Quaker Chemical Corp (KWR) 2014 Q2 法說會逐字稿

Greetings, and welcome to the Quaker Chemical Corporation second quarter 2014 results conference call. At this time, all participants are in a listen-only mode. 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, CEO, and President of Quaker Chemical Corporation. Thank you, sir. You may begin.

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 around the financials, and then we will address any questions that you may have. We also have slides for the conference call; you can find them in the Investor Relations part of our website at www.quakerchem.com.

I will start off now with some remarks about the second quarter. I am pleased to report that we had a good quarter, as solid operating performance led to a double-digit growth in non-GAAP earnings. Let me now try to give you a sense of what we experienced in the quarter, and I will start with sales.

Our overall sales were up 3.5% for the quarter versus 2013, with growth primarily driven by higher volumes. Going region by region, South America was our most challenging region. Our revenues were down 18% due to both foreign-exchange impacts and the poor economy, with both steel and vehicle production markets declining.

In our Europe or EMEA region, we saw 2% growth, as steel and automotive industries continued to modestly rebound from the very depressed levels of a year ago. In our Asia-Pacific region, we had 6% growth, with China being the main driver. And in our North America region we had growth of approximately 8%, with very strong growth coming from Mexico and our grease business.

Overall we continue to do well in gaining share in the marketplace throughout the world. We believe this is due to our commitment to our customer intimacy model, which puts the customers' needs as our top priority and provides them with strong service and business solutions. We believe this approach continues to differentiate us in the marketplace.

As I've mentioned in the past using a baseball analogy, our goal is to score many runs by hitting many singles. We have a great deal of initiatives in our base business line and in each of our regions, as well as with our growing -- the growth through our recently acquired technologies around the globe. I see each of these initiatives as singles, and our goal is to hit many singles which produce multiple runs, as we show continuous growth despite what can be a tough market conditions at times.

Looking at the sequential quarterly trend of the second quarter versus the first quarter, overall sequential growth was 5% quarter-over-quarter. We saw strong growth of 8% in both North America and Asia-Pacific, and modest growth of 2% in Europe. In South America, we experienced a 3% decline, due to the poor economic conditions I mentioned earlier.

On our gross margins, we saw them decline slightly by 0.7 percentage points from the second quarter of 2013, primarily due to product mix and slightly higher raw materials. Overall, gross margins continue to be very stable and have remained at this level for the past four quarters.

So I am pleased with our overall performance. Despite a very weak South American economy, we were able to achieve solid growth. And our adjusted EBITDA growth continues to do well; for the first half of this year, is up 8%.

The bottom line is I continue to be confident in our future. While we operate in a very competitive world with some still challenging environments and we may likely see some increases in raw materials, we expect 2014 to be another good year for Quaker in terms of key financial measures such as sales, earnings, cash flow, and adjusted EBITDA, as well as for 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 and making additional acquisitions, such as our recent acquisition of our JV partner in Australia. While a small acquisition, it allows us to achieve 100% of our growth initiatives in Australia, especially in the mining sector.

Regarding acquisitions in general, I continue to believe the right acquisitions over the next several years can create additional significant value for our shareholders, and we are actively working on these type of opportunities. I will also mention that since our last conference call, we have increased our dividend by 20%, which is another indication of our confidence in the future of Quaker and our dedication to adding shareholder value.

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. People are everything in our business and by far our most valuable asset, and I'm very happy with the Quaker team we have in place throughout the world.

Now I will turn it over to Margo Loebl, our CFO, so that she can provide more details behind our financials, and after that, we will address any questions you may have. Margo?

Thank you, Mike. Good morning, everyone. I reiterate that we are pleased with our results in the second quarter of 2014, despite the typical challenges of uneven markets and foreign exchange, especially in South America.

