Greetings and welcome to the Stepan Company Second Quarter 2022 Results Call. Today's call is being recorded on Wednesday, July 27, 2022. I would now like to turn the conference over to Luis Rojo, Vice President and Chief Financial Officer. Please go ahead, sir.

Good morning, and thank you for joining Stepan Company's Second Quarter 2022 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 Investors section of our website. We made these slides available at approximately the same time as the earnings release is issued. And we hope that you find the information and perspective helpful. With that, I would like to turn the call over to Mr. Scott Behrens, our President and Chief Executive Officer.

Thank you, Luis, and good morning. Thank you all for joining us today to discuss our second quarter results. To begin, I will share our second quarter highlights and strategy outlook, and Luis will provide additional details on our financial results for the quarter. The second quarter continued to be a challenging operating environment given continued raw material and transportation constraints, cost inflation, and global macroeconomic uncertainties. Nonetheless, I am proud of how our team has continued to overcome these challenges by delivering record results for the second quarter. Reported net income reached a record of $52.1 million or $2.26 per diluted share, while adjusted net income was a record $53 million or $2.30 per diluted share. Surfactant operating income was $48.2 million compared to $45.9 million in the prior year quarter. Growth was mainly driven by a better product and customer mix, but was partially offset by a 3% decline in global sales volume related to commodity laundry. Lower commodity laundry volumes were the result of continued raw material supply constraints in North America, and lower overall demand in Latin America. The sales volume decline was driven by laundry products within the Consumer Products business, partially offset by very strong functional products volume growth. Our Polymer segment reached a record operating income of $33.9 million compared to $23 million in the prior year, which represents a 47% increase. Margin recovery, improved mix, and a 2% increase in global volume were responsible for the record quarter. Our Specialty Products segment also had a record quarter, growing operating income by 41%, driven by improved margins within the MCT product line. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.335 per share, payable on September 15, 2022. During the second quarter of 2022, the company paid $7.5 million of dividends to shareholders and repurchased $7 million of company stock. For the first half of 2022, the company paid $15 million in dividends and repurchased $17 million of company stock. Stepan's has increased its dividend for 54 consecutive years. The company still has $133 million remaining under our share repurchase program authorized. Looking forward, we believe the operational environment will remain challenging. However, we are confident that we can deliver a good year as demand for our products remains healthy. At this point, I would like Luis to walk through a few more details about our second quarter results.

Thank you, Scott. My comments will generally follow the slide presentation. Let's start with Slide 4 to recap the quarter. Adjusted net income for the second quarter of 2022 was a record $53 million, or $2.30 per diluted share versus $42.2 million or $1.81 per diluted share for the second quarter of 2021. Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP measures, and this can be found in Appendix 2 of the presentation and Table 2 of the press release. Specifically, adjusted net income for the second quarter excludes deferred compensation expense of $0.6 million compared to last year's income of $1.1 million. It also excludes minor changes in our environmental reserves and restructuring costs. The deferred compensation figures represent the net income related to the company's deferred compensation plan as well as cash-settled stock appreciation for our employees. Because these liabilities change with the movement in the stock price, we exclude this item from operational discussion. Slide 5 shows the total company's net income bridge for the second quarter compared to the second quarter last year and breaks down the increase in adjusted net income. Because this is net income, the figure is not prepared on an after-tax basis. We will cover this segment in more detail, but to summarize, we delivered excellent income growth in all our segments. Corporate and all other expenses, which are not allocated to the business segments were lower during the quarter, mainly due to lower acquisition-related expenses. The company's effective tax rate was 25% in the second quarter, which was similar to last year. We continue to expect the full year 2022 effective tax rate to be in the range of 24% to 26%. Slide 6 focuses on Surfactant segment results for the quarter. Surfactant net sales were $485 million, a 26% increase versus the prior year. Selling prices increased 32% primarily due to the pass-through of higher raw material and logistics costs and improved product and customer mix. Volume decreased 3% due to supply chain constraints, mainly raw material availability issues and lower commodity laundry demand in Latin America. This was partially offset by higher global demand in Functional Products, Personal Care, and Institutional Cleaning end markets. Foreign currency translation negatively impacted net sales by 3%. Surfactant operating income for the quarter was $48.2 million, which represents a 5% growth versus prior year. This increase was driven by improved product and customer mix, mostly in North America and Europe. Latin America was down due to lower volumes in commodity laundry products. Now turning to Polymers on Slide 7. Net sales were $239 million, up 25% from the same quarter last year. Selling prices increased 30% due to the pass-through of higher raw material and logistics costs and recovering our margins. Volume increased 2%, driven by a 5% growth in Global Rigid Polyol, which was partially offset by lower demand in PA and lower volumes in the specialty Polyol business due to supply chain challenges. Foreign currency translation negatively impacted net sales by 7%. Polymer delivered a record operating income of $33.9 million, which represents a 47% increase. This is primarily due to margin recovery, improved mix, and volume growth. Both North America and Europe had excellent results in the quarter. The Polymer business in China was slightly down due to COVID lockdowns and restrictions. Finally, specialty product also had a record quarter, delivering $9.9 million of operating income, which represents a 41% increase. The operating income improvement was primarily attributable to a favorable customer mix and improved margins within our MCT product line. Turning to Slide 8. Our balance sheet remains strong, and we have ample liquidity to invest in the business. Our leverage and interest coverage ratios continue at very healthy levels. During the quarter, cash from operations was $84 million, and we deployed $123 million against CapEx investments, dividend and debt payments, share repurchases, and higher working capital requirements due to the strong sales growth. We continue to project full-year capital spending in the range of $350 million to $375 million inclusive of our 1,4-dioxane project and Pasadena investments in the U.S. Beginning on Slide 9, Scott will now update you on our 2020 strategic priorities.

