Quaker Chemical Corp (KWR) 2011 Q1 法說會逐字稿

Greetings and welcome to the Quaker Chemical Corporation first-quarter 2011 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, Dan. 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 comments Mark will provide 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'll start it off now with some remarks about the first quarter and then follow with what we are currently seeing in the marketplace. In the first quarter our sales were approximately $160 million, and our earnings were $0.91 per share. These are both quarterly records for Quaker. We also had a record EBITDA for the quarter as well.

If I had to summarize the quarter in a few words it would be strong volumes and reduced margins. So let's talk about the volumes for a minute.

As you can see in chart 1, from the first quarter of 2009 through the second quarter of 2010, we experienced good sequential improvement in our volumes for 5 straight quarters. Then demand tended to flatten out over the second half of last year.

However, we saw a strong uptick in our volumes in the first quarter of this year. Some of this was due to our acquisition of Summit Lubricants at the end of 2010, but even without the boost of our volumes from the acquisition this was an all-time record volume quarter for Quaker.

The volume growth was broad-based and we saw sequential quarter-over-quarter improvement in each region. The growth in volumes came from gains in existing business as well as new business.

As we look over this 2-year period, each region experienced its highest volumes over this 2-year period in the first quarter of 2011, with the exception of Brazil. While Brazil's volumes have been strong, the recent growth has been somewhat limited, primarily due to the negative impact their strong currency has had on exports.

Now let's talk about our gross margins. Increasing raw material costs continue to be an issue. We implemented major price increases in the first quarter and expected our gross margin percentage to increase versus the fourth quarter of 2010.

However, raw material costs escalated even further throughout the quarter, primarily due to the North Africa and Middle East tensions. While we have gone out with further price increases in the second quarter, we continue to see raw materials escalate. So we believe even further price increases will be necessary.

As we have mentioned in the past, there is usually a lag effect in our recovery of margin due to the time necessary to complete customer negotiation, or there can be contractual limitations that can restrict price changes to certain time periods.

However, our goal is to restore our margins to more accessible levels; but the continuation of raw material increases is providing a great deal of uncertainty on the timing in which this will be accomplished.

So looking forward there are two main uncertainties. One of course is the uncertainty on the timing of restoring our margins to more acceptable levels given the continuing raw material increases I just talked about. There is also some uncertainty on demand as well, given that some major countries like China, India, and Brazil are raising interest rates to keep inflation in check. However, we have no clear indication at this point if this will meet potentially lower demand or lower growth in these countries.

Despite these uncertainties, our goal for 2011 remains to build upon our record profitability achieved in 2010. And so far in 2011 we are off to a good start in this regard.

While uncertainties exist, we do have several items going in our favor for creating shareholder value in the future. One, we have picked up some new business, and our 2010 acquisitions are performing well, both of which should help negate the potential uncertainties in the short term.

Two, we have leadership positions in our core businesses in all regions of the world, which we believe bodes well for our growth over the next several years, as Europe and the US continue to recover and emerging markets continue their good growth. And three, we expect to have other new business and acquisition opportunities that can provide additional growth.

Given these positives and our strong balance sheet, I am confident in our prospects not only for 2011 but also beyond. In closing, I want to thank all of our associates, whose dedication and expertise helps to create value for our customers and differentiate Quaker in the marketplace.

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 will address any questions you may have. Mark?

Thanks, Mike. Good morning, everyone. Yesterday, we announced record earnings of $0.91 per share for the first quarter of 2011 compared to $0.84 per share in the first quarter of 2010.

Both quarters included a significant or $0.11 per share benefit from the release of FIN 48 reserves. In addition, there was a $0.03 per share charge in the first quarter of 2010 related to the devaluation of the Venezuelan currency.

As Mike mentioned, during the first quarter we implemented significant price increases to help recover some of the higher raw material costs we experienced in the second half of last year. With the turmoil in the Middle East, we are continuing to experience rapid escalation in raw material prices.

Additional price increases have been and will be implemented in the second quarter. However, we expect that recovering these higher raw material costs will continue to be a challenge for us for the rest of 2011.

Now in some ways 2011 reminds me of 2008, when we literally could not implement pricing actions fast enough as raw materials escalated rapidly and crude hit $140 a barrel. Despite significant price increases, our gross margins then as a percentage of sales declined for several quarters until we fully caught up to the raw material cost increases.

Despite this challenging raw material environment, I am pleased to report that we had a record first quarter in 2011 as volumes remained strong and we continued to pick up new business in addition to the acquisitions.

As you can see on chart 2, the first quarter of 2011 was also a record EBITDA quarter for Quaker, with EBITDA being approximately 50% higher than precrisis levels. I will now go on through the first-quarter P&L, and then we will go on to questions.

