Q2 2021 Quaker Chemical Corp Earnings Call
Greetings welcome to Quaker Houghton second quarter, 2021 results conference call.
At this time all participants are in a listen only mode.
The brief question and answer session will follow the formal presentation.
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Please note on this conference is being recorded.
At this time I'll now turn the conference over to Michael Barry Chairman CEO and President.
Mr. Barry you may begin.
Thank you good morning, everyone. Joining me today are of Shane who is better our CFO, Robert Traub, Our general counsel and David well, our global controller.
We of slides for our conference call you can find them in the Investor Relations section of our website at Www Dot Quaker Houghton Dot com.
Great deals changed over the past year with the Covid pandemic for us.
So our top priority is and has been the protect the health and safety of our employees and our customers, while ensuring our business continuity to meet our customers' requirements all of our plants around the world are operating and we're continuing to meet our customers' needs. Despite the challenging conditions caused by COVID-19 as well as the current year of global supply chain pressures.
That of impacted raw material availability.
I'm very proud of what the Quaker Houghton team has done the continue to service our customers as well as continue our integration.
Our results for the second quarter were stronger than we expected. This was primarily being driven by continued strong sales while sales volumes were down 3% from the first quarter. The first quarter was unusually strong as we believe some of our customers were replenishing their inventories.
If we compare our second quarter sales in the fourth quarter of 2000 of 'twenty, which was another strong quarter for us our current quarter sales volumes were up 4 per site.
You can see from chart 8 where we show our sales volume trends that our sales volumes were up 35 per cent from the second quarter of last year and half.
Sequentially improve that of steady rate since then with the first quarter of being unusually high as I mentioned earlier.
Overall, our top line revenue was up 52% for the second quarter of 2020.
With all segments showing strong growth.
Since 2000 of 'twenty was particularly hard hit from Covid.
On a sequential basis sales were up 1 per cent for the first quarter with 3 of our 4 of 6 segments showing growth, but our Asia Pacific segment was down 5%.
Overall sales for 8 for Asia Pacific continued to be strong, but did sequentially declined compared to the first quarter due to unusually strong demand in the first quarter in our China on metalworking does on us.
This is largely due to certain customers replenishing their supply chain in the first quarter.
We're also seeing higher selling prices, which we estimate increased an overall, 6% in the quarter with increases in all 4 segments.
I also want to point out that our ability of the gain new piece of the business and take market share also contributed to the strong performance as our analysis shows we had total organic sales growth due to net share gains of approximately 4% in the second quarter of 2000 of 'twenty, 1 versus the second quarter of 2000 of 'twenty.
So we continue to feel good about our ability to deliver on our historical performance of consistently growing 2 to 4 percentage points above the market due to our share gains and looking forward. We continue to feel good about these levels of the share gains given the opportunities. We have recently won or right or are actively working on.
While the strong sales were a positive for us on the quarter a clear negative was the continued increase in our raw material costs.
Well, we knew raw material costs were increasing the last time, we talked the increases have continued lager and out of a higher level than we expected.
Overall, our cost of raw materials have increased an additional 10% since our last call in may and what our original expectation was that they would begin to stabilize in June.
This has not been the case, there's tremendous stress on the supply chain of raw materials and logistics further of the availability of raw materials has impacted us at times for I'm proud to say that we've navigated the so far and of ensured that all of our customers' businesses continue to operate.
The increase in raw material cost.
Did put downward pressure on our gross margin in the second quarter and this increase in raw materials will continue into the third quarter, just given the sheer magnitude and duration of the additional increases and the lag effect, we experienced between the time raw material cost increase and the time, we have to fully implement price increases to all.
Offset them.
So overall, we're very pleased with the quarter given the raw material issues. We are facing as we achieved our second highest quarterly adjusted EBITDA ever.
Our trailing 12 month adjusted EBITDA is now 277 million compared to the $222 million in 2000 of 'twenty.
So we are already experiencing the step change we projected in our profitability.
Synergy of Chi and that also was a factor on our results as we achieved $18.5 million in the current quarter compared to $12.5 million last year.
