Quaker Chemical Corp (KWR) 2015 Q3 法說會逐字稿

Greetings and welcome to the Quaker Chemical Corporation third-quarter 2015 results conference. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Michael Barry, Chairman, Chief Executive Officer and President for Quaker Chemical Corporation. Mr. Barry, you may now begin.

Thank you, Rob. Morning, everyone. Joining me today are Shane Hostetter, our Global Controller, and Robert Traub, our General Counsel. After my comments Shane will provide the details on the financials and then we will address any questions you may have. We also have slides for the conference call.

You can find them in the Investor Relations section of our website at www.quakerchem.com.

I will start up now with some remarks about the third quarter. I am pleased that we have delivered another quarter of consistent earnings and strong cash flow despite a variety of market challenges. We have accomplished this, notwithstanding some significant changes in our external environment over the past several months, including a much stronger dollar against many of the world's currencies, lower oil prices, and the impact both of these had on regional steel production.

Let me now talk about each of these in greater detail to give you a better perspective in which to evaluate our third-quarter results.

Foreign-exchange rates negatively impacted both sales and earnings by 8%. So you can see that our earnings and revenue would have shown pretty good growth if not for this exchange rate impact. Lower oil prices also impacted our results in a couple ways.

On the plus side, we saw some expansion in our gross margins as there can be some lag effect to changes in our pricing and our raw material costs. On the other hand our top line was negatively impacted since we did see some declines in our product pricing.

We also saw some shifts in regional production, especially in our global steel markets, which make up over half of our business. The stronger dollar enticed more steel imports into the US, negatively impacting North American steel production. In fact, steel production was off versus last year by 7% in North America.

Globally, the story was not much better. In fact, all major regions or countries showed declining steel production versus the third quarter of 2014. Overall global steel production declined approximately 3.7% in the current quarter versus last year. However, on the positive side, most of the external data I have seen about the steel industry suggests that after 2015, we should see steel production growth in the 2% per year range for the next several years.

I would now like to make some comments on the quarter's sales, and I will do this region by region. North America showed growth of 2% of net sales despite a 3% negative impact due to foreign exchange. So given the 7% decline in steel production that I mentioned earlier, you can see we are continuing to have good market share gains in North America.

Our European or EMEA region showed a 7% decline in sales. Our base volumes there, without acquisitions, were down 2% reflecting weakness in the steel market and some timing issues with product shipments.

South America continues to be our most challenging region, and our sales have dropped 40% with currency and lower demand being the two largest causes for the decline.

Overall, though, I think it's important to point out that we continue to make money in South America and we have consistently reacted to the economic situation there as conditions change, through actions similar to our previously discussed streamlining efforts.

In the Asia-Pacific region, sales were down 7% with the primary driver being exchange rates. Overall, product volumes were slightly down but relatively flat from last year as our market share gains are essentially offsetting the weakness in steel and auto markets in China. As you can see, the sluggish global economic environment, strong US dollar and lower oil prices are significantly impacting our business dynamics for the quarter.

Nevertheless, we were able to maintain stable non-GAAP earnings and EBITDA.

In addition, we have strong operating cash flow in the quarter and have now generated $13 million more so far in 2015 versus 2014. We were able to achieve these results on the benefits from a recent acquisition as well as taking share in the marketplace. One way to see this share gain is to look at our overall product volumes and exclude the benefits from our acquisitions. And also the unique impact of Brazil, which is less than 4% of our sales is having on our business.

When you do this, our product volumes are flat in an environment where our largest market indicator, steel production, is off nearly 4%. This type of differential between our actual product volumes and trends in the market we supply is a high-level way of getting some visibility to our market share gains. We believe the share gains are due to our commitment to our customer intimacy model which puts the customer's needs as our top priority and provides them with strong service 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 a 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.