Thank you, Luis. In addition to delivering another record quarter, we continued to advance our strategic priorities. The following 2 slides capture our strategic priorities and vision for a cleaner, healthier, and more energy-efficient world with our customers' preferences in mind. Our diversification strategy into functional products, including agricultural and oilfield chemicals continues to be a key priority for Stepan. Our global agricultural volumes increased strong double digits in the second quarter of this year. High agricultural commodity prices, coupled with increased planted acreage in 2022, drove a strong season for crop protection sales in North America, while elevated agricultural commodity prices and a favorable currency impact on exports are driving increased planted acreage in Brazil. Oilfield volumes also increased in the second quarter. Demand for our products used in oilfield, including biocides remains robust as crude prices remain elevated at around $100 per barrel. We continue with the integration and supply chain planning of the KMCO Oilfield Demulsifier product line, which we plan to relaunch in the second half of this year. We remain optimistic about future opportunities in this business as elevated crude prices should encourage increased oil production and the use of production and stimulation chemicals. Our Millsdale plant continues to be one of our key priorities. We are accelerating investments to improve productivity and reliability and to increase capacity through de-bottlenecking projects. These investments will continue throughout the year, and we expect to see benefits from our efforts and investments starting next year. Moving to Slide 11. Work continues on our major investment in a new alkoxylation production facility in Pasadena, Texas. This asset will be a flexible state-of-the-art multi-reactor facility with approximately 75,000 tons of annual capacity. It will provide strategically located capacity and capability for long-term specialty alkoxylate growth across our strategic growth end markets, including agriculture, oilfield, construction, and household and institutional cleaning. Given the current supply chain disruptions and tight labor market, start-up of the Pasadena facility will be delayed into the first quarter of 2024. And also due to cost inflation and the disruptions previously mentioned, total project cost is now projected to be 10% higher. The underlying alkoxylation business that supports the Pasadena investment grew very strong double digits and at margins above our original projections. We remain confident and excited about the investment in Pasadena. As you know, we are increasing North American capability and capacity to produce either sulfates that meet new regulatory limits on 1,4-dioxane by the January 2023 deadline. 1,4-dioxane is a minor byproduct generated in the manufacture of either sulfate Surfactants, which are key cleaning and foaming ingredients used in consumer product formulations. Stepan is working to supply customers with either sulfates that meet these new regulatory requirements. Given the strength of our balance sheet, acquisition opportunities that align with our growth and diversification strategy remain a priority. We are excited about our progress in our fermentation product platform. Our priority remains the development and commercialization of Rondel lipids, our first anticipated biosurfactant offering. We believe this new bio-based product family has significant opportunities in several important end markets for Stepan, including agricultural chemicals, consumer cleaning, personal care, and oilfield. Our new fermentation laboratory, which opened in February continues to make good progress in regards to process development, and we expect to start providing samples to customers later in the year. As we wrap up comments on the quarter, we delivered record second quarter and first half results, driven by the effort and teamwork of our employees around the globe. I am proud of our team's resiliency in delivering record earnings despite the continued challenging supply environment and inflationary impacts. Looking forward, we believe that surfactant volume within the functional product end markets, including agricultural and oilfield will continue growing given the favorable current commodity pricing environment. We also expect to continue growing in the personal care and institutional cleaning end markets. We continue forecasting consumer products demand to remain healthy and around current levels. Within our Polymers business, we believe we will deliver full year growth over the prior year. The future prospects for Rigid Polyols remain attractive, especially when considering the energy conservation efforts and more stringent building codes. Lastly, we believe that our results within the Specialty Products segment will continue to improve on a year-over-year basis. In closing, external supply chain challenges and inflationary pressures clearly will remain as headwinds in our business. However, we are cautiously optimistic about the balance of the year. This concludes our prepared remarks. At this time, we would like to turn the call over for questions. Carlos, please review the instructions for the question portion of today's call.