Related to our liquidity, we did increase our net debt in the quarter due to increases in our working capital related to raw material costs and availability. However, our leverage ratio of net debt to adjusted EBITDA continued to improve from the 3.1 of at the end of the first quarter to 2.7 now.
As we look forward for the third quarter, we expect short term headwinds from higher raw material costs and additional impacts in the automotive market due to the continued the semiconductor shortage and some typical seasonality impacts.
I do not see the third quarter as our lowest quarter of the year of both in terms of gross margin and profitability.
However, we do expect our margins and profitability to sequentially improve in the fourth quarter.
We expect raw material prices to stabilize by the end of the third quarter, and we expect our product margins to get back to their target of levels as we exit the year.
As I think about our full year, we are continuing with our previous guidance, which is the floor or the low end of our expected adjusted EBITDA. However, I'm more optimistic on the year that I was several months ago, well, we may end up the year in the same place or slightly better based on restaurant first half that the.
The shape of our years expect the profitability trend has changed essentially we are seeing higher demand for the year, but greater margin pressures in the near term, which is expected to be largely offset the loss at this higher demand.
However, the margin pressures are expected to be short term in nature once our price increases are fully implemented.
So we are currently expect to exit the year at a better than expected demand for our products and our product margins largely returning to our expected levels.
So even though we expect the year's profitability to be in a similar or slightly better place compared to our previous expectations.
I feel better about the scenario than the already positive 1 I envisioned a few months ago.
We will have a step change on our profitability essentially complete our integration cost synergies continued to grow above the market by taking share and reach our target of net debt to adjusted EBITDA leverage of 2.5.
In closing I want to thank all of our colleagues at Quaker Houghton, whose dedication and expertise helps to create value for our customers and shareholders and differentiate us from the marketplace.
I'm so proud of how our team has performed and servicing our customers.
Meeting their needs and successfully continuing on with our integration execution, which is both critical and difficult for us given the conditions conditions, we face piece.
People are everything on our business and by far our most valuable asset and ensuring their safety and wellbeing is and will continue to be a top priority for us.
So I can't help but the re emphasize my pride for our Quaker Houghton team and what we have and we'll be able to accomplish for our customers and investors, both now and going forward.
And that concludes my prepared remarks on the I'll hand, it over to Shane So that he can review some of the key financials for you for this quarter.
Thanks, Mike and good morning, everyone.
Before I get into the results for the quarter I'd like to remind everyone. The comments made during this call include forward looking statements, which are based on current expectations and are subject to risks and uncertainties that could cause our actual results to differ materially.
For further discussion of these risks. Please review the cautionary statements regarding forward looking statements included in our earnings release, and our form 10-Q, which will be filed with the SEC. Later. This week. In addition, please reference our risk factors disclosed in our 2020 form 10-K for more discussion of the company's risks that could also impact our forward looking statements.
In addition, Mike and I make reference to several non-GAAP measures during the school.
And the this call such a consistent with the press release and called charged filed yesterday and also their of reconciliations between the U S. GAAP measures and non-GAAP measures provided in our culture. It's on pages 11 through 'twenty 2 for reference.
Looking at our second quarter performance, we had another strong quarter and as Mike mentioned it was really the story of a positive solid topline performance, but tempered by a negative higher input costs due to the global supply chain disruption that we and the rest of the world are currently facing.
As I begin to discuss our quarterly performance of point, you to slide 6.7 and 8 and our cultures, which provide a further look into our financials and also I want to remind everyone that our prior year comparison was heavily impacted by COVID-19, hitting us the hardest in the second quarter of 2020.
Our record net sales of $435.3 million increased 52% from the prior year and this was driven by 35 per cent higher volumes 8 per cent from foreign exchange 5 per cent from acquisitions and 4% from price and mix.
When looking sequentially, we were up 1% from the first quarter as increases from our pricing initiatives offset about 3% lower volumes quarter over quarter.
As the first quarter enjoyed some additional volumes due to the customers replenishing their inventories.
Turning to our gross margin trend our second quarter margin ended at 35, 5%, which as we expected was down roughly 1% sequentially due to the pricing lag the Mike previously discussed.
