Quaker Chemical Corp (KWR) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Quaker Chemical Corporation third 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 * 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. Thanks for joining us today. Here with me today, as usual, are Joe Bauer, our President, and also Neal Murphy, our Chief Financial Officer. Neal, as you may recall, joined us a few months ago, and he certainly had an interesting first quarter with the company. The process today is as we've done in the past. We will make some comments on the quarter, and then we will leave time to answer any questions you may have.

After my comments, Neal will provide financial detail, and then Joe will speak very briefly to bring you up to date on CMS. From a personal perspective after so many years of talking about good financial results, it's my unfortunately unhappy task today to discuss very disappointing earnings this quarter. You know the numbers -- 12 cents a share versus last year's 42 cents and last quarter's 29 cents. This of course is a dramatic departure from the past, and a departure from what we expect of ourselves. How did we miss so badly? First, the extraordinary price, pace and size of raw material price increases, led by crude oil, ran ahead of our ability to accommodate those cost increases with our customers. Second, as good as our sales were, our earlier expectations were higher in certain steel markets, among other areas.

And third, we were hurt by incremental administrative costs in a number of business support areas, from insurance to Sarbanes-Oxley and a few timing matters. As disappointed as we are in this financial result, I'm also very disappointed that one of the fallouts of bad news is that it obfuscates the many positive aspects of what we're doing today and the future we’re building. I would like to use this time today to help you understand, one, the anatomy of this difficult quarter and year, where we stand today, and where we're headed. As I said, Neal, Joe and I will combine to do that for you today. As I said, the story of the quarter is largely a dramatic movement in pricing for crude oil that came heavier and faster than we were able to work through this.

And crude oil is important for us, because derivatives of crude account for about one-third of our raw material usage, this alone hurt us buy about 18 cents in the quarter. We have been and we are continuing to work with our customers to find ways to offset the dramatic effect of raw materials. This effort began as far back as April in some parts of the world, picked up steam in the third quarter and, of course, continues more strongly now, as crude has moved up even higher.

This is an important effort with our customers, of course, because our strategic purpose is to bring them value and to get paid for that rather than be talking about price increases. This is an extraordinary environment, though, and we are addressing those realities with our customers. We expect the fourth quarter will show considerably more of this relief than the third quarter. Also, as mentioned regarding sales, we did see lower growth rates in some markets than we were previously expecting. And in the third quarter we did observe a prospect of some modest market slow downs as energy costs raised economic uncertainties in some areas. Our financials show a large increase in SG&A in the quarter versus last year.

The press release indicates how the relative comparison is affected. The important point is that our expense ratio has come down as a percentage of sales. In the third quarter, SG&A was about 29 %of sales versus historical levels in the mid to low 30s. For our first nine months of the year, this figure is about 28%of sales versus last year's almost 29%. Of course, we continue to challenge our costs, which we've always done, but which is particularly important in this kind of environment, and we will be doing more of that going forward. This lower expense ratio augers well for us as markets recover, which raises an important point that I would like to focus on for the rest of my remarks.

As I alluded to earlier, a reality is that in times of poor results, the bad news almost always captures all the attention and it's difficult to look beyond this and see all the good news that's obfuscated by this bad news. But it's particularly relevant at a time like this when the primary sources of the bad news are cyclical influences with their inevitable ups and downs, particularly as dramatic a cyclical influence as we are seeing today in oil.

But behind all this, the fundamental nature and strategic soundness of what we're doing hasn't changed, and we firmly believe we have the same capability to deliver in the future as we have in the past, as we've consistently done over the last eight years. We are building value for our customers, serving them through a global organization that lines up against their global needs, and using our vast source of knowledge -- we believe better than any of our competitors. And we're very well positioned - perhaps indeed uniquely positioned -- to provide global service to customers that are consolidating in response to a globalized world. The combination of this, that and ISP as only a recent example of what's happening in the steel markets.

We remain financially strong. We can invest in acquisitions and build market share and in working capital to build the CMS channel as a singular window to our customers that supports delivering special benefits to them. It's these things, the fundamentally important matters as opposed to the cyclical negatives that are playing out for us. Not enough right now to overcome the tremendous current negative of oil and other raws, true; but nevertheless, very valuable when translated into effect in more normal raw material times. How are they playing out? First, sales are up 20% for nine months and 11% in the third quarter. Without the raw material drag, this would have been and will be worth a great deal. It says volumes about how we're building our position around the world. Second, CMS is building.

