Quaker Chemical Corp (KWR) 2013 Q3 法說會逐字稿

Greetings and welcome to the Quaker Chemical Corporation's third quarter 2013 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, Christine. Good morning, everyone. Joining me today are Margo Loebl, our CFO; and Robert Traub, our General Counsel. After my comments, Margo will provide the details about 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. Overall, I'm pleased to be able to report that we had a good quarter, and we did so in a challenging environment. We had double-digit growth in earnings and EBITDA and we generated strong cash flow. Let me now try to give you a sense of what we experienced, and I will start with sales.

Our overall sales were up approximately 2% for the quarter versus 2012. Our volume showed similar growth. While the growth is modest in absolute terms, I believe it helps to look at it in context with our largest market, which is steel. On slide 4, we have a chart from the World Steel Association which shows steel growth by region for 2013 versus 2012 on a September year-to-date basis.

One general take-away is that China is the only significant area of the world where there has been growth generated. The other areas have largely seen declines led by North America and Europe. So in three out of our four regions, we have had declining markets overcome and we've done so by continuing to take share in the marketplace as well as continuing to grow our new technologies from our recent acquisitions.

Going around the regions, Europe is one of our most challenging regions relative to industrial market conditions. However, sales were actually up approximately 2%. We are fortunate that we have been able to pick up share in the marketplace which has helped us to more than offset the inherent industrial market declines in the region. In South America, our sales were down 2%, but when adjusted for foreign exchange rates, our sales actually increased approximately 12%.

In North America, we saw an increase in sales of 1%. We're still seeing a very mixed picture in North America with automotive doing well, but other industrial markets being down. In Asia Pacific, we saw a 4% increase in sales as we continue to have good growth for our business in both China and India despite their less-than-robust economies.

Looking sequentially at third quarter versus second quarter, our overall sales were relatively flat. Europe saw a decline which is typical due to the third quarter seasonality factors while North America and Asia-Pacific were growing. South America also showed decline in sales but this was due to foreign exchange, and excluding the foreign exchange impact, South America volumes actually showed good growth.

One question I normally get is -- how am I seeing the trends in industrial production today around the world? So I thought I would be proactively -- give you my take on this. As a general statement, I believe we may have hit bottom in all parts of the world already in 2013 in terms of industrial demand. So I do believe Europe has bottomed out and all the regions of the world should be at least flat or have some growth going forward, absent any typical seasonality impact. Therefore, I do believe our major markets in steel and automotive will grow modestly over the next year or so.

On our gross margins, we saw them expand by 3.2 percentage points from the third quarter of 2012 as our margins are back to more acceptable levels. This gross margin improvement was very important for our overall profitability given the challenging external environment.

So, all things considered, we are pleased with our third-quarter performance. While overall demand was relatively soft, we continue to take share and expand our margins to grow our profit. I am particularly proud of our EBITDA generation. If you see our EBITDA both for the third quarter and year to date, we are running at an annualized run rate of over $90 million. So we continue to show consistent EBITDA growth year over year and expect 2013 to be another year of double-digit growth in EBITDA. Looking forward to the fourth quarter, we expect to continue to produce good operating results subject to the typical negative seasonality impacts we tend to see near the holidays at year end.

The bottom line is that I continue to be confident in our future. We expect 2013 to be another good year for Quaker in terms of key financial measures such as sales, earnings, cash flow, and EBITDA, as well as our continued strategic positioning of the Company. In addition, I also believe our strong balance sheet and liquidity will continue to enable us to generate future shareholder value-creating opportunities, such as funding our strategic growth initiatives or making additional acquisitions.

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'll turn it over to Margo Loebl, our CFO, so that she can provide you with more details behind the financials; and after that, we will answer any questions you may have. Margo?

Thank you, Mike. Good morning, everyone. Turning to the financial portion of this call, I want to reiterate that we at Quaker are very pleased with the situation and continue to believe that we are going to deliver strong results despite the difficult global market environment.

