Quaker Chemical Corp (KWR) 2011 Q3 法說會逐字稿

Greetings and welcome to the Quaker Chemical Corporation third 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, sir, 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 Metalworking and Fluid Power. 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 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.

The third quarter was a record for Quaker in many different aspects. It was a quarterly record for sales, by far. Our sales were up 32% versus the third quarter of last year. The acquisitions this year represented 9% of the growth. Even without the acquisitions, this would be a quarterly sales record for Quaker.

Our earnings of $1.03 and net income of $13.4 million were also records for Quaker. However, the quarter did contain a one-time $2.7 million gain related to the purchase of our partner's shares in our Mexican joint venture. Even without this gain, our net income was a quarterly record.

And EBITDA -- if you look at page 5 and our slides, you will see our EBITDA trends. Even excluding the $2.7 million gain, our EBITDA was $21.2 million for the quarter, again a record, which translates to approximately $85 million on an annualized basis.

So it was a good quarter for us despite an increasingly challenging global environment. I will now try to summarize why and what we are seeing. From a volume/demand perspective, we saw a 16% increase in our volume versus the third quarter of 2010. Again, 9% of this growth is due to the 2011 acquisition, and 7% is due to organic growth.

As you can see on page 4 of our slides, this quarter was a record volume quarter for Quaker. The volume growth was broad and seen in all major countries. We also saw a sequential improvement in our volumes from the second quarter of this year. Again, all major countries and regions showed some improvement.

Now, part of that improvement is market share related. We have gained share in our steel markets with new business in both the US and Europe. Another example is that our mining business is doing well and we are increasing our share around the world. So our growth is a combination of an increase in demand in our base markets, share we have taken in the marketplace and acquisitions.

We're also seeing sequential improvement in our margins for the first time this year. As you may recall, our raw material costs have been increasing for over a year now. And, we have been putting in place numerous price increases throughout the year, but there has always been a lag effect. So now, our gross margins have started to increase as raw materials costs have finally begun to stabilize and our price increases are in place.

While the gross margins have improved, they are still not back to levels they need to be. Looking forward, there's greater uncertainty in the global economic and political environment. However, we have not felt a great deal of this negative impact to date, but there are signs that it may come. Steel prices are falling globally, and in Europe and China some mills have announced some cutbacks.

So in the fourth quarter, we could experience some demand impact from the uncertainty in the global economies. But again, to date, we haven't been significantly impacted. We do, however, expect sales in the fourth quarter to be impacted by seasonality as many of our customers take shutdowns around the holidays.

As we look to 2012, I thought it would be helpful to show a forecast for our two major end use markets -- steel and automotive. You can see these forecasts on pages 8 and 9. Both of these forecasts come from outside sources and were completed since the stock markets began to decline in early August.

As you can see, steel is forecasted to grow 5% in 2012, and automotive is expected to grow by 7%. Also, all major regions are expected to show growth with the exception of automotive in Europe, which will be slightly down. Given that these forecasts are relatively recent, they should include the growing uncertainty in the global economies. So if these forecasts are correct, Quaker's business in 2012 should continue to do well.

I also want to mention a few comments relative to our recent acquisitions. In October, we completed the acquisition of G.W. Smith & Sons. This is a US-based diecasting lubricant company with approximately $14 million of revenue. We believe this is a great fit for us, since it provides us a close-in technology that is currently not in our portfolio. We expect to be able to sell some of our products to their customer base. Likewise, we believe we can sell their products to customers in other regions as we leverage our global infrastructure.

This is the fourth acquisition we have made in the past 16 months. Three of the acquisitions were similar in nature by providing us a new close-in product technology that we can expand globally as well and sell our products to their customers. While these acquisitions are relatively modest, I am excited with the shareholder values that I believe each will create.

So in summary, this was a record quarter for Quaker in terms of sales, net income and EBITDA. And, while there is uncertainty in the global economies, I believe we are positioned to continue to do well. We have taken market share in our key markets. Our gross margins are finally expanding, but still not where they need to be. We are happy with the four acquisitions we have made over the past 16 months, and our balance sheet remains strong. The bottom line is that I am confident in our future, not only in the short term but the longer-term as well.

