Quaker Chemical Corp (KWR) 2017 Q2 法說會逐字稿

Greetings, and welcome to the Quaker Chemical Corporation Second 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 begin.

Thank you, Michelle. 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'll start off now with some remarks about the second quarter. I'm pleased we have delivered another good quarter despite some market challenges. The quarter's results were largely driven by 2 major factors: the first was strong sales; and the second, lower gross margins due to higher raw material costs.

Let me start with margins. For the past 4 quarters, we have been in a rising raw material cost environment. And as we discussed in the past, with raw materials, there's a lag effect between the changes in our raw material costs and the adjustments to our product pricing.

During our last conference call, we had expected a stabilization of raw material costs and that our second quarter gross margins would be consistent with our first quarter.

However, we saw several key raw materials increase in the second quarter, especially mineral oils, which negatively impacted our gross margin in the second quarter.

The good news is that we do expect raw material costs to stabilize going forward, leading to a gradual increase in our gross margins to our target 37% level.

So now, let me move on to sales, and I'll do that in each of our respected regions.

Our biggest segment, North America, showed a sales increase of 9%, due primarily to volume growth, both organically and through acquisitions, as well as price increases.

Our European or EMEA region showed a 3% increase in sales despite a 3% negative impact on foreign exchange rates, which was primarily due to price increases as well as some modest organic growth.

In our Asia Pacific region, sales were up 11% on strong volume growth, more than offsetting a foreign exchange headwind of 2%.

And for the fourth quarter in a row, we are happy to report that South America showed good revenue growth. The 14% growth in South America sales was due to a combination of good volume growth, pricing and positive foreign exchange impacts.

One way to see our market share gains is to look at our overall organic product volume growth in the quarter of 5% and compare that to the underlying production growth in our base markets of global steel and auto, which grew at approximately 3%.

We believe this spread of approximately 2% is indicative of our share gains and is 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 and in each of the regions that will extend our competitive advantage and help us gain further share, which includes growing our recently-acquired technologies around the globe.

As I've 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 challenging market conditions.

Despite the challenges we face with higher raw material costs and exchange rates, we were able to grow our non-GAAP quarterly earnings per share by 12% and our adjusted EBITDA by 1%. In a nutshell, we were able to do this by growing in our base markets, taking share in the marketplace and continuing to leverage our SG&A, which includes benefits from our 2015 restructuring program.

I'd now like to make a few remarks about our combination with Houghton International. Since our last quarterly conference call, we have been proceeding down numerous paths to close the deal. The one path that largely determines the timing of the close is the regulatory review process.

So far, all the reviews around the world are progressing as expected. In fact, recently we received approval from China. Overall, we still expect the remaining reviews will be finalized and closing will occur towards the end of the year or in the first quarter of 2018.

Another item we have been working on is the special shareholders meeting to approve the deal. We expect the meeting to be held in September, with the proxy filed with SEC within the next week or so.

Our financing for the deal is also completed with an expanded syndicate of banks that includes [16] banks, and provides us with a great deal of flexibility to pay down debt as we generate cash.

The other major activity, which we have been involved in is integration planning. We have hired several key consultants such as McKinsey and EY to help us plan appropriately before the close so that we can hit the ground running on day 1 and make it a seamless event for our customers, while we put the 2 companies together and achieve our expected synergies.

So all in all, we are being very disciplined and thoughtful as we plan the combination of these 2 strong companies.

As we look ahead to the second half of the year, on the positive side, we do expect a gradual increase in our gross margins back to the target 37% level. And we also expect exchange rates to no longer be a headwind. But based on external forecast, we also expect the relatively strong production volumes that we've seen in our main global steel and auto markets to moderate somewhat from the strong growth we've been experiencing in the first half of the year.

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 basis.

The combination of these growth vehicles gives us confidence that 2017 will be another good year for Quaker, as we expect to grow our non-GAAP earnings and adjusted EBITDA for the eighth consecutive year despite the overall foreign exchange and raw material 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, the most valuable asset. And I'm happy with our Quaker team and continue to be excited about the eventual combination with Houghton International team.

And now, I'll 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 will address any questions that you may have. Mary?

Thank you, Mike, and good morning all. Before I begin, please remember 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. Quaker reported a 12% increase in non-GAAP earnings per share to $1.24 this quarter versus analyst consensus of $1.23.

In a similar theme to Q1 of this year, strong volumes and good cost discipline continued to drive improvement in results despite challenges from rising raw material costs and the negative FX impact of about 1%.

