Quaker Chemical Corp (KWR) 2004 Q1 法說會逐字稿

Good afternoon and welcome to the Quaker Chemical Corporation first quarter earning results conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions following the presentation. It's now my pleasure to turn the floor over to your host, Mr. Ronald Naples, Chairman and Chief Executive Officer of Quaker Chemical Corporation. Sir, you may begin.

Thanks, Alyssa. Welcome, everybody and thanks for joining us. If it's as beautiful a day where you are, as it is here in Philadelphia, you have my commitment that we will take only as long as necessary to cover the subject, particularly since it's getting late on a Friday afternoon. As usual, Mike Barry, our CFO and Joe Bauer, our President are here with me. And also as usual, I will make a few introductory comments and Mike will give you some detail, and then we'll all be available to answer questions.

You have all seen the press release by now, I'm sure, so you know that the first quarter was a rewarding for sales, it was the highest in our history. Yes, and part of that was driven by the fact that we are reporting CMS sales in that number and, as you know, that was new business last year. And surely those revenues don't come in at the same margin, with the same margin characteristics as our product sales, but even without that roughly $10 million, our sales were still one of the highest quarters we've ever had. In fact, if you take that $10 million out and just leave the rest of it in there, the sales are still up almost over 21%. So it it really was a rewarding quarter in terms of sales.

One of Quaker's most salient features today, I think is our global presence and you really saw the impact of that in the first quarter. Quaker is an extremely global company for a company of any size, let alone a company of our size. When I say "global" I don't mean that we export, we're global in the sense that we have local feet on the ground all over the world, virtually in every industrialized country and some of you do business in every industrialized country.

Also by global, I don't mean international. And for me, there's a difference between the two, international and global. One is International is if you are located everywhere, as we are, but you operate as if you are located everywhere from a lot of different perspectives. Global on the other hand, means you are still located everywhere but that you operate as a single whole. Which is the way we try to operate and that goes exactly to the way we manage. We try to encourage and prepare our people to act on a global basis.

We don't do that because we simply want to be global, but we really think that we need to be global to line up against our customers and to compete in a way that others can't. In any case, one of the benefits of our global approach is the fact that we do get some portfolio effect and we do get global execution and we saw that portfolio effect in the first quarter.

Steel production around the world is pretty stable right now. There's some small pluses and minuses in the first quarter versus the end of 2003. There's a little weakness in the U.S.; although our U.S. steel brethren are enjoying pretty attractive prices right now and I say more power to them, especially with the relative absence of imports in the United States.

Europe has been slightly stronger last quarter to this quarter. Revenues have seen some moderate change in Asia/Pacific and South America. The big changes this quarter versus last year's first quarter. We think Asia is up around 10% in terms of steel production and North America is ahead a couple of percent, Europe is probably flat to down a bit, and we see really good progress in South America.

The important point of all of this is that Quaker is in all of these places with the leading share and that allows us to be the beneficiary of what's happening in the steel markets when they are as strong as they are now, and beneficiary of our global approach. We're building share in the United States. Our share has grown considerably over the last 18 months or so and we're growing with a market that's growing and building share in markets with greater growth, such as Asia, South America, where we also have an excellent position, the leading position.

And it works for the future too. For instance in China, there's a list of probably 10 or 12 integrated mills which will be built over the next three or four years. We'll be there, you can be sure of that and we're very well positioned with our leading share to take the leading share of these new mills as they come online. So we feel very good about how that's going on.

In other businesses, particularly metal working, whether it be the industrial business or automotive, we're seeing some of the same kind of thing that I talked about in steel; although the dynamics change, of course, and Mike Barry will cover these markets in a little bit more detail in just a bit.

So we feel good about the opportunity for top-line growth this year. And the first quarter gives some indication of that promise. Particularly, as the economies do better around the world, we'll get the benefit of that and our hope, of course is that nothing derails that. So being global is expensive to be sure, but it's also a very powerful tool, especially for the long run.

One of the other pleasing things about the first quarter is that we were really pleased to be able to report a 7% increase in net income. Our earnings per share were flat with prior year at 33 cents, but we are happy about the strong start in the income growth. Getting the full benefit of the kind of sales growth that I talked about, to our bottom line, is certainly not all that we would like it to be. And I think it's not all that it can and will be as we go into the future, particularly as our strategies and initiatives take hold and raw material cycles move in our favor.

