Ladies and gentlemen, thank you for standing by and welcome to the fourth quarter and full-year 2018 earnings call. [Operator Instructions] As a reminder, this conference is being recorded today, Thursday, February 21, 2019. I would now like to turn the conference over to Mr. Luis Rojo, Vice President and Chief Financial Officer. Please go ahead, sir..

Good morning, and thank you for joining Stepan Company's fourth quarter and full-year 2018 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 when the earnings release is issued, and we hope that you find the information and perspectives helpful. Now with that, I would like to turn the call over to Quinn Stepan Jr., our Chairman, President and Chief Executive Officer..

Thank you, Luis. Good morning and thank you all for joining us today. The Company had a good year in 201, with higher sales volumes, $2 billion in net sales, reported net income over $100 million for the first time, strong cash flows and no net debt at year-end.

Specifically, we recorded record reported and adjusted net income for 2018, which were driven by record Surfactant earnings and a lower 2018 effective tax rate. We now have had a record income for eight of the last 11 years. Reported net income in 2018 was $112.8 million, up 23% versus last year.

Adjusted net income was $113.8 million, 5% higher than 2017. Adjusted net income as a percent of net sales was 5.7%, an increase of 10 basis points versus 2017.

The quarterly and annual Surfactant growth reflects higher sales volume, the accretive impact of our 2018 Mexico acquisition, improved North American product mix and manufacturing optimization.

The Polymer business was down versus the prior year due to continued margin challenges in North America and the loss share for polyiso boards, the product that our customers sell into the European insulation market. The European insulation market is still growing due to energy conservation efforts.

Our Specialty Product business results improved both for the quarter and the full year. The Company increased its quarterly cash dividend in the fourth quarter 2018 by $0.025 per share or 11%, marking the 51st consecutive year that the Company has increased its cash dividend to shareholders.

At this point, I would like Luis to walk through a few more details about our fourth quarter and full-year results..

Thank you, Quinn. My comments will generally follow the slide presentation. Let us start with a Slide 5 to recap the quarter. Adjusted net income for the fourth quarter of 2018 was $23.7 million or $1.02 per diluted share, a 4% decrease versus $24.6 million or $1.06 per diluted share in the fourth quarter of 2017.

Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP measures, and these can be found in Appendix 2 of the presentation and Table 2 of the press release. Specifically, adjustments to reported net income this quarter consist of adjustment for deferred compensation income and restructuring expenses.

Adjusted net income for the quarter, excluding deferred compensation income of $3.4 million or $0.15 diluted share compared to deferred compensation income of $1 million or $0.04 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 change is based on the Company's stock price.

When the stock price decreases, the income is generated as we mark this item to market value. Because the future liability of employee compensation only changes consistently with the change in stock price, we exclude this item from our operational discussion.

The current quarter adjusted net income also excluded $200,000 or $0.01 per diluted share of after-tax business restructuring charges related to our Canadian plant closure in 2017. We expect an additional $1 million to $2 million of after-tax decommissioning expenses at our Canadian and German plants in 2019.

The Slide 6 shows the total Company earnings 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 noted here are on an after-tax basis.

We will cover each segment in more detail, but to summarize, Surfactants and Specialty Products were up while Polymer was down versus the prior year. Corporate expenses were lower during the quarter due to a one-time legal costs in 2017. The Company's effective tax rate was 19.4% for the full year 2018 versus 34.3% for the full year of 2017.

The decrease was mainly due to a lower U.S. statutory tax rate of 21% in 2018 versus 35% in 2017, and certain one-time discrete tax projects that favorable impacted 2018. We expect the full year 2019 effective tax rate to be in the range of 22% to 25%. Slide 7 focused on Surfactants segment results for the quarter.

Surfactant net sales were $323 million, basically flat from the same quarter a year ago. Volume increased 2% while average selling prices were flat. Foreign exchange translation had an unfavorable impact of 2 points.

The segment operating income increased $3.1 million or 11% versus the prior year, driven by improved operating margins of 100 basis points.

In the bridge, we showed North America and Asia in the same category, because our Surfactant business in Asia is relatively small and most of the surfactant production in that region is used to support business in United States.

