Quaker Chemical Corporation (NYSE:KWR) Q3 2023 Earnings Call Transcript
Quaker Chemical Corporation (NYSE:KWR) Q3 2023 Earnings Call Transcript November 3, 2023
Operator: Greetings and welcome to the Quaker Houghton Third Quarter 2023 Earnings Conference Call. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Jeffrey Schnell, Vice President of Investor Relations. Mr. Schnell, you may begin.
Jeffrey Schnell: Thank you. Good morning and welcome to our third quarter 2023 earnings conference call. On the call, today, are Andy Tometich, our President and Chief Executive Officer; Shane Hostetter, our Executive Vice President and Chief Financial Officer; and Robert Traub, our General Counsel. Our comments relate to the financial information released after the close of the U.S. markets yesterday, November 2, 2023. Our press release and accompanying slides can be found on our Investor Relations website. Both the prepared commentary and discussion during this call may contain forward-looking statements reflecting the company's current view of future events and their potential effect on Quaker Houghton's operating and financial performance.
These statements involve uncertainties and risks, which may cause actual results to differ. The company is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures and the company has provided reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measure in the appendix of the presentation materials, which are available on our website. For additional information, please refer to our filings with the SEC. Now, it's my pleasure to hand the call over to Andy.
Andy Tometich: Thank you, Jeff and good morning everyone. The third quarter was another strong quarter for Quaker Houghton, we achieved consistent top line performance and further enhanced the profitability of our business. Delivering another consecutive quarter of double digit increases in adjusted EBITDA and non-GAAP earnings per share. Cash flow was also higher in the quarter, we have generated approximately $200 million of operating cash flow year to date, a record for the Company providing significant balance sheet optionality for the enterprise. Net sales were $491 million in the third quarter, similar to the prior year. We continue to benefit from our value-based pricing actions and cost management, which helped offset sustained soft end market activity in a challenging operating environment.
Volumes declined approximately 3% compared to the prior year after excluding the impact of the wind-down of tolling for products divested as part of the combination. However, sequentially volumes improved slightly, and have been largely stable as we progressed throughout the year. We are encouraged by demand in our aerospace, automotive and China businesses, but we are being impacted by softer steel and industrial activity, as well as customer order patterns, primarily in the Americas and Europe. Positively, we continue to gain additional business with new and existing customers and we are pleased that these gains are trending at the high end of our long-term range. This drives us to outperform our end markets as we are doing in 2023. The diversification of our broad portfolio is also providing resilience in the current dynamic market environment and our people are continuing to deliver, supporting the productivity, sustainability, and growth of our customers and our company.
In the third quarter pricing increased an additional 2% compared to the prior year and has increased 11% year to date. We remain focused on earning value with our customers for the products and services we provide. While we continue to implement targeted actions that are balanced with our cost to serve, the pace of pricing gains is anticipated to slow in the coming quarters. Throughout 2023 we have made significant progress recovering our margin profile, while balancing customer relationships and the long-term aspirations of our business. Gross margins in the third quarter were 37.4%, nearly 5 percentage points higher than the prior year and our fifth consecutive quarter of year-over-year margin improvement. This was a result of a combination of our value-based pricing actions, product mix, and cost management, as well as a slight moderation in raw material costs that still remain at historically elevated levels.
In the third quarter, we generated adjusted EBITDA of $84 million and $2.05 of non-GAAP diluted earnings per share, a 20% increase compared to the prior year. Our financial results are primarily driven by consistent execution, driving a recovery in our margins by focusing on solutions our customer value as we manage the ongoing unsettled and complex market environment. Despite these challenges, we continue to control what we can control. We generated $83 million of operating cash flow in the third quarter and approximately $200 million year-to-date. This is a testament to the strong cash generation capabilities of Quaker Houghton. The year-over-year improvement in our cash generation reflects not only the increase in our earnings, but also improved working capital management.
We have continued to further strengthen our financial position and we have paid down $127 million of debt in 2023. With this performance, the company is well positioned to capitalize on the organic and inorganic opportunities ahead. Turning to our segments, we once again delivered earnings and margin performance in all of our segments on a year-over-year and sequential basis. We continue to contend with a soft demand environment compared to the prior year, especially in the EMEA and Americas segment. Volumes in the Asia-Pacific segment increased due to a broad improvement in underlying demand. Notwithstanding, our results are generally in line with our underlying markets. On a sequential basis, overall volumes improved, comprised of an increase in Asia Pacific; a decline in EMEA; and flat volume in the Americas.
We are pleased to see above market volume performance in Asia Pacific, led by new business wins in China in both metals and metalworking. We expect to continue to grow from these current low levels in Asia Pacific in the fourth quarter and in 2024. Sequentially, volumes in the Americas remained steady in the third quarter, despite some incremental headwinds in the packaging and industrial markets. The impact of the UAW strike was not a significant driver in the quarter. That said, we have continued to increase our share of wallet in 2023 in the Americas. EMEA continues to be impacted by soft market conditions and uncertainty, we expect demand in the EMEA market to remain at trough-like levels through the end of the year. We have continued to improve our cost position and financial performance in EMEA and are cautiously optimistic that market in the Americas and EMEA will begin to recover in the coming year.
