Quaker Chemical Corporation

Michael F. Barry - Chairman, Chief Executive Officer, President and Member of Executive Committee Margaret M.

Loebl - Chief Financial Officer, Vice President and Treasurer

Laurence Alexander - Jefferies LLC, Research Division Daniel D. Rizzo - Sidoti & Company, LLC Liam D.

Burke - Janney Montgomery Scott LLC, Research Division Summit Roshan - KeyBanc Capital Markets Inc., Research Division Scott B. Blumenthal - Emerald Research

Great. Thank you, Jesse.

Good morning, everyone. Joining me today are Margo Loebl, our CFO; and Robert Traub, our General Counsel.

After my comments, Margo 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 part of our website at www.quakerchem.com. I'll start it off now with some remarks about the second quarter.

Overall, I am pleased to be able to report that we had a solid quarter, and we did so in a challenging environment. Let me now try to give you a sense of what we experienced in the quarter, and I'll start with sales.

Our overall sales were up approximately 5% for the quarter versus 2012, as well as versus the first quarter of 2013. Our volume showed similar growth.

We believe our business strategies are largely responsible for these results, as we are benefiting in 2 ways: one, we continue to benefit from our recent acquisitions; and two, we have grown our volume by executing our business strategies and taking share in the marketplace. So the combination of both the acquisitions and new organic growth is the reason we have continued to do well under difficult circumstances.

Going around the regions. Europe is one of our most challenging regions, relative to the industrial market conditions.

However, sales were actually up approximately 5%. This excludes the impact of our acquisition of NP Coil Dexter from 2012, which added an additional 5% growth in Europe.

We are fortunate that we have been able to pick up share in the marketplace, which has helped us to more than offset the inherent auto and industrial market declines in the region, which we estimate to be 10% or more. In South America, our sales were down 4%, but when adjusted for foreign exchange rates, our sales actually increased approximately 3%.

This increase is primarily due to price and mix effects rather than volume increases. Steel and automotive markets continue to be very challenging in Brazil.

In North America, we saw a decline of sales of 3%. Steel production this year in North America is below steel production last year.

In other North America markets, while autos continued to do well, the other industrial markets are relatively weak. So overall, North America is one of our weaker regions from a market demand perspective.

In Asia-Pacific, we saw a 15% increase in sales as we continue to have good growth for our businesses in both China and India, despite their less than robust economies. One indicator of our success is the percentage of new mills in which we get business.

So far in 2013, we have been awarded new business in 8 out of the 10 new mills being built that we've been on. Looking sequentially, second quarter versus first quarter, our sales were up 5%, with all regions showing growth, except South America.

And South America would have had a slight increase in sales if we adjusted for foreign exchange rates. Some of the growth was due to our continued progress with our key strategic initiatives, which is providing us market share gains.

Seasonality is also a factor in our sequential quarterly gains as the second quarter is traditionally one of the strongest quarters of the year for Quaker. On our gross margins, we saw them expand by 2.1 percentage points from the second quarter of 2012, as our margins are back to more acceptable levels.

This gross margin improvement was very important for our overall profitability given the challenging external environment. So all things considered, we are pleased with our second quarter performance.

While overall demand was relatively weak, we continue to take share and expand our margins to grow our profit. Looking forward, we continue to expect sluggishness and a challenging global economic environment.

Based in our views of our inherent markets, we do not expect any large market demand changes, either up or down, for the near future. Raw materials have been relatively stable year-to-date in 2013, but there are indications that some raw material prices will be going up in a few regions around the world.

The bottom line is that I continue to be confident in our future. We have demonstrated in the past that we can manage through uncertainty, and we expect 2013 to be another good year for Quaker.

In closing, I 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 Margo Loebl, our CFO, so that she can provide you with more details behind our financials.

And after that, we will address any questions you have.

Thank you, Mike. Good morning, everyone.

Turning to the financial portion of the call today, I will reiterate that Quaker continues to deliver solid results in the second quarter of 2013, despite a difficult global economic environment. Quaker announced net sales of $184.8 million for the second quarter of 2013, up approximately 5% compared to the second quarter of 2013 net sales of $176.8 million.

Earnings per diluted share for the second quarter 2013 were $1.22 compared to $0.85 for the second quarter of 2012. For the first 6 months of 2013, the company reported net sales of $361 million, up approximately 2% compared to the first 6 months of 2012 net sales of $354.4 million.

