Good day, and thank you for joining us for the Q2 2023 Stepan Company Earnings Conference Call. I would now like to introduce your host for today's call, Luis Rojo, CFO. Please proceed.

Good morning, and thank you for joining Stepan Company's Second Quarter 2023 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 are 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 on the investor 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 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 second quarter results. I plan to share highlights from our second quarter performance. I will also share updates on our key strategic priorities while Luis will provide additional details on our financial results. The company reported second quarter adjusted net income of $12.1 million. Earnings were significantly impacted by a 19% decline in sales volume versus the all-time record prior year second quarter due to continued demand softness across most of our markets and continued inventory destocking in certain market channels. In the second quarter, margins in our Surfactant and Polymer segments were only slightly lower versus the prior year as a result of less favorable mix, while unit margins for Specialty Products were significantly lower versus the prior year due to high-cost inventory and pricing pressure. Gradual volume improvement throughout the quarter within our rigid polyol business was more than offset by destocking activity within our agricultural business. Cash expenses were slightly lower versus the prior year due to proactive headcount and discretionary expense controls implemented earlier in the year and lower accruals for incentive-based compensation. For the quarter, adjusted EBITDA was $45.8 million versus $96.7 million in the prior year quarter, primarily driven by the decline in sales volume. Adjusted EBITDA in the second quarter of 2023 was slightly lower than the first quarter of 2023. Second quarter Surfactant operating income was $15.1 million versus $48.2 million in the prior year quarter, primarily due to a 15% decline in global sales volume. In addition, unit margins were slightly lower due to less favorable product mix, high-cost inventory carryover, and increased competitive pricing pressure in Latin America. Polymer operating income was $16.3 million, a decrease of $17.6 million versus the prior year. This decrease was primarily due to a 29% decline in global sales volume, including a 28% volume decline in Rigid Polyols. Specialty Product operating income was $3.8 million versus $9.9 million in the prior year. This decrease was primarily attributable to lower unit margins and sales volume within the medium chain triglycerides product line versus a record prior year. During the second quarter of 2023, the company paid $8.2 million in dividends to shareholders and $16.3 million during the first 6 months of 2023. The company did not repurchase any company stock during the first half of 2023 and has a $125 million remaining under the share repurchase program authorized by its Board of Directors. Yesterday, our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.365 per share, payable on September 15, 2023. Stepan has paid and increased its dividend for 55 consecutive years. Despite the challenging current macro environment and our reduced second quarter earnings, we remain confident in the strength and diversity of our business and its ability to generate cash that will allow us to continue to invest in our business and return cash to our shareholders. Luis will now share some details about our first 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 was $12.1 million or $0.53 per diluted share, versus $53 million or $2.30 per diluted share in the prior year. 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 first quarter excludes deferred compensation income of $0.7 million compared to an expense of $0.5 million in the prior year. It also excludes minor business restructuring expenses and environmental remediation costs. 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 liabilities change with the movement in the stock price, we exclude these items from operational discussion. Slide 5 shows the total company net income bridge for the second quarter compared to last year's second quarter, and breaks down the decrease in adjusted net income. Because this is net income, the figure is not here and on an after-tax basis. We will cover the details in more detail, but to summarize, we experienced lowered operating income in all segments driven by lower volumes. The company's effective tax rate was 20% in the first half of 2023 versus 25% in the first half of 2022. This decrease was primarily due to more favorable tax benefits derived from stock-based compensation awards exercised or distributed in the first half of 2023 versus the first half of 2022. Let's move to Slide 6. Slide 6 focused on Surfactant segment results for the quarter. Surfactant net sales were $392 million for the quarter, a 19% decrease versus the prior year. Selling prices were down 5% and volume decreased 15% year-over-year. The reduction in volume was due to overall lower demand, customer and channel inventory destocking and the previously disclosed backward integration by one customer associated with the low 1,4-dioxane transition. Foreign currency translation positively impacted net sales by 1%. Surfactant operating income for the quarter decreased $33 million versus the prior year. Most of this decrease is due to a 15% decline in volume. Unit margins were slightly lower due to less favorable product mix, high-cost inventory carryover, and increased competitive pressures in Latin America. Higher expenses associated with the company's transition to low 1,4-dioxane and preoperating expenses in our Pasadena site were also headwinds during the quarter. Operating income declined in all Surfactants regions, primarily due to the lower overall demand mentioned before as well as pressure from imports in Latin America. Now turning to Polymers on Slide 7. Net sales were $164.5 million for the quarter, a 31% decrease versus the prior year. Volume decreased 29%, primarily due to a 28% volume decline in regional volumes and lower demand in the specialty polyol businesses. This was partially offset by volume growth in China. The lower demand reflects customer and channel inventory destocking and lower construction-related activities. Selling prices decreased 3% and foreign currency translation positively impacted net sales by 1%. Polymer operating income decreased $17.6 million versus the prior year, primarily due to the 29% decrease in global volume. North America and Europe results were both impacted by lower volumes. Asia results improved on increased demand following the reopening of China. Finally, Specialty Product net sales were $23.8 million for the quarter, a 14% decrease versus the prior year. Volume was down 16% between years, while operating income decreased $6 million versus a record second quarter in 2022. The decline in operating income was primarily due to high-cost inventory carryover and pricing pressures. Turning to Slide 8. Also our balance sheet remains healthy. We have increased our efforts to lower working capital and reduce capital spending to adapt to the current business environment. For the second quarter, cash from operations was a healthy $108 million, and we deployed $103 million against CapEx investments, debt payments, and dividends. Our net debt improved from $584 million in the first quarter of 2023 to $549 million this quarter as we continue to deliver strong cash generation. Now on Slide 9 and 10, Scott will update you on our strategic and capital investments.

