Quaker Chemical Corp (KWR) 2005 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Quaker Chemical Corporation second quarter 2005 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 key pad. 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, Dan, and welcome everybody. As in the past, Neal Murphy, our Chief Financial Officer, is here with me today and we will do what we've done in the past. We will both make some comments and then be available for questions at the end should any arise. Joe Bauer, our former president who has been a fixture at these conferences over the last few years, is not here. As you'll recall, last time I mentioned that he was retiring as of July 1 and he's in fact done that. We just reiterate, as I said last time, that we've decided not to replace Joe but rather have split his duties among me and Neal and Mike Barry who runs our metalworking business and Mark Harris who runs our steel business. All three report to me and it will be up to this group to bring the day-to-day focus to our, day-to-day operating focus to our business.

I would like to make some brief overview comments on the second quarter. We continue to fight the good fight. The second quarter has considerably, shown considerably better operating results than the first quarter of '05. We are moving in the right direction and getting back to where we want to be and showing earnings growth which has always been our goal. The bad news is that margins are not where they were two years ago, even one year ago. That's made clear by the '05 to '04 comparison where our gross margins in the second quarter of '04 were 33% versus 30.6% this quarter. Part of the decline flows from our conscious strategy to build share in automotive and build on the values/total solutions initiative we have with customers. That is to develop a CMS business. The simple mathematics of the CMS business accounting with gross revenue accounting for revenues and costs caused part of the decline in gross margins.

We talked about that over the last couple of years. Of course, a big part, a bulk of the gross margin decline flows from the extraordinary raw material cost movement that we've seen in the recent past, the last year or so. Most important, of course, is in crude oil. It's been a dramatic point of discontinuity there. As you all know, very fast, very large, very unstable in terms of those rises in costs. We've talked in the past. It's had a major impact on us. Second quarter is another good example of that. Second quarter of '04, our oil costs that we realized were somewhere in the neighborhood of $38. In the second quarter of '05, that cost was about $53. So it's a dramatic impact that we've had to deal with. Of course if you look at the first quarter versus last year's first quarter, it's even more dramatic. We are not finished with this. Yesterday, of course, oil closed over $61. I guess it got over 62 for a bit. Come down a little bit today. But we hope that the bulk of the absolute increase is behind us and the other good side of this is it's put us into a position where we have regular price discussions with our customers to help us live with this impact.

Another element of the bad news is that the sale demand softness that we are seeing in our business applies virtually everywhere except Asia Pacific which is doing very well. South America is holding its own but in North America and Europe, we definitely are seeing soft demand for rolled steel. Steel mills are cutting back production schedules in a major way because of the demand, their own demands coming down, and also their own high inventories in the last year.

Even with the sales up, we see our volumes down in the second quarter. These are a tough combination for us right now. To the extent that growing volumes would help us grow gross margin dollars, even with the gross margin percentage decline, we are not fully able to realize that with the demand softness we are seeing. And, of course, the absolute of higher oil prices works against us also.

But in the face of all this, I want to return you to the second quarter. Both the financial results and the market results, because there are positive signs imbedded in these. Second quarter to first quarter sequential results are much improved, as I mentioned earlier. For operating income, with the first quarter restructuring charge that is shown on the face of our income statement removed, we show an improvement in operating income of about one-third in the second quarter. Our gross margin is up one point. So those are both positive aspects. And I point you one step up the income statement to sales. We had a record second quarter in sales, up about 8% over the second quarter of '04.

This takes us to a few very important observations about our competitive position I would like to make. Because after all, when all is said and done, our competitive position is the factor that most importantly points to our longer term prospects which I believe remain very strong. So what are these observations? One, we achieved a sales increase in face of steel demand much softer than we had anticipated. This was reflective of some increase in sales even though volumes were down. It was reflective of a metalworking product business that continues, that contributes growth even as automotive production has slowed. That flows from new efforts underway in tube and pipe and coatings, both relatively new ventures for us and both relatively small right now, but at the margin they make a contribution and we think they have very significant potential to contribute considerable new business in the next year or two.