Before launching into my recap for the quarter, please note that Quaker provides a non-GAAP earnings-per-diluted-share table in an effort to provide shareholders with visibility into our Quaker operations, excluding certain items which we believe do not reflect our core operations, including, but not limited to, earnings related to Primex, our investment in a captive insurance company. This table is outlined in chart 10 of the investor slides, as well as, yesterday's earnings release, and our Form 10-Q filed yesterday.

As referenced in chart 4, a recap of Quaker's performance for the second quarter of 2014 includes the following highlights. With respect to highlight number one on chart 4, it reads, solid volume increases net sales. Net sales increased by 3.5% to $191.3 million in the second quarter of 2014, compared to $184.8 million in the second quarter of 2013, primarily due to increased product volumes, mainly in Asia-Pacific and North America.

Base volumes, including acquisitions and increased organic sales, are up 3% over the prior-year quarter. In addition, price and selling mix increased by 1%, which was partially offset by a foreign-exchange translation decrease of less than 1%. The foreign-exchange rate translation decrease was led by the Brazilian real, the Argentina peso, and the Indian rupee, partially offset by increases to the euro.

Turning from the top-line story to margins: with respect to highlights number two on chart 4, it reads, stable margins continue to drive strong operating results.

Turning to chart 7, gross profit was higher by $900,000 in the second quarter of 2014, compared to the prior year quarter, primarily due to increased sales volume. However, gross margins of 35.7% in the second quarter of 2014 was lower compared to 36.4% in the prior year quarter, primarily due to a change in price and product mix, and additional manufacturing cost to finalize the cost streamlining initiative in Europe that was started in 2013.

The strong gross margins in the second quarter of 2014 have been an important driver in Quaker's strong performance. Notably, increases in raw material costs will always be a risk, but we have said in the past, our target is to have gross margins averaging at least 35% over time.

With respect to highlight number three on chart 4, it reads, SG&A down compared to the second quarter of 2013. Also, the reduced SG&A cost contributed to strong profits in the quarter, with SG&A margins of 24.7% in the second quarter 2014, down versus last year's 25.7%.

SG&A decreased $300,000 versus the second quarter of 2013. The main driver of the decrease was lower incentive compensation and prior year cost-streamlining initiatives in South America, partially offset by higher inflation in merits as well as acquisition expense.

With respect to highlight number four on chart 4, solid growth in operating income and adjusted EBITDA. Operating income and adjusted EBITDA in the second quarter of 2014 are both up 6% versus last year.

Further, Quaker's adjusted EBITDA increased to $25.8 million in the second quarter of 2014 from 25 -- $24.5 million in the second quarter of 2013. Adjusted EBITDA remains a key metric for Quaker and is summarized in charts 6 and 8.

Similar to earnings per share, we adjust EBITDA to reflect items which are not part of our core business activity. On a trailing 12-month basis, adjusted EBITDA is $93.4 million for the period ending June 30, 2014. Looking at the range of 2008 to the annualized 2014 data, the compounded average growth rate for adjusted EBITDA is 16.3%, with margin on adjusted EBITDA up 640 basis points in annualized 2014 versus 2008.

Managing margins, as we've discussed, is a key tenet of our business model, driving profitable growth. Coupled with our customer intimacy, which Mike mentioned, as a competitive differentiator, Quaker continues to make strides building its industry leadership. Managing SG&A costs closely contributes to the business model and profitability, especially when we are faced with uneven market environments.

Notably, from a global perspective, Quaker has wrapped up the cost streamlining activities now in both Brazil and Europe as of this last quarter. While Quaker began to realize the benefit of the Brazil cost streamlining in late 2013, Europe will now begin to realize the benefits of cost streamlining in the second half of 2014 and on a full-year basis next year in 2015.

With respect to highlight number five on chart 4, it reads: higher operating income leads 11% increase in non-GAAP earnings. Earnings per diluted share for the second quarter of 2014 were $1.16 compared to $1.22 for the second quarter of 2013, which included $0.14 of earnings per diluted share related to the prior year receipt of a mineral oil excise tax refund in Italy. Non-GAAP earnings per diluted share of $1.11 increased by 11% in the second quarter of 2014, compared to $1.00 in the second quarter of 2013.

