Quaker Chemical Corp (KWR) 2016 Q2 法說會逐字稿

Greetings and welcome to the Quaker Chemical Corporation's second-quarter 2016 results conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Michael Barry, Chairman, CEO, and President of Quaker Chemical Corporation. Thank you, sir. You may begin.

Thank you. Good morning, everyone. Joining me today are Mary Hall, our CFO, and Robert Traub, our General Counsel. After my comments, Mary will provide the details around the financials, and then we'll address any questions that 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 off now with some remarks about the second quarter. I'm pleased we have delivered another quarter of solid earnings and strong cash flow despite a variety of market challenges, such as foreign exchange headwinds, slightly lower steel production, and the continuing challenges in South America. Let me now talk about each of these in greater detail to give you a better perspective in which to evaluate our second-quarter results.

Foreign exchange rates negatively impacted sales by 3% and earnings by 4%. This marks over two years of consecutive quarters where foreign exchange has negatively impacted our results compared with to the prior-year period due to a strong US dollar.

Overall steel production per the World Steel Association was down 0.2% compared to the prior-year quarter, with South America and Europe showing declines and North America and Asia/Pacific showing gains. The latest full-year forecasts we have seen indicate that global steel production should be stable or slightly positive for the remainder of 2016 compared to the same period last year.

I'd now like to make some comments on the quarter's sales, and I'll do so in each of our respective regions. North America showed a decline of 3%. We had good base volume gains of 2%, but they were more than offset by exchange rates and lower product pricing.

Our European or EMEA region showed a 29% increase in sales. This increase was primarily due to the Verkol acquisition, as well as strong organic volume growth.

South America continues to be our most challenging region, as sales dropped 13%, with currency and lower demand being the two largest drivers of the decline. Overall, I think it's important to point out that we continue to make money in South America, as we have consistently reacted to the economic situation there when conditions have changed through a series of cost-saving efforts.

In our Asia/Pacific region sales were down 10%, due primarily to exchange rates, while product volumes also declined somewhat.

Despite the volume challenges we have faced, we were able to grow our adjusted EBITDA by 5%. In addition, we had strong operating cash flow for the quarter, which increased 31% compared to the second quarter of 2015.

We were able to achieve these results from the benefits from our recent acquisitions as well as taking share in the marketplace. One way you can see this share gain is to look at our overall product volumes while excluding acquisitions. When you do this, our base volumes are actually up 2% in an environment where our largest market indicator, steel production, was slightly down in the quarter.

This type of differential between our product volumes and the trend in our end markets we supply is a high-level way of getting visibility into our market share gains. We believe that these share gains are due to our commitment to our customer intimacy model.

Specifically, we put our customers' needs first as our top priority, which we achieve through providing strong service and business solutions. I believe this approach continues to differentiate us in the marketplace.

In addition, we continue to invest in many other initiatives in our existing business lines in each of our regions that will extend our competitive advantage and help us to gain further share, including 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, and 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 our sales will continue to be impacted by challenging market conditions and a strong dollar. In the case of raw material costs, we expect some to increase -- for example, coconut oil -- but the timing and the magnitude of these increases and the impact they will have on our gross margins is really hard to determine. However, to give you more direction, we expect our gross margins in the second half of 2016 to be modestly lower than the second quarter and are more likely to begin with a 37 rather than a 38 or a 36.

Also, the majority of our SG&A cost savings from our previously announced restructuring program will be coming into effect in the second half of 2016 and will continue to build as we progress throughout the year. So these savings should help mitigate the potential declines in our gross margins.

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 continue to grow our annual earnings and generate strong cash flow despite various 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 similar to the acquisition of Verkol announced last July.

The combination of all these growth vehicles gives us confidence that 2016 will be another good year for Quaker. And our outlook remains unchanged as we expect to grow both our top and bottom lines despite continued economic challenges and further foreign exchange headwinds.

In closing, I want to thank all of our associates whose dedication and expertise helps to create value for our customers and shareholders 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 our team that we have in place throughout the world.

Now I will turn it over to Mary Hall, our CFO, so that she can provide you with more details behind our financials. Once Mary has completed her comments on the financials for the quarter, we'll address any questions that you may have. Mary?