We announced sales of $184.1 million for the third quarter of 2013, compared to the third quarter of 2012 net sales of $180.9 million. Earnings per diluted share for the third quarter of 2013 were $0.95 per share compared to $0.83 per share for the third quarter of 2012, representing 14% earnings-per-share growth despite the market challenges.

Further, the Company had expected to receive recertification of a prior concessionary tax rate in Asia-Pacific which would have increased earnings an additional $0.08 per share in the third quarter, but the approval was delayed until earlier this month and is expected to be recognized in the fourth quarter.

In the past, as you may recall, we started to provide a non-GAAP earnings per diluted share table in an effort to provide shareholders with visibility into our operations, but excluding certain items which we believe do not reflect our ongoing operations, starting with but not limited to earnings related to Primex, our investment in a captive insurance company.

As outlined in chart 11, I will walk you through our non-GAAP adjustments in yesterday's earnings release. Please note that non-GAAP earnings per diluted share were $0.91 per share for the third quarter of 2013 compared to $0.80 for the third quarter 2012, up 14% year-over-year. The adjustments to get to non-GAAP earnings per diluted share include a $0.09 per share and $0.03 per share amount related to equity income in a captive insurance company, Primex, in the third quarter of 2013 and 2012, respectively. Again, we believe Primex is not necessarily reflective of our ongoing operation.

And in the third quarter of 2013, we had a $0.05 per share charge related to certain cost streamlining initiatives.

Speaking of cost streamlining initiatives, while we are profitable in all regions at Quaker, we still believed we needed to enhance our profitability and align our cost structure with the market conditions, most notably in South America and EMEA. In the second quarter of 2013, as you may recall, we booked expense related to a cost streamlining effort in South America. Additionally, we recorded expense in the third quarter of 2013 related to a cost streamlining program in EMEA.

We are realizing cost savings already in South America in connection with the first program and we will realize savings in EMEA starting in approximately the second half of 2014. Clearly, we expect these annual cost savings related to these initiatives to exceed that which we expended in connection with these streamlining efforts.

Turning to performance, we continue to take share and leverage our acquisitions from a top-line perspective while 35.9% gross margins for the third quarter of 2013 drove a 10.2% operating margin for the quarter. Earnings per diluted share for the third quarter of 2013 were $0.95 per share compared to $0.83 for the third quarter of 2012, again, representing a 14% earnings-per-share growth despite the market challenges. Please note that the non-GAAP earnings per diluted share were $0.91 a share for the third quarter of 2013 compared to $0.80 for the third quarter of 2012, also up 14% year-over-year.

Consistent with the earnings growth for the quarter, our other highlights for the quarter include outstanding adjusted EBITDA growth and record net operating cash flow. First, the key metric for us is adjusted EBITDA, and it's summarized in chart 13. We adjust EBITDA on a very selective basis for unique items which we believe are not part of the base business activity. On this basis, annualized adjusted EBITDA of $91.5 million is up 13.1% year-over-year versus $80.9 million at the end of 2012. With respect to net operating cash flow, Quaker generated $24.5 million in the third quarter of 2013, a record for a single quarter at Quaker. Liquidity is a strength of ours as we prepare for potential acquisitions.

Now let's turn more specifically to our reported financial resort results for the third quarter of 2013. As shown on chart 5 of the investor slides, third quarter 2013 volume, including acquisitions, were consistent with record levels and up from the same quarter last year.

Turning to the financial snapshot shown on chart 6, net sales in the third quarter of 2013 were $184.1 million, which increased approximately 2% from net sales of $180.9 million in the third quarter of 2012, which primarily related to an increase in product volume.

Looking at gross profit and margins on chart 7, gross profit increased approximately $6.9 million, or approximately 12% from the third quarter of 2012. The increase in gross profit was primarily driven by the improvement to gross margin to 35.9% from 32.7% in the third quarter of 2012. The 3.2 point increase in gross margin reflects the return of Quaker's product margins to more acceptable levels. In 2013, this performance had been a cornerstone to our profitability given our uneven steel and automotive markets throughout each of our regions.

