Quaker Chemical Corp (KWR) 2010 Q2 法說會逐字稿

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

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 the details around the financials and then, we will address any questions that you may have. We also have slides for our conference call. You can find them in the Investor Relations part of our website at www.quakerchem.com.

I will start it off now with some remarks about the second quarter and then follow with what we are currently seeing in the marketplace. Our earnings for the second quarter were $0.80 per share. This is a large improvement from the second quarter of 2009 when we made $0.29 per share. As you can see on chart 1 or page 4, our earnings for the past three quarters are now significantly higher than before the crisis.

We continue to see an increase in demand for our products as our volume increased by 7% from the first quarter. The growth we are experiencing is broad based as we are seeing strong demand in the fastest growing countries such as Brazil, Russia, India and China, as well as in a more mature markets such as the US and European countries as they continue to recover from the global crisis.

As a general statement, our volumes in the emerging markets are now higher than before the crisis while the volumes in the more mature markets, while recovering, are still below where they were. Overall, however, our volumes are essentially back to where they were pre-crisis. So, while we did see volume improvement in the second quarter, our gross margin declined 1.2 percentage points from the first quarter due primarily to higher raw material costs.

We are in the midst of implementing price increases where necessary to cover the raw material cost increases. However, as we have discussed in the past, there are some timing differences in our customer base due to negotiations or contractual limitations that restrict price changes to certain time periods. The bottom line is that we expect to eventually recover the raw material cost increases although it does not happen all at the same time.

Looking forward, we continue to see strong fundamentals over the next few years that should lead to solid growth, although we do expect somewhat lower demand in the second half of this year versus the first half. There are several reasons for this short-term impact. One is the demand in countries such as Brazil, Germany, Italy, France and the UK where tax incentives for auto purchases have ended.

Another reason is there is seasonality in parts of our business where the months of August and December are traditionally lower. We are also expecting to see some softening in steel production in certain countries as steel producers take actions to keep supply and demand in balance. All of these will tend to temper demand in the second half of the year.

Looking past 2010, over the next several years, we continue to expect to see strong growth in both the emerging and mature markets for our core steel and automotive businesses, and we believe we are well positioned to take advantage of this growth. As you know, we do not give specific guidance as it relates to future earnings. What I will say is that we continue to expect to see strong second half earnings but have them below the first half due to the softening in demand and potential lag effects on margins as I mentioned earlier.

All in all, we expect 2010 to be a record year for earnings and EBITDA generation for Quaker. We also generated strong operating cash flow in the quarter and used the cash flow to reduce our debt level. Our net debt to total capital ratio is now 19%, which is our lowest level since 2003.

While we consider ourselves under-levered at this point, it does provide us with greater financial flexibility as we continue to look for acquisition opportunities that will be a good fit for us. In fact, we recently completed the acquisition of DA Stuart's aluminum rolling business in the US. While this is a modest acquisition for us, given that it is $7 million in size, it does have a good global potential for us since we have the ability to use the technology on a global basis.

The other item I believe that is worth mentioning is the amendment of our bank credit facility. This amendment's extended maturity date decreased our interest costs and gives us additional financial flexibility by increasing our borrowing capacity by $50 million. And finally, we increased our dividend that is payable tomorrow. This marks the 38th consecutive year we have increased or maintained our dividend.

In closing, I am excited about our current situation and our prospects for the 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 CFO, so that he can provide you with more details behind our financials, and after that we will address any questions you may have.

Thanks, Mike. Good morning, everyone. Yesterday, we announced second quarter 2010 earnings of $0.80 per share compared to $0.29 per share in the second quarter of 2009. Compared with the first quarter 2010, which included an $0.11 benefit from FIN 48, reported EPS was down $0.04. As I mentioned during last quarter's conference call, we are coming out of the recession in stronger shape financially than when we went in. This improvement is shown on chart 3 where you can see our current EBITDA run rate is at record levels.

I'll now go through the second quarter P&L and then, we'll go on to questions. It is important to recall that last year second quarter represented the initial stages of the recovery from the global economic crisis. As a result, many of the comparisons are not fully relevant. For that reason, I've also included some comparison with the first quarter of 2010. Revenues for the second quarter, compared with the same period last year, were up 33% to $136 million. Compared to the first quarter of 2010, sales were up 6%.

