Quaker Chemical Corp (KWR) 2014 Q3 法說會逐字稿

Greetings and welcome to the Quaker Chemical thirdquarter 2014 results conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Michael Barry, Chairman, CEO, and President of Quaker Chemical. Mr. Barry, please go ahead.

Thank you, Kevin. 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 our 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 third quarter. I am pleased to report that we had a very good quarter, as strong revenue growth led to double-digit growth in earnings per share.

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 8% for the quarter versus 2013, with growth primarily driven by higher volumes. We saw double-digit growth in sales in our three largest regions, which were partially offset by a decline in our South America sales.

Going region by region, South America was our most challenging region. Our revenues were down 25%, due primarily to lower volumes associated with the poor economy and the decline in the overall steel and auto markets. In our Europe or EMEA region, we saw 11% growth, despite only a modest increase in the auto and steel markets. In our Asia-Pacific region, we had 13% growth, with China being the main driver, and in North America region, we had a growth of 10%, with very strong growth coming from Mexico and our coatings 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. I believe this approach continues to differentiate us in the marketplace.

We have a great deal of initiatives in our base business lines and in each of our regions, as well as through growing our recently acquired technologies around the globe. As I mentioned in the past, using the baseball analogy, I see each of these initiatives as singles. Our goal is to hit many singles to produce multiple runs and thereby show continuous growth, even in tough market conditions.

Looking at the sequential quarterly trend in the third quarter versus the second quarter, overall sequential sales growth was 4% quarter over quarter. We saw strong growth of 7% and 10%, respectively, in North America and Asia-Pacific and a modest decline of 2% in Europe, due to the traditional summer holiday period. In South America, we experienced an 11% decline, due to the poor economic conditions I mentioned earlier.

On our gross margins, they were slightly down, but relatively consistent with our third quarter of 2013, primarily due to slightly higher raw material costs. Overall, our gross margins continue to be very stable and have remained at this level for the last five quarters.

So I am pleased with our overall performance. Despite a weak South American environment, we continued to achieve very good growth in revenue, earnings, and cash flow, and our EBITDA growth continues to do well. For the first three quarters of this year, it is up 11% and we are now closing in on the $100 million adjusted EBITDA mark.

The bottom line is I continue to be confident in our future. In the fourth quarter, we expect to have typical seasonality impacts on our business, as well as operating in a slowing global economy with a strengthened dollar. Despite this, we expect 2014 to be another good year for Quaker, not only financially, but as well 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, similar to our recent acquisition of ECLI Products.

While still a relatively small acquisition in size, ECLI is our largest acquisition to date and it provides us an entry into the specialty grease market in the auto industry. We believe their product and application expertise, in combination with our global footprint, can help drive their global growth.

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 continuing to actively work on these type of acquisitions and opportunities.

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 am 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 you with more details behind our financials, and after that, we will address any questions you may have. Margo?

Thank you, Mike. Good morning, everyone. I am delighted to be here on the call and I reiterate that we are very pleased with our results in the third quarter, despite the continued challenges in Brazil, as well as a slowing global economy.

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

Next, I would like to mention our special Quaker items which relate to the third quarter. First, Quaker acquired ECLI Products, LLC, a specialty grease manufacturer, in the third quarter for $52 million, with estimated 2014 EBITDA of $7 million on sales of $25 million.

Second, Quaker announced on June 30 the acquisition of the remaining 49% ownership interest in its Australian affiliate, Quaker Chemical (Australasia), for AUD8 million from its joint venture partner, Nuplex Industries.

I mention the secondquarter 2014 transaction now, given that the resulting incremental impact on Quaker's consolidated net earnings only started to impact us in the third quarter of 2014. I also note that the impact of the two acquisitions on earnings was minimal this quarter, due to the offsetting impact of the fair value accounting for ECLI and acquisition-related costs.

Third, Quaker announced in May 2014 a 20% increase in the quarterly cash dividend to $0.30 per share, payable July 31, 2014, versus the $0.25 per share declared over the previous four quarters.

As referenced in chart 4, a financial review of Quaker's third quarter includes the following highlights. With respect to highlight number one on chart 4, the title reads, "Record volumes drive above-market growth in net sales."

Turning specifically to charts 5 and 6, net sales for the third quarter of $198.9 million increased approximately 8% from net sales of $184.1 million for the third quarter of 2013, primarily due to higher record product volumes.

