Quaker Chemical Corp (KWR) 2006 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and thank you for holding. Welcome to the Quaker Chemical Corporation's first quarter 2006 earnings conference call.

At this time all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host. Mr. Ronald J. Naples, Chairman and Chief Executive Officer of Quaker Chemical Corporation. Thank you, Mr. Naples. You may begin.

Thanks very much, and welcome everybody. Glad to have you here. Appreciate your interest. As usual, in attendance with me today is Neal Murphy, our Chief Financial Officer, and we will follow the same process we've always followed in the past, where I'd like to make a few comments and Neal will follow up with some more details and then we'll have time for any questions you may have. And I do promise to keep my comments relatively brief today. You have seen our press release, and I won't repeat what you can read, but I would like to give you some further color on the year.

Our sales, at almost $110 million, are actually a quarterly record for us, the highest quarter we have ever had, up about 5.4%, which, of course, we're please with. I just tacks on another quarter of solid sales growth. That growth is attributable to both volume -- that is, real growth overall, real volume growth, as well as price increases. And in fact price increase was a pretty important part of it.

The volume growth we saw was particularly powerful in China, where we're growing near a double-digit percentage rate. That reflects our continuing to have and to build a powerful steel market position. We've been fortunate in our efforts in China and steel particularly. Metal working has been behind the curve for us in China, but we're also seeing significant growth in metal working in China, but it is, admittedly, off a small base.

Our reported earnings per share of $0.26 compared to last year's $0.32, which, of course, for those of us who really know numbers, represents a down result. But I would like to draw your attention to the comparison on earnings from a base, or what I'll call core earnings perspective.

Last year, we had the positive in the first quarter of last year of a $4.2 million pre-tax gain from the sale of a real estate joint venture we put together a few years before, which was offset by about 1.2 million of charges related to staff reductions and other restructuring steps. In this year's first quarter, we had the one-time help of a $900,000 pension add-back, which was due to some legislative change in Europe.

But the net of these items amounts to about a $2.1 million positive swing in the quarterly comparison, which as I point out, points to a significant improvement in what might be termed our quarter earnings.

A look at least year's fourth quarter also shows significant sequential quarterly progress, after adjusting for the fourth quarter restructuring charge that we recognized in last year's first quarter and a one-time tax charge related to repatriating foreign earnings. But forget the tax item, you don't have to go to the bottom line to get the point: If you look at the operating increase and factor out last year's restructuring charge and this year's pension gain, there, again, is about a $1 million net improvement from quarter to quarter.

So the first quarter is better than last year's first quarter, considerably better. We feel like it's a good start to 2006, but we also recognize that the environment remains very challenging and there are events unfolding that we have to stay focused on. So I thought it might be useful for me to just take a minute to run down a few positives and negatives that are incorporated into the first quarter which are working for us and against us, just so that you'll have a better perspective on the year as it unfolds.

On the positive side, we had really good pricing success. We have embarked on a regular discussion with our customers focused on the constant realities we face, particularly related to our input cost, and on the kind of value we can bring our customers. And we've had success from those discussions and of course the way input costs continue to march along, we're probably going to have to continue those discussions.

Second, we've had the benefit of reasonably solid steel markets around the world. In cold rolled steel, in most places, it's doing pretty well. Prices are up, inventories are modest, and demand looks like it's pretty sound.

We have also seen the benefit of continued development of CMS penetration and capability, and that's really more than just the U.S., but around the world. Back in April we put out a press release which you may have seen, which pointed to the fact that we had a number of new CMS contracts in the automotive and truck plants, both in the U.S. and China, as well as in Canada.

These contracts with were a range of companies, from DaimlerChrysler and Ford, a Koyo plant in Knoxville, Tennessee, and a General Motors plant in China. And the important point about this I think is that our CMS effort is seeing more diversity than it has seen in the past and that this is our first CMS effort in China, so we hope that it will be the start of better penetration there. CMS also contributed better financial results in this first quarter as we continue to figure out how better to deal with the needs of our customers and our needs at the same time.

