Quaker Chemical Corp (KWR) 2011 Q2 法說會逐字稿

Greetings and welcome to the Quaker Chemical Corporation's second-quarter 2011 results conference call. 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, after my comments 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 the website at www.quakerchem.com.

I will start it off now with some remarks about the second quarter and then follow up with what we are currently seeing in the marketplace. In the second quarter, our sales were $168 million, which was a quarterly record for Quaker, and represented a 23% increase in the second quarter of last year.

We also had strong EBITDA. If you look at page four in our slides, you will see our EBITDA trend in the second quarter was an all-time record in quarterly EBITDA for us. In fact, our annualized run rate of EBITDA is now at $75 million.

In the second quarter, we also completed an equity offering and raised $48 million. We use the proceeds to pay down debt as we wanted to strengthen our balance sheet in order to better position us to make acquisitions. An example, although a small one, is the recent purchase of our partners' 60% interest in our Mexican joint venture.

I'll now talk about our volumes in the second quarter and then follow with some comments on our margins, which are a big part of the story in the second quarter. As you can see on slide 5, we had a slight decline in our volume from the first quarter. There were a couple of reasons for this. There can be a seasonality effect with certain customers, and this was part of the impact we saw in the second quarter. For example, a customer may buy from Quaker for six months and then switch to a competitor for six months.

How this hits during the year can certainly impact our quarterly volumes. We also saw some softening in the demand in China towards the end of the quarter, but the second-quarter volumes for China were still higher than 2010. So overall, while our global volumes are slightly down from the first quarter, the second quarter was still the second-strongest quarter in our history. Compared to the second quarter of 2010, we are up 5%, with acquisition-related volume being the primary driver.

Now let's talk about our gross margins. Our gross margin did decline 1% from the first quarter. This was expected by us since we experienced very large raw material increases throughout the second quarter. Of course, we have been increasing our prices as well. We implemented major price increases in the first quarter and the second quarter, but they were not enough to keep up the escalating raw material prices.

We are in the midst of implementing more price increases in the third quarter, and we expect to see some margin percentage expansion from the second quarter. As we have mentioned in the past, 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.

However, our goal remains to restore our margins, but there is still uncertainty on the exact timing in which this will be accomplished, given the raw material market and the timing of customer negotiations.

So looking forward, there are two main uncertainties. One, of course, is the uncertainty on the timing of restoring our margins, given the continuing raw material increases I just talked about. As I mentioned, we do expect our gross margin percentage in the second quarter to be the lowest of the year, as we do expect to see improvement in the second half. Just how much and how fast is difficult to define for the reasons I mentioned earlier.

There is also some uncertainty on the demand side as well, given that some countries like China, India and Brazil are raising interest rates to keep inflation at check. We have no clear indication at this point if this will mean potentially a dampening demand or lower growth in these countries.

We also expect to continue our investment in emerging markets as we continue to hire new people, especially in China and India. We are also investing in new plants in China and India. Construction of our new plant in China is underway, and we have obtained land for our new site in India.

Concerning guidance, I realize that you may want more explicit views and guidance but, of course, our policy is to not give explicit guidance. However, I thought it was worth pointing out that our own internal estimates for our net income for the year have not changed significantly since the beginning of the year. And this takes into account the positives and negatives and investments I mentioned earlier.

Overall, 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 some uncertainties exist in the short term, 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 recent acquisitions are performing well. Two, we have leadership positions in our core business and 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 the emerging markets continue their good growth.

And three, we expect to have other good 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 CFO, so that he can provide you with more details behind the financials. And after that, we will address any questions that you may have.

Thanks, Mike. Good morning, everyone. Yesterday we announced earnings of $9.8 million or $0.79 per diluted share for the second quarter of 2011. This compares to $9.2 million or $0.80 a share in the second quarter of 2010. The second quarter 2011 EPS reflects a $0.04 per share dilutive impact from our recent equity offering.

During the quarter, we continued to implement significant price increases to help recover some of the higher raw material costs that we have been experiencing. Throughout the second quarter, we continued to experience rapid escalation in raw material prices. In fact, the second-quarter raw material cost increases exceeded those in the first quarter.

Additional price increases have been and will be implemented in the third quarter as part of our ongoing effort to restore margins. Historically, we have generally experienced a three- to six-month lag in recovering higher raw material costs through pricing actions. Despite the raw material challenges, as you can see on chart 1, I am pleased to report that the second-quarter 2011 was a record EBITDA quarter for Quaker.

I will now go through the second quarter P&L, and then we will go on to questions. Revenues for the second quarter compared with the same period last year were up 23% to almost $168 million. Compared to the first quarter of 2011, sales were up about 5%.

Overall product volumes were up approximately 5%, primarily due to acquisitions, while exchange rates increased sales by about 7%. Price of mix accounted for the remaining 11% increase in sales.