Earnings per diluted share for the first 6 months of 2013 were $2.26, compared to earnings per diluted share of $1.80 for the first 6 months of 2012. In the past few quarters, I note that we have started to provide a non-GAAP earnings per diluted share table in an effort to provide shareholders with visibility into the Quaker operation, excluding certain items, which we believe do not reflect our ongoing operation.

Particularly, knowing our captive insurance company, Primex, was not indicative of our ongoing operations and will continue for the foreseeable future, our preference was to lay out these non-GAAP measures for you. I will walk you through our approach to non-GAAP adjustments in yesterday's earnings release.

Please note that non-GAAP earnings per diluted share were $1 for the second quarter of 2013, compared to $0.90 for the second quarter of 2012. The adjustments to get to non-GAAP earnings per diluted share include: in the second quarter of 2013, $0.14 per share related to the recovery of a mineral oil excise tax refund in related interest; $0.13 per share related to equity income in a captive insurance company, Primex, as I mentioned; a $0.03 per share charge related to a change in an acquisition-related earnout liability; and a $0.02 per share charge related to certain cost streamlining initiatives; in the second quarter of 2012, $0.04 per share related to equity income in Primex; a $0.03 per share charge related to CFO transition costs; and a $0.06 per share charge related to certain customer bankruptcy costs.

Please note that the non-GAAP earnings per diluted share were $1.96 for the 6 months ended June 30, 2013, compared to $1.81 for the 6 months ended June 30, 2012. The adjustment to get to non-GAAP earnings per diluted share in this case include: in the first 6 months of 2013, $0.14 per share related to the recovery of mineral oil excise tax refund and related interest; $0.24 per share related to Primex; a $0.03 per share charge related to a change in acquisition-related earnout liability; a $0.02 per share charge related to certain cost streamlining initiatives; and a $0.03 per share charge related to the devaluation of the Venezuelan Bolivar; in the first 6 months of 2012, $0.08 per share related to Primex; a $0.03 per share charge related to CFO transition costs; and a $0.06 per share charge related to certain customer bankruptcy costs.

With that said, now let's take a deeper look at Quaker's performance in our reported financial results for the second quarter 2013. As shown on Chart 4, on the investor's slides we provided, second quarter 2013 product volumes including acquisitions were at record levels, up from the same quarter last year and versus the previous quarter.

Turning to the financial snapshot shown in our Chart 5. Net sales for the second quarter of 2013 were $184.8 million, an increase of approximately 5% from net sales of $176.8 million in the second quarter of 2012.

Product volumes, including acquisitions, increased revenues by approximately 6%, which was partially offset by a decrease of less than 1% due to selling and price mix. The impact on net sales due to foreign exchange rate translation was relatively consistent between the second quarter of 2013 and the second quarter of 2012.

On a year-to-date 2013 basis, net sales for the first 6 months of 2013 were $361 million, an increase of approximately 2% from $354.4 million in the first 6 months of 2012. Product volumes, including acquisitions, increased revenues by approximately 3%, which were partially offset by a decrease due to foreign exchange rate translation of approximately 1%.

The effect of selling and price mix on net sales was relatively consistent in the first 6 months of 2013 compared to the first 6 months of 2012. A summary observation regarding our top line growth.

We have been able to take share and leverage our acquisitions despite continued economic challenges in the markets around the world, most notably in Europe and Asia for the first 6 months of 2013 and especially in the second quarter of 2013. Looking at gross profit and margins on Charts 5 and 6.

We had a gross profit increase of approximately $6.7 million or approximately 11%, from the second quarter of 2012. The increase in gross profit was primarily driven by an improvement in gross margin to 36.4% from 34.3% in the second quarter of 2012 and 35.5% in the first quarter of 2013.

This increase in gross margin reflected the company's product margins have returned to more acceptable level. With respect to the first 6 months of 2013, gross profit increased by approximately $9.5 million or approximately 8%, from the first 6 months of 2012.

The increase in gross profit was driven by an improvement in gross margin to 36% from 34% in the first 6 months of 2012, reflective of the company's product margins returning to more acceptable levels, as noted previously in my conversation. Going forward, potential increases in raw material prices as an example could put pressure on gross margins in the second half of 2013.

Moving down the income statement. Selling, general and administrative expenses increased $3.9 million or approximately 9%, in the second quarter of 2013 from the second quarter of 2012, primarily due to increased costs related to acquisitions, higher incentive compensation and higher selling, inflationary and other labor-related costs.

