Quaker Chemical Corp (KWR) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, welcome to the Quaker Chemical Corporation third quarter 2006 earnings results conference call. At this time, all participants are in a listen-only mode. [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.

Thanks very much. Welcome everybody, glad to have you here this afternoon. It's always nice to have these conferences when we have a nice quarter to talk about, which I'll do in just a moment. My usual cast is here, Neal Murphy our CFO and myself. And we will cover the results for the third quarter and year to date and then we'll stop and take some questions and try to address any issues that you all may have.

We really feel we had a fine third quarter. Our sales were ahead more than 10%. In fact it was a third-quarter record for us with sales over $116 million. Our profit after tax is up 42%. You have seen that in the press release, of course. Year to date our profit after taxes is up almost 22%, and that is considering the fact we had a pretty big plus in last year's result -- in last year's profits, given the $4.2 million of Quaker Park that we have which was a plus netted by the $1.2 million of restructuring charges we took in the first quarter. In fact if you take those two charges out of our pretax profit, the after tax -- the after tax for nine months may be up almost 22, but the pretax with those two numbers out is up 60%. So it's -- we've had a fine year so far. Earnings per share, $0.23 last year to $0.32 this year. Again very pleased about that and what's even more positive for us is that we've seen through the year the three quarters of '06 sequential improvement quarter to quarter. Part of that was driven by gross margin that has been improving throughout the year. We had sequential improvement in that and that has been a big challenge for us and an important goal. In fact our gross margins are beginning to approach last year's margins. So we feel we are making progress there also.

This final result was done in the face of some actually significant negatives or at least increased costs in some areas. One, -- one of the negatives we had to deal with was demand softness in some automotive markets around the world. We have seen that effect of business in certain places, so it hasn't been a completely positive story in terms of demands around the world. Two, mineral oil costs have been -- been an increasing cost for us this year and it's, as I mentioned before, our most important raw material. Oil -- crude oil prices have come down, and it should be a positive for us in the long term, but our costs are much more directly affected by the price for mineral oil rather than crude, so that's continued to effect us. Now of course crude's usually the main influence on mineral oil, but these days it is as much influenced by capacity constraints and refining as it is by crude. So while crude has turned down recently, mineral oil continues up. So we haven't been able to catch a break from raw materials in that regard.

Three, we've put significantly increased resources in certain markets and on certain projects where we think there's real promise. So we've had some increased costs along the way this year in areas where we think that they'll pay out for us and areas where we think we need to make progress and we have an opportunity for progress, but as I will mention in a moment, we have been able to with stand those increases and costs without an effect on our income statement because of an action we took last year. And fourth, we've achieved these profit results another increased cost area is our improved performance over year which has led high -- considerably higher increased incentive comp, which recognizes that increased performance, and it comes from a very low base last year.

So even with these so-called negatives, if you will, we have been able to achieve a very positive third quarter. We did that because of several things. Number one, we've had a dramatic improvement in CMS in North America. We're getting better at it. We moved way down the learning curve. We are now considered I think one of the best providers in the business. We are finding ways to deliver more to our customers. Finding ways to be more valuable to them. And we are finding ways to shift our relationship with our customers to allow us to do better -- for us to do better, as Quaker, improve our profitability while still serving the customers' needs better. We're working on new contracts and we have the renewal of several of current contracts coming and we are optimistic about those. So we feel like we've a dramatic improvement in North America and that of course has paid real dividends to us.

We did -- we had this kind of third quarter in actually the nine months results so far because we have paid real attention to pricing. We know our customers under as much pressure as we are in terms of their profitability, and we try to go to our customers, be realistic about the kind of pressures we are under, what we need to do to try to keep our margins where is we would like them to be and how we can continue to serve their needs. And we have been consistent in that message to our customers and fortunately we have been able to make real progress there with our customers and we appreciate that.

