Some information contained in the Management's Discussion and Analysis is forward looking and involves risks and uncertainties. The Company operates in a cyclical industry and the results achieved this year are not necessarily an indication of future prospects for the Company. Actual results in future years may differ materially from the results presented below. Potential risks and uncertainties include, among others, fluctuations in the volume and timing of product orders, changes in demand for the Company's products, changes in technology, continued competitive pressures in the marketplace, outcomes of environmental contingencies, availability of raw materials, the ability to pass on raw material price increases, foreign currency fluctuations and general economic conditions.

Overview

The Company produces and sells intermediate chemicals that are used in a wide variety of applications worldwide. The overall business comprises three reportable segments:

• Surfactants - Surfactants, which accounted for 75 percent of 2008 consolidated net sales, are principal ingredients in consumer and industrial cleaning products such as detergents for washing clothes, dishes, carpets, floors and walls, as well as shampoos, body washes, toothpastes and fabric softeners. Other applications include germicidal quaternary compounds, lubricating ingredients, emulsifiers (for spreading agricultural products), plastics and composites and biodiesel. Surfactants are manufactured at six North American sites (five in the U.S. and one in Canada), three European sites (United Kingdom, France and Germany) and three Latin American sites (Mexico, Brazil and Colombia). The Company also owns 50 percent of a surfactant joint venture in the Philippines, which is not included in consolidated results or in the surfactant segment results, as it is accounted for under the equity method. In September 2008, the Company entered into a joint venture agreement with Nalco Company. The joint venture TIORCO, LLC was formed to market chemical solutions for increased production of crude oil and gas from existing fields. The Company has a 50 percent ownership interest in TIORCO, LLC and accounts for the venture under the equity method.

• Polymers - Polymers, which accounted for 22 percent of 2008 consolidated net sales, include three primary product lines: phthalic anhydride, polyols and polyurethane systems. Phthalic anhydride is used in polyester alkyd resins and plasticizers for applications in construction materials and components of automotive, boating and other consumer products. Polyols are used in the manufacture of laminate insulation board for the construction industry and are also sold to the appliance, flexible foam and coatings, adhesives, sealants and elastomers (C.A.S.E.) markets. Polyurethane systems products are used in specialty applications like aerospace and adhesives. In the U.S., polymer product lines are manufactured at the Company's Millsdale, Illinois, site. Polyols are also manufactured at the Company's Wesseling (Cologne), Germany facility, as well as at its joint venture in Nanjing, China (which is included in consolidated results). During the

• Specialty Products - Specialty products, which accounted for three percent of 2008 consolidated net sales, include flavors, emulsifiers and solubilizers used in the food and pharmaceutical industries. Specialty products are manufactured primarily at the Company's Maywood, New Jersey, site.

The Company has numerous competitors due to the diverse markets it serves. Competition is generally based on price, product performance and the ability to meet specific needs of customers. In some instances, particularly in the surfactants segment, the Company competes with internal manufacturing capabilities of its customers. This situation can lead to large period-to-period sales volume swings when such customers decide to internally manufacture product that the Company once supplied. In addition, the Company's manufacturing costs are relatively fixed in nature. As a result, gross profit (defined as net sales less cost of sales) is susceptible to disproportionate declines when volume decreases.

A number of the Company's key raw materials and energy sources are commodities, principally petroleum-based and plant-based materials and natural gas (used to power the Company's manufacturing facilities), whose prices fluctuate due to weather, general economic demand and other unpredictable factors. In recent years, raw material costs have escalated due to increased global demand, instability in the Middle East and tight supplies. This trend continued throughout most of 2008, and the Company passed on the increased costs to customers as quickly as the marketplace allowed. In the fourth quarter of 2008 the trend reversed, and raw material costs began to decline as a result of the global economic slowdown.