Included in the Company's net sales growth for this quarter was 1.7% of additional sales from the acquisition of ECLI. Notably, the consolidated total volume increase was partially offset by price and selling mix decreases of approximately 2% and foreignexchange translation decrease of less than 1%.

Our diverse geographic footprint helped us, as the double-digit revenue growth in three of Quaker's four regions more than offset the 25% decline in revenue in South America year over year due to poor economic conditions in the region.

Importantly, it should be noted that the growth in volume and net sales in Q3 2014 versus Q3 2013 outpaced the end-use market growth of the steel and automotive industries served by Quaker. Although official data are not readily available at this time, we estimate Q3 percent end-use market growth to be low single digits.

The key driver for Quaker's sales growth has been and continues to be Quaker's ability to take share of wallet with existing customers on pre-acquisition products and, more recently, acquired products and technologies.

Turning from the top line growth story to margins, with respect to highlight number two on chart 4, the title reads, "Stable margins continue to drive strong operating results." Turning to chart 7, gross profit increased approximately $4.3 million or 7% from the third quarter of 2013 on the increase from sales volumes noted earlier on relatively consistent gross margins of 35.4% and 35.9% for the third quarter of 2014 and the third quarter of 2013, respectively.

Gross margins have been approximately 35% or better for the past five quarters, demonstrating Quaker's ability to manage price, mix, and raw materials effectively, targeting the 35% gross margin level.

The relatively stable raw material cost environment has been a major contributor to the stable margins. Selling, general, and administrative expenses (SG&A), increased approximately $2.6 million from the third quarter of 2013. The increase in SG&A was driven by higher labor-related costs, primarily on increased sales, and merit inflation, incentive compensation increases, acquisition-related costs and a US customer bankruptcy, partially offset by the Company's prior-year cost-streamlining initiative and the effects of foreign exchange.

Notably, SG&A as a percent of net sales of 25% in Q3 2014 is down versus 25.6% in Q3 of 2013. I note that Q3 2014's SG&A levels would have been lower if not for the timing of certain expenses -- as an example, incentive compensation -- and the uncommon nature of other expenses -- as an example, acquisition-related costs.

Three out of four of Quaker's regions achieved improved operating results in Q3 versus last year, while South America's results were down significantly year over year. Notably, South America is recognizing the full-year impact in 2014 of the region's cost-streamlining efforts initiated last year, which has at least partially mitigated the downside related to the poor economic environment.

With respect to highlight number three on chart 4, the title reads, "Below operating income items contribute to strong results." The current quarter is benefiting from the following operatingincome items. The $1.6 million net year -- year-over-year increase in other income for the third quarter was largely the result of foreignexchange gains and receipt of annual government grants in one of the Company's regions.

Comparatively, the third quarter of 2013 had significant foreignexchange losses and minimum related government grants, as the majority of such grants were recognized in different quarters of the prior year.

Higher interest income of $0.4 million in the third quarter compared to the third quarter of 2013 was primarily due to interest received on certain tax-related credits and an increase in the level of the Company's invested cash in regions with higher returns.

The lower income tax rate in Q3 2014 is based largely on bookings at a 25% statutory rate for China in the prior year compared to the 15% concessionary tax rate that currently prevails, as well as timing of adjustments and reserves for uncertain tax positions.

With respect to highlight number four in chart 4, the title reads, "Continued EBITDA growth in non-GAAP EPS is up 31%." Quaker's adjusted EBITDA increased 16% to $26.5 million in the third quarter from $22.8 million in the third 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 $97 million for the period ending September 30, 2014.

Looking at the range of 2008 to the thirdquarter year-to-date adjusted EBITDA annualized, equaling an estimated $101.4 million, a compounded average growth rate for adjusted EBITDA is 16.7%, with margin on adjusted EBITDA up 6.4% or 640 basis points in annualized adjusted EBITDA 2014 versus 2008.

Referencing chart 6, earnings per diluted share for the third quarter was 1.18 -- compared with -- $1.18 compared to $0.95 for the thirdquarter 2013, with non-GAAP earnings per diluted share increasing 31% to $1.19 for the third quarter compared to $0.91 for the third quarter of 2013.

Notably, Quaker exceeded analyst consensus expectations of $1.03 a share with these $1.19 per diluted share non-GAAP results in the third quarter of 2014.

With respect to highlight number five on chart 4, the title reads, "Strong cash flow and balance sheet from acquisitions." Strong quarterly earnings and improved working-capital management drove net operating cash flows of approximately $30 million for the third quarter, compared to $24.5 million in the third quarter of 2013, which increased the Company's year-to-date net operating cash flow to $38 million, compared to $51.9 million for the first nine months of 2013.

