Quaker Chemical Corp (KWR) 2018 Q1 法說會逐字稿

Greetings, and welcome to the Quaker Chemical Corporation First Quarter 2018 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Michael Barry, Chairman, Chief Executive Officer and President for Quaker Chemical Corporation. Mr. Barry, you may begin.

Thank you, Donna. 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 first 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 sales and the second was gross margins.

Let me start with margins. Since mid-2016, we've been in a generally rising raw material cost environment. And as we have discussed in the past, with raw materials, there is a lag effect between changes in our raw material costs and adjustments to our product pricing.

On the last conference call, our expectation was that gross margins would begin to increase in the first quarter, and they did. While raw materials continue to rise sequentially from the fourth quarter, our previous price increases were enough to begin to turn the tide, and we saw our gross margin increase.

The good news is that we expect our gross margins to trend upwards over the next few quarters and expect that for 2018, our gross margins will be around 36%.

While we expect certain raw materials to continue to increase, especially in the first part of the year, we also have price initiatives in place to offset the raw material cost increases where necessary.

While we will continue to experience more of this lag effect that we talked about in the past, we are making good progress and that is the reason for our higher margin expectations. So we do expect our margins to continue to increase, but the exact timing of when we will reach our 37% target is hard to predict.

Now let me move on to sales. Our sales increased 9% versus prior year with 6% of the increase coming from foreign exchange. Let me now give you some additional color on our regions performance for the quarter. Our biggest segment, North America, showed a sales increase of 5% with volume growth near 2% and the remainder mainly due to price increases. Our European or EMEA region showed a 15% increase, with exchange rates being the primary reason. We did see a volume decrease of 6% being offset by primarily higher prices. The EMEA volumes in the first quarter were actually quite strong, but the prior year volumes were unusually high due to an atypical sales pattern. In our Asia Pacific region, our sales increased 8% with higher volumes being the primary driver.

And for the seventh quarter in a row, we're happy to report that South America showed good revenue growth. The 11% growth in South America sales was primarily due to volume growth as well as price increases.

One way to look at our market share gains is to look at our overall organic product volume growth in the quarter and compare that to the underlying production growth in our base markets of global steel and auto. We estimate that our overall volume growth, excluding EMEA due to the atypical sales in Q1 2017, was 4% as compared to the underlying growth in our base markets, which we estimate at 2%.

We believe the spread of 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 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 globe.

And as I mentioned in the past, using a baseball analogy, I think each of these initiatives are singles and our goal is to hit many singles to produce multiple runs and thereby show continuing growth even in a challenging market.

One item worth mentioning that I believe was worth a number of singles was our recent purchase of our partner's interest in our India JV. We now have 100% ownership in our India business, which we believe will have strong inherent growth characteristics in our base markets for the foreseeable future.

So in summary for the quarter, despite the challenge we faced with higher raw material costs, we were able to grow our adjusted EBITDA by 9% and our non-GAAP earnings by 17%. In a nutshell, we were able to do this by growing in our base markets, taking share in the marketplace, beginning to increase our gross margins and continuing to leverage our SG&A.

I now would like to make a few remarks about our combination with Houghton International. Since our announcement in April of last year, we've 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. We have received approval from China and Australia. The U.S. FTC and European commission are still in the process of their reviews, and we do expect to divest a small number of product lines, but the current expected remedies are consistent with our original expectations.

We had expected to close in the second quarter once we filed with the European commission in Q1. We were going down a 2-step path with the European commission of first gaining approval on the remedy from the European Commission, and then after that, getting approval for the buyer.

As we were going down this path, and based on discussions with the European Commission, we decided that it would be best to go for one approval for both the remedy and the buyer at the same time.

So we stopped the filing that was underway, and we're now in the process of choosing the buyer for the divested product lines. We expect the buyer to be chosen in the second quarter and expect to file with the European Commission for both the approval and the remedy of the buyer.

The good news is that we are in general agreement with the regulatory authorities on the remedies that have to be made. We currently expect regulatory approval from both the U.S. Federal Trade Commission and the European Commission as well as the closing to be completed over the next few months.

As we said in the past, we're excited about this combination as it will essentially double the size of the company, enable continued above-market growth through good cross-selling opportunities and provide at least $45 million in cost synergies.

Our intent is to have an Investor Call after the closing and provide an updated view of the new company as well as our expected synergies.

So I believe 2018 will be another good year for Quaker. We expect to close the combination with Houghton, see gross margin improvement and get benefits from tax reform. In addition, we expect to see growth in our end markets in most regions of the world, and we expect to continue to grow above the market as we have done historically through our growth initiatives and market share gains.

