Quaker Chemical Corporation (KWR) Q1 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the Quaker Chemical Corporation First Quarter 2016 Results Conference call. At this time, all participants are in a listen-only mode. [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. You may begin.

Thank you, Donna. Good morning, everyone. Joining me today are Mary Dean Hall, our CFO, and Robert Traub, our General Counsel. After my comments, Mary will provide the details around the financials and then we will 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 it off now with some remarks about the first quarter. I am pleased we have delivered another quarter of solid earnings and strong cash flow, despite a variety of market challenges such as foreign exchange headwinds, 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 first quarter results. Foreign exchange rates negatively impacted sales by 5% and earnings by 2%. This marks over two years of consecutive quarters where foreign exchange has negatively impacted our results compared to the prior year period due to the strong U.S. dollar. For steel production, per the World Steel Association, production was down approximately 3.5% in the first quarter with all major regions showing declines compared to 2015. The good news is that the World Steel Association's forecast for global steel for the remainder of the year is that production to be relatively stable, maybe even slightly up, compared to the same period last year. I would now like to make some comments on the quarter's sales and I will do so in each of our respective regions. North America showed a decline of 1%. We had strong volume gains of 3.5%, but they were more than offset by exchange rates and lower product pricing. Our European, or EMEA, region showed a 10% increase in sales. This increase was primarily due to the Verkol acquisition and some organic volume growth, partially offset by exchange rates and lower product pricing as well. South America, South America continued to be our most challenging region, as sales dropped 35%, 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-streamlining actions. In our Asia Pacific region, sales were down 8%, due primarily to exchange rates, while product volumes slightly increased. Despite the challenges we faced, we were able to grow non-GAAP earnings and adjusted EBITDA. In addition, we had strong operating cash flow in the quarter, increasing 34% compared to the first quarter of 2015. We were able to achieve these results on the benefits from our recent acquisitions, as well as taking share in the marketplace. One way to see this share gain is to look at our overall product volumes, while excluding acquisitions and also the unique impact of Brazil, which is now less than 4% of our sales. When you do this, our base product volumes are actually up 2% in an environment where our largest market indicator, steel production, is down 3.5% in the quarter. Furthermore, this 2% volume gain is made up of positive growth in all three major regions. This type of differential between our product volumes and the trends in our end-markets we supply is a high-level way of getting visibility into our market share gains. We believe these share gains are due to our commitment to our customer intimacy model. Specifically, we put our customer 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 have many other initiatives in our base business lines and in each of our regions that we will continue to provide us a competitive advantage to gain further share, including growing our recently-acquired technologies around the globe. As I mentioned in the past using the 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 net sales will continue to be impacted by oil prices and a stronger dollar. In the case of raw materials, we suspect that we probably have reached a bottom at this time and we are starting to experience some increases in raw materials. But the magnitude and timing of these increases is really hard to determine with the fluctuations in the price of crude oil, foreign exchange rates and their impact on pricing, as well as other non-oil-related raw material prices such as vegetable oils. Over time, we expect to see some compression in our gross margins, but again, the exact magnitude and timing of this is hard to determine. The good news is that our SG&A cost savings from our previously-announced restructuring program will be coming into effect late in the second quarter and we will continue to build – this will continue to build as we progress through the year. So the savings should help mitigate the potential declines in our gross margin. 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 which we announced last July. The combination of all these growth vehicles gives us confidence that 2016 will be another good year for Quaker, 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 the Quaker team we have in place throughout the world. Now, I will turn it over to Mary Dean 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 you may have.