We have executed very well in 2023 despite a considerable amount of uncertainty, difficult market conditions, and limited visibility in many of our end markets and regions. Looking to the fourth quarter. We are encouraged by improvement in some products and end markets. We expect the current tepid demand environment will likely continue through the balance of the year. We also anticipate some increased variability in customer order patterns in the fourth quarter as companies manage their own working capital. If ratified the three recently announced tentative agreements with the UAW will lessen the impact in the fourth quarter. By region, we expect a sequential improvement in the Asia Pacific region led by China and for demand to remain at lower levels in the Americas and the EMEA regions.
We anticipate the fourth quarter will follow a more normal seasonal trend compared to recent years. However, we continue to expect to deliver another quarter of year-over-year improvement in adjusted EBITDA. We also expect another quarter of solid cash generation. In summary, we are on track to deliver a meaningful improvement in margins and a strong double-digit increase in earnings in 2023. Additionally, throughout this year, we have generated significant cash flow invested in our business, increased our dividend, and strengthened our overall financial position. Looking towards 2024, we are squarely focused on profitable growth by advancing our strategy, including contemporizing the organization, and enhancing the value we provide to our customers.
While macro and end market visibility remains limited. We believe that destocking impacts our customers have faced are largely behind us and we are cautiously optimistic on many of our end markets for 2024, including automotive and aerospace, as well as our China and emerging markets businesses. Taken together, we expect to grow volumes above our market rates in 2024. We are also making progress on our cost and efficiency actions and remain laser focused on earning share of wallet through additional customer valued solutions. We have built momentum in our business and we are well positioned heading into 2024. As we continue to manage the immediate realities of the world. The leadership team at Quaker Houghton remains fully committed to our enterprise growth strategy and driving long-term value for stakeholders.
Much of our focus over the past two years, has centered around mitigating the top financial and operational risks the company faced and driving efficiencies to further optimize our delivery of customer valued services and solutions. Our strong business model and financial position has also enabled us to simultaneously continue investing in developing future opportunities. As I’ve highlighted in previous quarters, our strategic pillars are centered around leveraging our global scale, deploying digital capabilities, and leading in sustainability. These pillars are positioning Quaker Houghton to continue to meet the current and long-term needs of our customers and deliver value for our company and our shareholders. One area of focus is to leverage our scale to advance the intimacy of our model.
There are several commercial initiatives underway and I am pleased with the early progress. For example, we are optimizing our current direct and indirect channel strategy, we are advancing our capabilities and partner strategy to effectively and efficiently deliver the level of service and support that customers value more exactly. This will be further enhanced with our fluid intelligence offering as we deploy digital capabilities to complement our service model which will in turn provide openings to both deepen relationships with our customers and improve the productivity of our people as well as our customers' operations. We are also working to accelerate opportunities to increase wallet share supported by our scale. One example is through better leveraging our full global technology portfolio, including expanded sustainability options into new and existing markets.
This is especially true with our portfolio of advanced and operating solutions whether for developed or emerging geographies. We have added talented local leaders and experts who are working closely with our global strategy, R&D and, other teams to advance our efforts, many of which were made possible by the combination. We expect to realize some additional benefit from these ongoing efforts, which are making good use of our global scale in 2024 and beyond. These important initiatives are just some of the ongoing activities that are bringing our enterprise strategy to life. They are natural extensions of our differentiated approach building on the foundation of providing customer intimacy. In summary, we are focused on capitalizing on the positive momentum we have built and we are fully committed to further unlocking our potential.
We have a strong market position in our industry, which in turn has attractive long-term growth characteristics. We are making meaningful progress on our financial and operational priorities and have significantly improved our margin profile, strengthened our balance sheet and, are demonstrating the strong cash generation capabilities of Quaker Houghton. We are focused on driving success for and with our customers and earning new business supporting our customers as they pursue new opportunities as well as managed through the challenges impacting their business. We continue to prudently investing to advance our growth initiatives, building on our strong foundation. It is through our strategic pillars that we will deliver profitable, above-market growth in 2024 and beyond.
I'm proud of our execution through 2023, delivering on our financial, operational, and strategic objectives while managing through a myriad of challenges that have impacted us and our customers. I am confident in the Quaker Houghton team who continue to develop and deploy our leading portfolio of products and services in our differentiated customer intimate solution based business model. And I remain excited by the opportunities we have together to enhance the value of our customers and our business as we generate long-term value for shareholders. With that, I'd like to pass it over to Shane to discuss the financials.