Our net sales of just over $201 million for Q2 set a record for Quaker and were driven by organic volume growth of 5% and acquisition-related volume growth of 2% from the Lubricor acquisition late last year.

The overall 8% increase in sales Q2-over-Q2 was achieved despite a negative foreign exchange impact of about 1% on sales.

The FX impact was primarily due to depreciation of the euro of about 3%, the Chinese RMB of about 5% and the Mexican peso of about 3%, compared to Q2 2016, with a stronger Brazilian real up about 8%, helping to mitigate the overall negative impact to debt.

As Mike discussed, the challenges we faced with the continued rise of raw material costs is reflected in our gross margin. Specifically, our Q2 gross margin of 35.7% is down 2.5 percentage points from 38.2%, Q2 of 2016 and is also down sequentially from last quarter.

This gross margin erosion is the direct result of the rising trend in raw material cost, which began an upward climb at the end of Q2 2016.

As Mike mentioned, we sat here 1 quarter ago and believed that the rising trend in raw material cost had plateaued and that our price adjustments would catch up after the normal 3 to 6-month lag.

What we saw in Q2 was raw material costs continuing to rise, particularly mineral oils and derivatives.

On the positive side, we began to see our raw material costs begin to level out towards the end of Q2, so we're cautiously optimistic that raw material costs will stabilize allowing price adjustments to catch up and that we will see gradually improving gross margins in the second half.

The company had good operating performance in Q2 as our cost discipline led to relatively consistent SG&A levels, Q2-over-Q2, on strong net sales growth, which helped to offset the lower gross margins I just discussed.

Note that our GAAP operating income and operating margin reflect $4.3 million of Houghton-related expenses.

The current quarter's results were also negatively impacted by a charge of about $1.9 million relating to settlement of certain pension obligations and a charge of about $0.3 million relating to the significant devaluation of the Venezuelan Bolivar fuerte late in the quarter, which were partially offset by a lower effective tax rate of 26.2%.

The lower effective tax rate in the quarter was primarily due to our adoption of new accounting guidance regarding the tax impact on certain stock-related compensation expense.

For the full year, Quaker expects that effective tax rates will be in the 26% to 28% range, excluding the impact from Houghton-related costs.

Despite all these moving parts, as a result of our solid operating performance, adjusted EBITDA was up 1% and Quaker's liquidity and balance sheet remained strong with cash on hand exceeding debt by $24.2 million.

Turning to Chart 6, here you can clearly see the trend of improving volumes, which started in Q1 2016.

In Chart 7, you can see on the right-hand side the erosion of gross margins since Q2 of 2016, when raw material costs began an upward trend, which continued through Q2 2017.

As discussed, we believe raw material costs have stabilized and we expect our pricing adjustments to gradually return our gross margin to the 37% area.

The adjusted EBITDA on Chart 8 shows continued growth with our trailing 12 months adjusted EBITDA of $110.2 million, our highest to date.

Chart 9 depicts our cash and debt balances with a net cash position of $24.2 million as mentioned earlier.

In summary, Quaker continues to consistently deliver good earnings and strong cash flow despite significant market challenges. We continue to expect 2017 will be another good year, and that we will deliver our eighth consecutive year of positive growth in non-GAAP earnings and adjusted EBITDA.

Thank you all for your interest in Quaker. And now, I'll turn it back to Mike.

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

(Operator Instructions) Our first question comes from the line of Laurence Alexander with Jefferies.

It's Dan Rizzo on for Laurence. You mentioned getting back to the 37% gross margin level. I think -- and I might be wrong, but I think a few years ago, 35% was kind of the bogey. Just given what you've accomplished over the past few years, is 37% now more of a -- I guess, the level that you guys think you can maintain over a longer-term time frame?

Yes, that's correct, Dan, yes. We -- a few years ago, we'd kind of given guidance around that 35%, 36% range. And that's when crude was at a much higher level, and then as raw materials declined over the past couple of years to a different level as crude came down, we came to the conclusion, as we saw things starting [starting lining] up, that 37% is kind of the new level of these type of levels for raw materials.

But if crude were to rebound, obviously that would have a negative near-term effect, but if it were to rebound, say, up to $80 -- around $80 and then stay there for a long period of time, could 37% still be achieved? If they were to make like -- just stay, like there wasn't as much volatility?