North America increase was primarily driven by sales growth in our distribution channel and improved operating margins due to positive price mix and manufacturing cost savings. Latin America results were up, primarily due to increased demand in Brazil and a strong sales volume related to the first quarter acquisition in Mexico.

The acquisition was accretive for the quarter and for the year. First quarter 2019 results for Latin America should be negatively impacted by a sulfonation equipment failure that occurred at our Ecatepec Mexico plant in January of 2019. However, we still expect to deliver on our business case for 2019, albeit at the low end of our range at $4 million.

We're working diligently to fix the issue. European results were down primarily due to the favorable resolution of a product claim in the fourth quarter of 2017. Lower European volume also unfavorably impacted results. Now turning to Polymers on Slide 8; net sales for the quarter were $123 million, down 6% from the prior year period.

Total sales volume decreased 4%, principally due to lower European rigid polyol volume. The translation in back of a stronger U.S. dollar negatively impacted net sales by 2% while selling prices were flat quarter-over-quarter. Operating income was $10.8 million for the quarter versus $19.1 million in the same quarter last year.

Operating income was down mostly due to lower volume, margin pressures and higher costs associated with the scheduled PA maintenance shutdown. Global polyol volume decreased 4% with global rigid polyol volumes down 3% driven by Europe, where volume decreased due to a lingering effect of the 2017 MDI shortage.

As anticipated global rigid polyol volume in the second half of 2018 increased 1% versus the second half of 2017, driven by a 6% increase in North American rigid polyol volume. We believe the global market for insulation material remains strong due to continued energy conservation efforts.

PA operating income decreased due to a scheduled maintenance shutdown. Specialty Product operating income increased $2.9 million versus the prior year, primarily due to anticipated favorable order timing differences with our pharmaceutical business and higher volume and margins in our food business.

We will now take a moment on Slide 9 to recap the full-year 2018 financial performance. Adjusted net income was again at record of $113.8 million or $4.88 per diluted share, a 5% increase from $108.7 million or $4.65 per diluted share in 2017. Surfactant operating income was a record $137.5 million, up 14% from 2017.

The increase was due to net sales growth of 7% and operating income margin expansion of 60 basis points. The increase in net sales was driven by a strong demand in North America and the first quarter 2018 acquisition in Ecatepec in Mexico. The Polymer segment delivered $64.5 million of operating, a 22% decrease versus prior year.

The decrease versus last year was primarily due to margin challenges in North America and lower European volumes. Specialty Product operating income was $11.7 million, a 17% increase versus the prior year due to strong volume and productivity in our flavor and pharmaceutical business. Specialty operating income margins improved from 12.3% to 14.5%.

Slide 10 shows the total Company's earnings bridge for the full year 2018 compared to 2017. Like the quarterly bridge, the figures here are noted on an after-tax basis. Turning to Slide 11, our balance sheet remains strong, as we had no debt at year-end. We have returned $36 million to our shareholders via dividends and share repurchases.

In 2018, we also increased our cash dividend for the 51st consecutive year, placing us in a very select group of companies. Beginning on Slide 14, Quinn will now update you on our plans to increase shareholder value..

Thank you, Luis. After record results in each of the past three years, we believe our Surfactant business will continue to benefit from our diversification efforts into functional products, new technologies, improved internal efficiencies and expanded sales into our broad customer base globally.

We believe our Polymer business will benefit from the growing market for insulation materials and we are optimistic that our Polymer business will deliver both full year volume growth and incremental margin improvement versus 2018. We expect that Specialty Product operating income should also improve in 2019.

We expect to increase our capital expenditure levels in 2019 to fund projects to support growth, innovation and sustainability. While we delivered another record year in 2018, we also made progress delivering on our long-term strategic priorities and are well positioned to continue the momentum in 2019.

We will continue to maximize shareholder value by focusing on our strategic priorities, innovation, market diversification customer intimacy, operational excellence and M&A. Our core values, which are engrained throughout the organization, serve as the foundation for the Company's execution of this strategy.