Notably, Quaker exceeded analyst's consensus expectations of $1.08 per share, with its $1.11 per diluted share non-GAAP results in the second quarter of 2014. Changes in foreign exchange rates, excluding the current quarter conversion of certain Venezuelan bolivar fuerte negatively impacted the second quarter of 2014 and income by approximately $100,000, or $0.01 per diluted share.

The Company's effective tax rate for the second quarters of 2014 and 2013 were generally consistent at 30.6% and 31.7%, respectively, with certain timing items slightly decreasing the current quarter's effective tax rate. Quaker's effective tax rate for the full year 2014 is estimated at this time to be approximately 31%.

With respect to highlight number six on chart 4, it reads: liquidity remains a Quaker strength. The Company's net operating cash flow of approximately $10.1 million for the second quarter of 2014 increased its year-to-date net operating cash flow to $8.3 million, compared to $27.5 million for the first six months of 2013. The Company's operating cash flow continued to be impacted by cash invested in working capital during the second quarter of 2014.

The Company had a positive net cash debt position of $34.2 million at June 30, 2014, with $60.2 million of cash on hand and $26 million of debt outstanding. Overall, the Company's liquidity remains a Quaker strength, as its cash position continued to see that debt, in June, and also, the Company's consolidated leverage ratio continued to be less than one time EBITDA.

From an investment perspective, in June 2014, the Company acquired the remaining 49% ownership interest in its Australian affiliate, Quaker Chemical Australasia Limited for UAD8 million, or approximately $7 million from its joint venture partner, Nuplex Industries. Quaker had been a joint venture partner in Australia for 50 years, selling Quaker products to the metalworking, steel, tube and pipe, and mining industries in various locations of Australia. Australia's market with good growth opportunities in several of our business lines. This acquisition further strengthens our position in Australia, and allows us to simplify our overall corporate structure and improve our organizational efficiencies.

Again, we are pleased with our very strong operating results in the second quarter 2014, and we believe 2014 will be another good year for Quaker. I would like to personally thank all of the Quaker associates around the world for the commitment to our customers and contributions to the success of Quaker Chemical.

This concludes my prepared remarks for today. Thank you. And I will now turn the call back over to Mike.

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

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Mike Harrison, First Analysis.

Hi, good morning. Mike, the results look pretty good in the North America market, but you saw some margin declines in all three of your other regions. Could you maybe give us a little bit more color on some of the margin headwinds you're seeing in each of those regions, and whether we might see some improvement in the second half?

Sure, no problem at all. With -- let's start with South America, because that was really the most challenging region that we had. That is really was primarily being driven by much lower steel production and auto -- production, especially in auto. We really saw significant decline. Some of the industry information I've seen in the second quarter showed a 20% decline year-over-year in auto production over that, and maybe a 5% decline in steel. So the industry numbers I have seen you know highlight that. And part of that is due to the overall economic conditions we've seen there, as well as there is a World Cup impact of this as well. We're continuing to take actions down there to manage that situation. I was just down there recently, and I think that will continue to get better for us as we go forward.

In EMEA, Europe, we showed a decline quarter-over-quarter, but I think there are really two aspects to that. One is we had a cost streaming that we completed this year that we started last year and we completed in the first quarter of this year, where we consolidated some operations in Italy. And now we will see some cost savings from those going forward, and there were some costs associated with that. You take that into account, then the operating incomes come pretty close.

The other aspect I will mention is you look at what happened in Europe last year. It was actually a very strong second quarter for them, and I think there was a time -- to me, I view this as a timing issue, because you always have issues around when shipments go, first quarter versus second quarter or third quarter. And I think this quarter in Europe, we had a little bit lighter than we expected, but the first quarter was stronger. So you can actually look at the first half of the year, and it was actually much higher overall in the first half than last year's first half. Europe I feel very good. I think we're going to continue to see modest improvement. Our cost streaming activity will start to kick in, so I feel good about that.

