Quaker Chemical Corp (KWR) 2017 Q1 法說會逐字稿

Greetings, and welcome to the Quaker Chemical Corporation First Quarter 2017 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, Chief Executive Officer and President for Quaker Chemical Corporation. Thank you, Mr. Barry, you may now begin.

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 our 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 first quarter. I'm pleased that we have delivered another good quarter, driven by strong organic volume growth, more than offsetting continued foreign exchange headwinds, which negatively impacted sales by 2% and earnings by 3%.

I'll now make comments on this quarter's sales and I'll do so in each of our respective regions. Our biggest segment, North America, showed a sales increase of 6% due primarily to volume growth. Our European or EMEA region showed a 13% increase in sales despite a 4% negative impact from foreign exchange rates. So it was clearly a very good sales quarter for EMEA, due again to organic volume growth. And for the third quarter in a row, we're happy to report South America showed good revenue growth. The 30% growth in South America sales was due primarily to positive foreign exchange impacts and higher pricing and product mix.

In our Asia Pacific region, sales were up 9% on strong volume growth, more than offsetting a foreign exchange headwind of about 3%. Despite the challenges we faced in currency and higher raw material costs, we were able to grow our non-GAAP quarterly earnings by 20% and our adjusted EBITDA by 13%. In a nutshell, we were able to do this based on good growth in our base markets, taking share in the marketplace and continuing to leverage our SG&A, including benefits from our 2015 restructuring program. One way to see these market share gains is to look at the overall organic product volume growth in the quarter of 9% and compare that to the underlying production growth in our base markets of global steel and auto, which grew at 5.7% and 5.2%, respectively. We believe this spread of over 3% is indicative of our market share gains and are due to our commitment to our customer intimacy model. Specifically, we put our customer needs first as our top priority, providing them with 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 gain further share, which includes growing our recently acquired technologies around the world. As I mentioned in the past using the baseball analogy, I see each of these initiatives as singles, and our goal is to hit as many singles as possible to produce multiple runs and thereby show continuous growth, even in tough market conditions.

Of course a month ago, we did announce the combination of Quaker and Houghton International and we do anticipate the benefits from this to eventually enhance our results as well. Since our announcement, we have begun the regulatory approval process and filed with government authorities around the world. Other than that, there have been no new developments to note since our last conference call, and we continue to expect closing to take place in the fourth quarter or first quarter of 2018.

Over the next quarter, we expect our sales will continue to be impacted by the strong U.S. dollar; however, we do believe that the foreign exchange impact may decline as we progress through the year.

As far as our markets are concerned, recent external forecasts have put global steel growth for the full year 2017 at 1% to 3% dependent upon the source. Likewise, global auto growth is expected to be at about 3% for the full year. As you can see, both of these full-year forecasts are less than the growth mentioned in our end markets during the last two quarters, which were both about 5%.

So to recap, based on these external forecasts, we should be seeing lower growth on our base markets of steel and auto production over the next few quarters.

In the case of our raw material costs, we've had some more near-term increases than we expected so far this year. Going forward, we expect our gross margins for the second quarter to be around the same levels we have seen in the past two quarters. In the second half of the year, based on what we're seeing today, we do expect margins to be a bit higher than the 36.4% in the current quarter and trend closer to 37%. So while there's 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 will continue to leverage our past acquisitions by selling our newly acquired technologies on a global base. The combination of these growth vehicles gives us confidence that 2017 will be another good year for Quaker as we expect to grow both the top and bottom line through the full year, despite continued 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. I'm very happy with our Quaker team and continue to be excited about the eventual combination with the Houghton International team.

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

Thank you, Mike, and good morning, all. As Mike said, we are pleased with our Q1 results, particularly the strength in volumes across the company, which drove our strong operating performance. Before I dive into the details, I would like to remind you that comments made during this call include forward-looking statements, which are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially. For a discussion of these risks, please review the cautionary statements regarding forward-looking statements included in our earnings release and the risk factors included in our 2016 Form 10-K filed with the SEC. These are available on our website.

Please refer now to charts 4 and 5 as I head into the financial discussion. There are a lot of words on Chart 4 but there was a lot going on in the quarter and I hope this helps with understanding all of the moving parts.