Market diversification continues to be a key component of our strategy. More specifically within Surfactants, greater penetration into the agricultural, oilfield and personal care specialty end markets provides an opportunity to improve returns from our current asset base.

Stepan currently has relatively low market share in these large markets, which are growing at rates above GDP. First, we believe our efforts in the agricultural market will lead to participation in several of our customers' new product launches.

With regards to oilfield, our portfolio of chemistries including biocides and farmers are well suited for use in the production of oil and, in fact, grew 25% last year, albeit from a small base by providing cost-effective solutions to our customers.

In the Personal Care specialty market, our efforts remain focused on delivering higher-performing, environmentally friendly solutions to our customer base. Opportunities to expand our presence in specialty alkoxylates across all end markets are being aggressively pursued with new technical resources.

Next, customer intimacy continues to be a key priority as we seek to maintain our market leadership position and several of our businesses. Growth within Tier 2 and Tier 3 customer base continues to be a priority for our Surfactant group. Our sales to these customers grew 5% in 2018.

Our knowledge and expertise in applications within the consumer product industry enables us to help smaller companies develop products so they can compete and win in their local markets. Our objective is to reach, divide, and acquire more new customers, local heroes around the world.

In order to reach these customers effectively, we have added sales and product development resources, as well as enhanced our digital strategy to touch this fragmented customer base more frequently. Innovation is also a key aspect of our strategy.

As a leader in the rigid polyester polyol market, we continue to work on developing the next-generation value-added technologies for our customer base, and are excited about the advances in our research pipeline.

Despite the recent headwinds in our rigid polyol business, we remain optimistic about the continued growth of the market due to increased insulation standards, energy conservation efforts and growth in construction globally.

Within our Surfactant segment, we continue to innovate to create more environmentally friendly green solvents and surfactant chemistries for our customers. Our launch of a new environmentally advantaged solvent for the Personal Care end market allows customers to replace more expensive solubilizers while maintaining foam and viscosity performance.

This technology enables customers to reduce formula cost for liquid cleansing products such as shampoos, body washes and hand soaps. Finally within the oilfield market, the stimulation segment including hydraulic fracking is projected to grow between 5% to 10% per year over the next five years. U.S.

oil producers have successfully reduced the cost of hydraulic fracking. New chemistries can help reduce production costs further. Stepan has developed patent pending technology for use in fracking, including flowback modifiers and friction reducers boosters that offer significant costs advantages.

Use of biocides is growing in the fracturing market due to regulations that restrict the use of freshwater, which should provide opportunities for our biocidal [indiscernible] products.

Although we saw reduced demand due to lower oil prices during the fourth quarter of 2018, we remain confident that the oilfield market will still be an area of growth for our Surfactant business in 2019. Next, our focus on operational excellence is an integral part of our strategy.

We continue to actively pursue opportunities to reduce excess capacity in our networks. The restructure of our Fieldsboro, New Jersey plant in 2017 contributed $2 million of savings in 2018.

During the fourth quarter of 2018, we executed a plan to seize surfactant production at our German plant to further reduce our fixed cost refocus resources on higher margin surfactant markets and repurpose assets to support future polyol growth.

We also believe that the application of sulfonation best practices, network synergies and drive cost saving opportunities will create further value in 2019 from our Ecatepec acquisition.

We continue to examine our asset base for opportunities to further optimize, improve the capacity utilization and more efficiently serve our customers around the world. Finally, M&A represents an important tool as a means to deliver EPS growth.

Although multiples in the marketplace for chemical acquisitions have been relatively high over the last few years, we have seen multiples drop recently. Given the strength of our balance sheet, we plan to continue to prudently utilize M&A to fill gaps in our product portfolio and to add new platform chemistries.

In 2018, we strengthened our position as the largest producer of anionic and amphoteric surfactants in the merchant market in the western hemisphere with the Ecatepec surfactant plant acquisition.

The acquisition was accretive in 2018 and should contribute at the lower end of our previously disclosed $4 million to $6 million operating income range in 2019 given the production issues that we discussed.

