UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007MARCH 31, 2008

FOR THE TRANSITION PERIOD FROM            TO            

1-4462

Commission File Number

STEPAN COMPANY

(Exact name of registrant as specified in its charter)

Edens and Winnetka Road, Northfield, Illinois 60093

(Address of principal executive offices)

Registrant’s telephone number (847) 446-7500

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a non-accelerated filer.smaller reporting company. See definitiondefinitions of “accelerated filer and large“large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Item 1 -— Financial Statements

STEPAN COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

Unaudited

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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STEPAN COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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STEPAN COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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STEPAN COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007March 31, 2008

Unaudited

The condensed consolidated financial statements included herein have been prepared by Stepan Company (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate and make the information presented not misleading. In the opinion of management, all normal recurring adjustments necessary to present fairly the condensed consolidated financial position of the Company as of September 30, 2007,March 31, 2008, and the condensed consolidated results of operations for the three and nine months then ended and cash flows for the ninethree months then ended March 31, 2008 and 2007, have been included. These financial statements and related footnotes should be read in conjunction with the financial statements and related footnotes included in the Company’s 20062007 Form 10-K.

In January 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.SFAS No. 159 expands the scope of what entities may carry at fair value by offering an irrevocable option to record many types of financial assets and liabilities at fair value. Period-to-period changes in fair value are recorded in an entity’s income statement.

On January 1, 2008, the Company elected the fair value option for the mutual fund investment assets related to its deferred compensation plans. The fair value election for the mutual fund investment assets was made to reduce the income volatility caused by the prior accounting treatment for the Company’s deferred compensation plans. In accordance with SFAS No. 159, the mutual fund investment assets, which were previously classified as available-for-sale securities, are treated as trading securities. Therefore, beginning in the first quarter of 2008, fair value changes for the mutual fund investment assets are recorded in the income statement in the same periods that the offsetting changes in the deferred compensation liabilities are recorded. In prior years, value changes for the mutual fund investments were recorded as direct adjustments to shareholders’ equity in accumulated other comprehensive income.

In compliance with the transition rules of SFAS No. 159, $834,000 of cumulative unrealized mutual fund investment gains (net of taxes of $540,000), which were included in accumulated other comprehensive income on December 31, 2007, were reclassified into retained earnings in January 2008. Unrealized gains on trading securities for the period ended March 31, 2008, were $1,291,000. The gains were recorded in the Other, net line of the consolidated statements of income.

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In January 2008, the Company also adopted SFAS No. 157,Fair Value Measurements. The guidance in the new standard is applicable in circumstances where other accounting pronouncements mandate or permit fair value measurements. In February 2008, the FASB issued FASB Staff Position Nos. FAS 157-1 and FAS 157-2 (FSP FAS 157-1 and 157-2). FSP FAS 157-1 excludes SFAS No. 13,Accounting for Leases, as well as other accounting pronouncements that address fair value measurements for leases, from the scope of SFAS No. 157. FSP FAS 157-2 delays the effective date of SFAS No. 157 for all nonrecurring fair value measurements of nonfinancial assets and liabilities until fiscal years beginning after November 15, 2008.

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard establishes a framework, in the form of a three-level hierarchy, for measuring fair value. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value. It gives the highest priority, Level 1, to inputs that are quoted prices in active markets for identical assets and liabilities. Level 2 represents inputs other than quoted prices included within Level 1 that are directly or indirectly observable and market-based information for similar assets and liabilities. Level 3 includes unobservable inputs which reflect the entity’s own assumptions about the assumptions market participants use in pricing the assets and liabilities.

Currently, the only recurring fair value measurement that the Company makes is for the mutual fund assets related to the deferred compensation plans. The fair value for mutual fund assets are measured using observable quoted prices for identical assets in active markets, and their total fair value is the published market price per unit multiplied by the number of units held. The fair value measurements for the Company’s mutual funds fall entirely within Level 1 of the fair value hierarchy. The fair value of the mutual fund investment assets were $13,267,000 and $14,803,000 at March 31, 2008 and December 31, 2007, respectively.

The Company has stock options outstanding under its 1992 Stock Option Plan and stock options and performance stock awards outstanding under its 2000 Stock Option Plan and its 2006 Incentive Compensation Plan. Compensation expense charged against income for all plans was $274,000$921,000 and $757,000, respectively,$207,000 for the three and nine months ended September 30,March 31, 2008 and 2007, compared to $102,000 and $298,000, respectively, for the three and nine months ended September 30, 2006.respectively. Unrecognized compensation cost for stock options and stock awards was $688,000$1,177,000 and $667,000,$1,962,000, respectively, at September 30, 2007,March 31, 2008, compared to $370,000$504,000 and $314,000,$574,000, respectively, at December 31, 2006.2007. The period-to-period increasesquarter-to-quarter increase in compensation expense and the increases in unrecognized compensation costs since December 31, 2006,2007, resulted primarily from management’s first quarter 20072008 assessment that the probable levels of profitability on which the vesting of performance stock awards are based would be higher than originally projected, which led to an increase in the number of performance stock awards that are ultimately expected to vest. Also contributing to the increase in compensation expense and unrecognized compensation costs were first quarter 2008 grants of 113,600118,850 stock options and 90,00094,500 performance stock awards made under the Company’s 2006 Incentive Compensation Plan.awards. The unrecognized compensation expensecost at September 30, 2007,March 31, 2008, is expected to be recognized over weighted average periods of 1.21.6 years and 1.92.1 years for stock options and performance stock awards, respectively.

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Inventories comprise the following:

Inventories are priced primarily priced using the last-in, first-out (LIFO) inventory valuation method. If the first-in, first-out (FIFO) inventory valuation method had been used for all inventories, inventory balances would have been approximately $29,080,000$32,544,000 and $24,555,000$30,961,000 higher than reported at September 30, 2007,March 31, 2008, and December 31, 2006,2007, respectively.