The $13.9 million increase in cash flow primarily relates to -- the decrease in cash flow primarily relates to the year-over-year increase in working capital.

Turning to chart 9, the Company had positive net debt cash debt position of $1.6 million at September 30, 2014, with $64.2 million of cash on hand and $62.6 million of debt outstanding. It is also the Company's consolidated leverage ratio of 0.65 to 1 continued to be less than 1 time EBITDA, despite the added borrowings for the $52 million purchase of ECLI.

We continue to believe that making acquisitions is the best way to create significant shareholder value. Including the acquisition in Australia and ECLI, Quaker has made a total of nine acquisitions over the last four years. We believe our strong balance sheet and ongoing cash flow generation will allow us to make significant future acquisitions, while continuing to pay consistent dividends to shareholders.

Again, we were pleased with our very strong operating results in this third quarter and we believe 2014 will be another good year for Quaker. 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 Chemical.

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

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

(Operator Instructions). Daniel Rizzo, Sidoti & Company.

You indicated that stable raw material costs have helped you over the past couple quarters, but now with petroleum prices falling, would that provide more of a tailwind or are you going to have to also lower your own prices as well to catch up?

We don't think of it internally as a windfall to us at all. We don't think it's going to be a major impact.

We are -- if I look at -- just talk about the raw materials themselves in a second, we buy a mixture of raw materials. Certainly the ones related to crude should start to decline, but we haven't seen much already on that. They are just starting. And then, and even in some places like in Europe, they are not going up -- or going down, I should say.

Then you have other raw materials that we buy, like vegetable oils, that we expect to have upward pressure on, and then we have animal fats. There is a mixture; in some regions, it's down; in other regions, it's up. And then, we also buy a whole bunch of other things, like ethylene derivatives, and they are actually increasing.

Overall when you look at the basket of our raw materials, we expect it to be maybe slightly down, maybe a couple percentage points. But then, we have some contracts that automatically adjust based on raw material prices, and so you're not going to see much of an impact on it from a gross margin level, we don't see, because between that and other just regular discussions and negotiations with customers, our whole goal still remains to keep our gross margins in that consistent range we have been in over time.

Again, bottom line is you might have some slight thing. There is always a lag effect in some things, but we don't expect this to be a big thing one way, positive or negative, for us.

The goal for gross margin is 36%, right? I think you've said that in the past?

35%.

35%, so we are above that, and we think we can probably stay up above 35% for the (multiple speakers)

Yes, obviously, it is hard to -- we have so many different kind of product types and all around the world and so forth, but in round numbers, yes, we always say the 35%. But if you look at where we were for the past five quarters, we have been between 35% and 36%, and certainly that's our goal, to continue to stay in that range.

Okay, thank you, guys.

Liam Burke, Wunderlich Securities.

Mike, when I looked at revenue growth traditionally and your revenue tracked with steel production, roughly during the quarter steel was -- production grew around 3%. But looking at your organic growth at more than twice that number, you mentioned acquisitions and market-share gains. Was there anything in particular that was stronger in the quarter to drive that, I will call it, twice organic growth?

No, there is nothing in particular. It's really -- think of our growth in different buckets. Some of it could be new mills that we picked up over the past several years, and as mills start ramping up in time, because we get the disproportionate amount of business of new mills that come up, so when they come upthat gives us a little boost.

Then we are continuing to take share in our core products, so we might be picking up a new mill here and there around the world, or we could be actually selling other products besides our core cold-rolling lubricants and maybe making more penetration in cleaners or hydraulic fluids and so forth.

Then the other aspect is we are continuing to make progress in some of the recent acquisitions that we have made, whether it is grease or surface technologies or tin plating or die-casting.

So it's not any one of these things; it's a mixture of all these things that's leading to our growth.

Okay. Margo, as the global footprint grows, you add acquisitions, do you see any need to up any kind of capital expenditure?

We have been managing to date to stay pretty constant in our SG&A, albeit we have grown and built a plant in China and there has been some offsetting -- managing the CapEx to offset that.

I think we are evaluating. We are going into the budget season now and evaluating where we are going with that. I do believe we will -- there will be investments for growth that you will see from time to time, but we will continue to be a CapEx-light company.

Great. Thanks, Mike; thanks, Margo.