Moving down the income statement, selling, general and administrative expenses increased $3.9 million in the third quarter of 2013 from third quarter of 2012 which was primarily driven by higher selling-related costs on improved Company performance and higher labor-related costs on general year-over-year merit increases. In addition, non-operating related SG&A expenses increased due to certain uncommon costs. For instance, the third quarter of 2013 SG&A includes approximately $700,000 or $0.04 per share of costs related to streamlining certain operations in the Company's Europe, Middle East and Africa region, (EMEA).

Operating margin, driven largely by stable raw material prices and strong growth margins was 10.2% in the third quarter of 2013 versus 8.8% for the same period last year. On a year-to-date basis, operating margin was 10.3% in 2013 versus 9.3% in 2012.

Continuing down the income statement, the increase in other expense in the third quarter of 2013 was primarily driven by foreign exchange transaction losses of approximately $600,000 and a charge of $200,000 or $0.01 per diluted share related to the cost streamlining initiative noted above compared to foreign exchange transaction losses of $200,000 in the third quarter of 2012.

The decrease in interest expense was primarily due to lower average borrowings and lower interest rates experienced in the third quarter of 2012 (sic -- see press release "2013") as compared to the third quarter of 2012, as well as for the first nine months of 2013 versus the first nine months of 2012.

The Company's effective tax rate for the first time of the 2013 and 2012 were 30% and 26.9%, respectively. The primary contributor to the higher effective tax rate in the current year was an increase in Asia-Pacific's effective tax rate. While recertification of a prior concessionary tax rate in Asia-Pacific was pending renewal, the Company recorded tax expense at a statutory tax rate of 25% in the third quarter of 2013, compared to the concessionary tax rate of 15% to the prior year.

For the third quarter of 2013, the Company expected to receive recertification of the prior concessionary tax rate in Asia Pacific, as I mentioned before, which would have increased our earnings an additional $0.08 per share. But, again, as I said, it was delayed until earlier this month due to a period of public notice and comment.

As of the date of our release, the period for comment had expired and the Company has not received a notice or comment challenging its approval status. So the change in the Company's effective tax rate is expected to be recognized in its financial statements in the fourth quarter of 2013, pending no other significant developments in this regard.

Finally, we expect our effective tax rate for the full year to be in the high 20% range.

The increase in equity and net income of associated companies from the third quarter of 2012 was primarily due to higher earnings from Primex. Earnings from this affiliate were $1.2 million or $0.09 per diluted share in the third quarter of 2013 compared to $400,000 or $0.03 per diluted share in the third quarter of 2012.

In chart 8 of the investor slides, we chart the trend of Quaker's adjusted EBITDA historically since 2008. Annualized adjusted EBITDA of $91.5 million at September 30, 2013 is up $51.4 million from $40.1 million in the year 2008, driving a 17.9% compounded annual growth rate over the five-year period. Margins were up 570 basis points from 6.9% in 2008 to 12.6% at September 30, 2013.

Now turning to charts 9 and 10 of the investor slides, the Company's net operating cash flow for the third quarter of 2013 was $24.5 million, which increased its year-to-date 2013 net operating cash flow to $51.9 million as compared to $41.8 million for the first nine months of 2012. The improvement in the Company's net operating cash flow during the first nine months of 2013 was primarily driven by increased net income and better working capital management. Notably, Quaker had record annual net operating cash flow of $62.9 million for the full year in 2012, and our 2013 year-to-date net operating cash flow is well ahead of the prior year's year-to-date net operating cash flow.

During 2013, the Company revised its credit facility, expanding the amount available for borrowing under this facility from $175 million to $300 million which provides the Company further financial flexibility for potential future initiatives. In addition to the revised facility, consolidated cash is up $21.4 million from year end 2012 at the end of the third quarter of 2013, Quaker had $53.9 million of cash on hand versus $19.2 million of debt, or net cash debt position of $34.7 million.

Also, the Company's consolidated leverage ratio continued to be less than one times EBITDA.