There are a variety of legal proceedings pending or threatened against the Company. Some of these proceedings may result in fines, penalties, judgments or costs being assessed against the Company at some future time. The Company’s operations are subject to extensive local, state and federal regulations, including the U. S.U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and the Superfund Amendments of 1986 (“Superfund”). Over the years, the Company has received requests for information related to or has been named by the government as a PRP at 23 waste disposal sites where clean up costs have been or may be incurred under CERCLA and similar state statutes. In addition, damages are being claimed against the Company in general liability actions for alleged personal injury or property damage in the case of some disposal and plant sites. The Company believes that it has made adequate provisions for the costs it may incur with respect to these sites.

The Company has estimated a range of possible environmental and legal losses from $9.0$10.1 million to $38.0$34.4 million at September 30, 2007.March 31, 2008. At September 30, 2007,March 31, 2008, the Company’s accrued liability for such losses, which represents the Company’s best estimate within the estimated range of possible environmental and legal losses, was $17.2$17.1 million compared to $22.1$17.2 million at December 31, 2006. The December 31, 2006,2007. During the first three months of 2008, non-capital cash outlays related to September 30, 2007, reductionlegal and environmental matters approximated $0.5 million compared to $3.9 million in the accrued liability balance for environmental and legal losses resulted primarily fromfirst three months of 2007. In the payments made forprior year quarter, the previously disclosedCompany paid a personal injury settlement related to the Company’s formerly owned site in Wilmington, Massachusetts and the settlements reached with respect to the D’Imperio and Ewan Superfund Sites.Massachusetts.

For certain sites, estimates cannot be made of the total costs of compliance or the Company’s share of such costs; consequently, the Company is unable to predict the effect thereof on the Company’s financial position, cash flows and results of operations.

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Management believes that in the event of one or more adverse determinations in any annual or interim period, the impact on the Company’s cash flows and results of operations for those periods could be material. However, based upon the

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Company’s present belief as to its relative involvement at these sites, other viable entities’ responsibilities for cleanup, and the extended period over which any costs would be incurred, the Company believes that these matters, individually and in the aggregate, will not have a material effect on the Company’s financial position.

Following are summaries of the material contingencies at September 30, 2007:March 31, 2008:

Maywood, New Jersey Site

The Company’s property in Maywood, New Jersey and property formerly owned by the Company adjacent to its current site and other nearby properties (Maywood site) were listed on the National Priorities List in September 1993 pursuant to the provisions of CERCLA because of certain alleged chemical contamination. Pursuant to an Administrative Order on Consent entered into between USEPA and the Company for property formerly owned by the Company, and the issuance of an order by USEPA to the Company for property currently owned by the Company, the Company completed a Remedial Investigation Feasibility Study (RI/FS) in 1994. The Company submitted the Draft Final FS for Soil and Source Areas (Operable Unit 1) in September 2002. In addition, the Company submitted the Draft Final FS for Groundwater (Operable Unit 2) in June 2003 and also submitted additional information regarding groundwater in May 2007. The Company is awaiting the issuance of a Record of Decision (ROD) from USEPA relating to the Maywood site and the proposed chemical remediation. The final ROD will be issued sometime after a public comment period.

Also, the New Jersey Department of Environmental Protection (NJDEP) filed a complaint against the Company and other entities on February 6, 2006, alleging that the defendants discharged hazardous substances at the Maywood site and at neighboring properties not part of the Maywood site resulting in damage to natural resources and the incurrence of response costs. The complaint was amended and removed to federal court but was remanded to state court on September 22, 2006.

The Company believes it has adequate reserves for claims associated with the Maywood site, and has recorded a liability for the estimated probable costs it expects to incur at the Maywood site related to remediation of chemical contamination. However, depending on the results of the ongoing discussions with USEPA, the final cost of such remediation could differ from the current estimates.

In addition, under the terms of a settlement agreement reached on November 12, 2004, the United States Department of Justice and the Company agreed to fulfill the terms of a Cooperative Agreement reached in 1985 under which the United States will take title to and responsibility for radioactive waste removal at the Maywood site, including past and future remediation costs incurred by the United States.

8

Ewan, D’Imperio and Lightman Drum Company SitesProperty Site

During the mid-1970’s, Jerome Lightman and the Lightman Drum Company disposed of hazardous substances at several sites in New Jersey. The Company has beenwas named as a potentially responsible party (PRP) in the caseUnited States v. Lightman

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(1: (1:92-cv-4710 D.N.J.), which involved the D’Imperio SuperfundProperty Site and the Ewan Superfund Site, both located in New Jersey. In the second quarter of 2007, the Company reached an agreement with respect to the past costs and future allocation percentage in said litigation for costs related to the D’Imperio Superfund Site,site, including costs to comply with USEPA’s Unilateral Administrative Orders, as well as for the past costs and allocation percentage at the Ewan Superfund Site.Orders. The Company paid the settlement amount in the third quarter of 2007. OnThe resolution of the Company’s liability for this litigation did not have a related matter and as a conditionmaterial impact on the financial position, results of settlement,operations or cash flows of the Company. In December 2007, the Company dismissed its appeal currently pendingreceived updated remediation cost estimates, which were considered in the Company’s determination of its range of estimated possible losses and reserve balance at December 31, 2007.

Remediation work is continuing at this site. Based on current information, the Company believes that it has adequate reserves for claims associated with the D’Imperio site. However, actual costs could differ from current estimates.

Ewan Property Site

The caseUnited States Third Circuit Court of Appeals objectingv. Lightman (1:92-cv-4710 D.N.J.), described above for the D’Imperio site, also involved the Ewan Property Site located in New Jersey. The agreement described above also included a settlement with respect to the lodging of a partial consent decree in favor of the United States Government in this litigation. Under the partial consent decree, the government recovered past costs and future allocation percentage in said litigation for costs related to the past costs and allocation percentage at the D’Imperio Superfund Site from all PRPs including the Company.Ewan site. The Company paid its assessed share but will not seek to recover the sums it paid now that the settlement amount in the third quarter of 2007. The resolution of the Company’s liability for this litigation did not have a material impact on the financial position, results of operations or cash flows of the Company.

