Stepan Co Q3 FY2022 Earnings Call

Greetings and welcome to the Stepan Company Third Quarter 2022 Results. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. This conference is being recorded on Wednesday, October 19, 2022. I would now like to turn the conference over to Luis Rojo, Vice President and Chief Financial Officer. Please go ahead.

Good morning and thank you for joining Stepan Company's third 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 filing. 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 make these slides available at approximately the same time as when the earnings release is issued, and we hope you find the informational perspective helpful. With that, I would like to turn the call over to Mr. Scott Behrens, our President and Chief Executive Officer.

Good morning and thank you for joining us today to discuss our third quarter results. To begin, I will share our third quarter highlights and strategy outlook and Luis will provide additional details on our financial results for the quarter. The third quarter continued to be a challenging operating environment given continued raw material constraints, the energy crisis in Europe, cost inflation, foreign currency exchange impacts from a stronger U.S. dollar and overall global macroeconomic uncertainties. Nonetheless, I am proud of how our team has continued to overcome these challenges by delivering record results for the third quarter. Reported net income reached a record $39.4 million or $1.71 per diluted share, while adjusted net income was a record of $46.3 million or $2.01 per diluted share. Surfactant operating income was $39.0 million compared to $34.5 million in the prior year quarter. Growth was mainly driven by a better product and customer mix, partially offset by an 8% decline in global volume. Our Polymer segment reached a record operating income of $31.9 million compared to $19.8 million in the prior year, which represents a 61% increase driven by margin recovery and improved mix. Our Specialty Products segment also had a record quarter, growing operating income to $9.7 million, representing a $7.3 million increase over the prior year. Our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.365 per share, payable on December 15, 2022. This represents a 9% increase in our dividend, and Stepan has paid and increased its dividend for 55 consecutive years. During the third quarter of 2022, the company paid $7.5 million of dividends to shareholders and repurchased $5.3 million of company stock. During the first 9 months of 2022, the company paid $22.5 million in dividends and repurchased $22.3 million of company stock. The company still has $127.7 million remaining under our share repurchase program. Looking forward, we believe the operational environment will remain challenging. However, we are confident that we can deliver another record year. At this point, I would like Luis to walk through a few more details about our third 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 third quarter of 2022 was a record $46.3 million or $2.01 per diluted share versus $36.4 million or $1.57 per diluted share for the third 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, the adjusted net income for the third quarter excludes deferred compensation income of $1.1 million compared to last year's income of $1.3 million. It also excludes changes in our environmental reserve of $7.9 million compared to last year's excluded reserve of $0.7 million. The company increased its pretax environmental reserve from $23 million to $33.5 million based on new remediation cost estimates associated with the Maywood New Jersey site. The deferred compensation figures represent the net income related to the company's deferred compensation plan as well as cash-settled stock appreciation rights 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 net income bridge for the third quarter compared to the third quarter last year and breaks down the increase 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, we delivered excellent income growth in all our segments. Corporate and all other expenses, which are not allocated to the business segments, were up $2.3 million, driven by higher interest expenses and overall inflation. The company's effective tax rate was 24% for the first 9 months of 2022 versus 19.6% for the first 9 months of 2021. This year-over-year increase was primarily due to nonrecurring favorable tax benefits recognized in the third quarter of 2021. We expect the full year 2022 effective tax rate to be in the range of 23% to 25%. Slide 6 focuses on Surfactant segment results for the quarter. Surfactant net sales were $475 million, a 22% increase versus the prior year. Selling prices increased 35%, primarily due to the passing through of higher raw material and logistics costs and improved product and customer mix. Volume decreased 8%, primarily due to lower commodity laundry demand and raw material availability issues in North America. This was partially offset by higher global demand in functional products and institutional cleaning end markets. Foreign currency translation negatively impacted net sales by 5%. Surfactant operating income for the quarter was $39 million which represents a 13% growth versus prior year. This increase was driven by improved product and customer mix that was partially offset by the 8% decline in volume. All regions grew operating income in surfactant despite volume reductions, supply chain challenges, inflationary pressures and FX headwinds in Europe. This is the result of our diversification strategy to deliver higher value behind product and customer mix. Now, turning to Polymers on Slide 7. Net sales were $215 million, up 8% from the same quarter last year. Selling prices increased 26% due to the pass-through of higher raw material and logistics costs and recovering margins. Volume decreased 10%, driven by an 8% decline in global industrial volume, primarily due to softening demand in Europe. Foreign currency translation negatively impacted net sales by 8%. Polymers delivered a record operating income for the quarter of $31.9 million which represents a 61% increase versus prior year. This is primarily due to margin recovery and improved mix which was partially offset by the 10% decrease in global volumes. North America Polymer and PA income increased driven by margin recovery and mix improvement. The decrease in Europe was driven by FX and volume reductions. China operating income was down slightly due to suppressed demand from the COVID lockdowns and restrictions. Finally, Specialty Products also had a record quarter, delivering $9.7 million of operating income, an increase of $7.3 million. 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. Despite our CapEx investments, our leverage and interest coverage ratios continue at very healthy levels. During the quarter, cash from operations was $71 million and we deployed $132 million against CapEx investments, dividends and debt payments, share repurchases, and higher working capital requirements due to strong sales growth and the acquisition of the PerformanX business. We project full year capital spending in the range of $330 million to $350 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 2022 strategic priority.