Success in China has been another reason why we have been able to achieve this kind of result even with the negatives I mentioned earlier. We've established a really strong base in China. We have leading share in the steel markets there. We're building our position in the medal-working markets there. We are able to participate in market growth there. And we have new facilities going in there, strong customers relationships, so China has been a real success story. We started this joint venture up in 1997, as I recall, and it has been profitable day one. So we feel -- really feel good about that and we of course think China has great promise for us going ahead.

We've had the kind of results we had this year because of our strong position in steel. It has always been one of our most well established markets. We continue a very strong position particularly in rolling oils, but even in all the chemicals that go in steel, we have a leading share and that has paid dividends for us this year. We've achieved the results we had this year because of the improved shared market in automotive metal working particularly in U.S. but also in Europe. That has gone hand in hand with the CMS effort we've made, particularly in North America. But the share of market in these -- in these customers is also grown outside of just CMS alone. And I mentioned earlier the fact that we have increased significant spending in certain markets and in certain projects where we think they have promise. We have been able to do that without a disproportionate impact on our expense because of the restructuring action we took last year. That was not done just to save money but really was done to allow us to reposition the way we spend money to provide new investment in important places without the margin effect of the increased spending. In fact our SG&A for nine months even with all the additional things we have done this year is up only 1.5%.

So we feel good about our progress this year. It's been I think a great performance by our organization and everybody has been working hard at it. While we are still in a very tough environment, tough environment in terms of raw materials and an environment that is affected by demand uncertainty in certain markets. I mentioned that sequential quarterly improvement, and we are pleased to be able to continue to do that. Our share in CMS has certainly gone up. It's a real sign of our progress this year, just as much as our share in the metal working that I mentioned earlier and our share in -- in steel around the world. We feel good about our progress this year because we have significant projects under way for the future. Strategic initiatives in products and markets that we think will pay real dividends for us. For instance Fluid Power, an old product, it's a current product but it's going to new markets. Coatings, something we talked about in the past, it's a new product going to current markets and there are other examples of the way we've been able to use our business to extend our strategic reach.

So on a whole, we feel much better about where the Company is today. There are some near-term concerns. We mentioned a few of those in the press release. We're seeing an inventory build-up in certain markets in steel and also in automotive. We see that there maybe some market and price weakness coming along in steel and something we will have to deal with. But all in all we feel much better about where the Company is positioned today than we did a year ago and I would like to observe that I think our results reflect that. So with that, I'll stop and turn to Neal who will give you a bit more detail of some of the things I've talked about. Thanks, Neal.

Thank you, Ron, and good afternoon, everyone, and welcome. As Ron mentioned and was indicated in our press release yesterday, we had a positive third quarter with earnings up 42% over the prior year third quarter, which continues our quarter-over-quarter improvement trends of the -- of the first and second quarters. I'll spend the next couple of minutes focusing on more detail on the P&L for the quarter. Revenues compare with the same quarter last year were up 10% to 116.4 million. Revenue growth was driven by a combination of pricing improvement and volume growth, with the bulk of the volume growth occurring in China, and the pricing improvement was broadly across all regions. Foreign exchange also contributed to our revenue growth for the quarter on the strength of stronger currencies in Europe and Brazil versus a dollar as compared to the third quarter of last year. The higher selling prices reflect our continuing efforts to work with customers to recover higher raw material costs, which continued to increase during the third quarter, albeit at a slower pace, while recent declines in oil prices have relieved some of the upper pressure on raw material costs as we move into the fourth quarter. As Ron mentioned, we don't purchase crude but rather downstream derivatives of crude so -- such as mineral oils. And so far we have not been able to secure pricing reductions as our mineral oil market does not move in lock-step with crude. However, an extended period of crude oil prices below $60 should put some downward pressure on the raw material costs that we incur. Volume growth in double-digit increases in our volumes in China as well as growth in North America were offset by lower volume in Europe and South America regions with some of our automo -- automotive customers are experiencing softness in sales. Sales for the steel sector were generally strong across all regions for the quarter; however, we are starting to see some inventory build up in the steel supply chain, particularly in the U.S. and Europe, and recently a few of our steel customers have announced planned production slowdowns to deal with this inventory build-up.