There is finalized.

In addition tosome monitoring and operational work continuing at the Ewan and D’Imperiosite. Based on current information, the Company believes that it has adequate reserves for claims associated with the Ewan site. However, actual costs could differ from current estimates.

Lightman Drum Company Superfund Sites, theSite

The Company received a Section 104(e) Request for Information from USEPA dated March 21, 2000, regarding the Lightman Drum Company Superfund Site located in Winslow Township, New Jersey. The Company responded to this request on May 18, 2000. In addition, the Company received a Notice of Potential Liability and Request to Perform RI/FS dated June 30, 2000, from USEPA. The Company decided that it will participate in the performance of the RI/FS as a member of the Lightman Yard PRP Group. Due to the addition of other PRPs, the Company’s allocation percentage decreased. However, the allocation has not yet been finalized by the Lightman Yard PRP Group.

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The Feasibility Study was submitted to USEPA in December 2007. The PRPs who agreed to conduct the interim remedial action will enterentered into an Administrative Settlement Agreement and Order on Consent for Removal Action with USEPA, and these PRPs will also enterentered into a Supplemental Lightman Yard Participation and Interim Funding Agreement to fund the agreed uponagreed-upon removal action. Both of these agreements are currently being negotiated. When the agreements are finalized, theThe Company will pay forpaid a soil removal assessment upon execution of the agreements which isdid not expected to have a material impact on the financial position, results of operations or cash flows of the Company. In December 2007, the Company received updated remediation cost estimates, which were considered in the Company’s determination of its range of estimated possible losses and reserve balance at December 31, 2007.

The Company believes that based on current information it has adequate reserves for claims associated with the Jerome Lightman-related environmental sites.Lightman site. However, actual costs could differ from current estimates.

Wilmington Site

The Company is currently contractually obligated to contribute to the response costs associated with the Company’s formerly-owned site at 51 Eames Street, Wilmington, Massachusetts. Remediation at this site is being managed by its current owner to whom the Company sold the property in 1980. Under the agreement, once total site remediation costs exceed certain levels, the Company is obligated to contribute up to five percent of future response costs associated with this site with no limitation on the ultimate amount of contributions. To date, the Company has paid the current owner $1.4$1.5 million for the Company’s portion of environmental response costs through the secondthird quarter of 2007 (the current owner of the site bills the Company one calendar quarter in arrears). At September 30, 2007,The Company has recorded a liability for its portion of the Company’s reserve is $1.1 millionestimated remediation costs for current and future claims associated with thisthe site. Depending on the ultimate cost of the remediation at this site, the amount for which the Company is liable could differ from the current estimates.

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In addition, in response to the special notice letter received by the PRPs in June 2006 from USEPA seeking performance of an RI/FS at the site, certain PRPs, including the Company, signed an Administrative Settlement Agreement and Order on Consent for the RI/FS effective July 2007.

The Company and other prior owners also entered into an agreement in April 2004 waiving certain statute of limitations defenses for claims which may be filed by the Town of Wilmington, Massachusetts, in connection with this site. While the Company has denied any liability for any such claims, the Company agreed to this waiver while the parties continue to discuss the resolution of any potential claim which may be filed.

As a result of the settlement for the case regarding alleged personal injury claims, the company recorded a fourth quarter 2006 charge of $3.0 million for this settlement. The settlement amount was paid in the first quarter of 2007 and the case has been dismissed.

The Company believes that based on current information it has adequate reserves for the claims related to this site.

Other Sites

The Company has been named as a de minimis PRP at other sites, and as such the Company believes that a resolution of its liability will not have a material impact on the financial position, results of operations or cash flows of the Company.

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Defined Benefit Pension Plans

Millsdale/Anaheim Hourly Defined Pension Plan

In July 2007, the hourly workers at the Company’s Millsdale plant in Elwood, Illinois, ratified a new union contract, which resulted in an amendment to the Stepan Company Retirement Plan for Millsdale Hourly and Anaheim Hourly Employees (the “Plan”), a defined benefit pension plan. The amendment was effective July 16, 2007. The Millsdale portion of the Plan was frozen at August 31, 2007, and, as a result, accruals for service benefits ceased as of that date. In addition, no new Millsdale union employees are eligible to participate in the Plan. Benefits earned through August 31, 2007, are available to participants when they retire, in accordance with the terms of the Plan. The amendment also increased the multiplier that is used in the formula to compute the benefit due a Millsdale union participant. The Plan changes had no impact on current retirees, former employees with vested benefits, or Anaheim union participants. As of August 1, 2007, the Company established a defined contribution plan for the Millsdale union workers that has a fixed Company contribution rate of four percent of base wages. In addition, the Company agreed to a supplemental transition benefit.

As a result of the amendment, the Company remeasured the obligations and assets of the Plan as of July 2007. With the exception of the discount rate, which was increased from 6.00 percent to 6.25 percent, the assumptions used in the remeasurement of the pension plan obligations were the same as those used in the December 31, 2006, measurement, as disclosed in the Company’s 2006 Annual Report on Form 10-K. The amendment resulted in a $1,325,000 curtailment loss that was recognized as a component of the net periodic benefit cost recorded for the three-month period ended September 30, 2007. At the time of remeasurement, the funded status of the plan was an excess of plan obligations over plan assets of $2,166,000 compared to $2,913,000 at December 31, 2006.