Revenues for the first quarter compared with the same period last year were up 25% to almost $150 million. Compared to the fourth-quarter 2010, revenues were up about 12.5%.

Compared to last year's first quarter, volume increases were experienced across the globe, with overall volume being up 16% including acquisitions. In addition, foreign exchange rates increased sales by 2%; and selling and price and mix resulted in a 7% increase in sales.

Turning to chart 3, North America steel industry production levels have been ramping up in early 2011, after dipping towards the end of 2010. Capacity utilization rates have climbed from just below 70% at the start of the year to about 76% currently. By comparison, in the first quarter of 2010 capacity utilization averaged a little over 70%.

Looking ahead on the volume side, governments in both China and Brazil have been taking actions to limit inflation and have raised interest rates which, as Mike mentioned, may cause some uncertainty in demand. However, our recent acquisitions and the new business we have picked up should help to offset that.

Turning to gross margins, gross margin as a percentage of sales was 33% this quarter, a decline of 7/10 of a percentage point from the fourth quarter of 2010 and also below the first quarter of last year. The decline in the gross margin percentage from last year was largely due to higher raw material costs.

In addition, the gross margin percentage of our recent acquisitions tend to be somewhat lower, although we expect that their overall operating margins will be similar. This has also resulted in a slightly lower gross margin percentage.

We have implemented and are implementing price increases in both the first and the second quarters to recover some of the raw material cost increases that occurred late last year and that have continued into 2011. Historically, we have generally experienced a 3- to 6-month lag in recovering higher raw material cost through pricing actions. Of course, this may vary due to competitive or contractual constraints, as well as other factors.

Moving onto SG&A and other expenses, our SG&A as a percentage of sales of 24.2% in the first quarter of 2011 decreased compared to both the fourth quarter of 25.1% and 2010's first quarter of 26.2% of sales, and is at its lowest level since 2008. So we are getting some SG&A leverage with our increase in sales.

In absolute terms, SG&A for the quarter was higher than last year's first quarter due to our higher sales, professional fees, our 2010 acquisitions, as well as exchange rates. In addition, higher inflationary and other costs were partially offset by lower incentive compensation expenses.

As we discussed in our year-end investor call, we are also continuing to invest in additional resources where we have good growth opportunities, particularly in emerging markets.

Looking at the tax rate, similar to last year's first quarter, our tax rate in the first quarter of 20.6% is low due to the expiration of certain positions related to FIN 48 accounting for uncertainty in income taxes. For 2011, we currently anticipate that our full-year tax rate will be somewhere in the mid to high 20% range. However, this rate may vary as the year progresses due to income mix and other factors.

Turning to the balance sheet and cash flow, historically the first quarter is our weakest cash flow quarter of the year due to timing of incentive compensation and other payments. In addition, our increased sales also resulted in higher working capital needs.

Despite this, our leverage, which is debt divided by EBITDA, ratio remains a healthy 1.3 times. 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 any questions from any participants on this conference. Dan, I will turn it back to you.

(Operator Instructions) Daniel Rizzo, Sidoti & Company.

Hi, guys. You indicated that you got and I saw that you got good leverage on your SG&A expenses. Is further leverage achievable? I mean, are we kind of maxed out on the amount as a percentage of sales that SG&A can decrease?

I think, Dan, over time -- yes, as we have talked about in the past there is opportunity to leverage some of our corporate expenses and to a certain extent some of our direct or commercial expenses as well. But that will be a very gradual thing.

I mean you guys really don't -- and I am not knocking you. You guys don't focus on the CMS program too much anymore. Is that something that is still making inroads, or something that is still a value add? What is going on with the program?

No, I think our CMS remains a very valuable part of our offering to customers. What has happened is, as contracts have been renegotiated, most of those contracts have gone from a gross basis of reporting, where it inflates our sales, to a net basis.

We also have had a number of CMS site closures, particularly in the auto industry over the last couple years. But worldwide I still think we have the better part of 80 CMS programs, including about 40 in the US.

Okay. Thank you, guys.

Liam Burke, Janney Capital Markets.

Thank you. Morning, Mike. Morning, Mark. Mike, you talked about new business. You typically have 60% market share in steel production. Where is this new business coming from?

Obviously you are going more with existing customers, but there is a share gain there. Where is this coming from?

It's actually pretty broad-based. We have picked up some -- a good piece of the business in all regions of the world, and certain customer pickups that we've made. It is not just one region.

Is it in metalworking, or is it in the steel production side?

Certainly it has been in steel; but we have also had nice pickups in metalworking as well.

Okay. Mark, I apologize in advance. Did you give an organic growth or volume increase?