Thanks, Mike, and good morning, all. Quaker delivered another strong quarter despite continuing headwinds from foreign exchange and lower global steel production and a higher effective tax rate in this first quarter. We continue to benefit from market share gains, margin expansion, and acquisitions, which are key drivers to our positive performance. Before I jump into a more detailed discussion, 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 these investor slides and they are also in yesterday's earnings release and our Form 10-Q filed yesterday. In addition, remember not to place undue reliance on any forward-looking statements. Please refer now to charts 4 and 5 as I provide more color and context around our first-quarter performance. Quaker's non-GAAP earnings of $0.98 a share for the quarter is a 4% increase over first quarter 2015, as Mike mentioned. This reflects solid operating performance in the face of foreign exchange headwinds that negatively impacted earnings by $0.02 a share and the higher effective tax rate I mentioned, which also hurt earnings by approximately $0.02 a share compared to Q1 2015 and I'll talk more on this later. Net sales were down 2% Q1 over Q1 as volume growth in each of our three largest regions was offset by the negative impacts from foreign exchange at 5% and price declines of 2%. The volume increases in North America, EMEA, and Asia Pacific are indicative of our continued ability to gain market share, even in this tough environment. The negative foreign exchange headwinds impacted all regions with the Mexican peso, the euro, the Chinese RMB, and the Brazilian Real all weakening against the U.S. dollar Q1 versus Q1 2015. The downward pricing pressure on our products was caused by the continuing decline in raw material costs, but this also benefited our margins. Our gross margin increased 1.5 percentage points to 38.1% Q1 over Q1, with most of this improvement dropping to operating income, which increased 8% Q1 over Q1 with an operating margin of 10.8% versus 9.9% in Q1 of 2015. Our operating margin improved despite an uptick in SG&A expense, which was due to incremental costs from our recent acquisition of Verkol, higher labor-related costs, and also other smaller one-time costs that, when combined, contributed to the increase. These costs are not expected to recur and we expect to leverage our SG&A infrastructure as sales grow. I mentioned earlier that earnings were negatively impacted by a higher effective tax rate in the first quarter of 2016 of 32.3% compared to 30.8% in Q1 2015. The main contributor to this increase is the timing of a concessionary tax rate we expect to renew toward the end of this year at one of our non-U.S. subsidiaries. In our last call I alerted you that we expected our first-quarter 2016 effective tax rates would be in the 31% to 33% range and we continue to believe that the rate in Q2 will be similar to Q1. We also continue to expect that we will renew the concessionary tax rates later this year, decreasing our full year effective tax rate to approximately 28% to 30%. Turning to our balance sheet, our solid operating performance drove strong operating cash flow of $10.9 million, up 34% over Q1 2015. The strong cash flow allowed us to reduce net debt over 50% to $4 million versus Q1 last year. Keep in mind that during the past 12 months we bought Verkol for net cash of about $26 million, paid dividends of about $16.8 million, and repurchased 171,000 shares for about $13.1 million. This includes the 84,000 shares repurchase that I mentioned in February, which we purchased for just under $6 million in late January, when the whole stock market was down. Quaker is committed to a balanced approach to capital allocation. To us, this means using our strong balance sheet to grow the Company and return cash to our shareholders. The next few charts give you some additional history and context to certain key items. Chart 6 shows trends in volume. Mike and I have both discussed how volume is the key highlight for the quarter. This chart shows that Quaker is able to grow volume over time both organically, including market share gains, and through acquisitions, despite challenges in our key end-markets. Chart 7 highlights our margin story and the continued expansion of our gross margins as raw material declines have outpaced price adjustments. Chart 8 shows our adjusted EBITDA trend, which continues to show good annual growth and is up 8% Q1 of 2016 versus Q1 of 2015, reflecting the strong operating performance we discussed earlier. And in fact, our trailing 12 months EBITDA of $103.3 million is our highest ever. Chart 9 highlights our balance sheet strength with a good cash position and low leverage, and we believe we are very well-positioned to drive future growth, including acquisitions. In summary, Quaker continues to deliver consistent earnings growth and strong cash flow despite continuing challenges in our end-markets and the negative effect of foreign exchange. As we move forward in 2016, we expect auto to continue to show positive growth; steel end-markets to show flat to modest growth for the rest of this year; continued market share gains; some decline in our gross margin as we do expect our raw material costs will begin to rise, although the magnitude and timing is hard to predict, as Mike mentioned; the benefits of our restructuring program to result in savings of about $3 million in the latter half of this year and $6 million per year going forward; continued volatility of FX rates with an expected negative impact ranging from 3% to 6% for the year on the top and bottom lines; and a full year effective tax rate of 28% to 30% with second quarter's effective tax rate similar to first quarter in the 31% to 33% range. These expectations are very much in line with what we communicated in February as we currently see no significant changes on the horizon at this point. Overall, we expect another good year in 2016, with growth in our top and bottom lines and we continue to expect Quaker to deliver its seventh consecutive year of positive non-GAAP earnings growth. Thank you for joining us today and for your interest in Quaker. And now back to you, Mike.