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Components of Net Periodic Benefit Cost

Employer Contributions

U.S. Plans

The Company expects to contribute approximately $4,931,000$750,000 to its U.S. qualified defined benefit pension plans in 20072008 and to pay $108,000$328,000 in 20072008 related to its unfunded non-qualified plans. As of September 30, 2007, $4,931,000March 31, 2008, no contributions had been contributedmade to the qualified plans and $89,000$39,000 had been paid related to the non-qualified plans.

U.K. Plan

Stepan UK Limited expects to contribute approximately $427,000$381,000 to its defined benefit pension plan in 2007.2008. As of September 30, 2007, $286,000March 31, 2008, $95,000 had been contributed to the plan.

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Defined Contribution Plans

Defined contribution plan expense for the Company’s retirement savings plans was $1,125,000 and $3,183,000, respectively,$1,386,000 for the three and nine months ended September 30, 2007March 31, 2008 and $1,017,000$1,129,000 for the three and nine months ended September 30, 2006. The Company began sponsoring defined contribution retirement savings plans on July 1, 2006.March 31, 2007.

ExpensesExpense related to the Company’s profit sharing plan were $75,000was $674,000 and $725,000, respectively,$343,000 for the three and nine months ended September 30,March 31, 2008 and 2007, compared to $300,000 and $800,000, respectively, for the three and nine months ended September 30, 2006.respectively.

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Below is the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2007March 31, 2008 and 2006.2007.

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Comprehensive income includes net income and all other non-shareholdernon-owner changes in equity that are not reported in net income. Below is the Company’s comprehensive income for the three and nine months ended September 30, 2007March 31, 2008 and 2006.2007.

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 $15,000,000 in Company net sales. The products, which are manufactured at the Company’s Maywood, New Jersey, facility, will continue to be produced for The HallStar Company during a transition period of up to one year. The sale was for $6,200,000 of cash plus the transfer to the Company of a specialty agricultural surfactant product line, which included $250,000 of intangible assets and $196,000 of inventory. As a result of the sale, the Company reported a $4,290,000 pretax gain in the second quarter ended June 30, 2007. The entire gain was attributable to the Company’s surfactants segment. The gain was net of $2,356,000 of write-downs for equipment and inventory ($739,000) as well as severance charges ($17,000) and a provision for expected losses on the fulfillment of a manufacturing agreement associated with the product line sale ($1,600,000).

For the three months ended September 30, 2007, the Company recorded an additional $35,000 in severance expenses, primarily for severance accruals for employees who will remain on the workforce until HallStar can successfully transfer the manufacture of the specialty esters to its own facilities. It is anticipated that an additional $30,000 of severance expense will be recorded in the final quarter of 2007. As of September 30, 2007, the pretax gain on the sale of the specialty esters product line was $4,255,000.

The Company pursued the product line sale after reviewing strategic alternatives for improving the profitability of its Maywood, New Jersey, plant. The reconfigured plant will continue to produce esters for the industrial markets as well as the Company’s specialty flavor and food ingredient products.

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The Company tests its goodwill balances for impairment in the second quarter of each calendar year. The 2007 test indicated that the goodwill related to its United Kingdom subsidiary (Stepan UK) was impaired. Stepan UK is a reporting unit of the Company’s surfactants reportable segment. 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 for the business. Improvements in the reporting unit’s operating results have been lower than previous forecasts used to test for impairments. As a result of the impairment, the Company recorded a non-cash $3,467,000 charge against operating income for the three months ended June 30, 2007. The charge equaled the entire balance of Stepan UK’s goodwill. The fair value of Stepan UK was estimated using the present value of future cash flows. No impairment of goodwill related to other Company reporting units was indicated by the annual test.

The Company has three reportable segments: surfactants, polymers and specialty products. Segment operating results for the three and nine months ended September 30,March 31, 2008 and 2007, and 2006 are summarized below:

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Below are reconciliations of segment operating income to consolidated income before income taxes and minority interest:taxes:

Debt comprises the following:

The various loan agreements contain provisions, which, among others, require maintenance of certain financial ratios and place limitations on additional debt, investments and payment of dividends. The Company is in compliance with its loan agreements.

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Other, net in the consolidated statements of income included the following:

The changes in foreign exchange gains/Investment related loss for the first three months of 2008 included $1,291,000 of unrealized losses reflected the sharp decline in the U.S. dollar in relation to other foreign currencies. The majority of the 2007 exchange loss related to the re-valuation of dollar-denominated receivables held by the Company’s Canadian subsidiary.on mutual fund investment assets. See Note 2.

In January 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation 48 (FIN 48),Accounting for Uncertainty in Income Taxes. As a result of the implementation, the Company recognized a $467,000 decrease to liabilities for uncertain tax positions. As required by FIN 48, this decrease was accounted for as an adjustment to the January 1, 2007, balance of retained earnings on the balance sheet. Including the cumulative effect decrease, the Company had approximately $1,599,000 of total unrecognized tax benefits at January 1, 2007. This liability included an estimate of interest and penalties. Of the total liability for unrecognized tax benefits, $1,392,000 (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future period. As of September 30, 2007, unrecognized tax benefits totaled $1,622,000. Of this liability, approximately $1,385,000 (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future periods.

The Company elected to include interest and penalty amounts within the tax provision. The total amount of accrued interest and penalties as of the date of adoption was $374,000. For the nine months ended September 30, 2007, an additional $56,000 of interest and penalties were recorded.

The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The Company is not subject to U.S. federal income tax examinations by tax authorities for years before 2003. Some foreign jurisdictions and various U.S. states jurisdictions may be subject to examination back to 2001.

The effective tax rate decreased to 32.0 percent for the quarter ended September 30, 2007, compared to 34.1 percent for the quarter ended September 30, 2006, primarily due to increased tax credits recognized in 2007. The year-to-date effective tax rate rose to 33.1 percent compared to 31.8 percent in the prior year. The increase was attributable to the goodwill impairment charge of $3,467,000 (see Note 9), which is not tax deductible.