Our third quarter was better than the first half, and we expect the fourth quarter to be better than the third quarter. And our improved results here are not just about doing better for ourselves, but also doing better for our customers. We still have a ways to go in conversions and usage reductions, and we continue to work with our customers on these. More success here will be good for both of us, we believe. So CMS is contributing increasingly more and we expect more from it.

Our market shares are building in both steel and metalworking in the U.S., Asia and South America, and are up worldwide. We are doing particularly well in growth markets such as China and India, and increasingly powerful industrial markets such as Brazil. Even in these hard times, we are maintaining our long-term outlook. We are investing in new business development and related processes, but in markets that give us more opportunity -- coatings and tube and pipe are two examples.

And our enterprise resource-planning project continues, as it is central to our ability to be a globally integrated whole, a key part of our competitive differentiation. Fifth, as you know, we've made five types of acquisitions over the past couple of years. They are all contributing, both in share of market and profit, even though the U.S. based steel business we acquired has been hurt this year, particularly by raw material increases here in the U.S. In sum, we're having considerable success in all these fundamental strategic building blocks. These fundamentals have accounted for our success over the past number of years and will continue to drive our future.

Add to these in the short term the more current energy we are putting into pricing recovery, and as I mentioned, constant renewed vigilance on costs, and we're -- we're responding to this difficult period in a way that will make us stronger in the future. We'd like to be in a position today to look ahead definitively. We noted in our press release that we felt there was just too much volatility in raw material price behavior , which could yet have a dramatic impact, to make a high confidence forecast for the fourth quarter. Let me make clear, though, that we do think we'll continue to see the kinds of sales success we've seen, as we continue to build on our customer expansion and customer penetration.

As I mentioned, there is some demand uncertainty creeping into certain places. Persistently high costs -- high energy costs -- sooner or later put a crimp in the demand for the kind of consumer durables and capital goods -- cars and airplanes and the like -- that depend on energy, and this does create some uncertainty in the demand for these consumer durables, with inevitable impact on the demand for our process chemicals and our customers who make these products and their suppliers. We do think, however, that our sales performance will continue to be very solid. The long-term trend in our SG&A ratio has come down, and as I noted, we'll of course continue to pay great attention to that.

This leaves us with the volatility of raw material pricing trends. And at this point, we simply think it's inadvisable to rely on predicting the unpredictable in trying to make a forecast. So with that, I will turn it to Neal to give you the detail on the third quarter.

Thank you, Ron. Good afternoon, everyone. As Ron mentioned, I joined Quaker as our Chief Financial Officer at the end of July of this year. And I've had an opportunity to speak to many of our investors already, and I look forward to speaking to more of you in the very near future.

While my first quarter with Quaker has been a rocky one in terms of the company's financial performance, I'm quite excited about being part of the leadership team and I believe that our strong market position, our global footprint and integration, some exciting growth initiatives that we are embarking on and our history of double-digit revenue growth will result in sustained earnings growth as the raw material markets -- and in particular, crude oil -- stabilize. A macro level view of the third quarter consolidated statement of income, which accompanied our earnings announcements -- announcement -- shows a continuation of strong year over year revenue growth, but a lower gross margin percentage. Absolute dollar growth at the gross margin line is negated by higher selling, general and administrative costs.

I will focus in more detail on each of these components: Sales, gross margin, and SG&A, to provide a more complete understanding of our third quarter performance, and then I'll briefly discuss the balance sheet. Let's turn to sales. Revenues for the third quarter compared with the same period last year were up 11% to a record $99.7 million. This substantial revenue growth follows 34%and 18% revenue growth over prior year that we reported in the first and second quarters. On a year-to-date basis, revenues are 20% higher than the prior year, with double-digit organic growth in North America, South America and Asia, augmented by growth through acquisition and foreign currency translation.

As discussed in prior press releases and conference calls, we entered into several new CMS contracts during the second quarter of 2003, and this CMS business is a significant contributor to comparative revenue growth in the first two quarters of the year. However, the current quarter is the first quarter in which the new CMS business is fully reflected for both the current and prior year quarter. Thus, the 11% revenue growth in the third quarter is largely unrelated to the CMS business and breaks down into three major components: Organic growth of 4%, growth through acquisitions of 4%, and foreign exchange benefits of 3%.

The foreign exchange benefit of 3% is primarily due to the stronger Euro, as the average Euro rate was 122 this quarter, as compared to 113 during the third quarter of 2003. The company's acquisitions of Vulcan in the fourth quarter of 2003 and Eural in the third quarter of 2003 drove the 4% acquisition growth for the quarter. The remaining growth of 4% is primarily due to double-digit growth in our North and South American regions, with lower sales in Europe during the quarter. I would now like to give some revenue data on a segment basis.

