Quaker Chemical Corp (KWR) 2010 Q3 法說會逐字稿

Greetings, and welcome to the Quaker Chemical Corporation's third quarter 2010 results conference call. (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.

Thank you. 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 third quarter and then follow with what we are currently seeing in the marketplace. Our earnings for the third quarter were $0.55 per share. This is a 22% improvement from the third quarter of 2009 when we made $0.45 per share. Our year-to-date earnings of $2.19 are up 192% from 2009 and are higher than any full year earnings in our history.

The third quarter earnings contained a charge related to the previous CEO's final pension payment, which was approximately $0.08 per share. The earnings also contained a $0.21 per share charge related to a non-income tax contingency. So if the impact of these two items were excluded, in order to get a sense of our operational earnings, you can see that our business is generating earnings consistent with the level we experienced in the first and second quarters of this year.

The non-income tax contingency charge is related to a historical VAT issue for one of the Company's subsidiaries that recently came to light. The charge that we took is the Company's best estimate of a liability, but this is an extremely complex issue. To learn more about it, please read our disclosure in the 10-Q.

So let's talk about our volumes for a minute. Since the Q1 2009 we have seen sequential improvement in our volumes for five straight quarters, as you can see on chart one. In the third quarter we saw essentially flat volumes with the second quarter. This was actually a positive for us since the third quarter normally sees some lower demand especially in Europe due to seasonality effects. However, we did begin to experience some softening in our core steel and automotive markets, but these were offset by new business that we have been awarded, as well as the acquisition of the D.A. Stuart aluminum business, which was completed in July.

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 improving and recovering, are still below where they were. Overall, however, our volumes are essentially back to where they were pre-crisis.

So let's talk about our gross margins a bit. Our third quarter gross margin was consistent with the second quarter. We experienced increases in our raw materials in the second quarter, and we implemented price increases in the third quarter. Unfortunately, our raw materials continued to escalate, especially in September and October, so we're in the process of evaluating and implementing price increases once again.

However, as we 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 our goal is to recover the raw material cost increases, although it doesn't always happen immediately.

Looking forward to the fourth quarter, we are seeing some softening in most regions around the world as steel production begins to decline as producers get their inventory levels back in line. We also expect some seasonality effects, as well, as some industrial production typically declines in December due to the holiday period.

Given the lower demand and timing of price increases versus raw material increases, we do expect our earnings to be below the $0.80 per share type level we were experiencing earlier in the year. However, we still expect our earnings to be strong. And, again, I'll repeat that, we expect our earnings to be strong. As you know, we do not give specific guidance but I hope this gives you a sense of what we are expecting.

And while demand may be softening in the near term we do expect this -- we do not expect this to be a long-term trend. Looking past the immediate future a bit we do continue to see strong fundamentals over the next few years that should lead to solid growth for us. In the more mature markets, such as the U.S. and Europe, we believe that industrial production will continue to increase over the next few years as we come back from the global crisis.

In the faster growing countries, such as China, India, and Brazil, we have leadership positions that will allow us to grow with these strong and dynamic economies. So overall we are optimistic about our growth prospects of the Company.

A few final comments. We also have generated strong operating cash flow in the quarter and used the cash flow to reduce our debt levels. Our net debt to capital ratio is now 15%, which is our lowest level since 2002. I believe this was especially significant considering we had a cash outflow of approximately $10 million related to our acquisition and our former CEO's final pension payment. 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 would be a good fit for us. In fact, we recently completed the acquisition of D.A. Stuart's aluminum rolling business in the United States. While this is a modest acquisition for us, given that it is $7 million in size, it does have good global potential for us since we have the ability to utilize this technology on a global basis. And, finally, we increased our dividend paid in the third quarter. This marks the 38th consecutive year we have increased or maintained our dividend.

In closing, I'm 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'll turn it over to Mark Featherstone, our CFO, so that he can provide you with more details behind our financials. And, after that, we'll address any questions you may have. Mark?

Thanks, Mike. Good morning, everyone.

Yesterday we announced third quarter 2010 earnings of $0.55 per share compared to $0.45 per share in the third quarter of 2009. As Mike mentioned, we also continued to generate strong cash flows during the quarter with $9 million of operating cash flow. We also closed on a small but strategic acquisition while continuing to pay down debt. As you can see on chart two, our current EBITDA run rate is near the record level, and we are well positioned to take advantage of acquisitions and other opportunities that may arise.

First, I'll go through the third quarter P&L and then we'll go on to questions. It is important to recall that during last year's third quarter we were still recovering from the global economic crisis. As a result, many of the comparisons are not fully relevant. For that reason, I have also included some comparisons with the second quarter of 2010.

Revenues for the third quarter compared with the same period last year were up 16% to almost $138 million. Compared to the second quarter of 2010 sales were up about 1%. Compared to last year's third quarter, double-digit volume increases were experienced across the globe, with overall volumes being up about 15%. In addition, selling price and mix resulted in a 5% increase in sales. Partially offsetting this were decreases in sales due to foreign exchange rates and lower chemical management, or CMS revenue reported on a gross basis, each of which decreased sales by 2%.