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.

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 that you may have.

Good morning, everyone. Yesterday, we announced earnings of $13.4 million or $1.03 per diluted share for the third quarter of 2011. This compares to $6.3 million, or $0.55 per share in the third quarter of 2010. However, both quarters include some unusual items. This year's third quarter includes a $0.22 non-cash gain related to the purchase of the remaining interest in our Mexican JV. Last year's third quarter included charges totaling $0.29 per share related to a non-income tax contingency and the final CEO transition costs. Even excluding these items, as seen on page 5, both EBITDA and net income were awesome quarterly records for Quaker. I should also note that third quarter 2011 EPS also reflects a $0.09 per share dilutive impact from our recent equity offering.

I will now go through the third quarter P&L, and then we will go onto questions. Revenues for the third quarter compared with the same period last year was up 32% to $182 million. Compared to the second quarter of 2011, sales were up about 9%. Overall product volumes were up about 16% including acquisitions, while exchange rates increased sales by about 5%.

Price of mix accounted for the remaining increase in sales. Acquisitions represented about 9% of the overall 16% increase in volume for the quarter.

Looking at our volume trends on page 4, during 2010 I noted that the continued recovery of the steel industry and, therefore, our volumes was not expected to be a straight line upward. Instead, our volume has plateaued for several quarters before increasing. Now, if we look at page 6, North American steel industry production levels have been fairly steady for most of 2011. Capacity utilization rates have generally hovered between 70% and 75% all year.

As Mike mentioned, looking ahead on the volume side, there is generally more economic uncertainty around the world than a quarter ago, particularly in Europe. And the price of steel has fallen somewhat as the year has progressed. So we do have some demand uncertainty in the short term.

Now, so far, our volumes in the fourth quarter have been good, although we expect some seasonality towards the end of the quarter. In Europe and in China, there have been some announcements about downtime later this year. Historically, steel makers have often taken extended downtime around the holidays to better balance inventory supply and demand. However, so far, these announcements have been fairly limited.

Currently, overall inventory levels in the steel industry appear to be in much better shape than they were in 2008, when a combination of slackening demand and high inventory levels resulted in a double hit to the steel production. One positive for Quaker is that our recent acquisitions and the new business we have gained should also help to offset any volume impacts from a weakening economy.

Turning to gross margins, historically we have generally experienced a 3 to 6-month lag in covering higher raw material cost through pricing actions, and we're beginning to see signs of that margin recovery as we continue to implement significant pricing increases in the third quarter. Gross margin as a percentage of sales was 32.6% this quarter, the first sequential increase in gross margin in several quarters. And while the gross margin percentage is still below last year, we currently anticipate some further margin improvement in the fourth quarter as recent price increases will have been in effect for a full quarter.

Moving onto SG&A and other expenses, our SG&A as a percentage of sales was 23% in the third quarter of 2011 compared to 2010's third quarter of 25.2% of sales. 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 third quarter, due to our higher sales, foreign exchange rates and acquisition-related cost, both in our transaction costs and costs related to the acquired business. In addition, higher inflationary and other costs were partially offset by lower incentive compensation expenses.

As we have discussed in the past, we are also continuing to invest in additional resources where we have good growth opportunity, particularly in the emerging markets. In the fourth quarter, we also expect to incur more costs related to our acquisition activity, including the recent acquisition of G.W. Smith, which closed earlier this month. Now, looking at our tax rate, as expected, our tax rate in the third quarter was higher than the second quarter. For 2011, we anticipate that our full-year tax rate will be in the high 20%. However, this rate may vary due to income mix and other factors.

Turning to our balance sheet and cash flows, our third quarter cash flow improved while our increased sales and higher raw material costs continued to result in higher net working capital lease. Our leverage, or debt divided by EBITDA ratio, is very healthy at less than 1 times EBITDA, which provides us with significant financial flexibility.