And another positive factor in the quarter is the fact that we are realizing the cost savings that we have put in place as a result of last year's restructuring. As we pointed out then, this restructuring allows us to invest in needed increased spending in places where we're trying to build market share, where we're trying to do new things, trying to cover inflation, but it allows us to do that at the same time that we keep SG&A basically constant with the prior year.

Unfortunately, there are some negative things that continued to play through the first quarter. One is the familiar bugaboo: input costs. Oil has reached all-time highs. I know we all read the same newspapers, and there really has been no moderation of base oil refined products. This challenges our gross margins and it keeps us focused on responding to the realities of what happened to our input costs and what that means to us and our customers.

Another negative is that while we did see gross margin growth, dollar growth that is, about $1.6 million, we were not able to achieve percentage gross margin growth. And we're focused on making our way back in that regard because we want to be in a much better position to invest in the opportunities that we feel we need to to do better for ourselves and for our customers, and of course, having the [inaudible] that flows from that is an important part of that.

Also, metal working market growth worldwide is not as strong as we would have liked to see it. I think that results from mixed end product demand around the world. Europe particularly saw some decreased and weak demand in for cars. In the U.S. it was okay but not great. So the metal working markets are something we want to keep a careful eye on through the year. And of course another negative that we saw in the first quarter was what is happening to interest rates.

So it is a mixed bag, but we found our way through all of that with -- and were able to achieve a good first quarter. But I'd point to that there are certainly market and industry factors still out there, from what happens to -- in a particular instance, to somebody like Delphi, through the coarse of mineral oil prices if higher crude prices are sustained for a long period. So we keep our eye on these things.

But as I pointed out in the past: One, we're very well situated among our competitors with our global reach, our globally integrated focus, our market leadership positions, and our continued discussions with customers based on value and that allow us an opportunity to talk about price.

Two, we have taken major steps to address the realities of our business, from the pricing initiatives I've already mentioned -- although we try never to have a price discussion with our customers that doesn't include a discussion of value, how we can make them better.

Two, the kinds of cost initiatives internally we need to take to respond to the kind of reduced margins we see in our business.

Three, we are very well positioned in strategic markets: China, India, Brazil -- these are important and growing industrial markets and we have excellent positions in these markets.

Four, we continue to invest in new market initiatives, from coatings to mining, where we're beginning to make real gains. And we need to do this to find ways to add real growth over time, in particular as a complement to the improved core business that we're focused on that we need to keep solid as a base for that growth.

So the first quarter is a bright spot as the year starts, but we know we have much yet to do and we'll stay focused on improving our results in what we see as still challenging days.

And with that, I'll stop and ask Neal to provide a bit more detail.

Thank you, Ron. Good afternoon, everyone and welcome.

Ron provided a high level view of revenues and earnings and business performance for the first quarter. I'm now going to spend the next couple of minutes focusing on the P&L in more detail and we will then open up the floor to questions.

Net sales for the first quarter were a record $109.8 million. This represents a 5.4% increase from the prior year first quarter. It should be noted that this revenue growth would have been 6.6% but for foreign exchange movement which had a 1.2 million or roughly 1.2% negative impact on our revenues.

Revenue growth was driven by a combination of volume improvement and pricing improvement, with the bulk of the volume growth occurring in China, as Ron had mentioned, and the pricing improvement broadly across all regions and market segments of our company.

The negative foreign exchange impact that we saw in the first quarter was due to the weaker Euro versus the first quarter of last year, and this was partially offset by a stronger Brazilian ReaI.

Higher sale prices reflect our continuing efforts to work with our customers to recover higher raw material costs, and the strong volume growth in Asia-Pacific, with our volumes up more than 10% versus the prior year first quarter, is flowing from a combination of both continued growth and general demand for our products, but also increased market share as we continue to advance our presence in the region.

I would now like to give you some revenue data on a segment basis. As you may recall, we segment our business into three areas: Metal Working Process Chemicals; Coatings; and Other Chemical Products.