Now 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 third quarter of 2010, which is slightly below the rate where we ended the first two quarters.

Now year-to-date capacity utilization is also around 70% and is well ahead of the same period in 2009, where capacity utilization was around 50%. However, the 2010 level is still far below the almost 90% capacity utilization of early 2008.

As you can see on chart three, North America's steel industry production levels showed a slight decline in the third quarter, after peaking in the second quarter, but they are still well above the depths of late 2008 and early 2009.

Looking ahead, several mills have announced downtime so we do anticipate some volume declines in the fourth quarter. We are seeing this in the U.S. but also in Europe, as well. In addition, the strengthening of the Brazilian Real has also caused some production declines due to imports.

The good news is that U.S. inventory levels, while somewhat higher than earlier this year, are still in decent shape, so at this point it appears that the actions needed to bring supply and demand into better balance should be limited.

As I noted before, compared to the second quarter of 2010, overall volume was basically flat.

Turning to gross margin, gross margin as a percentage of sales was 35.6% this quarter, essentially even with second quarter levels but below the 37.4% in the third quarter of last year. The decline in gross margin percentage from last year was largely due to higher raw material costs.

During the third quarter we implemented price increases as part of our effort to recover the higher raw material costs that we began seeing in the second quarter. However, raw material prices have continued to increase, and we are beginning to work with customers on additional pricing actions.

Historically, there's generally been a three to six-month lag in recovering raw material cost increases so most of the impact of the additional actions now underway will not likely be apparent until early next year.

We are also experiencing higher costs this year related to the startup of our Middletown, Ohio plant expansion.

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 costs incurred with the tier two product purchases. For the last several years, most of our major CMS contracts were accounted for on a gross basis. Recently, as CMS contracts have been renewed or renegotiated, more sites are moving to a net basis. The move towards more net reporting of CMS resulted in a slight increase in gross margin percentage when compared to the third quarter of 2009.

Let's move on to SG&A and other expenses. In absolute terms, SG&A for the quarter was flat with the third quarter of last year. Higher selling costs with increased business activity, as well as inflationary increases, were largely offset by reduced incentive compensation.

In 2009, we recorded most of our incentive compensation expense in the third quarter, as our earnings ramped up in the second half of last year. This year the distribution of earnings and accrual of incentive compensation has been much more even.

I'd also like to note that our SG&A as a percentage of sales in the third quarter decreased compared to both the second quarter and last year's third quarter, and now is at the lowest level since 2008.

Turning to the tax rate, our tax rate in the third quarter benefitted from some drop-off of FIN 48 on uncertain tax positions. In addition, improved earnings in the U.S. and other countries allowed for previously unbenefitted foreign tax credit and net operating losses to be utilized.

We currently project a full year tax rate percentage in the mid to high 20s, however, this may change as the year progresses due to the income mix and other factors.

Looking at the balance sheet and cash flows, during the third quarter, as I mentioned, we generated $9 million in operating cash flow and we were able to reduce debt levels despite closing on the aluminum acquisition and making a significant pension payment.

Our leverage ratio, which is debt divided by EBITDA, is currently under one time and in absolute dollar terms our net debt or debt less cash is now at its lowest level since 2003 when we were a $340 million sales Company. Our net debt to total capital ratio is at a strong 15% at September 30th, 2010 compared to 21% at this time last year.

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

Thanks, Mark. At this stage we would like to address questions from any participants on this conference.

(Operator instructions.)

Our first question is coming from the line of Daniel Rizzo with Sidoti & Company.

Hi, guys.

Hi, Dan.

Hi, Dan.

Hey, you indicated that you just raised prices in the third quarter, just given the continuing increase in raw material costs are you going to be raising prices again in the near future?

Yes, that's certainly the plan, yes.

And you -- I mean I read in the Wall Street Journal this morning that there was some push -- that steel producers are seeing a lot of increase in raw material costs. I was wondering if you anticipate any pushbacks, I guess, when you try to raise them again?

Our customers certainly never like price increases, but I think we work very closely with our customers and if you look at historically what we've been able to do we've been able to get our price increases back to where they need to be, our prices where they have to be for our margins.

Okay, and then you also indicated that you termed your debt level as de-levered, so that means I would imagine debt reduction is no longer really something you're focusing on, more on acquisitions and things like that?

Yes, we certainly continue acquisitions -- you know, that's not the main goal to pay down our debt but certainly in the interim here we're taking that cash flow, paying down our debt, and that just gives us greater flexibility to make acquisitions. So then that's something we're actively working on.

And you have no problem with increasing that debt level if you see the appropriate acquisition?

That's correct, but I would still say we're generally a conservative Company, so we don't expect to go to maybe extreme levels of debt to EBITDA, but certainly we have a lot of flexibility now from where we are.

All right. Thank you, guys.

Thank you.

Thank you, Dan.

Our next question is coming from Liam Burke with Janney Montgomery Scott.

Good morning, Mike. Good morning, Mark.

Hi, Liam.