In conclusion, I would like to personally thank all the Quaker associates around the world for their commitment to our customers and contributions to the success of Quaker. This concludes my prepared remarks for today. Thank you, and I'll now turn the call back over to Mike.

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

(Operator Instructions) Mike Sison, KeyBanc Capital Markets.

Hey, good morning. Very nice quarter, again. In terms of the market share, the gains, could you give us a little bit of color, maybe by end market? I know in steel, cold-rolled particularly, your market share is very high. So is that an area where you're still gaining share, or is it in metalworking? Or maybe it's across the board. But I just want to get a little bit of color where you're doing so well.

Sure. It's pretty much across the board kind of thing. We are gaining share and even in steel, like you mentioned, we already have a pretty good position in the steel industry. But we feel people are valuing our total package of both products and services that we provide and the breadth of products and we've been increasing the amount of products we can offer to the industry over time.

I think all that together has allowed us to -- our dedication to this industry has allowed us to continue to be seen as the leader and pick up share throughout the world and even in our other industries as well. In metalworking and so forth, we've been picking up share as well.

Okay. Great. And then in terms of volume, if demand starts to pick up a little bit, could you maybe give us a heads-up on what type of leverage you'll get? Your earnings growth this year and EBITDA growth has been pretty impressive in a sluggish environment. How would it look if demand gets incrementally better from here?

Well, we generally would say we think of our growth in a series of buckets, so hopefully as our demand will pick up in the steel and auto markets, our sales will grow consistent with that. And then on top of that, we continue to hope to spread our new technologies out around the world. That's from the recent acquisition, so that should hopefully add some additional growth.

At the same time, I know your question is -- how much does that leverage fall to the bottom line? I tend to think of it relatively consistently. Hopefully, it will be more than that, but -- because we should have some leverage on our SG&A. But we haven't really given too much guidance around that, so I hesitate to throw anything out there.

Sure, no problem. And then final question, when you think about your balance sheet, it continues to be in very, very good shape. Any thoughts on redeploying that via acquisitions? Any good opportunities to for you broaden your technology or product lines in the next year or so?

Yes, we consistently look at making acquisitions. We've made in total probably 6 or 7 smaller type acquisitions over the past 3 to 4 years, and we continue to look for other opportunities, both opportunities that -- I kind of think of them in two buckets. One is the same kind of industries or product lines that we're in that we can leverage and have good synergies, and then there's other ones that bring different technologies that we have, and then we can use our global infrastructure to take advantage of those technologies in our customer base basin.

And we are currently looking at opportunities everywhere. We never know when they're going to hit, but we're looking at opportunities in both those areas, as well as all geographic areas around the world. So we continue to hope to make it happen, but we also want to make sure we're smart about making acquisitions and certainly that they're going to add shareholder value like the ones we've made in the past.

Great. Thank you very much. Nice quarter.

Thank you, Mike.

Laurence Alexander, Jefferies.

Good morning.

Good morning, Laurence.

I guess first of all, on the cost-cutting and rationalization you've been doing, can you give a little bit more detail on the type of cutting you're doing and to what degree you think it is structural or cyclical or likely to leak back to customers over the next 3 to 4 years? I mean, is it part of an ongoing process, or is there structural change in your business model?

Sure. Yes, I mean when we look at our -- we constantly look at our business. We tend to look at it on an EVA basis, and certainly looking at what's been happening in South America and Europe or EMEA region. Over the past year or two, we felt that we needed to take some actions, just react to the market realities that we're dealing with in those geographic areas. We are making money in both South America and in Europe, but we felt we needed to take some actions to increase our profitability to the areas that should be.

So we are making some structural changes. South America has been somewhat challenged because, from a cost perspective, the cost of doing business is very high down there. Salaries and other types of costs tend to go up almost double digits each year, yet their growth has been slowing down over time and that's caused a compression. So we've made some structural changes in the way we organized our business down there, and that took place a few months ago.

And then in Europe, we are making a combination of people changes as well as looking at how we produce our product and where we can consolidate some things. So we're making some changes there to kind of streamline our activities. So we believe these actions have good paybacks to them, and of course, obviously, as things pick up in Europe and so forth and we need the add resources again, we will do so.