Thanks, Mike, and good morning, all. Before I start, please note that Quaker provides certain non-GAAP information, including non-GAAP earnings per diluted share and adjusted EBITDA, in an effort to provide shareholders with visibility into Quaker's performance, excluding certain items which we believe do not reflect our core operations, including earnings related to Primex, our investment in a captive insurance company. Reconciliations are provided in charts 10, 11, and 12 of the investor slides, and they are also in yesterday's earnings release and our Form 10-Q also filed yesterday.

In addition, please do not place undue reliance on any forward-looking statements.

Q2 was another strong quarter for Quaker, despite the continuing headwinds from foreign exchange and relatively flat global steel production and a higher effective tax rate Q2 versus Q2 of 2015. We continue to benefit from market share gains, strong gross margins, and our prior acquisitions, which are all key drivers to our positive performance.

Overall, our key performance drivers remain very consistent with the first quarter. So, let's take a look at our Q2 financial performance in detail; and I'll refer you to charts 4 and 5 in particular.

Our reported EPS for Q2 of 2016 of $1.13 is the same as Q2 2015, with non-GAAP EPS of $1.11 for Q2 2016, decreasing from $1.15 in the prior year. Notably, this quarter's reported and non-GAAP EPS would both have been higher if it had not been for the negative impact of foreign exchange of about $0.05, and a higher effective tax rate which had a negative impact of about $0.09.

As you can see, without the noise of foreign exchange and a higher quarterly tax rate, the Company had a strong operating performance in the quarter. This performance started with our net sales, which reflected good volume growth of 6% versus last year, with 2% from core growth and 4% related to our acquisition of Verkol last July.

As a result, net sales were up 2% quarter-over-quarter last year, despite a negative foreign exchange impact of 3% and continued pricing pressure. The negative foreign exchange headwinds impacted all regions and was driven by most of our major currencies, with the exception being the euro, where we saw modest strengthening versus Q2 of last year. The overall 3% negative impact on sales Q2-over-Q2 was driven primarily by depreciation in the Chinese RMB, the Mexican peso, and the Brazilian real.

We continue to see pricing pressure, as I mentioned earlier, as certain key raw materials continued to decline in the quarter. And as a result, gross margin was down a bit to 38.1% this Q2 versus 38.4% in Q2 last year.

However, operating income was up 3% to $22.1 million versus last year with an operating margin of 11.8% versus 11.7% last year. Our operating margin improved slightly despite a lower gross margin and increased SG&A related to our Verkol acquisition, as these were offset by good cost discipline and certain cost-saving initiatives. We expect to continue to leverage our SG&A infrastructure as we grow.

Also, we continue to expect that our global restructuring program will generate savings of about $3 million for 2016, mostly in the second half of this year, and $6 million per year going forward.

The higher effective tax rate I mentioned in Q2 of 32.6%, versus 27.1% in Q2 of 2015, was within the range we expected and communicated last quarter. As discussed in Q1, the higher tax rate is only a timing issue as it relates to a concessionary tax rate in one of our non-US subsidiaries that was available to us throughout 2015, versus this year we expect to receive and recognize the tax benefit in the fourth quarter.

Given this timing issue, we estimate our third-quarter effective tax rate will be between 29% and 31%. However, we expect the fourth-quarter effective tax rate will bring our full-year effective tax rate to a more normalized range between 28% and 30%.

Turning to our balance sheet and liquidity, our strong operating performance drove a 32% increase year-to-date in net operating cash flow to $36 million, resulting in a net cash position of $12 million as of June 30. We accomplished this over these past 12 months while spending net cash for Verkol of about $26 million, paying dividends of $17 million, and repurchasing 171,000 shares for about $13.1 million. We believe this balanced approach to capital allocation, using our strong balance sheet to grow the Company and return cash to shareholders, creates sustainable, long-term value for our shareholders.

The next few charts in the deck give some added history and context to certain key metrics. Chart 6 shows our volume trends over time and highlights how we're able to continue to grow volume both organically and through acquisitions despite certain challenges in our end markets.

Chart 7 highlights our margin story and largely reflects how the continuing decline in raw material costs has outpaced pricing adjustments. But looking ahead to the rest of the year, we do see that trend flattening out and, as Mike mentioned, expect to see some modest decline in the second half.

