Quaker Chemical Corp (KWR) 2007 Q2 法說會逐字稿

Greetings, Ladies and Gentlemen, and welcome to the Quaker earnings results conference call. At this time, all participants are in a listen-only mode. A 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 CEO for Quaker Chemical. Thank you Mr. Naples, you may begin.

Thanks, Claudia, and welcome everybody. Thanks for taking the time to join us. We'll try to make our time productive this afternoon. As usual, Mark Featherstone, our CFO, is here with me and our process will be as it has been in the past. I'll make a few introductory comments and then Mark will cover some further detail and then we'll be available for any questions. And I will try to keep my comments brief.

We had a fine second quarter, I think, and it follows a fine first quarter. Now, I'm pretty much inclined to let the numbers speak for themselves. But I thought I'd make a few observations and point to a few implications. We had very good sales growth. The quarter and the year, so far are both in the range of 15%. And the important point here is it's not just the sales dollars, but the second quarter saw a very solid real volume growth in a number of markets. I mentioned that in the press release. The gross margin -- pardon me, improved in the quarter and that's despite raw material pressure during the quarter. And I'll say a word a bit later about raw materials and I know Mark will have some comment on it. I just wanted to point out that we work very hard with our customers on price and value. So price is part of improving our gross margins, but it's not all of it, certainly. We also work on moving our customers to higher value and therefore higher gross margin products when they're right for the customer. And you see in our business some mix toward higher margins and newer markets on certain products. It's not a big sea-change, not a big one-time charge in the quarter or a one-time advantage in the second quarter or anything of that sort. But it does help and I hope it will continue to help in moving our margins forward.

Profit growth for the quarter, and actually for the first half is up 39% in terms of net income. And yes that net income figure was increased by -- was helped by our lower tax rate but of course lower tax rate flows from initiatives that we've taken over time to do the most rational thing with our operations around the world. But even without that tax rate help, it's worth noting that our operating income was up 21% from the first half.

Cash continues to be very high on our agenda. Simply put, we want to make sure our financial progress is across the board in all dimensions, not just earnings, but cash, as well. And I'm glad to say that we're making solid progress. Our operating cash flow is $2.6 million better than last year's first half and, in fact, we had a $2.2 million positive in operating cash flow in the second quarter. Working capital is one of our most important uses for our cash. And, of course, working capital goes up as sales go up. And it's always good to talk about good progress in sales. We look very hard at working capital absorbed as a percentage of sales as our sales growth. And I'm glad to say that figure is moving down. We made progress in that figure in the second quarter versus the first quarter. It's a continual management focus we've set goals if the year and we check our progress every month. And indeed we do expect for the year to have a positive operating cash flow. Our management team feels good about the progress all of this represents. We think it demonstrates resilience and continuing promise in what we're doing here in the company.

I promised a further word about raw materials. And as we look to the rest of the year, from here on out, raw material prices are, I must say a bit of a wild card. On a year-to-year basis in the first half, we did get hit by over $4 million negative because of raw material prices. Mineral oil is at pretty high absolute levels and as you know, mineral oil is a big input for us. It's at a pretty high absolute level, but it's been pretty stable over the last few months, even though crude has been pushing on its highs and how that will make it through to mineral oil and of course what timing is of course an open question. However, we're looking also to non-mineral oil materials in a way that we haven't looked in the past. Vegetable oils and animal fats in particular. We think both of those will see considerable price increases as '07 continues to unfold, particularly price increases as related to where the prices were at the the latter part of '06. This is driven by new demands for products like or commodities like coconut and palm oil for biodiesel uses and it's also driven by higher food demands in lower supplies for some of these commodities related to poorer harvests. We believe our plans and our activities recognize these realities. So we feel good about our ability to handle this. But it is an area where visibility looking forward is not always so great.