As you may recall, we have segmented the business into three areas -- metalworking process chemicals, coatings and other chemical products. Metalworking process chemicals are products used as lubricants for various heavy industrial and manufacturing applications, and they make up approximately 92% of our sales. Reported revenues in this segment in the third quarter compared with 2003 were up 11%.

Currency accounted for three percentage points of this growth, and our acquisitions from 2003 increased growth in this segment by five percentage points. The other 3% of the growth in this segment is driven by 16% growth in South America, and increases in the U.S. of approximately 13%. In Europe, we experienced a 2% decrease in our sales, thereby lowering the overall consolidated growth rate. These growth rates are calculated on a constant currency basis. Our second business segment is coatings, which makes up approximately 7% of our sales and contains products that provide temporary and permanent coatings for metal and concrete products, as well as chemical milling maskants.

Revenues from this segment increased .5 million or 9%, due to higher chemical milling maskant sales in the aerospace industry. In our smallest business segment, representing approximately 1% of total sales, called "other chemical products", sales were up 200,000 versus the third quarter of 2003. This segment was higher primarily due to our Q2 Technologies joint venture, which provides sulphur removal products for industrial gas streams. Moving to gross margin, gross margin as a percentage of sales was 31.8% this quarter, versus 34.3% from the prior year quarter. This margin reduction resulted in $2.5 million of reduced gross profit in the quarter.

While product and regional sales mix certainly contributed to this shortfall, the key driver was raw material cost increases that we have not fully recovered from our customers. We have made progress in implementing price increases and surcharges throughout the year, and particularly during the third quarter, which will offset the negative margin impacts of higher raw material costs, which we experienced in the first half of the year. The full quarter effect of the third quarter price increases will be reflected in the fourth quarter.

However, our pricing actions to date have not been sufficient to keep up with the speed and magnitude of the raw material cost increases that we have experienced in the third and now fourth quarters of the year. We are planning additional pricing actions during the fourth quarter and the full effect of these increases will be reflected in the 2005 first quarter. A key component of this raw material cost escalation is spiraling crude oil prices, which have moved from a price per barrel in the high $20 range at this point last year to the high $30 range at the end of the second quarter, to the low $50 range today. A substantial component of our raw materials are direct and indirect derivatives of crude.

And while a 10% downward movement in the price of crude over the past few days is directionally encouraging to us, it also serves to highlight the current volatility and unpredictability of this market. The market price of a key vegetable oil used in our formulation has also escalated by 50% from this time last year. And we've experienced general increases cross our raw material base due to a tightening of the global supply/demand situation and the impact of higher energy prices on our suppliers. We continue to leverage our R&D capabilities to explore product substitution, and our global sourcing capabilities to reduce the effects of these raw materials.

For the year-to-date, gross margin is 3.1 percentage points below last year, of which 1.6 percentage point is attributable to our new CMS business, which, as discussed in prior earnings announcements and teleconferences, has caused different relationships between margins and revenue than in the past. Joe Bauer will provide an update on CMS a little later in this teleconference. The remaining 1.5 percentage points of our year-to-date margin shortfall, or approximately 4.4 million, is primarily driven by the same factor as the third quarter -- higher raw material costs.

So to summarize the gross margin situation, we have implemented pricing actions, particularly during the third quarter, to offset the rising raw material costs that we saw in the first half of the year. We will see the full quarter impact of third quarter pricing actions in the fourth quarter. We will take additional pricing actions in the fourth quarter to mitigate the effect of continuing escalations in crude and other raw material costs that we experienced in the third and fourth quarters. The effect of these new pricing actions will not have a full quarterly effect until the first quarter of 2005. Moving down the P&L, I will now discuss our SG&A and other expenses. Reported SG&A of 29.2 million this quarter is up 4.8 million compared to 24.5 million reported in the third quarter of 2003.

It's important to note that the third quarter of 2003 was unusually low due to reductions in incentive compensation in that quarter. The incentive compensation adjustment, unfavorable foreign exchange rate translation and the Eural and Vulcan acquisitions accounted for two-thirds of the SG&A increase. The remaining increase is due to a combination of rising insurance and Sarbanes-Oxley costs, as well as infrastructure costs for such critical initiatives as CMS growth, Asia/Pacific expansion and ERP systems implementation. As a percentage of sales, SG&A for the quarter is 29.3%, which is higher than our nine-month 2004 SG&A percentage of 28%, and full year 2003 SG&A of 28.6%.

