Quaker Chemical Corp (KWR) 2010 Q4 法說會逐字稿

Greetings, and welcome to the Quaker Chemical Corporation fourth-quarter and year-end 2010 results conference call. 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 for Quaker Chemical Corporation. Thank you, Mr. Barry, you may begin.

Thank you, 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, after my remarks, Mark will provide the details around the financials, and then we'll 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 the website at www.quakerchem.com.

I will now start off with some remarks about the fourth quarter, and then follow-up with what we're currently seeing in the marketplace. Our earnings for the fourth quarter were $0.59 per share. For the full year, our earnings were $2.77, which is up 88% from 2009. The full-year net income and EBITDA are a record for Quaker.

So, let's talk about volumes for a minute. From the first quarter of 2009 to the second quarter of 2010, we experienced good sequential improvement in our volumes for five straight quarters, as you can see in Chart Two. In the third quarter and fourth quarters, our volumes slightly declined but were essentially flat, which I found encouraging, since we have seasonality effects, especially in the fourth quarter. Overall, our volumes are essentially back to pre-crisis levels, although our mix has changed as our volumes in the emerging markets are now higher than before the crisis, while the volumes in the more mature markets, like the US and Europe, are still below where they were but continue to improve.

Now, let's talk about our gross margins a bit. As we mentioned last quarter, our raw materials were increasing in the fall, so the lower gross margin percentage we experienced in the fourth quarter was expected. There is usually a lag effect in our recovery of margins due to the time necessary to complete customer negotiations, or there can be contractual limitations that can restrict price increases to certain time periods.

We have implemented significant price increases in the first quarter of 2011 to help restore our margins to more acceptable levels. Of course, the recent tensions in the Middle East will result in higher raw material costs for us and, therefore, we will need to do more price increases, which we expect to do in the second quarter. Overall, we expect the first quarter gross margin percentage to be higher than the fourth quarter, although the ever changing crude oil situation provides uncertainty.

At the end of the year, we also made an acquisition of Summit Lubricants for $29.1 million. We are excited about this acquisition. We believe that the specialty grease market is complementary to our other product lines, and an excellent strategic fit for Quaker. Summit is in the process of significantly expanding their manufacturing capacity, and this will provide us the ability to grow their sales, not only with their current customer base, but also by using some of our sales channels around the world. Overall, we expect the acquisition to be accretive to earnings in 2011.

Going forward, we continue to see acquisitions as an important part of our growth strategy. I believe the two acquisitions we made in 2010 are good examples of buying a new business or technology in one region, and being able to expand it geographically. We also can see acquiring businesses that are similar to an existing business within Quaker. This type of acquisition can provide additional market share as well as other synergies.

In the coming year, we expect to be active again in acquisitions, and we are currently evaluating several opportunities. Looking forward to 2011, I expect to see good growth in almost every region of the world. In the more mature markets, such as Europe and the U.S., we see industrial production increasing, so expect to continue to see growth in these markets as they recover from the significant hit they took during the global crisis. In the emerging markets such as China, India and Brazil, we see strong inherent growth just because there tends to be a greater amount of new manufacturing facilities being built in these countries, such as new steel mills or auto plants.

The good news is that in all regions, we have strong operations and are able to take advantage of this demand growth. We also plan to invest in our business by hiring more people in 2011. While most of the investment will be in emerging markets, we will be investing in all regions, in areas where we have significant growth opportunities. However, a major uncertainty I see with 2011 is our raw material situation. Of course, over the past week or so we have seen crude prices increase dramatically. This will mean higher raw material costs and the need for additional price increases.

However, there is typically a lag effect due to the implementation of price increases like we experienced in the fourth quarter. Only time will tell how much crude and, consequently, our raw materials will increase due to the geopolitical issues. Overall, I can only state that our goal is to get our margins to the proper levels, and we are very focused on doing this. The bottom line for 2011 is that we see good growth in the top line, and our goal is to continue our profit growth and build upon the record profits we achieved in 2010.

So, in summary, 2010 was a really good year for Quaker. We achieved record earnings, generated strong cash flow, made two strategic acquisitions, enhanced our financial flexibility by extending and increasing our credit line, raised our dividend and continuously improved our average stock price each quarter. In fact, we were named to Investors Business Daily's Best of 2010 top 100 stocks list, given our shareholder return in 2010 of 106%. However, more importantly than looking in the past, I continue to be confident in our future.

I believe the plans and investments we have made in 2010 will allow us to continue to build upon our strong 2010 performance for years to come. 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 fourth-quarter 2010 earnings of $0.59 per share, compared to $0.71 per share in the fourth quarter of 2009. I would like to note that the fourth quarter of 2010 includes two charges totaling $0.10 per diluted share. There is a $0.05 charge related to an out-of-period pension reserve shortfall at one of our equity affiliates. In addition, there is a $0.05 charge related to a non-income tax contingency.