Thank you, Luis. In addition to delivering another record quarter, we continue to advance our strategic priorities in the third quarter. The following two 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 double digits in the third quarter of '22. 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 third quarter of 2022 despite raw material availability constraints. Demand for our products used in oilfield remains robust as crude oil prices remained elevated at around $90 per barrel. Additionally, we expect the raw material constraints in this business to improve over the next few quarters. We continue with the build-out of our KMCO oilfield Demulsifier product line. 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 operational excellence initiatives. These investments will continue throughout the year and we expect to see benefits from our efforts and investments starting next year. One of the key priorities at Millsdale is the execution of our low 1,4-dioxane project. Moving to Slide 11. Work continues on our 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 per annum of annual alkoxylation 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. We expect the plant to be up and running in early 2024. The underlying alkoxylation business that supports the Pasadena investment continues its strong growth and at margins above our original projections. We remain confident and excited about our investment in Pasadena. The recent acquisition of the PerformanX alkoxylates business should deliver additional baseload volumes for Pasadena in the future, and the chemistries are well known by Stepan. This acquisition is a strong fit within Stepan's surfactant business and provides attractive market diversification opportunities for our alkoxylation product line. The acquired surfactants are supplied to key customers and end markets covering personal care, pulp and paper, lubricants, household institutional cleaning, oil and gas, agricultural and other industrial markets. We are excited to expand our customer base in some of these new end-use markets for Stepan. As you know, we are increasing North American capability and capacity to produce ether sulfates that meet new regulatory limits on 1,4-dioxane by the end of January 2023. The 1,4-dioxane is a minor byproduct generated in the manufacture of ether sulfate surfactants which are key cleaning and foaming ingredients used in consumer product formulations. Stepan is working to supply customers with ether sulfates that meet the new regulatory requirements. As part of this transition, one key customer chose to invest in internal production capabilities so that lost volume was recognized starting in the third quarter. However, we have gained volume with other customers, and we'll continue focusing on the strategic priority of growing within our Tier 2, Tier 3 customer segment. We expect this transition to go through 2023 and our focus is on generating value growth. The good news is that the overall market continues to believe that ether sulfates which meet the new regulation levels for 1,4-dioxane are the best alternative for performance and costs. We are pleased with our progress in our fermentation product platform. Our priority remains the development and commercialization of rhamnolipids, 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 process development, and we expect to start providing samples to customers later this year. Finally, given the strength of our balance sheet, acquisition opportunities that align with our growth and diversification strategy remain a priority. Summarizing the quarter, we delivered record third quarter and first 9 months net income, and I am proud of our team's effort and resiliency in delivering record earnings during this challenging market environment. We expect to deliver another record year, both on a reported and adjusted basis, despite approximately $8 million of incremental fourth quarter expenses related to planned maintenance activity in our PA plant at Millsdale and low 1,4-dioxane related transition expenses. We believe that surfactants, polymers, and specialty products will all deliver full-year operating income growth over the prior year. Growing the 3 segments at the same time would represent an extraordinary outcome for 2022. From a segment perspective, we believe that Surfactant volume within the functional products and institutional cleaning end markets should show full-year growth over 2021, despite the short-term challenge demand challenges and volatility. We believe that the long-term outlook for rigid polyols will remain extremely attractive as energy conservation efforts and more stringent building codes are expected to continue and are a critical step to deliver a world with less energy consumption. In closing, looking forward to the next few quarters, we believe the company will be challenged by slowing global economic growth, weakening consumer and construction demand, continued inflationary pressures, and a stronger U.S. dollar. Despite this projected macro environment, we remain committed to executing our long-term growth strategy. This concludes our prepared remarks. At this time, we would like to turn the call over for questions to Kathy, please review the instructions for the question portion of today’s call. Thank you, Kathy, and thank you all for joining us on today's call. We appreciate your interest and ownership in Stepan Company. Have a great day.