Quaker reported a 20% increase in non-GAAP earnings per diluted share to $1.18 versus analyst consensus of $1.06 with strong volume growth and good cost discipline driving these results despite a negative foreign exchange impact on earnings of 3%. The good volume growth across the company resulted in a 9% increase in net sales despite a 2% hit from foreign currency translation on the top line. This was primarily due to depreciation of the euro of about 3%, the Chinese RMB of about 5% and the Mexican peso of about 12% versus Q1 2016 with appreciation of the Brazilian real of about 20% mitigating the overall negative impact a bit.

On the gross margin front, we did experience pressure in Q1, as Mike mentioned, with a gross margin of 36.4% in Q1 versus 38.2% percent last year. However, the comparison serves to highlight the comment we frequently make around the lag effect of our pricing adjustments versus the change in raw material costs. In Q1 of 2016, our gross margin benefited from raw material cost decreases in the second half of 2015, while this quarter, we are seeing the pressure on our gross margin from a rising raw material cost trend since the second half of 2016. We currently expect our gross margin in Q2 will be similar to Q1, as Mike mentioned.

Despite the pressure on gross margins, our operating margins benefited from continued cost discipline as we were able to hold SG&A flat despite our strong volume growth. It's important to note that our GAAP numbers include $9.1 million of Houghton-related expenses. These expenses were nondeductible for tax purposes resulting in a Q1 effective tax rate of 50.8%. Our Q1 effective tax rate would have been approximately 30% excluding the impact of the Houghton-related costs. Similarly, we continue to expect our full year effective tax rate will be in the 28% to 30% range, excluding the impact from these combination-related costs.

The strong volumes and good cost discipline drove up strong operating performance, with adjusted EBITDA increasing 13% to $28.2 million, and our adjusted EBITDA margin continuing its positive trend to 14.5%, up from 14% this time last year. Net operating cash flow in the quarter was down a bit versus last year as working capital increased to support the current quarter's strong volumes. But we still added to our net cash position with our current cash exceeding our debt by $24.2 million.

The next few charts we include to give some history and trends of our past performance. In Chart 6, you can see how the positive volume trend began several quarters ago and has continued in this quarter. Chart 7 shows the gross margin tick up in 2015 and 2016 as raw material costs trended down significantly from 2014 levels and we benefited from the lag in price adjustments. As compared to the pressure on gross margin in the second half of 2016 and into Q1 of this year, as raw material costs showed an increasing trend. As mentioned, we expect Q2 gross margins will be similar to Q1 but that gross margin will trend toward the 37% area in the second half of the year.

Chart 8 shows our continued and consistent positive trend in adjusted EBITDA as we further leverage our operating costs while growing the company. And Chart 9 demonstrates the consistency and strength of our cash flow generation as we continue to strengthen the balance sheet. This last chart is one, in particular, that I expect will look very different at the close of the Houghton combination. However, I do expect our ability to generate even stronger consistent cash flow, post the combination, will allow us to quickly reestablish a similar looking positive trend albeit from a different starting point.

In summary, Quaker delivered a strong quarter and we believe Quaker will have another good year. We expect growth in the top and bottom line and continue to expect that 2017 will be our eighth consecutive year of positive non-GAAP earnings and adjusted EBITDA growth.

And now back to you Mike.

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

(Operator Instructions) Our first question is from Edward Marshall from Sidoti & Company.

So the first question I had was on the pricing and the lag that you see. Being that you gave the second quarter guidance on gross margin, I'm curious, as we move into -- as we progress into Q2, are you continuing to see raw material prices increase? And I'm assuming you're raising prices to offset that. So just help me think that through.

Sure. Yes, it's really -- it's a very complex situation because it's different everywhere around the world. But in general, I would say we definitely are seeing price increases, pretty broad based, but some more than in other places around the world. Currency certainly plays a role. And also, we have this lag effect that some contracts are indexed and some where they go up automatically. But it might wait a period of time before you hit that index -- - that reset button. And then we also have contracts that are just straight negotiation with customers. So we're kind of in the midst of -- in that process. And when you put all that together, we think the second quarter will be roughly the same as the first quarter of this year in gross margin. And then after that, based on what we see, and things could certainly change, but we would expect it to kind of trend up a bit and get closer to the sub 37% type of level.

So are the raws plateauing in their pricing? Or you're just catching up faster?