Thanks, Luis. I will focus my comments on our cost and cash management initiatives and on the progress of our major capital investments. In regards to our 2023 cash expenses, we continue targeting to hold full-year cash expenses flat or down versus the prior year despite continued pressure from elevated cost inflation. Based on the disappointing second quarter financial results, we are taking further actions to control costs and improve cash flow, including a voluntary early retirement program for eligible employees at our corporate headquarters and Global Technology Center, which are both located here in the Chicago area. This program should help position us to deliver improved earnings in 2024. We expect to take a restructuring charge in the third quarter. Our second half capital spending should decline by $70 million to $80 million compared to the first half of the year as we finish our 1,4-dioxane projects in the coming weeks and begin to wind down spending on Pasadena sequentially over the remaining quarters. We also expect to reduce inventories by $40 million in the second half, freeing up additional cash. Moving to Slide 10, construction on our new alkoxylation production facility in Pasadena, Texas is approximately 35% complete and has surpassed 500,000 construction hours without an injury. The new estimated capital investment now stands at $265 million. We expect the Pasadena plant to be 90% complete by year-end and to start up in mid-2024. The underlying consolidation business that supports the Pasadena investment continued its strong double-digit volume growth in the first half of the year and at attractive margins. As you know, we are increasing North American capability and capacity to produce ether sulfates that meet new regulatory limits on 1,4-dioxane. The new assets in our Millsdale facility are now mechanically complete and are being commissioned this quarter. New contracted low 1,4-dioxane volumes have already started and should drive volume growth in the second half of 2023. Once completed, Stepan will have the largest installed low 1,4-dioxane production capacity serving the North American merchant market, which will enable Stepan to maintain and grow our North American sulfonation business in 2024 and beyond. Looking forward, we continue to believe the second half of the year volume and margins will incrementally improve versus the first half of 2023, driven by the continued gradual recovery in rigid polyol demand growth in Surfactant volumes associated with new contracted business and sequentially lower raw material costs. While first half financial results were disappointing, our anticipated lower second half CapEx spending and an improved working capital position should benefit our balance sheet and free up cash, allowing us to continue to invest and advance our long-term strategic growth and innovation initiatives. We expect additional actions to control costs, including today's announced voluntary early retirement program will benefit our earnings in 2024. While the current market environment continues to present near-term challenges, we believe second half adjusted earnings will improve over the first half of 2023. This concludes our prepared remarks. At this time, we'd like to turn the call over for questions. Justin, please review the instructions for the question portion of today's call.

Our first question comes from Mike Harrison from Seaport Research Partners.

So I think I wanted to start here. Maybe just to understand a little bit more on what you guys were seeing in terms of volume trends in both the Surfactants and the Polymers business as the quarter progressed. And I think what I'm really trying to get to is understanding in both of those segments, when do you expect to see volumes stabilize and become a little bit more representative of what underlying demand looks like?