I would like now to give some revenue data on a segment day basis. As you may recall, we have segmented the business into three areas, metal working, process, chemicals, coatings and other chemical products. In our Metal Working Process Chemical segment which makes up 92% of our sales, reported revenues in the third quarter compared with 2005 were up 10% to 107.4 million. Sales in our Coating segment, which makes up approximately 7% of our sales increased 1.5 million or 21% due to both higher coatings and chemical milling [inaudible] sales to the Aerospace Industry. This continues to be a nice growth segment for us. And in our smallest segment representing approximately 1% of sales, called Other Chemical Products, sales were down $100,000.

Turning to gross margin. Gross margin, as a percentage of sales, 31.6% this quarter, with an improvement over the first and second-quarter percentages of 29.6% and 30.4% respectively. And only slightly below the 32% margin from the third quarter of 2005. Again, our persistence on the pricing front has enabled some margin restoration despite dramatic escalations in raw material costs over the past year and which have continued through the third quarter. Gross margin in dollar terms was up a little over 8.6% or almost $3 million due to our pricing actions, volume growth and continued improvement in our CMS channel. In CMS, we've generated internal process efficiencies, we've in [ter] -- approved the terms of certain key contracts were not -- which were not meeting profitability requirements, and we've gained higher Quaker product sales through this channel. Our ongoing pricing efforts to sustain and improve margins are an important part of our everyday business activities; however, any substantial forward gross margin percentage improvement will likely be driven by movements in raw material costs.

Moving down the P&L, I would like to discuss SG&A and other expenses. SG&A at 31.5 million this quarter is 1.5 million higher than the third quarter of 2005. Cost savings from restructuring efforts completed in 2005, as Ron mentioned, are in line with expectation and substantially offset increased spending in higher growth areas such as China as well as higher variable comp, inflation, and other increases. SG&A as a percentage of sales was 27% during the third quarter of '06 as compared to 28.3% in the prior year quarter. We expect that SG&A for the fourth quarter as a percentage of sales will approximate third-quarter levels as we continue to invest in growth opportunities, as well as incur higher incentive compensation associated with improved financial results. The increase in other income was due to higher license fees in 2006, as well as the final distribution related to last year's sale of our Quaker Park real estate joint venture. The increase in that interest expense over the third quarter of 2005 reflects higher average debt balances as well higher interest rates. The effective tax rate for the second quarter is 29.9%, versus 32.5% for the same quarter last year.

Our third-quarter tax rate benefited from tax incentives associated with increased investments in China to support growth in that region. In addition to the China tax incentive recognized in the quarter, many external and internal factors effect this rate, the most significant of which is shifting income levels amongst various taxing jurisdictions. Minority interest was lower for third-quarter of 2006 compared with the same period last year, primarily due to reduced business activity and profitability in the Company's minority affiliates.

Turning to the balance sheet, the Company's net debt has increased from December 2005 primarily to fund working capital needs associated with our growth initiatives, as well as the restructuring actions taken in the fourth quarter 2005. The Company's net debt total capital ratio was 38% at September 30, 2006, down from 39% as of June 30, 2006, and 40% as of March 31, 2006, but higher than our year-end 2005 level of 35%. And that concludes my prepared remarks.

Okay, thanks, Neal. We will be glad to take any questions you all may have. So I will open it up for questions at this time.

[OPERATOR INSTRUCTIONS] Our first question is coming from [Robert Felice of Cabelli and Company]. Please proceed with your question.

Hi, guys. Just a couple of quick questions.

Great.

I was hoping we could focus for a moment on the inventory build in auto and steel. Maybe you can -- you can give us a little more color on -- on the extent of the build-up and whether or not you are seeing signs of a slowdown in demand as the inventory is worked out of the system?

So far, Bob, we haven't seen too much of a slowdown but we're -- we're cautious going into the fourth quarter. Everything that we've seen says that -- if you recall last year there was a pretty heavy build-up, particularly in the steel inventory levels towards -- towards the end of the year. And everything we are hearing is we are not -- we are not near that level, but -- there seems to be some -- some actions taken by the -- the steel producers to try to get inventory in line with where it typically be. I guess the rough estimate is -- we are hearing there is about three months of inventory out there within the steel supply chain and more typically the industry likes to see about two and a half months.