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 upcoming combination with the 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 the financials. Once Mary has completed her comments for 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 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 2017 Form 10-K filed with the SEC. These are available on our website.

Please refer now to Charts 4 and 5 as I review our financial performance. Quaker reported a 17% increase in non-GAAP earnings per share to $1.38 this quarter versus analyst consensus of $1.25. These results were driven by strong sales growth and continued discipline in managing costs. While our gross margin continued to reflect some pressure year-over-year due to increased raw material costs, we did see sequential improvement over Q4 2017.

Our net sales increased 9% to about $212 million compared to Q1 of last year, benefiting from organic volume growth in all regions, except EMEA, as Mike explained, and the positive impact from selling price and mix. We also benefited from a generally weaker dollar with foreign exchange translation increasing our top line by 6%. Appreciation of the euro versus the U.S. dollar was the largest driver for the FX impact with the euro appreciating about 15% versus Q1 last year from $1.07 to $1.23 per euro. The favorable FX impact flowed through to the bottom line with a positive 5% impact on earnings this quarter. Our gross margin of 35.6% is down from last year's Q1 of 36.4%, but up sequentially from 35.1% in Q4.

As we discussed on our last call, gross margin is beginning to show the positive impact from price increases. As Mike mentioned, we continue to expect gradual gross margin improvement trending up to the 36% area this year. Also, Quaker continued to show good cost discipline as we leveraged our infrastructure to support the strong top line growth, helping to offset the gross margin decline.

Note that our GAAP operating income and operating margin reflects $5.2 million of Houghton-related expenses. If we look at the ratio of the SG&A line to sales on Chart 5, the Q1 ratio of 23.6% compares favorably to the 24.7% in Q1 of last year, helping to drive the improvement in operating income and operating margin.

Please also note that our effective tax rate in Q1 of 29.8% is down from last year's rate of 50.8% as, both periods reflect the impact of Houghton combination-related expenses, some of which are nondeductible.

The company estimates that excluding these nondeductible expenses, our effective tax rate would've been approximately 26% this quarter and 28% in Q1 of last year. The decrease is primarily the result of U.S. Tax Reform. For the full year, we continue to expect that our effective tax rate will be between 23% and 25%, excluding the impact of Houghton combination-related costs.

As a result of our solid operating performance, adjusted EBITDA was up 9% to a record $30.8 million for the quarter. Operating cash flow of $2.7 million is down a bit from last year's $8.3 million, primarily as a result of investment in working capital to support the 9% sales growth. Our liquidity and balance sheet remains strong with a net cash position of $17.2 million.

Turning to Chart 6. Here you see the volumes were up Q-over-Q despite the atypical volume levels in EMEA in Q1 of last year, as Mike mentioned.

In Chart 7, we see the sequential uptick in gross margin that I described earlier. We believe barring significant increases in raw materials from current level, that we will see our gross margins trending upward over the next few quarters to the 36% area.

Chart 8 shows our continued and consistent positive trend in adjusted EBITDA, as we further leverage our operating costs while growing the Company. And the current trailing 12 months adjusted EBITDA of $117.9 million is our highest to date.

Chart 9 depicts our cash and debt balances and reflects our strong balance sheet with a net cash position of $17.2 million as I mentioned earlier.

In summary, Quaker continues to consistently deliver good earnings and cash flow despite various market challenges. We expect 2018 to be another good year for Quaker as we focus on delivering value to our shareholders and closing the Houghton combination.

Thank you all for your interest in Quaker. And now 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) Our first question is coming from Edward Marshall of Sidoti & Company.

So I wanted to start with the volume. It looked a little bit weak, only up 1%. I know excluding a few things in EMEA, looks like it was up 4%, but that still seems like it's under trend from the prior quarters. Is it something in particular going on there that you can address that the markets that you serve slowed a little bit? I noticed that you said it was just up 2% for the market.

Yes. I mean, If you look at some of the markets that we were in, steel, especially cold-rolled steel and so forth, relatively almost kind of flat. Automotive was roughly in that 2% range, but I've even seen some conflicting things around that. So overall, we estimate it to be around 2%, which is consistent really with our expectations going forward. We expect these are kind of markets to be in that kind of modest growth range. And you're right, I mean, I think compared to last year, we had some higher growth in both the steel and automotive markets. But this is always our expectation are for longer term in these markets.

