Feb 26, 2009
Executives
Mike Barry – CEO and President Mark Featherstone – VP, CFO and Treasurer
Analysts
Liam Burke – Janney Montgomery Scott Robert Felice – Gabelli & Co. Mark Rushco [ph] – Raymond James Associates Daniel Rizzo – Sidoti & Co.
Operator
Greetings ladies and gentlemen and welcome to the Quaker Chemical Corporation fourth quarter and full year earnings conference. 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 Mr. Mike Barry, CEO and President, Quaker Chemical.
Thank you, Mr. Barry, you may begin.
Mike Barry
Thank you. Good afternoon, everyone.
Joining me today is Mark Featherstone, our Chief Financial Officer; and Jeff 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.
But I will start it off now with some remarks about the fourth quarter, what we are currently seeing in our marketplace and discuss what actions we have taken to address the market realities that we are facing. The first quarter was a very poor quarter for us after posting three very strong quarters.
For the fourth quarter, we had a loss of $0.25 per share, which included a restructuring charge of $0.18 per share. However for the full year, we were still profitable and made $1.05 per share even with the restructuring charge.
We saw a dramatic decline in our fourth quarter demand with volumes being down 25% versus 2007. Since October we still have descent volume for us, the volume declines in November and December were even more severe, and many of our customers temporarily shutdown blast furnaces or stopped production for an extended period over the holidays.
We saw the declines in all regions of the world. For example, at the beginning of the quarter the information we received said that South America only be down slightly since most of their steel and automotive facilities were operating at high levels.
Unfortunately, South America ended up being hit as hard as the United States and Europe. Even China saw decline in volumes, but not as much as our other three regions.
Just to give you some more flavor for the type of declines we saw, in December, our overall volumes were down nearly 40% when compared to our average September year-to-date 2008 monthly volumes. So what are we seeing now?
We are seeing volumes gradually increasing. January volumes were up slightly from December volumes, and we expect to have gradual improvements as the year progresses, as our customer base brings back capacity and slowly increases production levels.
However, we do not expect our volumes to return to levels seen prior to last October any time soon as there is still a great deal of uncertainty in the global economy. Despite this, we expect to be profitable in 2009 even with lower volumes.
And that is what I want to discuss now. What are we doing to help offset the impact of lower volumes on our profitability?
The first item I’ll talk about is a set of cost reduction actions we have taken. The first action was in December and it eliminated more than 80 positions in the United States and Europe.
In addition, we cut back discretionary spending in numerous ways. As the size and duration of the volume decline became clear here in the first quarter, we decided we needed to take more action to further reduce our costs.
In February, we implemented another round of cost reductions. Among other evict actions, over 50 additional positions were eliminated, no corporate bonus was paid out for 2008, we suspended our 401(k) plan match for 2009, and a general salary freeze was implemented where legally possible.
The second item relates to our margins; we expect our margins to begin returning to more acceptable levels. Our margins were negatively impacted last year to very large increases on our raw materials.
For example, in 2008 our raw materials increased more than the previous three years combined. We are currently seeing declines in some, but not all of our raw materials and we were able to get price increases at many customers in the second half of 2008.
If you look at our gross margin in the fourth quarter, it was down significantly, 24.2% versus 30.6% in 2007. This is due to a combination of higher raw materials and low volumes as our manufacturing and other costs are spread over a lower volume.
So as we enter into 2009 we do expect to see our gross margins return to more normal or acceptable levels. The third item that will help us offset the decline in profitability due to lower volumes is new business.
We are continuing to pick up new pieces of business in mining; automotive with some new conversions at our CMS sites; and also in our steel business. While these pieces of new business are relatively small compared to the overall volume decline, when put in combination with improving margins and our cost reduction actions we expect to get through this period of uncertainty in a profitable manner.
We also completed an amendment to our credit facility earlier this month. Mark will go through some of the changes, but the bottom line is that we now have exclusion of our recent restructuring charges and some CEO transition costs from our leverage ratio calculation, as well as some temporary expansion in (inaudible) of our leverage ratio.
These changes will provide us more financial flexibility during this uncertain economic period. A question that I am sure is on everyone's mind is our dividend.