It's possible, Dan, but it's hard to say, because you have a whole host of other raw materials as well. I just know -- I feel -- we feel good at these type of levels in the foreseeable range of what people are predicting crude to be to kind of be at a 37% level.

Okay. And then when you announced the Houghton deal, I think it was -- $45 million was the year 3 synergy target. Is that still the goal? Or is -- I mean, is there any update to what you're expecting over the next -- the 3 years?

No. There's really no further update. All the information that we communicated, both the timing or closing of the deal on -- the expectations from the benefits of the deal are still consistent from everything we know today.

Our next question comes from the line of Mike Harrison with Seaport Global Securities.

Mike, can you comment on how gross margin trended during the second quarter, if we were able to look at April, May and June? Just kind of curious if June was the worst month or the best month or somewhere in the middle, in the process of trying to get a sense of whether the improvement that you're expecting toward that 37% level should be more linear or whether we should expect maybe some more near-term improvements or maybe it's more fourth quarter improvement?

I think it will be linear in nature. That's hard to say because you also have product mix issues in a quarter as well. But generally from a raw material perspective, we kind of saw things bottoming out and towards the middle of the second quarter and starting to get better from a gross margin perspective in June. So it's kind of -- we see the turn starting to happen.

And you mentioned the increase in mineral based raw materials. I know there was some tightness in the base oil market that was driven by some unusual maintenance outages. Is that part of what you were seeing? Or were there other raw materials that were causing problems in that bucket?

That was one of the primary ones, but there were certainly other raw materials and it could vary in different parts of the world as well. But there were definitely other -- some other increases. But if I had to pinpoint one, it would definitely be mineral oils.

Okay. Looking at the volume growth in Asia, obviously very strong, but then pricing was lower. It doesn't seem like it would be consistent with Quaker's strategy to compete on pricing in order to win market share. But that's maybe what the appearance kind of looks like there. Can you help reconcile that strong volume growth with the weak price mix?

Well, in our -- in the way we calculate price mix, we're seeing prices in -- price mix kind of being up 3% in Asia Pacific -- wait have I got the wrong [bar] chart...

No. Yes, no, it was down -- it was down. Let me -- I'll chime in here for a second. Price mix, yes, there was a negative impact in Asia. And we do attribute some of that really to mix. Mining for example was strong in that part of world and that has a bit lower margin. So there definitely was some mix impact in Asia.

But it's not as...

Yes, we don't -- it's not a price phenomenon.

Right. More of the mix issue, Mike, than a price issue.

Got it. And then just digging a little deeper into Asia. Was wondering if you can comment on what you're seeing in the steel market in China and their efforts to take some of the less-efficient capacity out of the market? Is that part of the strength in your numbers, is that we're seeing the impact of bigger and more efficient mills, that are your customers, starting to run at higher utilization rates?

It's really hard to kind of say exactly what that effect is. We know that, in the second quarter itself, China's steel production was up 4% versus where it was in the second quarter of last year. So we're definitely benefiting from that. We also know we're benefiting from, as Mary mentioned, rebound in mining and other -- just taking share in the marketplace in different places. So I think, as we've talked in the past, we think the shutdowns of some mills will maybe directionally help us here and there. And because we're tend to be more in the newer mills rather than less -- lower efficiency mills. So it could help, but I just don't have that exact breakout to provide you any more guidance.

All right. One last question for you. Just on the Houghton business and kind of the pace of pricing that they may be seeing right now. Having just watched a merger in another part of the industry between Sherwin-Williams and Valspar, it really looks like the Valspar business, they were giving the store away as the merger was in process and pricing really languished. Is that a concern on the Houghton business right now, if you're in an environment where raw materials are, you need to be pushing pricing to catch up? And Houghton is in the process of getting acquired. Do you have any sense of whether that could be going on?

No. We haven't seen -- as a competitor, we haven't seen any evidence of something like that going on at all. So we don't -- they'll have similar trends that we have, whether it's in sales or margins and so forth. But there's nothing to make us feel uncomfortable or alarmed at this point.

Our next question comes from Jon Tanwanteng with CJS -- I'm sorry, CGS Securities.

It is CJS.

Morning, Jon? You there, Jon? Hello?

I'm showing he is no longer in queue. (Operator Instructions)

Can you hear me now?

Yes.

Sorry about that. In prior quarters, you mentioned that revenue growth was likely to moderate going into the second half. Any update to your expectations for production levels in steel and autos for the rest of the year?