In summary, I believe that we are well positioned to take advantage of acquisitions and other opportunities when they arise, such as the recent acquisitions of our partner's interest in our Mexican affiliate as well as G.W. Smith. And that concludes my prepared remarks.

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

(Operator instructions) Michael Sison, KeyBanc Capital Markets.

Good morning, very nice quarter, guys. In terms of the fourth quarter, when you think about the normal seasonality on a sequential basis from sales and you think about maybe getting some of that margin recovery back, should you see earnings sort of follow that seasonality down, or could you actually maybe buck the trend with the pricing and some of that other good stuff?

Well, it's hard to say. On the positive side of things, as you mentioned, we should see some margin expansion in the fourth quarter. But on the downside, I think we will be -- the seasonality effect that you just mentioned as well as the kind of uncertainty hanging out there -- we haven't seen anything yet in the global economies with the demand side, but if something like that comes -- so it's all how that kind of thing plays out.

I think also, Mike, that we will have some transaction costs related to acquisitions occurring in the fourth quarter as well.

Got it. And then, could you remind us a little bit, given the uncertainty out there is certainly -- sort of keeping an eye on whether the economy sours again. But you've made a significant amount of improvement since 2009, particularly when you take a look at 2010 versus 2009. So can you just give us a little bit of a reminder of what you have done since the last downturn that probably would maybe limit any downside, if things do go sort of south?

Well, I think we have kind of changed our cost structure around to the right places. Of course, since that time we have continued to grow and continue to invest in our Company. I see the biggest changes between the 2008-2009 timeframe, and now -- you know, when 2009 happened, we lost a third of our business kind of overnight. And we lost that for a considerable period of time.

And that's why I thought I would show at least these forecasts that we are showing in the marketplace for steel and automotive where those two markets are still forecasting growth. So to me, it seems like it's a different dynamic at this stage versus anything we've seen in the 2008-2009 period.

The other thing I would add to that is, if you look over really the last 10 years, we are increasingly international, increasingly emerging markets. And while there has been a lot of uncertainty about maybe trying to have a little lower growth rate next year, I haven't really heard any forecast where the Chinese GDP would actually go down. So I think that's a very good anchor and an increasingly important anchor for us as well.

And final question -- when you look to 2012 and you think about the market share gains that you have won this year, does that give you a little bit of a tail wind in terms of your volume growth next year? Does it represent a couple percent of sort of wins that you will see next year, maybe irregardless of what happens in the economic environment?

Yes, that's our plan. Of course, share gains can come and go. But based on the kind of business that we have, and in our expectations it's that you get a full-year effect of those type of things. And we are continuing to have different initiatives in the marketplace which we expect to help us gain volume as well.

Okay, great, thank you.

Daniel Rizzo, Sidoti & Company.

In terms of the SG&A expense which you have done a good job with, is there a lot more room for leverage with that and for a reduction as a percent of sales?

I think that -- well, first of all, thanks for the complement on that. I think there's limited opportunity, at least in the short term. We have a pretty broad global infrastructure we are supporting, so we will need to add people exactly in correlation to as we grow our sales. But we still plan to continue to invest in growth areas, particularly emerging markets. But I think there is some potential.

And then, with your acquisitions, are we going to be expecting like in terms of size, similar sizes to what we're looking at now? Or is there more, I guess, larger targets out there that you think might be attractive?

That's a good question, Dan. When we think about acquisitions, I tend to think of them in two kind of buckets. There's the kind of acquisitions that we have been doing where we get maybe smaller regional technology plays where we can pick up the technology and leverage that globally in the marketplace. And we continue to investigate and look at those type of opportunities. There's also potential for bigger type of acquisitions, but they would -- there's just a few of those companies around. So it's more opportunistic or more when a company like that becomes available.

So I would say more likely than not, it's probably going to be on the smaller side of things. But you never know when maybe a larger one comes along.

All right, thanks, guys.

Liam Burke, Janney Capital Markets.

Mike, you talked about the sales traction you are getting on the acquisition side. Are you satisfied with the speed and the progress you are making with the integration of these acquisitions as you move along here?

We are. I think we are in a business in general that has a long sales cycles, so a lot of times just because you buy a company it doesn't mean you can immediately, then, turn around and start selling these products immediately everywhere because you usually have to go into a customer -- first, usually you have to stabilize what you just bought; that's the number one priority. Then you bring in your global people, you understand the technology and you start to do trials around the world.

I think a good example of that, Liam, is what we did in the first acquisition we did 16 months ago, with the D.A. Stuart aluminum business, where that business in itself has done well for us in the United States and has grown and really exceeded our expectations there. But we are just, in the past, I would say, three months or so, really starting to make some traction in getting global sales. We have -- we now have some pretty serious trials going on in three places in the Europe and Middle East region, and we are getting our first trial, major trial, coming up here over the next several months in China, where the biggest market in the world is.

So it takes time. But we are very happy and very excited about that progress.

So if I just sort of straightened that straight line, but if I looked at the other acquisition you made beyond D.A. Stuart, you had that same potential on those as well?

Yes.

Great, thank you. And, Mark, working capital stepped up considerably. You did touch on it on your prepared comments. But how much is that in timing? And would you anticipate some improvement in working capital needs to the end of the year because you were cash flow negative for the first nine months of the year?

Yes, I would expect some improvement in working capital. We had very strong sales in both August and September. And of course, you only have a limited amount of that that you could collect by the end of the quarter. So we have a good cash flow so far in the quarter and if you jump forward to the fourth quarter December is typically our slowest sales month of that quarter, so I expect some favorable working capital coming out of that as well.

As Mike mentioned also, we have been chasing raw materials for a couple quarters. Those seem to be stabilizing. And we also had some spot shortages of raw materials where we had to carry more inventory than we would like. So we expect to see some progress on that front as well towards the end of the year.

Great, thanks, Mike; thanks, Mark.

Scott Blumenthal, Emerald Advisers.

Congratulations on the quarter. Mike, you talked about the market share gains that you believe that you're making. Can you talk about maybe where those might be coming from and what you are doing in order to bring those about? Are your customers or the customers that you are acquiring -- maybe they have got some needs for increased support, more hands-on support, kind of a higher-touch support that you might provide them?

Yes. Actually, I think that's pretty much it because I think that we provide a lot of service to our customers, and there were certain cases where -- I won't get into specific customers at this point, but where maybe they were not as happy with their current supplier and we were able to get trials with the customers, prove the value that we could create for them and also provide the type of service level that we need.

So we have been sticking with our model, our business model in that regard. And it seems to really be paying off, and we have been picking up some nice pieces of business in both the US and Europe.

So this is both your ability to provide them with customer formulations and a high level of support that you provide?

That's correct. Usually, we have to -- you go through a trial, you have to show your value that you create both on the service side as well as what the product and the total package will do to lower their overall costs, and we believe we are very good at that and providing them both the service and the customized formulation.

And because of that, I guess, you need a lot of boots on the ground there. So you did mention that you're still looking for some people. Are you having trouble, or is it getting a little bit easier to find some of those people, especially in the emerging markets?

Yes. In the US and Europe, we have a real critical mass of people, especially in the steel business. So there, we can take advantage of these type of opportunities. In the growing markets, emerging markets like you mentioned, especially like India and China, we are actively looking for more and more people with the right skill set not only to have the technical knowledge to service the customer but also from a sales perspective. And that -- it's more challenging to find that type of people in the marketplace. But we continue to do that, and/or develop our own people in that regard.

If you are able to find enough people, how many positions do you think you would be able to fill currently?

You mean how many open positions we have? I don't know. It's really hard to say at any point in time. But just to give you a sense, if we were looking at the beginning of this year as we budgeted at the beginning of this year, over 100 positions in our Company, with the vast majority coming in emerging markets. And we have made good progress towards completing those positions, but there are still some empty spots that we have not filled yet.

Understood. And I guess my last one is, you did talk about some of the steel companies, especially in Europe and China, announcing cutbacks. Have any of your direct customers announced anything other than a normal seasonal kind of maintenance shutdown?

