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Quaker Chemical Corporation (NYSE:KWR)

Q1 2010 Earnings Call Transcript

April 28, 2010 8:30 am ET

Executives

Michael Barry – Chairman, President and CEO

Mark Featherstone – VP, CFO and Treasurer

Analysts

Gregory Macosko – Lord Abbett

Liam Burke – Janney Montgomery Scott

Operator

Welcome to the Quaker Chemical Corporation first quarter 2010 results conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (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. Thank you, Mr. Barry, you may begin.

Michael Barry

Thanks, Rob. Good morning, everyone. Joining me today is Mark Featherstone, our CFO, and Jeffry Benoliel, our General Counsel and Head of Global Strategy. As usual, Mark will provide some more details around the financials and then we will address any questions that you may have.

We have also added some slides for our conference call. You can find them in the Investor Relations part of our website at www.quakerchem.com. I will start it off now with some remarks about the first quarter and then follow with what we are currently seeing in the marketplace.

Our earnings for the first quarter were $0.84 per share. This is a large improvement from the first quarter of 2009, when we essentially broke even. About a $0.11 per share is due to an unusually low tax rate because of the expiration of some FIN 48 tax reserves. So as since, this tax effect our earnings would have been $0.73 per share.

I ask you to see on page four. This is now the fifth quarter in a row that we had seen improvement in our earnings level. As you may recall, we had a loss of 26%, a $0.26 of share in the fourth of 2008, breakeven results in the first quarter of 2009, earnings of $0.29 per share in the second quarter, $0.45 in the third quarter, $0.71 in the fourth quarter and now $0.84 in the first quarter of 2010. So we are seeing very good improvement and we are pleased with these results considering the volumes are still down approximately 7% from where they were before the global prices began. You can see this on the volume chart on page five.

Looking forward, we continue see strong fundamentals in the next two years that should be the good growth although we do expect somewhat lower demand in the second half of the year versus the first half. There are really several reasons for the short-term impact.

One is the demand in countries such as Brazil, Germany, Italy, France and the U.K. where tax incentives for auto purchases are running. Another reason is there is seasonality in parts of our business where we supply certain customers for portions of the year. For 2010, at some key customers, the first half will have greater sales than in the second half, given their two supplier strategy.

Then there is the impact of China tightening credit as well as the supply chain restocking impact ending in parts of the world. Again all these will tend to tamper demand in the second half of the year. However, the undercurrent of recurring economies and its impact on our four steel and automotive markets is expected to partially offset this impact.

We are also seeing pressure on margins due to higher raw material costs. We currently are or will be soon in discussions with customers for price increases given our increasing raw material cost but there will likely be a lag effect before we recover our margins.

On the SG&A side, we are investing in key initiatives that will lead to future growth, both these investments are in the emerging markets or BRIC countries. As you know, we do not give specific guidance as it relates to future earnings but I will say that while our earnings for the remaining quarters of the year will probably be lower than the first quarter, we do expect them to at least equal or exceed the pre-crisis quarter’s levels we achieved in 2008.

All-in-all 2010 is expected to be a strong year for Quaker and looking beyond 2010, I also believe Quaker is well-positioned for future growth. For example, as you can see on page six, approximately one third of our business is now tight, the highest growth regions of the Asia and South America. Our strong positions in both regions will allow take advantage of the good inherent growth expected in these regions.

Then, when you look at the other two thirds of our business in the more matured markets of the U.S. and Europe. These regions should experience growth rates above GDP in our markets, just due to the gradual recovery of demand for steel and autos in these regions over the next two years.

An example can be seen on page seven, where the U.S. steel industry is currently operating around 70% capacity utilization and pre-crisis, it was around 90%. This recovery will not come in one year, but it’ll likely take several years but it should provide us with good growth.

This is quite a difference from a few years ago, even before the crisis on the matured markets of the U.S. and Europe were flatten down. So, whether we are talking about the high growth markets like China, India or Brazil or the more matured markets like U.S. and Europe, we believe our product markets show promising growth for the next two years.

