Quinn Stepan Jr. - President & CEO Scott Beamer - VP & CFO.

David Stratton - Great Lakes Review Jacob Schowalter - Seaport Global Securities Curt Siegmeyer - Keybanc Capital Markets.

Ladies and gentlemen thank you for standing by and welcome to the first quarter 2017 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we'll conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, April 25, 2017.

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

Hello and thank you for joining Stepan Company's first quarter 2017 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 other factors outlined in our Securities and Exchange Commission filings.

Whether you're joining us online or over the phone, we encourage you to review the Investor Slide Presentation, which we have made available at www.stepan.com, under the Investor Relations section of our website.

We make these slides available at approximately the same time as when the earnings release is issued and we hope that you find the information and prospectus helpful. Now with that, I'd like to turn the call over to Quinn Stepan Jr., our Chairman, President and Chief Executive Officer..

Thank you, Scott. Good morning and thank you all for joining our call today. Following a record year in 2016, the company had a good start to 2017 by delivering record quarterly reported and adjusted net income results. Reported net income was $31.9 million, up 14% versus last year. Adjusted net income was $31.7 million, 7% higher than last year.

Adjusted net income as a percent of net sales was 6.8%. The strong quarter was driven by record Surfactant operating income, which benefited from structurally lower manufacturing costs related to previous actions taken to close the plants in Canada and Brazil.

Strong Surfactant results were partially offset by a slight decrease in polymer operating income, which was attributable to higher costs associated with the new production facility in China and raw materials. Global rigid polyol volume was up 13%.

Specialty products results were lower due to order timing differences within our pharmaceutical and flavor business. First quarter results benefited from a lower effective tax rate, which was partly attributable to tax benefits from stock-based compensation awards.

Our balance sheet remained strong as the company’s net debt to total capitalization ratio was 15% at quarter end despite seasonal cash deployment. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.205 per share payable on June 15, 2017.

At this point I'd like Scott to walk through a few more details about our first quarter results..

Thank you, Quinn. My comments will generally follow the slide presentation and I'd like to start on Slide 4, to recap the quarter. As Quinn stated, adjusted net income was $31.7 million and this was our highest ever earnings for any quarter.

Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP figures and these can be found in an appendix to the presentation and Table 2 of our press release.

Specifically regarding adjustments to reported net income, this quarter included deferred compensation income of $800,000 million or $0.03 per diluted share, compared to deferred compensation expense was $1.8 million or $0.08 per diluted share in the same period last year.

Naturally all employee compensation expenses are reflected in our normal operating income. However, we allow employees the opportunity to defer their incentive payouts until some future date and the future payment changes based on the company's share price. When the stock price declines, income is generated.

Because the future liability of employee compensation only changes consistently with changes in the stock price, we exclude this item from our operational discussion. The first quarter of 2017 results also included a business restructuring charge related to the closure of our Canadian plant.

This was related to decommissioning at the site, and was in line with the expectation we mentioned on last quarter’s call. We expect that an additional $900,000 of decommissioning expense in 2017.

Let's move to Slide 5, which shows the total company earnings bridge for the first quarter compared to last year's first quarter and breaks down the $1 million increase in adjusted net income. Because this is net income, the figures noted here are after the effective taxes.

We'll cover each segment in more detail, but surfactant was up, while polymers and specialty products were down versus the prior year. The all other category primarily represents lower environmental remediation costs as compared to the first quarter of 2016.

Our effective tax rate was 28% for the first quarter of 2017 compared to 31% in the first quarter last year. The decrease was attributable to tax benefits derived from stock-based compensation awards. In addition the first quarter of 2016 had an unfavorable tax settlement related to a foreign income tax audit that did not recur in 2017.

We continue to believe that our 2017 full year effective tax rate should be between 28% and 30%. Our discussion on Slide number 6 focuses solely on the results of the surfactant segment in the first quarter. Surfactant sales were $322.6 million, up 4% from the same quarter a year ago.

Prices were 12% higher due to pass through of higher raw material costs. Sales volumes were down 7% versus the prior year mainly due to lower North American and Europe [spend] consumer product and agricultural volumes. The negative translation impact of a stronger US dollar lowered sales by about 1%.

The segment delivered a record $31.2 million of operating income, a 3% increase over the first quarter of 2016. In the bridge, we show North America and Asia in the same category because our surfactant business in Asia is relatively small and much of the surfactant production in the region is used to support business in the US.