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Partially offsetting this increase was a $711,000 reduction in the German valuation allowance based on recent and forecast improvement in the German taxable income. As a result, 100 percent of the remaining German tax loss carryforward has been recognized.

During the quarter ended March 31, 2006, the Company reached a $900,000 settlement agreement with its electricity provider for lost profits and expenses incurred by the Company as a result of a 2005 unplanned electric outage precipitated by an undersized transformer installed by the electricity provider. The settlement income was recorded as a reduction of Cost of Sales in the Condensed Consolidated Statements of Income and was allocated to the polymers ($667,000) and surfactants ($233,000) segments.

In September 2006,December 2007, the FASB issued Statement of Financial Accounting Standards (SFAS)Board (FASB) issued SFAS No. 157,141(R),Fair Value MeasurementsBusiness Combinations, which is effective on a prospective basis for business combinations having acquisition dates on or after the beginning of the first annual reporting years beginning on or after December 15, 2008 (January 1, 2009, for the Company). SFAS No. 141(R) replaces SFAS No. 141,Business Combinations. This statement definesThe objective of the standard is to improve the reported financial information about an entity’s business combinations and their effects. The standard establishes principles and requirements for recognizing and measuring the identifiable assets acquired, the liabilities assumed, noncontrolling interests and goodwill acquired or bargain purchase gain. Major changes from current accounting treatment for business combinations include measuring more types of acquired assets and liabilities at fair value, provides a framework for measuringremeasuring any contingent consideration at fair value in generally acceptedsubsequent reporting periods and expensing all acquisition-related costs. Principles and requirements are also set forth for determining relevant financial statement disclosure information. Because the requirements of SFAS No. 141(R) are primarily for prospective business combinations, the standard is not expected to have an effect on the Company’s financial position, cash flows or results of operations.

In December 2007, the FASB released SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements, which is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (January 1, 2009, for the Company). SFAS No. 160 amends Accounting Research Bulletin No. 151. The objective of the standard is to improve the financial information about noncontrolling interests reported in an entity’s consolidated financial statements. SFAS No. 160 establishes accounting principles and expands disclosures aboutreporting standards that require the clear presentation of noncontrolling interests in an entity’s consolidated balance sheets and income statements. This includes reporting noncontrolling interests as a component of stockholders’ equity, but separate from the parent company’s equity. The standard also requires that noncontrolling interests are initially to be measured at fair value measurements.value. The guidanceCompany is in the new standard is applicable in circumstances where other accounting pronouncements mandate or permit fair value measurements.process of analyzing the impact, if any, of this pronouncement on its financial statements.

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In March 2008, the FASB released SFAS No. 157,161,Disclosures about Derivative Instruments and Hedging Activities, which is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2007, does not require any new fair value measurements. However,2008 (January 1, 2009, for the Company). Early application ofis encouraged. SFAS No. 161 amends and expands the new standard may alter an entity’s current practice. The Company is in the process of determining the effect, if any, that adoptiondisclosure requirements of SFAS No. 157 will have on its133,Accounting for Derivative Instruments and Hedging Activities, with the intent to provide users of financial statements with an enhanced understanding of how and why an entity uses derivative instruments, how these instruments and related hedged items are accounted for under SFAS No. 133 and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and, cash flowsflow. To meet those objectives, this statement requires qualitative disclosures about objectives and results of operations.

In February 2007, the FASB issued SFAS No. 159,The Fair Value Optionstrategies for Financial Assets and Financial Liabilities.SFAS No. 159 expands the scope of what entities may carry atusing derivatives, quantitative disclosures about fair value by offering an irrevocable option to record many typesamounts of financial assets and liabilities at fair value. Changesgains and losses on derivative instruments and disclosures about credit-risk-related contingent features in fair value would be recorded in an entity’s income statement. This accounting standard also establishes presentation and disclosure requirements that are intended to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for the Company on January 1, 2008. Earlier application is permitted under certain circumstances.derivative agreements. The Company is inwill begin to assess the process of assessing the impact, if any,effect that the adoption of SFAS No. 159 will161 may have on its financial position, cash flows and results of operations.reporting.

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Item 2 - 2—Management’s Discussion and Analysis of Financial Conditions and Results of Operations

The following is Management’s Discussion and Analysis of certain significant factors whichthat have affected the Company’s financial condition and results of operations during the interim period included in the accompanying condensed consolidated financial statements.

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:

Two events having significant effects onOn January 1, 2008, the Company’s year-to-date resultsCompany adopted Statement of operations occurred inFinancial Accounting Standards (SFAS) No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.SFAS No. 159 expands the second quarterscope of 2007: the sale of the Company’s specialty esters product line and the impairment of the goodwill related to the Company’s United Kingdom subsidiary (Stepan UK). The following is a discussion of those two events:what entities may carry at fair value by offering an irrevocable

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Saleoption to record many types of Specialty Esters Product Line

On April 30, 2007,financial assets and liabilities at fair value. Concurrent with its adoption of SFAS No. 159, the Company sold its specialty ester surfactant product lineelected the fair value option for the personal care marketmutual fund investment assets related to its deferred compensation plans. The HallStar Company (formerly CPH Holding Corporation)fair value election for the mutual fund investment assets was made to reduce the income volatility caused by the prior accounting treatment for the Company’s deferred compensation plans and related investment assets. Specifically, beginning in 2008, fair value changes for the mutual fund investment assets are recorded in the income statement in the same periods that the offsetting changes in the deferred compensation liabilities are recorded in the income statement (the changes, however, are on different lines of the consolidated income statement: Other, net for mutual fund investment value changes and Administrative expense for deferred compensation liability changes). No physical assetsIn prior years, value changes for the mutual fund investments were recorded as direct adjustments to shareholders’ equity in the accumulated other comprehensive income line of the balance sheet while the changes in deferred compensation liability related to the mutual funds were recorded in the income statement. The accounting treatment for the portions of the deferred compensation liabilities that are tied to the Company’s common stock values is not affected by the fair value election. In compliance with the transition rules of SFAS No. 159, $834,000 of cumulative unrealized mutual fund investment gains, net of taxes, which were included in the sale. The product line represented approximately $15.0 millionaccumulated other comprehensive income on December 31, 2007, were reclassified into retained earnings in Company net sales. The products, which are manufactured at the Company’s Maywood, New Jersey, facility, will continue to be produced for The HallStar Company during a transition period. The sale was for $6.2 million of cash plus the transfer to the Company of a specialty agricultural surfactant product line. AsJanuary 2008. In addition, as a result of the sale, the Company reported a $4.3 million pretax gain in the second quarter ended June 30, 2007. The gain was netapplication 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. See Note 8 to the Condensed Consolidated Financial Statements for additional detail regarding the recorded gain.