Chart 8 shows our adjusted EBITDA trend, which continues to grow and reached $104.8 million on a trailing 12-month basis, our highest level ever.

Chart 9 highlights our balance sheet strength, with a net cash position of $12 million at quarter end. We continue to have ample liquidity and debt capacity to execute our growth strategies, including acquisitions.

In summary, Quaker continues to consistently deliver good earnings and strong cash flow growth, despite the continuing challenges in our end markets and the negative effects of foreign exchange. In last quarter's call, I outlined specific expectations we had with respect to our end markets and our performance.

These expectations have not changed much, but let me just summarize them by saying we expect flat to modest growth in our key auto and steel end markets for the remainder of the year. We expect to continue to grow with those markets and to continue to take market share, with additional growth from leveraging our past acquisitions. We expect the majority of the $3 million of current-year estimated cost savings from our restructuring program will occur in the second half of this year, with estimated savings of $6 million each year going forward.

We expect FX will continue to have a negative impact, which we estimate will be 3% to 6% on the top and bottom lines for the year. And as mentioned, our effective tax rate will continue to be inflated in the third quarter in the 29% to 31% range, but should decrease in the fourth quarter to drive full-year effective tax rate to a range of 28% to 30%.

Finally, we continue to expect some modest decline in gross margin as raw materials look to be trending up. And as Mike mentioned, we expect our gross margins in the second half will more likely begin with a 37 versus a 36 or a 38.

Overall, we continue to expect 2016 will be another good year for Quaker, with growth in our top and bottom lines, and we expect Quaker to deliver its seventh consecutive year of positive non-GAAP earnings growth. Thank you all for joining us today and for your interest in Quaker, and now I'll turn it back to you, Mike.

Thank you, Mary. At this stage we'd like to address any questions from the participants on the conference call.

(Operator Instructions) Laurence Alexander, Jefferies.

Good morning. This is actually Dan Rizzo on the line for Laurence. How are we doing?

Hey, Dan; how are you?

Good. So for the second quarter in a row, Europe seemed to outperform the rest of the segments in terms of sales. Are you taking more share there? Is there more of a rebound? Or is it -- I mean, I guess what's the reasoning behind that?

Yes, I think it's -- what you're seeing in that -- because we had more -- stronger organic growth there and market share gains there. And I think it's really just timing of when we pick up pieces of business and where we pick them up. In this quarter versus the quarter of last year we've taken more share in Europe.

So it's just taking share? It's not that the markets are stronger in that region?

Certainly auto is strong. Steel was actually down in Europe, steel production. So for the most part, the kind of growth that we're seeing in our volumes was market share gains.

Okay. Then just in terms of your M&A strategy, would you ever consider, I guess just thinking outside the box, so to speak, and just going for another leg or another platform for growth? Or do you just want to stick to what you're doing now?

Yes, we believe there's opportunities in our existing space. We do things that are basically around metal, and from the time metal is made, whether it's steel or aluminum, until the time it's made into a final body part or some kind of part that gets used by consumers, and we see us sticking to that platform.

We are in coatings, for example, to some extent. That's an area we could potentially continue to grow to a larger extent as well.

But right now we don't see going too far afield from where we are. We believe there's sufficient opportunities in our space to continue to grow both organically and with acquisitions.

Okay. Then final question, then, with the performance in Asia/Pacific being down and being based on FX, would that suggest that you have more -- I guess you're more sensitive to currency changes within that region versus, say, the euro or the peso or just other parts of the world?

Well, certainly we saw some movement in China's currency this quarter, and that was a large impact to our things; and it looks like hopefully recently things have stabilized a little bit and even strengthened. But definitely that's been a -- China is a big part of Asia/Pacific earnings.

All right. Thanks, guys.

Liam Burke, Wunderlich Securities.

Thank you. Good morning, Mike; good morning, Mary. Mike, Asia/Pacific was down volume-wise; China volumes were up slightly. Was there any change in the markets in China for you?

Well, the challenging part in China for us has certainly been some mining business that we've had. Auto continues to do okay in China, but steel for us is a major influence there and, as you know, depends upon sometimes we have little supply situations with some of our customers and you could get into some seasonality effects.

Overall, we feel really good about our China position. We feel we continue to take share in China. So we're still pretty -- feel really good as China is one of our growth drivers for the Company.