Included in SG&A for the second quarter of 2013 was an expense of approximately $0.4 million or $0.02 per diluted share, which related to actions taken to streamline the costs of certain business operations. Included in the second quarter of 2012 were charges of $1.2 million or $0.06 per diluted share, associated with the bankruptcies of certain U.S.

customers, and $0.6 million or $0.03 per diluted share, related to the transition of the company's CFO. From a year-to-date perspective, SG&A increased approximately $6 million or approximately 7%, from the first 6 months of 2012, primarily due to increased costs related to acquisitions, higher incentive compensation and higher selling, inflationary and other labor-related costs.

Also included in SG&A for the first 6 months of 2013 was an expense related to streamlining the costs of certain business operations, as I noted previously in this call. Compared to these increases in SG&A for the first 6 months of 2013, there were decreases due to foreign exchange rate translation and the prior year costs associated with the bankruptcies and CFO transition noted in the previous comment.

Continuing down the income statement. Other income for the second quarter of 2013 included a refund of $2.5 million or $0.14 per diluted share, related to excise taxes paid on certain mineral oil sales, which was partially offset by the increase in the fair value of an acquisition's earnout liability of $0.7 million or $0.03 per diluted share.

Also, there were lower foreign exchange rate translation losses in the second quarter of 2013 compared to the second quarter of 2012, contributing to the increase in other income. By way of background, this excise tax matter dates back to 2002 and 2003, when the company's Netherlands and Italian operations were paying excise taxes on mineral oil sales in Italy while, at the same time, the company filed an action against the Customs Authorities of Milan, requesting a refund on the basis that the mineral oil excise tax was contrary to European Union directives.

After prevailing in the courts, Quaker received a refund plus interest totaling $2.5 million only now in the second quarter of 2013. Other income increased in the first 6 months of 2013 compared to the first 6 months of 2012, for largely the same reasons as the increase related to the year-over-year comparison of the second quarter.

The decreases in interest expense was due to lower average borrowings and lower interest rate experienced in the second quarter of 2013 as compared to the second quarter of 2012, as well as for the first 6 months of 2013 versus the first 6 months of 2012. The company's effective tax rate for the first 6 months of 2013 and 2012 of 28.3% and 26.1%, respectively, reflect decreases in reserves for uncertain tax positions due to the expiration of applicable statutes of limitations for certain tax years of approximately $0.10 and $0.12 per diluted share, respectively.

Also contributing to the increase in the effective tax rate is an increase in the statutory tax rate in China from 15% in 2012 to 25% in 2013. While the company's recertification of its Chinese subsidiaries' high-tech status is pending, the company will record tax expense at the current statutory rate of 25%.

The company's experienced and expects to further expense volatility in its effective tax rate due to the varying timing of tax audits and expiration of applicable statutes of limitations, as they relate to uncertain tax positions among other factors. The company currently estimates that its effective tax rate will be in the high-20% range for the full year of 2013.

Moving on. The increase in equity in net income of associated companies from the second quarter of 2012 was primarily due to higher earnings related to the company's equity interest in Primex.

Earnings from this affiliate were $1.7 million or $0.13 per diluted share, in the second quarter of 2013, compared to $0.6 million or $0.04 per diluted share, in the second quarter of 2012. Also, equity in net income of associated companies also increased in the first 6 months of 2013 compared to the first 6 months of 2012, due to higher earnings related to the company's equity interest in the captive insurance company or Primex.

Earnings attributable to this equity interest increased from approximately $1 million or $0.08 per diluted share, for the first 6 months of 2012 to approximately $3.1 million or $0.24 per diluted share, for the first 6 months of 2013. This increase in equity and net interest associated -- of associated companies was partially offset by a charge of approximately $0.4 million or $0.03 per diluted share, related to the devaluation of the Venezuelan Bolivar forte during 2013.

Changes in foreign exchange rates negatively impacted the second quarter 2013 net income by approximately $0.1 million or $0.01 per diluted share, while changes in foreign exchange rates also negatively impacted the first 6 months of 2013 net income by approximately $0.2 million or $0.01 per diluted share. In Chart 7 of our investor's slides, adjusted EBITDA of $84.4 million on a trailing 12-month basis is up sequentially versus adjusted EBITDA of $80.9 million at the end of 2012.