Looking at volumes, compared to last year second quarter, double-digit volume increases were experienced across the globe. In addition, foreign exchange rates increased revenues by about 1% 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.

Now, the volume increases I mentioned must be kept in perspective. For example, capacity utilization rates in the US steel industry averaged about 70% in the second quarter of 2010, which is about the same as the first quarter rate. This compares to about a mid-40% level last year at this time; however, this level is still far below the almost 90% capacity utilization rates of early 2008.

As you can see on chart 4, production levels are relatively flat during the second quarter compared to the sharp rise that occurred during the first quarter. Several mills have announced downtime during the second half of the year, so we anticipate some volume declines in the second half. We are seeing this in the US, but also in Europe as well.

The good news is that inventory levels while somewhat higher than earlier this year are not overly high. So, the actions needed to bring supply and demand into better balance should be somewhat limited. Compared to the first quarter 2010, overall volume was up about 7% with volume increasing around the world.

Turning to gross margin -- gross margin as a percentage of sales was 35.7% this quarter versus 36.9% in the first quarter and 35.2% for the second quarter last year. As Mike mentioned, the decline in gross margin percentage was largely due to higher raw material costs. We are implementing pricing increases in the third quarter as part of the effort to recover these raw material costs and we are also experiencing higher costs related to the start-up of our Middletown, Ohio plant expansion.

As we said in the past, we report our CMS contracts on either a gross or net basis depending on our terms with the customer 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 re-negotiated, more sites are moving to a net basis. And speaking of CMS contracts, we have been awarded extensions on our current Chrysler and General Motors power train and stamping plants CMS contracts through August 2011 for Chrysler and June 2012 for GM. The move towards more net reporting of CMS revenue also resulted in a slight increase in gross margin percentage when compared to the second quarter of 2009 and also the first quarter.

Moving on to SG&A and other expenses, in absolute terms, SG&A for the quarter increased about $6 million compared to the second quarter 2009. Approximately 70% of this increase related to higher selling costs related to increased business activity as well as higher incentive compensation and professional fees. I would also like to note that our SG&A as a percentage of sales in the second quarter did decrease compared to both the first quarter and last year second quarter, and is at its lowest rate since 2008.

Looking at the tax rate, as anticipated, our tax rate in the second quarter was higher than the unusually low first quarter tax rate. 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 currently project a full-year tax rate of approximately 27% to 28%. However, this may change as the year progresses due to income mix and other factors.

Turning to the balance sheet and cash flows -- as for our seasonally weak first quarter cash flow, we generated $15 million of operating cash flow in the second quarter and reduced our debt level to low year-end 2009 levels. Our net debt to capital ratio is at a strong 19% at June 30th, 2010 compared to 23.4% at June 30th, 2009.

As Mike mentioned, during the second quarter, we also amended our primary credit facility to extend the maturity date until June 2014, and increased the size of the facility from $125 million to $175 million. Early in the third quarter, we closed on the acquisition of the DA Stuart aluminum hot rolling business, a small but strategic acquisition.

I believe that our strong balance sheet, financial flexibility and increase in EBITDA position us well to take advantage of other opportunities that may arise. And that concludes my prepared remarks.

Thank you, Mark. At this stage, we'd like to address any questions from any participants on the conference.

Ladies and gentlemen, we will now be conducting the question-and-answer session. (Operator Instructions).

Our first question is coming from Liam Burke with Janney Montgomery Scott. Please state your question.

Thank you. Good morning, Mike. Good morning, Mark.

Hi, Liam.

Hi, Liam.

Mike, you mentioned, and this is not new, I mean you have talked about it in the last quarter that the second half will be not as strong as the first half. But are there any offsets to some of the things that you've talked about specifically, the seasonality and lower auto sales in Europe? Would there be any positive offsets to that?

Yes, there is, Liam. Certainly with this acquisition, we're picking up volume and profits with that. So, that'll be a good thing and that will kick-in here starting July. And then, we also are picking up new business as well from different places around the world. So, we continue to do well in our various businesses, our steel business, metalworking and mining business, fluid power. So, we expect to certainly have some increased business as well.