Now, when you take the good expected growth over the next two years and put it on our revised infrastructure, I believe this will translate into good earnings growth as well for us over the next two years. In closing, I am excited about our future and I specially want to thank all of our associates whose dedication and expertise helps to create value for our customers and differentiate Quaker in the marketplace.

And now, I’ll turn it over to Mark Featherstone, our Chief Financial Officer, so that he can provide you with more details behind our financials and after that we will address any question you may have.

Mark Featherstone

Thanks Mike. Good morning everyone. Yesterday, we announced first quarter 2010 earnings of $0.84 per share, compared to breakeven results in the first quarter of 2009, compared with the fourth quarter of 2009, reported EPS was up $0.13. However, I should note that the first quarter of 2010 included a $0.11 per share tax benefits from FIN 48.

I’m also pleased to report that our current EBITDA run rate is now higher than before the economic crisis. And we are coming out of recession in stronger state financially than when we went in and this improvement can be seen on page eight.

Now, I’ll go to the first quarter P&L and then we’ll move on to questions. It is important to recall that last year’s first quarter was in the mid of the global economic crisis. As a result, many of the comparisons are not fully relevant. For that reason, I’ve also included some comparison with the fourth quarter of 2009.

Revenues for the first quarter, compared with the same period last year were up 30% to $128 million over slightly below the fourth quarter of 2009. Compared to last year’s first quarter, double-digit volume increases were experienced across the globe.

In addition, foreign exchange rate increased revenues by about 7% versus the prior year quarter. Partially offsetting this was the 5% decrease in sales due to selling price of mix as well as lower chemical management derivatives revenue reported on a growth basis.

The volume increases as I mentioned not speak as a perspective. For example, capacity utilization rates in the U.S. steel industry averaged about 70% in the first quarter of 2010. And this compares about 40% last year at this time but as Mike mentioned, it’s still far below the almost 90% capacity utilization rates of early 2008.

Compared to the fourth quarter 2009 overall volume was about 3%, with all regions reporting increases. We also continued to benefit from some end market inventory restocking during the quarter, but this impact is expected to decrease going forward.

Turning to gross margin, gross margin as a percentage of sales was 36.9% this quarter versus 36.1% in the fourth quarter and 29.1% for the first quarter last year. Last year, at this time, we were using up inventory purchase when raw materials were much higher and the aggressive cost reduction actions we took were not fully in place.

In this year’s first quarter, we began to experience higher raw material prices, although most of these increases do not occur until the end of the quarter or into the second quarter. We’re also experienced in higher costs related to the startup of our Middletown Ohio plant expansion. And we are also beginning to add back some people particular in manufacturing as our volumes increase.

Turning to CMS, we report our CMS contracts on either a gross or net basis, depending on the terms with our customers and how directly our revenue was tied to the cost incurred for Tier 2 product purchases. For the last several years, most of our major CMS contracts were accounted on a growth basis.

In 2009 and 2010, as CMS contracts had been renewed or re-negotiated, more sites are moving to a net basis. Now, the move towards net – more net reporting of CMS, result in about 2% increase in gross margin percentage, when compared to the first quarter of 2009 and about 1% when compared to the fourth quarter.

Turning to SG&A expenses. In absolute terms, SG&A for the quarter increased almost $7 million compared to the first quarter of 2009. More than 80% of this increase related to either higher foreign currency rates or higher incentive compensation approval versus reductions and incentive compensations in our prior year quarter.

SG&A is lower than the fourth quarter due to the lower foreign currency exchange rates and lower legal and professional fees among other factors. As the year progresses, we do plan to add the resources to key growth areas, especially in the BRIC countries. I would also like to note that our SG&A as a percentage of sales in the first quarter decreased compared to both the fourth quarter 2009 and last year’s first quarter.