The Company pursued the product line sale after reviewing strategic alternatives for improving the profitability of its Maywood, New Jersey, plant. The reconfigured plant will continue to produce esters for the industrial markets as well as the Company’s specialty flavor and food ingredient products. The reduced cost structure of the remaining businesses is expected to increase the site’s profitability in 2008.

Goodwill Impairment

As required by SFAS No. 142,Goodwill and Other Intangible Assets, the Company performs an annual impairment test159, $1.3 million of goodwill. The Company performs its test during the second calendarexpense related to a first quarter of each year. The first step of the goodwill impairment test is to compare each reporting unit’s net book value to its fair value. If fair value exceeds net book value then no impairment is indicated, and no further steps must be performed. The 2007 test identified that the book value of Stepan UK, a reporting unit of the Company’s surfactants segment, exceeded its fair value. The fair value of Stepan UK was estimated by applying a discounted cash flow method to the projected cash flows of Stepan UK. Because the first step of the test indicated a potential impairment of goodwill, a second step was required to determine the amount, if any, of the impairment. The second step compares the implied fair value of goodwill (i.e., the reporting unit’s fair value less2008 decline in the fair value of the reporting unit’s netCompany’s mutual fund assets excluding goodwill) to the book value of goodwill. If the book value of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized in the amount of the excess. Upon completion of the second step, the Company determined that the impairment loss for Stepan UK was $3.5 million, the entire amount of goodwill on Stepan UK’s books. The $3.5 million non-cash goodwill impairment loss was recorded in the Other, net line of the consolidated income statement for the three month periodmonths ended June 30, 2007.

March 31, 2008. The goodwill impairment reflected an estimated reduction indeferred compensation liability impact of the fair value decline in the mutual fund investments, which was $1.3 million of Stepan UK’s business as a resultincome, was part of the increased risk$0.7 million deferred compensation expense included in the Administrative expense line of attaining the forecasted future cash flows.condensed income statement for the three months ended March, 31, 2008. An increase in the Company’s common stock price accounted for the balance of the deferred compensation expense. The increased riskpretax effect of all deferred compensation related activities is attributed to increases in sales volume expected from the shutdown of a competitor not materializing to the degree originally anticipated, coupled with lower than expected margins.displayed below:

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No impairment of goodwill related to other Company reporting units was indicated by the annual test.

RESULTS OF OPERATIONS

Three Months Ended September 30,March 31, 2008 and 2007 and 2006

Summary

Net income for the thirdfirst quarter of 2007 declined 492008 improved 54 percent to $3.1$8.7 million, or $0.31$0.85 per diluted share, compared to $6.1$5.7 million, or $0.61$0.56 per diluted share, for the thirdfirst quarter of 2006.2007. Operating income increased $6.3 million, or 60 percent, due largely to improved profitability for the surfactants segment. Pretax income was down $4.6increased $4.7 million, or 50 percent, from quarter to quarter. Gross profit58 percent. The effect of the operating income improvement on pretax income was down $1.0 million between quarters. Third quarter 2007 gross profit was negatively affectedpartially offset by $1.3 million of curtailment expense resulting from freezingrelated to a decline in the Millsdale portionfair value of the Company’s Millsdale/Anaheim defined benefit pension plan. Operating expenses increased $2.1 million, due principally to a $1.6 million increase inmutual fund investment assets held as partial funding for deferred compensation expense. A $1.4 million increaseplans. (See the foregoing ‘Overview’ section of this discussion for comments regarding the change in foreign exchange losses also negatively affected pretax income. The value of the U.S. dollar fell sharply relative to the value of other foreign currencies. A majority of the exchange loss related to the re-valuation of dollar-denominated receivables held byaccounting treatment arising from the Company’s Canadian subsidiary.January 1, 2008, adoption of SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.) Below is a summary discussion of the major factors leading to the quarter-to-quarter changes in net sales, profits and expenses. A detailed discussion of segment operating performance for the thirdfirst quarter of 20072008 follows the summary.

ConsolidatedFirst quarter 2008 consolidated net sales for the third quarter of 2007 were $35.6$68.4 million, or 1222 percent, higher than thirdfirst quarter 20062007 consolidated net sales. All reportable segments reported net sales increases. A nine percent improvement inHigher average selling prices and the favorable effects of foreign currency translation accounted for approximately $28.1$63.0 million and $8.0$12.8 million, respectively, of the net sales increase. Consolidated salesHigher average selling prices reflected numerous price increases effected since the first quarter of 2007 to pass on the cost of rising material costs to customers and a more favorable product and customer mix of surfactants sales. Sales volume was down less than onedropped about two percent between quarters primarily as reduceda result of a decline in volume for all surfactants regions, particularly within the personal care product line. The decline in sales volume reduced the quarter-to-quarter net sales growth by about $7.4 million. The foreign currency translation effect resulted from a U.S. dollar that weakened against all local currencies of the countries where the Company has operations.

