Quaker Chemical Corp (KWR) 2004 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Quaker Chemical Corporation Fourth Quarter and Full Year 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. (OPERATOR INSTRUCTIONS). 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.

Thank you for that introduction. Welcome everybody. Here with me today are Neal Murphy, our Chief Financial Officer, and Joe Bauer, our President, as is normal. Both of them will have a few words to say. And then we’ll take questions later.

I am going to begin with some overview comments. I am going to try to keep these very short, because I want to address some general themes, frankly because I think the strategic commitment and market capability that we have developed and are developing is critically important as we confront short-term challenges. And I think it’s important for you all to understand how the long term fits with the short-term.

When I am finished, Neal is going to cover some detail. And then Joe is going to make some comments about updating CMS. And then we’ll begin with questions. We’ve all seen the fourth quarter, of course. It’s now what we would like. But it is pretty much what we expected for the quarter. We said the fourth quarter would be better than the third. And it was, by a considerable margin.

Third quarter earnings per share of $0.12, and the fourth quarter earnings per share, if you add back the $0.03 of restructuring that we took in the quarter, were $0.20. Our margins moved in the right direction. We are on the road to improvement. But we do know we have farther to go. We saw improvements as we moved from the third quarter to fourth quarter in our margins. The third quarter was 31.8. And the fourth quarter 32.8. And, frankly, in the quarter itself, through the quarter, we did see some even slightly further improvement.

This improvement was not because raw materials got any better, because raw materials in the quarter were actually up considerably over the prior year quarter. The margin effect was the increase, was the effect of mitigating the raw material increases by our pricing actions. But it still didn’t take us far enough. If you just look at the net effect, we think probably that the increase in raw materials, unrecovered raw materials, probably costs us about $2m in the quarter versus the fourth quarter of last year. It’s maybe $0.13 a share or so.

So this has been an extraordinary year for the commodities we depend on. Last year at this time, if you will recall, oil was probably in the range of $28, $30, $31 a barrel. This year, as we sit here today, we’re talking about a range in the high 40s, 46, 48, 47. It depends when you’re measuring it. So there’s a dramatic change in what we’ve seen over the past year, even a commodity such as vegetable oils, which is an important one, has had dramatic increases over the course of the year.

So it certainly has been a dramatic year in that regard. I want to add though that it’s been an extraordinary year in many other ways, one of the most important of which is that sales were up 18% for the year. In the fourth quarter, sales were up 11%. And even if you take out the exchange rates, sales were still up about 8%. I think this is a testament to the global reach and the market presence we’ve built in the Company.

Of course we don’t operate in high growth markets. And our customers, our end users, our customers who sell to the end users, operate in very challenging businesses. And that makes them very cost conscious. That’s simply a reality of the world we live in. We grow though, because we’re focused on what we can do for our customers, and how we do it. High service, global knowledge and expertise, and global delivery -- three very important aspects of what our customers can get from us. And in many ways, what we deliver that differentiates us from our competitors.

We are well positioned in the geographies where there is growth to be had -- China, India, Brazil. I think you saw that in the fourth quarter. Our growth in Asia was almost 13%. Brazil was 22%. We’re very well positioned in these businesses where we think there is growth to be had.

We are pushing hard on internally developed business extensions, that build off a technological capability we have, or a know-how that we have, to build businesses in related markets. I’ve discussed in the past (indiscernible) in coatings. We’re investing in these businesses to add growth, to build positions in markets outside, but still complimentary to our core steel and metalworking customers. In fact, our plans in 2005 reflect doing this further.

We’ve stepped out to provide a service to our customers, such as CMS, because we’re willing to bet on finding new ways to do more for our customers, and put ourselves in the position to be their key resource. This is another thing which differentiates ourselves from our competitors.

We’re always challenging our costs. But we’re, at the same time, very mindful of the service levels and global infrastructure that deliver for our customers. Indeed, we’ve pointed out in our press release that we have taken certain actions to reduce costs, and realign costs. But we are doing this always being mindful about the thing that makes us unique for our customers and the competitive advantage on which we can build.

Our financial status is strong. Our cash flow and our balance sheet both give us flexibility, staying power, and strength to build on, whether it be the prospect of making an acquisition, where we think opportunities are good, or whether it be the prospect of maintaining the dividend policy, all financial aspects that have promise for our shareholders.