Our core values, customer focus, people first, continuous improvement, integrity, growth and innovation and sustainability describe how we will accomplish our plan. The market provides challenges and opportunities we feel we are positioned well to capture opportunities for you, our shareholders.

This concludes our prepared remarks at this at this time. We'd like to turn the call over for questions. [Leiva] please review the instructions for the question portion of today's call..

[Operator Instructions] Our first question comes from the line of Mike Harrison with Seaport Global Securities. Please go ahead..

Quinn, I was wondering if you could comment a little bit on what you're seeing in terms of the competitive environment in Polymers.

Obviously, you pointed to the flat pricing, but wondering if some of the price competition has slowed down or if you still are seeing a pretty intense environment there?.

Yes, I think it - the short answer is, it's probably slowed down a bit. I think the lower margins available to us in the marketplace have decreased the amount of price competition in this space today currently..

And can you maybe comment a little bit on what you're seeing just overall in terms of construction trends as it relates to the Polymers business? We've heard from several players that the Europe in particular was slowing during the fourth quarter.

Have you seen any improvement as we're starting to hopefully head toward a better spring season?.

Mike, I would say we saw an improvement in January in Europe specifically; a little bit of improvement and February, but I would say, it's a little bit early to state that the market has recovered fully at this point.

So we're encouraged by what we've seen in the first month and a half of the year, but I think we need to see that sustain itself before coming to any conclusions about that..

And then you referenced the plant in Mexico in the surfactants business. Wondering if you can talk about the integration process there.

Have you completed the efficiency improvements that you aim for? Have you - it's fully integrated it into your network and maybe just give a little bit more detail about the production issues that you saw in Q1?.

So our sulfonation unit at that facility is currently shut down and will be shut down for the balance of the first quarter and probably for a month into the second quarter. So we had an equipment failure that we are working to address and so that has probably delayed the full integration process that we had anticipated to occur by a quarter.

So our plan is to rationalize sulfonation in our historic Mexican facility in Matamoros and move those customers and move that volume into the Ecatepec facility. We believe there are meaningful synergies available to us as we complete that.

So that probably won't occur until the end of the second quarter at this point, so that's probably three months delayed from what our initial plan would be. But we are - I have been very encouraged by the market response to Stepan acquiring that facility.

Our business prior to the shutdown had grown by about 30% down in Mexico, so we believe we're on a good path down in Mexico and albeit that will be at the lower end of our range that we've communicated because of the production outage. We are very excited and enthusiastic about our ownership of that facility..

And then last question for now and then I'll turn it back, is just on the raw material environment that you're seeing. I am wondering if you can talk about both polymers and surfactants.

Were raw materials versus pricing a drag on operating margin in either segment during Q4? And can you maybe comment on the outlook for raw material versus pricing as we look out into 2019?.

Yes. I would say, it was a tailwind in our Surfactants business with falling oleochemical prices throughout 2018. So I think that enabled us to slightly improve our margins through the year. We're looking at a relatively stable oleochemical environment for the most part in 2019 - the start of 2019.

We are seeing some benefit or we'll see some benefit in our Specialty Products business, relatively small in the big picture, but that should benefit that business in Q1 and then going into Q2. So from a petroleum based perspective, we've seen some declining prices on diethylene glycol, which is a key raw material for our Polymer business.

We will work through some higher priced inventory for the first two months of Q1 and then we should see some benefit the tail end of Q1, but really more in Q2 due to falling specifically diethylene glycol prices in our Polymer business in the United States and a little bit also in Europe.

So we talk about incremental margin improvement in the Polymer business; we do believe it will come mostly from the decrease in diethylene glycol..

All right. Thanks very much..

Other petroleum products that we buy are bumping up and down within a relatively narrow range today, so that does not appear to be a significant headwind or tailwind at this point..

Our next question is from the line of Jason Rodgers with Great Lakes Review. Please go ahead..

You talked about optimism that volumes could grow in the Polymer business in 2019.

I am wondering if you could just kind of frame that for us what are the factors that are positive that you see out there in that segment?.

So, last year, we talked about some lost share in the market. We have regained that share in the marketplace. So that's one aspect that we can point to in terms of increased volume 2019 versus 2018. The second issue relates more to our European business.