Over the next quarter, we expect to see continued impacts of lower oil prices and a stronger dollar on our revenue. In the case of raw material, we expect that we are probably reaching the bottom at this time and we will eventually see some modest firming in raw material costs going forward. But this is really hard to determine with the fluctuations in the price of crude oil.

As mentioned during the last call, we expect more volatility in our gross margins this year as there can be timing differences between raw material costs changes and our product price adjustments as we have seen in 2015.

As raw materials continue to settle, we would expect our margins to be in the 35% to 36% range but it is difficult to predict the exact timing of this or where gross margins will eventually settle.

So while there is a great deal happening around us the bottom line is I continue to be confident in our future. We believe that we can to grow our annual earnings and generate strong cash flow despite the market challenges. We will do this by executing our business strategies which we project will lead to continued share gains in the marketplace. Also, we continue to leverage our recent acquisitions by selling our newly acquired technologies on a global basis.

And finally, we will continue to work on new acquisition opportunities such as the acquisition of Verkol, which we announced in July. The combination of all these growth vehicles gives us confidence that 2015 will be another good year for Quaker and we expect full-year non-GAAP earnings to exceed 2014, which would mean our sixth consecutive year of earnings improvement.

For the fourth quarter, we expect to experience the typical negative seasonality impacts we tend to see in this quarter and we expect our non-GAAP earnings to exceed the fourth quarter 2014 levels.

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 Shane Hostetter, our Global Controller, so that he can provide you with more details behind our financials.

Before I do that, I am pleased to mention that our new CFO, Mary Dean Hall, will be joining Quaker at the end of November. Currently the Treasurer at Eastman Chemical, a large international chemical company, Mary brings to Quaker a great deal of global experience in all relevant financial disciplines. Going forward, Mary will be participating in the quarterly conference calls.

Once Shane has completed his comments on the financials for the quarter, we will be happy to address any questions that you may have. Shane?

Thank you, Mike. Good morning, everyone.

To begin, please note that charts 4 and 5 of the call slides include an outline of the key themes and financial metrics for the quarter, which I will highlight during this call.

As Mike mentioned, we are pleased to report strong quarterly operating results in non-GAAP earnings of $1.19, beating consensus analyst expectations of $1.13 for the quarter. Notably, these non-GAAP earnings were consistent with the prior year quarter despite a negative foreign-exchange impact of approximately $0.09 per diluted share.

Related to foreign exchange, the translation of foreign currency against the strong US dollar continued to have a significant impact on our reported results during the third quarter 2015, similar to other domestic-based companies with global footprints. Specific to sales, approximately 60% of our revenue is outside the United States, which drove a foreign currency translation decrease of $14.9 million or 8% in the third quarter of 2015.

Given this foreign-exchange impact, our consolidated revenues declined 5% from approximately $198.9 million in the prior year quarter to $189.2 million in the current quarter. However, as displayed in chart 6, this decline in sales due to negative currency translation, overshadowed year-over-year product volume and acquisition growth of approximately 4%, which came in the face of difficult dynamics in the global markets and an overall decline in global steel production. In addition to volume growth, our gross margin expanded from 35.4% in the prior year quarter to 37.7% in the current quarter due to product mix and timing differences between raw material cost decreases and corresponding product pricing.

As depicted in chart 7, the current quarter's margins remain inflated over our past averages but decreased somewhat compared to our most recent second-quarter margin level. We still believe are normalized margin structure remains between 35% and 36%, but the timing of a decrease in our current margins to this level continues to be unpredictable.

Our increased product volume and gross margin expansion led to a gross profit increase of 1.5% compared to the prior year quarter. Notably, the current quarter operating income would have patterned this gross profit increase but the year-over-year comparison was skewed by certain non-GAAP SG&A expenses.

Specifically, the Company's reported SG&A increased $2.9 million in the current quarter. However, this increase was primarily driven by one-time transaction expenses of $2.8 million related to the current quarter acquisition of Verkol. Other changes to our SG&A in the current quarter included higher labor costs and incremental costs associated with the current and prior year acquisition which were offset by lower foreign currency translation.