Yes. Thanks, Mike. We believe we have seen the stabilization of both the Polymers and the Surfactant volumes in the, I'd say, the May, June time frame. So sequentially, month-over-month in Q2, our rigid polyol volumes continue to grow. And the Surfactant volume sequentially down 6% versus Q1; we believe that has stabilized. And in our prepared remarks, we shared that the contracted volumes we have for the second half will drive the incremental growth from here. So from a Surfactant polymer perspective, I think the stabilization was experienced in June and in July. And I think we're going to be on our incremental path to recovery in the second half.

So Mike, this is Luis. Let me add a few other points. As Scott mentioned, we believe we hit bottom in Q2. Now the dynamic, as we mentioned in our remarks and in the earnings release is, we saw a sequential improvement in our rigid polyol business from Q1 to Q2, but that was offset by significant destocking in the ag business in Q2. So that's the piece that actually offset the progress that we saw in Polymers. And we still expect probably some further destocking in the ag business. But again, the Polymers business and the new contracted volume should offset that. So we believe we saw the bottom, and we believe we have the elements for a gradual improvement in the second half.

As it relates to your pricing and cost situation, pricing is declining, and it appears to be lower in both of your main segments. However, you're still incurring some higher-cost inventory in your profit and loss statement. Could you provide an update on when you anticipate these factors will begin to balance out and when you might see some improvement in unit margins as your inventory costs decrease and align more with the current pricing environment?

No, good question, Mike. Let me clarify two aspects. First, we experienced a significant compression in unit margins within the specialty products segment, which represents only 5% of the company. We also had a high base in the first half of 2022. When considering inventory carryover and pricing pressure due to imports from Asia, this is where we observed a noticeable effect on unit margins. In contrast, our unit margins for Surfactants and Polymers remain quite healthy. Overall, the company experienced a 4% decline in price mix, while our raw material prices decreased by 5%. Thus, our unit margins align with our expectations. As mentioned, we anticipate that in the second half of the year, we should witness not only gradual volume growth but also gradual margin improvement as we continue to reduce the high inventory costs. This won't happen suddenly in one month or one quarter, but we expect steady improvement over the next couple of quarters. Additionally, regarding oil prices and our current raw materials, we are seeing some stabilization. While we are still dealing with higher costs, we do not anticipate significant fluctuations in raw materials in the third and fourth quarters on a spot basis. This outlook aligns with the general consensus for the upcoming months.

All right. Understood. And I guess my last question here is you mentioned some cost actions you're taking and early retirement plan and expected to take a restructuring charge in the third quarter. Just maybe a little bit more color on some of the actions that you're taking? And do you have any sense of what the savings associated with those actions could look like at this point?

Yes, Mike, we just announced that program today internally. So this is really premature to be talking about or estimating what the potential size could be. We'll be back in Q3 when we have more details about the progression of the plan.

And our next question comes from Vincent Anderson from Stifel.

Yes. So if I go back a little ways, and I look at implied dollar contribution from volumes and Surfactant since 2020, if you don't mind, you had about like a $75 million tailwind during 2020. And then since then you've had cumulative volume declines of a little over $300 million. And yet until this year, you were maintaining dollar earnings despite that kind of general trend lower. Can you just maybe refresh my memory on how the business has trended over the last few years in that respect? And what specifically about this leg of volume headwinds is really finally weighing on dollar earnings?

Vincent, let's consider the Surfactants over the past three years. In 2020, we experienced a significant increase in volume due to the pandemic. Our strategy has been clear: to keep expanding in the functional business, which offers higher margins, and to grow with Tier 2 and Tier 3 customers, which also provide better margins. Despite the volume decline from the pandemic peak in 2020, we successfully executed our strategy by enhancing our functional and construction and industrial businesses, as well as our presence in Tier 2 and Tier 3 markets. This is why we observed differences in profitability; for instance, GBP 100 million in one area could translate to GBP 10 million in another. Our strategy was effective, and we followed through on it.

Okay. That's helpful. And then can you talk about maybe in a bit more detail, the import pressures on Latin America and maybe separate that out between your Mexican sulfonation business, which, if I recall, has a pretty significant market position and then maybe the rest of the Latin American exposure broadly?