For the full year 2004, we expect that our SG&A as a percentage of sales will be in line with 28.6% of 2003. In the other income category, the increase is reflective of higher priority return distributions from the company's real estate joint venture in the third quarter of 2004 versus the prior year. Moving to interest expense, the increase in net interest expense is primarily due to higher debt balances outstanding during the third quarter of 2004 as compared to the prior year. The effective tax rate for the third quarter is 31.5% versus an unusually low 26.3% for the same quarter last year.

The year-to-date effective tax rate is 31.5% as compared to 30% in 2003. On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004 into law. We are in the process of assessing the impact of this law. Over the long-term, a key provision which provides for a special deduction for qualified domestic production activities could have a positive effect on the company's tax rate and cash flow. It is unclear whether this tax law provision will negatively impact the carrying value of our existing deferred tax assets under Financial Accounting Standards Board Pronouncement 109. The FASB is expected to issue guidance on this matter in the fourth quarter, and we will implement such guidance at that time.

Continuing down the P&L, equity income for the third quarter of 2004 was relatively flat for the prior year, and the minority interest was higher for the third quarter of 2004 compared with the same period last year, driven by stronger performance from our Brazilian joint venture. I'd also like to make a few remarks on the balance sheet and cash flow. We continue to have significant cash balances in many of our foreign entities. We periodically bring this cash back when it is advantageous for the company from a tax perspective.

Our net debt is slightly lower than at the end of the second quarter; and overall, our net debt to capital ratio remained strong at 29% at the end of the third quarter as compared to 25% at the end of 2003. The company's credit lines total $70 million, $40 million of which committed and $30 million uncommitted; and at September 30, 2004, the company had approximately $55 million outstanding on these credit lines. That concludes my prepared remarks.

Thank you, Neal, and now I'd like to ask Joe Bauer to give us a brief update on the status of CMS. Joe?

Thanks Ron, good afternoon, everyone. At the last quarterly review, we reported on the performance of our CMS business. I would like to now give you an update on that business. If you recall, our CMS strategy is to focus on selective customers serving the engine and transmission market. Why this market segment? Because of the high demand in this segment for our type of metalworking technology.

We currently have 24 sites under contract within CMS. The basic structure of these contracts is that we are paid a fee which covers both the product and service we are to deliver. The profitability of these contracts is primarily driven by meeting or exceeding agreed upon consumption reduction targets and conversion to Quaker products. As it relates to product conversion, you'll recall we got off to a slow start in 2004 as a result of unexpected performance requirements imposed by our customers. In the early part of the third quarter, we were able to reformulate our product to meet these added product performance requirements, and thus we were able to refocus our product conversion plants -- two of our product conversion plants.

We have made real progress in the third quarter in this area. The sales in the third quarter resulting from conversions were equal to the total sales for the first half of this year, and we anticipate this progress will continue in the fourth quarter as well. So did this business contribute as it relates to our results for the quarter? Yes, it did. In fact, our CMS contribution in the third quarter has improved considerably. As we stated in the past, we see the CMS business model as a channel to market and as a way for to us more directly apply our chemistry and application know-how, and in so doing create value for our customers.

In summary, our product conversions are going well. We continue to make progress in identifying and implementing cost savings opportunities. And as a consequence of these two initiatives, our profitability is and will continue to improve. As an additional point, as a result of our product conversion improvements, as well as some other market gains, we are forecasting a 40% growth in our North American automotive product revenue in 2004.

Thanks a lot, Joe. I know we talked at you a big longer than we usually do in these conferences, but I beg your indulgence for just a little bit longer because I'd like to try to wrap it up in a way that I haven't done in the past, because I think this is important. It's clear that we're in a hard place right now to be able to maintain the financial performance record we've established for ourselves. And that's what we're committed to.

There's a fundamental question that could be attached to this. Is this current period, one, a short-term aberration driven by a very unhappy combination of current circumstances, largely cyclical forces extraordinary in their impact working against us that will change direction as markets move? Or, two, does this represent some kind of fundamental long-term shift in our business and our position and our role in the world in this business? Two different ways you can look at it. We don't see any reason to conclude that it's the latter. In fact, we are convinced it's the former.

Our revenue strength indicates our success in customer expansion and penetration, it's indicative of how our strategies address our global world and our customers' needs. Our acquisition are contributing. Our CMS major initiative is contributing, and it shows more future promise. We have a great position in growth markets such as China and India and Brazil. We have the financial strength to take advantage of opportunities. And we are working on the realities of pricing and costs to reflect today's world.