As many of you know, Quaker has paid a steady or increasing dividend without fail since 1972 when we became a public company. So we realize the importance of the dividend to our investor base.
Prior to the record date of each quarterly dividend, the Board does an evaluation of whether a dividend should be declared. So in December of this past year, the Board and management evaluated all the factors and determined that we would declare a dividend for January.
We will go through the same process again in March with the Board. So I just want to say that there will be no discussion at the Board level, there has been no discussion at the Board level yet on the April dividend and it will not be until next month.
I will wrap up my opening remarks by commenting that despite this uncertain period, we feel confident about our future. We believe the actions we have taken will enable us to be profitable despite the large declines in volumes in our customer base.
We are also continuing to invest in our key growth initiatives. As a mentioned in our press release, while 2009 will be a challenging year for Quaker we remain confident that our business model, strong associate base, key growth initiatives and solid balance sheet will get us through this difficult period in 2009 in a profitable manner and position us well for the future.
And now I will 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 questions that you may have.
Mark?
Mark Featherstone
Thank you, Mike. Good afternoon everyone.
Yesterday we announced a fourth quarter 2008 loss of $0.25 a share, which included a fourth quarter restructuring charge of $2.9 million. Excluding the restructuring costs, results were slightly below break-even due to the dramatic decrease in volumes we experienced as the quarter unfolded.
The restructuring actions we took in the fourth quarter occurred late in the quarter and therefore the resulting savings did not have a significant impact on the fourth quarter results. However, these savings are in place for the full year of 2009.
In addition, as Mike discussed, based on lower volume projections than originally forecast when we did the fourth quarter 2008 actions, we have taken additional restructuring and cost reduction actions in 2009 to further reduce costs. I will spend the next few minutes focusing on the fourth quarter P&L and then we will go on to questions.
As Mike mentioned, revenues in the fourth quarter compared with the same period last year were down 18% to $116.2 million. Double-digit volume decreases were experienced in all regions with the steepest declines being experienced in Europe and North America.
The drop in volumes was partially compensated by pricing improvements to help offset higher raw material costs. Foreign currency exchange also decreased revenues be approximately 4% as the US dollar was stronger against most currencies, in particular the euro and the Brazilian real.
Regarding volume, overall volume for the quarter was down about 25%. Overall pricing mix was up about 11% from last year's fourth quarter and the higher sales reflects our continuing efforts to work with our customers to deliver value but also recognizing the impact of higher raw material costs.
Now some raw material prices actually increased during the fourth quarter, particularly in Europe and South America due to the strengthening of the US dollar against those currencies. I would like to now give some data on the segment basis.
We segment the business into three areas. Metalworking Process Chemicals, Coatings, and Other Chemical Products.
In our Metalworking Process Chemical segment, which makes up 93% of our sales, revenues in the fourth quarter compared with 2007 were down 19% to $108.9 million [ph]; and operating income decreased to $6.1 million, which is a 67% decrease. Sales in our Coatings segment, which makes up about 6% of our sales, decreased about $1.5 million or 18% due to lower chemical milling maskants sold to the aerospace industry.
Now, sales in this segment were impacted by the strike at Boeing. Operating income decreased 26% to $1.5 million.
In the smallest segment, representing 1% of total sales, which is called Other Chemical Products, sales were up $0.1 million.
In addition, as I mentioned previously, in Europe and South America the significant strengthening of the dollar against those currencies also resulted in some higher raw material costs. Another factor is that margins were also hurt where our pricings are tied to indexes and the new index price did not go into effect until late in the fourth quarter or in the first quarter 2009.
And finally, margins were also impacted by unfavorable change in product mix as well as the effect of spreading relatively fixed manufacturing and other costs over a smaller volume base. While crude oil prices have declined significantly in the last few months, our raw material costs have been very slow to follow.
We have implemented limited pricing increases in the first quarter of 2009 in certain regions to help recover higher input costs. We are also experiencing some decreases in raw material prices, but overall raw material prices remain significantly higher than prior year levels.
The effective tax rate in the fourth quarter was 25.4% as a result of FIN 48 tax reserves falling off due to audit settlements and statutory expirations, as well as a tax holiday in China. As previously discussed, we expect to continue to experience volatility on a quarterly basis in our tax rate due to FIN 48 and potential change in the income mix.