Similar to SG&A, the performance drivers below operating income generally netted and were consistent in total compared to the prior year quarter. We benefited from a lower effective tax rate of 24.4% in the current quarter compared to 26.7% in the prior year, driving a decrease of $1.2 million in tax expense. However, this current quarter tax benefit was offset by lower other income, primarily related prior year government refunds in one of our foreign subsidiaries and lower interest income primarily related prior year tax-related credits. Related to our full-year effective tax rate, we continue to anticipate it will draw approximately 28% for 2015.

In regards to our current quarter Verkol acquisition, please note that outside the aforementioned transaction expenses of $2.8 million, we only realized a minimal impact to our quarterly earnings as Verkol's operational results were offset by initial adjustments related to fair value accounting. However, for a full year without such adjustments, we still expect an annual impact of approximately $0.10 to $0.15 per diluted share from this acquisition.

So, in summary, the story of our quarter's financial performance was higher gross profit on solid product volumes and higher margin which would have largely fell to our bottom-line results if it were not for the uncommon acquisition expense.

Turning to liquidity, we generated quarterly net operating cash flows of $23.5 million which increased our year-to-date net operating cash flows to $50.8 million compared to $38 million for the first nine months of 2014. This $12.1 million increase in net operating cash flows was driven by our solid operating performance and lower working capital investment during the first nine months of 2015.

Highlighting the improved working capital were lower cash outflows from accounts receivable during 2015, primarily due to enhanced collection efforts compared to the prior year.

Also contributing to our cash flow was an increase in our adjusted EBITDA from $26.5 million in the third quarter of 2014 to $26.8 million for the third quarter of 2015 despite the negative earnings impact from foreign exchange of 8% as mentioned earlier. Also, noted on chart 8, the quarter's performance increased our trailing 12 month adjusted EBITDA to over $100 million versus $97 million in the prior year despite similar impacts from foreign exchange.

Overall, our operating cash flow generation in the quarter offset additional borrowings to fund $24.5 million of net payments related to the acquisition of Verkol, $3.4 million of payments to continue our share repurchase program announced in May of 2015, and $4.3 million for our normal quarterly dividend payment. Detailed in chart 9, this led to an increase in our net debt to $12.2 million and a leverage ratio of approximately one times EBITDA.

Overall, this quarter is a good reflection of our strategy for providing future shareholder return as we continued to target a 2 to 2.5 times leverage ratio. For instance, we were able to expand our balance sheet leverage through strategic acquisition while maintaining our quarterly dividend payout and continuing our share repurchase plan of at least offsetting the dilutive impact of shares issued during 2015.

To conclude, we had solid product volume levels. We delivered consistent non-GAAP earnings and we continued to improve our overall liquidity this quarter despite various headwinds. I would like to thank you all for your time today and for joining us on the call this morning.

And I will now turn the call back over to Mike.

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

(Operator Instructions) Laurence Alexander, Jefferies.

It's Dan Rizzo on for Laurence. You indicated that there is sluggish or slow growth in your steel end markets. How are the metal end markets holding up? Are you seeing growth there or is that slowing down at all? Just a little color.

On our metalworking business, (multiple speakers) yes. Well, if you look at automotive markets in general, the auto markets on a global basis grew in the quarter, auto production, a little less than 1% quarter over quarter on a global basis. If you look at some specific markets like China, China actually was down in auto production in the third quarter 2%. So in these other markets which is primarily driven by auto, it's -- I would say slightly growing.

I have heard from other companies potentially that China might have hit a bottom and that they have seen some uptick in production in September and into the first part of October. Are you seeing anything similar?

Well, it's hard to tell so early on in the quarter for that. I have been reading some things, steel production a little bit, might be upticking a little bit in September. But with China in particular, the whole September/October timeframe is kind of a tough time for it. Because they have this one-week holiday the beginning of October, which can skew things between the months.

