Quaker Chemical Corp (KWR) 2010 Q1 法說會逐字稿

Greetings. Welcome to the Quaker Chemical Corporation First Quarter 2010 Results Conference Call. At this time, all participants are in a listen-only mode. (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 for Quaker Chemical Corporation. Thank you Mr. Barry, you may begin.

Thanks, Rob. Good morning, 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. We have also added some slides for our conference call. You can find them in the Investor Relations part of our website at www.quakerchem.com.

I'll start it off now with some remarks about the first quarter and then follow with what we are currently seeing in the marketplace. Our earnings for the first quarter were $0.84 per share. This is a large improvement from the first quarter of 2009 when we essentially broke even. About $0.11 per share is due to an unusually low tax rate because of the expiration of some FIN 48 tax reserves. So, absent this tax effect, our earnings would have been $0.73 per share.

As you can see on Page 4, this is now the fifth quarter in a row that we have seen improvement in our earnings level. As you may recall, we had a loss of 26% -- $0.26 a share in the fourth quarter of 2008, breakeven results in the first quarter of 2009, earnings of $0.29 a share in the second quarter, $0.45 in the third quarter, $0.71 in the fourth quarter and now $0.84 in the first quarter of 2010. So we are seeing very good improvement and we are pleased with this result considering that volumes are still down approximately 7% from where they were before the global crisis began. You can see this on the volume chart on Page 5.

Looking forward, we continue to see strong fundamentals over the next few years that should lead to good growth. Although, we do expect somewhat lower demand in the second half of the year versus the first half. There are really several reasons for the short-term impact. One is the demand in countries such as Brazil, Germany, Italy, France and the UK where tax incentives for auto purchases are ending. Another reason is there is seasonality in parts of our business where we supply certain customers for portions of the year.

For 2010, at some key customers, the first half will have greater sales than in the second half given their two-supplier strategy. Then there is the impact of China tightening credit, as well as the supply chain restocking effect ending in parts of the world. Again, all of these will tend to temper demand in the second half of the year. However, the undercurrent of recovering economies and its impact on our core steel and automotive market is expected to partially offset this impact.

We're also seeing pressure on margins due to higher raw material costs. We currently are or will be soon in discussions with customers for price increases given our increasing raw material costs. But there will likely be a lag effect before we recover our margins.

On the SG&A side, we are investing in key initiatives that will lead to future growth. Most of these investments are in the emerging markets or BRIC countries. As you know, we do not give specific guidance as it relates to future earnings, but I will say that while our earnings for the remaining quarters of the year will probably be lower than the first quarter, we do expect them to at least equal or exceed the pre-crisis quarterly levels we achieved in 2008. All in all, 2010 is expected to be a strong year for Quaker.

And looking beyond 2010, I also believe Quaker is well positioned for future growth. For example, as you can see on Page 6, approximately one-third of our business is now tied to the highest growth regions of Asia and South America. Our strong positions in both regions will allow us to take advantage of the good inherent growth expected in these regions.

Then when you look at the other two-thirds of our business in the more mature markets of the U.S. and Europe, these regions should experience growth rates above GDP in our markets just due to the gradual recovery of demand for steel and autos in these regions over the next few years. An example can be seen on Page 7 where the U.S. steel industry is currently operating around 70% capacity utilization and pre-crisis it was around 90%. This recovery will not come in one year, but likely take several years, but it should provide us with good growth. This is quite a difference from a few years ago even before the crisis when the mature markets of U.S. and Europe were flat to down.

So whether we are talking about the high growth markets like China, India or Brazil, or the more mature markets like U.S. and Europe, we believe our product market show promising growth for the next few years. Now when you take the good expected growth over the next few years and put it on our revised infrastructure, I believe this will translate into good earnings growth as well for us over the next few years.

In closing, I am excited about our future and I especially want to thank all of our associates whose dedication and expertise helps to create value for our customers and differentiate Quaker in the marketplace.

And now, I will turn it over to Mark Featherstone, our Chief Financial Officer so that he can provide you with more details behind our financials. And after that, we'll address any questions you may have.

Thanks, Mike. Good morning, everyone. Yesterday we announced first quarter 2010 earnings of $0.84 per share compared to breakeven results in the first quarter of 2009. Compared with the fourth quarter of 2009, reported EPS was up $0.13. However, I should note that the first quarter of 2010 included an $0.11 per share tax benefit from FIN 48.

