Quaker Chemical Corp (KWR) 2003 Q4 法說會逐字稿

Good afternoon, and welcome to your Quaker Chemical Corporation sponsored fourth quarter and full year 2003 earnings results conference call. At this time, all parties have been placed on a listen-only mode and the floor will be open for questions following the presentation. I would now like to turn the floor over to your host, Ronald J. Naples, Chairman and CEO. Sir, the floor is yours.

Thanks very much and welcome everybody, thanks for being with us here today. As is our typical practice, I am going to make some comments and then Mike Barry, our CFO, who will try to give you some more detail and with us here today also is Joe Bauer, our President, who can help answer some questions as they may arise afterwards.

I'm not going to say much, anything at all actually, about the fourth quarter, Mike will cover the details of the fourth quarter with you and I will have a few words to say about '03. But I do want to talk about '03 a bit because, in some ways, it was a disappointing year in terms of where we ended up in our earnings. It was considerably below our expectations when we started the year and certainly, it was below our internal long-term expectations for what we wanted to try to achieve to get where we'd like the company to be.

But let me hasten to say that, even though I characterize it as a disappointing year in some ways, revenues were up 24%, which is, of course, anything but disappointing. We are pleased with that year, although its composition is a bit unusual and I will talk about that in a moment. And net income for all the difficulties was up 4%, our after-tax income.

Well, 4% is certainly not long-term satisfactory to what we want to achieve, in many ways it masks what was a strong year. We met and made up for a number of challenges, some of them unexpected and still were able to produce a 4% increase. I mentioned the 24% revenue increase which, of course, is a really good number for us and we're pleased by it, it was helped by a couple of external things. One was the weakness in the dollar versus the euro. Now, by that I don't mean it was export-driven but rather that we got the benefit of translating those euro sales at a weaker dollar.

The acquisitions we made during the year, we made two in '02 which helped, of course, and we made three in '03, which helped during the year and those acquisitions did contribute to our sales growth. And our new CMS contracts, as we have discussed during the year, did create a sales bump although it created a differential earnings effect. In the revenues, those are the things that helped along the way and in our revenues we did overcome some softness in demand in the sheet steel markets in the U.S. and Europe, in particular. The market demand in those markets, those developed markets, is down probably 3 to 5% during the year.

In the U.S. we built our share of market to what is now a leading position even in the face of markets trending downward, we were building share and in Europe, we maintained what is still a very strong leadership position. We've been the leader by far in Europe for a long time in sheet steel, we still are by far, although I must say that toward the end of the year, we did see some increased competitive activity.

Contributing to the sales growth and overcoming those weaknesses was excellent growth in South America and excellent growth in Asia, two areas that are still growing, particularly in our steel business and of course also in metalworking but particularly in steel where they're still building steel plants. We have an excellent market position in those markets and I think they have great promise for us.

Now, of course a revenue increase of 24% is much greater than a net income increase of 4% and that raises a question of why the differential? In part, it was due to the nature of some of the sales increase. We have spoken several times during the year about how CMS has very different margin characteristics because we put sales and costs on about -- some sales and some costs on at about the same numbers in our new contracts in CMS so that sales increase does not deliver the same kind of increase in profits in terms of percentages. And, of course, acquisitions in a year tend to contribute less to the bottom line in the early days than they will later, so that helps to explain some of the differentiation between the sales and profit increase.

But it's important to note that both for CMS and acquisitions, the sum of those were accretive through the year. We work hard to make sure that what we do contributes, and that was certainly the case in acquisitions, not only the ones we made in '02 but the ones we made in '03 and, of course, we expect more of them going forward.

Also we were hurt during the year and that explains part of the difference in sales and earnings increase to some cost areas that we simply had to step up to. I'm talking about areas such as pension and insurance and increasing costs in complying with new governance regulations on Sarbanes-Oxley. Most important, we had to deal with raw materials which we found that four to five year highs through year and exiting the year in our three major categories: Crude oil derivatives, vegetable oils and tallow, or animal fat. and it wasn't just three year highs for us, but it was a big number for us in terms of costs we had to overcome, I mentioned a number in the press release of about $2.5 million, actually, more than $2.5 million and, of course, that's a big number for us to overcome in our operations.