Mike Sison, KeyBanc.

Very nice quarter there. In terms of South America, where do you think you are at in terms of demand there? Is it stable? Is it getting a little bit worse, getting a little bit better going forward?

We think we're at the bottom. I don't think we are -- we don't expect getting worse, but you never know, right?

I think we saw -- we have definitely seen a decline in the economic environment in Brazil. Say from the first quarter through the third quarter, it has gotten consistently worse. But the feedback or the sense we have is hopefully we have reached the worst, and now that elections are over in Brazil, maybe that will have a positive impact. But we don't expect it to get worse, that's for sure, and hopefully it will improve.

Okay, great. You talked about the market growing 2% to 3%, I think, in the current quarter. How do you look at the -- where do you see the market growing in maybe the fourth quarter and heading into 2015? Do you think this 1.5 to 2 times the market type growth that you have been generating, which is impressive, will continue?

On the first part of the question around market growth, we -- or certainly our sense is that the market itself, the overall global markets that we are dealing in, tend to be slowing, say, versus earlier in the year, if I think of places like China. We already just talked about Brazil. Even Europe is slowing. So our sense is the market will have low growth.

And then the second part of your question is our goal continues to be to hit on these bunch of singles, whether it's the new technologies we acquired. We still think we are very early in that game of rolling those out and we have a lot of leeway there.

We continue to want to take share in the marketplace. That's been our track record, like you said, in the past several years, so our goal is just to continue to, as we have been with our business model and our strategic initiatives, as well as bringing on new acquisitions, and our goal is to continue to grow no matter what the market conditions are.

Okay, and then, Margo, final question. When you think about the acquisition contribution expected for the next couple quarters in terms of top line growth, can you give us a little help of roughly how much that is?

We haven't really -- we have told you in the past that we -- prior to ECL, we thought we had about $75 million of added sales for our acquisitions when we put them on. We have another $25 million with ECLI. So that's the base starting point, and then you would have to make assumptions from there as to how we would grow -- our acquisitions would grow and add to the bottom line.

But as Mike said, we are in the second inning of adding those -- rolling those out around the world, so I would anticipate it will be at a measured, steady pace.

Great, thank you.

(Operator Instructions). Mike Harrison, First Analysis Corporation.

Just following up a little further on the acquisition stuff, does the ECLI acquisition put you where you need to be in terms of your specialty grease portfolio, or do you see the grease market as having some additional consolidation opportunities that you guys could execute and benefit from?

I think on the specialty grease, first of all, it's a huge market. It's well over $1 billion total market and that's what attracted us to the specialty grease market to begin with.

Certainly going into the first acquisition that we made, Summit Lubricants gave us an entree into it, an ability to start getting grease to penetrate some of our existing markets. One of the things as we -- that was hard to penetrate was this existing automotive market where you have to be spec'ed in and it is just a level of approval. And it wasn't -- to do that organically wasn't really that kind of -- wasn't really feasible.

So we are very happy with the ECLI because that gives us that ability to penetrate that segment of the specialty grease market, and then grow it more globally than they have. We are very pleased with that.

We also believe there is[are] other segments in the grease area that we want to continue to go after. Geographically, right now we are predominantly a US -- almost all US -- in grease, and we want to grow that and look at acquisitions elsewhere around the world for grease.

And there are other markets that grease goes into as well that we haven't really begun to penetrate. So we think there's a lot of potential head room to grow in grease with -- both organically and acquisitions throughout the years.

Then, obviously, the volumes were pretty strong across the board, with the exception of Brazil, but I think the Europe year-over-year growth at 14% is the one that stands out to me. Obviously, sometimes you get a one-time sale in association with a plant fill. But was there a one-time benefit in that number, or are you viewing Europe as a region where you can see sustained better growth, given the work that you have done to grow that business over time?

Any quarter when you are only looking at a quarter piece of business, you always have the potential of shipments falling in one quarter when you go to the comparative period versus another quarter and so forth. But there are definitely -- in Europe, we did see, over the years, some good share gain in how we were -- especially in the primary metals area.

The bulk of what we are seeing, I believe, is true business, true overall growth that we've achieved. It is hard to predict. I'm not saying we are going to expect to see that kind of growth every quarter from Europe, because you always do have these fluctuations in order patterns and so forth, but we are definitely seeing some good overall growth in Europe.

The margin strength in Europe, is that the volume growth driving that or are we starting to see some of the restructuring benefits contribute there?