That said, we did show improvement compared to <unk> 34 per cent in the prior year, but this 1.5% improvement year over year. It was really due to the impact of fixed manufacturing costs on prior year low volume levels as well as the benefit of strong execution of integration synergies, which offset higher raw material costs on the current quarter.
We expect third quarter gross margin to be at or somewhat below our second quarter level before beginning to increase in the fourth quarter as.
As we exit the year, we do expect our product price to catch up to the current your raw material increases however, the impact of price increases to our top line will naturally impact our overall gross margin levels as we price to ensure we retain our product margins at least on a per kilo basis to ensure we maintain our levels of gross profit in dollar.
Rather than per cent.
SG&A was up $22 million compared to the prior year quarter as we had additional direct selling costs due to our increase in sales higher labor and other costs that were directly impacted by Covid last year additional costs associated with our recent acquisitions and higher SG&A due to the impact of foreign exchange, which were partially offset by additional savings.
From integration cost synergies the.
The net of this performance resulted in our second highest ever adjusted EBITDA of $70.1 million for the quarter up 118 per cent compared to the prior year of Covid impacted $32 million.
As you can see in short 9 this increased our trailing 12 month adjusted EBITDA to a record $277 million.
From a segment perspective. These worlds results for really driven by higher operating earnings in each of the company's segments year over year.
This was certainly attributable to the prior year weak performance due to COVID-19, but this quarter also benefited from recent acquisitions higher integration cost synergies as well as the market share gains Mike previously mentioned.
When looking at our segments of the sequential performance each segment's top line was above the first quarter as global pricing initiatives offset some volume decline quarter over quarter with the exception of Asia Pacific who had a decline in sales as the experienced a very strong first quarter, specifically in certain China metalworking markets.
Each segment's top line performance drove the sequential operating performance to be relatively consistent compared to the first quarter in the Americas, EMEA and U S. B as the pricing initiatives, largely offset lower volumes and the impacts of higher raw material costs.
Whereas Asia Pacific did have a sequential decline in earnings which was largely due to their exceptional first quarter that I previously mentioned.
From a tax perspective, we had an effective tax rate of 32, 2% in the quarter compared to 57, 9% in the prior year excluding.
Excluding various 1 time items in each period, our tax rate would have been 24 per cent for the current quarter compared to 18% in the prior year, which was a bit low due to the impacts from COVID-19 on our effective tax rate.
To note, we do expect or both of our third quarter and full year effective tax rates will be in the range of 24 to 26 per cent.
Our non-GAAP earnings per share of a dollar of 82 grew over 700 per cent compared to the prior year as our strong operating earnings coupled with over 1 million of interest savings due to the lower borrowing rates were partially offset by slightly higher tax expense.
As we look to the Companys liquidity summarized on chart 10 of our net debt of $759.2 million increased about $9 million in the quarter, which is primarily driven by $7.1 billion of dividends paid $6 million of additional investments and normal capex as well as the small acquisition.
Which were partially upset by $3 million of operating cash flow.
The quarter's low operating cash flow was driven by further investment in the company's major capital requirement working cap working capital.
Specifically the company had considerable increases in the inventory, which were due to higher raw material costs restocking of low levels, given past impacts of COVID-19 as well as bulk purchases to ensure safety stock given the disruption in our global supply chain.
Looking ahead to the second half of the year, we believe our operating and free cash flow will return to the typical levels. We've demonstrated in the past as we don't believe we will have such dramatic increases in working capital to sustain our day to day operating requirements.
Despite an increase of net debt the company was able to significantly improved our reported the leverage ratio to 2.7 times as of Q2.2021 compared to 3.1 times at the end of March.
Overall I want to emphasize we are committed to prudent allocation of our capital. This includes prioritizing debt reduction while continuing to pay our dividends, which we just announced the 5% increase as well as investing in acquisitions that provide growth opportunities, which makes strategic sense.
And all while remaining committed to reducing our leverage which we still expect to be at our target of 2.5 times by the end of the year.