Turning to the tax rate as I’ve mentioned previously, we did benefit from a lower tax rate in the first quarter, due to some FIN 48 tax reserves falling off. We expect to continue to experience volatility on a quarterly basis in our tax rate due to FIN 48 and potential changes in the income mix.

We expect our tax rate for the rest of the year will be higher than the first quarter rate. We currently project the full-year tax of about 28%. However, this may change as the year progresses due to income mix and other factors.

Now, turning to the balance sheet and cash flows. As I discussed in last quarter, the first quarter is historically our weakest cash flow quarter of the year due to the seasonal factors including the payments of incentive compensation. Despite this, our net debt-to-total-capital ratio was a strong 24% at March 31, 2010 compared to 31% at March 31, 2009.

I believe, our strong balance sheet and increase in EBITDA, the business as well to take advantage of any opportunities that may rise. And that concludes my prepared remarks.

Michael Barry

Thanks Mark and at this stage we’d like to address any questions from any participants on this conference call.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Thank you. Our first question is from the line of Gregory Macosko with Lord Abbett. Please go ahead with your question.

Gregory Macosko – Lord Abbett

Yes. Thank you. Very nice quarter. Would you talk a little bit about CMS and you talked about moving to a net basis and you’re up – the gross margins benefited obviously because of that. Can you give us an idea of the current mix and when you expect it to stabilize?

Michael Barry

Well the – for CMS contracts, for example with General Motors last year, that contract had to be reported on a gross basis because we adjusted things on an index basis and there were some potential lag effect. So accounting rules said that had to be, we put in it on gross basis. When we renew the contracts for this year, GM preferred to have them on a straight pass through on the products that we’re not, see place your product there and there for we did not, we don’t recognize that. So, it really does depends upon and when you stay stabilize, it depends upon year-to-year, what we negotiate with the customers and what our customers prefer in the form. So, it could change again as we go in to the contracts for 2011. But right now, we expect certainly for the remainder of 2010 to be kind of in the same kind of note we’re, the best majority of it is on a net basis.

Mark Featherstone

To follow up on my point Greg, as back in the fourth quarter conference call, we noted that we anticipated about $20 million effect for the full-year 2010 based on this switch from gross to net. That may change based on any renegotiations that may occur with all of our estimates, as the year – as in the start of the year and in sales, that profitability that will be affected.

Gregory Macosko – Lord Abbett

Right, I understand. And then with regard to sales growth, did you give it CMS versus everything else or did you breakout? Could you give us an idea of the growth rates in the very – the groups?

Mark Featherstone

Well, CMS sales were down compared to last year because this was growth versus net effect.

Gregory Macosko – Lord Abbett

But, can you adjust that and give us an idea. I mean did you have any customers, give us a sense for how CMS is doing?

Mark Featherstone

Yes, in terms of the impact on the sales of CMS, it was down about $7.5 million because of the switch from gross to net. Our volumes as I mentioned, we are up significantly and that was up in all regions. To the point that in Asia and South America now, our volume were actually higher than they were at peak crisis. Yes, versus North America and Europe and as the big opportunity that Mike had mentioned before, it was still down double-digits compared to pre-crisis levels in those more material markets.

Gregory Macosko – Lord Abbett

But if I look at CMS alone, you are saying that is growing as well. Is that on a sort of a same customer basis or you are adding new customers there?

Mark Featherstone

While the reported revenues is down, we are picking up some CMS business, but as we’ve talked about before, particular amounts on the RO makers some of their sites have closed in previous years and there is also some sites that will likely close by the end of 2010 or 2011 as they’re kind of downsized their production. So, we all have kind of a mix of new contracts coming on and contracts falling off. Yes. There is more dealings of the site closures in ABL.

Michael Barry

But in general most, a lot of our CMS is certainly in United States. The United States in the first quarter of this year, auto sales, our products in the – and towards CMS account or significantly up from where they were in the first quarter of last year just because of auto production. So it’s more that effect than anything kind of happening in CMS.