I'm also pleased to report that our current EBITDA run rate is now higher than before the economic crisis. And we are coming out of recession in a stronger state financially than when we went in. And this improvement can be seen on Page 8.

Now, I'll go through the first quarter P&L and then we will go on to questions. It is important to recall that last year's first quarter was in the midst of the global economic crisis. As a result, many of the comparisons are not fully relevant. For that reason, I've also included some comparisons with the fourth quarter of 2009.

Revenues for the first quarter compared with the same period last year were up 30% to $128 million. But we're slightly below the fourth quarter of 2009. Compared to last year's first quarter, double-digit volume increases were experienced across the globe. In addition, foreign exchange rates increased revenues by about 7% versus the prior-year quarter. Partially offsetting this was a 5% decrease in sales due to selling price and mix, as well as lower chemical management services revenue reported on a gross basis. The volume increases I mentioned must be kept in perspective.

For example, capacity utilization rates in the U.S. steel industry averaged about 70% in the first quarter of 2010. And this compares to about 40% last year this time, but as Mike mentioned, it's still far below the almost 90% capacity utilization rates of early 2008. Compared to the fourth quarter of 2009, overall volume was up about 3% with all regions reporting increases. We also continued to benefit from some end market inventory restocking during the quarter. But this impact is expected to decrease going forward.

Turning to gross margins, gross margin as a percentage of sales was 36.9% this quarter versus 36.1% in the fourth quarter and 29.1% for the first quarter last year. Last year at this time we were using up inventory purchased when raw materials were much higher and the aggressive cost reduction actions we took were not fully in place. In this year's first quarter, we began to experience higher raw material prices, although most of these increases did not occur until the end of the quarter or into the second quarter.

We are also experiencing higher costs related to the start-up of our Middletown, Ohio plant expansion and we're also beginning to add back some people, particularly in manufacturing as our volumes increase.

Turning to CMS. We report our CMS contracts on either a gross or net basis, depending on the terms with our customers and how directly our revenue is tied to the cost incurred for Tier 2 product purchases. For the last several years, most of our major CMS contracts were accounted for on a gross basis. In 2009 and 2010, as CMS contracts have been renewed or renegotiated, more sites are moving to a net basis. Now the move towards net -- more net reporting of CMS resulted in about 2% increase in gross margin percentage when compared to the first quarter of 2009 and about 1% when compared to the fourth quarter.

Turning to SG&A expenses. In absolute terms, SG&A for the quarter increased almost $7 million compared to the first quarter of 2009. More than 80% of this increase related to either higher foreign currency rates or higher incentive compensation accruals versus reductions in incentive compensation in the prior-year quarter.

SG&A is lower than the fourth quarter due to lower foreign currency exchange rates and lower legal and professional fees among other factors. As the year progresses, we do plan to add resources to key growth areas, especially in the BRIC countries. I would also like to note that our SG&A as a percentage of sales in the first quarter decreased compared to both the fourth quarter 2009 and last year's first quarter.

Turning to the tax rate, as I mentioned previously, we did benefit from a low tax rate in the first quarter due to some FIN 48 tax reserves falling off. We expect to continue to experience volatility on a quarterly basis in our tax rate due to FIN 48 and potential changes in income mix. We expect that our tax rate for the rest of the year will be higher than the first quarter rate. We currently project the full-year tax rate of about 28%. However, this may change as the year progresses due to income mix and other factors.

Now turning to the balance sheet and cash flows, as I discussed last quarter, the first quarter is historically our weakest cash flow quarter of the year due to seasonal factors, including the payment of incentive compensation. Despite this, our net debt-to-total-capital ratio was a strong 24% at March 31, 2010 compared to 31% at March 31, 2009.

I believe that our strong balance sheet and increase in EBITDA positions us well to take advantage of any opportunities that may arise. And that concludes my prepared remarks.

Thanks, Mark. And at this stage, we'd like to address any questions from any participants on this conference call.

Thank you. We'll now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question is from the line of Gregory Mocosko with Lord Abbett. Please go ahead with your question.

Yes. Thank you. Very nice quarter. Would you talk a little bit about CMS, you talked about moving to a net basis and that you were up -- your gross margins benefited obviously because of that. Can you give us an idea of the current mix and when you expect it to stabilize?