Shane Hostetter: Thanks, Andy, and good morning everyone. In the third quarter, we delivered net sales of $491 million, which was consistent with the prior year. The primary drivers to our sales performance was an increase in our selling price and product mix of 2% and a favorable impact from foreign currency, up 2%, offset by a 4% decline in sales volumes. The decline in our volumes was driven by softer market conditions, primarily in the Americas and EMEA segments at approximately 1% due to the wind down of previous tolling on volumes we divested as part of the combination. Sequentially, volumes increased in the third quarter by 1%, but were offset by a slight decline in price and mix and foreign exchange. Gross margins in the third quarter were 37.4%, which represents an increase of 470 basis points compared to 32.7% in the prior year and 150 basis points compared to 35.9% in the second quarter of 2023.
This improvement reflects continued execution on our pricing actions, as well as the low single-digit decline in our raw material costs sequentially. Excluding onetime items, SG&A increased $12 million or 10% compared to the prior year and $3 million or 2% sequentially. These increases reflect that year-over-year inflationary impact on our labor costs, the timing and levels of our annual incentive compensation, as well as impacts due to foreign exchange. We delivered $84 million of adjusted EBITDA in the third quarter, which is an increase of 20% compared to the prior year and our fifth consecutive year-over-year increase. Our adjusted EBITDA margins expanded to 17.2%, an increase of 290 basis points compared to the prior year and an increase of 100 basis points sequentially.
These improvements reflect the progress we've made, advancing our strategy while balancing our near-term priorities with delivering our long-term profitable growth initiatives. Switching to our segments. Net sales in the Americas declined approximately 3% year-over-year, driven by lower volumes and partially offset by higher selling price and product mix and foreign exchange. The decline in sales volumes was primarily due to softened market activity compared to the prior year, as well as some declines due to our value-based pricing strategy, which were offset by new business wins. Volumes were impacted by lower metalworking demand including the direct and indirect impact of the UAW strike. On a sequential comparison volumes were flat in the Americas.
Our EMEA net sales increased 4% compared to the prior year, primarily due to increases in selling price and mix and foreign exchange, partially offset by decline in sales volumes. We continue to contend with soft end market conditions in India, especially metals, but these were partially offset by improvements in automotive and new business wins. The wind down of the tolling for business divested as part of the combination also contributed to the decline and we will lap this beginning in the first quarter of 2024. Volumes declined sequentially in EMEA segment due to the soft market conditions noted earlier. Net sales in Asia Pacific increased compared to the prior year as we experienced broad-based improvements in both metals and metalworking in China, as well as broader Asia Pacific.
Also, new business wins contributed to the improved performance, while foreign exchange was a modest headwind to this segments sales in the quarter. Volumes also increased in Asia Pacific compared to the second quarter, as expected, due to a modest improvement in underlying demand across many end markets. During the third quarter, we continued to make progress on our margin recovery across all segments, having increased on both year-over-year and sequential basis and we delivered strong year-over-year increases in operating earnings in all of our segments. Overall, we continue to build on the strong performance we delivered in the first half of 2023, and we are making significant progress improving the profitability of our business. Below the line, our interest expense was higher in the third quarter compared to the prior year, but flat sequentially.
Our cost of debt in the third quarter was approximately 6%, which is in line with where we exited the prior quarter. Our effective tax rate, excluding nonrecurring and noncore items, was approximately 29% in the third quarter. Our GAAP diluted earnings per share were $1.87, and our non-GAAP diluted earnings per share were $2.05. This represents an 18% year-over-year increase and a 6% sequential increase, both driven by the improvement in our operating earnings. Switching to liquidity. We generated $83 million of cash from operations in the third quarter. Year-to-date, we have generated $200 million of operating cash flow. This year-over-year improvement reflects our solid earnings and improvements in working capital efficiency. Year to date, we have invested $26 million in capital expenditures, paid $23 million to shareholders through dividends and reduced our debt by $127 million.
Our balance sheet and liquidity remains strong. Our net debt at the end of the third quarter was $628 million, and our net leverage ratio improved to 2 times adjusted EBITDA compared to 2.3 times at the end of last quarter and 3 times at the beginning of the year. Our capital allocation priorities remain consistent. Return on capital through dividends, strengthen our balance sheet, and invest to grow the business both organically and inorganically. For full year 2023, our anticipated CapEx spend remains unchanged at approximately 1.5% to 2% of net sales. We have ample opportunities to drive growth, and we have conviction in the cash flow generation of our business. We will continue to balance the current macroeconomic environment and short-term outlook with our long-term strategy to deliver shareholder returns.
To summarize, we've executed well in 2023. We've delivered strong earnings growth and record cash flow thus far despite a very difficult macroeconomic backdrop. We are committed to our growth strategy and remain confident in the earnings power and cash generation capabilities of this company. With that, I'll turn it back over to Andy.
Andy Tometich: Thank you, Shane, and I'd like to thank the entire organization for their dedication and commitment to our company and our customers for their trust and partnership. I'm excited with the opportunities ahead. And with that, we'd be happy to address your questions.
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