Another factor looking forward, of course, is demand. And for the most part, we think that demand is pretty solid and will stay solid, although it's not uniform around the world in all of our businesses. Particularly, (inaudible) China. China has had a very good percentage growth rate period over period for some time now. Our share in China, particularly in steel is very strong, our volume there is still growing, and we see it's staying that way. I just wanted to point out that comparisons period to period may moderate a little bit, though as we proceed through '07 because there's not a great deal of production expansion in China in '07. They're taking a breather in terms of building new mills. So we don't have the new mills to add to our totals. And of course, we'd be comparing to strong levels in prior periods. So, we think China's going to continue to lead the growth parade, but the extent to which they do may moderate a bit in the rest of '07. Before I start, I'll just say that all in all, all things considered we continue to see the prospect of very good progress in the various dimensions of our performance for '07 and look forward to reporting a good year to you. With that, I'll stop and I'll turn to Mark to cover a little more detail. And as I said, then we'll be available to answer questions.

Thank you, Ron. Good afternoon, everyone. Yesterday, we announced record second quarter 2007 sales of $137.6 million and diluted earnings per share of $0.41. This compares to sales of $118.7 million and the earnings per share of $0.30 for the second quarter of 2006. And, as Ron mentioned, net income increased 39% to $4.2 million versus $3 million in the prior year quarter. The second quarter earnings up $0.41 a share represented our highest quarterly EPS since the fourth quarter of 2003 while net income as a percentage of sales at 3% represented the highest level since the first quarter of 2005.

I will spend the next few minutes focusing on the second quarter P&L and will then, we will go on to have some questions. Now on sales, as Ron mentioned, sales for the second quarter compared with the same period last year were up 15.9% to $137.6 million. The growth was driven by volume growth, pricing improvement, as well as higher revenue related to our CMS channel. Now, volume for the quarter was up almost 7% from the prior year, including the additional CMS revenue. Pricing and mix improvements total almost 5% of sales and really occurred broadly across all regions and market segments. Foreign exchange also increased revenues by approximately 4% as the U.S. dollar weakened against most currencies, particularly the euro and the real where we have significant operations.

Now volume growth was led by double digit increases in our volumes in China and good growth in both Europe and South America. And while North America steel volumes were improved over the first quarter of 2007, they remained below prior year levels with limited improvements currently expected for the rest of the year. And while we continue to see pockets of slowness in a few of our automotive customers, our sales particularly through our CMS channel have increased due to continued conversions of systems from a competitor to Quaker products as well as other factors. The higher sales prices reflect our continuing efforts to work with our customers to deliver value while also recognizing the impact of higher raw material costs.

Overall raw material costs continue to remain significantly higher than prior year levels. And, as Ron mentioned, up about $4 million compared to the first quarter, I mean, through the first half of last year. As we've discussed before, we are generally able to recover at least most of our increased raw material costs through higher selling prices. However, there's usually a lag between when our raw material costs increase and when our price increases go into effect. During the second quarter, we experienced somewhat of a catchup effect on pricing compared to raw material costs, i.e. recovering costs that we incurred previously.

I would now like to give some data on a segment basis. Now, as you recall, we segment the business into three areas. Metalworking processing chemicals, coatings, and other chemical products. In our metalworking process chemicals segment, which makes up 92% of our sales, revenues for the second quarter compared with '06 were up 16.4% to $126.8 million. Operating income improved 26% to $19.7 million. Turning to our coatings segment, sales were up $1 million or 11% due to higher temporary and permanent coatings sales. Operating income was flat at $2.3 million. Our smallest business segment represented about 1% of sales is called other chemical products and consists of our sulfur removal products from industrial gas streams and that's sold by our Q2T joint venture. We had a small acquisition occur during this quarter, which has complementary technology to this segment. And this should help increase our sales and profits in this segment going forward.

Turning now to gross margin. Gross margin as a percentage of sales for the quarter was 31%. And this represented a strong improvement over the 30.4% from the first -- from the second quarter of 2006, as well as a slight improvement over the first quarter of 2007. Our persistence on the pricing front has enabled some margin restorations despite higher raw material costs. Our gross margin in dollar terms was up almost 18% or $6.5 million for the quarter, due to a combination of volume growth, price recovery action, as well as stronger performance in our CMS channel where we continue to add new sites. As noticed previously, we continue to gain product conversions at our CMS sites which continues to add profitability to this channel. While we expect production reductions and plant closures at some sites in North America, we expect product sales and service opportunities at new CMS sites both in North America and other regions to help offset any profit loss from volume reductions at existing sites.