The Company's administrative expenses are subject to period-to-period fluctuations due principally to obligations associated with environmental remediation and related legal issues and to the accounting for the Company's deferred compensation plans. The Company operates in a setting of extensive local, state and federal regulations concerning the environment and has been named as a potentially responsible party to perform environmental remediation at a number of geographic sites. The Company believes it has adequate reserves for all known environmental sites, but an adverse determination could result in a significant negative effect on the Company's results of operations and cash flows. Expenses related to legal and environmental matters were essentially unchanged from 2007 to 2008 and declined $4.5 million from 2006 to 2007. Compensation expense related to the Company's deferred compensation plans declined over $2.0 million between 2007 and 2008 and $1.4 million between 2007 and 2006. Not included in administrative expenses is the investment-related income or expense for the mutual funds held by the Company to fund its deferred compensation obligations. The investment income or expense is included in the "Other, net" line in the "Other Income (Expense)" section of the Consolidated Statements of Income. The pretax effect of all deferred compensation related activities is displayed below:

                                                                  (Income) / Expense
                                                           For the Years Ended December 31
(Dollars in millions)                                    2008              2007            2006
Deferred Compensation (Administrative expense)        $      0.2        $      2.3        $  3.7
Investment Income (Other, net)                              (0.3 )            (1.2 )        (1.2 )
Unrealized (Gain) / Loss on Investments (Other,
net) (a)                                                     5.0                -             -

Net Pre-tax Income Effect                             $      4.9        $      1.1        $  2.5

(a) On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The Company elected the fair value option for the mutual fund investment assets held for its deferred compensation plans. As a result, unrealized gains and losses for the mutual funds are recorded in the income statement. See the 'Critical Accounting Policies' section of this Management Discussion and Analysis for additional information.

A number of events having significant effects on the Company's results of operations occurred in 2008 and 2007. The following are descriptions of those events:

Sale of Commodity Polyurethane Systems Product Lines

On July 31, 2008, the Company sold select polyurethane system product lines to Bayer MaterialScience LLC (Bayer). No physical assets were included in the sale. The sold product lines comprised insulation materials used in appliances, water heaters, doors, roofs, picnic coolers and other similar applications, and represented approximately $16.0 million in Company annual net sales. As consideration for the sale, the Company received $9.9 million of cash, all of which was recorded as a pretax gain in the third quarter ended September 30, 2008. The gain was attributed to the polymer segment. The Company will manufacture the products for Bayer during a transition period of up to two years.

Sale of Land

In September 2008, the Company sold 88 acres of land at its Millsdale manufacturing facility in Elwood, Illinois, to an industrial park developer for $8.6 million. The land had a cost basis of $0.1 million, so the Company recorded a pretax gain of $8.5 million in the third quarter ended September 30, 2008. The gain was not attributed to any reportable segment. For income tax purposes, the land disposition along with the acquisition of an office building near the Company's corporate headquarters were structured as a tax-deferred like-kind exchange, pursuant to Section 1031 of the Internal Revenue Code. The office building, purchased for $6.4 million, will house employees currently located in a leased facility that is nearing the end of its lease term. The Company will spend approximately $2.2 million to refurbish the facility.

Sale of Specialty Esters Product Line

On April 30, 2007, the Company sold its specialty ester surfactant product line for the personal care market to The HallStar Company (formerly CPH Holding Corporation). No physical assets were included in the sale. The product line represented approximately $15.0 million in Company annual net sales. The sale was for $6.2 million of cash plus the transfer to the Company of a specialty agricultural surfactant product line. As a result of the sale, the Company reported a $4.2 million pretax gain in 2007. The gain was net of related write-downs for equipment and inventory as well as severance charges and a provision for expected losses on the fulfillment of a manufacturing agreement associated with the product line sale.

Goodwill Impairment

As a result of performing the annual test of goodwill impairment (required by SFAS No. 142, Goodwill and Other Intangible Assets) in 2007, the Company determined that the goodwill reported for Stepan UK, a reporting unit of the Company's surfactants segment, was impaired. The amount of the impairment was $3.5 million, the entire balance of goodwill for Stepan UK. As a result, a $3.5 million non-cash goodwill impairment loss was recorded in 2007. The goodwill impairment reflected an estimated reduction in the fair value of Stepan UK's business as a result of lower discounted cash flow forecasts. Improvements in operating results were lower than previous forecasts used to test for impairments.