There was just an article in this morning's "The Wall Street Journal" as a matter of fact about U.S. Steel and [USLaw and Metal] looking at flat rolled demand going down, and, therefore, starting to trim production. So we think there is a slowdown coming in that regard.

Okay. Can you just remind me what percentage of your revenue serves those two markets combined?

Steel and -- and automotive?

Yes.

Well steel cascades through into automotive and we really lump automotive together as part of overall metal-working business. But steel is still in the area of close to 50% of our overall revenues.

Don't forget not all of that steel goes to the automotive industry. But we -- we've estimated that the automotive industry -- and we don't have a hard number on this so don't stick me with a number here, but in terms of ballpark, we estimate that about 40% of our business is somehow driven by automotive industry. Both steel and metal work. In what we call steel and metal working.

Okay. And then -- you know, you had said that mineral oil hasn't -- hasn't yet come down in relation to the decline in crude, but I would imagine if, you know, crude oil stays at these levels for -- or persist at these levels for a while, you would expect to see mineral oil to decline.

Yes, you would expect -- in the past there have been a pretty tight linkage between -- there has been a very tight linkage between crude and mineral oil as you might expect. The wild card and the reason they have diverged at this stage is because of refinery capacity constraints. Those should be less and less of a deal going forward, but they're still there. And relieving those constraints doesn't relate to only the price accrued. So it's the price accrued isn't the single influence.

Okay. Well I guess my question is, is whether or not you are seeing any push-back on the pricing or if -- if mineral oil does come down, whether or not you'd -- you'd anticipate -- you would anticipate giving the pricing back?

To my customers you mean? Push back from our customers? No, we're not -- at this stage, that hasn't been an issue for us, and certainly we would be seeking to maintain our margins in any case.

Okay. And then -- I guess lastly, just was hoping I could get some guidance on the full-year tax rate. It was lower than I -- than I would have expected this quarter which is -- which is definitely a good thing, but just hoping I could get some guidance on that.

Yes, I think the best I can give you is -- obviously things can change between now and then but we are looking at mid-30s tax rate for the full year.

Okay. Thanks for taking my questions. I will hop back in queue.

Thank you.

Thanks for your interest, Robert.

Our next question is coming from Daniel Rizzo of Sidoti & Company. Please proceed with your question.

Hi, guys, how are you doing?

Hi, Dan, how is it going.

Good. You have most of my questions. Just one, can you determine what -- what percentage of revenue growth is from CMS? Can you break that out at all?

Yes, we don't break that out separately, Dan.

Okay. That's all I had.

Okay.

[OPERATOR INSTRUCTIONS] Our next can coming from Patrick Flavin of Flavin , Blake & Company. Please proceed with your question.

Congratulations, guys, nice quarter.

Thank you, Patrick.

Ron, could you -- could you help us out on this steel thing? You are such a supplier and in such a commanding position worldwide that -- that the fact that Chinese steel is encroaching on the U.S. market, it strikes me as -- as a dual impact. One, it -- it -- it could improve your sales in China where as it impinges on those in the U.S. Can you help us with the inner flows of this? In other words, unless there are concerted worldwide curtailments of production, does it make -- how does the math work in terms of impact on U.S. versus higher production in China?

Yes. I'm not sure I am in a great position to give you a lot of the math on this, Patrick, but I can maybe give you some color. China -- demand in China is still growing very significantly, of course. Now, of course, of the steel that we -- that affects us is flat-rolled steel, and that goes to typically high value uses like cars and roofing materials, and the face -- fascia of appliances and that kind of thing. The -- China has been a -- has actually shifted back and forth of it being a net importer and an net exporter of steel. It's been surprising. You would think their demand has been so high that they could not be in a position of being a net exporter. But that has happened in the past. It's -- I don't believe it's now a -- much of a factor in the markets as the way we see it. In some sense, we don't really matter -- it doesn't matter to us where the steel is made. We just want the bulk of the share wherever it's -- of the steel plants.