Operating income for surfactants offset sales volume improvements for polymers and specialty products. Average selling prices improved due primarily to the pass throughfirst quarter of raw material price increases.

Third quarter 20072008 was $6.3 million, or 60 percent, higher than operating income for the first quarter of 2007. Gross profit was $3.1up $11.0 million, or 27 percent, lower than third quarter 2006 operating income. Gross profit declined $1.0 million, or three32 percent, while operating expenses increased $2.1$4.7 million, or eight19 percent. The above-noted pension curtailment expense negatively impactedsurfactants segment drove the quarter-to-quarter improvement in gross profit, due to a more favorable product and customer mix of sales and to selling price increases that began to recoup some of the profit margin lost in prior years to escalating raw material costs, particularly within the fabric softener product line. Gross profit for the third quarterpolymers segment was down between quarters, as the effects of 2007. Both the surfactants and polymers segments reported quarter-to-quarter declines in gross profit. Lower sales volume for North American surfactants operations and higher raw material costs particularlyand lower sales volume in North America more than offset profit improvement for biodiesel products, ledEuropean operations. The favorable effects of foreign currency translation contributed $1.9 million and $1.1 million, respectively, to the declinequarter-to-quarter increases in surfactants gross profit. Phthalic Anhydride production problems and higher raw material costs for North American polyols caused the decline in polymersconsolidated gross profit despite an increase in sales volume. Gross profit for the specialty products segment was up between quarters due to sales volume improvement.and operating income.

The eight19 percent quarter-to-quarter increase in operating expenses was attributable primarily to the $1.6a $3.1 million, or 40 percent, increase in administrative expenses, a $0.8 million, or nine percent, increase in marketing expenses and a $0.8 million, or 10 percent, increase in research and development expenses. A $2.0 million increase in compensation expense related to the Company’s deferred compensation expense, which is includedplans and a $0.4 million increase in administrative expenses. Operating expenses also included $0.5 million of costsU.S. salary and related to registration and testing fees for the Company’s biocide products that are sold in Europe.

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Otherfringe benefit expenses accounted for much of the increase in administrative expenses. Higher U.S. salary and related fringe benefit expenses also accounted for $0.5 million and $0.7 million, respectively, of the marketing and research and development expense increased $1.5increases. The effects of foreign currency translation accounted for approximately $0.7 million or 69 percent, from quarter-to-quarter. of the $4.7 million rise in consolidated operating expenses.

Other, net, which includes foreign exchange gains and losses and investment related income and expense, was $1.2$1.5 million of expense in the first quarter of 2008 compared to $18 thousand of expense for the thirdfirst quarter of 2007 compared2007. Most of the unfavorable quarter-to-quarter variance was attributable to $0.3the effects of the January 1, 2008, election of the fair value option (afforded under SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities) for the Company’s mutual fund investment assets as described in the ‘Overview’ section of this discussion. In the first quarter of 2008, the Company recorded $1.3 million of income for the same period of 2006. Foreign exchange losses were up $1.4 million between quarters, while investment income was down $0.1 million. As noted earlier, the significant change in foreign exchange losses resultedexpense resulting from the sharp declineDecember 31, 2007, to March 31, 2008, reduction of fair value of the mutual fund investment assets. In prior interim and annual periods, changes in the U.S. dollarfair value of the mutual funds were recorded to accumulated other comprehensive income in relation to other foreign currencies.the equity section of the balance sheet.

The effective tax rate was 32.031.8 percent for the thirdfirst quarter ended September 30, 2007,of 2008 compared to 34.129.6 percent for the thirdfirst quarter ended September 30, 2006. The declineof 2007. Reduced tax credits recognized in 2008 accounted for most of the change in the effective tax rate was primarily attributable to increased tax credits recognized in 2007.rate.

Segment Results

Surfactants

Surfactants net sales for the thirdfirst quarter of 20072008 increased $21.5$53.8 million, or 1023 percent, over net sales for the thirdsame quarter of 2006. An eight percent increase in2007. Higher average selling prices and the favorable effects of foreign currency translations accounted for approximately $18.3$52.1 million and $6.4$9.5 million, respectively, of the quarter-to-quarter change. Sales volume declined onedropped three percent between quarters, which reduced the growth in net sales growth by about $3.2$7.8 million. A quarter-to-quarter comparison of net sales by region follows:

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The 22 percent increase in net sales for North American operations was attributable to a seven26 percent increase in average selling prices and to the favorable effects of foreign currency translation, accounted for $10.4 million and $0.9 million, respectively, of the increasepartially offset by a four percent decline in net sales.sales volume. A four15 percent drop in sales volume for U.S. personal care products drove much of the sales volume decline. A reduction of specialty esters sales, due to the second quarter 2007 sale of the product line, and a switch by some customers to high active products from low active products accounted for the drop in personal care sales volume. The drop in sales volume was somewhat mitigated by increases in commodity laundry products and in higher priced agricultural chemical products. Higher selling prices accounted for approximately $39.2 million of the net sales growth, but the effect of lower sales volume reduced the net sales increasegrowth by $5.5$5.6 million. The higherfavorable impact of foreign currency translation was about $2.0 million. The quarter-to-quarter improvement in average selling prices reflected 2007 and first quarter 2008 price increases across all major product

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lines implemented over a period of time aimed at continuing to recover increasing rawpass on rising material costs. The majority of the sales volume decline was attributablecosts to a 14 percent decrease in biodiesel product sales volumecustomers and a 12more favorable product and customer mix of sales.

The 27 percent decreaseincrease in U.S. personal care products sales volume. Weaker demand for biodiesel products led to the quarter-to-quarter decline in the Company’s biodiesel sales volume. Loss of some business due to price competition caused the decline in personal care sales volume.