No, we are staying away from that. But we did have increases in all regions, even before you factor in the acquisitions.

Yes, I would say by far -- certainly the acquisitions were part of our growth. And if you look at what we said those acquisitions were going to be, it gives you an idea. But I think that puts -- really the vast majority of our growth is more from our existing businesses, not through acquisitions.

Right. Thank you.

Scott Blumenthal, Emerald Advisers.

Good morning. Thanks for taking my questions. Mike, you mentioned during your prepared remarks that you wanted to get margins back to acceptable levels. Would you take a shot at maybe defining acceptable?

That's a great question. Well, certainly it is above where we are today. There's a lot of things that go into that equation, because in a lot of ways we don't target gross margin levels as we look at -- each customer by customer we look at what kind of profitability we need based upon the amount of service that we provide to them.

But I understand when you're looking at an aggregate level from the Company that you would like to have more of a target. If I had to throw out a number, in the past we have said more like the 35% type range, and that is probably as good as any.

Although the more you go up in raw material costs -- and even if you recover all the raw material costs and maybe a little bit more, it still can put downward pressure on to that percentage. Also, when we make acquisitions -- like we made the Summit acquisition at the end of last year -- on an absolute term it has very high margins, but on a gross margin percentage it can have a little bit lower, and that can have a little effect as well.

So it is hard to give you a precise number, but I hope that gives you some kind of flavor.

Okay, yes, that does provide me a little bit of direction. Thank you.

Can you also talk about maybe the meaningful increase in aluminum production year-over-year? You made an acquisition that was aluminum focused last year. Maybe give us an idea as to how much that helped and how much that contributed.

We don't have exact numbers here, and we tend to stay away from providing exact numbers. But just to give an order of magnitude, at the time we made that acquisition it was approximately a $6 million to $7 million type business. We have since grown that business. Again, for competitive reasons, for all the reasons, we don't want to give out exact numbers, but I think it can give you kind of the magnitude.

We are seeing certainly growth in that business, based on what you just mentioned, Scott, just the demand for aluminum. But also we are starting to be able to take that technology and use it globally as well.

Was that only a domestic business, when you acquired it, Mike?

Yes. That was actually the thing that was very nice about this business, is that was a domestic business that we bought. The company we bought it from had to sell it because of FTC issues, antitrust issues. So we ended up buying it, but we had rights to the technology globally. And we can use our global infrastructure and relationships to be able to sell that globally.

It's not like we have made huge inroads into that yet, but we are in the process of doing that. And we are making some progress.

Okay, great. Can you maybe provide us with your feelings as to whether the takeout of one of your suppliers by Berkshire Hathaway affects your ability to access any type of materials from them, and how it might change maybe the supply environment?

No. Well, certainly Lubrizol is a supplier to Quaker Chemical. But it still continues to be a supplier, and even with Berkshire Hathaway purchasing them. So we actually don't see that event at all impacting us.

Okay. I guess my last one if I may, I think you mentioned that you were looking perhaps this year towards possibly siting a second plant in China. I was wondering if you had gotten any farther on that decision.

Yes, that's actually a very good question. We actually are in the -- I think within the next few days of finalizing the agreement for the land at that site. And then probably sometime this quarter we will actually start the construction there for our second plant.

Will that double capacity there? Or can you give us an idea?

You know, I don't have the exact numbers, to tell you the truth, in front of me. But it will certainly be a significant increase in our capacity.

In a lot of ways, capacity in our industry is not that critical, because you can put on extra shifts. We generally are a 1-shift, 5-day-a-week type of production; and then when demand increases we go to multiple shifts and can even work around the clock.

That is kind of where we are today in China, where to meet demand in our existing facility we are working a lot of extra hours, 7-days-a-week type of arrangements. Then once the new plant comes on we will have additional capacity and can go back to our normal cycle. Then as things continue to ramp up in China we can add more shifts as well.

Would you be able to tell us whether you would have any of the second plant presold?

Again, I don't know if that's -- the way I think about our business, it is probably not that relevant. Because once the new plant comes up, we will actually shift production and we won't have to work overtime at our existing plant.

Then -- and so our business in China has dramatically increased year-over-year for the past several years. We expect that to continue. So we do expect once the plant is up and running that it will be utilized quite a bit.

Okay, terrific. Thank you.

(Operator Instructions) It appears there are no further questions at this time, gentlemen.

All right, okay. Given there's no further questions, we will end the conference call now. I want to thank all of you for your interest today.

We are pleased with our start in 2011, and we continue to be confident in the future of Quaker Chemical. Our next conference call for the second-quarter results will be in late July or early August.

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 now disconnect your lines at this time, and thank you for your participation.