Just to clarify on that, because of the changes you are doing, if you do get a rapid reacceleration in demand, you will have to do some incremental CapEx or some new hires that would depress your incremental margins near-term to keep up with this, like taking slack out of system, so to speak.

Yes, I mean I don't think from a CapEx perspective, we see anything. We -- from a capacity, that's not a big issue for us and I think in every place around the world, we're okay there, even if things pick up.

So -- and then as -- certainly as business picks up and really would accelerate; yes, we would definitely add people. We're needed like we have been over the past several years. We've added a tremendous amount of people in Quaker, but we generally don't see a depression necessarily because we're getting the sales and the product margin with that at the same time we're adding people.

And then on the market share, it's two related questions on sequential issues, one on the market share. It looks as if over the course of the year, you've been picking up share each quarter. So if that's the case, if you think about the run rate that you're at now, how much of a tail wind if you just annualize where you are now would you be having year over year in 2014?

I understand that question. I don't have an exact response to that, because some of the benefits were actually seen in the third quarter now is based on share we picked up. It could have been -- some of it could have been in the fourth quarter of last year or the first quarter or second quarter. So it's hard for me to exactly pinpoint that, and we're actually putting together our plans for next year right now.

But my sense is, I still continue to see us have good growth. Again, I tend to think of our growth in these buckets of the way we tend to grow the Company. One is the inherent markets which I think will be modestly growing. I think we'll continue to take some share in the marketplace, and I also think we'll continue to exploit our new technologies that we have picked up in the recent acquisitions. I just don't have exact -- we generally don't give too much guidance around the exact proportion of each of those.

Okay, understood, but I guess it's fair to say it's probably more like low-single digits than high-single/low-double of a tail wind.

For the market share gains in itself; right?

Right. Exactly.

Yes. Yes.

And then the other question on sequential trend where you mentioned you feel that the industrial markets have bottomed this year. Are you seeing any of the geographies improving sequentially above and beyond what you would've expected for normal seasonality? Because I think other companies have been saying they're not seeing the normal September to October bounce, particularly in Asia. So any color that you would have on the sequential trends would be helpful.

Sure. It's hard to say necessarily the fourth quarter, because where we are, and we're through the fourth quarter. But certainly we saw some sequential growth in both North America and Asia-Pacific between the second quarter and the third quarter. I haven't seen any indications in the fourth quarter that would give me pause to say things are going to go backwards or anything.

So, again -- South America, as I mentioned, we were kind of down on an absolute dollar basis, but if you strip out the FX effects, they have improvement as well. So it was really -- I kind of see things either being flat or modestly up over the next several quarters.

Thank you.

Liam Burke, Janney Montgomery Scott

Thank you. Good morning, Mike; good morning, Margo. Mike, acquisitions are always a priority or a big priority in your uses of cash. Your cash balance is beginning to accumulate here; your net cash is beginning to accumulate here. Are there any priorities you have for alternative uses of that cash?

Well, right now, we believe the best way we can create value for our shareholders is to use that cash to make acquisitions, again, either companies that are very close in that would have good cost synergies or other technologies that we can bring into our portfolio and exploit in our global platforms. So we feel both of those opportunities would be better shareholder creation of things for our shareholders than if we give the money back.

However, having said that, if we find out over a period of time that it looks like the cash is continuing to grow and we don't have those opportunities to make the acquisitions, we will find a way of returning that money to our shareholders in some way. So we're all about creating shareholder value, and so we'll figure out the best time when -- if we have to change from our acquisition strategy, but right now we feel that's the best way of doing it.

Well, would you go and just pay down debt, continue to pay down debt; or, would you look at the debt versus returning cash shareholders as two separate alternatives?

Right now, we have paid down debt and all our debt is pretty much paid down that we can. So right now, we're just building up cash. So I think if we found, again, if we found we couldn't find an acquisition opportunity sometime in the future we say, okay, it's time to -- we feel that's a limited opportunity for our shareholders, then we would return it to the shareholders in some other mechanism.