Surfactantnet sales for European operations rose $10.8 million. Approximately $3.4 million of the increase was attributableentirely due to a sevenan 18 percent increaseimprovement in average selling prices whileand the favorable effectseffect of foreign currency translation, which accounted for $4.2$9.5 million and $5.4 million, respectively, of the increase. Sales volume for the first quarter of 2008 was up seven percentessentially unchanged from sales volume for the first quarter of 2007. Selling price increases effected in 2007 and the first quarter of 2008 to quarterpass through rising raw material costs and accounted for $3.2 million of the net sales growth. Aa more favorable customer and product mix of sales along with selling price increases, particularly for Stepan UK, led tocaused the higherimprovement in average selling prices. The foreign currency translation effect resulted from the strengthening of the European euro and the British pound sterling against the U.S. dollar. Higher volumes of laundry and cleaning products caused the seven

The 14 percent increase in net sales volume improvement.

Forfor Latin American operations reflected a 1913 percent increaseimprovement in average selling prices and the favorable effects of foreign currency translation, partially offset by a seven percent decline in sales volume. Selling price increases and foreign currency translation accounted for $3.9about $2.8 million and $1.4$2.1 million, respectively, of the increaserise in net sales. SalesThe decline in sales volume was down two percent between quarters, which reduced the growth of net sales increase by $0.4approximately $1.6 million. All three Latin American subsidiaries reportedThe improved average selling prices resulted primarily from the pass through of higher net sales. Selling price increases aimed at passing on raw material cost increases coupled with a more favorable mixcosts. Lower fabric softener sales volume from the Company’s subsidiary in Mexico accounted for most of the drop in sales led to the increase in average selling prices.volume.

Surfactants operating income for the thirdfirst quarter of 20072008 was down $2.9up $10.2 million, or 31147 percent, fromover operating income for the same period of 2006.2007. Gross profit declined $1.9increased $11.3 million, or eight51 percent. All three regions posted higher quarter-to-quarter gross profit, primarily due to a more favorable customer and product mix of sales coupled with selling price increases that more than offset the effects of a three percent driven by a decrease of biodiesel profitability.decline in sales volume. Operating expenses increased $1.0$1.1 million, or seven percent between quarters.percent. Quarter-to-quarter comparisons of gross profit by region and total segment operating expenses and operating income follow:

Gross21

The 51 percent increase in gross profit for North American operations declined 12 percent between quarters primarily duewas attributable to a decline in sales volume and an increase in raw material costs for the Company’s biodiesel products. In addition, approximately $1.0 million of the previously

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mentioned defined benefit pension curtailment expense was charged to North American surfactant operations. Gross profit for biodiesel products fell $3.5 million from quarter to quarter. Average biodiesel raw material costs increased more than 30 percent from quarter to quarter. Excluding biodiesel, North American surfactant gross profit rose by $1.3 million on improved sales mix and further recovery of margin previously lost to higher raw material costs.

The increase in gross profit for European operations resulted from the seven percent increase in sales volume combined with a more favorable mix of sales and continued efforts to recover higher raw material costs in selling prices, which more than offset the aforementionedeffect of the four percent decline in sales volume. The effect of foreign currency translation contributed $0.4 million to the improvement in gross profit. Raw material costs continue to move upward, and another selling price increases. Mostincrease was announced for April 1, 2008.

Gross profit for European operations increased 24 percent from quarter to quarter due to higher average selling prices and to a $0.6 million favorable impact of foreign currency translation. Excluding the currency translation effect, Europe’s gross profit increased $0.5 million, or 12 percent, from quarter to quarter on sales volume that was unchanged. As mentioned earlier, first quarter 2008 selling prices averaged 18 percent higher than first quarter 2007 selling prices due to a more favorable mix of sales and to selling price increases implemented to regain some of the gross profit improvement was attributablemargin lost in previous years to Stepan UK.rising raw material costs, particularly for fabric softener products.

GrossThe 120 percent increase in gross profit for Latin American operations declined eight percent between quarters duewas primarily attributable to higher material costs andimproved profitability for the Company’s Mexico subsidiary, although all three Latin American subsidiaries contributed to the growth. Despite a twoseven percent decline in sales volume. Stepan Mexico raisedvolume, gross profit improved due to higher selling prices on October 1.and to a reduction of outsourcing expenses. In the first quarter of 2007, the Mexico subsidiary purchased some product for resale while an expansion of its manufacturing facility was being completed. The favorable effects of foreign currency translation added approximately $0.3 million to the quarter-to-quarter gross profit growth.

OperatingSurfactants segment operating expenses for the surfactants segment were $1.0first quarter of 2008 increased $1.1 million, or seven percent, over first quarter 2007 operating expenses due primarily to higher in the third quarter of 2007 as compared to the third quarter of 2006. Approximately $0.4 million of the increase was attributableU.S. research and development ($0.5 million) and marketing expenses ($0.3 million) and to the effects of foreign currency translation as($0.6 million). Lower operating expenses for European operations ($0.4 million) partially offset the increases. Increases in salary and related fringe benefit expenses accounted for the higher U.S. dollar was weaker against the currencies of nearly all the foreign countries in which the Company has operations. The remainderresearch and development and marketing expenses. Lower bad debt expense, due to a non-recurring first quarter 2007 specific provision for a customer entering bankruptcy, accounted for most of the decline in operating expense increase was primarily attributable to $0.5 million in registration and testing feesexpenses for the Company’s biocide products that are sold in Europe.European operations.

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Polymers

ThirdFirst quarter 20072008 net sales for the polymers segment increased $12.6$12.2 million, or 1718 percent, over net sales for the thirdfirst quarter of 2006.2007. Higher selling prices, a five percent increase in sales volume and the favorable effects of foreign currency translation and a two percent increase in sales volume accounted for $7.0approximately $7.7 million, $4.0$3.3 million and $1.6$1.2 million respectively, of the net sales increase between quarters.improvement, respectively. A quarter-to-quarter comparison of net sales by region is displayed below: