Quaker Chemical Corp (KWR) 2009 Q3 法說會逐字稿

Greetings. Welcome to the Quaker Chemical Corporation third quarter earnings results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael Barry, Chairman, Chief Executive Officer and President of Quaker Chemical Corporation. Thank you. You may begin.

Good afternoon, everyone. Joining me today is Mark Featherstone, our CFO, and Jeffry Benoliel, our General Counsel and Head of Global Strategy. As usual, Mark will provide some more details around the financials, and then we will address any questions that you may have.

But I will start it off now with some remarks about the third quarter and what we are currently seeing in our marketplace. Our earnings for the third quarter were $0.45 per share. This is certainly real sequential quarterly improvement over the past year. As you may recall, we had a loss of $0.25 per share in the fourth quarter of last year, breakeven results in the first quarter and earnings of $0.29 a share in the second quarter. So, we are seeing good improvement in sequential performance. While we also may want and need a higher level of profitability for our business, we are pleased with this result considering the significant volume decline we are experiencing due to the continuing global economic crisis.

Let's talk about the volume impact. The third quarter volume is up 18% from the second quarter, so while we have dramatic reductions in our volumes in our year-over-year comparisons, we are seeing improvement in our volumes on a sequential quarterly basis and the volume increase from the second quarter to the third quarter was broad based with double-digit increases in all regions of the world. The largest sequential increase was in the United States, but this was also the region that had the largest overall decline for us starting last fall.

During the third quarter, we did see many of our steel customers increase their production throughout the quarter, as did many of our major automotive customers. However, I think we need to keep a perspective that while we saw good sequential improvement in our volumes in the third quarter, our volumes are still down 22% from a year ago. Longer term we do expect volumes to gradually increase, but it will take awhile to get back to our historical highs and volumes. In the short term, we expect there will continue to be uncertainty in many of our end use markets. While we believe the overall trend is up for volumes, we do not expect it to be a straight line up and there is likely to be several ups and downs in the demand dependent upon the end use market or the geographic region.

As you know, we had to take significant actions with our cost structure to help offset this dramatic volume decline. We took two major cost reduction efforts, one in the fourth quarter of last year and one in the first quarter. Both sets of actions were taken with the goal of minimizing the impact on our associates, while also continuing to provide a higher service level for our customers. The results of our cost actions are fully in place and you can see from our P&L that they have helped us significantly.

First, margins are also getting back to acceptable levels. This is critical given that our volumes are so much lower. The margin improvement is in part due to the cost reductions we have taken in manufacturing, as well as lower raw materials. However, we are now seeing raw material prices starting to increase in a number of areas.

We also feel good about new business opportunities. Given that industrial production levels are down, companies are now more open to looking at opportunities for new products and services that can help their profitability. We are seeing these opportunities in all regions of the world, and this is also beginning to help us offset some of the volume declines in our markets.

Concerning cash flow, we are pleased with our significant cash flow generation this year which is primarily a result of working capital reduction, as well as a return of profitability since the first quarter. This has enabled us to pay down our debt by 24% since the beginning of the year, while maintaining our dividend and investing in our future. Our major investment in 2009 has been an expansion of our Middletown, Ohio plant which is near completion. We are also completing an upgrade to our global ERP system. Even during this difficult period, we have remained committed to longer-term initiatives that enhance the products and services to our customers. A stronger balance sheet will also give us greater financial flexibility to be able to grow organically or through acquisition. And we are actively looking at strategic acquisitions while only making them under the right circumstances.

In closing, this October marks my one-year anniversary as CEO with Quaker and it has been quite a year. Considering the global recession, I am pleased with our overall progress and with the third quarter earnings and cash flow. We feel that the actions we have taken over the past year enabled us to get our profitability back to reasonable levels, despite the dramatic fall in volumes. Just as important, I believe we are well positioned for the future. We believe we have a differential business model, a strong management team and associate base, a solid balance sheet, and growth initiatives in place with significant potential.

All in all, we feel we are in a good place today and we are very confident in our tomorrow. I especially want to thank all of our associates whose dedication and expertise helps differentiate Quaker in the marketplace. And now I will turn it over to Mark Featherstone, our Chief Financial Officer, so that he to provide you with more details behind our financials. And after that, we will address any questions you may have.

Thank you, Mike. Good afternoon, everyone. Yesterday we announced third quarter 2009 earnings of $0.45 per share, including CEO transition costs of $1.3 million or approximately $0.07 per share.

EPS was up 55% from the second quarter of 2009 and up 10% from the third quarter of 2008. With our cost reduction efforts, we have been able to more than offset the decrease in gross margin dollars with SG&A and other expense reductions, resulting in increased earnings despite continued lower volumes. I will spend the next few minutes focusing on the third quarter P&L and then we will go on to questions.

Revenues for the third quarter compared with the same period last year were down 25% to $119 million, but were 16% better than second quarter. Compared to last year's third quarter, double-digit volume decreases were experienced in all regions except for Asia where volumes were up slightly. In addition, foreign exchange decreased revenues by about 3% versus the prior year quarter. Compared to the second quarter, overall volume was up 18% with all regions experiencing double-digit percentage increases.

However, these volume increases must be kept in perspective. For example, the capacity utilization rates in the US steel industry averaged in the low 50 percentile in the third quarter of 2009 versus in the low 40% in the second quarter, which translates to an increase of more than 20%.

However, this is still far below the almost 90% capacity utilization of the third quarter of 2008. While the near-term demand outlook is uncertain, overall steel inventory remains low from a historical perspective. For example, in North America, steel inventories at the end of August were just over half of those levels of the previous year.

Turning to gross margin, gross margin as a percentage of sales was 37.4% this quarter versus 35.2% in the second quarter and 29.2% for the third quarter last year. The margin expansion was in part the result of the cost reduction actions we have taken as well as the favorable raw material cost environment. In addition, the impact of reduced CMS gross revenue where we resell tier two supplier's products at low margins accounted for about one quarter of a percentage increase.

Quaker reports the CMS contracts on either a gross or net basis, depending on the terms of the contract and how directly our revenue is tied to the cost incurred with the tier two product purchases. For the last several years, most of our CMS contracts have been accounted for on a gross basis. In 2009, as CMS contracts have been renewed, extended or renegotiated, relatively more contracts are moving to a net basis. This has resulted in the higher reported gross margin percentage that we are currently experiencing.

Crude oil prices have also moved up significantly in the last week or so and as you know, we use crude derivatives in many of our products. While raw material markets remain volatile, we are beginning to experience some raw material cost increases and we will be monitoring this very closely.

Moving to SG&A and other expenses, in absolute terms, SG&A for the quarter declined by 9% or $3.6 million compared to the prior year. Most of the decrease is related to savings from our restructuring programs and other cost savings measures, offset in part by the timing of incentive compensation accruals, and lower foreign exchange rates accounted for most of the remainder of the decrease.

As I noted previously, we did incur approximately $0.07 of CEO transition costs during the third quarter related to the supplemental retirement plan of our former CEO. This represents the final CEO transition charge for 2009. An additional final charge of approximately $1 million is expected in 2010.

Turning to the tax rate, the 36% tax rate reported for the third quarter of 2009 was significantly higher than the 17.6% rate we reported last year. Last year's low tax rate was largely driven by FIN 48 tax reserves falling off, due to audit settlements and statutory expirations. As previously discussed, we expect to continue to experience volatility on a quarterly basis due to FIN 48 and potential changes in income mix.

Looking at the balance sheet and cash flows now, with almost $35 million of cash flow from operations so far this year, the Company's net debt to total capital ratio has improved dramatically to 21% as of September 30th, 2009 compared to a strong 32% at December 31st, 2008 and this was the lowest since 2003. Net debt at September 30, 2009 was also at its lowest level since 2003.

We have realized strong cash flow from working capital so far this year, but we anticipate some increase of working capital going forward as sales and raw material prices begin to increase as expected. Another key cash flow indicator, EBITDA, is tracking toward an annual run rate of about $50 million, similar to where we were prior to the economic downturn. This factor combined with our strong balance sheet positions us well to take advantage of opportunities as they arrive. That concludes my prepared remarks.

Thank you, Mark. At this stage, we would like to address questions from any participants on this conference call. And hopefully we will not have any technical issues this time.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). One moment please while we poll for questions. Our first question is from Liam Burke with Janney Montgomery Scott. Please go ahead with your question.

Thank you. Mike, you were talking about steel production, obviously an important driver in your business. Steel production is growing or not growing at different rates this year throughout the world. Are you seeing your revenue by geography changing in terms of distribution, vis-a-vis the way it was maybe a year ago?

We certainly have seen Asia Pacific becoming a bigger part of the Company's regional mix from a revenue perspective as well as well as from a profitability perspective just because while they were impacted by this downturn, even in China, it wasn't the same magnitude as what we saw elsewhere around the world. The US was hit the hardest, then Europe, then Brazil and then Asia Pacific for us. So, definitely we are seeing Asia becoming a bigger part of Quaker Chemical.

On the gross margin side, it looks like prices are -- of oil -- oil prices were increasing. Raw materials helped you through most of the year, in terms of improving your margin. How much of the margin improvement can you preserve and how much will the Middletown facility get going into 2010 help you maintain your gross margin levels?

We don't have exact numbers on that, but certainly you point out the Middletown will help us in the US region become more efficient. That was one of the reasons we've done that. We're going to be starting to move production, part of our products there starting actually this month. That will probably take six months to complete. That will certainly help out.

Concerning raw materials and our gross margins, we really don't make any predictions or forward-looking statements on that. The other thing I would say, Liam, is that with our raw materials going up, we have, certainly, a part of our business that tracks raw materials or has indexes that track them, and there may be timing differences, but we will get back those raw material increases. Likewise with other contracts or other business that does not have that our goal would be as prices go up or down in raw materials to go back to our customers with price increases or decreases. It is -- over time there might be timing differences in here, but overall we try to make sure we get our -- track those raw material increases or decreases.

Good. Thank you.

Sure.

The next question is from Daniel Rizzo with Sidoti and Company. Please state your question.

Hi. You kind of answered this, but with the raw material cost -- price increases, is there still a three-month lag? Or is that gone? I knew -- that used to be the case a couple years ago. I wonder if it is still the case now?

There's still some lag. It is hard to say because it is customer by customer. And it depends on when you hit on cycles of some contracts that are indexed. Might be six months; some might be monthly; some might be quarterly. Then by the time -- if you don't have a contract that has that indexing and by the time you go out and get price increases, it could be that type of magnitude -- that three-month timeframe.

Okay. Thank you.

Sure.

The next question is from Gregory Macosko with Lord Abbett. Please go ahead with your question.

Yes. Thank you. With regard to the question on gross margin, it clearly went up quite a bit and you mentioned the CMS contract. How much -- where do you figure those -- how much of that increase of 8% or so over the year -- year-over-year is from the CMS? Where do you figure that is going to shake out?

A little bit over a quarter of that 8% increase relates to CMS. Our overall tier two volumes were down with auto production, where a lot of CMS contracts are centered, being down. But as I mentioned, we're having more and more contracts that come up for renewal or renegotiation, moving to CMS. That's been a fairly consistent trend all year. We do have more contracts up for renewal later on this year and early next year so that trend will continue.

How much has been done? Do you expect them all to be on a net basis? How much has been accomplished so far?

I'd say we are relatively indifferent on the contracts. It all depends on the business conditions and a case of negotiations with customers. It is not necessarily an objective of ours to convert all of them to a net basis versus a growth basis. We're evaluating the contract in total.

Okay. But you expect ultimately them to -- in other words this is going to continue to improve the gross margins as they convert over. Correct?

Reported gross margins, but the underlying dollar profitability should be relatively unaffected.

I understand. Okay. With -- regarding the previous question on raw materials, did you in fact have a benefit in the current quarter on a sequential basis?

I think it was fairly flat with the second quarter. Raw materials were stabilized, as far as the increases, towards the end of the quarter.

Okay. And then if I were to compare the quarterly earnings of your $0.45 -- if I add back the $0.07 for the CEO transition, et cetera, would that be on a normalized basis for one-time issues, etc. ?

Yes. The CEO transition cost is a normalized adjustment. But that is really our tax rate which was pretty low last year is at a pretty good level now -- may be a little higher than our historic tax level. So, I think that's probably a decent level.

The tax rate is a little higher you saying?

We have been averaging more in the low 30s as opposed to 30% to 36% we did this year. But as I mentioned, there's a lot of volatility with FIN 48 when items are being released.

Right. Okay. Next year you only have $1 million more charge on the CEO issue.

Right. We will be done with it next year.

I see. Okay. And with regard to the -- there was a European land sale or something?

Yes, in the first quarter.

Okay. And finally, steel production. You mentioned 50% utilization. What's your take on the industry on that regard? Are you expecting utilization -- has it come too fast, too quickly, what is your take or your sense of the industry and where we stand, particulary in the U.S.?

In the United States, as Mark said, we are in the -- probably in the mid 50s -- low to mid 50s in the third quarter. And they probably exited the quarter closer to 60%. But keep in mind that it was around 90% a year ago. From what we read and all we can do is -- what we hear from customers, what we read from people like AK Steel or US Steel just announced their earnings. They're projected that they're going to continue to see some flat to slightly increasing steel production, say in fourth quarter. I don't think it is going to jump back to anywhere near the 90% rate soon. But we may see some very modest type increases from where we are today.