And three, success in our pricing discussions with our customers focused on offsetting raw material increases. We haven't been able to totally offset these, given the size of the kind of oil increases we've seen. We always seem to be running behind a bit given the volatility of the price movements but our success in pricing discussions does reflect the quality and seriousness of our discussions with customers which we work to keep focused on value, that is on how we save, how we serve their needs, not just on price even as we have to talk about price in this extraordinary period.

The second point observation about competitive position I would like to make is that we, our share of market worldwide in most of our business has grown over the last couple of quarters, even in a business like steel where we see real volumes come down. In our fastest growth market, China, we are doing extremely well. In fact, our position in that market really is demonstrated by the fact that so far this year, China has put on line five new tandem steel mills and we have been awarded the business in every one of those. That's a testament to our strength in China which, of course, is the fastest growing market in the world.

The third observation I would make that's imbedded in the numbers is we have come way up the learning and experience curve in CMS. I have commented in the past that CMS definitely contributes to our results but not as much as we had planned when we took the big step into this new approach to business about two years ago. We have a much better perspective on the business today born of our experience in the business on how to move the business where we would like it, working to, we are now working to incorporate this in our current operations and certainly we will be putting the thinking that we have on this to work as we look to rolling over contracts in the first part of next year.

Adding to these kind of steps that are imbedded in the second quarter results, of course we have taken steps to continue to build our business, just two most obvious examples. One is a Brazilian acquisition of our joint venture interest there. It's been very successful operation for us and we think we can build on that further. And the announcement we just made recently about an Italian joint venture in the automotive business, markets in Europe where we don't have the kind of share we would like to have, particularly in Italy specifically, and we think there's good potential for us.

So all in all, while we are very disappointed about the year over year results because it hasn't met our expectations or our plans to be sure, we believe that what we are seeing so far this year demonstrates, in particularly the second quarter, demonstrates that our market position is strong and it's getting stronger and that we are moving in the right direction.

Now let me hasten to say that we don't for a moment presume we are out of the woods. It's not risk free from here to be sure. We know that raw materials and demand could still hurt in ways that we've not now projected. So obviously we will stay alert and focused on the market expansion and customer penetration plans that we have and, of course, pricing requirements.

And even with things running in the right direction as we now see it, we don't think we can get all the way back to where we would like to be in 2005 to be sure. But as I said, our current standing, our current progress in the markets says all the right things about the market and competitive position on which we've always been able to build and I think we will be able to build in the future. I should add we are not looking only externally for improvement. We realize that our world has shifted around us and we're putting energy into re-evaluating our strategies and our structure with these realities in mind, and these will be playing out through the remainder of the year as we put these efforts under our belt.

So with that, I will stop and ask Neal to spend some time and give you a little more detail on the numbers and then, of course, we can address some questions.

Thank you, Ron, and good afternoon, everyone. Yesterday we announced record quarterly sales of 107 million and diluted earnings per share of $0.18 for the second quarter, as compared to sales of 98.7 million and earnings per share of $0.30 in the second quarter of last year. For the next few minutes, I am going to focus on the drivers of the second quarter performance and then we will open the floor up to questions. Again, revenues for the second quarter compared with the same period last year, we are up 8% to a record 107 million. Of the 8% revenue growth, approximately 3% was due to foreign exchange with the remainder primarily attributable to higher sales prices. The 3% revenue improvement due to foreign exchange is primarily due to the stronger Euro. The average Euro rate was 1.26 this quarter and 1.21 during the second quarter of 2004. In addition, the Brazilian real contributed as the average rate this quarter was .4 compared to .33 in the second quarter of 2004.