The U.S. demand has -- has been the place where -- while it's been pretty strong this year, it's a place where we hear most of the concern about having a slowdown, although as I mentioned earlier Europe -- the U.S. Steel mentioned Europe as being a problem for them in today's "The Wall Street Journal." So how to draw bottom line on all that, is we think that it is not likely that given the growth in China, that long term -- this is personal opinion now. I can't chart all the data on this. But that in the near term China's going to be able to be a net exporter of the kind of flat-rolled skills -- flat-rolled steel products that we're -- that concern us. So we are looking to cap -- capture that in China. And that where other markets are concerned, we think that China will not -- since they won't be a net exporter of that kind of steel, that we don't think that will necessarily affect our position in these other markets. I am sorry I can't be more specific, but I hope that gives you some flavor for it.

Okay, that was a good try.

[ Laughter ] How do I take that, Patrick? [Inaudible].

No. That's --that's as good as I can expect, I mean, because unless you've done an econo-metrics study of the thing you have pluses and minuses all over the place. On -- on the CMS business, Ron, are you insulated from the plethora of chapter 11s that are being filed by a lot of the suppliers to the -- to the automotive kingpins?

No, I wouldn't say we are insulated, but we are more -- we are more concerned with the -- the bankruptcy of a key -- key maker as opposed to a supplier to these automotive makers. So we are not certainly insulated in any way from the -- the CMS doesn't insulate us in any way from the possible bankruptcy of a key customer like Ford or GM. But the bankruptcy of a supplier wouldn't typically be a concern for us.

Is that because the maker is the one that holds the -- the payable?

Yes, they are the one that owes us the money.

I got you -- well they owe the -- the supplier the money. In other words, you -- you are not in the middle of this. You are not the purchaser from the supplier?

Yes, in some cases we are. And in some cases we are just passing it along.

Well how does that -- how do you protect yourself then against the supplier going into chapter 11?

When you mean by -- I'll let my CFO answer this question. He's probably -- I probably already told you more than I know. But the -- it's the -- I mean, if we have a problem with a supplier, we go out and find a new supplier.

Right.

The people who -- whose receivable affects us is the automotive maker itself.

Got you.

Neal, you want to add anything to that?

Yes, no, I think Patrick, we -- we monitor the credit and receivables on a regular basis but there's -- and we try to diversify away our risk. And one of the things we look too is we don't have any single customer, although GM's a significant customer to us, we don't have any single customer that is -- is taking it -- in which we have a dominant amount of sales to. But there is no question when we -- when we look at our pricing and the profitability on these accounts, we factor in the fact that there's a -- there's a receivable risk associated with the credit worthiness of some customers.

But that's -- just to be clear on that, Patrick, that's not an issue of the supplier with whom we are dealing with, that's a matter of the customer with whom we are dealing with.

Understood, thanks.

Our next question is coming from Brad Evans with Heartland Funds. Please go ahead with your question.

Good afternoon.

Brad, how are you doing?

Good, thank you. I hope you're well. Could you just break out the components of revenue growth between price mix volume and the foreign currency impact please.

Yes, I will give you rough -- rough estimates. You can always get hung up on these things because there is kilograms and there's gallons and there's price and there's mix. But I would say that foreign exchange contributed about 2% for us, and the combination of price mix was in the five -- five percentage range -- five percentage type range and volume was in the 3% type range.

Would you care to just give us a sense as to what October looked like from a volume perspective? You know roughly? I mean are you -- have you seen the trends of kind of the third quarter continue into the early fourth quarter volume-wise?

Yes, we don't have that information available yet.

Okay. And can you just talk about additional pricing actions you might contemplate as you move forward here?

Well I think -- I am sorry.

I will just jump in. Our guys in the marketplace are always looking at our customer performance and customer relation -- it is always a balance, of course, between customer relationship and what you need in terms of customer profitability. And we really look at this both in terms of -- in both of those areas and we are focused more and more specifically on customer profitability as opposed to broad cuts in the markets that we should raise all metal working prices or raise all steel prices. So it's really a customer-by-customer, market-by-market thing and our -- our operating managers look at that very hard to see where we have to make improvements in customer profitability. Neal, maybe you can add some color to that.