Moving on to SG&A and other expenses, as a percentage of sales, SG&A for the quarter was 25.7% of sales this year versus 25.1% in the second quarter of 2006. SG&A as a percent of sales is also down from the full year 2006 percentage of sales up 26.3%. For the full year, we expect our SG&A percent of sales to be in the 26 to 27% range as we continue to fund a number of growth initiatives. In absolute terms, SG&A for the quarter was up $5.6 million with foreign exchange rates, higher legal environmental costs and higher incentive compensation costs related to higher earnings accounting for more than half of this. Continued planned spending in higher growth areas such as China, as well as higher commissions on higher sales also contributed to the increase.

Turning to other income. Other income was higher than 2006 because of foreign exchange gains realized this year. And interest expense is higher than last year because of both higher average debt balances as well as higher interest rates.

Turning to the tax rate, the tax rate, the effective tax rate for the second quarter is 34.8% this year versus 39.3% for the same quarter last year. The current year second quarter rate benefited from a change in mix of income levels towards lower tax jurisdictions and as we mentioned in the first quarter tax incentives related to our new facility in China. And while the second quarter rate is higher than the first quarter rate, we continue to expect that our full year 2007 tax rate to be lower than the 33.8% full-year 2006 rate, excluding any provisions for FEN48.

Turning to the balance sheet, our net debt has increased from 2006, December, primarily to fund working capital needs and our continued expansion into China. Our net debt to total capital ratio was 42% at June 30th 2007 compared to 43% at the end of March, and 40% at the end of December. Now there were a few questions on working capital and cash flows during our first quarter conference call. So I wanted to spend another minute on this area.

Similar to the first quarter, accounts receivable increased due to higher sales later in the quarter. May actually was an all-time record sales month for Quaker. And our payment terms with our customers meant that most of those receivables would not have been collected by the end of the second quarter. Inventory levels also increased compared to the first quarter due in part to the start-up of a few new CMS sites during the quarter as well as some stockpiling of inventory prior to the shutdown of our old plant in China. We are in the process of relocating equipment to our new plant in China and we expect this extra inventory level to decrease over the course of the year. Over the longer term, as we continue to increase local sourcing in China, overall inventory levels should improve further.

Turning to working capital. While working capital in absolute dollar terms has increased during the second quarter due to the strong sales increase versus the first quarter, working capital as a percent of annualized sales has improved verses the first quarter. And dependent on whether you look at total working capital or operating working capital, which we define as accounts receivable inventory and payables on accruals as a percentage of annualized sales, the decrease from March 31st to June 30th was between half and three quarters of a percent. As Ron and I discussed on our first quarter conference call, we expect further improvement on the working capital front as the year progresses.

On an operating cash flow basis, the second quarter was positive after being negative in the first quarter and further improvements in this area are expected as the year progresses. And, as Ron said, we expect full-year operating cash flows to be positive. And that concludes my prepared remarks.

Okay, Mark. Thanks very much. And at this stage we'll take any questions you all may have. I guess the operator needs to come down and fix that for us.

Ladies and gentlemen, we will now be conducting a question and answer session. (OPERATOR INSTRUCTIONS) Our first question is coming from Robert Felice with Gabelli and Company.

Hi, guys. Congrats on a nice quarter.

Thank you.

Thank you.

Just have a couple of quick questions. I guess it sounds like in the back half of the year you expect certain raw materials to continue to escalate. And I know base oil prices have ticked up a little bit in the past couple of weeks. As I look to the back half of the year, do you expect margins to compress sequentially? Or do you think you'll be able to get enough pricing to maintain margins at these levels?

Well, we hope that the margins should be pretty solid going through the rest of the year. They're unknown for us, of course, is what Mark mentioned about how fast the price increases can get implemented and in the range of customs we have around the world. And how much of the price increases we already have in place will play out against these new costs. The one reality that we're sure of is that as Mark said, Mark said, we're always behind the power curve in terms of relating our price increases to the pace of raw material increases. But having said that, we hope that and are working to achieve stability in our margins. If not growth, if we have some moderation, if, the price increase effect is not as large as we fear it may be.