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

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Laurence Alexander of Jefferies. Please proceed with your question.

Good morning. This is Dan Rizzo on for Laurence. I'm sorry, could you just clarify of the volume growth in the quarter, how much was from volumes and how much was from M&A?

We had a 5% growth in overall volumes: 1% was due to organic growth, 4% was due to M&A, and if you take out the effects of Brazil, the actual organic growth was 2%.

Okay. And then you indicated that raw material prices hit bottom; you're starting to see some increases. Are you raising your own prices or is it too soon for that? Or what is the dynamic there?

Right. I mean, generally what we always say is we certainly have a number of contracts that have automatic adjustments with that will eventually kick in. Every quarter they will adjust up or down based upon the raw material mix of that product. So some contracts with that; other ones are more negotiate at the time. And generally, we always kind of say in either case it's generally as raw materials go up or down there is like a three to six-month lag period between a change in raw material price and how it gets ultimately reflected in our product pricing.

Okay. And then last question. Your shares count seemed to go down a touch I think year-over-year or quarter-over-quarter. Are you increasing share repurchases? I mean is that going to be something that is focused on going forward or what's the deal there?

Well, one of the things we said, Dan, like – last night we put in our share repurchase program and we announced that. And we said, hey, we're going to, at a minimum, keep our shares flat or buy back the dilution that comes from incentive comp plans. And then, but we also said we would also continue to look at times when it's – to buy and what we say always as kind of our first priority is acquisitions. But when we have the ability to do the acquisitions that we are looking in front of us and still be able to do some share repurchases, we will do both. In the first quarter of this year we decided that, given that the market was down, we thought it was a good time to buy the shares at a minimum for this year. So we took advantage of that.

And then, I'm sorry; just refresh my memory. What size is the share repurchase authorization?

It was $100 million of shares that were authorized total.

Thank you very much.

Thanks, Dan.

Thank you. Our next question is coming from Liam Burke of Wunderlich Securities. Please proceed with your question.

Thank you. Good morning, Mike. Good morning, Mary

Good morning.

Good morning, Liam.

Mike, EMEA was up over 10%. If I step back and look at steel production numbers, they were down, say, mid-single digits. If I net out the acquisition, the benefits of the acquisition, what was driving organic growth there?

Market share gains, basically. So we were continuing to take share as we – most places, I would say, around the world on a consistent basis we are generally gaining some share. So that was a big good reason for Europe to go up.

Okay. So you typically have – in the past you've had a range of market share gains that you could look back on. Was this inordinately higher than normal?

I would say probably in that same range.

Okay.

I mean like you said, we’ve kind of historically – it's hard to look at any one point in time and get exact numbers, but we've probably been growing generally 2% to 4% above the market over various periods of time in our past. And so I think that's what we saw in Europe this time was consistent with that.

Okay. And then, lastly on the organic improvement. Was there any particular product or customer that you saw outsized performance?

I’m sorry. Could you repeat that again?

Sure. Was there any particular product or – was it your core product in steel processing or was it new product, acquired product that you saw stronger?

You mean from our growth?

Yes.

I'm sorry, yes, the volume growth. I think it's really a combination. It's a combination of both our existing businesses, but we are continuing to make penetration in some of the product lines that were newly acquired as well. We are starting to get some traction, more traction in greases, aluminum, surface technologies as well, so there's definitely areas we are penetrating there.

Good. Thank you, Mike.

Thanks, Liam.

Thank you. Our next question is coming from Curt Siegmeyer of KeyBanc Capital Markets. Please proceed with your questions.

Good morning. Nice start to the year.