Compared to last year's second quarter, volume increases were experienced in North America and Asia. South American volumes were lower as the strengthening of the Brazilian real continues to impact steel production levels in that country due to imports. European volumes are also slightly down.

While our volumes have remained strong, they were slightly less than the first quarter, but remain above pre-crisis levels, even excluding acquisitions. Turning to our volume trends on chart 2, during 2010, I noted that the continuing recovery of the steel industry and, therefore, our volumes was not expected to be a straight line upward. Instead, our volumes plateaued for several quarters before increasing. We may experience that again as we move through 2011.

If we look at chart 3, North American steel industry production levels have been slowly ramping up in 2011. Capacity utilization rates have climbed from just below 70% at the start of the year to approximately 75% currently, and appear to be stabilizing.

Looking ahead on the volume side, as Mike mentioned, governments in China, India and Brazil have been taking action to limit inflation and have raised interest rates. And we are beginning to see some impact from that. So there is some demand uncertainty in the short term. However, our recent acquisitions and the new business we have gained should help to offset that.

Turning to gross margin, gross margin as a percentage of sales was 32% this quarter, a decline of about 1 percentage point from the first quarter 2011, and also below the second quarter of last year. The decline in gross margin percentage from last year was largely due to higher raw material costs, which were only partially offset by price increases.

In addition, the gross margin percentages 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 implemented and are implementing price increases in the first, the second and again in the third quarters to recover some of the raw material cost increases that have occurred. As I mentioned previously, there is a lag effect in recovering higher raw material costs through pricing actions and, of course, this may vary somewhat due to the competitive pressures or contractual constraints as well as other factors.

Let's move on now to SG&A and other expenses. Our SG&A as a percentage of sales of 23.1% in the second-quarter of 2011 decreased compared to both the first quarter and 2010 second quarter. And it 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 second quarter due to our higher sales, foreign exchange rates, professional fees, our acquisition-related costs, both in transaction costs as well as the cost of the acquired business.

In addition, higher inflationary and other costs were partially offset by lower incentive compensation expenses. As we have discussed, we are also continuing to invest in additional resources where we have good growth opportunities, particularly in emerging markets. In addition, we expect to incur some higher costs related to strategic initiatives, including an acquisition in the second half of 2011.

Looking at our tax rate, as expected our tax rate in the second quarter was higher than the first quarter. You may recall that our first-quarter tax rate benefited from 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 in the mid-to-high 20% range. However, this rate may vary as the year progresses due to income mix and other factors.

Looking at our balance sheet and cash flows, our second-quarter operating cash flow rebounded somewhat from the traditionally weak first quarter. But our increased sales and higher raw material costs did result in higher net working capital needs.

Our leverage or debt divided by EBITDA ratio is very healthy at less than 1 times EBITDA. Combined with our recent equity offering, this provides us with significant financial flexibility.

In summary, I believe that we are well positioned to take advantage of acquisitions and other opportunities that may arise, such as the recent acquisition of our partners' interest in our Mexican affiliate. And that concludes my prepared remarks.

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

(Operator Instructions) Mike Sison, KeyBanc Capital Markets.

Hey, good morning, guys. Nice quarter.

Thanks, Mike.

Good morning, Mike.

In terms of the outlook for the second half of the year, I understand some of the slowing. But in terms of the volume, do you sort of see sequentially about the same as the second quarter or do you actually see it coming down a little bit as we head into the third and the fourth?

It's hard to tell. And really the wild card I think is what I said before, is what's going to happen in some of these emerging countries like China, India and Brazil. It could be continued growth there and we could see some kind of a softening. So there it's really hard to tell, I think. In other regions like Brazil, we see a relatively constant, Europe constant; US maybe slightly up and so forth. But the wild card will be -- to us will be what happens in the Asia-Pacific area.

It looks like auto production is getting better third, fourth, versus what you saw in the second quarter. Is that a positive for you guys?

Sure. I mean any auto production is a big part of our end use markets that our products would end up in. So auto and steel are the big drivers. So definitely if autos are up, that would really help.

In terms of raw materials, can you just characterize sort of where they are at to date? Did they peak in the second quarter? Are they still going up heading into the third, stable?

Well, of course it depends. If I would say overall, our overall raw material costs we expect to be higher in third quarter than the second quarter. But we do see from a raw materials perspective some kind of stabilization.

It's certainly not the same kind of what we were facing this time one quarter ago, three months ago, where things were still dramatically escalating. So there can be still some upward movement in raw materials but probably not at the same rate we have been experiencing, hopefully. That can always change overnight.

So the gap between pricing and raw materials you feel should be closed maybe by year-end or the first quarter of 2012, something in that timeframe, assuming some stability in the third quarter?

Yes.

Okay, great. Thank you very much.

Laurence Alexander, Jefferies & Company.

Good morning. I guess first of all as you look at the M&A landscape, are you seeing any signs yet that M&A multiples might be becoming more reasonable, given the amount of uncertainty out there?