Turning now to our balance sheet and cash flow. The company's net debt to total capital ratio remains strong at 32%, both at December 31, 2008 and 2007.
I would also like to comment on a few other financial matters. As indicated on our Form 8-K filed February 20, 2009, we have amended our primary credit facility to provide covenant relief for a number of items, including the 2008 and 2009 restructuring charges, as well as CEO transition costs.
In addition, in order to allow increased financial flexibility during these turbulent economic times we've also temporarily increased our maximum leverage ratio, that is the ratio of consolidated debt to EBITDA from a maximum of 3.5 to 1.0 to 4.0 to 1.0 for the second and third quarters of 2009 and it’s at 3.75 to 1.0 for the fourth quarter 2009 and first quarter 2010. As part of the amendment, our credit spreads, other than the credit facility, will range from 2.25% to 2.75% over LIBOR.
The credit facility matures in 2012. We also amended two industrial revenue bonds at the same items.
In addition, as I noted last quarter, the financing for our Middletown capacity expansion is largely in place with little net additional borrowing needed to complete that expansion.
And that concludes my prepared remarks.
Mike Barry
Thanks, Mark. And at this stage, we would like to address questions from any of the participants on the conference call.
Operator
(Operator instructions) Our first question comes from the line of Liam Burke with Janney Montgomery Scott. Please proceed with your question.
Liam Burke – Janney Montgomery Scott
Thank you. Good afternoon Mike, Mark.
Mark, I have a few questions on the capital expenditures. There were roughly $11.7 million for the year.
In the context of your CapEx, what percentage of the Middletown project is reflected in that number?
Mark Featherstone
I think the Middletown is being $4 million of that capital spending.
Liam Burke – Janney Montgomery Scott
Okay. And I should know this, but the total anticipated cost of the project would be?
Mark Featherstone
Around 15.
Liam Burke – Janney Montgomery Scott
Okay. So we'd look for the balance to be in the next year?
Mark Featherstone
Yes, we anticipate fourth quarter completion of that expansion.
Liam Burke – Janney Montgomery Scott
I know you went into detail, Mike, about the relief you have in covenants and in light of the current environment, but are they acquisitions out there that make sense?
Mike Barry
There are acquisitions out there. Of course it takes two to have to agree to an acquisition.
And we continue to have discussions but I honestly don't see anything in the near term happening with us in the year 2009 with acquisitions.
Liam Burke – Janney Montgomery Scott
Okay. Thank you.
Operator
Thank you. Our next question comes from the line of Robert Felice with Gabelli & Co.
Please proceed with your question.
Robert Felice – Gabelli & Co.
Hi guys, just a couple of quick questions. I guess first, what's the magnitude of the cost savings you expect in 2009 from the restructuring actions?
Mark Featherstone
Well, the number – we use a number internally. If we look at the impact it's in the order of $20 million, but that's relative to what we had expected originally to spend in 2009.
So it's not related to any kind of prior period, but that gives you an order of magnitude of the total reductions put in place.
Robert Felice – Gabelli & Co.
Okay, and I guess you know you detailed a couple of actions you're taking or some of the tailwinds you'll have next year to help offset the volume declines, decline in raw material costs, your restructuring, how do I think about balancing the gives and takes next year in terms of profitability?
Mike Barry
Well, it really comes down to what we eventually see is the – in volume. So, again we expect volume to gradually pick up throughout the year, but not get back to where we were.
So it really depends. Certainly, the three items I talked about was margins and cost reduction and new pieces of business.
Certainly there are many scenarios can go a long way to offsetting the volume decline we expect to see.
Robert Felice – Gabelli & Co.
Should we think of fourth quarter profitability as a base case level in the event that volumes don’t improve? Or do you – if we were to assume for a moment that volumes don't improve do you think you could still improve profitability off of this base in the fourth quarter?
Mike Barry
I think with the actions that we have taken even under volumes that we are seeing currently today, we would still be making money.
Robert Felice – Gabelli & Co.
Okay. So I guess as I look to the first quarter do you expect a sequential improvement in operating income?