Yes, and I think it's just -- it's -- going forward I think it will be much more of a -- of a customer-by-customer focus as opposed to a -- when we've seen substantial raw material price increases, it was much more broad-based approach to -- to price increases. Whereas now it will be more looking at profitability by customer and assessing where -- where we need to improve that profitability. So it will be much more targeted.

I guess I should have asked. Do you feel like at this point you -- you're -- you're in front -- you know you're in front of the cost curve now? Or are you still chasing that cost curve?

Well I think what we -- what we saw in the third quarter was -- call it a slower pace of raw material costs increases, and that has enabled us to -- to pretty well catch up with the cost curve. There is always more that we can do. But we've -- we've -- it's enabled us to minimize the lag that we've seen in the last several quarters before the third quarter.

But I will hazard a specific answer to your question. We are still not in front of the cost curve, because there is always a lag in getting price increases and there's always a differential impact on our customers of the kind of increases we get in terms of whether it's in the mineral oils or vegetables oils or whatever. And in fact, the -- the cost and the rise in costs have been much greater over time than a rise in our -- in our prices. So I would say we are certainly not on the edge of getting ahead of it. I think we are managing to stay even.

Do you think that there is something that has changed structurally that would prevent you from get back to gross margins in the 35% range over time?

Yes. I think one of the things is just pure math, Brad, in the sense that I think we mentioned at the last conference call, that over the last two years, we experienced about a $35 million increase in our raw materials costs. And, you know, even -- even if you -- even if we had gotten 100% recovery of that 35 million, just by increasing sales and increasing cost of sales, it -- it has a -- a downward impact on -- on our margins. So there is a structural issue that will prevent us from getting back to historical margins until such time as raw material costs return to historical levels

The other aspect of that that is important to recognize, Brad, is the way we've always been able to improve our profitability in our customers is serving them better with the better technology, maybe a raw -- more robust product for better use of the raw materials we have. And while we certainly are going to have that kind of mathematical phenomena that Neal mentioned, we certainly are still focused on trying to develop products that allow us to serve our customers needs better obviously and at the same time allow us to take -- take more -- take more out of doing that well for them. So in the past, you know -- you know you go back four or five years ago, the notion of a price increase was pretty scarce and the way you got improved profitability with a customer is to deliver a better product. And while we've had to push on prices in the last couple of years simply because that's simply a reality. You can't face the kind of raw material cost increases we face and not do that. We haven't walked away from the real primary thing that we want to do and that's not just push-up prices. The real way to get better with our customers is to give them products that work better and that's the focus of our R&D effort.

Again, I am sorry --

It is a two -- it's a two-edged thing. One is the mathematical problem that Neal has outlined, and two is -- is continuing to make progress with our customers and delivering a higher technology product.

Thank you for that color. Did you say that you expect a -- a marginal amount of gross margin improvement in the -- in the fourth quarter, is that correct?

No we didn't -- we didn't provide any guidance for the fourth quarter.

Okay. You mentioned in the SG&A line that there was some -- sounds like some bonus incentive accrual, as well as -- as well as investment spending over in China, I guess was the [art] was discussed. I mean could you -- seems like a significant increase sequentially. Can you just maybe break out the key components and maybe try to just bookmark the size of those increases?

Well, we -- we -- again, I don't want to go too far into the details, but I think it is safe to say that we -- we've restored incentive compensation to -- to where the targeted levels. Whereas last year, because of the poor performance, there was very -- very little incentive compensation in there. So certainly as -- as the profitability base has grown and as sales and contribution margin has grown, we've had higher sales commissions and variable comp. Beyond that, we don't want to get into breaking out all the different segments of SG&A.