Yes, we began to feel competitive pressures earlier this year due to China's reopening, which led to increased production in Asia. However, China has not rebounded as quickly as anticipated, resulting in significant import pressures along the South American coast and into Mexico. Additionally, there are ongoing supply chain issues in Mexico's Surfactant market that necessitate imports for reliable supply. As a result, the Mexican business has been affected by imports and competitive pricing pressures, which have reduced margins. To a lesser extent, our operations in Colombia and the surrounding Indian region have also experienced pricing pressures. This area often sees aggressive imports aimed at maintaining production levels at the plants we launched in China. Brazil has been somewhat less impacted, as its market relies more on local supply, resulting in less pressure there. Overall, we believe that activity has stabilized, and we anticipate an incremental improvement in volumes for the second half.

Okay. No, that's very helpful. And maybe just specifically on price, I know raw materials are a significant component of that. But did you make a conscious effort to prioritize price over volume in some of these areas with the expectation that the competition would be pretty transient and you'd exit in a better position? Or do you expect your prices to have to react to this competition?

No. Your former statement is correct. So once we assess the situation, we acted appropriately with pricing measures to ensure that we could stabilize volumes.

And our next question comes from Dave Storms from Stonegate.

Just hoping you could discuss the current customer acquisition environment and kind of what you're seeing on that front?

Yes. In the Surfactant industry, there are still many new customer acquisitions taking place. In the first half of the year, there was definitely a higher level of customer turnover in our Surfactant business due to competitive pressures and customers seeking lower prices. However, on the positive side, our new business acquisition has been strong and has not been affected by pricing issues in the market. I would describe this situation as having a higher churn rate, but the pace of new customer acquisitions remains satisfactory from our viewpoint.

Very helpful. And then just turning to the balance sheet. Your net debt was down slightly sequentially quarter-over-quarter. Just curious how comfortable you are with the 31% level or if debt repayment is expected to take center stage once Pasadena is up and running?

Yes. So as you saw, right, I mean we have invested in the business in the last few years because we believe in our end markets. We did the INVISTA acquisition. We have 2 big programs in low 1,4 and Pasadena. The good news is that a lot of that investment is behind us, right? These are investments for the next 5, 10 and 20 years. These are not investments for the short, short, short term only. So we need to look at them with a long-term view that these are the right investments. And again, the good news is that we are past the biggest cash outflows. And from here, we need to continue improving the business so we can continue deleveraging a little bit the balance sheet to invest in other new opportunities that for sure will materialize.

Our next question comes from David Silver from CL King & Associates.

Yes, Scott. I'd like to start by discussing the customer destocking activity and your perspective on it. Like many companies, you experienced a significant impact from customer destocking this quarter. However, it might be useful to delve deeper into this issue. Would you say the destocking primarily involves Tier 2 and Tier 3 customers facing some regional price competition, or is it more about the larger merchant market customers who seem to carry more inventory into this seasonal period than expected? In other words, could you provide more detail on the nature of the destocking beyond just the raw percentages or numbers? Additionally, you mentioned anticipating further inventory reductions in the second half of the year. Could you share more about this? Is the change in inventory levels due to customers trading down, or are regional economies underperforming compared to your expectations? Any insight into the destocking activity you've observed in the second quarter and the outlook for the second half of the year would be helpful.

Yes. Thanks, David. With regards to destocking, so the destocking obviously started to happen in Q1, definitely in the polyol side of our business for sure and in, I would say, all segments of our consumer products business. I think when you look back and try to appreciate how much inventory was stuffed throughout the channels, I don't think anyone had a really good handle on it. What we can say going forward is in the rigid polyol business, we think that the destocking is predominantly behind us, and we're now starting to get into a normal demand pattern for the second half of the year. I would say the same thing is true in consumer products. The destocking probably bottomed out in late April, May, and we're now going to be entering a normal stabilized volume pattern going forward. The surprise for us was in agricultural chemicals. So we had an all-time record volume in agricultural chemicals in Q1. And in May, that kind of all stopped abruptly. And it has to do with what segment of the market you're servicing, whether you're in the commodity generic pesticide end markets or if you're in the proprietary branded, our business is more associated with proprietary branded. You saw companies announced in Q1 a massive slowdown in ag; we did not see that because we're in a different segment of the market. We did see it, and we are experiencing it now. The channel is full in ag, and it will probably take us through the end of Q3 before we get back to a normal inventory and demand pattern for ag. So I'd say the different industries, different markets, all experienced the same issue at different times, but I want to leave you with, I think Polymers, the destocking is predominantly done and the Surfactant side, we expect a normal demand pattern for the second half.

To clarify, the back half liquidation is mainly focused on agricultural chemicals and not significantly on other surfactants or Polymers. Is that a fair summary of what you have outlined?