By far our largest segment, making up 92% of sales, is Metal Working Process Chemicals, which include products used as lubricants for heavy industrial and manufacturing applications. Reported revenues in the first quarter are up 5% in this segment versus first quarter of last year, and again, the growth is reflective of pricing actions as well as volume growth in Asia with some offsetting foreign exchange impact.

Second business segment is our Coatings segment, which makes up approximately 7% of our sales and is growing 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 $1.5 million or 25%, in large part due to chemical milling maskant sales for the aerospace industry, which has experienced a recent increase in the aircraft build rate.

In our smallest segment, representing 1% of total sales, called Other Chemical Products, sales were down 600,000 versus the first quarter of 2005, largely due to high prior year sales as a result of the timing of a large international shipment in the first quarter of last year.

We turn now to gross margin. When you look at gross margin, quarter versus quarter, there doesn't appear to be a lot of change, but there's a lot of things going on in the gross margin area. As a percentage of sales, gross margin is 29.6% this quarter, consistent with the first quarter of last year. And this consistency is despite a significant escalation in raw material cost over last year, which we continued to experience through the first quarter this year.

As Ron mentioned, we are again working with our customers to mitigate the margin impact of the most recent spike in crude derivatives, as crude prices have recently moved above $70 a barrel and mineral oil prices are also moving up. We continue to target margin improvement at such time as market prices for crude oil derivatives stabilize or, better yet, decline for a sustained period of time.

While gross margin percentage remains stable as compared to the prior year quarter, we did achieve a gross margin dollar increase of $1.6 million versus the prior year first quarter, despite a difficult raw material situation.

So, again, we continue to work with your customers to increase prices and recover some of our input costs, but we also continue to lag a market where we're continuing to see escalating raw material costs.

In our last conference call, we mentioned that we had successfully renegotiated some CMS contracts in the fourth quarter of 2005, and that we are actively negotiating other contracts which were scheduled to expire in the second quarter. We're pleased to inform that these contracts have been renegotiated under generally more favorable terms for the remainder of 2006. Further, as Ron mentioned, we have won several new CMS contracts during the quarter, as we continue to expand our CMS customer base.

Moving down the P&L, I'll now discuss SG&A and other expenses. Reported SG&A of 27.4 million this quarter is $900,000 below the first quarter of 2005. Cost savings from our restructuring efforts completed in 2005 offset increased spending in higher growth areas such as China as we continue to build our infrastructure there, higher variable compensation, inflationary, and other increases. It should be noted that due to a legislative change effective January 1, 2006, the Company recorded a pension gain of $900,000 related to one of its European pension plans. We continue to believe that SG&A for the full year 2006 will approximate the full year 2005 in absolute dollar terms as was indicated in our prior conference call.

Operating income increased substantially to 5.1 million in the current quarter from 1.5 million in the prior year quarter. The key drivers were higher gross margin dollars and lower SG&A in the current quarter, as well as the fact that operating income in our prior year was negatively impacted by 1.2 million of restructuring costs.

Moving down the P&L, the decrease in Other Income is attributable to the 4.2 million of gain from the Company's real estate joint venture in the first quarter of 2005, which Ron previously alluded to. The remainder of the decrease was the result of foreign exchange losses in 2006 versus foreign exchange gains in 2005. The increase in net interest expense over the first quarter of 2005 is reflective of higher average debt balances outstanding during the first quarter of 2006, and higher interest rates.

The effective tax rate for the first quarter is 36.2% versus 32.5% for the same quarter last year. Many external and internal factors impact this rate, the most significant of which was a shifting mix of income amongst taxing jurisdictions. We continue to explore opportunities to reduce our effective tax rate.

Continuing down the P&L, equity income for the first quarter was higher than the prior year due to a stronger performance from our company's Mexico joint venture, and minority interest was lower for the first quarter of 2006 compared with the same period last year. As you may recall, we acquired 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. The Company's net debt has increased from December 2005, primarily to fund working capital needs associated with growth initiatives, as well as restructuring actions taken in the fourth quarter of 2005. The Company's net debt to total capital ratio was 40% at the end of the first quarter of this year compared to 35% at the end of 2005.