Thanks, Curt. Good morning.

Just a couple questions; one in terms of your gross margin outlook that you talked about. You guys still saw a benefit here in the first quarter. You did mention likely to moderate sort of as we go forward. So if you think about gross margin being less of a benefit, you do have restructuring kicking in you said late second quarter, so it seems to be back-half-weighted. And then currency should probably be neutral, I would think, in the second half. So if you net all those out would you expect it to be a wash or just kind of thinking about second half earnings growth potential. Should we think that maybe there's a little bit more opportunity in the second half to see earnings accelerate or would you think it should be kind of neutral as we move forward?

I think it's really hard to say. I wish I could – If I knew that – I mean I really don't know because the wildcard, I would say, in all this is raw materials and what happens to them. We expected as you kind of described it with modest increases and that will start over time getting us back into our more typical range of gross margins, which has been 35%, 36%. How fast we get there or not is really hard, it's hard to say and somewhat, really unpredictable. But everything you kind of pointed out; foreign exchange rates. They were still pretty negative for us in the first quarter of the year. Yes, maybe as we go through maybe that’s on a will. Maybe it won't, I don't know. So it's just really hard for me to say. But I think based on certainly our forecast for the only thing I can really point to is I say when we look at things and we look at our forecast for raw materials and prices and we look at our foreign exchange forecasts and steel production and take all those things into account. I think we feel pretty consistent with all of our prior guidance is that, for the year, it will be an up year and we will see increases in both our top line and our bottom line.

Okay, great. And then maybe just to follow-up, could you talk a little bit about the acquisition pipeline now versus sort of what you saw last year in terms of opportunities? And then maybe just update us on what you expect in terms of accretion from Verkol in 2016.

Sure. With the Verkol accretion, we said in the past we think for the full year impact of that would probably be $0.10 to $0.15 higher in 2016 than 2015. And as far as the pipeline, hard to say, I mean I'd say the pipeline is consistent with what it has been in the past. We are consistently working on potential deals; which ones will come to fruition or not, it's hard to say. We try to be – want to make sure we're doing the right thing and be conservative and do our right due diligence, so it's hard to say when things are going to actually materialize and be a good deal for our shareholders. But that's our goal. Our goal is to continue to try to make acquisitions happen. We've made 11 of them now in the past six years and we want to continue that going forward.

Great. Thank you.

Thanks, Curt.

Thank you. Our next question is coming from Mike Harrison of Seaport Global Securities. Please proceed with your questions.

Hi, good morning.

Good morning, Mike.

Good morning.

Mike, can you talk about whether you are seeing market share gains on the metalworking side as well as primary metals?

Yes. I mean we are seeing in the both businesses or both areas. And so I would say it's a combination of both our steel business, our metalworking business, as well as the new product areas that we've acquired recently, the new technologies that we've gotten into. We are starting to make some penetration there as well.

And when you are gaining share within primary metal markets, can you talk about what specific product lines you are seeing success in? Is it fluid power? Is it greases? Is it some of the surface treatment and pretreatment areas? What specific areas are you seeing that you are capturing from competitors?

Yeah, it’s actually pretty broad-based. That's a good question. Bus as like we’re – are we getting generally new mills, mills that we didn't have in the past and opportunities there. Yes, we are actually, so even our base markets, our cold roll and lubricants and the chemicals around there, cleaners. With temper fluids we're getting new business there. We're penetrating in the new technologies that we've gotten into: surface technologies, greases, templating, for example. So it's actually a relatively broad-based in some ways. I keep going back again to my knowledge about baseball. It's like we – none of these things are big amongst themselves, but when you start putting them together you're hitting a lot of singles and that hopefully is helps us turn these into runs.

All right. And then was curious just in terms of the global steel market. You mentioned where you saw the production numbers, but have you seen any impact from the steel tariffs that were put in place in the U.S.? I know you've said in the past that you are agnostic as to where the steel actually get produced, but have there been any shift geographically in the production rates that you've seen?