Okay. I guess with a month of visibility so far into the third quarter, have you seen raw materials tick up? Are you in terms of margin, have they maintained or have you started to see them slip a little bit?

We definitely have seen some increases in raw material costs in the third quarter. As I mentioned in earlier remarks, we're also having discussions with customers to try to recover those costs. How that balances out, we are seeing higher costs already versus some of the announced price increases we've taken place until the end toward the end of the quarter.

Okay. So it sounds like depending on how quick they rise and whether they rise and flatten out, it'll be a catchup game.

We don't have numbers on your specific question, Bob. We don't have numbers for July yet in terms of what our margins are.

Okay. Okay. Fair enough. And then SG&A was higher this quarter, and it sounds like given your expectations where they'll fall as a percent of sales they'll tick up even more in the back half of the year. When I factor that in with a little bit of potential gross margin compression depending on your view on raws, it sounds like operating income margins should compress a little bit in the back half. Do you expect for the full year to achieve greater than 5% operating income margins?

No, we probably won't be at that 5% level for the year as a whole, but we will be, we think considerably ahead of prior year.

Okay. Fair enough. Thanks for taking my questions.

You're welcome.

Thank you.

Our next question is coming from Patrick Flavin with Flavin Blake & Company. Please proceed with your question.

Nice numbers, fellows.

Thanks, Patrick.

The one question I have for you, Ron, is how in a time of good growth, which the company is in now, the operating leverage is not extending down into the P&L? The degree of top line growth is -- it has flattened appreciably when it gets down to operating income. How do you deal with that?

Well, I guess I want to make sure we're working with the same numbers. Our sales are up for the first half,-- our sales are up about 15%. Our operating income's up around 21% if I'm not mistaken. So, to that extent our operating income growth is outstripping our sales growth. Are we on the same page with that?

Yes. I guess what I'm addressing specifically is the rapid increase in SG&A cost.

Yes, well, SG&A costs are obviously related to a whole bunch of things, some of which have to do directly with the sales increase because there are commissions and that kind of thing related to it. Some of which is related to incentive compensation, which obviously ties to our goals which are set based on our earnings improvements. So some of it ties to that.

The big point about SG&A, I guess is the fact that we've looked at that hard to make sure that where we extend ourselves in SG&A are areas where we think we have the opportunity to really build the business. And here I look to I think specifically about Asia-Pacific or generally about Asia-Pacific and specifically about China. And what'll happen, the reason it may go up in the latter part of the year is that we are increasingly trying to extend our staffing in China, particularly to build the business influencing positions where we think we have more opportunity. So it's not a matter of SG&A going up because costs across the board are going up. It's a matter of being very targeted about where we we think we can spend money to get benefit. You have to remember, we're a very high service business. We run on how well we service our customers. We've looked at our business time and time again to see how we can sharpen that, and I can point back to not so long ago where SG&A was much more like the mid 30's in terms of a percentage of sales. So we've driven that number down as a general proposition. And where we increase those numbers, those increases are related to business increases or to where we think we have the most promise. So that's the way we're trying to manage the SG&A and we're just being realistic in the sense that we think we'll be making more investment in people in the second part of the year as we try to staff up to get better growth in our businesses and particularly again that's Asia-Pacific related.

I think longer term also we're looking to increase operating income as a percent of sales. But that's not a quarter by quarter goal.

We're not all all happy with our operating income level in terms, as Mark said, as a percentage of sales. We still think that they have a ways to go. And that's going to have to come through a combination of leverage on SG&A, which we can get some, and particularly when we feel like we've got staffing where it needs to be in the areas where we have the best opportunities and where we can improve, if we can continue to improve our gross margins as we go along.

Okay. And then finally on a capital sufficiency basis given the growth that's occurring, it would be helpful if free cash generation were to improve and I guess my question to you on that is it looks like you're running about 90 days on your accounts receivable. Is that, is that simply because of the amount of business you do foreign? Or is there something else in there?