Sure. Well, all I can really point to is external forecasts that we have. So just to give you a sense, in the first half of the year, global steel production grew at 4.3%; and in the second half of the year, it's projected to be 1.3%. Global auto in the first half of the year was 2.8%; and in the second half, it's projected to be 2.2%. So we are -- external forecast anyway are projecting somewhat of a decline, but still growing. It's still growing in our markets, but just a little less than where it was.

Got it. And Mary, do you expect SG&A to remain flattish at these levels. How should we think of that -- how they scale as revenues do in the cost-saving programs that you did last year to get that?

Yes. The cost-saving program was completed and as expected. So we view that as a success. And the run rate that we put out there before, and our expectation has continued, good cost control would -- should play out in the second half of the year.

Okay. And Mike, finally, you mentioned hiring outside experts. How much will that cost you? Is that something that will be excluded outside of adjusted earnings? And are you expecting greater synergy realizations either in speed or magnitude as a result?

Yes. We do have, in the [Q] , that we expect additional expenses related to the combination with Houghton between now and year-end to be in the $15 million to $20 million range.

And then just the realization speed of synergy?

The realization speed of the synergy has not changed from what we had put out there before. I think $20 million in year 1.

Yes, $35 million and $45 million, year 2. And then those would be -- you had a question in there, I think, Jon as well around the -- those would be non-GAAP, the expenses.

Our next question comes from Mike Harrison with Seaport Global Securities.

Just a couple more from me. In North America, you mentioned the outlook for global auto production to maybe moderate just a little bit. But I think in North America auto production looks like it could actually go negative in the second half if it hasn't already. Can you talk about how your steel and metalworking customers are positioned to deal with that weakness?

How they're positioned to deal with that weakness? I don't know if we...

How -- just, I mean, what's -- I guess, the concern that I have is that maybe you have customers were are doing some prebuying while you were raising prices and they're sitting with some elevated levels of inventory, and now we're potentially going into a situation where demand could actually slow and their production could slow. So I guess, what -- maybe the broader question is, what's your outlook for North America in the second half relative to the comments that you made about global steel and auto moderating in the second half?

Well, I think in -- one of your questions was relative to inventory. Can people prebuy and can they -- could that be a negative impact on that? That's not a concern for us. Customers have very little inventory, just because they can't hold that much inventory of our type of product. So we don't have a big concern over something like that. And then on North America, in general, we continue to believe in what's happening in North America, we are continuing to get new pieces of business and we project that in the second half of the year. So when we -- as I think about North America, I still think of it as something that's going to do well.

All right. And then just in terms of the Lubricor business. I know all the excitement is around Houghton right now but can you just give us an update on how the integration of that Lubricor business has progressed?

Yes, it's been very good. We've been very happy with the performance of Lubricor since we bought it through the end of last year and -- so we've been very pleased. And we've been integrating it well within our other technologies. We've been able -- they've been very helpful in making other -- customer connections for us. So again, it's a relatively small acquisition. And it brought in -- just like our other kind of small ones that we did brought some different technologies with a different customer base. And we're very pleased with the -- as I talk about, singles, it's another series of singles that is going to help us, not only present, already, but in the future. So we're happy.

Got it. And then the last one from me is, just looking at globally the steel business or the primary metals business, are you expecting any new mills to be starting up in the second half that you're going to be involved with?

We have Big -- one mill has started up already in North America, the Big River mill as an example. We -- that's a good example, in fact, to your other question, Mike. We -- it started up in -- already, but it's ramping up in its production. And that's a good example of something that we expect to have considerably more sales in the second half of the year versus the first half of the year.

Our next question comes from the line of Edward Marshall with Sidoti & Company.

So I just wanted to kind of talk about Houghton for a second. If I could relate that to kind of what you talked about with margins. How are the gross margins in respect to the core gross margin for Quaker?

Yes, we're not at liberty to really share Houghton International data. What I would just say that they're kind of same trends in the business, higher sales and the raw material impacts, we're kind of seeing the same overall trends. And I also would make a comment that, nothing have we seen from what they've experienced and what they've produced is different than our expectations we had coming into the transaction. So everything is kind of playing out as expected in my mind.

Could you talk about, maybe, the gross margin? Whether they're stronger or weaker or you'd rather wait until you see the consolidation?

Exactly. I don't feel comfortable sharing another company's financials. But I think the overall message that I would like to provide is, we feel comfortable with the overall performance of the company. And in fact, it's producing at our expectations.