Hi, Liam.

Mike, you talked about the second half being lower than the first half, and you had a terrific third quarter. So if you do the arithmetic you can see that on a year-over-year basis fourth quarter probably won't match 2009. Having said that, did anything -- the recovery, your business recovered in the second half of '09, was there anything particularly strong about the fourth quarter of 2009 that would be typically different from a normal fourth quarter?

Well, it was a pretty strong recovery at that point, and people actually kind of worked through some of the holiday periods, where they normally would shut-down. That might be part of the issue. Also, we saw some expansion in our margins.

The timing of margins can go both ways, you know, if raw materials go up and then we get price increases there could be a lag that way. Sometimes as raw materials are going down and how raw materials adjust margins could actually be maybe higher than normal, so that might be part of the issue in the fourth quarter, as well.

And, yes, we're not -- again, we didn't comment, per se, that the fourth quarter would be below last year, so I want to make that clear we didn't come out and say that statement.

The other thing I would just add, Liam, is we saw in the fourth quarter of last year and to a certain extent the first quarter this year you also saw a little bit of the inventory restocking effect, you know, which obviously wouldn't be repeated this year.

Okay, great. Thank you. And on the acquisition front, Mike, you've mentioned in the past that metalworking is an area of interest. Is there -- how has the environment been just generally?

The metalworking environment in general right now is good, especially with automotive production doing generally well in most regions, maybe with the exception of Europe right now. And the acquisition there, certainly an area -- that's one of the areas we're focusing on.

Competitively what we're seeing is that in metalworking there's certainly some companies that as they went through the global crisis it seems to us may be less dedicated maybe to this industry than they have been in the past. So we would like to, you know, we are continuing efforts to see if we can make something happen there from the acquisition side, although it always takes another party to agree to that, and so I don't want to give the impression something is imminent but it's something we continue to work on.

Great. Thank you.

Thanks.

(Operator instructions.)

Our next question is coming from Scott Blumenthal with Emerald Advisors.

Good morning. Thanks for taking my call.

Sure. Thanks, Scott.

Mike, you talked about the contractual requirements for putting through price increases and how that could affect timing. Is there any thought to or do you have in any of your contracts a surcharge mechanism?

Well, we have -- I think one of the common mechanisms that we have, Scott, is we have indexes, so as raw materials go up the contract allows us to recover the raw material costs. And but sometimes there's just timing differences, so some indexes might set every 90 days, some every six months. And so generally this is something that's worked well for us and on average it kind of evens out as raw materials go up or down, but sometimes in a rising environment it provides a lag.

And those are indexes that are published in I guess standard industry publications?

That's correct, yes, like mineral oils, for example, or tallow or other type of raw material costs.

Okay, and mineral oils and tallow are those actually good examples of a couple of raw materials that you're I guess struggling with at this point?

Yes.

Okay, but would you be able to at least to give us an idea as to maybe the magnitude? Obviously, not come out and tell us the exact amount, but the magnitude of the increases in Q3 and whether you expect Q4's price increases to be more or less?

Well, the -- certainly, if I compare it to where we were maybe two years ago, a little over two years ago, as crude was just skyrocketing in the mid part of 2008, in that time period we were going out and doing double-digit type price increases on a fairly regular basis just because we had to to survive, just how things were happening in that timeframe.

What we're experiencing right now is not nearly anything like that. I mean, you know, so and each region of the world is different, you have different dynamics. You have currency effect, so it's hard to say. But we're not -- we're certainly not talking about any kind of double-digit price increases --

Across the board.

-- across the board, or anything like that.

Okay, and do you expect what you're doing here in Q4 to be more or less than what you needed to do with regard to the Q3 increases?

I don't have that specific information because I don't -- but off the top of my head I would think it would be somewhere consistent with that.

And I guess my last one, and once again thank you for taking my questions --

Sure.

-- how far in advance do your customers kind of prepare for increased activity? I know a lot of us out here who follow you and the metals industry in particular were kind of planning on a I guess a little bit of a bump in Q1 with regard to steel activity, and I was wondering if you might be able to tell us if you're seeing some of that show-up in your orders yet?

Generally not. I mean we have pretty short lead-times for us. Our customers don't really have the ability to store a lot of our material on site, so generally they might hold anywhere from a month or under of our type of products. So while we don't, from that perspective, from an order pattern perspective, we don't get to really see that, but we certainly do talk to our customers on a frequent basis, and because we're there day-in, day-out in the mills and we can generally get a sense of what's happening.

But, again, I think there's kind of mixed feelings right now, depending upon where you are around the world talking to different steel producers. You know, some would say we expect to see things pick-up in the first quarter, others may be a little more uncertain. That's the best I can tell you.

Okay, fair enough. Thank you.

Thank you.

Thanks, Scott.

Gentlemen, this does bring us to the end of the Q&A session. I'll now turn the floor back over to Management for any closing remarks.

Okay, given there are no other questions we'll end our conference call 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 continue to be confident in the future of Quaker Chemical.

Our next conference call for the fourth quarter results will be in early March, 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.

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