Right now, though, raws eat into our ability to drop the sales growth to the bottom line. In Quaker we rely on generally three categories of raw materials. About one third is crude based and you all know that story. Certainly the current crude prices are above the plan we had for the year. And we don't expect that they'll be coming down dramatically during the year, but we figure that we can make our way through that. Vegetable oils is about another third of our raw materials. The things like coconut oil and palm oil which are sources from around the world.

These prices in pretty good shape for us, because due to our global purchasing and planning around the world, we feel we've got those prices pretty well nailed down going into the end of summer, early fall. The other third of our product line really depends largely on animal fat. This is a pretty volatile market. We saw it at highs at the end of last year. In fact, at the end of last year, virtually all of these markets were at four- or five-year highs. Animal fat came down a little bit earlier this year, but we see them back up a bit now. So those costs will continue to have an impact on us as we go throughout the year.

And, of course, other costs do have an impact on us and among these are the usual suspects that we've talked about over the past couple of years, including outside increases in pension and benefit expenses, and sizable incremental costs in Sarbanes-Oxley and related compliance. And another incremental cost for this year, depending how the year goes, will be the restoration of performance-based incentive pay compared to 2003, when there were no bonuses paid. And, of course this all dependent on performance. For all of these categories these will be moderating incremental influences going into next year since we think the bulk of the -- we've already been been through the eye of the needle on this.

So our outlook for the year still takes us to our expectation to be up during the year, although only slightly up as our press release said and as we said last time around. Even in these circumstances, we're keeping a weather eye on our long-term capabilities and our strengths and our needs, because we do believe it's important to make sure we have in place all that we need to have in place to grow for the long term.

We are not going to waiver in our commitment to these activities; although, of course, I have to say that we're always very mindful of our imperative financial performance. That's always been the case here. I hope that's something that's been apparent to you and it's no different today than it has ever been.

We're staying with important strategic initiatives. Among these, global integration, and operations. We've been working on putting in place an ARP system, which brings a common transaction system to our operations and allows to us operate around the world on an equal footing as if we were in that one place I talked about earlier.

New business development, spending and our acquisition appetite remain where they are. We've got several new business efforts underway and we continue to look for acquisitions at good incremental growth to our business and that are a tight fit.

We're also putting money this year into people, where we think there's a prospect of growth. And where there's prospect of growth merits the new dollar investment. Particularly this is true in Asia where we're staffing up to make sure that we can take advantage of market growth in China. It's also true in CMS, which we talked about several times. As you know, we began a new approach to this market effort last year with a number of GM Powertrain contracts that we won, among others. Recently we added a few contracts with DaimlerChrysler sites.

CMS as an idea that's not new for us, we have been providing CMS for years. However, the approach that we adopted last year, puts us at the center of the customers' efforts to improve manufacturing costs. It is a way for to us become an integral part of that portal [ph] effort for them and it's really a way for us to demonstrate to them value that we wouldn't be able to demonstrate as purely a product provider.

It's also a great window on our customers' needs, it's an opportunity to learn what new products they need and what new services they need, how we might better serve their overall needs and it's a great opportunity for us for penetration in our customers, but built around partnership, not built around just simply trying to sell some more products.

This business as a whole, still relatively new, has not yet had much of a bottom-line impact on us, as we continue to build our processes in these sites. Of course, it has had a drama impact on our margin percent. We have discussed that in the past, we have discussed it again in this press release and, of course, we can talk about it again this afternoon if that's of interest to you and if you would like to know more about that. And we're confident that the profitability of these sites will come along as we become more successful at converting the product usage in these sites, the Quaker products and that will be based on where we have a chance to add value for our customers and that's the case we always want to make to our customers.

As I said earlier, we added a few sites recently, but our real focus this year is to build our processes on our current sites and to get the best out of what we've got rather than to add a lot of new sites. We think it is a tremendous share builder for us in this business.

So we feel good about what we are up to and how things are going. I hope that our recent dividend increase conveys that message message to you all. And the economies around the world may even start to help us a little more than they have recently, and that's certainly a welcome respite for us.

That's a quick look at the quarter and where we stand in the world today and I will turn to Mike to cover some more of the details.

Thank you, Ron. Good afternoon, everyone. As I usually do, I will now discuss some of the components of the P&L for the first quarter in more detail and I will start with sales. Revenues for the first quarter compared with the same period last year, were up 34% to a record $98.1 million. There was some significant swings in some of the major revenue components that I would like to review.

First of all revenues from the new CMS contracts implemented in 2003 represent 14 percentage points of the growth. Currency translation, primarily due to a stronger Euro, increased sales by 9% as the average Euro rate was 1.25 this quarter and 1.07 in the first quarter of 2003. And the Company's acquisitions of Vulcan, Eural and KS Chemie accounted for 8% of the percentage points of the growth.

So you can see this new CMS contract, the acquisitions and the change in currency accounted for 31 percentage points of the 34% growth. The remaining increase of approximately 3% is to the growth in all four of our regions with the majority of this growth being price related.

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. Metal working process chemicals, coating and other chemical products. Metal working process chemicals, products used as lubricants for various heavy industrial manufacturing applications and make up approximately 90% of our sales. Reported revenues in the first quarter compared with 2003, were up 39%.

I will now break down the major drivers for the growth in this segment. Again, the new CMS contracts implemented in 2003 accounted for approximately half of the revenue growth or 16 percentage points. Currency accounted for 10% of the growth, and our three acquisitions from 2003 increased growth by 9 percentage points.

So these three items accounted for 35 percentage points of the 39% growth in the segment. The other 4% of the growth in this segment is primarily being driven by 16% growth in South America, and 25% growth in Asia/Pacific. In the U.S., our business was relatively flat and our European business grew at approximately 3%. All of these regional growth rates that I just mentioned are on a constant currency basis.

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 up approximately 9% for the first quarter of 2004, compared with 2003, primarily due to higher chemical milling mask and sales to the aerospace industry.

In our smallest business segment, representing approximately 2% of total sales, called "other chemical products," sales were down approximately $300,000 versus first quarter of 2003. This segment was lower primarily due to our Q2 technologies joint venture, which produces sulfur removal products for the industrial gas streams.

Moving to gross margin, gross margin as a percentage of sales declined from 38.7% for the first quarter of 2003, to 33.1%. As we have mentioned previously, the Company's new CMS contracts implemented in 2003 have caused different relationships between margins and revenue than in the past. At the majority of our historical CMS sites, the Company effectively acts as an agent and records revenue and costs from these sales on a net sales or pass-through basis.

The new CMS contracts implemented in 2003 have a different structure, which results in the Company recognizing the reported revenue, the gross revenue received from the CMS customer, and the cost of goods sold, the third party product purchases. The negative impact of gross margin to the first quarter related to the new CMS contract is approximately 4.5 percentage points. The remaining decline in the first quarter gross margin of approximately 1 percentage point is due primarily to the increased raw materials cost, as well as some products and regional sales mix.

Moving down the P&L, I will now discuss our SG&A and other expenses. Reported SG&A of $26.6 million is up $3.9 million, compared to first quarter of 2003. Approximately 60% of the increase is due to foreign exchange rates and the Company's 2003 acquisitions. The majority of the remaining increase was due to higher expenses associated with the Company's ERP implementation, Sarbanes-Oxley compliance, as well as inflationary increases.

The increase in other income is reflective of our priority return distribution from the Company's real estate joint venture and the first quarter of 2004. And foreign exchange gains in the first quarter of 2004, versus losses in the first quarter of 2003. The increase in interest expense is primarily due to higher debt balances, outstanding during the first quarter of 2004 versus the prior year.

The year-to-date effective tax rate was 31.5%, versus 33% in the prior year. We currently anticipate our effective tax rate will remain in the 30 to 32% range for the full year. Of course, many external and internal factors can impact this rate and we'll continue to refine the number, if necessary, as the year progresses.

Continuing down the P&L, the increase in equity income for the first quarter of 2004 is primarily due to stronger performances from our Japan and Mexico could joint ventures. And minority interest was higher for the first quarter of 2004 compared with the same period last yea, which is driven by strong performances from most of our minority interest affiliates.

But before we leave the income statement, I wanted note the increase in diluted shares. The increase of approximately 450,000 shares is primarily due to some option exercises, as well as Quaker's higher stock price, quarter over quarter, which impact the diluted share calculation.

I also want to make a few remarks on the balance sheet and cash flow. We continue to have a significant cash balances in many of our foreign entities. We periodically bring the cash back when it's advantageous for the Company from a tax perspective. Also our net debt has increased in the first quarter, primarily to fund our working capital needs due to the growth in sales in the first quarter. Also we entered into an additional CMS contract in the United States with DaimlerChrysler. And this also had a working capital impact.

Overall, our net debt-to-total capital remains strong at 28% at the end of the first quarter, compared to 25% at the end of 2003. In the fourth quarter of 2004, our capital expenditures were $2.3 million, major projects included the Company's U.S. lab renovation, global ERP implementation, and a capital expansion project related to the Vulcan acquisition. We are near completion on both the Vulcan acquisition-related capital and the U.S. lab renovation.

The capital related to the Vulcan acquisition will allow us to move essentially all of our production from Vulcan to other facilities and save on external manufacturing costs. Also our capital related to the European implementation will be considerably less in 2004 than over the past few years. Overall, we are expecting our total 2004 Capex to be slightly under $10 million, which would be a 20% plus reduction from our 2003 Capex levels. And that concludes my prepared remarks.

Okay, thanks, Mike. And at this stage we will open it up to any questions or items of discussion you are interested in. The floor is in your hands, Alyssa, if you can make that happen.

Thank you. The floor is now open for questions. If you have a question, please press star one on your touch-tone phone at this time. Once again, the floor is open for questions. If anyone does have a question, you may press star one on your touch-tone telephone at this time. Please hold while I poll for questions.

I think the good weather may have gotten to folks and their interest in trying to get out to the sunshine.

Our first question is coming from Robert Kosowsky with Sidoti.

Hi. Robert Kosowsky from Sidoti.

Got you, Bob!

Hey, guys, how are you doing?

I'm well, thank you. How are you?

I'm doing all right. I wonder if you could give us some more information about the new CMS contracts with DaimlerChrysler, like what kind of stuff are you working on? Is the structure of it similar to the G.M. contracts.

I will tell you briefly that there are two of them, as I mentioned. One of them is not similar to the G.M. contracts, it's more the traditional kind of CMS contract. And the other is the newer type of CMS contract. We''ve just barely started these things up, we don't really have a lot to say about them at this stage, except we did win the business. And it is the same kind of activity that we're undertaking for General Motors and the other places. Where we've got this general metal working, machining and grinding and that kind of thing.

Transmissions and engines.

Joe just mentioned it's a transmission and engine plant. Two plants.

Okay. So you guys just entered into that contract?

Yes, we did.

So I guess we'll be looking for a little bit of a working capital strain in the second quarter or was it mostly recognized in the first quarter, do you think?

It's relatively split. There was certainly a working capital impact on the first one -- in the first quarter and then the next one starts up May 1st, and then we'll also see a working capital impact there as well, Bob.

Okay. And let's see, I'm just kind of curious, why the sequential decline in the gross margin?

Fourth quarter to --

For the fourth quarter to the first quarter, I know the first quarter is a little bit sequentially low. At least in terms of earnings.

Yes, I guess it's really part of that is is due to, again, as we get more of the CMS contracts on, Bob, and we have greater revenue, say, from the first DaimlerChrysler, but not much bottom line impact yet, so that would hurt the gross margin. Also, raw materials and product sales and mix between the region also would be another cause for that.

Okay. Do you think your -- if I were to rate your product mix improvement, I know that's the way to mitigate some of the commodity-type pricing pressures you have in the market, you guys try to come up with new innovative fluids and lubricants . How would you guys rate your current product mix now, compared to where it was a year ago?

Our product mix in terms of the orientations to value?

Yes. In terms of new products that have come out here at maybe a little bit of a higher margin.

We measure that by looking every quarter, actually more frequently than that, at what we call our "contribution margin per kilo" which reflects what kind of pricing are we getting after raw materials per unit of production. And we see that going up, frankly, in steel as well as metal working. So we're feeling better about that and we're feeling good about that. It reflects the kind of effort we're putting into this business.

We said a long time ago that we didn't want to just simply sell fluids, but we wanted to sell value, and if we are going to do that, we really need to focus on advantage to technology and products that create something more than just basic lubrication. While it would be disingenuous to say that everything we do fits that criteria, we are increasingly getting that done.

All right. Thank you.

You're welcome, Bob. Thanks for your interest.

Our next question comes is from Greg McCowsko with Lord Abbott & Company.