Results of Operations

2008 Compared with 2007

Summary

Net income for 2008 improved 146 percent to a record $37.2 million, or $3.52 per diluted share, compared to $15.1 million, or $1.50 per diluted share, for 2007. Below is a summary discussion of the major factors leading to the year-to-year changes in net sales, profits and expenses. A detailed discussion of segment operating performance for 2008 follows the summary.

Consolidated net sales increased $270.2 million, or 20 percent, between years. All reportable segments reported net sales increases. Higher average selling prices and the favorable effects of foreign currency translation accounted for approximately $278.4 million and $12.0 million, respectively, of the net sales increase. The recovery of higher raw material costs was the principal driver for the increase in average selling prices. A more favorable customer and product mix of sales also contributed. Sales volume fell two percent between years, which reduced the growth in net sales by $20.2 million. The lower sales volume was primarily due to lower phthalic anhydride and biodiesel volume, whereas higher margin products posted sales volume growth. Specialty products was the sole segment reporting a year-over-year increase in sales volumes, as surfactants and polymers posted volume declines of one percent and two percent, respectively.

Operating income for 2008 was $35.6 million, or 101 percent, greater than 2007 operating income. Gross profit was up $28.1 million, or 20 percent, from year to year. The

surfactants segment accounted for essentially all the year-to-year growth in gross profit. A favorable customer and product mix coupled with selling price increases that continued to recover margin lost in prior years due to rising raw material costs drove the surfactants result. Gross profit for the specialty products segment was up slightly. Lower sales volume and higher raw material and production costs led to a decline in polymer gross profit.

Operating expenses declined $7.4 million, or seven percent, between years. Operating expenses for 2008 included the $9.9 million gain on sale of the commodity polyurethane systems product lines and the $8.5 million gain on the sale of Millsdale land. Operating expenses for 2007 included a $4.2 million benefit from the gain on the sale of the Company's specialty esters product line, partially offset by a $3.5 million impairment charge of Stepan UK goodwill. Excluding the gains on sales and the impairment charge, operating expenses increased $10.2 million, or 10 percent. The following accounted for the increase:

                                                     Increase /
                  (Dollars in millions)              (Decrease)
                  Incentive-based Compensation       $       3.7
                  Provision for Bad Debts                    2.0
                  Salaries                                   1.6
                  Transition Pension Expense                 1.0
                  Foreign Currency Translation               1.0
                  Consulting and Professional Fees           0.9
                  Deferred Compensation Expense             (2.0 )
                  Other                                      2.0

                  Total                              $      10.2

Improved operating results drove the rise in incentive-based compensation, which includes stock-based pay, bonuses and profit sharing. The increase in bad debt expense reflected provision increases for specific customers and reserves for non-specific accounts. The increase in defined contribution transition pension expense was principally attributable to a Board of Directors-approved acceleration of a portion of discretionary Company contributions established to compensate certain employees for benefits lost when the Company froze its defined benefit plans in 2006 (consolidated pension transition expense was up $2.1 million between years; $1.1 million was allocated to cost of sales). The reduction in deferred compensation expense reflected a large drop in the market values of mutual funds held for the deferred compensation plans, which was somewhat mitigated by a $14.46 per share increase in the price of Company common stock (see the 'Critical Accounting Policies' section of this management discussion and analysis for an explanation of the accounting treatment for the Company's deferred compensation plans). The other category primarily comprises the culmination of smaller year-to-year variances for temporary help, agents' commissions, travel and entertainment expenses and miscellaneous fringe benefits.

Losses from equity joint ventures, which includes results for the 50-percent owned Stepan Philippines Inc. (SPI) and 50-percent owned TIORCO, LLC joint ventures, increased $2.3 million between years. SPI's loss increased $1.9 million between years and reflected the effect (approximately $1.1 million) of the Company reserving for royalty receivables due from SPI, the

collection of which was determined to be unlikely. Lower sales volume, unplanned production outages and foreign exchange losses also contributed to the increased loss. The recently-formed TIORCO, LLC contributed $0.4 million to the year-to-year increase in losses due to planned start-up costs.