We're going to continue to build on our strengths, we're going to invest in growth, and we're going to manage our affairs with a firm grip on facts as we find them rather than as we wish they were. So we believe that while this short-term aberration is a great disappointment for us, we do believe it's that rather than some kind of long-term shift -- and as I said earlier, we expect to come out of this stronger than we went in. So thanks for listening, and I'll -- we'll stop now and turn it around and open it up for questions.

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press * one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press * two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. Our first question is coming from Robert Kosowsky of Sidoti & Company. Please proceed with your question.

Good afternoon.

Hi, Bob, how are you?

Doing all right. Hey, I was wondering if you can comment on some of the revenue weakness that you're going to be seeing, exactly kind of where you're seeing this little slow down in the domestic auto market in particular? And can you comment on your October sales so far?

Where we do think there is a potential for some wiggles are certainly in steel demand in the U.S. we've seen already in the third -- and toward the end of the third quarter and starting into the fourth quarter that the inventories are growing in steel and the capacity is slowing down -- the level of production is slowing down. That certainly indicates that there's some fall off in demand, and we think that's directly related to what's happening with energy and the demand for vehicles. I think that's confirmed with the car companies. We see the same kind of thing happening in Europe, although neither one of these is tremendously dramatic at this stage. I'm talking about small changes here. But it’s a little bit of a wiggle in terms of the strength of the demand. In Asia, in this third quarter, we didn't have the kind of growth that we expected; although for the year, our performance in Asia's going to be quite strong and we expect the fourth quarter to be pretty good in Asia, actually. But that's the nature of the concern we have going forward. But let me say, Bob, that we don't think this is -- I didn't raise that as a big negative for us. It's just a reality we want to stay close to. We still think our sales going forward are going to be very strong and are going to be indicative of the kind of growth we've had this year.

Okay, so you kind of perceive it as more of a soft patch as opposed to a meaningful slow down?

Well, yeah -- I don't want to get caught up on words, but it's not of tremendous concern to us at this point, but it's something that be want to keep our eyes on.

Okay, and I know your raw materials have gone up quite a bit. Are they priced right now more on supply and demand or is it mainly oil?

When you say our raw -- you mean our raw -- is the different categories of our raw materials up?

Yeah, like are they in tight supply. some of these raw materials that you're using right now that's contributing to the price increases?

Yeah. There are in very small pockets there are some supply demand issues; but fort most part, Bob, it's really -- it's really crude oil driving it and some aberrations in the specific parts of the vegetable oil market where there were some -- there was really a bad crop earlier in the year. But that seems to be working its way out. So it's not an issue of getting raw material. It's a question of the price we have to pay for it.

Okay. And just one other question. I see where your gross margin is right now. I'm just kind of curious what it would be adjusted for CMS, you know, say third quarter '04 versus third quarter '03 versus third quarter '02, just to get an idea of some of the margin lost since oil has gone up and your confidence that you'll be able to regain the margin when oil goes the other way.

Yeah, I think -- the best answer I can give you right now is that the year-to-date impact of CMS versus the prior year is 1.6 percentage points. Now, we had some CMS in last year, but only from May to September versus the full year this year. So that's 1.6 percentage points. The year over year impact for it in the third quarter is not significant in terms of it -- the year over year comparison. I don't have for you, though, the -- you know, what the margins would have been without CMS in all three years.

Okay, I'm just trying to get a gauge of how much margin was lost from '02 when oil was a little bit more reasonably priced.

I don't really have the '02 margins right here in front of me to be honest. Can you address that question any further, Neal?

No, I really don't have that information available.

Okay. That's okay. I will get back in line.

Thank you, Bob.

Our next question is coming from Gregory Mocosko of Lord Abbott. Please proceed with your questions.

Yes, thank you. With regard to the CMS business, I think you said that the contribution increased in the course of the third quarter. Explain that to me.

Yeah, Greg, the contribution being the absolute profit, we are realizing from CMS in the third quarter was significantly higher than it was in the prior quarters.

And is that just a function of increasing sales?

That's primarily driven by the product conversions we realized in the quarter.

Okay. So, in other words, how many -- I mean, you have 24 sites. How many did you put on in the quarter?

We didn't put on any new sites. What we do is, while we're at these sites we have the opportunity to convert from some other product to our own, and that's what generated the increased profit in the third quarter.

Okay. So additional operations at the same site?

Yeah.

That's correct.

Okay.

And of course, we want to continue to work with our customers to try to do those kind of thing where we think there's real value in making a product switch.

Right. And do we -- have you said how much CMS is of the metalworking?

Well, CMS -- the contribution of CMS revenues, is that what you mean, Greg?

Yes.

Yeah. We have that number. The overall CMS revenues are in the 40 to 45 million range on an annual basis.