Thank you. That does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.

Hi, good morning, Congratulations on a nice quarter.

Thank you, Michael.

Scott, I was hoping that you could talk about price cost dynamics in both the Surfactants business and polymers as we look from Q3 into Q4, are you still seeing higher costs and expecting that maybe we could see some sequential margin headwinds? Or are you seeing the costs moderating a little bit and price cost is turning into a good guide for you? I think that seems to be particularly the case in polymers but maybe you could give us some color again on both of your key segments?

Yes. From a high level, Mike, what I would say is we've done a good job recovering our margins and covering our inflationary costs to this point. Although we are seeing raw materials somewhat moderating, they still remain highly volatile and the other inflationary costs that the business is facing still remain. And those remain in the freight area, utilities, and even labor. So I would say we are not at a point where we're done in terms of covering future cost escalations, and I think it's going to remain volatile going forward. And I would say it's pretty evenly spread between the surfactants and polymers business. Each is facing similar continued cost pressures.

So Mike, this is Luis in line with what Scott was mentioning, raw materials, if you think about raw material specifically, we are seeing kind of the peak. However, there are still a lot of volatility, and some things are coming down and others are going up. But we believe at least the raw material piece is in a better spot versus the previous quarter. But again, the other inflationary pressures on freight and other elements will continue...

All right. And maybe kind of a related question on how you're seeing the energy availability situation unfold in Europe and with your European operations. Are you planning to continue running all of your plants in the winter? Or could you see that maybe energy availability or demand issues could lead you to idle some of your facilities in Europe?

Good question, Mike. At this point, we do not see a disruption in any of our operations in Europe and are expected to continue to operate throughout the winter. We have worked on contingency plans with alternate sourcing of energy. That gives us a little more confidence if there was a constraint put on industrial use of natural gas or electricity. But as of this point, our anticipation is that we're going to operate as normal throughout the winter.

All right, Thank you. And then my last one for now is on the Surfactants business and the margin performance there. I'm just curious if that lower commodity laundry volume number is having a negative impact on your fixed cost absorption? Or is maybe the plant loading factor less of an issue for you guys than it might have been in the past? And also just curious if you're seeing any trading down in this more challenging economic environment for consumers, any trading down to lower value products in surfactants, whether that's on the laundry side or in Personal Care?

No, good questions, Mike. Of course, when you have lower volumes, you have the fixed cost impacting you. But again, we feel very good with the work that we have done in margins in both surfactants and polymers. And remember that we focus first on dollars per pound and the percentage of sales is a consequence of our sales growing significantly higher. But we’re very happy with the year-to-date margins that we have, the 10% in surfactant and 13% in polymers. And of course, you also know that we have some seasonality by quarter. So of course, Q4 is the lowest volume quarter. You see more fixed cost impact and, therefore, lower margins there. But again, our strategy is to continue growing the high growth, high-margin businesses functional, as Scott was mentioning, the strong double-digit growth in ag and oilfield. So those will continue helping our margins despite whatever fixed cost impact that we’re going to have. And I will let Scott talk a little bit more about the dynamics of consumer demand.

So Mike, I would say the trading down from premium to mid or economy tiers. I think that started well earlier this year and even late last year. I think what's different now is the sustained inflation that the consumers are facing, it's actually starting to show demand softness across the board. Stepan is agnostic to whether we participate in all segments of consumer products, whether it be premium economy or mid-tier. So we're agnostic there. But I think now we're seeing the overall softness in demand from the consumer.

And fair to say that, that’s primarily Europe and emerging market trend rather than something you’re seeing in North America?

Yes. Yes, as it follows the other industries, the first signs of softness happened in the emerging markets and Europe with the energy crisis and interest rate rises. Definitely, Europe is going to be in that board as well. North America to this point has held up much better than the other regions.