And our first question comes from Vincent Anderson with Stifel.

Yes. So I wanted to start on Surfactants. Maybe just if you're willing a rough idea of the volume impact from laundry detergents compared to the growth in functional products? And then just kind of generally, how much of the decline maybe in asset utilization on laundry versus just price versus raw material spreads as always for the bigger impact on margins in the quarter?

Vincent, this is Luis. Look, as we mentioned in the call, the volume for global surfactant was down 3%. Of course, as you know, a portion of commodity laundering, our total volume is a big percentage. That's why when that business is down, you see the total business down. But we were able to offset a lot of that with Functional Products, Personal Care, with Institutional Cleaning, growing our Tier 2, Tier 3 channel. So we haven't provided publicly the details of how much is our laundry business. But the important point is that we were constrained in several raw materials, especially in North America. So we were not able to supply the whole market. So when we saw demand destruction, it was more in the Latin America business. But at the end, as you know, that's a significantly lower portion of our total business. And the good news is that we are growing in the high-margin business in Functional Products, Institutional Cleaning and all of that.

Okay. Yes. And so then with what should have been a pretty positive mix shift then at the very least, where would most of the margin degradation have come from?

Yes. Let me elaborate on that because if you examine data from the past five to seven years, you'll consistently find that the margins for Surfactants in the second quarter are slightly lower than in the first quarter. This historical trend is something you can observe. Our absolute volumes have decreased, which affects the margin due to fixed costs. This is why Surfactants showed 10% of sales margins in Q2. About one percentage point is attributed solely to the volume effect. Additionally, we are experiencing sales growth significantly outpacing our bottom line and dollars per pound margin growth. Therefore, the transition from 11.5% margins in Q1 to 10% in Q2 is primarily due to lower volumes and the fact that we are raising prices more rapidly than in earlier quarters.

Okay. All right. That's very helpful. I appreciate it. If I could just ask about Pasadena with the delay there. I mean this is not an emergency situation yet, but maybe it's worth just talking about your contract with your engineering and construction provider, what kind of ranges have they promised in terms of cost and timing where if you were to exceed those, you might have some contractual recourse to reclaim some costs associated with the project? Is there anything there that you'd be willing to share at this stage?

No, Vincent. In today's environment, making a significant capital investment is challenging. The delay we are experiencing, which is about a quarter or three months and 10%, is not surprising given the current conditions. We remain committed to the project and have a strong working relationship with the general contractor, and we do not foresee any additional issues moving forward.