In face of all of this we still managed a 4% net income increase and perhaps, more important for the long term, we stayed the course of our long term efforts which are important to our future; from the technology efforts we have underway and here, I mean our enterprise resource system, the transaction system we're putting in place which helps our ability to operate as a globally integrated whole which is a very important value for us, we stayed the course with our value-based differentiation with customers, the CMS relationship with customers is an important part of that and we stayed the course in terms of investing in growth I already mentioned by the three acquisitions we made in '03. These were tight-fit acquisitions that built our core and I think they're going to help us leverage earnings going forward as we integrate those acquisitions and as we get the benefit of the market share we're building.

We also, of course, had another year of dividend payments higher than the previous year. We're pleased by that, it is an important thing for us, it's our 31st straight year of having dividend payments higher from one year to the next and we continue to view dividends as an important part of return to our shareholders and it is the balance sheet strength that we built over the years, that what we stayed focus on that makes that possible. So, yes, 4% net income increase is very disappointing in way but it is satisfying in another. We overcame major obstacles to produce the gain and we've advanced major priorities that are very important to our future during the year.

Now, 2004 is going to be somewhat similar year. We remain committed to trying to deliver an up year, again, not all we would like in that regard. In the face of a solid revenue growth again, although we don't expect a 24% increase again, we still to have deliver again some tough cost items, particularly raw materials again. We don't think raw materials are going to retreat in terms of levels, and there are some risks of them going higher than anticipated in our plan, particularly where crude oil is concerned.

Also, where raw materials are concerned the reality is the strength of the euro hurts here for our financials because we source a large part of our raw materials in Europe in euros tho be used by our European operation and these can't simply be replaced from dollar regimes. Indeed, it was a major extra cost in terms of our raws in '03.

And of course, there are the other costs outside of the direct operations of the business, the old culprits I've already mentioned as far as pension, insurance and even greater incremental Sarbanes-Oxley corporate governance compliance costs. I should also say it's notable and unfortunate for our people here that '03 led to no annual incentive payments because we didn't meet the goals we set for ourselves but our '04 does allow for annual incentive payments based, of course, on performance but that is another differentiator.

It's also important to say we'll keep our major long-term priorities going strong because we want to keep our future in focus which is -- and that focus really, is to build the strongest competitor delivering better than anyone else what a global manufacturer wants and needs to be a better global player because we want to be there and be ready when the demand in commodity markets change to be more in our favor and however bad they may get, they always do.

So we continue to invest in global knowledge and learning. We recognize we're in the knowledge business and our ability to share that knowledge around the world in our business is going to be directly proportional to how well we serve our customers. We continue to invest in global integration. I already mentioned building the common transaction systems in the technology to share knowledge and we continue to invest in value, that is, solution kinds of relationships with our customers and I don't buy that I don't just mean CMS, I mean the way we service our customers but it is true that CMS is probably our most powerful vehicle to do this even given its risks and its operating challenges.

Indeed, the CMS effort is an important way to deal with pricing dilemmas that suppliers today to big manufacturers face while commodity prices move up and down. We increasingly want to move our compensation from our customers away from simply paying for fluids to paying for how we make them better combined with the fluids we provide.

So, as I said in the press release, we're confident we're on the right track to create the market position and business model that ultimately, will deliver on our high expectations and we're going to stick with it. With that I'll turn to Mike to cover in more detail the quarter and the year.

Thank you, Ron. Good afternoon everyone. As I usually do, I will now discuss some of the components of the P&L for the fourth quarter in more detail. I will also make some selective comments for the full year as well and I'll start with sales.

Revenues for the fourth quarter compared with the same period last year were up 30% to a record $93.7 million. There were some significant swings in some of the major revenue components that I'd like to review. First of all, the new CMS contract revenues represented 14 percentage points of the growth. Currency translation, primarily due to the stronger euro, increased sales by 10% as the average euro rate was 1.19 this quarter and 1.0 during the fourth quarter of 2002. So you can see the new CMS contract and the change in currency accounted for 24 percentage points of the 30% growth.

Current year acquisitions of Vulcan, Eural and KS Chemie accounted for six percentage points or the bulk of the remainder of the growth. On a year to date basis, net sales were $340.2 million up 24% from the $274.5 million reported for 2002. The change of revenue reflects the following break down: CMS represented 10% of the growth, currency translation, primarily due to the stronger euro, increased sales by 7% and the company's acquisitions increased sales by 5%. Product volumes of our businesses without including the acquisition and the new CMS contracts were down 2% primarily due to weaker demand in our steel business and price and mix effect accounted for four percentage points of the revenue growth although approximately half of this increase is due to higher prices in Brazil which were necessary to recover some of the currency impact on raw materials.

As I usually do, I would now like to give some revenue data on a segment basis. As you may recall, we had segmented the business into three areas: One, metal working process chemicals, two, coating and three, other chemical products. Melt working process chemicals are products used for various heavy industrial and manufacturing applications and make up approximately 90% of sales. Reported revenues in the fourth quarter compared with 2002 were up 31%. I'd like to break down the major drivers for this 31% growth.

Again, the new CMS contract accounted for approximately half of the revenue growth, or 14 percentage points. Currency accounted for ten percentage points of the growth and our three acquisitions in 2003 increased growth by six percentage points. So these three items accounted for 30 percentage points of the 31% growth in the segment. The other 1% of growth in this segment was made up of swings in our regional businesses.

For example, our U.S. business was down 3% without the new CMS contracts and Europe was down 4% on a constant currency basis. However, offsetting these declines was a 5% increase in our Asia Pacific business and a 20% increase in our South America business. So, while our global based business in the fourth quarter was close to flat you can see there were some major regional growth difference on a constant currency basis as the U.S. and Europe declined and Asia Pacific and Brazil increased significantly.

Our second business segment is coatings which makes up approximately 8% of our sales and contains products that provide temporary and permanent coatings for metal and concrete products. Revenues for this segment were essentially flat for the four quarter of 2003 compared to 2002.

In our smallest business segment, representing approximately 2% of sales called other chemical products, sales were down 21% or $241,000 versus the fourth quarter of 2002. This segment was lower primarily due to our Q2 technologies joint venture which produces sulfur removal products for industrial gas streams.

Moving now down to gross margin, gross margin as a percent of sales declined from 40.2% for the fourth quarter of 2002 to 35.5%. As we had mentioned previously, the company's new CMS contracts have caused different relationships between margins and revenue in the past. At the majority of our current CMS sites, the company effectively acts as agent and records revenue and costs from these sales on a net sales, or pass-through basis. The new CMS contracts have a different structure which results in the company recognizing a reported revenue to gross revenue received from the CMS side customer and then cost of goods sold, the third-party product purchases. These additional revenues and costs will substantially offset each other in the short term since the company has very little of its own product converted, as of yet, at these sites.

The negative impact to gross margin for the fourth quarter related to new CMS contracts is approximately four percentage points. The remaining decline in the fourth quarter gross margin of approximately one percentage point is due primarily to increased raw material costs as our major raw material segment ended the year at four-year highs.

Moving down to P&L, I will now discuss our SG&A and other expenses. Reported SG&A of $26.8 million is up $5.2 million compared to the $21.6 million reported in the fourth quarter of 2002. Approximately half of this increase is due to foreign exchange rates and the company's 2003 acquisitions. Increases in other expenses including pension, insurance, and the company's continued roll-out of its global ERP system contributed to the remainder of the increase.

Included in the fourth quarter results is $100,000 net restructuring charge where 2003 severance program costs of approximately $300,000 were partially offset by the release of $200,000 of unused restructuring accruals if the company's 2001 restructuring program. For the full year, SG&A expenses increased $9.6 million from 2002. Approximately three-quarters of this increase is due to foreign exchange rates and the company's acquisitions. Increases in other expenses, including pension, insurance and the company's continued roll-out of its ERP system partially offset by lower incentive compensation, accounted for the remainder of the increase.

The other income category is essentially flat quarter over quarter. For the full year, other income is down $371,000, primarily due to foreign exchange. Net interest expense is higher than the prior year for the fourth quarter, primarily due to higher debt levels. The full year effective tax rate is 31% and reflects the company's favorable settlement of several outstanding tax audits and appeal issues. We currently anticipate our effective tax rate will remain in the 30% to 32% range for 2004. Of course, many external and internal factors could impact this rate and we will continue to refine this number as necessary as the year progresses.

Continuing down the P&L increase in equity income for fourth quarter of 2003 reflect priority distribution received from the company's real estate joint venture. In addition, the real estate joint venture also had an improvement in its year-over-year perform appears. Minority interest was higher for the fourth quarter of 2003 compared with the same period last year driven by stronger performances from most of our minority interest affiliates.