Asia-Pacific. Asia-Pacific, I think what we're seeing there is a slight decline. We're continuing to gain share. We're continuing to grow our volumes. We had some slight decrease in our gross margin, due to some product mix issues and maybe slightly higher raw materials. But the real driver is SG&A, and we are investing heavily in China and in India, because of the growth aspects of the countries. But we are investing, in particular, in new initiatives there like grease, passivation, those kinds of things. We haven't seen the results yet, but now we have these technologies, and we've been able to hire some people. So I think we're doing some pretty good investing there. I hope that helps.

That's very helpful. And then on the SG&A, Margo, you mentioned lower incentive comp but higher merit increases. Maybe just give us a little bit of help on how the incentive comp structure works, what portion of SG&A is fixed, and how much is variable based on the sales level. I think I'm just trying to see if I can get a little better triangulation on what the second half outlook would be for SG&A versus the Q2 level.

Okay. I think what you've hit on is correct, that in the current period we're seeing lower incentive comp impacting our administrative costs, and I believe that however is heavier loaded in the back end of our year. So I would keep that in mind as you consider run rates. That's the information I have for you right now. I think you see the amounts -- what we have given you is the amount of administrative costs that's allocated directly to the product, and we have given you that which is not allocated directly to the product. And so that's what we have given you to work with at this point in time.

Thanks very much.

I hope that helps. Thank you, Mike.

Thank you, Mike.

Laurence Alexander, Jefferies.

Good morning, a couple of questions. First, can you walk us through any regions of end markets where you are seeing noticeable accelerations and/or pickup in share gains? Secondly, as you look at the growth initiatives in the M&A that you've done this year, how much of a tailwind do you see going into 2015 as we're thinking about the bridge? And then thirdly, can you update your thinking on the balance sheet? And a question that's been coming up recently, frame this, is given the strength of the balance sheet, what would be the obstacles to adding either an adjacency or the cultural obstacles, adding an adjacency outside your core areas?

Sure. Good questions. All right. I will start with the first question that you had around the -- are there any particular areas that we see stronger than others, and especially in share gain and things like that. I would say that Mexico, in particular, is an area that we're seeing a lot of strength and there's a lot of investment going into Mexico. We have made an acquisition of our joint-venture partner, which -- a few years ago, which was great timing for us. And so, our Mexico business is booming. We're also seeing good growth in Southeast Asia. So from a regional perspective it's that way.

And is there any particular product line or any market share in the area, I would say pretty much seeing good market-share gains around the world. Again, and I go back to my baseball analogy of hitting singles. I think we're working on our strategic initiatives and our base business and these new technologies everywhere around the world, and we're continuing to gain share. I see these singles happening everywhere, but the geographic areas have to be more like Mexico at this point.

On the M&A front and going into 2015, we will certainly see benefit getting the full-year of the Australian JV, having 100% of the EBITDA. There is no sales impact of that, but there will be certainly an EBITDA impact. And then you have -- really what I see happening from a 2015 perspective is we are another year in to trying to sell, for example, grease or passivation globally. And we have done a lot of investment over the past 12 months in these areas. And as these things start to bear fruit, we will see more sales and earnings from these going into 2015.

And then on the balance sheet question, Laurence, I think there is no -- we tend to look at businesses that are adjacent and a similar type of -- either in the core of our business or just adjacent to us, same kind of customer base and so forth. We feel we have a lot of opportunities in there. We don't feel we are necessarily short of opportunities; we just have got to get these opportunities to fruition. We've mentioned in the past that grease is an area, for example, we invested in a few years ago. We made our first acquisition there, and that is a place, in particular, we would like to grow and make acquisitions, as well into other aspects of grease. And it's a pretty large category. So we feel good about the acquisitions that we're working on, and hopefully they will come, and we always want to make the right decisions on those. We put a lot of work and due diligence on that.