Okay, 40 to 45 is what it will be this year, you figure?

Yes.

And in the quarter -- we have that number in the quarter, too, wasn't it something like 15 million?

Yeah, it was.

Okay. I see. All right. And with regard to the steel business, I was interested in your comment about the inventories. You're just looking at the inventories that you see that the public companies have, or are you hearing that from your salespeople and people talking about and that suggests to you that demand for your chemicals will be down going forward?

Well, the way -- this information is developed from our own internal efforts to try to understand our markets, and certainly to the extent to which the steel production -- the level of steel production has an important impact on the demand for our products and services -- in cold rolled sheet steel. So you know, one goes with the other. In the last business review we did, it was -- it was interesting to observe that we saw -- we saw production levels coming down as we were finishing the third quarter, and inventories up. It's hard to get a direct picture on the demand side, but you can derive demand from those kinds of -- that kind of information and that's what we are seeing. As I said earlier, though, Greg, I don't mean to imply that these are dramatic impacts at this stage, but they're nevertheless changes at the margin that we want to keep our eye on.

And do you look at that monthly?

I think we kind of look at it quarterly.

Quarterly. So you're saying at the end of the quarter it was kind of weaker than it had been in the previous quarter?

To be specific, we saw at the end of the quarter that U.S. North American steel production levels were down and inventories were up.

Okay. And you said that Europe was negative in local currency?

No, I don't think --

No, in constant currency terms it was slightly down, yes.

And -- are we talking about sales here?

Yeah, sales. I'm sorry, I jumped to Europe from sales, excuse me.

Yeah, is that -- I mean, and why -- is it because of the steel business? What is driving that in Europe?

Yeah, it -- for last several quarters, it's really been stable. There were some competitive pressures in the latter half of last year -- primarily in the fourth quarter of last year. So on a quarter -- you know, on a quarter over quarter comparison, we are seeing some decrease. But we really have seen a fairly stable market for 2004.

Yeah, I mean, the comparisons you just heard Greg went back to last year's third quarter; but if you look at the market share this year, as Neal said, they would be stable. And the other aspect you have to understand about steel in Europe is that our market share there is very, very high. So switches in accounts that are going to inevitably happen along the way do affect market share over time, but our market share remains there very powerful.

I see. Okay. And the analysis that you gave me for the U.S. steel industry, have you done the same for Europe?

Yes, but Europe I would think has been a little more steady from the numbers that I recall seeing. The one that stuck out in my mind was the U.S. numbers.

Okay, so it's -- it's not going up, not going down -- it's kind of steady as she goes.

Yeah, that's right.

With regard to pricing -- and I'm -- this is in the steel business -- forget about CMS for a minute. I'm assuming that the pricing that we're talking about is in the non-CMS metalworking business where you raised prices?

That's -- in terms of responding to raw material increases, that is the most important area for us, yes. Although that's not the only place that we require price relief, and the only place we've gone to our customers to work this out. But the biggest area is steel.

Okay. And so if CMS was $11 million, we're talking order of magnitude sort of 75 million of that is affected by this pricing. Is that what we're talking about that you're raising prices on? Am I thinking of that right?

In terms of the quarterly -- in terms of the quarterly base, you mean?

Yes.

Of the 99 million quarterly base.

92% minus 15 is kind of 75, I think -- I don't know maybe I didn't calculate that right, but.

In terms -- okay, in terms of metalworking segment.

Yeah, so that -- now that's where the price -- that's the part of the business that's being affected by the pricing, correct?

Right.

Correct.

That's correct.

Okay. Could you raise prices once a week?

No, I don't think so.

Why not?

Because, you know, there's a -- obviously a market sensitivity out there, and it's not easy just to even start with in some of the markets we serve like automotive and steel. And -- but we haven't aggressively gone out to do it every week. I'm sure that the customer, because of the process they have to go through, would not be necessarily accepting that type of an approach.

Well, explain to me how it works? I mean, are you, -is this a surcharge or is this just pricing?

We have different methods that we use for price increases. Surcharge is one of them. Indexing is another. And the third is, we just raise prices on an absolute basis.

All right. If -- can you give us a feeling for, you know, on a year-to-date basis or year over year or something, how much prices have gone up, and can you break it down between surcharges, indexing and -- what was the third one?

Just normal pricing.

Yes.

Well, we're not prepared to do that kind of detail, Greg, and there's obviously some competitive implication to that kind of information. So we are reluctant to --

Let me put it another way.

All right.

If you've raised prices with regard to surcharges, as soon as oil comes down you are going to have to give that back. What about the indexing and the normal?