Okay. I was actually talking about auto in China, but I guess it is similar.

In auto, yes, I think that what I have read anyway would suggest that auto should start to be picking up a little bit after three months to four months of year-over-year declines.

Okay, and then with the -- in regards to the Verkol acquisition, you said $0.10 to $0.15 annually in EPS. Would that be starting next quarter? Or is there still some dilution for a couple quarters?

Dan, this is Shane. I would anticipate going into next quarter with some similar adjustments to this quarter as well. However, my discussions from a full-year perspective would be with 2016 in mind.

Okay, and finally, how much revenue is -- does Verkol provide, if you can just remind us?

Generally, it is right in the mixture between $25 million.

Okay, thanks, guys.

Liam Burke, Wunderlich Securities.

Operating margins in North America were really strong year over year. Was that a function of raw materials and volume? Or is there anything else in there?

Yes, it is both that, both of those. They've had a really strong performance with cash so they have the same lag effect going on with margin expansion that we have seen. And they also have the very good growth for the share gains they have been able to achieve in the business. So I think those are the two major drivers.

Okay, and on the working capital front, you made progress there. To use your baseball analogy, where are you in terms of the innings, in terms of getting those ratios more in line with where you would want them?

We continue to progress in that regard. We are always trying to streamline things from a working capital perspective. There is definitely some trends we have been seeing for the past couple of years. We talked about that a little bit especially in China where some of our customers are pushing back and using bank notes, which is a way of extending terms, but -- so we continue to -- and as our customers -- it is basically a very high level of focus area for us. So we continue to try to do the best we can there. But I think we will hopefully continue to see some incremental improvement there.

Great, thank you Mike.

Mike Harrison, Seaport Global.

Mike, I was wondering if you could help me understand. You mentioned the US market was impacted by steel imports, but then you also mentioned that steel volumes out of Asia were flat to a little bit weaker. So, if these imports are not coming from Asia, where are they coming from?

No, I am sorry. I misspoke if I said that. But I think they are coming from predominately Asia. But I think and actually everywhere around the world, anywhere I go or we see or we talk to people, we see China steel is showing up everywhere around the world. So that is the major source of -- you know, you look in places like in the US, the inherent demand for steel is actually good. It is just the production of steel is down because of these imports, and the same thing in Europe.

All right, and can you talk about how many new steel mill wins you have had so far in 2015 and maybe talk about your expectations on the number of new steel mill start-ups you are seeing in 2016 and what portion you might be positioned to win.

I don't have the exact timing of some of these mills. I have looked at some recent data around that. And there is a number of steel -- this is from a presentation I was at a couple months ago -- there is a number of steel projects that are ongoing right now that are coming up either later this year or in 2016. And again, I think for the most part we would expect our success rate has generally been in the 80% timeframe -- range of success of getting that business on start-up. We would expect that to happen.

I don't have the exact breakdown or anything around that. But I would expect that to continue. And generally what happens is a new mill comes up, it does not come right up to full speed right away. It takes a little time to ramp up and then after a couple of years eventually gets there. And so right now, we are really probably seeing more of the benefits from the steel mills that have started up in 2014 as an example.

All right, and then looking at the pricing versus raw material trends, I know we saw a little bit of a decline in the gross margin here and you have given your outlook that you expect to come back to that 35%, 36% range but is it fair to assume that we see another modest leg down in Q4? Or have -- I know that base oil costs, for example, came down a little bit in Q3 and probably a little bit more tailwind. Could we see that -- the raw material benefits actually tick up in Q4?

I'm sorry. Your last part of that question was -- could we see raw materials actually tick up?

Yes.

Yes, they could. I think for the most part, I think if we see any major or modest increases even in raw materials, I think it will be more likely in next year. But I think what we have is a dynamic of, like you said, flat the following raw materials that are still coming through the system. I think we are -- as we sit here today, I think we are at bottom is our projection. And at some point here, they will start to go up.