Other, net expense increased $2.4 million from year to year. A $5.9 million drop in investment related income partially offset by a $3.5 million favorable swing in foreign exchange gains and losses, accounted for the year-to-year expense change. Unrealized losses on the mutual fund investments held for the Company's deferred compensation plans caused $5.0 million of the decline in investment related income. Prior to the Company's January 1, 2008, election of fair value accounting treatment for mutual fund investment assets, unrealized investment gains and losses were recorded directly to the equity section of the consolidated balance sheet. Lower capital gains distributions made by the mutual funds in 2008 than in 2007 accounted for the remainder of the investment income decline. Much of the favorable swing in foreign exchange gains and losses was attributable to the impact that the recent strengthening of the US dollar against the Canadian dollar had on a US dollar-denominated receivable carried on Stepan Canada's books.

The effective tax rate was 32.1 percent for 2008 compared to 36.6 percent for 2007. The prior year rate was unusually high due to the recording of a charge for UK goodwill impairment for which no tax benefit was realized. See Note 12 to the consolidated financial statements for a reconciliation of the statutory U.S. federal income tax rate to the effective tax rate.

Segment Results



                                                                Specialty      Segment
(Dollars in thousands)              Surfactants    Polymers     Products       Results     Corporate        Total
For the year ended
December 31, 2008
Net sales                           $  1,199,438   $ 359,014   $    41,678   $ 1,600,130          -      $ 1,600,130
Operating income                          52,261      34,103         5,949        92,313     (21,633 )        70,680

For the year ended
December 31, 2007
Net sales                           $    975,726   $ 321,228   $    32,947   $ 1,329,901          -      $ 1,329,901
Operating income                          29,716      28,044         5,946        63,706     (28,611 )        35,095

Surfactants

Surfactants net sales for 2008 increased $223.7 million, or 23 percent, over net sales for 2007. Higher average selling prices and the favorable effects of foreign currency translations accounted for approximately $233.3 million and $4.3 million, respectively, of the year-to-year change. Sales volume dropped one percent between years, which reduced the growth in net sales by about $13.9 million. A year-to-year comparison of net sales by region follows:

                                     For the Year Ended
                                December 31,     December 31,     Increase /    Percent
   (Dollars in thousands)           2008             2007         (Decrease)    Change
   North America               $      810,509   $      650,194   $    160,315       +25
   Europe                             269,524          228,970         40,554       +18
   Latin America                      119,405           96,562         22,843       +24

   Total Surfactants Segment   $    1,199,438   $      975,726   $    223,712       +23

Net sales for North American operations increased 25 percent between years due to a 26 percent increase in average selling prices. Higher selling prices accounted for approximately $167.6 million of the net sales growth. A one percent decline in sales volume reduced the net sales growth by $7.3 million. The increase in average selling prices reflected price increases related primarily to rising material costs and to a more favorable customer and product mix of sales. A 24 percent drop in biodiesel sales volume was the major contributor to the one percent decline in North American sales volume. Most other major product lines except laundry and cleaning products were also down between years. Sales volumes for laundry and cleaning products, North American operations' largest product line, increased 12 percent due to higher sales volume of fabric softener and new business.

The 18 percent increase in net sales for European operations was attributable to a 22 percent increase in average selling prices and the favorable effect of foreign currency translation, which accounted for $48.5 million and $1.8 million, respectively, of the increase. Sales volume declined four percent between years, reducing the year-to-year growth of net sales by $9.7 million. Selling price increases, related primarily to rising material costs, and a more favorable customer and product mix of sales caused the increase in average selling prices. Both the France

and UK subsidiaries contributed to the decline in sales volume, which resulted from business lost due to price competition and to the slowdown in business for two large customers.

Net sales for Latin American operations increased 24 percent from year to year due to a 22 percent improvement in average selling prices, the favorable effects of foreign currency translation and a two percent rise in sales volume, which accounted for about $19.4 million, $1.9 million, and $1.5 million, respectively, of the net sales increase. Selling price increases related to higher raw material costs led to the improved average selling prices. Additional business for the Company's Brazil and Colombia subsidiaries, partially offset by lower fabric softener sales volume for the Company's Mexico subsidiary, drove the sales volume gain.