Gregory Macosko – Lord Abbett

Okay. Good. And then finally, just with regard to raw materials as you mentioned that, you see that it started the raw materials, started to move up in the first quarter and into the second quarter. I’m assuming you are on a LIFO basis correct?

Mark Featherstone

No, we are on a FIFO.

Gregory Macosko – Lord Abbett

On FIFO, okay. And was there any change in the reserve there or?

Mark Featherstone

Well, with FIFO, you wouldn’t have a...

Gregory Macosko – Lord Abbett

Your FIFO, I’m sorry, not LIFO, I’m sorry it’s FIFO I didn’t hear it, okay. And your expectation there is I mean you’re pretty quickly to be able to pass that through relative to customers as it – what kind of time lag you expect that?

Michael Barry

It depends – it’s hard to say because for some contracts we have are formula based and they may adjust every three months, some may adjust every six months, some are just negotiations straight with the customers. So generally, over the process now of having those discussions or shortly, we’ll be having those discussions and then, we see some lag effect so I would tell you any, three to six months kind of number.

Gregory Macosko – Lord Abbett

Thank you very much.

Michael Barry

Sure.

Operator

(Operator Instructions). Our next question is coming from the line of Liam Burke with Janney Montgomery Scott. Please proceed with your question. Mr. Burke, your line is opened for question.

Liam Burke – Janney Montgomery Scott

Yes. Hello Mike, Mark.

Michael Barry

Hi Liam.

Mark Featherstone

Hi, Liam.

Liam Burke – Janney Montgomery Scott

How you’re doing this morning?

Mark Featherstone

Good, thanks.

Liam Burke – Janney Montgomery Scott

Mike, could you talk a little bit about metal working specifically, I know, overall steel production is strong, but could we go down and talk about how the metal working business is going?

Michael Barry

Sure. A lot of our metal working business is tied to automotive production. And automotive production is certainly doing better now than it was certainly a year ago and especially in the United States as well as in countries like China and Brazil, pretty strong auto production. In Europe, we actually had pretty decent auto production and auto sales in the first quarter although as I pointed out in my comments that at least in a lot of the European countries and maybe Brazil that will be one area that because these tax incentives set up, they’ve put in place where scrappage programs are ending. And therefore we see little bit lower sales certainly in autos in a couple of those regions but in general, we see metal working are rebounding very well in most of the regions around the world.

Liam Burke – Janney Montgomery Scott

And could you give just a status? I know Mark touched on the Middletown Ohio project, how that is going in terms of sense of timing?

Michael Barry

Sure, the project itself...

Liam Burke – Janney Montgomery Scott

Yes.

Michael Barry

Has been completed. So we’ve – completed from a perspective that we got most of the equipment in and we are transferring our products from our Detroit facility down into Middletown, but we are in the midst of that we expect to have the majority of the product that can be transferred from Detroit to Middletown done by probably sometime late in the second quarter of this year.

Liam Burke – Janney Montgomery Scott

Great. Thank you very much.

Michael Barry

Thanks Liam.

Operator

(Operator Instructions) Our next question is a follow up from the line of Gregory Macosko with Lord Abbett. Please proceed with your question.

Gregory Macosko – Lord Abbett

Well, I guess I can ask questions pretty quickly here, if you don’t mind.

Michael Barry

No problem, Greg.

Gregory Macosko – Lord Abbett

Okay, good. With regard to the really strong results here, how much of that would you say is from kind of the on a – sort of on an incremental basis. Can you give me a sense of the incremental profit – profitability here, the sales growth was pretty nice, kind of, higher than expected, I think. How would you typify the good earnings growth relative to the sales growth versus obviously restructuring and you’ve got lower costs as a result of looking at the operations?