In sum, if I just draw a bottom line on this, it’s a difficult time to be sure for us. The Company prides itself on first rate financial performance. And we haven’t been there over the last year or so. It’s important for you to notice, however, that our focus hasn’t changed. We’re committed to build our competitive position through our service to customers and our global delivery. This is true, even as cyclical characteristics, characteristics such as demand cyclicality for basic metals and commodity costs hurt us in the short-term. Our plans call for us to return to profit growth in 2005, even as we deal with this cyclical phenomenon. We’ll build our stake and our share, and be a stronger than ever force in the market when ‘05 ends. So we know the challenge is still out there. And we’ll stay focused on managing raw materials and other costs and prices. But we won’t lose sight of being the best long-term competitor, ready and willing to take advantage of market and environment changes.

If I just step back and come to a few simple conclusions, the things that we focus on hard here are number one, our revenue growth. The kind of sales growth we’ve had is a real indication of the strength and success we’ve had in our customer expansion and our penetration. It’s indicative of how our strategies address our global world and our customers’ needs. Everything begins with the revenue growth on the top line. And as long as we keep that going, we feel like that we’ve got the promise to deliver the kind of financial performance that we expect of ourselves.

Our acquisitions are contributing in gross profits and the share power we build in our markets. Our major initiative, such as CMS, is contributing. And it shows more promise for the future. As I said, Joe will talk about that in a few moments. We have a great position in growth markets that I’ve mentioned -- China, India, Brazil, and other parts of the world. 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.

That’s just the backdrop that I wanted to offer to you. And I will ask Neal to now cover the details of the quarter.

Thank you Ron. Good afternoon everyone. Yesterday we announced record quarterly and annual sales, and diluted earnings per share of $0.17 for the fourth quarter, and $0.90 for the year, inclusive of a $.5m pre-tax charge for restructuring and other related charges. I will spend the next 10-15 minutes focusing primarily on the fourth quarter P&L. I’ll also make selective comments on the full year.

Revenues for the fourth quarter compared with the same period last year were up 11%, to a record $104.2m. This substantial revenue growth follows 34%, 18%, and 11% revenue growth over prior year that we reported in the first, second, and third quarters. As Ron mentioned, on a year to date basis, revenues are 18% higher than prior year.

Eleven percent growth for the fourth quarter breaks into a few components. Organic volume and pricing improvement agFrankated 8%, inclusive of 1% growth through acquisition. And foreign exchange benefits contributed 3% of our fourth quarter growth. The 3% revenue improvement due to foreign exchange is primarily due to the stronger Euro, as the average rate was $1.30 this quarter, versus $1.19 during the fourth quarter of 2003.

The remaining growth of 11%, including price increases, is primarily due to double-digit growth in our North and South American and Asia Pacific regions, with lower sales in Europe. I would like to now give some revenue data on a segment basis. As you may recall, we have segmented the business into three areas -- metal working process chemicals, coatings, and other chemical products. Our largest segment, making up approximately 92% of sales, is metal working process chemicals, which includes products used as lubricants for various heavy industrial and manufacturing applications.

Reported revenues in the fourth quarter compared with 2003 in this segment were up 10%. Currency accounted for 4%. And the other 6% of the growth in this segment is driven by 22% growth in South America, 12.3% growth in Asia Pacific, and increases in the U.S. of approximately 9%. These were partially offset by a 3% decrease in our European sales. The growth rates that I just mentioned are calculated on a constant currency basis. So we’ve really eliminated the strength of the Euro in these percentages.

Our second business segment is our coatings segment, which makes up approximately 6% of our sales, and contains products that provide temporary and permanent coatings for metal and concrete products, as well as chemical milling maskants.

Revenues for this segment increased a million dollars, or 22%, due mainly to higher chemical milling maskant sales to the aerospace industry, as well as new customer penetration in roofing sealants. In our smallest segment, representing 2% of total sales, called other chemical products, sales were up $1.1m, versus the fourth quarter of 2003. Special one-time sales to this segment’s largest customer accounted for this increase.

Moving now to gross margin, gross margin as a percentage of sales was 32.8% this quarter, versus 35.5% from the prior year. While product and regional sales mix contributed to this shortfall, the key driver was raw material increases that we have not fully recovered from our customers. We did make progress in implementing price increases, as evidenced by a full percentage point increase in gross margin as a percentage of sales, as compared to the third quarter of 2004.

This percentage point increase was achieved, despite continued escalation in raw material costs in the fourth quarter. Our year to date gross margin is three percentage points below last year. 1.3 percentage points is attributable to our new CMS business which, as discussed in prior earnings announcements and teleconferences, has caused different relationships between margins and revenues than in the past. Joe Bauer will make additional comments concerning our progress in CMS in just a few moments.

The remaining 1.7 points is primarily driven by the same factors as the fourth quarter -- high raw material costs, as well as regional and product mix changes. As discussed in prior quarters, a key component of this raw material escalation in 2004 is crude oil prices, which have moved from a $30 per barrel range at this time last year to the $48 range today.