Same thing would be -- would apply to indexing. You're indexing up based on whatever you are measuring against, and as that index change is coming down, it would come down. And in the case of normal price increases, no, that wouldn't be the case.

You have to remember the indexing is concerned, rightly, that nothing -- I'm sorry, the surcharges, they're based on certain levels of oil -- it's not a dollar for dollar shift.

I understand.

But rather, if oil has a certain characteristics for a certain period of time, then there will be a change in the price.

Okay. I guess what I'm getting at is, I want to get a -- I'd like to get a feeling for how much of the price increases you're going to have to give back if and when -- not if, but when oil comes down? I mean, are you going to -- can you, --I mean if half of the increase happened to be a normal price increase, I would assume you wouldn't have to give that back unless, you know, you had competition from the marketplace,.

Right, right. We do not have the information available. I don't want to dance around the question. We do not have the information available in terms of how the price increase breaks out against those three categories.

Okay. Thanks very much.

You're welcome.

A reminder, if you do have a question, you may press *one on your telephone keypad at this time. Our next question is a follow-up coming from Robert Kosowsky of Sidoti & Company. Please proceed with your question.

Just a follow-up on the CMS. What percent of the products have been converted that could be converted?

Trying to remember now, Bob, exactly what the potential is. My estimate would be of the -- one, we had never had intention of totally converting all products, but of those that we were focusing on, I would say that we are somewhere between 20 and 25%.

Okay. And I think that's all I have. Thank you.

Hey Bob, a follow up to your prior question. I don't know that this gives you the full answer, but if we, -- the margin reduction, excluding CMS over the two-year period, is about 4.5 percentage points. Now that's -- there's several factors that enter into that -- raw material being a significant factor, regional product and -- regional and product mix are impacting it, acquisitions are impacting it. So there's a whole series of factors. But specifically carving out CMS, it's about 4.5 percentage points.

Okay, so you think that you could get, you know, the lion's share of that back once oil prices normalize?

Well, again some of it is changes in the underlying products plate; but, yes, we would be looking to restore the bulk of that margin over a period of time.

Yeah, it's not just a -- not totally just subject to oil prices, but also that's the intent of the pricing activity that we have and the conversations we're having with our customers. Our focus is on value, of course, as I said earlier, where we recognize and they have to recognize that price is a real issue when you're in this kind of an environment. So it's not just a matter of waiting around for oil to change it's price level, but to go out there and replace and to make up for those costs with a relief from our customers.

Okay. And actually, getting back to the price flow increases. Is this the type of thing where, I guess generally speaking, you go to the customer with a 5% price increase and you only get 3%? Is that the type of environment or have the customers been a little bit more receptive to your price increases?

Well it's -- no question it's a negotiated matter, and how much we get varies from situation to situation. But it is, no question, you have to sit down and negotiate.

Okay. And just following up on what Greg asked, how quickly can you go back to some of these customers? And I know a lot of times raw materials now have moved from being priced on a quarterly basis to a monthly basis -- is there a little bit of a lag, you know, that kind of could go against you right now -- or is going against you right now?

Well, there's certainly a lag in terms of when we get hit with the pricing and going to our customer, because much of the pricing is very sensitive -- our customers are very sensitive to the actual raw material change. But our prices -- I mean, it's certainly not a weekly thing, as Greg was offering. I wish that could be the case if we could have that kind of discussion with our customers. But I would say that in the last four months, we've probably had two price increases, three price increases, on certain products, yes.

Okay, thank you.

Our next question is a follow-up coming from Gregory Mocosko of Lord Abbott and Company. Please proceed with your question.

Okay, and just with regard to the steel market share, is it fair to say that -- I mean, you are -- you are in a maintenance mode? You said it was high market share. Can you gain more share with regard to those markets overseas -- the Eastern Europe, et cetera?

Yeah, we think we can gain share from where we are today in Europe, even with our high share. Our share today is not as high as it was a year ago today. But it's down marginally -- but we think there's still opportunity there for us with technology and with -- particularly with global consolidation on a customer base. And so that's certainly our plan is to try to build on our market share, not just to be in the position of kind of keeping it steady. Our share in the United States has grown dramatically over the last couple of years. Our share in Asia and China, specifically, is the highest in the marketplace. And we think we have -- our plans call for us further to increase that share as our -- as new capacity is coming on line, particularly in China. And in the market like Brazil -- South America, generally -- but Brazil specifically -- we have, again, a very high market share and we are the leaders in that industrial area.

And if I might say, sometimes we focus on cold rolled but in Europe we have other opportunities like in cleaners and corrosions and so on, for capturing more share. So there is opportunity to grow our position in Europe.