North America was positively impacted by lower manufacturing cost as a result of the Canadian plant shutdown, a decline in SG&A costs due to lower incentive-based compensation expenses, and continued strong performance in the segment’s niche Gypsum business.

This increase was partially offset by lower consumer product sales volume and a slow start to the agricultural season as compared to the same period last year. Latin America was down slightly due to lower consumer product sales volumes, which were partially offset by slightly accretive contributions from the Tebras and PBC acquisition.

Europe results were down due to lower consumer product demand and a slow start to the agricultural season in that region. Now turning to polymers on Slide 7, net sales were $126.6 million, up 11% from the same quarter a year ago.

A 4% increase in selling prices was related to higher raw material costs, volumes were up 8% in the quarter, primarily due to continued growth in polyols used in rigid firm installation and insulated panel, while the negative impact of foreign currency translation lowered sales by 1%.

Operating income was $21.4 million compared to $22.2 million in the same quarter last year. The decrease over prior year was primarily due to higher costs associated with the new production facility in China and higher raw material costs.

Global rigid polyol volumes were 13% higher than the prior year due to strong market demand from increased insulation standards and growth in construction. The operating income impact of the higher sales volumes was offset by increased raw material cost. Global specialty polyol volumes were up 21%.

Income was down slightly due to higher manufacturing costs in Poland and margin pressures from higher raw material costs. In China, the results were negatively impacted by higher plant operating costs, which were partially offset by higher export shipments.

Phthalic Anhydride results increased over prior year due to favorable production yields despite lower sales volume. Our balance sheet remained strong. Our net debt to total capitalization ratio has declined from 26% at the end of 2014 to 15% today.

Some deployment of cash in Q1 is typical, and we continue to expect our financial strength to enable growth going forward. Now Quinn will cover Slide 9 to address our path to further increasing shareholder value going forward..

Thank you, Scott. After a record first quarter, we remain optimistic about the balance of the year.

As previously explained, our path to increase shareholder value of three steps; improved asset utilization, support global polyol growth driven by energy conservation and diversify through innovation, new products, new end markets and geographic expansion. Our focused strategy should positively impact 2017 and position us well for the future.

Increased asset utilization is taking place across several product lines. The transfer of production from our Canadian site to our Millsdale site is complete and delivered $1.7 million of savings for the quarter.

Although reported results will be negatively impacted by an additional $900,000 of decommissioning expense in the remainder of 2017, we expect that these one-time cash costs will be more than offset by additional related savings of $4.6 million during the remainder of the year.

During the quarter, we consolidated Brazilian continuous sulfonation production into our Vespasiano plant, after shutting down the plant in Bahia. Although savings were minimal in the first quarter, we expect to save $1.6 million during the last three quarters of the year.

We will continue to examine our asset base for opportunities to further optimize and improve our production capacity, and more efficiently serve our customers around the world. Our capital expenditure plan is aligned with our strategy to support global polyol growth driven by energy conservation efforts in the United States and Europe.

Projects to enhance production at our Millsdale United States and Wessling Germany plants are underway. Rigid polyol volume was up 13% in the first quarter. Our new specialty polyol reactor in Poland, which began production in the third quarter of last year, is contributing and we anticipate it to grow.

A new specialty polyol reactor in Columbus Georgia should start later this year. Our strategic plan also supports product and end market diversification. We are committed to deliver volume growth within targeted geographic regions, case polyols, functional surfactants in Tier 2 and Tier 3 consumer product customers.

Functional surfactants are below expectations due to lower commodity crop prices. We are making inroads in our hydraulic fracing with new surfactant as the oil market slowly recovers. Our acquisition of Tebras and PBC is ahead of plan. Finally, our internal operation and efficiency program drive is an important component of our strategy.

To help support our long-term plan this process helps the company reduce cost, improve our raw materials margin and increase the capacity of our production units. We are targeting to deliver $15 million of pre-tax cash cost-out this year.

After a record first quarter, we remain optimistic about the balance of the year although we expect raw material costs to rise, which may pressure margin. Our path to increase shareholder value should advance in 2017. We believe earnings for the year should grow. This concludes our prepared remarks.

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

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

Good morning guys. Nice quarter. Thanks for taking the question..

Good morning David..

When we look at the China facility just to start out, can you kind of breakout the timeline at which you think that one, those costs are going to fall off and is it a combination of costs from the facility or is there some market aspect in there that you could kind of break out what is dragging results?.