The 2004 market price of key vegetable oils has also increased by greater than 40% over average prices in 2003. And we’ve experienced broad-based increases across our raw material base, due to a tightening global supply/demand situation, and the impact of higher energy prices on our suppliers.

The Company implemented price increases in the fourth quarter, and the full quarter effect of these increases will occur in the first quarter of 2005. The Company also plans additional pricing actions in the first quarter of 2005, as we continue to chase upward movements in raw material costs.

Moving down the P&L, I will now discuss our SG&A and other expenses. Reported SG&A of $30.5m this quarter is up $3.7m, compared to the $26.8m reported in the fourth quarter of 2003. Unfavorable foreign exchange rates and acquisitions accounted for one-third of the increase. The remaining increase is due to a combination of rising administrative costs, including Sarbanes-Oxley compliance costs, as well as infrastructure costs for such critical initiatives as CMS growth, Asia Pacific expansion, and ERP systems implementation.

During the fourth quarter of 2004, the Company began efforts to realign the organization and reduce costs, by announcing the consolidation of its administrative facilities in Hong Kong, with its Shanghai headquarters, resulting in a $500,000 pre-tax charge for restructuring and related activities. The Company continued these efforts in the first quarter of 2005, with the elimination fo additional positions in the U.S. and in Europe. An annualized savings of $1.3m to $1.5m is expected from these actions. These savings will be reinvested in higher growth areas, such as Asia Pacific, and in the continuing development of new complimentary businesses.

Other income in the fourth quarter is higher than prior year, primarily due to a gain on the sale of real estate by the Company’s majority owned Australian subsidiary, which also resulted in an increase in minority interest. The increase of net interest expense is due to higher debt balances outstanding, as well as higher interest rates, which were one percentage point higher during the fourth quarter of 2004, versus the prior year.

The effective tax rate for the fourth quarter is 31.5%, versus 34% for the same quarter last year. The year to date effective tax rate was 31.5% versus 31% in 2003. Continuing down the P&L, equity income for the third quarter of 2004 was significantly lower than the prior year, due to priority return distributions received by the Company’s real estate joint venture in 2003.

The minority interest was higher for the fourth quarter of 2004, compared with the same period last year, driven by strong performance by our Brazilian joint venture, as well as the gain on the sale relating to our Australian operations, which I noted previously.

I also want to make a few remarks on the balance sheet and cash flows. We continue to have significant cash balances in many of our foreign entities, and will periodically bring this cash back when it is advantageous for the Company from a tax perspective. Our net debt is slightly lower from the end of the third quarter. Overall, our net debt to total capital ratio remains strong at 28% at the end of 2004, compared to 25% at the end of 2003.

In the fourth quarter, the Company took action in the U.S. and Europe to increase its credit facilities by $25m. As a result, the credit lines total $95m, $40m committed and $55m uncommitted. At December 31, 2004, the Company had approximately $57m outstanding on its credit lines.

Lastly, the Company announced yesterday that its real estate joint venture completed the sale of its holdings, which resulted in approximately 4.2 million of proceeds to the Company. In the first quarter, we will report approximately $1.2m of income attributable to priority distributions which the Company is entitled to under the real estate joint venture agreement. In addition, we will report approximately $3m of gain attributable to the Company’s 50% ownership in this joint venture.

That concludes my prepared remarks. Joe Bauer will now speak to CMS.

Thanks Neal. Good afternoon everyone. As I have done in the last two quarterly conferences, I would like to give you an update on our CMS business. We divide our CMS business into two segments. One we call our metal fab division business, which is part of General Motors. There we enjoy 11 sites that are under contract.

These sites have been under contract for the past seven years. The other segment is what we call North American Power Train, a combination of 13 sites with GM, Ford, and Daimler-Chrysler. These sites have been under contract for the last year to year and a half.

As you will recall, these contracts call for us to be paid a fee, which covers both the product provided, to the services rendered under these contracts. The profitability of these contracts are primarily driven by meeting or exceeding agreed upon consumption reduction targets, and conversion of competitor’s products to Quaker products. From the 24 sites currently under contract, we are satisfied with the performance of 20 of these sites in 2004.

Today, our efforts are concentrating on improving the results of the remaining four sites. Our performance throughout 2004 showed steady improvement. Several examples of this continuous progress relative to our North American Power Train segment are our consumption, first half of 2004, compared to the second half of 2004, as decreased by approximately 15%. Our product sales, resulting from our conversion initiatives, first half compared to second half, increased approximately 65%.