No, there's really nothing else in there. It's a mix of business question in terms of industries and it's also a mix of business question in terms of geographies. I believe I said this before, but let me reiterate, because it's a good thing to keep in mind. Our geographies have very different characteristics in terms of their operating cultures, if you will, particularly around the receivables side. And we find that so far our business in China absorbs much more working capital and it's China again, not specifically just Asia-Pacific generally, although it's true in Asia-Pacific generally also absorbs much more working capital than say, South America. In South American, we have a very low percent of sales absorbed by working capital whereas Asia-Pacific is three times what we have in South America. So it's a real mix of the business conditions we have, but let me emphasize that this is not a question of people being strung out or our receivables being stretched to where we think we have higher risk or something of that sort. It's not that at all. We're trying to push the business along as aggressively as we can. And that tends to put us in areas where the receivables culture is just a little longer than we'd like it to be, to be honest with you.

We are very devoted to continue to work on our working capital.

And even in Asia-Pacific, that number is coming down because, again, we're very focussed on it. Given the culture you're operating and the industries we operate, we obviously can't change that culture wholesale, but we can certainly work at the margins to try to get the best result out of it we can.

Okay and on the CMS contracts, Ron, I assume that those have pretty fast turns on them, don't they?

Well, there's always an investment on the front end where you're going to CMS. You've got start-up costs and that kind of thing. The receivables or the working capital characteristics as a whole in CMS once it gets underway and rolling are about the same as the rest of our business. So we can't point CMS as an ongoing thing in terms of our dragging down our working capital.

Okay, thank you keep up the good work.

Thank you, Patrick.

Our next question is coming from Dan Rizzo with Sidoti and Company. Please state your question.

Good afternoon, guys.

Hi, Dan.

How you doing? You mentioned that you have several new CMS contracts. Could you quantify that?

I think in the second quarter we had two new CMS contracts in the third quarter. We have three more coming on board.

Okay and is there anybody notable that you want to say like GM or something along those lines?

With existing sites, some of our existing customers. New sites of existing customers. As I mentioned in my earlier remarks too. As everyone's heard, some of the big three happened announced some closures of sites. And during the quarter we also exited at least one CMS contract and that facility will be closing shortly. So, and we said, we expect our new CMS sites to more than offset the decrease related to either closures of exits preclosure.

Okay. And CMS is still primarily for metal as opposed to steel?

That's correct. We do have some services business in steel, but it's nowhere as extensive in terms of the amount of it what we do or in the nature what we do. The CMS model in metalworking of what we do is actually much more extensive in terms of actually chemical management.

Okay. And finally, you mentioned a planned expansions in Asia. You said in the press release that sales were good in Europe and Latin America. I was wondering if there's any talk about possibly expanding in those areas, as well.

Well, I don't think that people are building integrated steel mills as much anymore. Although you do see one pop up occasionally. They are still building them in China.

Right.

One of the reasons we think the comparisons in China may slow down a bit is the fact there there hasn't been new capacity added in China this year and we don't think that'll really start happening until '08.

Okay.

But our growth in terms of keeping up with the rate of growth of Chinese steel, we're still way ahead of that. So we feel like we're our business is staying very solid in terms of share. And we feel like we're building our position there. And very well-positioned to be as competitive for new mills coming on as we've been in the past. I think we've pointed out one year that it may have been '05 if I'm not mistaken where 6 new mills came online and we got them all.

Okay.

I don't know if we can have that batting average every time, but I think we're very well-positioned to build our share in China.

We see some new mills coming on next year. As any kind of planned expansion is, that's subject to some fluctuation.

Yes, nothing is ever promised, but in terms of what we think is happening and in terms of our positioning in the markets, we do think there should be some things happening in '08.

Would you know if you're going to be in those mills by the end of '07 or -?

No, it's not likely. But that doesn't happen until start-ups actually start to take place.

Okay. Okay. Thanks, guys.

You're welcome.

Thank you.

Our next question is coming from Jerry Heffernan with Lord Abbett and Company. Please state your question.

Good afternoon, guys.

Hi, Jerry.

Hey. I just want to clarify in regards to CMS sites, you said you had two new ones come on this quarter and you're expecting three more next quarter?