All right. Thanks very much. I'll turn it back for now.

Yes, good morning. I wanted to explore the acquisition further. I'm curious about how the alcohol ethoxylates fit into your portfolio. Do they serve as an intermediate product between your existing formulations, or are they completely new derivatives that will generally be sold as is? Additionally, are these products already compliant with 1,4-dioxane standards, or is that something you will be introducing to this company?

Yes. Great question, Vincent. First, the alcohol ethoxylates product line that we’re acquiring or have acquired from PerformanX. That is a standard product line that exists in the industry today and quite honestly, is in Stepan’s product portfolio and has been for 20 years. What it’s really doing is bringing new customers and new markets to Stepan, that is a great diversification opportunity for our ethoxylate business and provides, I believe, material opportunities for pull-through products within Stepan’s other product lines, including cationic and maybe even biocides into these new end-use markets. So that was really the driver. The chemistry is a standard chemistry line that we have in our product portfolio today. And can you remind me your second question?

1,4-dioxane.

So 1,4-dioxane is really primarily generated from the sulfonation process that's in our commodity anionic product line used in laundry. These non-ionic that are not sulfonative have much, much lower, almost negligible levels of 1,4-dioxane and not really of concern as it relates to the new regulations that are showing up next year.

Okay, perfect. And then just on the topic of 1,4-dioxane, you have your investments there to reduce its levels in your relevant products but we were reading about some switching to alpha olefin sulfonates as an alternative to just not even deal with the lower 1,4-dioxane concentration. Is that an opportunity within your portfolio to also push that as an alternative? Or would that be considered trading down? Or you really are focused on other end markets with your AOS capacity?

No. Stepan serves as a comprehensive provider for sulfonation chemistries, including ether sulfate, sulfonic acids, and alpha olefin sulfonates. We have been engaged in producing and selling these products for many years. We don't favor any particular customer base regarding what solution best meets their needs. Sulfates offer the best cost performance for certain consumer cleaning and liquid cleansing applications, so customers seeking strong consumer performance often opt for sulfates. Others who want to avoid reformulation challenges or address cost issues related to the new 1,4-dioxane regulations are interested in switching to alternative anionics. We are collaborating with these customers to modify their formulations to use ALS or lauryl sulfate or sulfonic acid. This situation presents an opportunity for our ALS franchise as customers seek tailored solutions that comply with the 1,4-dioxane regulation.

Great. That's very helpful. And just one more quick one from me on selling that we don't normally talk about. But MCT has had another nice quarter. You've mentioned in the past that you wanted to build out some of your raw material availability to improve output of those products. Is that still a strategy? And how much volume upside is there from those assets?

The supply of the fatty acid used to make MCTs has loosened up a bit. Global supply chains are operating a little more freely. But I would not say that there’s a significant opportunity from here in terms of continued profit expansion that we’ve seen over the last 4 months or last 4 quarters, I should say. Margins are probably close to being at their peak. I think we’ve done a really good job with our customer optimization and getting fatty acids into our manufacturing facilities in a time where they were constrained.

And Vincent, this is Luis. An additional perspective is that, as Scott mentioned, we have likely reached the peak in terms of margins, but we are still looking for opportunities to increase volume, and we currently have extra capacity at our Maywood facility. As fatty acid availability improves, our focus for the next few quarters will be to continue growing the business, acquire new customers, and increase volume.

Understood. If I remember correctly, these are mostly coconut oil or palm kernel oil fatty acid derivatives.

Yes.

Yes, good morning. My first question is about the Surfactant segment. You mentioned the price-cost balance earlier, and I'd like to understand the reasons behind the lower sales volume. For several quarters now, you've pointed out the differing trends in the personal care segment of your surfactants business compared to the institutional or commercial side, which has performed better. Can you discuss this a bit more and provide insight on how close we are to the personal care segment reaching its lowest point after the pandemic? Let's start with that.

Yes. David, if I understand your question as it relates to our personal care volumes, one thing I would say is we've had significant raw material constraints affecting our personal care volumes, specifically in our Amphoterics product lines. And that was, quite honestly, industry-wide in terms of a critical raw material that was short to the industry. So that's helped exacerbate some of the divergence that you're referring to. In terms of the post-covid demand in personal care as it relates to the increased use of hand wash factoring the peak of the pandemic, that has pretty much stabilized and is not in any declining or significant increasing trajectory. So that's kind of more stable. So I'd say most of the impact of divergence you're seeing has really just been with some isolated supply chain constraints on raw materials that has really impacted the volumes.