This revenue gain represents a 40% growth in our North American automotive product business in 2004. If you will recall, our primary reason for entering the CMS business was that we saw it as a channel to market for our products. Our 2004 product conversion performance certainly bears that out. Overall, good progress has been made. But, as most of you know, these contracts call for annual reductions in consumption. Thus, each contract year presents additional challenges for us. This concludes my prepared remarks.

Okay. Thanks Joe. Now gents and ladies, whoever is out there, I would like to open it up to questions if there are any.

(OPERATOR INSTRUCTIONS). Our first question is coming from [Patrick Flavin] of [Flavin, Blake] & Company. Please proceed with your question.

Ron, I’ve been reviewing steel production for the last year worldwide. And it’s really kind of an awesome exhibition of what’s going on in Asia, but also in general in the steel industry. With that kind of strength in demand, and your usage in the production of the product, shouldn’t there be more receptivity to price increases? And shouldn’t there be a higher level of volume gains?

Well, I totally agree with you Patrick, that there ought to be a lot more receptivity to price increases. From your lips to God’s ears on that question. And we are implementing price increases in the steel side of the business, including in Europe. The demand question is -- I will remind you that we did very well in Asia. And we did very well in Brazil, and in other parts of the Asian market. We did pretty well in the United States also, in terms of the growth of the business on the top line.

Where we had some -- where we did have a downturn in the top line for steel was in Europe. And that really wasn’t surprising, in the sense that the Europe -- the weakness in Europe we saw in a lot of different ways. It wasn’t just in the steel business. We believe our share in Europe has remained stable throughout ‘04. In fact, we think now we’re in a position to get back a couple of major accounts that we had lost near the end of ‘03.

So we believe that we did, in fact, see revenue improvements in the markets where it was happening. And where we really don’t think there was that much growth, where there was real growth in steel demand in Europe, we feel like we held our own, although our sales did turn down.

Okay. But in terms of the receptivity to price increases, with the mills operating at these rates, and with the price increases in their product going up, vis a vis – I mean if you just look at (NuCorp)’s (ph) results, that sort of thing, help me with why they wouldn’t be more accommodating in terms of at least maintaining gross margins for our products.

I mean I don’t know if we have any of those folks listening on the call. Just not very accommodating folks. They have their own business goals. And they have their own pressures. And even though their world got better, to be sure, with pricing, obviously they were working hard to try to keep their costs down as much as possible. Now we have gotten price increases through. It’s not like we’re, where this is a mission that has no success.

We have gotten price increases through. But it’s a kind of thing that, frankly, because the steel makers are seeing their prices get better, they don’t want to give it away, because we’ve asked for it. And of course, the competitive world out there is what we have to deal with in our own business. And of course that moderates what we can get done with our customers.

I mean I am really hard pressed to answer that question for you, because frankly it’s what’s in their minds. And all I can tell you is the approach we take to it in terms of presenting to them the kind of value we’ve delivered to them over the years, which I think is meaningful, and showing them how growing sales have hurt our profitability. And those are the conversations we had with folks.

And, as I said, it’s not like this is a hopeless venture. We are getting price increases. And we are seeing the benefit of that.

Okay. And our product slate is heavily proprietary in nature, rather than commodity. Is that right?

We believe so. We have a unique and customized product for virtually everyone we serve. It depends on not only our chemical knowledge, but it depends on our application knowledge and our know-how, and how we can help them with what they do, so that it’s not an easy matter just to substitute one for the other, nor is it impossible. I don’t mean to say that substituting one competitor for another is not something that goes on. Of course it does. But it’s not a matter of just simply buying commodity X from A or B, to be sure.

Okay. Thank you.

You’re welcome.

(OPERATOR INSTRUCTIONS). Our next question is coming from Robert Kosowski of Sidoti & Company. Please proceed with your question.

Good afternoon.

Hey Bob.

Hey, you guys mentioned, or Joe mentioned on the CMS section that each year calls for annual consumption reductions, can you guys maybe give us an idea of what the target was for 2004, and whether or not you guys hit that target, and kind of what the outlook is for 2005 and beyond?

Bob, the target in 2004, now it varies by contract that we have.

Yeah sure, but just kind of in the agFrankate.

I would say on average it was somewhere between 7% and 10%. And as I said in my statement, there was 20 of these sites that we were comfortable with the performance. And there were four sites that we were not. And then in those four sites is where we struggled for meeting the consumption reduction.

So those sites were mainly consumption issues, versus, I guess, changing over your products to another, to the Quaker product line?