So in summary, we made 41 cents per diluted share for the quarter and $1.52 per diluted share year to date but before we leave the income statement, I also wanted to note the increase in diluted shares. The increase of approximately 450,000 shares is primarily due to some option exercises as well as Quaker stock price hitting its all-time high on December 31st, which impacts the diluted share calculation.

I'd also like to make a couple comments concerning the balance sheet. Many of the line items on the balance sheet have been impacted by the stronger euro. This would be a common theme if I were to go up and down the balance sheet and explain each account. Concerning our leverage, our debt to total capital remains strong at 34% at the end of December 2003 compared to 25% at the end of 2002. As previously announced, the company completed its acquisition of the steel business from Cincinnati-Vulcan Steel Company during the fourth quarter of 2003 which increased the leverage ratio from 31% at the end of September 2003.

As previously disclosed, we increased our available credit lines during the second quarter from $25 million to $50 million currently. At the end of December, we had approximately 40 million outstanding under these credit lines. We have increased our credit availability by bringing in additional banks in order to increase the number of banking relationships which we felt would be valuable long-term to the company. In addition, the additional liquidity will be ready as we continue to look for more play set acquisitions as we have done several times over the past two years.

On our cash flow statement, I want to point out that we received $4.6 million in priority distributions from a real estate joint venture during 2003. Also, there was a significant decrease in cash related to increased accounts receivable and inventory balances. The increased accounts receivable are primarily due to the start-up of the company's new CMS contracts, the stronger euro, as well as increased sales volume quarter over quarter.

In 2003, capital expenditures were $12.6 million primarily related to company's global ERP implementation and the company's U.S. laboratory renovation. For 2004, we expect capital expenditures to be approximately $10 million, as most of our lab renovation is complete and we expect limited capital being spent towards our global ERP implementation. Also, payments related to acquisitions were $16 million in 2003 versus $21.3 million in 2002.

And that concludes my prepared remarks.

Thank you, Mike. Now, we'll be glad to respond to any questions anyone may have. Do we have the operator here to help us on this?

Thank you. At this time, the floor is now open for questions. If you do have a question, you may press the numbers 1 followed by 4 on your touch tone phones at this time. Again, those are the numbers 1 followed by 4 on your touch tone phones at this time. Please hold while we poll for questions. Our first question comes from Robert Kosowski. Sir, you may pose your question.

Hello, guys, how are you doing?

Hi, Robert.

I was just wondering if you could speak to some of the, I guess, some potential profitability milestones you might be looking for in CMS and also give us some color on the fact of the fixed price contract and some of the escalators you might have in there for the higher raw material costs, any perceived risks that you guys see in doing a fixed-price contract like that?

We don't have escalators for raw material costs. That's really actually quite contrary to how we want to try to conduct this business, we want to try to focus on value rather than the value created rather than simply the raw materials has we're using. The critical factor on these contracts is really related to two things: One is to create savings for a company based on our ability to help them apply the product better and help them improve their own processes and the second piece, is to convert more of the product being used to our product rather than competitor's product. That, of course, is going to be our focus, well, it will be our focus anytime we have a CMS contract but particularly this career because we did get a handful of these contracts with a really good running start in '03 and we'll be looking to consolidate those in '04.

In terms of milestones, I think I'd rather keep that more among our confidential information, but let me just say, Bob, that these have been -- these were -- they did contribute in '03 and we expect them to contribute more significantly in '04.

Okay. And I was hoping you could kind of speak to your, I guess, pension situation right now, I guess your current level of funding and what kind of drain we're going to be looking for in 2004?

Well, the pension charge will go up in 2004. It's not up as much as it was in 2003 but it's in the nature of I think, our numbers suggest now it's probably going to be in the nature of 3 to $500,000, somewhere in that range.

We do expect, Bob, to make a contribution of approximately million dollars into our pension fund this year.

Okay. Thank you very much.

You're welcome. Thanks for your interest.

Again, if you do have a question, you may press the numbers 1 followed by 4 on your touch-tone phones again, at this time. Sir, there appear to be no further questions at this time.

Okay. Thanks very much and thanks to all of you for listening and joining in. Thanks for your interest. We appreciate your continued support and we'll look forward to talking to you again in a couple of months. Good day, everyone.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.