In the third quarter, yes.

And you had one shut down in the second quarter or expect one to shut down in the third quarter?

Occurred in the second quarter.

Okay. And did that entire site shut down or did you just lose the business at that site?

We decided to exit the business because of the ramp down in production, it didn't make economic sense to stay there.

Okay. Fair enough. So it was a discretionary move?

Yes.

Okay.

I'm glad to say, Jerry, that every contract we've had, that we sought to renew, we've been successful at. Thank goodness, I'm trying to find some wood to knock on, but we've been doing very well with our customers.

Fortunately for me I can knock on my own noggin.

It tells you, We don't have any wood furniture in here, it tells you how much we watch our SG&A.

Or support your customers, one or the other. In regards to price increases and we did mention, you did mention this quarter saw a bit of a catchup as far as price increases versus raw material increases, are all of your customers currently paying at the stated book rates? You know, sometimes you institute a price increase, but it begins 90 days or whatever contract terms are. Is everybody paying at the price they should be paying now?

Well, first of all, let me clarify just to make sure there's no confusion. We don't really have such a thing as a stated book rate to the extent you're talking about, kind of a price list. Everything we do is customized for a customer. It's really a negotiation around a particular product for a particular purpose. And what we try to do with our customers obviously is over time offer them a higher value products, which will do better for them and therefore they would be willing to pay us more for them. But, of course, there is always a lead time in price increases. And it's a mix across our businesses at this stage and across geographies at this stage also about the price increases being in place or being discussed with our customers to be in place. So, I'm afraid there's not a simple answer to your question, Jerry. Okay.

When I said book price, I know there is no real book price. I was struggling for terms -. Certainly to the extent that the customer is using a product and they're going to continue using the same product. You've indicated there's going to be an increase in that product, have all those increases gone through yet or still some people -- you say that is what's going to happen and then you agree that yes, okay, beginning next quarter it'll take effect.

Well, I think that some customers the discussions take a little longer than others. And in some cases, what we've moved to is where the prices will automatically adjust over time. Now, some -- for some products that makes sense, that's readily available index out there to benchmark against. In other cases, it's more of a negotiation.

But I think the reality is Jerry, that every customer -- price setting exercise with every customer has different timing because of the conditions of their customer and the products we have in there.

Right.

It's really not the kind of thing where we say we'll have a price increase. In general, now in some, there are exceptions to this. So please don't take this as an exclusive statement. There are occasions where we'll say this group of products needs to go up by X times Y amount. But in general, that's not the case.

Okay. Okay. And just finally, I'd like to go back to a topic that a previous caller had brought up. And that is, I guess it's two topics. One is, I am somewhat surprised that the SG&A growth rate is as high as it is. And still perhaps a little bit confused as to understanding that you're targeting the expense increases are based upon targeted growth areas. That's still the growth rate in SG&A seems to be matching the revenue rate that there's no leverage there. And then the second area being the cash flow. You guys have done a great job of growing the business. But boy, it does seem like the interest expense has really stepped up and is eating into a fair amount of the profits that you guys have worked so hard to attain.

Yes, there's no question about it. That's the reason, as well as other factors the reason we're so focussed on cash flow. And as I've said before and as we've discussed on this call at other times, working capital is the thing that really absorbs what we're doing. We're not a very capital-intensive company, but we definitely have to invest in our businesses in terms of working capital to make possible the kind of growth we have. And the best thing we can do there is to find ways to make that as effective and efficient as possible. And I think we're making progress in that regard. And when we look at our first quarter and we look at our second quarter, we see that we have a whole bunch of metrics we use to measure how effectively beyond the simple what's working capital as a percent of sales and those all suggest that we're making progress. All things we monitor and try to push along. The working capital pieces are very important piece for us and we stay very close to it and are focused on it. And we're obviously monitoring our debt levels very closely because we want to make sure we put ourselves in the strongest position possible to have capacity available if we want to do an acquisition. And of course we want to stay in a healthy leverage kind of position where we have our debt as the multiple EBITDA in a very rational place.

That's a very good point too because times are pretty good right now. And you don't want to let your debt sneak up to a high point right as you, as the good times come to an end.