Surfactants operating income for 2008 was $22.5 million, or 76 percent, higher than the prior year. 2007 operating income included a $4.2 million gain on the sale of the Company's specialty esters product line and a $3.5 million charge for the impairment of Stepan UK's goodwill. Gross profit increased $30.1 million, or 33 percent. All three regions posted higher year-to-year gross profit. Operating expenses increased $7.5 million, or 12 percent. Year-to-year comparisons of gross profit by region and total segment operating expenses and operating income follow:

                                     For the Year Ended
                                December 31,     December 31,     Increase /    Percent
   (Dollars in thousands)           2008             2007         (Decrease)    Change
   Gross Profit
   North America               $       85,982   $       68,785   $     17,197       +25
   Europe                              17,843           14,649          3,194       +22
   Latin America                       17,872            8,179          9,693      +119

   Total Surfactants Segment   $      121,697   $       91,613   $     30,084       +33

   Operating Expenses                  69,436           61,897          7,539       +12

   Operating Income            $       52,261   $       29,716   $     22,545       +76

Gross profit for North American operations improved 25 percent between years due largely to higher selling prices implemented to recover some margin lost in prior years to rising raw material costs. A more favorable customer and product mix also contributed to the gross profit improvement. The regaining of profit margin and the improved sales mix more than offset the effect of the one percent decline in sales volume. Most of the year-to-year profit improvement occurred in the first three quarters of 2008. Fourth quarter 2008 gross profit fell $3.0 million, or 17 percent, from fourth quarter 2007 gross profit. Much of the quarter-to-quarter decrease was attributable to declining biodiesel profitability resulting from the consumption of high priced raw material inventories as falling crude oil and diesel prices drove biodiesel selling prices lower.

Gross profit for European operations increased 22 percent due to higher average selling prices and a $0.9 million favorable impact of foreign currency translation that more than offset the effect of a four percent decline in sales volume. Selling price increases were made throughout the year to recoup some of the profit margin lost in previous years to persistent rising raw material costs. A more favorable mix of sales contributed to the improved gross profit.

Latin American operations' gross profit increased 119 percent as a result of gains at all three Latin American subsidiaries. Lower outsourcing costs, higher selling prices and the two percent rise in sales volume led to the improved gross profit. Outsourcing costs were unusually high in the prior year because Stepan Mexico purchased finished goods for resale while an expansion of its manufacturing facility and product approvals were being completed. The favorable effects of foreign currency translation added approximately $0.4 million to the region's total year-to-year gross profit growth.

Operating expenses for the surfactants segment were up $7.5 million, or 12 percent, from 2007 to 2008. Excluding the effects of foreign currency translation, the 2007 product line sale and the 2007 Stepan UK impairment charge, operating expenses increased $6.2 million, or 10 percent. Marketing and research and development expenses for North American operations accounted for approximately $2.7 million and $2.2 million, respectively, of the total operating expense increase. Higher incentive-based compensation, pension transition expense and salary expense accounted for most of the North American marketing and research and development expense increases. Higher bad debt expense and consulting fees also contributed to the rise in marketing expense.

Polymers

Polymer net sales for 2008 increased $37.8 million, or 12 percent, over net sales for 2007. Higher selling prices and the favorable effects of foreign currency translation accounted for approximately $37.3 million and $7.7 million of the net sales improvement, respectively. Sales volume declined two percent between years, which reduced the sales improvement by $7.2 million. A year-to-year comparison of net sales by region is displayed below:

                                    For the Year Ended
                               December 31,     December 31,     Increase /    Percent
     (Dollars in thousands)        2008             2007         (Decrease)    Change
     North America            $      253,514   $      240,553   $     12,961        +5
     Europe                           93,072           69,840         23,232       +33
     Asia and Other                   12,428           10,835          1,593       +15

     Total Polymers Segment   $      359,014   $      321,228   $     37,786       +12

. . .