Michael Barry

Yes, I think with the – if you go back and you, kind of, look at our trend in earnings and you look where you are? Again, we lost like $0.26 in the fourth quarter of 2008 and then we were in the first quarter of broke even last year and then after that we are around $0.29 in the second quarter of last year. If you look at that time period, where we have pretty steep good growth – earnings growth through in that period. Essentially, volumes were relatively flat over that time period and what we really fall in that improvement over that time period was our costs reduction efforts coming into play as – kind of getting our margins back to more acceptable levels.

And then, once you get pass the second quarter of last year and you’re starting to look at the improvement we had between the third quarter and fourth quarter and then, now into the first quarter of this year. I think a lot of that improvement that you are seeing is volume driven to the improvement of the recovery in each of the economies around the world for us. So again early on it was a lot of the actions we got and you can kind of see that magnitude when you look at what happened back in that time period and then, what you’ve seen recently is more of the improvement in the volumes.

Gregory Macosko – Lord Abbett

Okay. I’ve been lacks and not calculating, kind of a sales growth versus the earnings growth. But are we at a point where a lot of that coming-off the bottom kind of that we’re seeing such strong incremental profitability. Going forward, is it fair to say that additional growth from here forward, yes, we’ll certainly add more to the bottom-line but is it, will that incremental profitability be somewhat less?

Michael Barry

Well, again we’re not going to kind of predict exact amounts right here. But that I will talk about the volumes, again we do, we had very strong again volume improvement over the last three quarters. We do expect between when you start get into the second half of this year versus the first half of the year for the reasons I’ve stated earlier. We do see volumes somewhat down but longer-term, we see very good trends in our – in the market that we are in, we are in.

Again, we’re in the steel, we’re in the automotive, these markets into parts of our business. In U.S., we’re hit really hard and there is still way down and we still think that over the next few years as they continue to have this gradual recovery in the matured markets, we will benefit from that and then, when you look at where we were in the stronger regions overall the India’s, the China’s, the Brazil’s, the Russia’s. We’re in a pretty strong position in those areas in both steel and automotive and we expect in those regions to benefit very well from growth.

So, we might get into a period where we’re kind of passing from a line perspective for the rest of this year, maybe slightly down but – but we do expect over the next few years some pretty good growth characteristics in these markets that we’re in.

Gregory Macosko – Lord Abbett

But I think what you said or you suggesting as well, earnings might not be as strong as the first quarter. You did suggest that they would be up on a year-over-year basis. Did I hear that correctly?

Michael Barry

Yes, definitely.

Gregory Macosko – Lord Abbett

Okay. And can we imply something similar for the rest of the second half of the year or the down volume on a – that volume you said down is that meaning a year-over-year basis or on a sequential basis?

Michael Barry

That’s – that sequential. Yes, and but earnings, if you look at the full-year earnings for 2010 versus the full-year earnings for 2009 will definitely beyond.

Gregory Macosko – Lord Abbett

Well, after the first quarter...

Michael Barry

That’s it. Yes

Gregory Macosko – Lord Abbett

Yes, okay. Well. Okay and I sense you, you’ve laid out quite a few negative factors here China and restocking in raw materials and et cetera, et cetera. But I mean that I’m assuming you’re really looking at the negative side. I mean – I mean, if China doesn’t tighten or raw materials don’t push through, don’t keep rising, I would assume the offset would be the case, correct?

Michael Barry

Yes, I mean, we’re just giving you what our expectations are.

Gregory Macosko – Lord Abbett

Okay.

Michael Barry

Based on all the information that we see right now.

Gregory Macosko – Lord Abbett

Right, okay. Very good. Thank you.

Michael Barry

Sure. Thanks, Greg.

Operator

Thank you. There are no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Michael Barry

Okay. Thank you. We will end the conference right now and I want to thank all of you for your interest today. We are pleased with how we are managing for these unusual times and we continue to be very confident in the future for Quaker Chemical. Our next conference call for the second quarter results will be at the end of July and if you have any questions in the mean time, please feel free to contact Mark Featherstone or myself. Thanks again for your interest in Quaker Chemical.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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