I think it's mainly volume that we have seen. It's not really -- we haven't really experienced that small kind of restructuring that we did over the past year.

Presumably if you keep the volume growth going, you should be able to leverage those restructuring benefits pretty nicely, then.

Sure, yes. Volume helps everywhere around the world. Yes.

The last question I have is on -- you referenced some of the year-on-year improvements in SG&A costs, but if I look sequentially, those costs crept a little bit higher. Are we seeing higher labor costs and incentive and merit compensation in the third quarter as compared to Q2 levels or were there other components contributing to the higher expense?

I guess just looking into Q4, is it fair to assume that we see further increase in the SG&A costs and the labor costs inside of your merit comp?

You know, that's a good question and I'm glad you asked. We are basically staying with the outlook that we have some timing issues here.

We don't see any unnecessary creep in the structure of our SG&A, so you are seeing the -- we're sticking with our standard approach; that is, we have some timing issues here. And at the same time, we continue to invest to grow our business, so we're steady and I don't see any unusual -- any things that would concern me.

(multiple speakers) pretty much --

We mentioned --

(multiple speakers) unusual expenses in the quarter, right, with the acquisitions and the bankruptcy and things like that.

How much acquisition-related cost was in SG&A?

We haven't put that in our disclosures at this point in time. We --

Was it bigger or smaller than the $300,000 for the customer bankruptcy?

Yes.

(laughter) (multiple speakers)

Bigger, bigger.

Bigger, okay, thank you.

Scott Blumenthal, Emerald Advisers.

Margo, you talked a little bit about interest income from overseas cash and maybe you can give us an idea as to -- obviously, however you feel comfortably doing it -- as to how much you have over there? What percentage, maybe?

That's a good question. Basically, we see a couple things going on. You look back about four quarters, and I see the last two quarters I had credits -- they are elevated levels because I have credits related to interest earned on some tax credits. So you can then go back to the period before the last two quarters and that's a little more normalized.

Basically, yes, we are seeing higher levels than you might get in the US because a large portion of the cash is overseas. If we -- so, yes, it's largely overseas.

(inaudible) how much cash is overseas.

I said the majority of the cash is overseas, yes. It is largely overseas.

Okay, that's helpful. Thank you. I guess we're all struck as to how much South America is down. Maybe you can give us some more details on what's happening there. Did you lose a customer? And maybe what -- is South America basically Brazil or maybe you can give us an idea as to what percentage of your South America sales Brazil represents?

It's certainly predominantly Brazil. It's the vast majority of it. We certainly have some in Argentina and some in other countries around there, yes, but over 90% would be Brazil. So, that's really driving it.

It's really -- we're just seeing pretty large declines. Really, it's not necessarily share related. If you look at our steel position, everything is -- steel, we haven't lost a customer, so it's really just showing what's been happening in the markets down there.

And the auto market has been really hit very hard down there. It has been showing double-digit type of declines quarter over quarter. It's just not a pretty place right now.

Okay, Mike, I appreciate that. Maybe you can -- my last one here, maybe you can delve into some of the non-petroleum raw materials a bit for us. You did mention that you are expecting some upward pressure on vegetable oils, and we understand that it is supply and demand, but maybe you can talk about where you are sourcing some of those and why you feel there may be continued upward pressure. I believe we are expecting a record harvest here, so maybe that could mitigate some of that for you.

What we have internally seen or at least the raw material people are saying is that there are certainly some lower yields globally on some of the key raw materials that we buy. We buy coconut oil and palm oil, and mostly that comes from Southeast Asia type area.

Yes, we expect to see some upward pressure on that. Obviously, things can change, but that's our best guess. But again, as I said, overall we expect to see our raw materials to be, as a basket, slightly decline.

One other thing, just mentioning, I guess, Scott, just to go back to Brazil for a second, I just wanted to mention, yes, I said Brazil was a pretty tough place, but it's not like we are losing money in Brazil. I want to highlight that. We're still -- Brazil is still a profitable place. We are generating cash in Brazil. It's just not at the standards where we expect to be.

Okay. That's really helpful. I appreciate that. Thank you, Mike. Thanks, Margo.

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

Okay, thank you. I appreciate it, Kevin. Given there are no other questions, we will end our conference call now, and I want to thank everyone for your interest today. We are pleased with our results for the third quarter and we continue to be confident in the future of Quaker Chemical.

Our next conference call for the fourth quarter and full-year results will be in late February or early March, 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.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.