Well, we’re starting to see some increases in, slight increases in the United States in capacity utilization of steel. I think it has been creeping up a little bit since that happened. And certainly when you look at some of the stock prices of our United States customers, they certainly have gone up pretty significantly over the past months since the U.S. came forward with its intentions.

And has it had any negative impact on your Asian customers?

Well, not – we haven't seen anything yet. I mean like the March – for example, March in China, I think China was a really strong month in steel production in China. And things we've been reading is certainly that a lot of customers around the world in steel are able to raise their prices, including in China right now. So it looks like at least as we're sitting here right now, it seems like the steel industry is feeling better right now than it was a few months ago.

And then the last question I had is just on – you've got a coatings business that I know had exposure in pipeline. Was just curious how much of a drag has oilfield weakness been on that business in particular and is it having an impact on your volume growth as a whole, just the weakness in that small coatings business?

Yes. It has been – we have been impacted by that. That's like the one sector of our business that has been real energy-related. And I think back of where we were in that business, it was probably at one time – in the order of magnitude, I don't have the exact numbers in front of me, 5% just to give you a sense of the scale of our business. Or maybe even a little less than that. And certainly over the past year or so we’ve seen that been impacted. So we are – we started seeing it really impacted, I would say, in the first quarter of last year, second quarter of last year I think was the biggest thing. So quarter by quarter it has been impacted and hopefully, now we don't expect to see going forward any additional impacts of that. Hopefully that's through the system at this point.

All right. Thanks very much.

Thank you, Mike.

[Operator Instructions] Our next question is coming from Garo Norian of Palisade Capital Management. Please proceed with your questions.

Hey, guys.

Good morning, Garo.

I’m just curious just to understand a little better, on the steel side, is the macro commentary and what you read and kind of the information you get from various sources more helpful in describing where the business is and where it's headed? Or how good is your internal data kind of collection and monitoring to know that you start to see volumes kind of get used up of your own products before some of the macro commentary might change?

I think it's pretty – it’s really at the same time, because our products are pretty much just-in-time delivery to our customers. They don't keep a lot of stock. We're not – and so we find it pretty consistent with what we see versus the external data regarding production.

Okay. So is it fair to say that – you have noticed the improvement in the market already and kind of the idea that it kind of holds more flattish for the rest of the year, makes a lot of sense to you on the ground basis?

I don't think we've seen – I think what we're – what at least the World Steel Association was saying is it was a pretty good decline in the first quarter versus first quarter of last year, but at least when we go into the last nine months and I'm really [indiscernible] implying data because they give full year forecasts here. And when you kind of go through that interpolation it's pretty much saying that the next nine months relative to the last nine months of last year should be relatively flat, maybe even slightly higher. It's too early to say. I think one thing we have seen, it seems like prices are going up. Of course, we are impacted by volumes. And we have – it's hard to say. We just did our first-quarter results; we're only into April at this stage, so it's not like we have total visibility of things yet.

Sure, okay. And on the metalworking side of things, has – I guess by implication, if you kidn of just look at IP or kind of ISM data, it seems like there was a bit of a downturn towards the back half of last year, but things have picked back up, recovered a little bit. Is that reflective of what you saw in the business?

Yes, we are definitely seeing some upticks. A lot of our business is generally in the – all places around the world really. So there has been decent growth in autos in the United States and in China and in Europe and then you had a huge negative growth in Brazil. And so when you put together, it – there was some, I would say, some modest growth in auto, roughly 2%. A lot of what I read saying it was supposed to grow globally on a 3% basis. So we are seeing this growth in our actual what we see out there.

Okay, great. Just last question for me. Can you provide a bit of a color update on the non-petrochem raw materials and what's been going on there?

So the main ones are vegetable oils and animal fats. They've been trending upwards. I would say that they're – they have sometimes different supply demand characteristics which impact pricing. There's some El Nino type effects on some of these raw materials and there's some seasonality in there, but generally I would say over the past few months they have been increasing.

Okay, great. Thanks so much.

Thank you, Garo.

Thank you. At this time, I’m showing no additional questions in the queue. I would 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 our conference call now. 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 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 teleconference. You may disconnect your lines at this time, and have a wonderful day.