Well, the -- our CMS contracts, for example, with General Motors, last year that contract had to be reported on a gross basis because we adjusted things on an index basis and there were some potential lag effects, so accounting rules said that had to be reported on a gross basis. When we renewed the contracts for this year, GM preferred to have them on a straight pass through on products that were not, say, Quaker products there. And therefore, we did not -- we don't recognize that. So, it really does depends upon, when you say stabilize, it depends upon year-to-year what we negotiate with the customers and what our customers prefer in the form. So, it could change again as we go into the contracts for 2011. But right now we expect, certainly for the remainder of 2010 to be kind of what in the same kind of mode where the vast majority of it is on a net basis.

To follow-up on Mike's point, Greg, back in the fourth quarter conference call we noted that we anticipated about $20 million effect for the full-year 2010 based on the switch from gross to net. Now that may change based on any renegotiations that may occur but that was our estimate as the year progressed -- at the start of the year --

And could --

That's sales. But profitability, that's not going to be affected.

Yes.

Right. I understand. And then with regard to sales growth, did you give it CMS versus everything else or did you break out the -- could you give us an idea of the growth rates in the groups?

Well, CMS sales were down compared to last year because of this gross versus net effect.

But can you adjust that or give us an idea, I mean did you add any customers, give us a sense for how CMS is doing?

In terms of the impact on sales of CMS, it was down about $7.5 million because of the switch from gross to net. Our volumes as I mentioned were up significantly and that was up in all regions.

So --

To the point that in Asia and South America now, our volumes are actually higher than they were pre crisis versus North America and Europe. And this is the big opportunity that Mike had mentioned before. It was still down double-digits compared to pre crisis levels in those more mature markets.

But if I look at CMS alone, you're saying that is growing as well. Is that on a sort of a same customer basis or are you adding new customers there?

While the reported revenue is down, we are picking up some CMS business, but as we've talked about before, particularly among some of the auto makers, some of their sites have closed in previous years and there are also some sites that will likely close by the end of 2010 or 2011 as they kind of downsize their production. So, we always have the kind of a mix of new contracts coming on and contracts falling off, more due to the site closures than anything else.

But in general, lot of our CMS is certainly annualized base. The United States in the first quarter of this year, auto sales, our products into our CMS accounts are significantly up from where they were in the first quarter of last year just because of auto production. So, it's more that effect than anything kind of happening in CMS.

Okay. Good. And then finally, just with regard to raw materials, you mentioned that your -- you see that -- it started -- the raw materials started to move up in the first quarter and into the second quarter. I'm assuming you're on a LIFO basis, correct?

No, we're on FIFO.

On FIFO, okay. And was there any change in the reserve there or --?

Well, with FIFO, you wouldn't have a --

You are FIFO, I'm sorry, not LIFO. I'm sorry. You're FIFO, I didn't hear it, okay. And your expectation there is, I mean, pretty quickly to be able to pass that through relative to customers as it -- what kind of a timeline do you expect there?

It depends. It's hard to say because some contracts we have are formula based and they may adjust every three months, some may adjust every six months. Some are just negotiations straight with the customer. So, generally, we're in the process now of having those discussions. We shortly will be having those discussions and then there's usually some lag effect though. So, I would say any three to six month kind of number.

Thank you very much.

Sure.

(Operator Instructions) Our next question is coming from the line of Liam Burke with Janney Montgomery Scott. Please proceed with your question. Mr. Burke, your line is open for question.

Yes. Hello, Mike, Mark?

Hi, Liam.

Hi, Liam.

How are you doing this morning?

Good. Thanks.

Mike, could you talk a little bit about metalworking specifically? I know, overall field production is strong. But could we go down and talk about how the metalworking business is going?

Sure. A lot of our metalworking business is tied to automotive production. And automotive production is certainly doing better now than it was certainly a year ago and especially in the United States as well as in countries like China and Brazil, pretty strong auto production. In Europe, we actually have pretty decent auto production and auto sales in the first quarter, although, as I pointed out in my comments that at least in a lot of the European countries and maybe Brazil that will be one area that because of these tax incentives they put in place where scrappage programs are ending. And therefore we see little bit lower sales certainly in autos in a couple of those regions. But in general, we see metalworking rebounding very well in most of the regions around the world.

And could you give us just a status, I know Mark touched on it on the Middletown, Ohio project. How that has gone in terms of sense of timing?

Sure. That the project itself...

Yes.