And that concludes my prepared remarks.

Okay. Thanks a lot, Neal. And at this stage, we welcome any questions that you may have.

Ladies and gentlemen, at this time we will be conducting a question and answer session. [OPERATOR INSTRUCTIONS]. Our first question is coming from Patrick Flavin of Flavin, Blake and Company. Please proceed, sir.

Good afternoon, gents.

Hi, Patrick. Good afternoon.

It's nice to see the quarter starting to come back here, Ron.

From your lips to God's ears, we keep it going.

A neat trick is making money off your pensions. Can you explain a little bit the 0.9 million of pension gain that was recorded?

Sure, Patrick. It was really -- in the Netherlands there was actually a change in the legislation over there as it related to an early retirement aspect of our pension plan. So the 900,000 is really a one-time benefit, although on an ongoing basis we should see some reduction in pension costs, but nothing of that magnitude.

Okay. And then operationally, can you give us a little precis as to -- you have talked a little bit about China, your positioning in India?

We have a joint venture in India, as you probably know. We have the majority share. Headquartered in Calcutta. We have a good strong position in the steel market there, and a -- well, let's say it's a growing position in the metal working market. I would say that we are the -- I'll say the leading competitor in the bulk of our businesses there. So I feel like we are pretty well positioned in India.

It's a competitive area because there are a lot of companies who are trying to stake out a position there, and fortunately we were there early, so that's a big help to us. And we have a good management team there, we've integrated -- even though it is a joint measure, we have integrated it pretty tightly into our Asia-Pacific operations. They are part of the operating committee and that kind of thing, so we have good cross-border cooperation that's part and parcel of the global way we want to try to approach our world.

There's a good flow of knowledge regarding technology and a good flow of customer information, although there aren't really a lot of customers. In fact, I would say offhand there really isn't any customer that has a major chunk in India and also has a major chunk outside of India.

But, so, all in all, I'm not quite sure if it's exactly your interest there, but I'll just summarize and say we have a good position in India with a pretty well established venture that's tightly integrated into our Asia-Pacific operation.

Does that address your question okay? .

Yes, and as a segue on that, which is what I was going to get to, was the acquisition of the minority interest in the Brazilian joint venture: Is that an indication of a change in your business model going forward, where instead of doing JVs you'll start owning whole interests in these emerging countries?

Yes, I think that you will see us have fewer joint ventures going forward than we have today. And where we do have them, they will be based on -- whereas in the past some of our joint ventures have been based on a partner who could provide manufacturing capability, in the future you'll see joint ventures, to the extent we have them, based on a partner who can provide market access.

We're not going to undertake a strategy of buying the equity in all of our joint ventures. You won't see us doing that because we don't think we can get an adequate return on that. But to the extent that we can start them up, when we feel the need to start one up, we'll focus on market position and we have in fact dialed back the number of joint ventures we have by taking on an equity position. We did that in Brazil, as you noted, and we are working on it in one or two other places, which we'll be in a better position to know more about in a few months.

Thank you.

You're welcome, Patrick.

[OPERATOR INSTRUCTIONS]. Mr. Naples, I show no further questions in the queue at this time.

Okay. I'll just wait another few seconds because I know there was one time we had a little frustration with somebody trying to get a question in.

We did just get another question in the queue, and that's coming from Steve [Benicello] of Thomson, Horstmann, and Bryant. Please proceed with your question.

Hey, guys, how are you doing?

Good morning, Steve. How are you? It's afternoon.

Good, good. Oh, very true, very true.

Why don't you just talk a little bit about gross margins here. I know that you're in constant conversation with your clients, and it seems like you've done a pretty good job. Where we are today -- where oil prices are, and I know it's not a one to one relationship, but is it safe to say that the 30% range is sort of the Mendoza line and it could be really trough margins for you guys here?