So to summarize Quaker Houghton had another strong quarter that was above our expectations due to continued strength in demand a good market share gains, which partially offset higher input costs, our liquidity remains very healthy.
Remain committed to our overall capital allocation of deleveraging strategy.
That concludes my remarks, thank you for your interest in Quaker Houghton and I'll now turn it back to Mike.
Thanks, Shane will now open it up for questions.
Thank you.
At this time, we'll be conducting a question and answer session if.
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1 moment, please while we poll for questions.
Thank you on our first question is from the line of Mike Harrison with Seaport Global. Please proceed with your questions.
Hi, good morning.
Good morning, Mike or Mike.
Grant's on the nice quarter had a couple of questions on the pricing front. The first of all of you mentioned, the 4% price mix number, but I think I also heard of.
On a 6% pricing numbers, so is the 6% pure pricing.
Or was that of sequential number.
Yeah. That's that's what we estimate our prices were higher in the second quarter because of the price increases that we put in place.
So it's it's 6.6% on pricing and maybe a negative mix as the way to think about it.
Yes got it Okay and then.
Are you guys, taking a different approach than the normal in this inflationary environment. So when it comes to pricing are you kind of business as usual or you know are you, putting a I guess more pricing actions in place or going for more global.
Price increases how are you approaching it and I guess, maybe how much more pricing.
Is needed in order to get the type of margin recovery that you've telegraphed a exiting the year.
Yeah and in some ways as business as usual with what's not usual here is just the magnitude and the continuation of of how many increases we have to do in such a short period of time. So that that's what's been the the unusual of that here. So we've had the continually go out.
There are I would say on a you know probably price increase number for <unk> or so and most of our places around the world and looking at price increase the number 5 so you know so it's it's that's very unusual to have to go out that many times and it's just because of the magnitude but again.
Our approaches is similar unusual as it typically is it's just that we had to do it more often again, we're just we're trying to get out there.
To recover it but we always always going to have this kind of the lag effect of that takes place.
And then a couple of questions on the guidance.
Just trying to get a little better sense of your views on Q3, you said you expect the lowest EBITDA of the year, which would be below 70 million.
But if the do you think you should still be ahead of last year's Q3, which was around $64 million and then and then we should be modeling a sequential EBITDA improvement in Q4.
Yeah, it's hard to it's hard to get the exact guidance like that it.
It all depends upon how raw materials.
And the band of course continue on here. So it's I think 1 thing. We you know, we said that our margins will be either at or somewhat below.
From a gross margin perspective, and the so you know I don't think we want to try to give any more guidance on what we already said.
Maybe on the a question on the free cash flow from Ben It sounds like a lot of the working capital investments in the the first half are not going to continue in the second half. So should we expect that free cash flow number to be better than the 160 million you did last year.
Hey, Mike This is Shane.
I wouldn't comment against last year, but certainly it's going to be better than the first half as I think about the working cap of dream. We will have some release of the working capital that we spent in the first half of but I don't really want to comment compared to the prior year.
Alright, thanks very much.
This is Mike.
Our next question comes from the line of for Katherine Griffin with Deutsche Bank. Please proceed with your questions.
Good morning, Thanks for taking the question Asbury.
I wanted to get a sense.
On the impact that you saw in Q2 from the lower automotive demand and the issues that they can't sort of edge. It. The only then well documented I think this earning season and sort of any you know kind of quantification on or just kind of more color. You can provide there would be helpful. So that we can think about it correctly for Q.
3 and and for the rest of the year.
Sure Good morning Catherine.
Yes, we did were impacted by the the semiconductor shortage in the second quarter of certainly.
More so than I would say the first quarter and I think it's hard to quantify weighted we're not going to kind of throw out of any numbers of exactly what that is but but the just to give you. Some work context I guess is that for example in the first quarter of the the year, we did not see really.
Much impact in the China automotive market around this issue, but starting to pick up in the second quarter, there and that will continue into the third quarter here for example, and in other places around the world are continuing into the third quarter. So.
I think eventually as well.
Lighten up but we don't see it in the short term you know I think it's gonna be continue to be an issue or you know.