But it's really hard to predict or piece it all together when you also have our product pricing also making adjustments over time. And as you know, we have some customers on contracts that have indices and they continually adjust. And then you have other contracts that are just straight negotiations. So, the net effect of that is over time, we would expect to see our margins come back to their more typical levels. It is really hard to pinpoint exactly when that would be and exactly where that all will shake out. So I think we would expect to see something trending in that direction, but it is hard to say to what magnitude.

All right, and then the last one for me is I saw the announcement on the new metalworking fluid platform. Can you just give us a sense for how major this new product platform is and maybe talk about what portion of your metalworking customers you would expect to see switch to the new technology?

I think we have a number of new platforms going on in metalworking that are really revolving around -- try to help our customers in many different ways. We are right at the initial rollout on many of these. Some of these will be replacing products where products that were continually selling, and some will be -- give us the ability to penetrate new areas.

I think we would continue to expect, as we do in all of our product lines, continue to have hopefully above market growth in these things, in all of these initiatives that we are working on right now. So I don't see it as something that is going to -- [that shows you], a step change. I think all these things are incremental changes.

As you know, things in our business have a sales cycle to them and you just keep at it, and you hit these singles and you get references you get -- and you continue to build upon your growth single by single.

All right, thanks very much.

(Operator Instructions) Curt Siegmeyer, KeyBanc.

Did you say how much pricing was down in the quarter?

No, we did not give you a specific to that. But it has been -- it is in the order of magnitude of around 2%.

Okay, that is about what I was thinking. And one of the questions I had was on gross margin but maybe more broadly the drivers for -- you did guide to earnings growth in the fourth quarter, so just kind of thinking about the good guys and the bad guys on the fourth quarter, I would assume revenue is going to be down again given the currency headwinds and probably pricing will be slightly down again.

Is it fair to say, then, that gross margin would be probably one of the positive drivers and up year over year at least, given raw materials are kind of stable here? Or what would be sort of the puts and takes for 4Q?

I think you actually described it very well. So when I think of fourth quarter, first of all when I compare fourth quarter versus the second or third quarters, that is always kind of the seasonality in effect and you can kind of see this historically in our earnings, that the fourth quarter earnings generally are a little lower than the second and third quarter, just because the holidays and people take some extended downtime.

So, you always have that effect. And then when you're going to your point of are we comparing ourselves to last year's fourth quarter, you're still going to see foreign exchange impacts. That is definitely going to be there.

Hopefully, we will start getting to this point where, once we get into the fourth quarter and pass it a little bit, these will lessen quite a bit, hopefully, because that is when we first started to see it last year. And then, you're right in that we would hopefully see some expanded margins, relative to prior year. So it's -- but I think some of these -- you're still going to see some of the macro things we talked about, like on steel production. I think that is going to be down the fourth quarter of this year versus fourth quarter of last year, based on the trends that are happening.

But at the same time, as we pointed out here, we are taking share in the marketplace and that impact will hopefully lessen, that is for sure.

Okay, great. And then maybe just as a follow-up, you mentioned share gains and I guess you talked about sort of the consensus for steel production next year is sort of for an uptick maybe 2% growth, but in the event that does not transpire and we are down again next year maybe even to decelerate from current levels, do you find, given the share gains -- know the importance of that in terms of your story and the success you've had there, is it more challenging? Or does it present maybe more opportunities in a weaker market environment to sort of continue or accelerate share gain or --? Maybe walk us through what sort of market is ideal to be able to continue to win business.

That is a really great question. I think bad times, tough times can be opportunities. An example could be in Brazil, really one of the toughest markets we have right now, it is a very tough marketplace. One of our -- we are the market leader down there in steel and metalworking, and we have -- we are committed to that area and one of our competitors, Castrol, has decided to exit that market. And so our goal is to help pick up some of the share that they have had.