We don't see -- just to add on to that comment. We don't see anything different from what we showed in the investor deck when we did give some high-level numbers regarding what the combination might look like.

Right. When I talk about -- I'm sorry, the approvals -- as you're working through the approvals, I'm wondering, which location is the most critical piece for you as you move forward? Is there one that you're more worried about than others?

No.

I wouldn't say so. Again, we've got China approval. So we were happy about that. The 2 other major approvals that we have outstanding is the U.S. and Europe. And things are progressing, all the filing submissions, the request for data, just like we expected. So we haven't picked up any singles or anything that will make us feel more positive or negative than our -- they're general expectations. So it's kind of playing out like we expect at this point. And we just have to kind of let it run its course and get to the finish line.

Got it. And when I step back and I look at the stock performance since the deal has been announced, is it right to think that there is -- that the price of the transaction's up about $85 million since the closure? I mean, is that -- or did you guys hedge any of those stocks -- the stock that was part of the deal?

No. I haven't calculated that number. So I can't comment on your number. But yes, we don't have -- the deal is they get 24.5% of Quaker and $172.5 million of cash.

And no hedge.

Our next question comes from the line of Liam Burke with FBR Capital.

Mike, could we just talk about some of the acquisitions outside of Houghton? And how they contributed to the organic growth rate of the business during the quarter?

Yes. Well, the overall impact, which is really just Lubricor at this point, in round numbers was about 2% of our volume growth or our sales growth.

Right. But part of the way the company has been laid out is, you've added these acquisitions, they've immediately given you a revenue bomb, but now how are they growing organically within the Quaker umbrella.

Okay. Yes, we don't -- we haven't provided that data in the past as I -- qualitatively, I can kind of say that we're very happy with the kind of growth that we've been getting. When I think about how we're doing in our grease business and the kind of growth we're seeing in both of the businesses we bought as well as the penetration we're starting to make in our existing business, I feel good about that. I feel good about things like the tin plating business which continues to pick up; new piece of business, die casting. So all of them are really providing singles to us. And I think that's -- part of that differential over the industry growth that we're seeing there makes us about 2% of additional growth over the market this quarter.

Okay. And some of the acquisitions, you could leverage your existing channels, some you had to add channels. All that has been -- all that is set up now. Is that right?

Yes, that's correct, Liam. The resources are all in place, we're kind of still at the stage of, get a new piece of business, use that as a reference for us and then helping us grow within each of the regions of the world.

Our next question comes from the line of Garo Norian with Palisade Capital Management.

Can you hear me?

Yes, Garo.

Great. Just one question back on the raw materials. Is there any major difference, regionally, on how you guys have been impacted through the first half of the year from the raw material increases?

Yes. I mean, there is a lot of regional differences. Some of those are caused by the supply issue. You could have raw material issues, for example, in Asia, that we saw in the year where some raw materials were even hard to get hold of. You had foreign exchange impacts as the euro was changing. That impacts raw material costs in Europe and the same thing in Brazil. So there are a lot of puts and takes around raw materials all over the world.

Okay. Just one on the [Houghton] closing, as far as I remember, I think July 3rd may have been a date for, I guess, maybe the U.S. request for more info. Is that correct? And can I assume that they did request? And then I'm curious what the next date might be?

Yes, you're right. They did a [CC second request] which is certainly always expected that they would do. And we're in process of conversations with them in determining [when] that request will eventually be submitted. And we're in the process of gathering that information to submit to them.

Okay. And what -- during this process, what level of insight do you have into their business?

We receive -- certainly we're working -- we receive their financials on an ongoing basis, especially at the end of each quarter. So we get to kind of see that. And we're not allowed certainly to communicate anything, interact on a commercial basis. We're still competitors out in the marketplace from that perspective. So we are obviously working with them in integration, but that's really how we're going to integrate the company structure of the company going forward and so forth. But -- so hopefully, that gives you a sense of what we're doing.

Got it. And what's the reasonable best case timing for a close?

Like we said, fourth quarter was -- some time in the fourth quarter. Like -- I think our best guess is still end of the year, early -- or into the first quarter. Nothing -- there's no information at this time that's different than actually when we first made the estimate that -- it's kind of playing out like we expect so far.

There are no further questions at this time. I would like to turn the call back over to Mr. Michael Barry for closing remarks.

Okay. Thank you. Since there's no other questions, we'll end the conference call now. And I want to thank all of you for your interest today. We're pleased with the results in the second quarter. 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.

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