And a lot of my comments actually tend to resolve around cold rolled steel, because that's one of our most important businesses.

Why did you lose share in steel in Europe?

Well, in the specific case of the instance I was talking about between last year and this year were a couple of accounts in Russia, and that's really what it comes down to, because there's such large accounts in the steel business around the world.

Is your share in Eastern Europe versus Western Europe higher, lower? I mean, you lost obviously in Russia, but I mean -- is the opportunity in Eastern Europe higher?

I would think the opportunity is higher because there's more growth going on there, yes. I think that we're, again, very well-positioned in that market. I don't think our share is as high in that particular area as it is in Western Europe, but -- so I think there's -- and when you throw Russia in there that's true; but I think there's real opportunity for us there because we are probably -- we are the leading global player in that area and that's what we're focused on, trying to pick up this business as new business comes online in Eastern Europe.

Have you gained share because of the Vulcan and Eural acquisitions?

Yeah, we have. When we talk about stability of market share, it's really in terms of organic growth.

So when you said you'd gained share in the U.S., that's without Vulcan or Eural?

Well Eural is -- doesn't have much impact in the U.S., but Vulcan does, and that's part of our share -- a considerable part of our share growth in the U.S. has come through acquisition.

Okay, so basically you're maintaining share -- you're gaining share through acquisitions. Is that what I'm hearing?

Well, yeah, it's a really combination, Greg. If you look around Brazil, you look around India, and you look around China, that's not through acquisition. If you look in Europe, that's not through acquisition. Our share has come down a little bit in Europe, as we mentioned, but we have plans to get that share back up. In Europe, and in the United States, it is true that much of our share gain has been through acquisitions, yes.

Okay. With regard to those acquisitions, is there any -- is there any margin gain from the consolidation of those operations and sales forces and things -- what's happened on that score? Is that complete now, or do we see any gross margin SG&A gain? I mean, the SG&A went up. Maybe that's -- I sense you said in part because of the acquisition -- the Vulcan acquisition, I guess -- but is there -- can we see that 28, 29% come down as a result of the acquisition consolidation?

It probably won't come down as a result of acquisition consolidation. Much of what we were going to do there we have done, and as that's resulted in very little increase in our administrative costs; but of course, it has resulted in some increase in our direct business costs. But obviously, part of the value of acquisitions is to try to make them more effective and efficient when we make them, and that's certainly something that we've done. But I would say that that's pretty much baked into the -- into the SG&A that you see there now.

Okay. Thank you.

You're welcome, Greg.

Our next question is a follow up from Robert Kosowsky of Sidoti & Company. Please proceed with your question.

Yes, hi, just a couple more questions.

Okay, go ahead, Bob.

I noticed your SG&A was up sequentially. And I'm wondering if you can comment on that?

Yeah, Bob. You know, I think if we focus on the full year, we'll really be as a percentage of sales at 2003 levels; but we had incentive compensation adjustments in the second quarter which really made the second quarter artificially low. And so there's some timing issues and some adjustment issues, but the base level SG&A as a percentage of sales for the full year should be very much aligned with prior year.

Okay. So by incentive compensation, that means you're paying some of your salespeople for, you know, the increased top line that we've been seeing?

Well, in effect, in the second quarter we had been accruing incentive compensation based on a different view of the year -- or in the first quarter -- and we reversed that in the second quarter; and that's why the second quarter as a percentage of sales is a bit lower than our norm.

Okay, and given the big steel deal that just happened, how are you guys positioned to take advantage of that?

Well, we hope very well. We are a key supplier to both of them. And we are also, we think among all our competitors, the best aligned against their global needs in terms of our global presence around the world, our global technology and knowledge around the world, and the global relationships we have with those two accounts. So we think we're very well aligned with them. As I said, we're important suppliers to both of them.

Okay, so you think there's an opportunity for you to end up ahead opposed to, you know, just kind of staying the same?

Well, we're certainly going to be working with our customers to try to show them the virtue of dealing with our global capability. Absolutely.

Alright, thank you.

All right, Bob. You're welcome.

Gentlemen, there are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Okay, thanks a lot. I really appreciate the interest of the listeners, and particularly Bob and Greg. I appreciate learning a little more about your perspective on this. I just would reiterate what I said before that in terms of our, -- in terms of how we come out of this, I think that we are very well-positioned in with our long-range strategies, and that's what we expect to be building on going forward. So thanks very much for joining us this afternoon. Thanks for your interest, and we look forward to talking to you again in the new year.

Take care, bye.

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

Thanks for your help.