The fourth quarter of 2010 results were obviously impacted by the higher raw material costs we continue to experience. However, as Mike mentioned, we have implemented price increases in the first quarter to help restore our margins. With the recent turmoil in the Middle East, we are experiencing further raw material cost increases. As a result, we are planning additional pricing actions for the second quarter.

We also continued to generate strong cash flows during the quarter with $18 million of operating cash flow. And as Mike mentioned, we also closed on the acquisition of the Summit Lubricants, our second acquisition of 2010. As you can see on Chart One, our current EBITDA run rate remains well above pre-crisis levels, and we are well-positioned to take advantage of additional acquisitions and other opportunities that may arise.

First, I'll go through the fourth quarter P&L, and then we will go on to questions. Revenues for the fourth quarter, compared with the same period last year, were up 8% to $142 million. Compared to the third quarter of 2010, sales were up about 3%. Compared to last year's fourth quarter, volume increases were experienced across the globe with overall volume being up 8%. In addition, selling price and mix result in a 5% increase in sales. Partially offsetting this were decreases in sales due to foreign exchange rates and lower chemical management services revenue reported on a gross basis. This decreased sales by 1% and 3%, respectively.

As you can see on Chart Two, our overall volume was down slightly, about 1%, from the third quarter 2010 level, and is approximately equal to pre-crisis levels. Turning to Chart Three, North America's steel industry production levels continue to gradually recover. For example, capacity utilization rates in the US steel industry averaged about 70% in the fourth quarter of 2010, which is about the same as the third quarter. In the fourth quarter of 2009, North America's steel capacity utilization averaged a little over 60%. Currently, in 2011, North America's steel capacity utilization has now climbed to about 75%.

Looking ahead on the volume side, some of the US steel inventory build we saw toward the end of the third quarter and into the fourth quarter has been reduced, in part, due to several months of strong auto sales. However, as we discussed last quarter, the strengthening of the Brazilian Real continues to impact steel production levels in that country due to imports.

Turning now to gross margin. Gross margin as a percentage of sales was 33.7% this quarter, a drop of almost two percentage points from the third quarter of 2010, and also below the fourth quarter of last year. The decline in gross margin percentage from last year was largely due to higher raw material costs. We implemented, and are implementing, price increases in the first quarter to recover some of the raw material cost increases that occurred late last year. However, as I mentioned earlier, the turmoil in the Middle East has resulted in recent spike in crude prices, and we are seeing further raw material cost increases in 2011. So, in response, we are planning further pricing actions for the second quarter. Historically, we have generally experienced a three- to six-month lag in recovering higher raw material costs through pricing actions.

Let's move on now to SG&A and other expenses. In absolute terms, SG&A for the quarter was essentially flat with the fourth quarter of last year, despite incurring significant acquisition-related costs in the fourth quarter. Higher selling costs with increased business activity, as well as inflationary increases in the fourth quarter of 2010, were largely offset by reduced incentive compensation.

In 2009, we recorded most of our incentive compensation expense in the second-half of the year, as our earnings ramped up during the second-half of last year. I would also like to note that our SG&A as a percentage of sales in the fourth quarter decreased, compared to both the third quarter and last year's fourth quarter, and is at its lowest level since 2008. Looking at the tax rate now, our tax rate in the fourth quarter of 32% was higher than the third-quarter tax rate due to income shifts among jurisdictions, as well as some dividend repatriation, which helped fund the Summit acquisition.

The full-year tax rate of 27.3% was in line with our expectations of mid- to high-20%. For 2011, we anticipate that our tax rate will be in the high-20s to low-30s range. However, this rate may vary as the year progresses due to income mix and other factors. Looking at our balance sheet, during 2010 we generated approximately $37.5 million in operating cash flow. As a result, our debt increased only modestly, despite closing on almost $36 million of acquisitions.

Even with the acquisitions, we closed the year with a stronger leverage ratio, or debt divided by EBITDA, of approximately 1.2 times, compared with approximately 1.4 times at the end of 2009. 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 Mike, that concludes my prepared remarks.

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

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions)

One moment, please, while we poll for questions. Thank you. Our first question this morning is coming from the line of Liam Burke of Janney Montgomery Scott. Please proceed with your question.

Morning, Mike, morning, Mark.

Good morning, Liam.

Mike, as 2010 unfolded your second half volumes were sequentially down as a result of the nature of some of your customers where they divide up market share, not on a, they divided up 100% and then zero. Is that the way we are supposed to look at 2011 in terms of how the revenues roll?

You mean quarter by quarter, you're talking about a seasonality effect?

Right, exactly.

You know, I've been with the Company for a while now, 12 years plus, and we can see different seasonality effects from year-to-year. Traditionally in the third and fourth quarters you do, in the summertime and in Europe for example, we see our business drop off there, and then in the fourth quarter we tend to see a lot of places around the world in December slow down or shut down for a period of time. But then there are also opportunities, or times, when people just work through the holidays, so it's really hard to say. But generally I would say we do see some seasonality effects in the third and fourth quarters.