As you layer in, Houghton, and I don't want to get too far ahead. And as you layer in, Houghton, on your core markets here, do you think that their volume of markets are growing faster than Quaker's markets themselves?

They are in certain markets that we're not as large in. So for aluminum, for example, which would have, I think, generally higher growth characteristics. For aerospace, they have a bigger position than we do. They definitely are much more diverse in their end-use markets around metalworking as well. How that all pans out, I think we're still in this modest range, I think, of a few percent market growth.

Got it. And then what I want to look at the tariffs that were on [in March are] at least delayed kind of customer reaction. Was there a sourcing move in North -- South America kind of discussion that might have occurred, maybe sourcing in Asia picked up a little bit more than North America? And how do you think now that we're kind of halting these tariffs that might change?

We don't feel that tariffs really have a meaningful impact on Quaker because we generally have equal shares in the steel business everywhere around the world. So if there were shifts, and we haven't seen them, I would say, too many shifts at this point, but if there were shifts, we don't expect it to impact us that much.

Got it. And the final question for me is, I'm just trying to get a gauge as to if raw material prices are up, say, 100%, how much of that have you captured on the index with your pricing increases? I guess, maybe what inning are you in to use a baseball analogy about recapturing that price? I understand your guidance for the year, but maybe you can kind of walk me through how much you think you've already gotten versus where you expect it to be?

It's a very complex question because generally the way price increases tend to go is that at a certain point in time, we make price increases based on the information we have relative to what already impacted us. And then other things happen subsequently from that. So if things just stayed flat from this point onward. We're already starting to see some price increases that were coming in place in the first quarter, price increases on our raw material cost, for example. So those are not fully baked in into the second quarter yet. Now we have to go out and get some more price increases. So it's continually having this lag effect going on. So once things costs stabilize, as we say, we think it's like a 3- to 6- month period before everything goes through. It's really the best I can kind of tell you. It's hard to forecast because things are just continuing to evolve, and you continue to see these upward trends in raw materials, it's just a continuing event for us.

Our next question is coming from Mike Harrison of Seaport Global Securities.

Wanted to go at the raw material question from a different angle. Just wondering what you're seeing in terms of trends, looking at presumably some of the crude-based raws are still showing some risk of inflation and are still moving higher here. Wondering if that's also the case for some of the animal and plant-based materials that you use. Wondering if you're seeing any signs of stabilization as you think about kind of the 3 main buckets within your raw material basket?

Yes. I think the one that has the most upward pressure would be the crude-based raw materials, mineral oils and so forth. Vegetable oils, depends on what vegetable you're talking about, but generally, I think they are more stable at this point. And then animal fat is really more -- gets into more supply demand around -- things around there. And then you have a whole host of other chemicals that are kind of unrelated, but they tend to be over time correlated with crude. So I kind of agree what you've kind of said there in beginning that I think it's mainly the crude ones that have the most chance for upward potential.

So fair to say that they're still at this point still moving higher, but maybe the rate of increase has slowed from what you've seen over the past few quarters?

Yes. I think that's fair. Although you never know what happens tomorrow, right?

And then just to clarify on the gross margin guidance. Do you expect to be able to hit 36% as a gross margin number for the full year 2018? Or is that 36% number just a number that you would expect to hit at some point before year-end?

We'll definitely try to hit that before year-end. We're not there in the first quarter, obviously, but we're trending upwards towards that. We would think that when you look at the end of the year; you would round up; when you round up or down where we are for gross margin, it would round to 36%.

Okay. And then, was wondering if you can talk a little bit about the Asia Pacific price mix component. It looks like it was negative again this quarter. It looks like it's been negative on sales if we go all the way back throughout 2015, '16, and '17, price mix was negative in Asia Pacific even as we've seen fairly persistent raw material inflation at least over the past couple of years. And then obviously, more recently, some pickup in demand in that region. So just wondering, can you help us understand where that dynamic is coming from? What it would look like if we could break out the mix piece versus the pricing piece? And then just wondering if there is any chance that we could see price mix in Asia turn positive during 2018?

First of all, it's really very difficult to break out price mix right now for us. But my sense, as we go through our business and so forth is that it's -- a lot of it is the product mix of things. And that you have a lot of different products, different countries that are in there. We've pointed in the past to mining, how mining has come back in, especially in China and how that has some lower points in there. So there's nothing fundamentally we feel bad or not good about in Asia. We feel really good. We're getting good growth in Asia Pacific. We're taking share in Asia Pacific. So we feel pretty good about it. I think you're just seeing mainly these mix effects.