And China hasn't been the only area of increased investment, although it has been the bulk of where it is, adding staff, adding infrastructure there. But we've tried to do that in other parts of our business where we think there have been opportunities. I mentioned new -- new markets for Fluid Power. I mentioned the fact that we have been working on certain kinds of coating products. So I wouldn't want us to be perceived as kind of a one note giant with China alone. We think we have opportunities that we can invest in other places. We are doing it. And the part of the restructuring we did last year was to enable us to shift our resources and to put more into places of promise as I mentioned earlier, but not necessarily take the full cost hit of doing that.

Okay. And -- I was curious also just to -- as far as the balance sheet is concerned, I mean, do you see an opportunity in the fourth quarter to -- to reduce working capital? Or do you think you are running the ship pretty tightly here?

It's something we're continuously focusing on. I think you saw a pretty -- pretty substantial reduction over all in working capital from the second to third quarter. So it's something we're -- we're continuing to focus on. But I don't want to lead to you believe that there will be some significant reduction in the fourth quarter. One of the -- one of the challenges we have that we will be working on longer term is that as we grow in China, our supply chain to China for many of our products is a -- is a fairly long supply chain, and that we ship a lot of our products out of -- out of Europe. And so that contend -- as China grows at the rate it has been growing, that contends to cause our working capital to -- to increase a bit. And then secondly, just as the exchange rate impact has had a positive impact on revenues, in absolute dollar terms, it's had a negative impact on our absolute dollar and working capital for the quarter as we translate receivables and inventory from other regions back to dollars.

Just -- I would like to add a little color to that also. Working capital has been a real focus for us, and we have made actually dramatic improvements throughout the year in several of our important markets, and actually China being one of them, although we have still have that long supply line problem that Neal was talking about and gets a tremendous amount of attention and will continue to do so. Of course, increases in business cause that number to go up, and as important as where the increase in business is. For instance, if the increases are [disportioned] disproportionately in China, that typically takes us -- absorbs more working capital than simply an increase in say South America where working capital levels are actually quite low. And the same thing is true with CMS. CMS tends to, as you get to take on new business, to have a fairly high working capital absorption component particularly on the front end. And we, in fact, have taken on some new contracts and will actually be negotiating as I mentioned earlier some of our contracts that are rolling over and that may have some impact on working capital. But you can be sure of one thing, that the big, big focus for us because it is the largest investment on our -- on our balance sheet as is obvious.

Okay. Thank you very much.

You are welcome.

Thank you, Brad.

Our next question comes from Steve DiNichilo of Thomson, Horstmann & Bryant. Please proceed with your question.

Hey guys how are you doing?

Hey Steve.

Quick question here. You mentioned in the past that give or take for a dollar in oil is about 400 to $600 thousand in higher raw materials cost. Correct?

We have given that you rough view, but, again, there's a presumption in there.

[Their moves] lock.

That they move in lock-step and the reality is that they don't.

They are not now anyway.

They are not now. But so then, I mean, you know this gross margin which was, I think, pretty impressive in the third quarter was done primarily through price increases, correct?

Pricing mix. But certainly -- certainly price catch-up has helped.

And then when we look at the downside, in theory, again, could we use that -- ?

Before you go on, there is also another factor in that -- that there was some shift in our CMS business, which causes some margins to -- percentage margins to look a little different. That is to say to the extent that business shifts between what we call "pass through" and agency business, that has a differential mathematical impact on our gross margins.

Okay. How much did that change in the third quarter say versus the second quarter?

That CMS change was probably very modest this quarter but it was not nothing.

Okay. Okay. All right. And so I was just trying to understand, you know, the downside in raw material prices and, of course, that's something that you can't expect. And you know, we don't know what mineral oil prices are going to do right now, but could you have that same leverage for a dollar decline of oil and the commensurate mineral oil, could you see that 500 grand go to your benefit assuming prices hold steady?

Let me see if I have the question right now and try to answer it. So if -- if mineral oil prices flow with crude oil prices and if they flow downward, should the relationship --

That you were experiencing --

Yes, the relationship should be the same, and then -- and then it becomes a question of the marketplace and competitive pricing in the marketplace from a -- from a customer perspective in terms of what we would retain or not retain.