Great. On the M&A front, are the valuations moving up? Do you have -- does the pipeline still look good? Give us a sense as to how that looks.

Sure. We have, obviously, a list of companies that we would like to acquire. A lot of these companies are either not available at any given point in time, but our goal is to continue to make contact with companies, so when they do become available that they would hopefully choose to go with Quaker.

And it's hard to say with valuations because it is such a fragmented thing. It's not like there's a bunch. We don't believe valuations are necessary and an issue for doing an acquisition; it's more the availability and the timing of those acquisitions.

But we continue to be optimistic as you look over the next several years that there should be some good acquisition opportunities available.

Great. Thank you, Mike.

Thanks, Liam.

Curt Siegmeyer, KeyBanc Capital Markets.

Morning, Michael; morning, Mary. Just a couple quick ones. Could you guys maybe clarify -- this might be a question for Mary -- just why currency is expected to be -- I know it was a 4% hit to the bottom line this quarter and you expect it to get worse, 6% for the balance of the year. Can you just clarify why that is?

That comment was really around a full-year outlook and it was giving a range. That doesn't mean it's going to be anywhere near that magnitude for the remaining part of the year.

Okay, okay. Then just in South America, you mentioned sales down 14%. Could you maybe parse out how much of that was currency and how much was volume?

Yes, sure. The volume piece itself in South America was down around 10%. Certainly you're seeing lower steel production down there and auto production is way lower. So we're continuing -- but again, if I look at the customer by customer what's happening actually down in South America, we're gaining share down there.

Some people have actually -- one company in particular has left the market. So anyway, it's a tough situation. But we're a market leader down there and we feel sticking it out will pay dividends as things rebound.

The exchange rate itself impact was probably down around 20%, 19% or so.

Is the situation -- would you characterize it as stable at low levels, or do you feel like it's actually deteriorating? Or is there anything -- any signs of life or green shoots at all?

Good question, Curt. Because -- yes, I would say. We feel it's been stable or it's stabilizing.

Our situation in particular, we envision that going forward that our profitability will be better than it has been in the past, because we've been -- the way we've been impacted by volume declines, and we continually make adjustments. But who knows?

But as far as light at the end of the tunnel there, we are getting indications in the marketplace that industrial production should be better going forward than it has been in the past. And really that's the first time we've gotten that indication in a long time in Brazil.

Great. Thank you.

(Operator Instructions) Mike Harrison, Seaport Global Securities.

Hi, good morning. Mike, I'm a little bit surprised that you didn't see more benefit in terms of the volume number in North America as it relates to steel production and the tariffs that were put in place. Is that not having much of an impact? Or is it you are just going to see it on a lag and maybe the second half looks a little better?

Well, yes, steel production was up in North America, and we did see volume gains. We continue to take share especially in the steel industry.

I would say -- and auto in general at the OEM level was good. But where we saw weakness, and I guess we really didn't comment on it because it's a relatively minor part of our business, but there are series of pieces of our business that we saw more weakness in.

So, for example, mining. Mining is not a big part of our business, but as you probably know and read, the volumes in mining have been declining globally. So that impacted us.

We also found in some of the other industrial markets outside of steel and auto that there was more weakness than you might expect. Tube and pipe as a market, for example; that still continues to show -- because of production of pipes is lower.

So, it's these other little markets that when you add them up is eating away a little bit at the stronger -- what's happening to steel and auto.

As we get into the second half, is the tube and pipe -- do we had easier comps and lap some of the pronounced weakness? I assume that's mostly oilfield-related weakness. Maybe start to see a pickup in the second half?

Indications are that we see where we were in the second quarter, again, hopefully in a bottom type of period. That's the anecdotal things that we've picked up in different parts around the world.

So our expectation is that, while it won't come rocketing back or anything like that, it should hopefully continue to improve as we go through time here.

All right. I appreciate the guidance on gross margin for the second half of the year, and I'm hoping that I can maybe push you to go just a little bit further. Any initial thoughts on where we might expect to be at this time next year?

Is something in the 37% range sustainable into 2017? Or are you expecting that we come under additional pressure?

It's really hard to say, with the fluctuations in raw materials and how they go about. So I think the only thing we feel comfortable at this point is the visibility we have through now and the end of the year and the raw materials that we're looking.