Okay. And if you go back to pre-recession gross margins, they were roughly 30%. Fourth quarter they were down year-over-year, but up almost 400 basis points from historical levels. Could you give us some color on what's different now? Even with rising oil prices?

Well, I think the difference is when we were back in the -- prior to the crisis in 2008, we were in a situation where there was severe raw material increases and we were putting through rapid price increases through the year but we were continuing to try to catch up during that time period. And then, of course, the crisis hit in the fourth quarter of 2008. So, yes, prior to the crisis, in the 2008 time period, they were down because of this severe raw material impact as raw materials were escalating. And they would have come back, or would have been in the, to more typical levels, I would say had we given it more time there.

And, Mark, are there common shares outstanding listed for the quarter and for the full year?

Yes. I think we are about 11.5 million shares outstanding currently, but I can get you that number.

Okay. And then on Middletown, Ohio, the project completed and CapEx will then go back to more normal levels in 2011?

Well, I think, actually 2010 was pretty much in line with previous years of about $10 million. And one of the things that we are certainly looking at in 2011 is the potential for a second plant in China. Our volume there has been increasing at double-digit rates for quite some time. The plant we built in 2006 was running pretty much near full capacity. However, the good news is constructing a new plant in China is considerably cheaper than it is constructing a new plant in either the US or Europe.

Great. Thank you.

Thanks, Liam.

Thank you.

Thank you. (Operator Instructions)

Our next question is from the line of Scott Blumenthal of Emerald Advisers. Please state your question.

Good morning, thank you for taking my question.

Hi Scott.

Thank you.

Mike, can you elaborate a little bit on the DA Stuart acquisition, maybe discussing how much of a contribution you got from the business in 2010, what your expectations are for 2011 and where you think that business can go?

Sure. I'll probably talk more qualitatively than quantitatively because we tend not to release specific things of that, but it was a relatively small acquisition for us. Sales at the time we bought it was in that $6 million to $7 million annual range and the good news is that we do see, certainly, pick up in that market. We bought the business, their business in the United States, but we also bought their technology to use globally as well. And that was the real advantage for us.

So we see good inherent growth in the US. We see the ability to move other products that we sell to their customer base, and we see the ability to take their technology and also use it around the world, and that's the real advantage for us. So we see eventually here, as time goes on, a real good multiplier effect. And in a lot of ways it's the kind of acquisition that we've found the most exciting where we can buy the technology in one region and be able to expand it with our strong set of operations around the world.

Got it. And correct me if I'm wrong, which I probably am, historically, your relationships are with steel manufacturers, fabricators, how long or are you comfortable already with your relationship with the aluminum industry which tends to be growing, obviously, more worldwide than it is domestically?

Well, we've had relationships with the aluminum producers, maybe not as strong a relationships as we had with the major steel producers, because that was really our core line and, again, this acquisition -- so we feel good about the relationships. This is a market that has a limited amount of suppliers in it and the customer bases generally are looking, I think, find that this acquisition is a favorable thing because now they have another good alternative to the market leader and we can build upon that. So we feel excited about the competitive dynamic there.

Much bigger is the market leader then DA Stuart?

I know in the US it was roughly, it was roughly half, equal. But when you go out globally, that other party was considerably bigger around the world .

Okay. That's helpful. Thank you.

Sure.

Can you talk a little bit about your hiring plans? And can you talk about whether they are service people, or what is going on there?

Sure. Generally, we are, again, as I mentioned in my comments, we are going to be hiring again. I don't want to give out any specific number but it's pretty considerable and it's going to be mainly in the emerging markets, the Chinas, the Indias, in those areas are the areas with the most growth. But we are doing it also in the US and Europe and in the areas where we have good opportunities. I would say the areas of where we are going to be hiring generally are people in the field, salespeople, as well as technical people. People that are for our labs or provide technical services for our customers.

Okay. And I guess the last thing is, might you be able to -- this is probably a better question for Mark -- might you be able to give us an idea of the magnitude of Q4 price increases and whether you think Q1 price increases are going to be more or less than those?

Generally, I would say we generally don't give out price increases, the amounts that we do, and there is a lot of reasons for that, and they are all over the board, of course. They can be different by product line and so forth, and I know you were looking at a real high level, and really if you look at the future price increases that we are going to be doing it is hard to say at this point just because we don't know where crude is going to land and so it's hard to determine.

Okay. Fair enough. Thank you.

Thanks, Scott.

Thank you.

Thank you. (Operator Instructions) We will pause a brief moment to poll for questions. Thank you. There are no further questions at this time. I would like to turn the floor back to management for closing comments.

Okay. Thanks, Rob. I want to thank all of you for your interest in attending the conference call today. We are pleased with 2010. And we continue to be confident in the future of Quaker Chemical. Our next conference call for the first quarter results will be in late April or early May, 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 your participation.