No, I don't think so. We're -- first of all, let's begin with attitude: We're not at all happy with that kind of 30% level. We have been able to achieve the 30% level at these -- historically very high levels for not only crude oil but also for mineral oil, which is the relevant factor for us. We saw mineral oil get disconnected a bit from crude at the end of last year, and it's still that way. So we're probably in as bad a raw materials position as -- well, certainly, as we have ever been and maybe as we will ever be, although that's not to say that the oil thing has ended. Please don't misunderstand me there. I wish I had that crystal ball.

But we don't see -- but even in those circumstances, we have been able to hang in there at the 30% level, so we think -- we're certainly shooting for upward potential there and that's the reason for our conversations with our customers, and for us in terms of these conversations, it's not just matter of we need -- we want to improve our profitability vis-a-vis our customers, it's really that if we're going to provide the level of service and technology and customer help that we've historically been able to do here at Quaker, we simply have to get that number up. That's the best way we can be a good supplier to these folks.

So we don't see 30% as kind of the Mendoza line, as you put it. We've been able to get to it, even the toughest circumstances we have seen historically, and our goal is certainly to move over that. I don't think -- to be honest with you, Steve, it's a difficult circumstance to see us getting back to the historical margins of the low to mid-40s. I don't think that's in the cards. I don't wish to mislead you. But we don't consider 30% as our long-term goal.

Okay. No, that makes a lot of sense.

Can you give a little more color on the increase in debt, if you will, and just kind of the specific initiatives you guys are working on that sort of ticked up our debt level here?

Yes. I'll let Neal answer that question, except to say that -- I will interrupt Neal's almost statement to say that the thing that we are focused on this year as a way to make a big difference for us is to focus on working capital. Because we have invested a lot in working capital necessarily, given our growth in sales and given our growth in CMS in particular, that's been an important piece for us and that's one of the places we're really focusing. But with that, I'll turn it to Neal.

Yes, Steve. It is a high focus for us, particularly the working capital area. A couple things occurred in the first quarter that increased our debt, much of which we expected. As you know, we had our restructuring at the end of 2005 in terms of the earnings impact of that restructuring, but the cash impact of the restructuring was substantially incurred in the first quarter of 2006. So that was a bit of a one-time event for us.

Also, we had a substantial customer receivable that came in -- the cash came in in the beginning of April as opposed to the end of March, and that was a few million dollars for us.

Okay.

But in general it is a high focus area for us. We do recognize that working capitol -- the nature of our business, working capital is an investment for us. The nature of the CMS model is such that it is working capital intensive.

Our growth in Asia, at this time we have a fairly long supply chain there, so we will -- part of our strategy is growth in Asia, so we will see working capital investment there, but overall, we see opportunity to drive down working capital and also drive down our debt levels.

One of the realities about growth in a place like China is that typically it does have a longer supply line, and it also has pay practices which are quite different from other parts of the world, which do make a bigger demand on working capital. That's just one of the things that we have to keep our eyes on.

Then just following up quickly on cash flow, do you have any specific comments about your dividend going forward?

No, the dividend is something the Board looks at every quarter and it will continue to evaluate it based on what -- as it always has, based on what we think is right for our business and what we think is right for our shareholders, and I'm sure that will continue with our Board.

But going forward, looking at your growth expectations and operating cash flow going forward, it seems like you guys are comfortable with where you are now.

To the extent we discussed this last with our board, they're comfortable with where we are now. But I don't wish to make any projections going forward. And that shouldn't be read as any -- as a negative sign, but I don't also want to mislead. I mean, this is a question the Board asks itself every quarter and we make the best based judgment we can every quarter.

Okay. All right, that's all for me, guys. Thanks.

You're welcome.

We show no further questions in the queue at this time, gentlemen.

Okay. Well, I guess if there was somebody else waiting, they'd have had time to put the question in the queue, so I will thank you for your interest and it was a pleasure to be able to give you a little better quarter than we've delivered in the past couple of years and I hope we can continue that, and I will look forward to talking to you and Neal and I will look forward to talking to you again in a few months. Thanks, everybody.

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

Thanks a lot.