This wraps up my review of the income statements. In turning to Charts 8, 9 of the slides, the company's net operating cash flow for the second quarter of 2013 was $16.2 million, which increased its year-to-date 2013 net operating cash flow to $27.5 million, as compared to $21.9 million for the first 6 months of 2012.

The increase in the company's net operating cash flow during the first 6 months of 2013 was primarily driven by increased net income and improved working capital management, and the receipt of a $2 million dividend from Primex. Notably, during the second quarter of 2013, the company revised its credit facility, increasing the amount available for borrowings from $175 million to $300 million, which provides the company further financial flexibility for potential future acquisitions.

The baking market was very strong and we were able to take advantage of the market opportunity and negotiate a 5-year credit facility with favorable terms. In addition, as of June 30, 2013, consolidated cash is up $6 million from year end 2012.

At the end of the second quarter 2013, Quaker had $38.5 million of cash on hand versus $23.9 million of debt at the end of the second quarter 2013. As such, the company's net cash debt position was $14.6 million at the end of the second quarter 2013, and its consolidated leverage ratio was less than 1x EBITDA.

In conclusion, I, too, would like to personally thank all of the Quaker Associates around the world for their never-ending commitment to our customers and contributions to the success of Quaker. This concludes my prepared remarks for today.

Thank you. And I will now turn the call back over to Mike.

Thanks, Margo. At this stage, we'd like to address any questions from any participant on the conference.

I guess, just a couple of questions. First, just a rather simple one.

When you look at the product volume by quarter slide, I guess that's number 4, there seems to be a pattern of the Q3 volumes being flat to slightly up from Q2. I just wanted to get your sense of how we should think about that cadence?

I mean, are you seeing -- and also, given the jump you've seen in Q2, any end markets or regions where you're seeing a sequential acceleration right now? I mean, above normal seasonality?

Sure. I mean, second quarter, it's hard to tell from that slide.

Like, for example, in the second quarter of last year, I guess early July of last year, we made an acquisition in Europe that would've increased the third quarter versus second quarter last year. But in general, I think the second and third quarters are traditionally our better quarters of the year, from a volume perspective, because there tend to be less holidays.

In the first quarter and fourth quarter, you tend to have more holidays in the mix. And then as far as the regions right now, I really -- I don't see -- as far as an acceleration or changes in any region, I don't -- we don't expect major changes one way or the other.

I'm just thinking of steel production and the various regions around the world or auto production and we don't get a sense that any of the regions right now are, let's say, accelerating around the world.

And then, I guess just secondly, as you think about the types of projects your customers are asking you to work on, are you seeing any shift or negative mix effects or attempts to move to lower-cost solutions? Or what's -- are there any themes in terms of the types of R&D they're asking you to do?

Well, our customers, for the most part, especially if you look at our steel business, our steel customers are not very profitable at this point. So those customers are, at times, asking or looking for other solutions, which can kind of do the same or similar type of things at a cheaper cost, but they have to be careful.

We have to be careful with that, as well as recommending, because our products provide a certain value to the customers in their process. So -- but there could be opportunities, there could be chances a customer may be just wanted to cut cost so much, that they could want to switch to a lower-cost product.

Okay. And then just lastly, are there any structural reasons or comments from your customers that require you to maintain a fairly strong balance sheet?

Or are you sort of rethinking your attitude on sort of your balance sheet strength, given -- or leverage levels, given where interest rates are?

Right. No, there's no customer constraint from that perspective.

Certainly, we have -- our balance sheet is under levered at this point. And we -- our goal is to make acquisitions and we continue to look at opportunities to make acquisitions.

But obviously, if we did not find adequate acquisitions over time, we have to find other ways to use that balance sheet to provide a value for our shareholders.

You indicated that you want to see contracts bid on, which is great. Can you tell us how many additional contracts you'll be bidding on this year?

Or is that something you can't disclose?

I don't have it's -- I don't have a lot of information in front of me, but it's really, generally, anytime a new mill comes up for -- gets commissioned, we are part of that process, as a general statement. So in general, I would say in the past few years, if I just give rules of thumb, you tend to have maybe 10 to 15 type of new mills being built around the world.

And, of course, the majority of those mills right now are being built in the Asia-Pacific region. So a lot of them going in into the Southeast Asia or China, India, that -- those areas.

Okay. And then, the last couple of quarters, SG&A as a percent of sales has been about 25%.

Is that the type of run rate we should think of when -- just modeling out forward?

Yes. I think if you look at our long-term averages, that's not a bad indication.