Tailwind or headwind for us a little bit on the in the third quarter and then hopefully after that it will start to get better but as people have said.
You know I think of originally.
Originally we thought maybe this will be of we'll get it back in the second half of the year, but I think of the people you know.
What we read as of this we'll be extending it to our.
2000 of 'twenty, 2 as well.
Okay, Great and then yeah, maybe on that point I'm wondering if you can kind of opine a little bit for US just on next year and you know kind of what is a normalized you know earnings growth for for Quaker Houghton, maybe on a sort of pre.
He pandemic basis, if there was on.
[laughter] okay.
Think about a normalized the earnings growth.
I would say I the way I think about it as our markets tend to grow on average 1 of the 3 percentage points.
So, let's say on average 2% and then of course, we're trying to and had been continually having additional.
Additional business wins in the marketplace that would increase that up from an additional 2% to 4 percentage points. So let's say on average 3%.
So you know under a normal situation I would say, 5% would be kind of the growth. We would expect to see the the question will be is what kind of conditions. We're facing in 2022, you know if if the for example in semiconductor of if that if that turns to be more positive in <unk>.
We have different end use markets that you know for example, like aerospace that are coming back that's taking longer. So so again, maybe that will be higher than normal next year as well. So it's really hard to kind of give precise numbers on that but hopefully that kind of gives you kind of some sense I would hope, we're still coming back a little bit more from the.
Pandemic next year and that hopefully will lead to a higher than normal growth.
Yeah.
Great. Thanks, and congrats again on the same Quaker.
Thank you.
Thank you Anza reminded me of Christopher I wanted to ask the question. The next question is from the line of Jon <unk> with CJS Securities. Please proceed with your questions.
Hey, good morning, guys. Thanks for taking my question really great quarter good job.
First of all of it can you update us on your expectations for the capital allocation and specifically the M&A environment as your willingness to engage changed and kind of how is the target environment changed since you on last reported.
Sure.
You know from.
We're kind of consistent I think that what we've been saying I think since the combination of.
That was completed 2 years ago is that we really wanted to focus on <unk>.
Reducing our or our debt to and have our leveraged free at this 2.5 level now we're at 2.7 so we're closing in on that and we expect to be there by the end of the year.
So in the meantime, we said we would.
We continue to focus on smaller or a type of acquisitions. We've done a number of those you know since the combination of loss.
The largest being Norman Hay, but then we did to 1 of the December 1 in February of this year.
We've recently made of very small 1 in the coatings area, but.
But that was pretty small so we're going to continue to look at those we are actively looking at a smaller acquisition opportunities, but as I would say as we get into the fourth quarter and it's only the first quarter next year, we will the thing kind of be looking at hopefully a larger opportunities.
Okay, great. Thank you and Michael just wanted to clarify your commentary on on feeling better about the year.
Are you are you, saying that maybe the minimum EBITDA that you're expecting to generate.
Little bit higher than when you entered the year.
And kind of how do you square that with just the.
We reaffirm the guidance that you have out there.
I would say I guess the way I would oppose it is.
I think when I.
I think back of the beginning of the year and how we thought the year was gonna be transpiring.
I would say I feel.
I feel will either get to that same point that we originally expected or where it would be better because of the strong first half.
Uh huh.
But what I feel really of a lot better is kind of how we would exit the year, because we'll be exiting the year with stronger demand profile. So as we enter into 'twenty, 2 we will have stronger demand.
What's kind of keeping it down this year from being even a lot better here as the margin.
The issues that we're facing with raw materials, and hopefully that will be behind us as we exit the year as well. So that's what I'm really kind of trying to emphasize I guess is more of the how we exit the year I think we'll be in a much better place than I expected.
Understood. Thank you for that clarification again, great job.
Thanks, John for sure.
Thank you for.
Next question is the follow up from the line of Mike Harrison of Seaport Global. Please proceed with your questions.
Hi, Thanks for taking a couple of more in terms of the chip shortage impact you guys are in kind of a unique position where you served some automaker Oems directly and you also serves from tier 1 and tier 2 suppliers were there any differences between the.