I don’t believe the costs to fill the facility are going to decrease. We have volume or market opportunity to change that situation. The market is developing slower than we anticipated. So we anticipate a slightly greater loss in 2017 than we had in 2016 as a result of the higher depreciation expense that we are experiencing this year.

No significant recovery in 2017..

All right. And then, when we look at the agricultural markets, can you breakout how much of your surfactant business goes to the agricultural markets, and just kind of maybe update us on what you are seeing there and what is driving the downturn globally..

The piece I would point you to David about the agricultural piece is reportedly within our functional surfactants, which we have a pie chart and if you do the math on that you will see that the functional surfactants are between $200 million and $300 million in total as a company, and we have said that agriculture is the biggest piece of that.

So that will help dimensionalize the business for you. In terms of the outlook [Indiscernible]..

So, I would say generally speaking in North America and Europe the low crop prices have put a damper on market growth for 2017 at least in the first half of 2017. Our customers are anticipating a stronger back-end of the year and typically that would support the 2018 season to a great degree.

So, we are also seeing significant consolidation in that space as well. So as we look at the consolidation that is occurring in the marketplace, there are going to be opportunities and vulnerabilities for that matter for suppliers on either side of those transactions. So we still feel very good about our agricultural business.

We are excited about the R&D investments that we have made in that space over the last five years, and many new products in which our surfactant is helping provide significant benefits to the active that is going to be delivered in the marketplace.

We will be rolling out in the marketplace over the next 18 to 24 months and we are going to be a big part of some of the new introductions..

Great. Thank you. I will get back in the queue..

Thanks David..

[Operator Instructions] Our next question comes from the line of Jacob Schowalter, Seaport Global Securities. Please proceed with your question..

Good morning. I am asking the question for Mike today..

Hi Jacob..

Hello.

In polymers, you guys posted 8% volume growth against one of the hardest comps of the year, do you expect that increase to increase as the year goes on or can you comment on the growth outlook from there?.

I'm not going to comment specifically on the growth projections. We do anticipate volume to continue to grow for the balance of the year. As we mentioned, we do believe that there is going to be some margin pressure, continuing margin pressure in that space in the second quarter.

We are optimistic that we will be able to make some progress on our margin in the second half of the year..

Okay, and then in the surfactants business, the volume declined 7%, could you breakout how that – what that looked like in the different geographies like North America, Europe and Latin America, and then any sense on when it might stabilize in those geographies.

It seems like with the manufacturing rationalization you guys could see a lot of operating leverage once that recovers, so any color on that would be great?.

Yes, I would say the volume decline was mostly associated with our commodity consumer products business split relatively evenly between North America and Europe, and also our Latin business was down slightly in terms of commodity tier 1 consumer product volume.

We are forecasting that that volume will stabilize in the second half of the year and would grow relative to last year's performance in the second half slightly..

And then on the pricing side in surfactants, can you talk about the traction you are getting there in kind of the softer volume growth environment in the first half of the year, and then where you see pricing going?.

Pricing relatively stable for the year. In terms of overall perspective, I would say our commodity margins were down in the first half. So we anticipate some improvement in commodity [Indiscernible] margins in the second half of the year, but net-net the falling commodity margins will be offset by improved product mix.

So we are anticipating our margins overall to be relatively flat..

Okay. Thank you guys for answering my questions..

Thank you Jacob..

[Operator Instructions] Our next question is a follow-up question from the line of David Stratton with Great Lakes Review. Please proceed with your question..

Thanks for the follow-up.

I was wondering if you could – you highlighted new surfactants in the oil fracing realm, I was just wondering if you could breakout what you are seeing there and if there is anything that is fundamentally changing that might be attractive or positive for the future?.

We have established a new laboratory for oil field surfactants down in Houston. So in the market we are working very closely with our customers, and we are slightly modifying traditional surfactants to provide performance benefits at the direction of our customers.

So for the most part it is not new breakthrough technology, but modification of existing chassis if you will that we have production capabilities for within our surfactant network..

All right, and then I guess lastly, when you look at your raw material inputs, you have given us color on where you saw those going previously.

Has there been changes that you see throughout the remainder of the year that in any direction of raw material inputs?.

We have certainly seen the petroleum derivatives continue to kind of have some upward price pressure. We are beginning to see some downward pressure on some natural based palm oil or coconut based feed stocks recently. So we are encouraged by the downward movement in naturals at this point..

[Operator Instruction] Our next question comes from the line of Curt Siegmeyer with Keybanc Capital Markets. Please proceed with your question..