Thank you.

Thanks, Laurence.

Thanks, Laurence.

Liam Burke, Janney Capital Markets.

Thank you. Good morning, Mike. Good morning, Margo.

Good morning, Liam.

Good morning, Liam.

Mike, you've laid out the strategy of share gains, with maintaining of the high-level service and customer care. I guess customer intimacy is what you call it now, but have you seen any competitive response? Once you are beginning to take share, it becomes a slippery slope for your competitors. Has there been any responses that?

Competition is always a key thing; I never want to underestimate our competition. It's a good -- I think our mission, our approach is to continue to have a business model that provides a lot of service to the customer that the customer is very happy with. We continually try to have programs in which we save the customer what we call TCO programs, total cost of ownership programs. And we save them money. And you get into those modes and the customer is very happy. Then there is no need for them to look elsewhere. And we have generally very high retention rate of our customers.

I think we will always have competitors. We'll always have, try to get back in or if they lose a piece of business, but we're hoping this approach to us creates such a -- hopefully a barrier where our customers just want to stay with us. And because we're not in a business that generally is driven just by price, because it's not just the price of our product and who can supply it at the lowest price. It's really we can make a big difference for our customers' overall profitability. So I think we just want to continue to maintain that approach, and hopefully continue to take share.

Great. And Margo, you pretty much itemized the different accounts on the working capital. And as you went through the net working capital change for the first half of the year and for the quarter, was there anything in there that was unusual or was it just timing issues on all these accounts?

That's a good question. We're very comfortable, we have a strong handle on the pieces, and I would only add one more thing to mention there is that we saw some of our customers had some very understandable items happen to them, like putting in ERP systems. So we saw some delay in AR due to that. Otherwise, we look at the AR as larger -- up, because there was larger shipments at the end of the quarter. We saw that going on, and we attributed some to growth. So that's the color I would give you in addition to what you read is that yes, some of our customers had ERP system implementation.

But you would expect the full -- the cash flow, those accounts to reverse and the cash flows to normalize for the full year?

I would expect some of it to come back, yes.

Okay. Thank you.

Thanks, Liam.

(Operator Instructions)

Scott Blumenthal, Emerald Advisers.

Good morning.

Morning, Scott.

Morning, Scott.

Margo, to follow-up on Liam's question, could you or would you be able to provide us with maybe some DSO information?

Yes. I think I can give you some DSO. Let me grab it. Do you have any other questions while I grab that?

Yes, and you mentioned you had some customers with some understandable situations. You don't see anybody out there struggling to pay or anything like that, right?

No. No. Absolutely not. That is not the case. No.

Okay, and could you give us an end of the quarter number of shares outstanding too?

Shares outstanding at the end of the quarter? That should be on our press release here, right on the face page of the Q. Can you go to the face page of the Q?

Okay. I can look that up. I'm sorry. Then Mike --

Scott, it's 13,242,167 shares.

Thank you for that.

You bet you.

And Mike, there were a couple of references made to raw materials. Any meaningful issues with any raw materials pricing or availability? I know that you use a broad spectrum of raw materials.

No. I would say in general, not, and it's not like broad categories are going up. It is really different types and different parts of the world, so to give you an example, we buy oleo chemicals; in Brazil it's going up. In other places it's relatively stable. Vegetable oils are going up for us in Europe. Ethylene derivatives are going up for us in North America, and you have some additives that are going up really everywhere. But generally, the bulk of our stuff is steady. It's just that you've got some pockets or some places where things are going up.

Okay. Thank you.

Scott, on the DSO, we ended this period with approximately 90 days.

Okay. Is that normal?

That was up nine days versus the prior year.

Okay. Perfect. Thank you.

Thank you, Scott. Have a good day.

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

Thank you, Christine. Given that 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 our results for the second quarter, 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 Margo Loebl 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. Thank you for your participation, and have a wonderful day.