Yes, hello.

Hi, Greg.

Hi. I wondered about the steel industry. Just generally how much of your demand would be through steel plants as opposed to metal working and others.

Steel accounts for about 51% of our total business around the world, and the way we categorize our business, Greg, is simply for organizational purposes internally and between steel and metal workings. Fundamentally, all of our business is metal work and it's all doing something to metal.

Right.

But when we say steel, we mean all the business in rolling mills. Everything we call metal working is outside of rolling mills and it has something to do with manufacturing some place. So when I talk about steel, which I as I said, it's 51% of our business, I mean everything we do in a steel mill, a rolling mill.

Mm-hmm. And talking -- just to understand the steel business, I guess on a year-over-year basis, if we exclude China, I guess it's fair to say that the volumes worldwide have probably been flat or maybe down a slight bit year-over-year?

Yeah, if you're talking about worldwide production?

Yes.

I would say you're probably right. Now, there's a mix, of course as I said earlier among the regions. South America has grown significantly in production capacity and production itself, as has China, and some of the South America, specifically, Brazil, some of that production increase has gone to China. And, in fact, China is absorbing most of the excess capacity in the steel business worldwide, particularly in Asia, of course.

But absent China and South America, I think it's probably right to say that steel production output, steel output is probably marginally down -- well, it's certainly down the fourth quarter to first quarter. I'm not sure how that would play out first quarter last year to first quarter this year, although it's probably close.

Well, but I guess would it be fair for that portion of your business, you would probably move almost, again, with the exception of China, would you move almost exactly in line with what's going on? Or would you benefit saleswise from steel growth to the growth in the steel industry?

I presume by that you mean growth in one area versus growth in another?

Yeah, I mean, if we see steel production go up, I mean, usually -- that's 51% of your business, should rise pretty much the same?

Yeah, we should be pretty much in line with steel production. Yes. We hope we do better than that because of our effort to build share around the world. But, frankly, we're, as I said earlier a global player. So whether the business migrates from one region to another, is only of marginal impact on us, except to say that different areas have different profitability characteristics because of the technology of the products they use.

What about China? I mean, you're in the process of moving into China. Are others there ahead of you?

No, we have the leading share in China. We have been in China for years, probably we started a joint venture there seven years ago maybe, something like that. We're very well established there. We have the leading share of rolling mills in China, I think quite clearly. We think we have the best basis on which to build share of these new mills coming on line over the next -- some will be this year and there will be several more in the next two to three years.

So I would assume then your business in China has grown tremendously?

Our business in China is our leading growth area no, question. Now China is not always a straight line up, I have to say, Greg. Five or six years ago if you would have asked us, we would have said then that there were a number of mills, new integrated mills on the drawing boards to be built, and the reality is because of what happened to the economic environment around the world, those mills didn't get built. So the same thing could happen here in this current cycle, but we don't think so, because China has come along so much further than it was five, six years ago.

Mm-hmm. And China would be 10 -- 5, 10% of revenues.

China as a total of our revenue?

Yeah.

8%.

8%.

I see. Okay.

And we grew about 25% quarter-over-quarter in the first quarter in Asia/Pacific.

I see. Which is is mostly China?

Mostly China.

And India too. Okay. All right. All right. Very good. And then with regard to raw materials costs, obviously you've had an increase in raw materials costs, but it looks as if it's not been that much of an impact on your business, or has it? I mean, there are other factors involved in terms of the change in gross margin, was about 1 percent. Half of that which was raw materials. Is is that what you're saying?

I think most of that is raw materials.

So maybe three-quarters of a percent?

Right.

Of that gross margin?

Right. It's in that magnitude about 8/10th or so.

Do you expect to, perhaps, do any surcharges or cost pass throughs for the raw materials increase?

If that happens it will be very selective because, we are really trying to move our position in this business away from simply past cost through into value creation. So where we think there is an opportunity for that and where we think there are really extraordinary circumstances we will do that, but as a whole, we want to tell our customers about our effort to create value for them, not simply pass along raw material rises or decreases.

But in CMS, that would automatically pass through, correct? I mean you wouldn't have -- there wouldn't be raw materials in the CMS business?

No, no, no, CMS is -- the accounting for this gets a little complicated, but CMS is largely comprises charges that relate to the supply of product; although, the way we get paid is through management service fees.