Just a follow-up on the raw material impact.

How should we think about sort of the cadence of the impact over the rest of the years? Is this something that the majority will follow in Q2 or should we expect some of that pressure to kind of push this in the second half?.

From a petroleum-based I believe that we would anticipate some upward pressure throughout the balance of the year, from a natural base we believe that we are going to see relief -- meaningful relief in the second half of the year..

I would just add to that Curt, in the polyol’s business 90% of our raw materials are petroleum-based in our polyol global polymers segment. So that's the segment that has experienced some significant increases in the quarter. We announced the price increase in Q1 that has not been supported yet in the marketplace.

We are more optimistic as the year goes on with the ability of us to be able to catch some price in the market consistent with the significant raw material pressures that we are facing there..

Got you.

And then could you just update us on your capital deployment priorities?.

Yes, I think that as, we will continue I mean, in terms of our capital priorities for 2017 number one priority is to continue to support the polymer growth both in the United States and Europe specifically for our rigid polyol insulation business.

We also have plant expansion that we completed in Poland for specialties and that we are – should complete startup kind of the second half of the year in terms of our Columbus Storage Facility. So those are the larger key investments that we are making to grow our business and our capital priorities for 2017.

From the Surfactant’s perspective we are adding additional multi-purpose reactor capabilities in Brazil to support our agricultural business and potentially fabric softeners done in that marketplace.

And then we will continue to look at investments to help us optimize our overall production capabilities across our network and hopefully be able to take some additional cost out of the network..

Yes. Thank you Quinn, good summary in terms of primarily CapEx and for broaden that just a bit that's where your interest lies, we talked about CapEx being expected to be between $100 million and $120 million for the full year.

We continue to expect to pay dividends that's been in the range of about $17 million and our dividends per share and how many shares we have outstanding. And from our debt perspective we will pay down debt as it comes according to the schedule and not prior to that.

So hopefully all of that together gives you a fair picture of what we expect overall cash and then specifically the cash deployment priorities to be for us this year..

Great. Thank you..

Our next question comes from the line of Mike Simpson with [Keybanc]. Please proceed with your question..

Hey guys nice start to the year. I wanted to revisit the polymers a little bit given the volume growth there was impressive.

If you can continue to generate the volume growth in the remaining quarters what type of earnings should follow through if you are successful with the pricing increases for the full year?.

We don't give specific projections for the company nor for the individual business units. But I would say that volume growth was mostly offset by margin compression in the first quarter of the year. So we need for – we need to be able to improve our margins to demonstrate growth for the year..

Right.

So if you think about 200 or so basis points squeeze in Q1 we should expect that's the delta to make up and then what type of incremental leverage or contribution margin would you get on volume growth you think once you catch up on that margin squeeze?.

Well, we understand the question. And we have said Mike a couple of frames here last year we had I think it was seven straight years of record earnings for the polymers business. And so far we haven't – we did not grow earnings in the first quarter..

Right. So I mean the – go ahead I am sorry..

I would just, I guess I would add to that that there is a dynamic in the marketplace which we have found challenging at this point in terms of our pricing and what has been supported in the marketplace.

So that's a bit of a again as Quinn mentioned we are more optimistic as the year goes on but it's really difficult to determine right now the level of earnings that that would come from that we could feel adding to the earnings in terms of our volume..

And just to make a comment in 2016 we had peak margin levels associated with that business. So we are not sure that we are going to be able to fully return that back to that level..

Got it..

So we are I mean we are working hard on our cost and also on opportunities in the market to improve our margins but it's – it remains a target for us to do that but it could be difficult..

Right.

Okay and then I mean if you think about that business it's generic volume growth you have got very good margins there, balance sheet is in good shape, other acquisitions that you can maybe continue to add on to this segment and can further grow it given how well it's done the last couple of years?.

As we said and as you noticed we have a very healthy balance sheet and we would like to be able to use that ability to leverage that balance sheet to make acquisitions to accelerate our growth in the areas that we targeted which includes rigid polyol, case polyol, functional Surfactants, and Tier 2 and Tier 3 consumer product account.

So we’re under leverage. We use that capacity to make both on acquisitions accelerate our growth in those areas..

Great. Thank you..

And we are showing no further questions at this time..

Okay. Thank you very much for joining us on today's call. We appreciate your attendance and we appreciate your ownership in Stepan Company. We look forward to reporting continue positive performance to you on our second quarter call. Have a great day..

Ladies and gentlemen this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines..