Quaker Chemical Corp (KWR) 2004 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Quaker Chemical Corporation, 2nd quarter earnings conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Ronald J. Naples, Chairman and Chief Executive Officer of Quaker Chemical Corporation. Thank you, Mr. Naples, you may begin.

Thanks very much and welcome everybody and thanks for being here with us this morning. With me this morning are Mike Barry, our current CFO and Joe Bauer, our President, as well as, I say Mike our current CFO because as you've probably seen in our press release recently Neal Murphy has joined us to become our new CFO on August 10th after we send in the second quarter financials. Neal comes to us as CFO after experience as CFO both International Specialty Products, both a public and private company, and PQ Corporation, a large basic materials, private basic materials company in this area. Mike is moving on to one of our major and key commercial roles. So they are both going to continue in the company and we look forward to a lot of contribution from both of them. I am pleased to welcome Neal, and you'll get to know Neal over the near-term. Our process today is going to be a bit different than in the past. I am going make some introductory comments as usual and then Mike Barry will cover the quarter in detail. But we've added one element this morning to look at in more detail and pay special attention to two specific matters, raw materials and CMS, because those two factors were determinative in terms of their impact on the second quarter and I've asked Joe Bauer to spend a few moments on each of those so you can get a little more background in detail on them and understand their impact on the quarter and where they fit in the scheme of things for us. And then of course at the end we will have the questions as usual. Before I ask Joe to do that for us, though, I'd like to make a few observations. Second quarter obviously was a disappointment for us. We take our projections very seriously. We prise our credibility. We've taken years to build it and we are committed to retaining it and we don't like being in the position of not being able to deliver.

In the second quarter the shortfall was due to identifiable and notable reasons for the earnings miss but it's a miss nonetheless. So that's not a happy story for us. And as I said it's a disappointing quarter for us. There is a bright side of the picture, though, we've had -- we had very good revenue progress and in the end I think that will really pay off for us. Our total revenues were up 18%. Asia Pacific was the real leader in this with India and China up each in the 15 to 20% range. On the other side of the world Brazil also has been a leader for us in this first half of the year, in particular in the second quarter with revenues up an excess of 15%. Acquisitions contributed both at the top line and the bottom line, foreign exchange helped a bit and CMS quarter-to-quarter revenue comps also helped. With this kind of growth we had expected earnings to be better. We had about a 7 cent shortfall against prior year and against our expectations. It is a pretty direct story, really. Raw materials didn't cooperate with us and CMS did not contribute as planned and that's while I'll ask Joe to address both of these head on. Raws alone accounted for about 5 cents of the 7 cent shortfall versus prior year and, of course, we did not have price increases in place to offset those raw material price increases. We've made a point in our competitive strategies to sell to our customers on the basis of what our products can do for our customers not on some raw material markup basis, so price increase is not the first place we look. Rather, we'd much rather be in a position to go to our customers -- to deliver more to our customers that makes us worth more to them. That is, we can deliver through higher technology products, better service, better processes. That's really the way we want two create value for our customers and the way we want to get rewarded.

We are still committed to this approach. What we can do for our customers is the conversation we want to have, not price increases. The reality is though we are in unusual times. For virtually all of our key raw materials, vegetable oils, animal fats and crude in particular, we are at the highest prices in recent history. So we are going to our customers with a range of price increases and surcharges and we should realize benefit from this in the second half. We don't expect cost relief in raws in the second half so we are planning accordingly. The second matter that I mentioned is CMS. Now CMS is not taking anything away from us versus prior year but the reality is its not contributing as much as we expect -- expected or needed in the context of our total expectations to offset the kind of raw material hits that I've mentioned earlier. As I said Joe will step back and I hope advance your understanding of the elements and critical factors in the business. But the short story is we are behind in the pace of product conversions and usage savings, which are two critical factors in our profitability against what we had planned. We made real progress in the first half, second quarter in particular, while we haven't yet realized the contribution to the extent expected. If all goes according to our plans much will play out in the second half. We are still very bullish long-term. CMS fits because it's, for us, long-term and into our strategies, one because it's the way to be a real asset to our customers. And that is always our most imper -- important imperative, how do we make our customers better? Because in the end that's how we both get rewarded. And two, it's a way to build share of market faster and in -- in markets where we are not really likely to build it very quickly any other way.

So to step back in the context of our strategies, we've worked hard over the last few years to differentiate ourselves through an unrelenting focus on value, how we can contribute to our customers success and how we can both be rewarded for that and we worked hard to maintain that differentiation. Through our global integration and execution, our competitors will find it hard to match because it's hard to do. And through using our global knowledge that is all we know and learn around the world , to deliver the best from anywhere to our customers everywhere. We are serious about these and we have imbedded them in our business and our approach to our customers. These are the beacons that are our enduring guide, even through periods such as this when we don't achieve all we want and it will be these beacons that will in the long run take us where we want to go and get us back on track. Just in closing I would say for 2004, as noted in the announcements, we are still shooting for earnings to come in around the prior year level. That's a quick intro and I would like now to ask Joe Bauer to address the raw materials and CMS.

Thanks, Ron. Good morning, everyone. As Ron stated in his remarks the two most important factors contributing to our not realizing our expectations in the second quarter were raw material cost increases and performance of our CMS business. We currently have improvement plans in place to address these issues in the second half of the year. Let me turn first to raw material costs. First I'd like explain how we manage raw materials within the company. Raw materials are managed on a global basis through a process team we call raw material vendor management. They have global responsibility for raw material procurement including contract negotiations. One of the objectives each year for this team is to find ways to reduce our raw material costs. They achieve these cost savings through use of our global positioning, material substitution and forward buying. Now let me provide you with some background as it relates to our cost issue in the second quarter. To do that I would like to give you some background on our raw material costs. Over the course of 2003 we experienced a gradual increase in raw material costs. And as we entered into our planning process for 2004, our estimates were that we would experience a gradual decline over the year in our raw material costs. And through the first quarter of this year we were on track to meet our plan. Whereas in the second quarter we were anticipating that a decline in raw material costs we experienced a slight increase.

And as we look forward our latest forecast for the remainder of 2004 calls for raw material costs to remain at today's levels rather than declining. And it is for this reason that we introduced our announced price increases to the markets we serve. From a financial point of view if you compare first quar -- first half '03 to first half '04, the raw material increases amounted to $1.3 million or 9 cents on an earnings per share basis. Now let me turn to the performance of the CMS business. Before getting into the specifics for the second quarter results, I would first like to explain how our CMS business works. Our contracts call for us to be paid a fee. And from this fee we are to deliver both products and services to our customers. The profitability of this business is primarily driven by, one, meeting or exceeding the consumption reduction targets or cost savings and two, converting competitive products to Quaker products. This second point is the most important reason for our being in this business, market growth. In this business we are executing a clearly defined strategy , a strategy that purposely focuses on customer selection and primarily on the engine and transmission markets where demands for metal working fluids is high. We view this CMS business as a channel for us to market our products while at the same time creating value for our customers. In the long-term we are looking to shift from the current contract structure to one of mutually sharing in cost savings with our customers.

So let me now turn to the performance issue that impacted our second quarter result. Our plans for the second quarter called for us to complete a number of product conversions. As a result of new and very recent product performance requirements imposed by our customers some of these product conversions were delayed. This shortfall in product conversions impacted our results in two ways: One, less incremental profit on the increased sales, and, two, higher product usage. Let me further explain this second point, higher product usage. Part of the benefit in converting to our products is that our products require less fluids in the production of parts. So as a result with those lack of product conversions our product usage within these various sites was higher than anticipated. As it relates to the delays in the product conversions, we now have an approved product and will be completing these conversions in the second half of this year. Let me say that even though we did not achieve our performance objectives for this business in the second quarter, the financials did contribute modestly to our results. That's all.

Okay, thanks, Joe. Mike, would you take us through the review of the quarter, please?

Sure, Ron. Good morning, everyone. As I usually do I will now discuss some of the components of the P&L for the second quarter in more detail and I will start with sales. Revenues for the second quarter compared with the same period last year were up 18% to a record 98.7 million. There were some significant swings in some of the major revenue components that I would like to review. Revenues from the new CMS contracts represented 5 percentage points of the growth as there is a full year's -- full quarter revenues for the contracts this year versus only two months in the prior year. In addition we entered into a new contract with DaimlerChrysler this year. Currency translation primarily due to the stronger Euro increased sales by 2% as the average Euro rate was 1.21 this quarter and 1.14 during the second quarter of 2003. And the company's acquisitions of Vulcan, Urael(ph) and Casheme(ph) accounted for 7 percent -- percentage points of the growth. So you can see that the new CMS contracts, the acquisitions and the change of currency accounted for 14 percentage points of the 18% growth. The remaining increase of approximately 4% is primarily due to double-digit growth in our Asia Pacific and South America regions, with lower sales in Europe offsetting the increases in sales in the United States. As I usually do I'll now give some additional revenue data on a segment basis. As you may recall we have segmented the business into three areas. One, networking process chemicals, two, coatings and, three, other chemicals products.

Networking process chemicals are products used as lubricants for various heavy industrial manufacturing applications and make up approximately 90% of our sales. Reported revenues in the second quarter compared with 2003 were up 21%. I will now break down the major drivers for growth in this segment. Again, the new CMS contracts implemented in 2003 accounted for approximately 5 percentage points of the revenue growth. Currency accounted for 3 percentage points of the growth and our 3 acquisitions from 2003 increased growth by 8 percentage points for these three items accounted for 16 percentage points of the 21% growth in this segment. The other 5% of the growth in this segment is primarily being driven by 15% growth in South America and 16% growth in Asia Pacific. And in the U.S. our increase in sales was offset by decreases in our European sales which were down 6%. Although our market share in Europe remained approximately stable during the quarter, the competitive pressures experienced last year are being realized in the quarterly comparisons. All of these regional growth rates 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 relatively flat compared to the prior year being down 2% for the second quarter. In our small business segment representing approximately 2 percent of sales, called other chemical products, sales were up approximately $300,000 versus the second quarter of last year.

This segment was higher primarily due to the Q2 key technologies joint venture which produces sulfur, removal products for industrial gas streams(ph). Moving on to gross margin, gross margin as a percentage of sales was 33% this quarter versus 34.7% from the prior year. Approximately one half of the decline in the gross margin percentage was due to higher raw material costs. As previously mentioned we have announced and implemented a number of price increases and surcharges to help offset the increases in raw material costs and we expect to see the positive results from these actions in the seconds half of the year. The bulk of the remainder of the decline is related to new CMS contracts that have caused a different relationships between margins and revenues as we have described in the past. Moving down the P&L, I will now discussion our SG&A and other expenses. Reported SG&A of 27.2 million this quarter is up $4 million compared to the 23.2 million reported in the second quarter of 2003. Approximately one-third 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 company has also increased it's infrastructure to support our growth initiatives in the CMS business and the Asia Pacific region. For other income the decrease is reflective of higher priority return distributions from our companies -- our real estate joint venture in the second quarter of 2003 versus this year. The increase in net interest expense is primarily due to higher debt balances outstanding during the second quarter of 2004 versus the prior year. On tax rate, the effective tax rate for the year is 31.5% versus 31% in the second quarter of 2003. We currently anticipate our effective tax rate will remain around this rate for 2004. Of course many external and internal factors can impact this rate and we will continue to refine this number as necessary as the year progresses.

Continuing down the P&L, equity income for the second quarter of 2004 was relatively flat with the prior year. And minority interest was higher for the the second quarter of 2004 compared to last year really being driven by stronger performances from most of our minority interest affiliates. But, before I leave the income statement I wanted to note the increase in diluted shares. The increase of approximately 300,000 shares is primarily due to option exercises as well as Quaker higher stock price quarter-over-quarter which impacts that diluted share calculation. For example our average stock price this quarter was $25.82. During last year's second quarter it was $22.96. I also want to make a few remarks on the balance sheet and cash-flow. We continue to have sniffing(ph) in cash balances in many of our foreign entities. We periodically bring this cash back when it's advantageous for the company from a tax perspective. Also our net debt has increased in the second quarter primarily to fund our working capital needs due to the growth in sales in the second quarter. Also we entered into an additional CMS contract in the U.S. with DaimlerChrysler and this also had a working capital impact. Overall our net debt to capital ratio remains strong at 30% at the end of the second quarter compared to 25% at the end of last year. In the first half of 2004 our capital expenditures were 4.9 million. Major projects included the company's U.S. lab renovation, global European implementation and capital expansion project related to the Vulcan acquisition.