Yes. So we're focused on that kind of thing. I don't want to skip over your question on SG&A. I'm not sure I can put it shine more light on that subject beyond what I've done. So obviously I need to sharpen it up for you all. There is the mix of some variable expense. I'll try one more time. The mix of variable expense related to things like commissions, mix of variable expense related to items like incentive compensation, which are big numbers for us, depending on how the business is doing and we're doing very well this year. And our incentive plans are built around paying against performance. So those are meaningful increases. Also, exchange rates, which I didn't mention earlier have a meaningful effect on us. The translation of results with the weaker dollar helps us a lot. But the translation or the conversion of foreign exchange expense where the weaker dollar hurts not helps us. That also plays out in the dollar level that you see of our SG&A. Other than that, we really do choose the areas that we want to invest in and I've said this already, Asia-Pacific is the major one there in terms of general operating expense, but we're also we'll be contemplating expense levels in say, R&D where we feel we need to push progress along for a particular product need or particular technology need. And we're also trying to put ourselves into a number of businesses which are new for us. Some coating areas, some tube and pipe areas, some mining areas where we have to make a little more up front investment in terms of marketing expense to get us there. So the best thing I can say about our expense levels in SG&A is that you can be sure that we are very focused on what are those levels and where are those levels going? We're not just kind of increasing SG&A across the board as our business grows. We're really trying to be very focused about where we put resources that we think are going to have a return for us. So I think there will be occasions where the growth in SG&A may look higher than you might think it is and higher than you might like to see, but there are always occasions where we're trying to manage SG&A to get the best result out of the business where we think we can returns on investments we put there. I don't know if that's a satisfactory answer for you, Jerry. but it comes down to really trying to make some judgments out of that.

It's good.

Okay. Thank you very much for all your time.

You're welcome, Jerry.

Appreciate your interest.

We have a follow-up question from coming from Mr. Robert Felice.

Hi, guys. You mentioned before that working capital in the Asia-Pacific region is a bit higher than other geographies. Is China free cash flow positive at this point?

It's more of a break even at this point. But one of the issues we have with regard to working capital with China is and I mentioned this in my comments is we're trying to move more and more to local sourcing. At this point, we're importing a lot of the products from either raw materials in some cases finished goods from either North America or Europe. So at any one point in time, we may have the 60 days worth of inventory on the water to China. And that tends to drive up our working capital in that region. We are -- we've made a lot of progress so far. But with local sourcing. But one of the issues with China is sometimes the product quality is not what we need for our products or the consistency. So we want to make sure that we give our customers the best product that's available while we try to qualify from local sourcing. And of course, China's also been the beneficiary of a lot of capital spending over the last year and a half, as well, which has used up some cash.

Okay. But it's not a large negative just --

No.

Okay. So as you look geographically, I guess which areas are contributing on a free cash flow basis and which ones are draws?

Well, we don't report our results on a geographical basis, Bob. And we'd like to keep it that way at this stage. But we do in terms of managing our working capital and receivables in particular, we do, of course, look to management groups who have much more local responsibilities than global responsibilities. And so we look to each area to produce the best possible on the working capital front. And there is a mix. It's some are cash positive and some are cash negative as you would expect in business and in any portfolio of businesses. And it relates directly in most cases not so much to -- in some case it's a culture thing like the working capital absorption in China. But it's generally related to profitability levels more than anything else. Which is why we're so focussed on trying to get our profitability levels up around the world.

And as we talked about particularly for this quarter we had some inventory build, as well in China the shutdown of our old plants. And also has some working capital going into some of the new CMS contracts that we talked about, as well.

Okay. Fair enough, thanks for taking my question.

You're welcome.

(OPERATOR INSTRUCTIONS) Thank you, we have no further questions.

Okay. Sorry to interrupt you there, Claudia. Well, I thank everyone for their interest and for your support. And I hope we can continue to report good results to you because one thing you can be sure about we're committed to the continuing to improve the business, not only on the earnings side, but on the cash side. And I look forward to discussing it with you in the next three months.

You may disconnect your lines at this time. We thank you for your participation.