There are kind of other opportunities as people get in a tough market might leave. It is hard to say in general, but although I would say the general statement still stands. I feel good about the ability to take share in our marketplace, I think the dynamics that have led to the continued share gains over the past several years will continue to be there. And so I don't see anything from that would help us or go against us in that way.

So I still feel good about those kind of share gains and increasing what we call our share wallet of our customers.

I think another way is that we continue in the future, expect to see more benefit from on the growth side is grow from the new technologies that we've acquired. We have made 11 acquisitions over the past five years. Six of those acquisitions brought technologies to us that we did not have in our portfolio. And we are -- it takes a while to get people situated around the world to help us grow these new technologies using our global infrastructure.

And so far, again, when I use my baseball analogy, if I said we are in the second inning of this game and I think there is a lot of way to go in this. And as we go in the future, I think that part of our growth will accelerate and be a bigger part of what we do. So, between these things of normal share gain and these gains through the new technologies, we would expect that even if we have tough situations in our base businesses because of steel production or whatever, we would still be able to overcome that.

Thanks.

(Operator Instructions) Garo Norian, Palisade Capital.

I was wondering if you could give an update on some of these tests that you guys have been working with the aluminum industry, how that is going.

Sure. We have over time -- for the benefit of people, we made an acquisition a number of years ago of aluminum. And we have been picking up over time over the past several years some mills in Europe and the Middle East. So our aluminum position continues to grow.

The one place that we are still in the early stages of penetrating is China and we have one major trial scheduled for the fourth quarter that will hopefully, assuming we are successful like we generally are in our trials, and most of our product lines, that if we are successful, though, that could lead to a reference and therefore once you get a reference there from a major player then you could use that reference to get other business. So that is our goal.

Great. And then you touched on this a second ago with the Castrol comment in Brazil. But is there anything else going on from a competitive standpoint, either players exiting markets or reacting differently to raw material price declines to try to use price per share or anything else, I don't know, people leaving, a competitor or anything like that?

Other than the comment on Castrol I don't see really see any other changes from a competitive environment perspective.

Okay, and then just lastly, I noticed that your share repurchase through the quarter was pretty ratable by month. And I'm just curious why it would not be a little bit more sensitive to price.

Well, right now we are -- as we mentioned back in the day, when we put this in place, one of the things that we -- there's kind of two aspects to the program. One is to offset the dilution from our compensation program on a number of shares and that is the way we've done it so far, and it has been pretty ratable in the marketplace. I think one thing we feel we can't do is necessarily predict timing of things, and so that has been a ratable thing.

And then the other part, as I said, we do have more flexibility to do something more than that. And the way we will analyze that is we look at what is on our plate, what acquisition opportunities are out there and there, we would consider both the acquisition opportunities and our stock price. And then, if we wanted to do something bigger at that point, then we could do that. But generally what we have said is the way we think we can add the most value for our shareholders is to make acquisitions.

But if we find that there is limited acquisition opportunities in front of us or opportunities that we could still do plus do some share repurchase, we will do that.

Okay. So I have to follow-up, though. How does the M&A pipeline look?

Well, we are always looking at a number of things at any point in time, so as you know we don't really comment on anything, is anything close or anything like that. But we are always looking at a host of projects and right now is no different.

Great, thanks so much.

(Operator Instructions) Mr. Barry, there are no further questions at this time. Would you like to make any closing remarks?

Okay, thank you. Rob. Given that there is no other questions, we will end the conference call now and I want to thank everyone for your interest today. We are pleased with the results in the third quarter and 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 me. Thanks again for your interest in Quaker Chemical.

Thank you. This concludes today's conference. Thank you for your participation. You may now disconnect your lines at this time.

In reference to Mr. Hostetter's reply to Dan Rizzo's question related to Verkol's revenue, as previously reported on July 30, 2015, Verkol's 2014 recorded revenues were approximately $33.0 million.