The higher sales prices, which I mentioned, are a reflection of the Company's actions throughout 2004 and in the first half of 2005 to mitigate the higher raw material costs that we've been experiencing. Volume growth in Asia Pacific was offset by lower demand in the Company's other regions. While, as Ron mentioned, we achieved increased market penetration in key market segments during the second quarter, our overall volume was slightly down from the prior year in the face of production cutbacks at major steel mills in both Europe and in the US due to inventory reduction efforts throughout the steel supply chain and softer user demand.

Moving along to gross margin. Despite an 8% increase in the revenue line for the second quarter, gross margin in absolute dollar terms was essentially flat with the second quarter of 2004. Gross margin as a percentage of sales was 30.6% compared to 33% for the second quarter of 2004. Again, higher prices for the Company's raw materials, particularly crude oil derivatives, outpaced the Company's price increase efforts. Approximately two-thirds of this 2.4 percentage point decline in gross margin is attributable to higher raw material costs associated with the manufacture of Quaker products. The remaining reduction is primarily due to higher third party purchase costs associated with our CMS contracts. As we've mentioned in previous quarters, certain of these contracts do not allow for pass-through of these third party purchase costs which have also escalated due primarily to movements in crude oil. As Ron mentioned, the price of crude continues to increase with current prices above $61. Crude averaged $53 in the second quarter as compared to an average of $49 in the first quarter and $38 in the second quarter of last year. So we've just experienced a dramatic and continuing escalation in crude prices and continue to try to chase that upward movement.

On a positive note, the pricing actions that we took in the first and second quarter of this year have contributed to gross margin improvement in the second quarter to 30.6% as compared to 29.7% in the first quarter of this year. This improvement has occurred despite the continued upward movement in crude prices during this period. We have and will continue to push for additional price relief in the third quarter despite the competitive pressures we are experiencing and the contractual limitations which I mentioned within CMS.

Moving down the P&L, I will now discuss our SG&A and other expenses. SG&A of 29.1 million this quarter is up 1.9 million compared to the 27.2 million reported in the second quarter of 2004. Foreign exchange rate translation accounted for 40% of the increase. The remaining increase is due to inflationary costs and reduced incentive compensation expense in the prior year as well as spending on higher growth areas. The increase in other income compared to the second quarter of 2004 was due to a foreign exchange gain associated with the declining relative strength of the Euro. Higher net interest expense compared to the second quarter of 2004 is attributable to higher average borrowings and higher interest rates on the Company's short term debt. The effective tax rate for the quarter is 32.5% versus 31.5% for the same quarter last year.

Continuing down the P&L, equity income for the first quarter of 2005 was lower than the prior year due to weaker performance from the Company's Mexican joint venture. A minority interest was lower in the second quarter of 2005 with the same period last year, driven mainly by the acquisition of the remaining 40% interest in our Brazilian joint venture in March of 2005.

I would also like to make a few remarks on the balance sheet and cash flows. The Company's net debt has increased from December of 2004, primarily to fund the acquisition in Brazil as noted above, as well as to fund working capital needs associated with the Company's growth initiatives. The Company's net debt to capital ratio is 31% at June, 2005, compared to 33% at March, 2005, and 28% at the end of 2004. The Company's credit lines total 94 million, 40 million committed and 54 million uncommitted. And at June 30, 2005, the Company had approximately 52 million outstanding on its credit lines. That concludes my prepared remarks. And, Dan, we would now like to open the floor for any questions that might arise.

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. [OPERATOR INSTRUCTIONS] Gentlemen, I show no questions in the queue at this time.

Okay, thanks. We won't hold everybody unnecessarily. Thanks for your joining us for this conference all of you on the line. We appreciate your interest in what we are doing here at Quaker and I would reiterate that what I ended my comments with, and that is I believe that even though this has been a tough year, if you go back the last four quarters, it has been a tough year for us. I think that we have many things that have demonstrated the power of our market position, our competitive position, and as I said earlier, is what you ultimately have to build on and that's what gives me the confidence about the business going forward. So with that in mind, I will thank you again for your joining us and I look forward to seeing you three months hence. Thanks a lot, everybody. Good afternoon.

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