... has been completed. So, completed from a perspective that we got most of the equipment in and we are transferring product from our Detroit facility down in to Middletown. But we're in the midst of that. We expect to have the majority of the product that can be transferred from Detroit to Middletown done by probably sometime late in the second quarter of this year.

Great. Thank you very much.

Thanks, Liam.

(Operator Instructions) Our next question is a follow-up from the line of Gregory Mocosko with Lord Abbett. Please proceed with your question.

Well, I guess, I can ask questions pretty quickly here, if you don't mind.

Of course, Greg.

Okay. Good. With regard to the really strong results here, how much of it would you say is from kind of the -- sort of on an incremental basis, can you give me a sense of the incremental profit -- profitability here, the sales growth was pretty nice kind of higher than expected, I think. How would you typify the good earnings growth relative to the sales growth versus obviously restructuring and you've lowered costs as a result of looking at the operations?

Yes. I think if you go back and you kind of look at our trend in earnings and you look at where we were, again we lost like $0.26 in the fourth quarter of 2008 and then we were in the first quarter broke even last year and then after that we were around $0.29 in the second quarter of last year. If you look at that time period where we had pretty steep good growth, earnings growth during that period, essentially volumes were relatively flat over that time period. And what we really saw in that improvement over that time period was our cost reduction efforts coming into play as well as kind of getting our margins back to more acceptable levels. And then once you get past the second quarter of last year and you start looking at the improvement we had between the third quarter, fourth quarter and then now on to the first quarter of this year, a lot of that improvement that you're seeing is volume driven due to the improvement of the recovery in each of the economies around the world for us. So again, early on it was a lot of the actions we took and you can kind of see that magnitude when you look at what happened back in that time period and then what you're seeing recently is more the improvements due to volumes.

Okay. I've been lax in not calculating kind of the sales growth versus the earnings growth, but are we at a point where a lot of that coming off the bottom kind of that we've seen such strong incremental profitability? Going forward, is it fair to say that additional growth from here forward, yes, we'll certainly add more to the bottom line, but is it -- will that incremental profitability be somewhat less?

Well, again, we're not going to kind of predict the exact amounts or anything like that. But if I talk about the volumes, again we do -- we had very strong again volume improvement over the last three quarters. We do expect between when you start getting to the second half of this year versus the first half of the year, for the reasons I stated earlier, we do see volumes somewhat down. But longer term, we see very good trends in our -- in the markets that we're in. Again we're in steel, we're in automotive, these markets in two-thirds of our business in the U.S. were hit really hard and they are still way down. And we still think that over the next few years, as they continue to have this gradual recovery in the mature markets we'll benefit from that. And then when you look at where we were in the stronger regions of the world, the Indias, the Chinas, the Brazils, the Russias, we've pretty strong positions in those areas in both steel and automotive. And we expect in those regions to benefit very well from growth. So, we might get into a period where we're kind of pausing from a volume perspective for the rest of this year, maybe slightly down, but we do expect over the next few years some pretty good growth characteristics in these markets that we are in.

But I think what you said or you're suggesting is while earnings might not be as strong as the first quarter, you did suggest that they would be up on a year-over-year basis, did I hear that correctly?

Yes, definitely. Yes.

Okay. And can we imply something similar for the rest of the second half of the year or the down volume is on a -- that volume you said down is that meaning a year-over-year basis or on a sequential basis?

That's sequential, yes. But earnings, if you look at the full-year earnings for 2010 versus the full-year earnings for 2009 it will definitely be up --

Well, after the first quarter I should hope so.

(inaudible).

Yes, okay. Well. Okay. And I sense you laid out quite a few negative factors here, China and restocking and raw materials and et cetera, et cetera. But I mean that -- I'm assuming you're really looking at the negative side. I mean if China doesn't practice the tighten or raw materials don't push through -- don't keep rising I would assume the opposite will be the case, correct?

Yes, I mean. I am just giving -- we're just giving you what our expectations are.

Okay.

Based on all the information that we see right now.

Right. Okay. Very good. Thank you.

Sure. Thanks, Greg.

Thank you. There are no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Okay. Thank you. We'll end the conference right now and I want to thank all of you for your interest today. We are pleased with how we are managing through these unusual times and we'll continue to -- and we continue to be very confident in the future of Quaker Chemical. Our next conference call for the second quarter results will be at the end of July. And 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.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.