Yes, there are some. And a lot of them are cutting back on blast furnaces, and sometimes it's hard to translate that into our type of business because we tend to -- a lot of our business tends to go into cold rolled steel, and sometimes there's not a direct correlation between those two. So, sometimes, you can shut down a blast furnace and still run the cold side and everything is fine.

So really, even as I've listened to AK Steel and they're reporting earnings yesterday, and they pointed out that, for example, US automotive is doing well. And that, again, comes from our side of where we process steel, cold rolled steel. So as long as automotive and those things hold up, then it's usually our type of steel does well.

And I guess you have 4 blast furnaces and you take one down, you can still operate the 3 fully and be at 75% capacity. Right?

Right.

Okay, terrific, thank you.

Laurence Alexander, Jefferies.

I guess, first of all, in terms of the seasonality in the order patterns that you are seeing from the customers, how much visibility do you normally get around year-end turnaround? That is, how much advance notice do you normally have? And is hearing about shutdowns in late October -- is that normal, or is that early compared to what you would have expected?

That's a great question, and I think it can vary around the world and as conditions change. For example, one of the traditional places where things might shut down is US automotive, where they might take the week between Christmas and New Year's. We are hearing that this year, that that may not happen as much, they might not take as much time around that. But again, that's not -- things can change in that regard.

And then, to me, it depends upon where inventory levels are and how things progress through the quarter, because what we experienced -- we have seen all different types of patterns in the past. In general, we just see more downturn or more seasonality in December just because of the holidays. But sometimes, if there's an overhang in inventory and people can shut down longer, they will tend to take that around the holidays because maybe they are already down.

So it's hard to give you a clear answer on that. We have seen it kind of both ways. But as a general trend, we expect -- it's a little too early right now to have a clear view on that. But we expect it to be down because of the holidays.

And I guess, separately, as you look to the acquisitions that you're doing and you are looking and are exploring, are you seeing valuation multiples coming down because of the external market conditions and uncertainty, or are people still holding out for relatively elevated multiples on pre-recession EBITDA levels?

Most of the -- I would expect them to be down somewhat, given what we are seeing. But again, if we are in discussions at this stage with different things, it's generally at preliminary stages. So it's kind of on a case-by-case basis. But if you're just asking my personal opinion, I would think multiples should be coming down.

And, separately, as you think about when you layer in acquisitions, do the synergies and the related integration costs -- do they come in waves as you build up scale in a particular adjacency? You then incur another layer of cost to realize and optimize and integrate the different businesses you have acquired? Or how should we think about synergies over time as you layer in a lot of small acquisitions?

That's a good question. With the smaller acquisitions, and I think this -- if I use the D.A. Stuart Aluminum business back in July, we just kind of integrated it into our organization. We didn't take any manufacturing from the previous owner and we only took a handful of people and integrated right away. And there really wasn't any cost associated with that.

The other two acquisitions of Summit and G.W. Smith, where we brought in different product technologies -- we are running them as stand-alone companies at this point, and we are not integrating it. So synergies weren't a major driver from the cost synergy perspective there. It was really on the sales side, what they could add to our portfolio and how we could leverage that on a global basis. And so -- but some of these, to your point, like some of these, and G.W. Smith as kind of Mark alluded to on his SG&A -- we do expect to see some more than normal kind of heavier expenses in the fourth quarter related to acquisitions, just because some particulars that are happening in that acquisition in itself, where there tend to be more expenses related coming out of the acquisition than maybe a normal one.

And some of your recent deals look to be fairly accretive. Is that sort of a reasonable benchmark and standard to hold you to ongoing forward, or how should we think about your return thresholds for acquisitions?

Well, as far as our criteria for acquisitions, we tend to look at internal rate of returns and want to, certainly, have a decent spread between our cost of capital. And generally, we target to have after-tax rate of returns of 15% or more on our acquisitions.

Thank you.

(Operator instructions). It appears there are no further questions at this time.

Given there are no other questions, we will end our conference call now. I want to thank all of you for our interest today. We are pleased with our results so far in 2011 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. 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.