But I mean you have been fighting pretty hard for these cost increases, and as a percentage of say a steel mills cost, you still remain relatively small. So I would think that you should be able to hold a majority of your cost increases, correct?

It is always a challenge, but we -- we sure hope you are right.

And we are working with our customers -- again, I mean, I don't want to sound like a marketing machine here, but we are working with our customers to find ways to deliver better value, not just to -- and try to get the focus off purely price because it doesn't serve either one of us as well as finding a way to help them be more productive. That is the conversation we prefer to have with our customers.

I understand that. Just real quickly on the SG&A line. You might have mentioned it in the beginning. But you guided to give or take about the same percentage of sales on the SG&A line, so 27%. Is there any reason to think that wouldn't be the run rate for '07 as you continue to invest in the business? Or should that start to tick down a little bit? Not asking for guidance just more -- just directionally or strategically how should we think about SG&A?

Yes, again, beyond knowing that the third quarter and our expect -- expectation for the fourth quarter is at 27%, I guess that's -- that's probably the right -- the right range for you.

Okay. All right, guys. That's all I have. Good quarter

Thanks. Thanks for your interest.

Our next question is a follow-up coming from Brad Evans of Heartland Funds. Please proceed with your question.

I guess I should have taken that gross margin question one step further, I guess. Could you just -- thinking out 12, 18, 24 months or over a longer period of time, where do you think you should be able to return from an operating margin perspective then if you're not -- I mean if we're talking about gross margins prehaps being structurally somewhat lower, what does that imply for where you should be optimally from an operating margin perspective over the long term?

Again, that's -- we are sort of in this -- we are moving out of a difficult period, Brad, and we've made a lot of progress over the last nine months, and beyond that. You know, it really depends on the future. One of the reasons we are not giving a lot of guidance has been the volatility of things like raw material costs. So -- so to give you an estimate is a little uncomfortable, because if -- if raw material costs move in one direction or the other, that could certainly impact gross profit percentage which will flow all the way down to -- to the bottom line. But certainly we're -- we're looking for every avenue we can to continue the uptick in the margin percentages that we've shown in the current quarter.

I am sorry -- I am asking for a number that is open-ended. I am not asking for a number that you will achieve next year. I am saying, you know, some time in the future, assuming things go your way, where should margins be? I am assuming higher than where they are today, but what -- what -- you know, what do you think is a sustainable normalized margin for business under normal circumstances, whatever "normal" is?

Are you talking about operating margins?

Yes, sir.

I would think in the long term, I would think we want to get to the kind of operating margins that we had a few years ago. It's just going to be in a different mix between how we use our costs below the line and how we use our -- how we use our -- what kind of pricing success we can have at the top line. But certainly our goal is to get the business -- the operating margins not only up but back to more of our historical levels.

So s back to that high single digit level you were in the '97 to 2003 time frame?

Yes, I have to say, though, that that's not something that we don't -- we're staying away from making projections.We're not going to make a projection for next year and would be disingenuous for me to leave you with the suggestion that that will be the case next year.

I am definitely not asking for that point estimate. Can you just give us your -- your thought for capital spending for the remainder of the year? What is your budget for 2006?

Normal maintenance capital hasn't -- hasn't changed much. So the normal ongoing business capital as we look forward and -- and even year to date is in the -- in the $6, $7, $8 million range each year. This year we have some expansion capital that we are looking at, so our total expected CapEX is in the -- about the 11 million, $12 million range.

Any major projects that you have on the drawing board for next year?

Not -- not as of this time.

Okay. Thank you very much.

You are welcome.

Thanks for your interest, Brad.

I show no further questions in the queue at this time. I would like to turn the floor over to management for any closing comments.

Okay. Well thanks for your interest, everybody. We're -- as I said earlier, we are pleased to be able to report to you on this quarter and although we do see some signs of concern in the near term going forward, we feel we are in a much better position for the long term than we have been for some time and we're optimistic about that. So I thank you for your interest and I look forward to talking to you next year after we've been completed our year and see how you all are doing. Thank you again for being with us today.

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