We believe that our customers are starting to regain some of the polyiso board or share that the polyiso board, which is one of several different competing technologies, phenolic boards, rock-wool, extruded polystyrene. So because of the MDI shortage in 2017, polyiso boards lost share in 2018.

And we've seen some signs that we are regaining that share in 2019. So those were the two things that we would point to that will give us optimism that our volumes are going to grow in that space. And then the third issue would be just the market growth itself.

We do believe that the market for insulation and that's due to the energy conservation efforts and government standards continue to evolve on a global basis will continue to benefit and encourage additional growth in this space..

And then, would you mind giving some more detail around that lost European insulation market share, what happened there?.

In 2017, MDI, which is the product that - which is mixed with our aromatic polyester polyol, you make - you put those two together to make polyiso board. In 2017, that product was very expensive and hard to get and there was a shortage in the marketplace.

So as a result of that architects who are specking projects in 2017 use alternative forms of insulation in 2018. Currently, the price of MDI is very low and currently there are no shortages, it is widely available in Europe.

And as a result of that, because of the historic advantages that polyiso technology contributes versus the other products, we are beginning - we've been told by our customers, they are beginning to recapture the share with the polyiso board..

And then finally, how large of an opportunity can that new solvent be in the Personal Care market? And anything else of significance on the new product front we should be aware of for this year?.

So, we're working with our - both our Tier 1 customer base and kind of our smaller local heroes, if you will, introducing the new technology.

We are in the developmental phase with the number of customers on a global basis and what I would tell you is that at this point, we are encouraged by the feedback that we're getting and that would be a meaningful contributor to our business going forward. And we'll provide updates as we start to convert customers.

We're just starting to sell some customers today relatively small volumes.

In addition to that, we've got a new technology that we just introduced in this past - this first quarter, new technology for a hair conditioner, which is what we believe is and as it better environmental profile, but also as significant performance advantages for our customers and their markets. So we'll see how that goes.

But those are the two big Personal Care technologies that we've offered today..

The next question is from the line of Vincent Anderson with Stifel. Please go ahead..

Could you walk us through the step up in capital expenditures for 2019.

How much of that you would expect to have sort of an immediate return associated with it versus more maintenance related or environmental and safety-related investments?.

Yes.

The short answer is, there's probably 50% of it, which is probably not immediate return related, that's maintenance capital and I would say, more sustainability capital, where we're reducing some co-products, reducing that are - some people's mind classified as hazardous, reducing some water consumption within our Company, reducing some of our emissions.

And so those I would refer to as sustainability initiatives and then there's just kind of maintenance capital on a regular basis. But we are going to be spending significant money to enhance the capabilities of our polymer products, getting prepared to sell the next-generation polyol technology.

So that is in the significant expenditure in 2019 that will carry over into 2020 as well. So there is a fair amount of capital dollars associated with that. And then we will be enhancing the capabilities of some of our Specialty Products, amine oxides or biocidal [indiscernible] to sell to higher margins to our functional product base.

We'll be enhancing capabilities for those specialty products as well..

On the M&A side, are you still building your acquisition pipeline or do you have a pretty good idea of what your targets are at this point, and it's just a matter of pricing and execution? And when you talk about platform chemistries, in your slide deck in your prepared remarks, are you referring to specifically surfactants chemistries or are you talking about potentially new verticals altogether that maybe complement Surfactants or Polymers?.

New platform chemistries, it could be chemistries or technologies that are sold to the same customer base that we sell to within our Surfactant --primarily in that case to more for our Surfactant customers than our Polymer customers. So we've identified some chemistries that we would like to add to our portfolio.

And I would say in the case of new platform chemistries, we are relatively early on, we've identified some targets, but we are not anywhere near deal execution stage at this point.

We have identified a couple other smaller bolt-on acquisitions which were in various stages of communication with - that are more, I would - I don't want say, just opportunistic, but there more complementary to an existing businesses that we have..

And then last one from me, I wanted to go back to the agricultural products.