Mike Barry
You mean quarter-by-quarter throughout the year?
Robert Felice – Gabelli & Co.
No, from first quarter of ‘09 versus fourth quarter ’08, do you expect profitability to improve? I mean obviously you'll have a full quarter of the weaker volumes but with that said, you will also have a full quarter –
Mike Barry
And you have restructuring charges and then other aspects in there –
Robert Felice – Gabelli & Co.
Well, excluding the one-time items.
Mike Barry
Incentive comps, there more incentive comp came back into the fourth quarter and so forth that obviously wouldn't be in there in the first quarter. But stripping out those kinds of items we certainly expect to see sequential improvement, absolutely.
Robert Felice – Gabelli & Co.
Okay. And then I guess if my math is correct as well, it looks like you had a pretty big decline year over year in your corporate unallocated line item.
And I guess I’m trying to get a sense as to what I should expect for 2009. Is the fourth quarter level an appropriate run rate per quarter for 2009 or would you expect that to step up?
Mark Featherstone
Yes, in that kind of corporate unallocated line item is a lot of incentive compensation expense that I talked about that, that would not pay out the bonus, there's a significant reversal in the fourth quarter. And I think as I commented earlier, that was the biggest piece of our drop in the SG&A cost this year versus last year.
Robert Felice – Gabelli & Co.
So, is there a, I guess, a proxy I could use as I think about corporate unallocated for 2009. So I'd imagine you're whittling down aspects of that number but obviously if things do improve you will have higher incentive compensation.
So just on balance how should I think about that line item for 2009?
Mark Featherstone
Well, I think we were trying to take cost savings actions in all areas of our business. So if you exclude incentive compensation, we would expect that number to be kind of flat to down.
Robert Felice – Gabelli & Co.
Okay, thanks for the help.
Mark Featherstone
You're welcome.
Operator
Our next question comes from the line of Mark Rushco [ph] with Raymond James Associates. Please proceed with your question.
Mark Rushco – Raymond James Associates
Yes, thanks guys. Can you address your level of exposure to GM, Ford and Chrysler and the amount of reserves that you may or may be taking for that receivable?
Mark Featherstone
Our receivables – our net exposure to GM and Chrysler obviously fluctuates within the month but generally it is in the $10 million to $15 million range. At this time, we don't have any significant reserve related to those receivables on our books because really accounting rules prohibit that at this point in time.
Mark Rushco – Raymond James Associates
Okay, great. Thank you.
Mark Featherstone
You are welcome.
Operator
Thank you. (Operator instructions) Our next question comes from the line of Daniel Rizzo with Sidoti & Co.
Please proceed with your question.
Daniel Rizzo – Sidoti & Co.
Hi, guys. Just to go over the raw materials again, I'm sorry you said you do expect future price increases to offset some of the run up in the first quarter?
Mike Barry
Not so much future price increases, but we put in place price increases throughout the year in 2008, so we will get a full impact of those. And then there were some price increases in the beginning of the year, especially at some of our contracts maybe change on indexes, that have some kind of time lag associated with them.
So it's – and to be honest we will actually start to see more so the price increases in the year, we'll be starting to see price decreases. Some of our contracts will, again index – raw materials will come down and so there will be more of a – this year price decreases.
But again, as I said, we expect to still see our gross margins expand because they have certainly been at an unacceptable level and then you throw into the equation the lower volumes. So, we need expansion in our gross margin even with all those dynamics we expect to achieve that in 2009.
Daniel Rizzo – Sidoti & Co.
Okay, thanks guys.
Mark Featherstone
Thanks, Dan.
Operator
Thank you. (Operator instructions) It appears there are no further questions at this time.
Mike Barry
Okay, very good. So I want to thank everyone for your interest today.
While these are certainly challenging times we will certainly get through them in a profitable manner, and we will certainly continue to prosper as a company. Our next conference call for our first quarter results will be at the end of April, and if you have any questions in the meantime, please feel free to contact myself or Mark Featherstone.
Thanks again for your interest in Quaker Chemical. Good-bye.
Operator
Thank you. Ladies and gentlemen, this concludes today's teleconference.
You may disconnect your lines at this time. Thank you for your participation.