Thank you for that. I wanted to get an update regarding your Tier 2 and Tier 3 customer strategy for Surfactant year-to-date. Do you have any figures for accounts this quarter or year-to-date? Also, could you comment on how this has affected your margins? Specifically, smaller volumes might come with a greater service component, potentially resulting in structurally higher margins. In light of the third quarter segment results, what would you say the impact of that strategy has been so far?

Yes, definitely contributing to the continued success. It's a core element of our strategic growth priorities going forward. I think in our earnings slide deck, you'll see that there's over 100 new customers that were gained in the third quarter. And yes, the smaller volume tends to be higher margin business and that's been a core foundation of our growth strategy going forward.

Great question, David. Yes, you're correct. We're expecting our annual interest net to increase, with guidance indicating it will be around $11 million this year compared to approximately $6 million last year. This clearly reflects the impact of the new debt we've taken on. However, it's important to note that we secured significant new debt at fixed interest rates under 3%. We believe we're positioned very well. Additionally, with the recent interest rate hikes, we are generating more interest income from our cash, which is beneficial. We're currently earning interest income that exceeds what we're paying on our debt, with interest rates for that income being around 3 to 3.5%. This is a positive sign. In February, I'll provide more precise guidance on our interest net forecast for 2023, which should exceed the $11 million we reported for 2022. I will share the specific numbers when we meet in February.

Okay, great. And then just one last question. I've noticed in the news recently that water levels in the U.S., particularly on the Mississippi, are affecting barge and vehicle vessel traffic. Considering Millsdale and possibly your other operations, or even your supply of raw materials, is this causing any unusual challenges for you? Are you having to switch to different transportation methods as a result, or is this something you can handle without too much trouble? Thank you.

Yes, great question. We have been operating our plants on the Illinois River and the Des Plaines River for 50 years, and we have strong contingency plans in place. Our sourcing and planning teams work very closely with our raw material suppliers to ensure alternative transportation methods are available for the Chicago area. Therefore, it has not been an impactful issue for us.

Yes. No major impact.

No major impact on our operations as a result of the Mississippi water levels.

Okay, great. Thank you very much. Appreciate it.

Just a few more for me. In terms of this $8 million fourth quarter impact related to some planned maintenance, how much of that is going to hit the polymers business? And how much of it impacts Surfactants?

Good question, Mike. Actually, I want to make a clarification that $8 million is after-tax, just make sure that everybody understands that it's roughly $10 million to $11 million on a pretax basis, and around 70% of that will hit polymers and 30% will hit surfactants...

Okay. And have you seen any customers pulling forward any volumes in Q3 in anticipation of that Q4 outage? Or were the order patterns generally pretty steady?

Yes. We work with our customers well in advance. Our shutdowns are planned 6 to 12 months in advance. So the supply chain has already been executed against the shutdown.

Okay. And then I guess, maybe hoping for a little bit more color on what exactly you guys are doing at that Millsdale site. You mentioned some operational excellence initiatives. But are some of these actions intended to help improve reliability? And I know if we look back over the last couple of years, we've had some power outages that have affected production out of that plant.

Yes, we are investing significantly in enhancing the reliability of the infrastructure at our Millsdale site. We have been undertaking several projects since Q2 to replace substrate substations and MCCs, and we are confident that these projects will greatly improve our reliability and prepare us for the upcoming winter.

And then, I guess, as it relates to the low 1,4-dioxane transition costs that are associated with this $8 million impact. What do those costs entail? And are they onetime in nature? Or are there going to be additional costs that we see you guys incur at some point in 2023?

Mike, I will say a good chunk will be onetime. But of course, as we mentioned in our prepared remarks, the transition for low 1,4-dioxane is going to go through 2023. This is not a 1-day switch. So we need to go through the transition, and after we execute all of these, of course, we're not going to incur in some of those one-timers.

Okay. But it sounds like maybe as we're thinking about 2023 that we should consider that there's still some headwinds associated with these transition costs.