Okay. Fair enough. If I could ask just one more quick one here. You've kept a pretty good handle on SG&A so far this year despite wage inflation and the broader trajectory of sales and profitability. Are there any specific items or timing considerations that specifically helped the first half that could revert in the second half? Or is this just good cost control and we can kind of expect this level going forward?

Look, as I mentioned in my prepared remarks, remember, last year, in the first half, we had a lot of expenses due to the INVISTA acquisition and integration. So we had a – that’s kind of a one-time that is helping a little bit the comparison here. But yes, we remain committed to be very cost conscious and continue improving our productivity and automation efforts in SG&A. And you saw that we’re investing in R&D. So we are very committed to continue investing in the most important part of the SG&A, which is our R&D investment.

Our next question comes from the line of Mike Harrison with Seaport Research Partners.

Congratulations on a nice quarter.

Thanks, Mike.

Thanks, Mike.

I was hoping that we could start with the Polymers business and specifically talk about what you guys are seeing in terms of price versus cost. I think the margin performance there surprised a lot of people. So just trying to get a better sense of what those margin drivers, is it primarily price cost? Or are there some other things going on, trying to get a sense of how sustainable the Q2 margin performance could be going forward?

Thank you, Mike. That's a great question. Our Polymer business is indeed crucial for us, and it experiences some seasonality. This business typically shows clear seasonal patterns throughout the quarters due to construction activities in winter, leading to lower margins in Q4 because of fixed costs. It's important to look at the numbers quarterly. For instance, we just achieved 14.2% in Q2 for Polymers. We're taking necessary pricing actions and the rise in raw material prices is beginning to slow down. We are working to recover the margins we previously had, and we still have some way to go. Historically, this business has performed even better. We are pleased with the efforts our Polymers team has made in the first half of the year to recover margins from last year. While 14.2% is a solid figure, it's not our peak yet. We will keep monitoring the market and raw material prices and make adjustments as needed.

All right. And then just in terms of overall demand by region, I'm particularly interested in what you're seeing in Europe. At this point, are there any signs of declining demand trends either in Surfactants or in your Polymers business?

Yes, Mike, I would say it's a bit early to have a clear picture. We are staying very close to our customers. On the Surfactant side, our Q2 volume performance aligned well with Q1, apart from some seasonal fluctuations in the markets. We haven't seen or heard any indications of a slowdown at this stage. However, on the Polymer side, there seems to be more discussion and concerns regarding demand for the second half from the market. There's a general sense that we might be talking ourselves into a recession, and there are increasing signs that this may be a higher probability and closer to reality. Each week presents new dynamics in understanding market trends. Overall, we still feel confident about our business, but that could shift in a matter of weeks or months depending on developments in Europe over the next 30 days.

Yes, Mike, you know the volatility will be high. I mean, based on where we are now, we feel we are cautiously optimistic about the second half, but Europe is still a big question mark.

Yes. I guess with that in mind, can you maybe talk about the contingency plans that you're putting in place in case we see some natural gas or other energy rationing happen in Europe? And do you have any ballpark figure on how much of your sales are tied to plants in Europe that rely on natural gas for energy or for power?

Yes, Mike, let me give you kind of a high-level perspective of contingency. So within our Polymers business, we do have 2 main manufacturing sites. We have 3 manufacturing sites in total in Europe, 2 main sites that are related to the Rigid Polyol production. And at those sites, we are actively looking at contingency plans to switch over utility capabilities to fuel oil and/or coal and some of our heating requirements. But from a larger perspective, we do have a global network of Rigid Polyol manufacturing capabilities with plants in China and the U.S. And we do believe that we could supplement supply into Europe from our global network to a level that depending on what the unforeseen or unknown allocation restrictions are going to be, which are not well documented or understood by industry, by country yet. We feel pretty good that we've got supply across our global network to supplement potentially any shortfalls that could be put upon us. And it also depends on what happens with our customers as well and their ability to get natural gas and energy for their lamination production lines.

All right. And that commentary was specific to Polymers, any concerns on the Surfactant side?

No. I would say there is risk. We do have 2 main Surfactant plants in Europe, one in the U.K. and one in France. I think France we're not as concerned as some of the Northern European countries. And I think the U.K. so far, we are not seeing any significant concerns growing yet. But once again, that could change. We need to understand what the European Commission's allocation process is going to look like.