Yes, I think it's -- I don't know if it's plateauing. It is -- I mean, actually -- I think based on our outlook of prices, I would say that's probably a fair comment. And then as we are also catching up with our pricing.

Got it. So if I move to the leverage that you saw on the operating margin line and some of the efforts that you put through with SG&A, I'm curious, what more can you do on the SG&A line in in line with the rising raw material prices to offset that gross margin compression that you've been -- that you did so well in Q1? Is there anything left to do on the leverage line there -- or the operating line there?

Well, we're always looking for opportunities where we can do things. We're still growing the company. And so we're going to be -- we're not on a mode of, I would say, cutting back. Our focus is on growth, but we always kind of look at ways to optimize different situations internally, whether it's in functional areas or in manufacturing footprints or things like that. We're always kind of pressure testing those. And of course we're -- of course a lot of what we're doing now is planning for integration with our eventual combination here with Houghton International. We're beginning that process and of course a lot of that is going to be focused on how we can optimize everything between the two companies.

Okay. And then the last question I had was on kind of the inventory growth in the year relative to revenue. And if you look out on a year-to-year basis, inventories grew faster. But on a sequential basis, it's even more dramatic. And I'm curious if there was anything, in particular, especially as you give the guidance as more of a tempered growth rate on a go-forward relative to what you saw in Q1. Wanted to get sense from you as to maybe what's going on in inventory? Seemed like cash flow has been a focus for the business.

Yes, I think, at the end of the year -- sequentially at the end of the year, people are managing -- our customers are managing inventory levels down. And what you see is restocking occurring in the first part of the year, which is not unusual.

The next question is from Liam Burke of Wunderlich Securities.

Mike, Asia Pacific, could you give us a little color on China? I know there's some consolidation of capacity going on there. Could you give us a sense how you're participating in it?

Sure, we've -- they are, over time, reducing steel capacity. In general, they're shutting down the older and more inefficient mills. We tend to be more in the newer mills in China. So we don't see or anticipate that the continued trend in that area will be detrimental to us, and may even be a slight positive -- so overall, we continue to be more tied to just general steel production rather than the capacity of steel. As long as steel is produced somewhere in the world, we're happy.

Are you still seeing the types of share gains in China as you're seeing in the rest of the world?

We are. I mean, we are seeing our gains are pretty broad-based, and especially when you look at it on a full-year basis. They're -- it's not like we're really dominating or having a real strong area in one part of the world versus another. It's pretty broad-based share gains. It's pretty broad-based in a variety of areas in both our base businesses and maybe getting new mills or getting -- picking up new lines in auto plants or whatever, but as well as with the new technologies. So it's really just the series of singles kind of thing that I always mention, where we try to do a lot of different things in different places and they add up to, hopefully, a lot of runs.

The next question is from Laurence Alexander of Jefferies.

Good morning. It's Daniel on for Lawrence. If we think about just the growth going forward, you guys definitely take some market share, but we kind of peg it as you usually taking 1% to 2% above whatever the regional sales trends are? Does that seems like a fair kind of rule of thumb?

Dan, what we've said in the past is -- we try to point these out in these conference calls, is looking at the underlying growth of our markets, global auto and steel, and then looking at how we grew. And generally, over time, that's been in in the, let's say, 2%, sometimes 3% or so range that -- when we pointed out this quarter, it was over 3%. Between 3% and 4%. So it was a stronger than normal quarter. But I would say on average, this trend of -- the 2% or so is about right.

Okay, and I apologize if you've answered this before, but post the Houghton deal, I assume you're going to focus on delevering, and I was just wondering what you're comfortable with in terms of just carrying debt in terms of a net-to-EBITDA ratio? Or just whatever ratios you look at?

Yes, so -- and I'll take that one, Dan. What we had said even before announcing the combination is that we view kind of our sweet spot in terms of average leverage over time in that 2% to 2.5% -- or 2 to 2.5x net debt-to-EBITDA area. And clearly, we were nowhere near that. We're going to start out in the mid- to upper 3s at close. And quickly, we believe work our way down to that 2.5x area within 2 years, is our target.

The next question is from Mike Harrison with Seaport Global Securities.