Your inventories are in shape to handle that at this point?

Yes. We are a make it to order. That's not a problem. We can react very quickly to their needs. Of course, some of the things too, Greg, is you have to consider at this time of year -- as you get into November, December a lot of the steel companies or the auto companies may go down over the holidays so that may have some seasonal adjustments to their production.

All right. Now you cut SG&A dollars by $19.5 million year-to-date. What will come back or what is -- what will stay gone or in terms of the variable? Obviously commissions, and other things, incentives will come back. But what of that do you figure you've kept out?

I don't have a real specific answer there. As our business comes back, we will certainly have to add more costs. We'll have some more commissions as we sell more.

Roughly any permanent -- A couple of million or something in terms of permanent cost reductions?

I really don't want to speculate on that number off the top of my head.

Okay. Nothing -- should I assume nothing then and it is all going to come back?

I don't want to tell you what to assume at this time.

All right.

Our overall strategy obviously, we cut our costs. It was a major part of making ourselves more profitable. We are obviously -- continue to be very cost vigilant and we don't want to add costs back unless we have to because it has been such a great benefit with loans being down.

Okay. You figure it out and I will ask you next time I see you. Thank you.

Okay.

The next question is from Robert Felice with J. Goldman.

Hey, guys. Can you discuss the magnitude of the potential cost inflation you are facing on a sequential basis from the third quarter into the fourth quarter? Can you also discuss your comfort level around your ability to get pricing through on the non index portion of your business?

You mean the cost inflation?

You mean the raw material?

Yes.

Okay. It may go up somewhat, but I don't think it is going to be that dramatic between the third quarter and the fourth quarter. But the way we do inventory accounting and the way it has to work through inventory and such, it generally takes a month or two to get through and we are already through October. It may go -- and probably will go up somewhat this quarter, but I think most of the impact will be starting next year.

It is fair to assume that on a sequential basis as we look to the fourth quarter, your gross margins should be relatively stable?

We really don't want to give any forward-looking predictions on that.

Okay. Then turning to price, as we move forward into 2010, what's your comfort level around the ability to put pricing in place to offset any potential cost inflation?

It is our goal to do that and again, we have some contracts that automatically allow that and other -- the other ones that don't have that we will go out with price increases. Certainly we have -- our customers -- we have worked closely with our customers in cost increases as well as decreases. We hope we have provided a lot of value to our customers so that at least during the period when we look at the year 2008 and that's all we can look at, what happened in that period when we had extreme price increases, we were able to work with our customers and get the necessary type of price increases we needed.

Maybe just stepping back a little broader, can you discuss your comfort level around your ability to sustain current profit levels? Obviously you have done a lot in the way of taking costs out of the business. Raw materials have been favorable this year. But as we look forward, we are all trying to get our hands around the extent to which current profit levels will continue if not improve off of this base.

As I mentioned in the press release, even at today's profit levels, we are not satisfied with that. I think through a combination of keeping our margins at a good place and volumes coming back, we expect that -- to have profitability at least at this level. That's our goal. It is our goal to have that -- and, like I said in the note, we really want to have higher profitability. As you know, it is just our policy that we don't give out forward-looking statements.

No, no, I understand that. I understand that. Lastly, did you have any benefit during the quarter from the Clunkers Program?

We certainly saw steel production in the United States shoot up as Mark said, pretty high -- pretty good amount. And actually we are continuing -- I read in some of the press releases from the steel companies recently that they were also pointing to that, that they're all actually seeing the benefit in the fourth quarter of that as well. They're still producing more steel trying to keep up with building the auto inventory now back up to levels it needs to be. Yes. We have seen it and we would expect to continue to see it in fourth quarter.

Okay. Great. Thanks for taking my questions.

Sure. Thanks, Robert.

There are no further questions in queue. I would like to turn the call back to management for closing remarks.

Okay. I want to thank everybody for their interest today. And while these continue to be challenging times, we are pleased with how we are managing through them and we continue to be confident in the future of Quaker Chemical. Our next conference call for fourth quarter results will be the end of February. If you have any questions in the meantime, please feel free to contact Mark Featherstone or myself. Thanks again for your interest in Quaker Chemical. And let's go Phillies.

This concludes the teleconference. You may disconnect your lines. Thank you for your participation.