The types of demand levels that you saw from the Oems and what you saw from the suppliers.
Just trying to get a sense of whether whether the the tier 1 of the tier 2 guys are still continuing to produce even if theres some slowing at the OEM level.
Yeah.
I think of general there, they're both being impacted on a similar way. We we are we do have differences, we do see differences on our portfolio based on obviously different customer mixes that we have and the different things in the different regions like I mentioned with China was really you know from our perspective.
The less affected.
And the first part of the year on now starting to get a little bit more so but in general I think the I would say that our oh.
Oh, we OEM and tier 1 tend to to come.
Come together.
And of similar fashion.
Okay, and then you you mentioned the aerospace business.
The the kind of lagged recovery that you've seen there.
What we're starting to hear is that the narrow body production is picking up on wide body production is still going to remain.
On a pretty depressed do you guys have.
Relatively stronger positions in narrow bodies, such that that's going to help drive recovery or do we really need to see this wide body.
Production rates are recover before your business gets back to pre pandemic levels.
I would say you know it's it's we're on all of all of all of the aircraft and the.
I would say the the main by the study with what has been a main driver for us in the past has been for example, the something like the set of 37, Max that's been up a big Big part of our you know if I look at the 2019 sales on that type of production that they had.
And we are we're seeing you know we're seeing the same thing that they are bigger.
The beginning to produce more.
Certainly it was essentially down on nothing last year and now it's coming.
Coming up and it's probably a little better this year than maybe we had expected but still nowhere near.
Where it was on 2019, but we would expect based on what Boeing said for that to come back overtime. So so again I think that will be it.
Relatively small piece of our overall business.
You know, maybe 4 percentage points of our sales or something like that but but as you know we do see that kind of be above market growth probably for us.
Over the next couple of years.
Alright, and then the last 1 for me are not that we're trying to get rid of you, Mike, but any update on the CEO search process.
Yes, so nothing new to report obviously, if we have news we will be reporting on it but we are continuing on on our process.
Are you now getting towards the you know the.
Let's say the last third of the process at this point, so I would expect that we'd be concluding that over the next the.
Several months on.
Making the announcement at some point.
Is it your hope to have an announcement made before year end, so that there could be kind of the transition period or do you think that yes. The.
Yes, it'll be yeah, like I said I think of it you know it.
It could be announcements all the time in this quarter. So you now see how the process ends up here.
Alright, thanks very much.
Thanks, Mike.
Thank you.
The next question is from the line of Garo <unk> with Palisade Capital Management. Please proceed with your question.
Hey, Good morning, guys wanted to just ask you guys highlighted the market share gains.
Or is it kind of just the the typical market share gains that you you get year on year out or you know with the challenges across the supply chain have you been able to maybe service some customers that you know of competitors.
We're challenged to the service.
Sure.
Great question the Garo.
I would say there are more of the typical gains that we have.
We've actually had some opportunities like you pointed out to kind of step on at times.
But the given how the supply chain is on how short things are we feel it's really been important to continuous service our existing customers. So so not all of them early saying I don't think any of this 4% is really due to anything that.
As picking up new opportunistic business at this time.
Got it.
And then secondly, you know a lot of companies have been really challenged on the labor side and the I guess you guys didn't really highlight that so I'm curious have you had any difficulties there you're because of the the way your business is it is it hasn't been.
As as much of a challenge.
There are certainly pockets of areas, where we are you know people the certain plants in certain parts of the world that you have labor shortages in and where are you now have the manage our way through that but so far that hasn't been a.
The issue that has kept us from.
Losing any sales of our products are you know as the production rather.
Great that's all I got.
Thank you Gary it's true.
Thank you at this time, we've reached the end of the question answer session I'll turn the call over to Mr. Michael Barry for closing remarks.
Okay, given the no other questions, we'll end the conference call now.
And I want to thank all of you for your interest today. Our next conference call for the third quarter will be in early November and if you of any questions in the meantime, please feel free to contact chain or myself. Thanks.
Again for your interest in Quaker Houghton.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.