 million a year.

Last year, we spent about $100 million, so we have a maintenance capital base in that 65 range, another 35 or so of growth capital that’s a more normalized sort of number, and then we add to that this year building the plant in China and expanding our capacity in Brazil, and then also in Poland for polymers.

So I think the combination of those three - we had the capacity to do it, and the factors aligned so that we were able to get favorable rates at historical levels as a second item, and our long-term capital requirements in terms of our capex, I think they are higher than historical levels.

So initially, that cash goes on our balance sheet and then we continue to spend it for those strategically important international areas for polymers and for surfactants..

All right..

Essentially organic growth..

Right, okay. The last question for me is on this specialty products segment here, where we’ve had three straight quarters here that appear to be well below where the margin had been tracking previously.

It sounds like a piece of the weakness in this quarter was related to timing, but then you also mentioned the outlook was for continued weakness in margins, so is there a point at which we get alarmed about this, and when should we think about maybe seeing margins improve? Do they drag through ’16, or should we see a better margin performance in ’16?.

So as we look at the specialty products business, timing of the pharmaceutical orders was an issue for us for the quarter. There was roughly $1 million impact, a little less than a million dollar impact in terms of timing of pharmaceutical orders that pushed those orders into Q3 versus Q2, so we’ll benefit from that in Q3.

But having said that, there is some fundamental demand problems for our nutriceutical product lines, the CLA in particular, where the demand is down in that marketplace today. So at this point, hesitant to say that we see an improvement in the forecast for demand for that product line.

Then if we look at our MCT product line, we’ve seen some pressure on margins in that space, so I don’t see a fundamental improvement in the short term in terms of ’15 or the first half of ’16 in terms of both the CLA and MCT product lines today. The historic flavor business and the pharmaceutical sales are relatively stable.

Timing issues in that area in those should--those are pretty solid businesses today..

And just to be clear, on the pharmaceutical timing, the $1 million impact, that’s a top line impact, not an operating income impact?.

That’s a bottom line impact..

Bottom line - okay. Thank you..

Mr. Beamer, there are no further questions at this time..

Okay, Quinn will go ahead and close the call..

Thank you all for joining us today. We appreciate your participating and we look forward to continuing to report positive performance to you in our third quarter conference call. Thank you and have a great day..

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. Have a great day..