Quarter-to-quarter, you can have fluctuations. We mentioned a number of things that were in this quarter, that might have been a little more unusual.

But yes, if you look at the longer-term trends, that's not a bad indicator.

Mike, you talked about market share gains and, as did Margo. Are you seeing market share gains in both the legacy Quaker product as well as acquisitions?

And have you seen any competitive response with price?

We -- on the first question as relative to -- yes, it's basing on our base business rather than, as far as market share gains, the way we think of it. So we are picking up pieces of business around the world, different mills, maybe that we haven't had historically.

So we continue to do that in our core businesses. And then, as you mentioned, we are -- continue to pick up new pieces of business relative to the acquisitions, the new technologies that we purchased over the past 3 years, where we brought in kind of new 4 -- 4 new different kind of new technologies in our product portfolio that we didn't have before.

So we're kind of growing in both those areas right now. And as far as price, there's always a competitive environment, and there's always things going on.

Generally, we -- our goal is certainly to sell on the value and the total offering that we're making and the value we can provide to the customers at a price. But sometimes, the customers or the competitors will try to maintain share and drop their price, that's for sure.

Okay. And the pipeline on acquisitions, is it maintaining itself?

Or are you seeing a slowing or building up?

We're going to keep continuing to go down a lot tracks. I don't think there's anything right now that's imminent, but we continue to have discussions and continue -- and hold different -- looking at our different segments of business and different geographies, to have those conversations and all up.

Acquisition is it takes 2 people to make it work. And so you never know when that is going to happen.

But it's something we're very actively working on in a lot of different fronts.

Just a quick one on raw materials. You had noted that you saw some indications that might be trending up in the second half.

Is that largely just on the back of crude oil being up over the last month or so? And then if you could remind us, how much of your raw materials is tied to the petrochemical chain?

Well, we have -- we kind of major -- 3 major buckets of raw materials, the way I think about it. You have mineral oils, which is the big chunk, but less than 50%.

And then you also have animal fats and vegetable oils. And you're right, crude has gone up a little bit.

We don't know what that will translate into a higher mineral oil prices. Generally, it will over time.

We have seen some on the animal fat market, some increases going on. And then vegetable oils, it's been a relatively good run for them.

They've been good pricing, but we see -- we sense some tightening, especially like in coconut oil. But so -- and then when I think about another aspect of this, as you know we have indexes, as well with our -- some of our customers, and you kind of have these lag effects in indexes as things kick in.

When you put all of that together, we kind of definitely see some of our raw materials potentially here going up in the third and fourth quarters, and putting some pressure on our margins. And one thing, I'd just reiterate some things I've said in the past about our gross margins is that long term -- longer term, we expect to have gross margins in the 35% range.

And now, we're slightly above that.

Okay, great. And If we go back to kind of taking market share, you've done generally well in Europe here.

Can you maybe give a little bit more color on maybe why that's Europe's specific story? Maybe why that type of level of market share gains haven't translated into say, North America or Latin America?

Well, we have taken share. You have to look at your, kind of some of these time periods we're talking about.

So if I look back in North America, in particular, over the past several years, we have taken some really nice share in our core steel markets and the mining markets. So sometimes when you look at a quarter-to-quarter thing, you kind of -- it doesn't kind of show up, but if you look at the longer term, and if you look at the longer term or the medium-term perspective in all these regions, we have, in every region in the world of taking share.

I think in this case, with Europe is that we've gotten some nice pieces of business that were significant in nature that a lot of thoughts that the inherent demand loss in that market.

Just one question for you, Mike. You mentioned that price and mix drove sales down a little bit during the quarter, less than 1%.

Can you identify any products, geographies, where you might have actually had negative pricing?

Well, we certainly have index contracts around the world. It was different customers, and some of those can go up or down.

I don't have that information in front of me, per se, but sometimes when a customer is buying a certain product and that product has a certain raw material, predominant raw material in it, that -- maybe that raw material went down in one quarter, you can see negative pricing. So I don't have any real specifics around pricing per region or anything like that.

But that would be specific to a particular raw material and not necessarily an indication of the end demand in your market?

Right. That's correct.

Okay. Given that there are no questions, we'll 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 second quarter and we continue to be confident in the future of Quaker Chemical.

Our next conference call for the third quarter results will be in late October or early November. And if you have any questions in the meantime, please feel free to contact Margo Loebl or myself.

Thanks again for your interest in Quaker Chemical.