Great. On the CMS side, Mark mentioned that you had extensions on awards. Are there any new awards that you had during the quarter?

No, not at this point. There are no major contracts put out to bid at this point from people.

In the US, we did pick up a couple sites internationally. But those plants have not fully started operations yet.

Right. Yes, I mean that's a good point, Mark. We have been able to leverage our relationships with General Motors and others from around the world and we were able to be awarded different new sites throughout the Asia-Pacific region because of these relationships.

Great. Thank you.

Thanks, Liam.

(Operator Instructions).

Our next question is coming from Scott Blumenthal with Emerald Advisers. Please state your question.

Good morning, Mike. Good morning, Mark.

Hi, Scott.

Good morning.

Mike, you just -- I guess Mark just mentioned that you picked up some new international sites from GM and Chrysler. Can you give us an idea as to when you think you may get started with those, since Liam asked the question about offsets.

Yes, I don't think they will be really material in this year. Most of that will really be kicking in next year.

Okay. And can you give us, Mike, maybe an idea as to how things will play out for the rest of the year between your steel manufacturing customers and what you feel the outlook is for your metalworking customers?

Well, there's certainly a relationship in some cases certainly because a lot of steel goes into automotive and most of our metalworking is into automotive. And it really depends upon what countries and what regions you are talking about. But in general, as I mentioned, some of this automotive which is primarily our metalworking business, you just have certain places around the world that these tax incentives have ended, and that's kind of Brazil and several European countries.

But then, you have places like the US and Asia-Pacific where automobile production should still continue to be strong and then steel will in some ways tend to follow that as well, but not entirely.

Do you have any geographies that you would expect in the second half to be stronger than they were in the first half?

Well, China is always a wildcard because China is -- continues to want to grow, and I think the thing with China -- China and India really had strong years so far. And as China kind of tries to clamp down internally on credit and that will maybe impact on some of the internal demand in China, it could be that the China mills will discontinue to produce and that means more exports. So, it's hard to say, but I would tell you we have about roughly the same amount of share everywhere around the world in steel.

So in some cases, we don't -- in lot of ways, we don't really necessarily care where steel is produced or not from a business perspective because we generally pick it up and when you look at the overall pie, that's where we see some softening maybe in the second half.

Okay, that's helpful. Can you talk about the DA Stuart acquisition and the possibility of selling legacy Quaker products into those customers and maybe what you're going to get from them that you might be able to sell to non-DA Stuart customers?

Right. Certainly with this acquisition. what we're picking up is customers in the United States that DA Stuart certainly has today, and we continue to expect to be able to service those customers after the acquisition. I think there's two aspects we see growth in other ways. One is we would eventually feel we can sell other products that we have to those same customers. For example, hydraulic fluids might be a good example of a product we would sell into them. That didn't initially come with the acquisition, but now that we're going to be even with that customer, we would have a better chance of selling eventually.

The other aspect is that we have this access to this aluminum rolling technology now that we can leverage in other places around the world. So certainly, the -- while we only bought the US business, now we'll have that technology and it'll take some time to roll it out to our other regions, but to us that was a big advantage of this acquisition to be able to take this technology and be able to use it in what are much bigger markets, such as China, Europe and so forth.

Do you have any of the DA Stuart customers, candidates for CMS?

Not that I know of at this time.

Okay. I guess one last question, if I may, for Mark. Mark, you mentioned you expect to have some higher costs in the Middletown, Ohio expansion. Could you elaborate on those and when you expect those might hit?

No. We have been experiencing them over the last couple quarters, just your normal kind of start-up costs as you go kind of on the learning curve on the plant expansion.

Okay. I must have misunderstood. Thank you both.

Thank you.

Thanks, Scott.

(Operator Instructions). Gentlemen, it appears we have no further questions. I'll now turn the floor back over to management for any closing remarks.

Okay. Thank you, Claudia. I want to thank all of you for your interest in the conference call today. We are pleased with how we are managing through what are still unusual times and we continue to be very confident in our future at Quaker Chemical. Our next conference call for the third quarter results will be at the end of October, and if you have any questions in the mean time, please feel free to contact Mark Featherstone or myself. Thanks again for your interest in Quaker Chemical.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.