Correct. And you asked about inventory reduction. We're really talking about our raw materials and a little bit of finished goods. Some of that is operational as well. One of our large plants is on a river that's going through major lock reconstruction. So we have to bring in higher levels of materials ahead of that 3- or 4-month outage. So when that project is done at the end of September, we'll be back in more normal inventory levels in the polymer business as well. So I think we shared earlier in the $40 million target reduction for the second half in inventories; that's a real number from our perspective and our expectations.

I'd like to discuss the current timeline for the Pasadena expansion. It seems that mid-2024 now suggests a possible slip of about a quarter in the overall planned startup, which isn't overly dramatic in the grand scheme of things. I'm curious if you could explain the reasoning behind shifting the timeline to mid-2024. Is this change influenced by customer demand or orders? Could it be related to the construction timeline, or are there other factors at play? Why do you believe that mid-2024 is the appropriate timing for your largest capacity expansion project to date?

Thank you for your question, David. The delays we are experiencing are solely related to the construction process. As noted earlier, the underlying business and product line associated with these new assets continue to show strong double-digit growth on a quarterly basis. The project is currently in the construction phase, which involves design changes and labor constraints. These factors have led to minor delays, and we are approximately six months behind our original startup timeline. We anticipate being mechanically complete by the end of Q1, with commissioning occurring in Q2. Therefore, from an external perspective, we believe that mid-2024 is the appropriate timeframe to expect commercial volumes to be available.

Go right ahead, sorry.

I was just going to say, David, it's in our highest best interest to get that asset up and running as soon as we can because the demand is there.

I heard your comment about demand. I missed the details on the construction timeline, so thank you for clarifying that. Regarding your development and rollout of the low 1,4-dioxane product, could you discuss it from a marketing perspective? Specifically, do your customers who switch to the newer low 1,4-dioxane version of an intermediate chemical find it easy to replace their legacy product with yours? How do you transition your customers from the traditional version to the new one? Has this caused any customer churn or issues that have affected your results over the past couple of quarters?

David, great question. The simplest comparison I can think of quickly here is, this is like the U.S. gasoline market switching from leaded to unleaded, okay? So everyone was putting gasoline or in this case, ether sulfates in their shampoos and now the regulation changes on a certain date that says it now has to have low 1,4-dioxane. So we've been working with our customers over the last 3 years to manage that transition from leaded to unleaded gas, right? So from a marketing perspective, there's not a lot of differentiation, etc. It's a regulation change, and it's the removal of that byproduct from our existing franchise that has been the heavy lift. So I hope that answers your question.

Yes. No. That was great. Cannibalization was the word I was trying to think of. But no, that's very helpful.

And we have a follow-up question from Vincent Anderson from Stifel.

I just had 1 more, quick one. You mentioned, I think, alkoxylation demand in your current product portfolio was up double digits year-to-date. Is that correct?

Correct.

Correct.

Okay. Yes, I believe the estimates that I've seen typically put demand growth for that family in kind of the mid- to high single digit area, at best. So can you talk about what's been driving your growth in your portfolio specifically?

It's a $265 million investment with significant focus from our commercial and R&D teams. We're successfully competing in the market with our product offerings and, more importantly, our service. There is considerable formulation activity occurring in the Surfactant industry due to sustainability requirements and supply chain challenges experienced in 2021 and 2022. This presents many opportunities to collaborate with customers on formulation projects, and I'm pleased to say we're achieving success.

That's good to hear. And then maybe just a quick follow-up on just how you commercialize the plant that size. With the growth that you've seen so far, is it really kind of with a customer mix today that is matched to your current capacity, and you'll just have to take what you've learned and start over with the higher volumes and higher volume customers? Or is this going to translate pretty quickly to larger offtake once the plant is up and running?

Yes. So when that plant starts up, there is a strong baseload demand already existing within our business as we move product around both an internal and external manufacturing co-producer network. So we're pretty confident that we're going to have a good baseload upon start-up. The transition timeline, so once the commissioning process will take months, there is a lot of different products, a lot of number of qualifications. So when you're talking about steady onstream continuous demand, it's going to be Q3 at the earliest before that sustainable stream of production is online.

And I am showing no further questions. I would now like to turn the call back over to Scott Behrens for closing remarks.

Thank you, Justin. 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 day.

This concludes today's conference call. Thank you for participating. You may now disconnect.