Yes. I understand it's all hypothetical. So I appreciate the detail there. The last question I have is on the specialty business. We don't talk about it very much, but this is the second year in a row that you guys have shown a very strong or surprisingly strong Q2. Can you give some additional color, I guess, on the seasonality of that business? It's always relatively lumpy or challenging, I guess, for us to model. But in the context, maybe the way to ask this question is in the context of doing about $10 million of operating income in the second quarter. How should we think about the third and fourth quarter looking there from an op income standpoint?

Yes. So Mike, this business has had some significant constraints in key raw materials over the last 2 years. And that's what's been driving some of the lumpy earnings as well as sales volumes throughout the last 8 quarters. Q2, I would say, is a little bit of anomaly in the fact that we did get access to some unanticipated key raw material, which allowed us to clear out some back orders on some very high-margin packaged goods inventory, which we were not able to service in the prior quarters. So I think you saw a really favorable product or I should say, customer mix in Q2 that was a large result driver for the results in earnings. I would not expect that level of profitability going forward in the second half of the year.

In our outlook, we anticipate the business will grow compared to 2021. However, you'll notice the results we reported for 2021, and as Scott pointed out, this growth was more of a one-time event in the second quarter.

Our next question comes from the line of David Silver, CL King.

I apologize for the connection issues. If I need you to repeat anything, I'm sorry in advance. I'd like to start by discussing currency. This quarter, you mentioned a negative impact of $0.08 per share on EPS due to currency. I'm a bit confused because I remember a year ago when you had a quarter with less currency volatility that resulted in at least a $0.11 impact. Given the current strength of the dollar against various currencies, particularly in Latin America and Europe, is the company taking any steps to lessen the effects of currency fluctuations? Are overseas sales priced in dollars? I'd appreciate any insights on your exposure to a stronger dollar moving forward and if the second quarter was affected by any unusual items or active hedging.

No, great question, David. The good news is that despite the $0.08 impact on EPS, we had an excellent quarter, growing EPS by 27%. FX was a headwind of 4 points, so without that, we could have seen a 31% growth in EPS. In Latin America, we have an active hedging program in several countries where the hedging costs are relatively low, which helps smooth our P&L without significantly impacting those costs. We also manage our business in that region on a dollar basis, although there is always some lag involved. The main concern right now is Europe and the euro. Our biggest issue comes from managing the European business on a euro basis, and it will be challenging to recover immediately. However, we will continue to manage our prices and margins to ensure we achieve the right return. While the euro remains a concern, we have successfully managed this business in the past and do not anticipate any major issues going forward.

Okay. I'd like to circle back next to the Polymers segment. And again, I apologize if I'm making you repeat yourself here. But one aspect I wanted to ask you about was the effect of business in China. So it was not called out in the press release. But when I think of what's happened there over the first half of the year, I mean, there's been a number of potential disruptions, lockdowns. I think in the news have quite a bit of commentary about what's happening to the property market there, etc. And I'm just wondering if you could comment on maybe how your construction-based China business firmed in the first half and whether you see a meaningful deviation from that end market maybe for the next quarter or two?

Yes, David. Our business in China has been affected by the lockdowns during the first half of the year. We have observed slightly lower demand from the market, which had a minimal negative impact on our Q2 results. Looking ahead to the second half, we can see the possibility of improvement, but it is unlikely to have a significant effect on our results for 2022. COVID remains a concern globally, and I cannot predict what China's lockdown strategy will be for the second half of the year. However, at this point, it is not expected to have a substantial impact on the company's overall results.

And as I mentioned in my remarks, David, I mean, the impact was very minor. So we are very happy with the work that our organization in China has done, despite all these lockdowns and despite the volume impact, they were able to recover that with margins and the impact on operating income is very, very small. So the team has done a very good job of finding other ways to compensate for all these COVID restrictions and lockdowns.