Mary, you and I have talked in the past about SG&A costs and your ability to leverage those and maybe what the appropriate run rate should be to support growth. Can you just take a little bit more time and walk us through the reasons that we saw SG&A decline, especially versus where we were kind of in the fourth quarter? And maybe comment on the outlook for SG&A costs. Is something right around $48 million a quarter a good run rate? Or do you see a reason that it should track higher or lower over the course of the year?

Yes. So some things that impacted this quarter, we continued to see the benefit of the 2015 restructuring program kicking in. And also, as you probably noted in the reconciliation tables, there were other cost streamlining initiatives going on. And as Mike mentioned, we're always looking for opportunities to continue to optimize the business. The $48 million a quarter and that level being flat to last year, should we expect that going forward? As Mike said, we are growing the business, we're not cutting the business. And so I think the communication that we've had is that we continue to want and expect to drive the operating margin north. Does that mean in order to support growth that the $48 million might be a little higher number nominally -- going forward? Perhaps. But again, our objective is to continue to drive that operating margin north.

So maybe we see us track higher from that $48 million a quarter number, but as a percentage of sales, expect to see continued leverage then?

Yes.

All right, great. And then, looking at the North America volumes flat this quarter compared to the strong growth that you showed in EMEA and Asia Pacific, I think the last time we saw good volume growth for a full year in North America was 2014. I think that probably coincides with some 2015, 2016 declines in oil field as well as mining that may have weighed on the business. But can you talk a little bit about why the North America region seems to be in decline? And is it a situation where you are gaining share and it's the markets themselves that are declining?

Well, volume growth did happen in North America. We had a 6% growth in volume - product volume growth in North America. And -- speaking of mining, we didn't mention this in the comments, but since you brought up, I think -- we are seeing tick-ups in our mining business as they predominantly are hitting North America and Asia Pacific, because that's where we tend to have the mining business. So part of that volume pickup that we did see in North America is due to that. But we continue to get share gains there in North America as well. So North America to us -- continues to do very well.

And just to clarify, maybe too, to add on. The 6% increase was sales and 8% actually volume growth, including the acquisitions, so we think it was a pretty good quarter in North America.

And I'm sorry, so how much was the Lubricor acquisition then? What was the organic volume growth number in North America?

Hang on one second. So in the order of 5% organic.

3% Lubricor

So sorry. 3% or 5%?

5% organic growth and 3% due to the acquisition of Lubricor.

Got it, okay. And then the last question I have is just around the EMEA and Asia Pacific strength. Were there any unusual fills from new mines in either of those regions? And do you have any expectation that you're going to see some new mills come on stream during the rest of 2017 in either of those regions?

Yes, I think it's -- we continue to expect the market share gains and things like that, but there's nothing -- any discrete events there. I would just say in general, in Asia Pacific, as I just mentioned, kind of mining has picked up. So that's been a positive and part of that growth that we showed there. And I think in Europe, you're really just seeing the combination of growth in the markets as well as our market share gain.

The next question is from Curt Siegmeyer of KeyBanc Capital Markets.

Just a follow-up on the gross margin. You talked about in the third quarter and fourth quarter, thinking that it's likely you can get back to that sort of 37% sort of range, even with higher raw material costs. So I know in the past, you sort of had a lower targeted gross margin -- maybe a normalized basis I guess. So given your confidence and the ability to offset some of the higher raws, should we kind of think about gross margin forward as this new 36% to 37% range kind of being like a more normalized range going forward?

Yes, I would say that the level of raw material prices that we see today. We, in the past, when it was much higher raw material prices and you had also higher product prices because of those higher material prices, things tend to level out in that 35%, 36% range. Based on where we are today in the kind of range of raw material prices, I agree with you it would be kind of in that 36% to 37% range. Hopefully, closer to 37%.

Okay. And then, just on the acquisition. Once that closes and you start thinking about going forward in 2018 and some of the product overlap and just the general obvious increase in size. How do you kind of think about the impact that will have on your ability to take share, which has been a key kind of part of your story for obvious reasons? You have one large competitor that you can't take share from anymore. And then just potentially -- the scale that you might have -- just sort of thinking through that and how that might impact that part of the story going forward?