Yeah. No, the conversions went even better than we had anticipated on the conversion side. But on the consumption side, yeah. We have to go find ways to reduce the consumption of the products that we’re responsible for, that go beyond just Quaker kind of products. And in that case, as I indicated, there were a few plants where we struggled to meet the targets that we agreed to with the customer.

Okay. And you’re going to be looking for another 7-10 reduction in ‘05?

It’s a little bit less than that. It depends again on the contract. Say it’s more like 5-7% in ‘05.

Okay. And –

These are not annual contracts that line up with our own fiscal year. They’re really kind of a May cycle.

Right. Primarily May to end of April.

Okay. And also, it’s kind of my understanding that you guys do some of the testing of some new products during like down time, over the holidays. So how is that period, this past holiday season, and do you guys see -- you’re pretty bullish on the product conversions in the first half of this year?

Yeah. We need approximately three days on any given weekend. So not just holiday seasons, like Christmas and New Years. But there’s other periods where we take advantage of the additional day to make conversions. And, as I said, in the one area that we’re most proud of in ‘04 has been the product conversions. And we see that success continuing into ‘05.

Okay. And just one other thing. I noticed SG&A lat two quarters has kind of come up like a $29m - $30m level. Is that kind of a more realistic run rate than the 26 to 27 we saw in the first half of ‘04?

Yeah. I think it is Bob. I think as a percentage of sales, for the full year we’re right about the same level as 2003. But as we keep ratcheting up our sales growth, and we reinvest in some of these growth markets, I think that you should expect SG&A as a percentage of sales to be at a steady level.

Okay. Thank you.

Our next question is coming from [Frank McCosko] of Lord Abbett & Company. Please proceed with your question.

Hi. Thank you. Could you talk a little bit about the fore sites that you currently need work on. Are those across all of the Big 3 customers? Or are those in one particular?

You’re talking about the four sites we’re still looking for improvement on?

Yes.

Those are spread across GM, Ford and Chrysler.

What’s the nature of the reason why they’re tough? You know?

Well, one, it could be just the plant situation that you encounter, where there’s a lot more structure and discipline necessary to be put in place, in order to achieve the reductions. It could be the complexity of the process, where there’s multiple pay points within each of these plants, that we have to address. It really is just the environment and the process flow that we encounter in these plants that basically gives us the difficulties, or what provides the difficulty in achieving the targets that we set out to achieve.

And any time frame for when you think those will kind of be equal to the other 20?

Well, there’s some of them in the latter part of the fourth quarter, showed improvement. And it’s certainly our intention that between now and mid-year that we will have these four sites in line with the other 20 that I spoke of.

So, by mid-year, they should be pretty close to the rest?

Right.

And is there a lot of variation between the sites themselves? I mean obviously the four on the bottom. But within the 20 that are “good”, is there a pretty big variation in terms of the gross margin, or whatever you use to measure them?

Well, there’s all different size plants Frank. So it’s kind of hard to gauge that. I would say it’s not a significant variation. Certainly the metal fab plants, where we’ve had those for seven years, we tend to enjoy a slightly better position there than we do say with the North American Power Train plants.

Frank, the challenge for us here is, of course, when we go in with one of these CMS contracts, we go in there and audit the operations of the plant with it’s management, and try to set a baseline for ourselves, which we then monitor with management. And the success in having -- in getting the reductions in consumption have a lot to do with the baseline we set.

Sometimes that’s a problem. Sometimes we have to go back and renegotiate that with the plant. And it also has to do with getting the plant to work on the projects that we’ve identified, and to have that – is this [Frank McCosko] we’re talking to?

Yeah. It’s all right. I thought it was interesting they called me Frank.

Somehow I wrote you down as Frank. But then it struck me.

Don’t worry about it. It’s Frank. It’s fine.

I apologize for that. In fact, everything else I said, because I was talking to Frank.

Okay. Okay Joe. That’s fine.

(OPERATOR INSTRUCTIONS).

Well folks, thanks very much for your interest. And we’re looking forward to talking with you in a couple of months when we finish the first quarter. And I just want to reiterate what I said earlier. This is a company and a management team and a group of associates here at Quaker that’s focused on the future, and focused on making sure we put in place the things that we have to do to be successful in the long-range.

We have a clear vision of what that looks like, and what we want to be in the world. And we’re, even in these short-term difficult times, and believe me we see these as difficult times, is we are not happy with where we are and what we’re accomplishing. But even in the face of this, we know what it takes to be – to build the kind of position we want to have in the long-term. And we’re focused on that big time. And our plans call for us to be building that kind of strength, so that when times change, we come out of this as stronger than we went into it.

I hope to be telling you the improvement on that story over the rest of the year. And I look forward to talking to you in a couple months. Thanks for your interest.