Okay. Great. Thank you. And I know it's a long sales cycle and you've been taking share. Have you seen any competitive response in the marketplace as you begin to start increasing your positions in either the metal or metalworking businesses?

Well, we still have -- it's certainly a competitive marketplace, and we have competitors and competitors want to continue to stay in business. So there is, continues to be competition. So I don't want to say in any way say there's not. Certainly there's give-and-take or responses at times. But, overall, like I said, we've been fortunate enough to take share.

And I think another dynamic in this too is our customer base. Our customer base are steel companies, and steel companies right now are not the most profitable organizations or companies right now. So, they're feeling a lot of pressure as well. So that's a dynamic that's out there that could impact us. But so far, it hasn't; but just something to keep in mind as well.

Thanks, Mike.

Thank you, Liam.

Mike Harrison, First Analysis

Hi, good morning.

Good morning, Mike.

Good morning.

I believe you had expected some raw material pressure in the second half. From the looks of the gross margin at least, it appears that raw materials were pretty benign or maybe even a little bit of a tailwind and a quarter. Can you just talk about the raw material outlook going forward the next few quarters. Is it possible that we see those become a tail wind here?

We don't expect it to be a tail wind. It's been a relatively stable environment for raw materials. You are correct that when we talked in the third quarter, three months ago, we had seen certain raw materials go up and we have seen in different parts of the world some of our raw materials go up. But then crude has also been kind of been relatively stable recently.

So, overall, it's been relatively flat. They may have gone up somewhat here, but I don't think -- I don't get a sense they're going to go down anymore. We haven't gotten anything that would suggest when you look at our total portfolio that they should increase dramatically or anything. But these are the kind of things that you can have a single event in the world tomorrow happen in the Middle East or something, and that just causes the markets to kind of go crazy. But right now as we've looked at it, we've been in a pretty prolonged environment now probably for a year or so where we've had relatively stable raw materials.

Okay. And then just looking at the new segment structure in the 10-Q, it looks like pricing was down 6% in the Europe region. Is that a continuation of a trend? Is that a more recent pricing picture, and can you maybe talk about what's driving the price decline there?

Some of the that could be product mix in how we do things. We have certain products that cost more than other products, and sometimes having to make sure of that where we could have -- in some ways, we have -- a lot of our contracts are negotiated and some contracts just have indexes to them.

So, for example, some of the contracts we may have go up and down with raw materials, so some quarters or every six months when they adjust, the pricing can go up or down. And that kind of keeps our margins relatively consistent, but the pricing can fluctuate. So I think it's kind of probably a combination of indexes on contracts changing, as well as product mix issues.

But it isn't the case that you're seeing any additional competitive pressure or anything that's changed in that regard?

Not across the board.

Here and there.

I mean, there's always bits and pieces, but I wouldn't say, like, our prices are falling everywhere or anything like that.

Okay. And then last question is just in terms of the steel plant, your expectations of new steel plants coming onstream. Do you have any new steel plant wins to discuss, and what would be your outlook for the next few quarters on new plants?

Yes, I mean the last information I had, I think there were roughly 9 or 10 new steel plants coming up in 2013 and we approximately won 80% of those. So I do not know of any additional ones being built for 2014. There's always some plants being built and we've been relatively consistent over the past several years. As people build new steel mills and so forth, we've gotten a pretty good amount of share of those new mills coming up. And we would expect that to continue.

All right. Thanks very much.

Thank you, Mike.

Mr. Barry, it appears we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Great. Thank you, Christine. Okay, we will end our conference call now, and I want to thank all of you for your interest today. We are pleased with our results in the third quarter and we continue to be confident in the future of Quaker Chemical. Our next conference call for the fourth quarter results will be in late February or early March, and if you have any questions in the meantime, please feel free to contact Margot Loebl or myself. Thanks again for your interest in Quaker Chemical.

Ladies and gentlemen, this does conclude today's teleconference. You may connect disconnect your lines at this time. Thank you for your participation and have a wonderful day.