You seemed to think you have a pretty strong chance of being spec into the new crop chemicals, based on your understanding of those product development cycles, roughly when would you expect both step in to have confirmation in the public to know about your success there?.

We believe we will be in new customer launches numerous that will be occurring over - that are occurring now and will continue to occur over the next 36 months. Based - and those will be the dates which our customers will launch products that - where the R&D work has previously been done..

[Operator Instructions] And our next question is from the line of Curt Siegmeyer with KeyBanc Capital Markets. Please go ahead..

I'm good. Just a couple of questions on Polymers. I know you talked about the raw material benefit that you expect starting in 2Q as to why you're optimistic on the margin front and some of the volume increases that you would expect as well, but if you kind of think back to 2017.

Would you be able to just kind of walk us through what would need to happen to get earnings back to that level in terms of your op income for that segment?.

We do not anticipate that happening in 2019 at this point. So I don't see that as the likely outcome at this point, so..

Just on a longer-term context, so is that something you can sort of walk through just what would have to happen?.

Yes. So in order for that to happen, we're going to have to grow the business from a volume perspective and continue to de-bottleneck and our plans to make those new volumes available from existing assets rather than new assets, and so there will be lower manufacturing costs.

So, I believe the most likely scenario for us to actually get back there will be to grow the volume and reduce our manufacturing cost correspondingly.

There could be some help from a margin perspective, but - and will continue to try to increase margin in this space, but in the current competitive environment, I don't see the margins going up that back to where they were in 2016..

Could you give a little more color on the MDI impact on European volumes just one - I know you talked about some of that seemingly turning but just when you expect that to no longer be a volume headwind?.

Well, I mean, we believe our volume will grow in Europe in 2019, and we've seen growth in the first quarter to date - in the first six weeks of the year, we've seen volume growth in Europe. So, we're seeing growth currently, so..

We have a follow-up question from the line of Mike Harrison with Seaport Global Securities. Please proceed sir..

One is on the phthalic anhydride business, I understand you had the maintenance shutdown in Q4. Just wondering if you can discuss kind of how the underlying business looked.

It looks like operating income might have actually been higher year-on-year if we exclude the impact of the outage, kind of what's your forecast for the underlying performance of that business?.

No significant change as anticipated at this point in time. I think if you look at from a historical perspective, our volumes are relatively stable, in terms of what we sell to the merchant market. Our customer mix has evolved and changed over the last three or four years.

The margins from that business are less than what they were from an historical perspective.

They're going to be some challenges just from a production standpoint this year, not only from - for ourselves, but from our primary competitor, because there is going to be some work on the Mississippi River coming up to the Chicago, parts of it are going to be shut down in 2019 and 2020, that will - we'll have some additional costs associated with the business.

So we'll try to recover that in the marketplace, but should - no significant changes anticipated in the PA business..

And then, you mentioned some additional sales and some digital marketing efforts related to accessing Tier 2 and Tier 3 customers in Surfactants.

Can you maybe help us frame up that investment and talk about how you're expecting to get returns from those investments?.

So in the past, we've talked about reaching the smaller customer base via video conferencing and connecting our laboratories in Brazil and soon to be in Mexico, and doing virtual real-time formulation with our small customer base.

But we're using salesforce.com to try to help us coordinate our activities at our smart - or at our customer base, globally, but just to give you an indication, in 2018, we added 418 new surfactant customers on a global basis.

Now, those customers are very small, some of them are served on a direct basis, some of them are served through our distribution partners, but we have great visibility to those customers, big or small on a global basis today.

And so, now that you have a new customer, then the opportunity is to sell them not one product, but two products, not two products but four or five products and so we do believe we're going to be adding strong number of customers on a global basis and we do believe that over a period of time, we will expand a portfolio of products that we sell to the customers, that volume in that space grew 5% last year and we believe that's just the tip of the iceberg..

And Mr. Rojo, there are no further questions at this time. So, I will now turn the call back to you, sir..

Thank you very much for joining us on today's call. We appreciate your interest and ownership in Stepan Company. We look forward to reporting to you on our first quarter 2019 call. Have a great day..

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