Okay. So in other words, raw materials would not affect CMS?

In our old contract that's true, because it's a pass through. In our new contracts that we talked about that were implemented May 1st of last year, they would impact us if there were price increases. If the other suppliers increased their prices.

Although we get paid in management fees, Greg. The costs that relate to those management fees are largely -- are connected to how well we control product costs. So if it's the supply of someone else's product or our product, that makes a difference to us. And if the costs -- and if raw material increases are somehow passed along in product costs, that makes a difference to us.

So when there's raw material cost pass throughs in the products that you are supplying to those CMS contracts on these new contracts --

Right.

You could be impacted by that raw material cost, you're going to have to eat some of that.

That is correct, to the extent that the pass throughs can make it through, we would be impacted by that, but, of course, I told you already our view on how we would look at our customers and certainly as we look at our suppliers in CMS, that's the same position we would be taking with them.

Mm-hmm. Okay. All right. Thank you.

You're welcome, Greg. Thanks for your interest also.

Our next question is coming from Patrick Clavin, with Clavin Blake & Company.

Could we continue in this same vein, Ron. Can you -- presumably at DaimlerChrysler and G.M. et al, buy gazillions of different products, by offering to be in essence their purchasing agent, implicitly there's a strategic value to the company, but in the discussion that we've been going through, it would appear that the strategic value has no economic value to it. Can you help me with that relationship?

Yeah, well that's certainly not our view of it, because when we look at these contracts, we actually go through a very, very detailed evaluation process that comes down to, are we creating economic value added by doing this. And I assure you that every contract we take meets hurdles in that regard.

First of all, we are not simply a purchasing agent, because what we do is manage the application and use of the chemicals. Which means it's not just a matter of buying these chemicals, but it's a matter of helping our customers with their processes and applying our products, not just our products but applying fluids so that the cost of the fluids goes down, the usage goes down and so that we create -- well, we create an advantage for the customer, of course.

The economic value to us comes in through the ability to add our products or substitute our products for the third-party products, if you will, that are supplying as a CMS provider and getting the margin that's related to those products. Now we add those products based on our window on the customer, in terms of being able to understand better what the customer needs in his operations and how we can improve those. So it's a multi-faceted thing. It's not simply a purchasing agent. It's not simply supplying product, but it's actually looking at the product, as well as their operations. Tooling costs, quality, throughput of the machine to lower their costs.

So presumably because you've got a self-interest, because they know that you would like to swap out your other products for yours, you've got to have a very strong credibility with them that you're not just going to do that on a random basis?

Absolutely. And that relates directly to our credibility. We do this when we think there's an advantage for the customer to do it and we have in place very elaborate processes to measure that and we report to the customer when we're going to do it and, frankly, the customer has to approve it. They qualify it. It's not a matter of our just running in and changing it out on our own.

Okay. So in essence if we try to break this in two, one, it's a marketing advantage because it allows you potentially to move your products in, but two, you also get paid on a performance basis; is that fair?

That's correct.

But the performance basis per the earlier question, I gather can be an exogenous event, like rising prices that can actually be deleterious to your return on a performance basis.

That's true, it could be. For instance, we're supplying right now products of, what we call "tier 2" or a third-party supplier, to the extent that that third-party supplier passes through price increases to us that we can't do anything about, then that could deteriorate the economics of this contract, but we'll inbound a pretty strong position vis-a-vis these suppliers to control that.

And, certainly, even if we migrated the product to our own product, to the extent that raw materials and that product went up, that would eat into our profitability, that's surely true. But then the issue there is to manage our effort with that customer to provide other ways for that customer to save money, not just the product costs.

Ron, one thing there to clarify that, too. If they raise their prices to us that would put us in a position to justify our own product to be placed into those plants too. That's the last thing they would want to do is put themselves in a position like that.

That's one of the points of leverage that we have with the arm's length suppliers.

Clever. And a final question is, just presumably having raw materials weigh on your P&L, if we get an abatement or a plateauing abatement or decline in raw materials prices, is that when we'll see margin pickup or is there a sort of window after this year when you can see margins beginning to secularly rise?

Well, I think if we get better raw material conditions we'll see margin pickups. Of course, the percent margins are going to be affected by the CMS phenomena that we've already discussed, but our product margins will certainly improve. I mean raw material is our largest cost. So to the extent that that's mitigated that certainly helps us.