Yes, a little bit. I mean, it's not going to be major. And I'm looking forward also to the meeting in February, we can provide a little bit more guidance about how we see the years and what are some of the key elements that we see going forward. But yes, you're going to expect some additional expenses there but nothing major.

Okay. And then the last one I had is on polymers. I was just hoping you could give a little bit more detail on what you're seeing in terms of demand trends as we're getting into Q4. Obviously, the 10% volume decline in Q3 suggests that you're definitely seeing some things getting worse. Curious if some of that is customer inventory destocking that might be a little bit more temporary but anything you can share on near-term demand in the construction-related portions of polymers would be appreciated.

Yes. I think as we all read what’s happening in Europe, specifically in the construction markets, there is a slowdown happening. Projects are being put on hold or canceled, which is really what’s driven our volume decline in polymers in Q3. And then the continued kind of lockdowns in China have also significantly impacted demand. Where is it looking sequentially quarter-over-quarter into Q4, we’re kind of expecting a lot of the same for Q4. And I think the overall hope is that there’s maybe a two or three quarter, call it, hiatus and expecting growth and recovery in the construction markets in Europe in the second half of next year. I think that’s kind of a general consensus right now across what we’re hearing in the market.

And as you know, Mike, at the end, insulation played a critical role in what needs to be achieved in the world which is to reduce energy consumption. So of course, people preserve cash in this environment and people put on hold some of the projects. But if you need to replace your roof, you need to replace it, right? And you can hold out for one, two, or three quarters but you cannot hold forever. So we believe this is a transitory theme. And if you look at North America, despite all the challenges, a region in North America year-to-date is growing volume, single low single digits but it's still growing. So the impact that we saw in Q3 is mainly Europe and Asia.

All right. That's very helpful. Thanks.

Good morning, gentlemen. Thanks for taking my call. You actually just touched on it with the demand weakening in Europe and the Chinese markets. I know the North American markets seem to still have pretty strong demand. Are there any indicators that you're keeping an eye on to forecast if or when any of this demand weakness does spread to the North American markets?

Yes, we are closely monitoring our customers and listening to their feedback regarding the installation contractors. There has been a lot of discussion about order backlogs and projects. The first indication of any weakness will be if we start to see those back orders decreasing. Currently, as Luis mentioned, our rigid North American volumes are still growing in the low single digits, and we expect Q4 to be similar, although it's too early to make definitive predictions.

Thanks. And one more, if I could. You mentioned earlier that labor is an inflationary pressure expected to continue along with freight and utilities. But the labor market in the U.S. remains as strong as it is, do you anticipate this to becoming an outsized expense relative to those freight and utilities expenses or just kind of maintaining as it has that.

No. What I would say is, of course, as a normal chemical company, we don't have a lot of labor in our site. But the situation is that we're coming from years where salary inflation was in the U.S. was roughly in the 3%, we could see a little bit more pressure on those numbers in the short term. So that's kind of the difference. And when you think about developing markets in Europe, it could be a higher single-digit type of number. So that's kind of the new thing on the labor piece. However, labor for us is not the biggest impact for us; it's about raw materials, freight, and utilities.

Okay. Thank you very much.

Yes, thanks. Just hopefully a quick one. I meant to ask the customer that took its 1,4-dioxane compliance internal. Was that a customer that was kind of core to your investment case into the low 1,4-dioxane capacity? Or are those customers more secure? And then I just have a quick follow-up on that.

Yes. So you know with the level of investment that we've made for 1,4-dioxane, we obviously had early and often conversations with our customer base, both existing and new to get ready for the type of capacity and capability we put in. So core to Stepan, yes but definitely within our plans and our forecast.

Okay, that makes sense. To better understand the commercialization of that product, I assume there's a bit more overcapacity than needed for Day 1 compliance. Is most of this being addressed with the purification step after the reaction that could potentially be bypassed, or are you managing this on the front end? So when the plant shifts over, are you primarily producing low 1,4 product, leaving it to our team to find a market for it at a profitable margin?

We have the flexibility and the design of the process that we've implemented. We have the flexibility to operate the units as we see fit. I'll leave it at that.

No, it's perfect. I appreciate it. That's all for me, I promise.

And there are no other questions. I'll turn the call back to you, Scott for closing remarks.

Thank you, Kathy. And thank you all for joining us on today's call. We appreciate your interest and ownership in Stepan Company. Have a great day.

Thank you. That does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.