Concerning the status of these projects, we are near completion on the U.S. lab renovation. The capital expansion project related to the Vulcan acquisition is completed and has allowed us to move essentially all the production from Vulcan to other facilities and reduce our external manufacturing costs. Also our capital related to the European felicitation[inaudible] will be considerably less in 2004 than over the past few years as -- since the majority of the remaining implementations are occurring in 2005. Overall we are expecting our total 2004 capital expenditures to be slightly under 10 million, which would be about a 20% cost reduction from our 2003 CapEx levels. And that concludes my prepared remarks.

Okay. Thanks, Mike. Dan, I would like to open it up for questions now if you'd do that for us, please.

Thank you. Ladies and gentlemen, we will now been conducting a question and answer session. [Caller Instructions]. Our first question is coming from Robert Kosowsky of Sidoti and Company. Please proceed with your question.

Good morning.

Hi, Bob,how are you.

Doing all right. Hey, it looks like you have lost about like 4 or 500 basis points off the gross margin comparing second quarter this year to second quarter of '02. What are your -- any hopes of getting all that back if oil prices remain high? I know you guys are raising prices right now. Can we maybe expect the gross margin to get back to 2003's levels? 'm just kind of curious as to how much margin you can capture back with the price increases.

Mike, you want to address the margin question.

Yeah, I mean, with price increases we will get some of that margin back but with our CMS contracts -- I think you were looking at the six-month numbers, Bob, is that right?

I just thought it was -- just taking how much the gross margin decline in the second quarter of last year and then adding the decline of this yea, too, contributable to the raw materials only.

We had the contract and, yeah, I think it's -- some of it's due to CMS as well as some of it's due to raw materials. So I think some of that will come bank with the price increases, Bob, I don't have an exact number for you. And over time, as Joe mentioned, you know, we get more and more product conversions that will start to increase as well.

And I think, also, once we get into the third quarter, the comparisons will be more direct year-to-year because the third quarter of last year will have affected, not all the contracts we have today in CMS because we have gotten some new ones, but it will affect all of the GM Powertrain that we got last year. So the -- the confounding effect of quarter-to-quarter differences because of that big chunk that came on in May of last year will go away in the third quarter.

Okay, but just kind of in terms of the raw material margins is there any hope of getting that back to where it was in '02?

Bob, when you talk -- comparing '02 to '04, you know, in '03 is when we took on the GM car train contract.

Yeah, but I'm already -- I'm already factoring that into the margin deterioration.

Okay. Well, as it relates to raw materials, yeah, we are hopeful of being able to recover the gross margin deterioration as it relates to that, to the raw materials. As relates to the CMS contracts they are what they are and as Mike said, as we make product conversions that will have some impact on the gross margin as we go forward.

I think the reality is, Bob, that raw material prices have increased considerably since 2002. And that we won't recover all of that in pricing certainly going into the second half.

Are you talking, Bob, just second half or talking longer time?

Talking longer term. I mean, if we have oil prices remaining high for the next 6 to 12 months, or 6 to 18 months, whatever, is there any hope of regaining, you know, the bulk of that margin that was lost while you were not raising prices?

Well, I think the idea of having the price increases run ahead of raw material increases is not very likely. So when you talk about regaining what was lost I would say probably that's not a very likely instance. But price increases are, we hope, will be able to -- will allow us to begin to recognize the impact of the raw materials going forward.

Okay. And just in terms of the CMS, I guess delays right now, is it in particular to one particular site or are some of the sites doing better than others? I know you are on seven on that lease for the powertrain contract.

Bob, there's no question that when you look at the multiple sites that some do better than others but to single out any particular one that is creating the variance that we saw in the second quarter, I wouldn't be able to do that. There's no question that would you get some sites perform better than others. There's no question.

Okay, but it's kind of a more across the board type of thing.

Right.

All right. Thanks a lot.

All right, Bob. You're welcome.

[Caller Instructions]. Gentlemen, there are no further questions at this time.

Okay, thanks very much. I guess we wore you out with our longer presentation this morning. I will blame that on Joe Bauer. Thanks very much for joining us. We really appreciate your interest. We are looking forward to a better second half than we had first half and we have plans in place to deliver that and I look forward to talking to you again in three months. Everybody have a nice weekend. Thanks a lot.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.