We feel it's in that -- like you said, it's going to start with 37%. It's hard to say long-term, because at any point in time you can have a spike up or down in raw materials, and that will impact our gross margins.

But overall, we always feel -- as we say, we feel good. We feel we've been able to adjust to the conditions that are surrounding us on raw materials. And while there may be some lag effect at times, we'll get back to good levels.

Maybe to ask it a different way, just in terms of your pricing, can you remind us how much of your business sees automatic contractual pass-throughs related to changes in raw material costs? And maybe how confident are you just in the overall pricing environment in terms of competition, supply-and-demand dynamics, and your ability to pass higher costs through to customers and sell them on the value proposition?

Well, the first part of your question, we estimate around 25% or so of our business is tied to these formula-based contracts. Then the rest are really straight negotiated contracts.

All I can point to is historically we feel we do a good job working with our customers as prices go up or down, and our raw materials, and providing them data which makes the business case to make changes in our pricing. And over at least historically we've been successful to do that, so we would expect to have the same kind of success going forward.

Then the last thing I wanted to ask, Mike -- or Mary, if you would like to discuss it as well. You mentioned the SG&A cost leverage. You were at about 26% of sales for Q3, and as I look back over the last few years you've gotten as low as the 24%, 25% range as a percent of sales at some point.

Is that where you see the long-term SG&A as a percent of sales, leveraging down to 24%, 25%? Or is that something we could drive maybe even to the low 20% range over time?

We really haven't given specific guidance around that, Mike. So I don't want to start giving SG&A as a percent of sales guidance.

I would just say our goal is over time, as we grow organically and inorganically, is to leverage our infrastructure as a Company and to continue to increase our operating margins, our EBITDA margins. And I think if you go back over the past several years you can see as we've been growing organically and through acquisitions that we've done that, and we'll just continue to work on that.

All right. Thank you very much.

(Operator Instructions) Garo Norian, Palisade Capital Management.

Hi, good morning, guys. Wanted to better understand, I guess, the cash flow improvement. It looks to me like it's been primarily working capital, and I guess particularly if I look over the last two years even it's really meaningfully improved there.

How much more is there to maybe work on there? Or have you got it as tight as you can reasonably get?

We -- working capital does continue to be a focus. I'm never satisfied that we've gotten as much as we can, and it certainly will continue to be a focus going forward.

Okay. There's nothing, I guess just to make sure, it's just more structural actions that you guys have been taking? Or are there any unique one-time-ish type of benefits that have helped?

Nothing special.

No.

A constant -- just the things we do on a normal basis every day.

Great. Then can you just update me on the aluminum side of the business and the exposure? How significant to the overall Company end markets is aluminum these days? And maybe perspective of what it was three, five years ago and what kind of progress you see going forward.

Well, we first got into aluminum back in -- six years ago when we made our first acquisition. That got us a presence in the United States, and at that point certainly it was in the order of 1% of sales. Again, we try to not give too much specific data relative to that, for competitive reasons.

But we have grown that area. We've grown it in the United States; we've grown it through cross-selling of products into the customer bases that we bought.

We've picked up additional mills in Europe and the Middle East, and recently we've been starting to make some traction in China. We've had three trials ongoing in first half of this year, which is really the first time we've had any kind of sustained growth in China, and so far those trials are proceeding well.

So we have definitely been growing in that area.

Great. I just -- I obviously think of steel as the key end market between aluminum and the auto value chain. Is the auto value chain still larger?

I'm sorry. Could you repeat that question again, Garo?

As far as exposures by broad end markets, if I think of steel versus aluminum versus auto or something in that camp, what's the, I guess, right ranking for broad exposures for the business?

Well, certainly steel is the biggest part in our Company overall, and the biggest part of steel will go into auto.

Oh, okay. So not really -- because the way you talked about steel versus tube, I mean, I think of tube as being part of steel also.

Yes. Actually the way we -- I know what you're saying. But the way we actually separate our business is we actually have that in our metalworking piece of our business, which is our designation. Yes.

Got it. Okay. All right; that's it. Thanks so much.

Thank you. At this time I'd like to turn the floor back over to management for any additional or closing comments.

Okay. Thank you. Given there's no other questions we will end the 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 Mary or myself. Thanks again for your interest in Quaker Chemical.

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day.