All right. And then last question for me is just on your efforts to win share with the transplant automakers in North America. I was wondering if you could give us an update on how you guys have been doing internally? And maybe talk a little bit about how the Houghton acquisition could give you additional opportunities to gain metalworking fluids business with those transplant automakers in North America?

Sure. We've been putting a lot of effort over time into that, and I think we're continually seeing increased sales into Asian automakers that are in the U.S. So I think we're definitely seeing, let's say, above-market-type growth there. So I feel good about the progress that we're making there. And as far as Houghton is concerned, Houghton has a very nice effort there as well and has probably been at it for a longer period of time than we have. And we're very excited about the team of people that they would bring to join our efforts as well. We think that bodes well for the combination.

Our next question is coming from Jon Tanwanteng of CJS Securities.

Net cash decreased a bit. Mary, I think you mentioned that was from working capital investments to support the sales growth. When you look ahead to future quarters, is that going to continue to be a draw on cash? And kind of how do you expect that to play out as we go through the rest of the year?

Right. We think that was primarily the first quarter. There is some seasonality in the first quarter, compensation payments and the like that occur in the first quarter. And there also were higher cash payments related to Houghton combination in the first quarter of this year than the first quarter of last year. So really primarily seasonality of working capital, which is typical for us in the first quarter.

Okay, great. And then just maybe a little more commentary on the Houghton expected close. I think the language is a little bit different from the last time you spoke about it. Maybe you could push out into Q3. Am I interpreting that correctly, and kind of the reason behind that?

So, Yes. As I kind of mentioned my remarks here, we were going down a path in a kind of a 2-step process with the European Commission. And in February, we had made a filing to get approval for the remedy. And then, as we learn more and we were in discussions with the European Commission, we thought that it's best that we pulled that filing and go for one approval with them for both the buyer and the remedy. So now we're in the process of finalizing the buyer. We expect that to happen in the second quarter. And then once we do that, we would file with the European Commission. And that is really kind of a timing thing and going through that process. So it's uncertain if that is something that will be completed in the second quarter or the third quarter, but like we said in your language it would be something that we would expect to be completed over the next few months.

Okay. So just to clarify, it's a change in the type of filing and the procedure as opposed to any kind of pushback or anything that you're getting from the regulatory bodies?

Yes, we're just trying to get approval on 1 step versus 2 different steps. Yes.

Okay, great. And then one final one from me. Just remind us what interest rate you're expecting to pay on the debt portion of the financing, especially if the date pushes on a little bit?

Yes. So the answer is straight on the financing, it does not change, Jon, with any delay in the close. So that's pretty much baked into the agreement with the banks. So it starts out at a LIBOR plus 2%, kind of, with a spread of about 2%. And just remember that roughly 20% or so, in Europe and the equivalent LIBOR rate there is less than the rate here that would be used for the U.S. dollar-denominated portion. So when we say, in the Q and we've said before that we expect the interest rate based on current rates to be in that 3.5% to 3.75% area, that's how you still get a balance. The rates balance out to that area based on the combination of U.S. dollar denominated and euro denominated financing.

(Operator Instructions) Our next question is coming from Laurence Alexander of Jefferies.

It's Dan Rizzo on for Laurence. You mentioned that this mix shift in APAC was an increase in mining. I was just wondering how would you rank your end markets on terms of like margin profile and mix? If the steel is the best or how it kind of works out? Is there one that's particularly better than others?

Well, there's a lot of different mix effects going on between the different businesses, different customers, different countries, and so forth. In general, our overall profitability in our Asia business is very good for us. And I think as you can kind of see by the profitability, I don't envision having poor or bad business, they're all good to the way I look at it.

And I don't think we've said, Dan, really that mining was the cause of that. We were just using that as an example we've used in the past of a mix issue that can show where volumes come up in a particular area that might have a slightly lower margin than some of the other businesses. So that was just an example of a mix effect.

Got you. And then I guess, along the same line though, when you, when Houghton's added in, how does that effect mix? Or does that change things at all. Is it higher or lower?

Yes. Once we close this combination, we'll have a separate call. We'll go through a lot of what the combined entity looks like, the new projections on synergies and so forth. By what we put in our proxy for the shareholder vote, you can kind of look at financial performance high level. There's not a real big material difference between the 2 companies from a margin perspective.

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

Okay. Given there is 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 for the first quarter, and we continue to be confident in the future of Quaker Chemical. Our next conference call for the second quarter of 2018 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.

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