Thank you very much.

You're welcome. Thanks again for your interest.

I'm showing that we have a follow-up question coming from Robert Kosowsky.

Okay.

Just one more question. Can you just give us an update on what's going on in the masking market? Or the masking business.

Sure.

Who would like to do that?

Or just your general coatings business.

Yes, the masking business, Bob, has been fairly strong in recent quarters. By that I mean not -- I think, Mike, you said, what about a 9% increase or something?

Right.

Yeah. As you know, the aircraft build hasn't dramatically improved from September the 11th, but it has improved slightly and we've been successful in penetrating other customers that we haven't enjoyed business with in the past. So the masking business, I would say is doing fairly well.

Okay. Do you have any gut feeling on when there's going to be an upturn in the aerospace market?

No, what we're looking at doesn't really give us a lot of hope, it's kind of flat from what we see, as far out as we look. We'd love them to start building more 747s.

That would help you out in a lot of different ways.

Absolutely.

I'm just kind of curious, say if your run of the mill integrated steel mill, I know that China will build 10 to 12 of those in the next couple of years, how much is rolling oils per steel mill?

Oh, that's a tough question, Bob. It depends so much on what kind of mill it is, who the OEM supplier of equipment is, and what type of process they use, whether they use cleaning or not cleaning. I don't wish to finesse your question, but it's almost impossible to give a meaningful answer to that question.

Okay. So there really is no average?

I'm sorry, Bob?

I was saying there really is no average?

Well, we'd certainly look to our steel mills to be in the million dollar range, three-quarter of a million, $1.2 million, and a big one will be more than that and a smaller one will be less than that. But I'm not sure that's a meaningful figure in terms of understanding the business at all, because it really depends on the quality of the technology embedded in the product in terms of margins and how fast they go through it, that kind of thing.

Okay. So you guys wouldn't recommend just applying $1 million times ten and then taking your market share out of that?

No, I would say that's probably not a safe thing to do.

Okay. I think that's all I have for you.

Okay, great, thanks, Bob. Does anybody want to add anything to my answer to that question?

No, that's --

Okay. Thanks, I have the vote of confidence from my folks here.

Once again the floor is open for questions. If anyone does have a question, please press star one on your touch-tone telephone at this time. Our next question is coming from Mark Robins with the Crown Group.

Hello, gentlemen.

Hey, Mark, how are you doing?

Couldn't be better. Thank you.

That's great to hear.

Thank you. I guess I'm still trying to put this into a neat box. That's how I like to think, pigeon holes. If I was to describe this approach for your CMS, what I am really hearing is that this is, like the engineering groups do, it's a consultive sale, and as you ramp the thing up you get hurt by a lesser margin, but as you swamp in your own products and realize improvements and efficiency, you can actually have greater than typical margins if you were just a product salesman?

Yeah that's pretty much it.

I mean that's where you are going, isn't it?

Yes. And beyond just the margins, it's also got to do with the market share that would drive those margins. We have a window on our customer that is impossible to get any other way.

And then essentially, two, five, ten years down the road what you really have done is you've built a customer that is just totally dependent on your ability to supply the chemicals they need to produce the products?

Well, I don't know about totally dependent, it is in our --

It's a small "t," Ron. It starts with a small t.

It is in our own view of the world, we talk about being indispensable to our customers, and this is certainly a way to at least make our customers understand how much that we contribute to their success. It's really a way for a customer to understand that a company like ours, is more than just -- it's value is more than paying just the cheapest price possible for a gallon of fluid.

Okay. So it is not your guy with your shirt taking over the keys to the supply closet and dribbling in and out stuff, it's listen, this is the kind of problem you have, let me help you with this kind of formulation or these combination of chemicals.

Absolutely. When we first go to a CMS project, much of the savings will be related to the fluid itself, how can you reduce usage and make usage more effective, but over time, it's increasingly going to have to go to things like improving tool life, improving throughput so that you look at a much larger basis of cost that you can affect for the customer.

I'm now with you. Okay. Great. Thanks very much, and good luck, gentlemen.

Yeah, Mark, thanks very much. Good to hear from you. I hope everything is going well for you.

I'm showing no further questions at this time.

All right, great. Thanks, everybody. I thank you very much for hanging in there on what here is such a lovely day. We appreciate your interest and we'll all look forward to talking to you again next quarter.

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