We still think we have a good ability to do that. First of all, we have a pretty fragmented market. So there's a lot of competitors of all different shapes and sizes and that's when we've been picking up share it's been really from a whole host of people. We still have these new technologies that we're rolling out. And I think more importantly, now we have new technologies in both companies that we can sell to each other's customers. We have a very complementary, not only product portfolio, but a customer base as well. So 15,000 customers -- unique customers between the two companies, 14,000 of which of those customers are unique to one company or the other. So it just gives us a lot of opportunity for cross selling. So when you put all those three things together, I would still expect to see above market growth.

The next question is from Jon Tanwanteng of CJS securities.

Can you tell us what the response has been from your customers regarding the merger announcement? What are the main points of enthusiasm? What are the main pushbacks, if any?

Generally, it's been a relatively positive response that has or non-event, I would say, it's not a -- we haven't gotten too much of a negative response, I would say as a general statement. I think customers see us both as 2 strong, good companies and see the merits of the combination.

Got you. Mary, can you just tell us what you expect in terms of merger expenses over the next 12 months? And if you expect any of them to be tax deductible at all?

Yes, I think our expectation, we took the $9.1 million in this quarter. Our expectation is that from this quarter going forward until close, that the additional expenses will be in the neighborhood of $15 million to $20 million. And we do believe that a lot of that will be nondeductible for tax.

Got it. Mike, you noted that end market forecasts imply lower growth going forward relative to what you saw in Q1. Has that been confirmed by what you've seen in the month of April so far?

Well first of all, we haven't seen our final results yet in April and 1 month is not a kind of a thing to make. So I'd rather not comment on those kinds of trends. But yes, it's -- we'll have to see. All I wanted to kind of point out is what these external forecasts are saying and if we believe them, it's hard to say, because they've constantly been wrong in the past. But if you believe them, then you would think trends would come down lower, but you also see other signs in the economy that things continue to look good in various places. So it's really hard to tell.

Okay, fair enough. And finally, Mary, can you just clarify the previous discussion on the SG&A? You expected the decline as a percent of revenue going forward even if the absolute value goes up?

Our target is to improve our operating margin leverage. So that does imply that SG&A as a percent should go down even if the nominal dollars go up.

(Operator Instructions) The next question is from Garo Norian from Palisade Capital Management.

One thing that may help me understand the SG&A side of things, can you talk about the currency impact? I know you kind of mentioned it, but if not for the currency impact on a dollar basis, would SG&A have been up?

Yes, we benefited. We benefit on the cost line from the depreciation in those major currencies that I mentioned, whereas they're hitting us on the top line from a translation perspective. So I think we did see -- obviously, we do get some SG&A cost increases associated with compensation and normal inflation in those kinds of costs. And for this quarter, I think the FX impact largely offset those increases, which is why it got flat.

Great. And then, I was noticing the EMEA segment and you had a relatively challenged 2015. You guys had a strong -- and I'm looking at profit line, strong recovery in 2016 and it started off strong again this year. Is there anything unique that's occurring in that segment? Or is this kind of just good steady business improvement?

Yes, I think it's just continued improvement and some share gains that we've achieved in the region more than anything else.

Okay, great. And then just last thing for me. You guys mentioned related to the -- having the combination that you'll be doing some financing, syndicated bank agreement, et cetera. Is that something that is going to be made kind of ultimately like contingent on a close? Or how -- I guess, I want to understand better how that will or won't really make a difference to the financials between now and the close?

Well, so we have committed financing. As we mentioned when we announced the deal, Bank of America and Deutsche provided the committed financing, which enabled the parties to sign the deal. And the way that committed financing works is it's in place and then, until close, if for some reason we don't close the transaction then we will incur some nominal costs -- relatively nominal costs associated with that commitment. But obviously, we would not incur the bulk of those financing fees associated with actually completing the combination.

Okay, so at least through the rest of this year, the interest expense line shouldn't change too much until things close?

Yes. And any costs that we do incur relative to the commitments and the financing arrangemens will be -- our plan would be to include those in our non-GAAP bucket, if you will, along with other pre-closing integration planning and pre-closing costs.

Okay, we have no further questions in the queue at this time. I would like to turn the conference back over to management for closing comments.

Okay, given that there are no other questions, we will end our conference call now. And I want to thank all of you for your interest today. We are pleased with our results in the first quarter and we continue to be confident in the future of Quaker Chemical. Our next conference call for the second quarter results will be in late July or early August. 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.

Thank you. Ladies and gentlemen, this does concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.