Not because of uncertainty, but we have seen -- if I looked at where we are today versus a couple years ago, it seemed like there was a big discrepancy between buyers and sellers around the time of the global crisis. Right now, we see more of the line that as people's businesses have improved and their expectations get more in line to what's realistic. So right now, we feel from an acquisition perspective things are fairly aligned.

And I guess separately on raw materials, just to take that a step further, is there anything you can do in terms of reformulation or mix that isn't already [serve] just part of the usual one-to-two-quarter lag that could help change your raw material profile, or is this about as good as it gets?

No, that is a great question. We have been delaying reformulation and mixes, working with our customers on that, because we can use some different raw materials that maybe have some slightly different characteristics but could help both us and the customer. We have been doing that.

Some of that can be done quicker as you pointed out. Some of that would still need to be trialed at a customer to make sure there is no issues. But certainly we have been doing that, and we expect to continue to be doing that in the third quarter as well.

Okay, thank you.

(Operator Instructions). Liam Burke, Janney Capital Markets.

Thank you. Good morning, Mike; good morning, Mark. Mike, you mentioned that in the quarter Europe was slightly down, Though when we are looking at the uncertainty in emerging markets, we're looking at a more stable North America and Europe. Do you expect those markets in Europe for the second half to be better than the way you finished the second quarter?

I think in general, Liam, it's kind of a case of the first quarter somewhat outperformed. It was a little more of a timing of certain customer shipments occurring in the first quarter. So we don't see a big downturn in Europe or anything like that happening. It's one of those -- a little bit of volatility just like in the US, but overall the market I think is pretty stable there.

Sure. And on the cash flow statement, Mark, your working capital needs were pretty steep across the board on current assets, and CapEx is $3 million higher than a year ago, resulting in negative cash flow. Do you expect those trends to reverse, and what was the step-up in CapEx?

Sure. Yes, we do expect operating cash flows to continue to improve as the year goes on. Obviously, if you look at our accounts receivable and inventory levels, both are up versus last year. On the AR side, that's primarily reflected in these price increases we have been putting through.

On the inventory side, part of that is due to the pricing. Part of it is some kind of spot buying in front of raw material price increases. And there have been kind of some selective shortages on some certain products, so we have also stopped up there.

On the CapEx side, as Mike mentioned, we earlier this year did purchase land for an additional -- for our second plant in China, so that is a trigger. Also, we acquired Summit, and at the time we acquired it, their second plant was probably 75% or so complete. So we put some capital into that as well.

As Mike mentioned, we are in the process of starting to construct a plant in India as well. But I think it's important to also remember that the cost of a plant in China or India is not anywhere near the same cost of a plant in the US or Europe. I think probably both the plant in China and India will each cost somewhere in the $6 million to $8 million range and will be over a couple year period.

So I would say in general, we have said that excluding some unusual expenditures, our base CapEx is somewhere in the $10 million range. And this may blip it up a little bit, but it's not going to be huge capital outflow.

Great, thank you.

Scott Blumenthal, Emerald Advisers.

Good morning, Mike and Mark. Mike, I believe it was you in your prepared remarks that said that Q2, the current quarter that we are discussing here, is going to be the lowest margin quarter of the year. I know that you have significant exposure to vegetable or plant oils. And if you look at the trend with soybeans, coconut and others, it looks like they are trending slightly downward this past month. Is that what gives you the confidence to make such a statement?

Yes, from the raw material perspective, certainly we see some of our raw materials down a little bit, and we see some of the increases in the other raw materials kind of slowing down. Again, as I said, overall, we expect our raw materials to probably be on average higher in the third quarter than the second quarter, mainly because of a lot of the price increases that we were going through in the second quarter were all through the timing of the second quarter.

The reason for my remark on the margins is because of the price increases as well that we have being implemented in the third quarter. So it's kind of a combination of the two that I would expect to see some beginning of our margin restoration.

Okay, thank you. And with regard to steel production, I know that you are mostly -- most of your sales are international, if I recall correctly. And we did see a record level of steel production in Q2 worldwide.

What have you been seeing in the current quarter, in July specifically, that gives you kind of -- that provides kind of your cautious stance?

Well, we are not even complete with July, so it's really kind of hard to give clear indications. We are not seeing anything from what I know at this point, which again is relatively limited. We don't see anything too far out of line from our expectations.

Okay, great. Fair enough, thank you.

(Operator Instructions) Gentlemen, it seems there are no further questions. I will turn the floor back over to you for closing comments.

Okay. Given there are no other questions, we will end our conference call now. And I want to thank all of you for your interest today. We are pleased with the first half of 2011, and we continue to be confident in the future of Quaker Chemical.

Our next conference call for the third-quarter results will be in late October or early November. 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 teleconference. You may disconnect your lines at this time, and we thank you for your participation.