I have one more overarching question, and this is for Scott. Several participants on this call have noted significant margin and mix improvements that stand out in these record results. However, one aspect not highlighted in the press release or in the remarks is the influence of your leadership, Scott. This quarter likely represents your first full period as CEO, during which you may have implemented various changes or tactical shifts. When reviewing these results, I noticed relatively minor changes in volumes and comments about recovering lost margins rather than increasing historical margins. I find myself wondering about the influence your leadership has had on these results. Could you take a moment to discuss any notable qualitative shifts or changes in policies or go-to-market strategies that you believe have positively influenced these results, either year-over-year or sequentially?

Thanks for the question, David. I’m really proud to say that this – these results are the efforts of our team for the last several years. We operate under a 5-year strategic plan, which has been in place and really has not changed over the last 2 or 3 years. What we are doing is effectively executing into – deep into that strategy today. When you look at the acquisitions that we’ve made in Latin America, we look at the acquisition we made of INVISTA last year. These are all part of our strategy to increase the earnings and profitability of the company and also get into higher strategic growth markets. So this is nothing more than execution of the team that’s been in place for the last several years.

We have a follow-up from Vincent Anderson from Stifel.

I just wanted to ask quickly, if we look back at 3Q '21, things were really, really starting to pick up on the pricing side. So I guess it's just worth getting a recap on outside of where raw materials go, how much pricing do you have left in the tank for the second half of this year in terms of planned initiatives?

Great question, Vincent. Yes, as you have noticed, we have improved our pricing mix every quarter over the past six quarters. We started in Q1 2021 with a price mix of 13%, then 20%, and 28%. We recently reported our highest price mix ever at 32% in Q2 2022. We will continue to monitor and adjust our prices in response to the inflationary pressures we observe in the market. Inflation is still ongoing, and I don’t believe we have reached the peak yet. However, as I mentioned earlier, the rate of increase is significantly lower now, especially concerning raw materials. If you consider our cost structure, it predominantly comprises raw materials, followed by logistics and other fixed costs. Fortunately, the escalation of raw material costs is gradually decreasing. In the last few weeks, we have seen oil prices stabilize a bit. Therefore, while we expect to see some pricing adjustments in the latter half of the year, I anticipate that those numbers will begin to gradually decline from the peak we recently experienced.

Okay. Fair enough. And then just a quick one, I might have missed it, but that strength in North American Rigid Polyols demand last couple of quarters, I think you had noted that it's really MDI availability that was constraining growth there. Is that what changed to the better? Was there another channel that was able to pull that through?

No. We see strong demand in the North America region. However, when you consider the 8% growth we reported in Q2, it's important to also reflect on Q1 and previous quarters. In Q1, we dealt with the Millsdale issue, and that 8% figure also accounts for some inventory recovery from our customers. Therefore, the full 8% shouldn’t be viewed as direct demand. Nevertheless, we feel positive about the overall demand in our business. We'll have to monitor how the recession impacts us in the latter part of the year and into 2023. However, with the infrastructure bill and ongoing efforts in energy conservation, insulation plays a crucial role in reducing energy consumption, which is why we remain optimistic about the long-term prospects of this business.

Another follow-up from David Silver, CL King.

I have a quick follow-up for Luis regarding the new credit agreement that was finalized in late June. Specifically, could you remind me what the benchmark will be for that credit facility when determining your ultimate interest rate? It seems we're entering a period of potential volatility in certain rates. Is the base rate based on LIBOR, a T-bill rate, or a T-bond rate? What specific benchmark should we consider as we think about your interest expenses moving forward?

No, great question. This was a very good accomplishment from the team in Q2. As you saw, we have a credit line there. When you add up all the blocks, it’s $700 million. That gives us a lot of flexibility to execute our M&A playbook for the future. And as you probably saw in the details, we got this new facility with better terms for Stepan Company than in the previous one. Which is great for us and for our shareholders. You know LIBOR is going away and everything is going to be based on SOFR. So that’s the base rate that everybody is going to be looking at with the exit of LIBOR rates. Again, the important piece here is we have a very strong balance sheet, and we have now this new facility up to $700 million that can help us execute our strategy.

And we have no further questions on the phone line.

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

That concludes today's call. We thank you for your participation and ask you to please disconnect your lines.