Quaker Chemical Corp (KWR) 2008 Q1 法說會逐字稿

Greetings ladies and gentlemen. Welcome to the Quaker Chemical Corporation first quarter earnings. At this time all participants are in a listen-only mode mode. A brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) as a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. Ronald J. Naples, Chairman and CEO for Quaker Chemical. Thank you, Mr. Naples, you may begin.

Thanks very much. Good afternoon. Welcome, everyone. As usual I've got Mark Featherstone our CFO here with me, and as usual I'll start with a brief overview, and I hope to keep it brief, I'm sure you'll be glad to hear, and then Mark will cover some detail in the second quarter and as was already said, we'll take some questions. It's always a delight to start a conference when your sales are up 18% and your profits are up 44%. We feel like we had a great start to 2008, particularly given the kind of environment we find ourselves in. Our earning per share of $0.50 in the quarter, which is significantly better than last year's $0.35 for the same period as well as the fourth quarter of '07 result of $0.46. And, in fact, it's the highest quarter our earnings per share we've had in some time. So we feel we did get off to a really good start. A point of note that I'd like to direct you to is our operating income margin was 6.2%, better than where we had been in some time. We've talked often about -- in the past -- about our determination to improve that figure because we think it's important to support our ability to invest in growth and technology and operating improvements, and it's really good from my standpoint to see the tangible result of the commitment we've made to do that and the effort we've made to get that done. Frankly, it's a tough time to accomplish this because, as you can see, our gross margins are under some pressure from raw material prices, but we remain determined to get it done, and we're finding ways to get that result. This fine result is really reflective of many aspects of what we do here at Quaker. I'd like to point ultimately to a number of fundamental issues and premises we build on, but first let me point to two financial issues that I think are buried in our effort in our result of achieving the kind of operating income we did in this report.

Number one is that we're getting more out of our SG&As as we go along, more than we ever had. That's a virtue of the infrastructure we have in place to serve our global world, and also it reflects the opportunity we have to grow revenues and run that through that infrastructure. SG&A as a percent of sales has been driven down by the focus that we've continually had on top line, of course, that has more purpose than just to reduce SG&A as a percent but also in our focus on costs to try to get the best out of money we spend.

Even though we're focused on cost, we do have plans for our continued growth. They'll involve market and customer penetration and new business development, and we remain committed to those, I want to say, because we will spend where we think it's appropriate to spend to get the long term result we want, but cost control with financial results in mind is always a balancing priority for that matter of where we're going to spend new dollars. So we're getting more out of our SG&A.

The second point I wanted to mention is the results we're getting from the energy and effort we've spent with our customers on the pricing front. We recognize that the key with our customers is to demonstrate our value to them, which we focus on in all our conversations with them, as well as make sure they understand our cost realities in today's world. It's a world of, as you all know, attention-getting crude oil prices and increasingly attention-getting vegetable oil prices in a world of biodiesel demand. It's just one of the other issues that we have to deal with.

All of us customers and us alike, as well as I'm sure you in your own businesses, face cost pressures, and we just need to keep pace with our customers to make sure they understand our pressures, and at the same time, make sure they understand the value they're getting out of way we deliver to them, so it's just not a pricing discussion, but a value discussion, and we feel good in terms of what we've been able to accomplish in that regard and I think it's reflected in our first quarter report. So at this stage I'd like to step back from that kind of detail and focus a little more fundamentally on some issues about Quaker because I think they're very important to our long term success, not just our quarterly success, and they should be important to you as investors in terms of what it is you're buying into here at Quaker and what can you expect of us in the future. Because fundamentally our progress really reflects three important things. One is our view of the world. Two is what Quaker has decided it wants to be in that world to be as competitive as possible, and three, the strategic choices we've made along the way.

When you combine these with the efforts of a management team and the people that we have around the world, these are what have allowed us to execute against what we expected of ourselves. Our current financial results are important, of course, and I trust by our continued performance the message is clear that we understand this and we're willing to deliver on it, and you can be sure that delivering financially is always front and center for us. Indeed, I think it's in our organizational DNA.

We also understand that getting the long-term value creation for our people, our customers and, of course, you our investors requires a clear-eyed view of what we need to accomplish in the long run. A clear-eyed view of the distinction that we need to compete best and how to deliver for global customers in the most responsible and productive -- most responsive and productive way. That's what's going to make us succeed going ahead. We've always focused on finding the right mix of short term performance and long term prosperity. We articulate that in our approach to the world, and we spend a lot of time confirming this to ourselves here in the company so we make sure we're all headed in the same direction and that approach is essentially a globally integrated company truly aligned with the needs of our global customers but also able to deliver to our local customers our global best. This is driven by one, our devotion to using global knowledge and learning to create competitive advantage. That's reflected in how our organization operates, and the tools we built in the company.

Two, our determination to operate in an integrated way around the world. That is that we have many operations located in many places, but we want to operate as if we're located in one place. That's the real virtue and value of a global organization and that's why integration is important.

Three, our commitment to provide advantages to our customers, the value of better quality, higher productivity and lower total costs for their products. This is what makes us a value to them.

All of our people around the world and our management in particular get it. We work to establish this unique competitive differentiation because this will drive today's financial success and tomorrows enduring prosperity. This competitive differentiation flows from being able to deliver for our customers in a truly global way, our best knowledge and experience focused on our customers' needs wherever they are in the world. And most of all, we work always to develop a sense of common purpose in our company wherever one happens to reside in the world, and indeed, I think it's this common purpose that's among our most powerful impetuses in the company.

Now, I know this is a quarterly results conference call, so thanks for bearing with me in this conceptual excursion. I wanted to step back a bit a couple levels of abstraction because as important as is what we deliver financially every quarter it's equally important for you to know what's going to keep that coming now and in the future, a future, by the way, of which we're very confident.

As we look to the future beyond just 2008, we see that one, we've got a stronger position than ever in our core business. That two, we have footholds in promising new business efforts with potential. Three, we have remarkable global reach and presence in all the right places from so-called BRIC countries, Brazil, Russia, India and China to virtually every developed country and every developing nation in the world. Four, we've got the plans and financial wherewithal to take advantage of our opportunities. Five, we've got a culture of earnings performance even in times of economic and commodity gyrations as we are seeing today, and sixth and maybe most important, we've got a strong management team and fine people all around the world committed to global -- to Quaker's long term prosperity.

So we're committed to being able to deliver for you today and in the future. That is a solidly established end and runs throughout our company. This outstanding quarter, particularly involving times, is only the latest installment on that commitment, and as we said in the press release, we have confidence today in the prospect of earnings improvement for the year. Okay. I've finished my conceptual excursion. These more abstract words on my part have probably whet your appetite for a little more down to earth financial detail on the quarter and for that I'm going to turn to Mark Featherstone.

Thank you, Ron. Good afternoon, everyone. As Ron indicated, we've gotten off to a fine start in 2008. I will spend the next few minutes focusing on the first quarter P&L, and then we'll go on to questions. Now as Ron mentioned, revenue for the first quarter compared with the same period last year was up 18% to $147.7 million. The growth was driven by volume growth, pricing improvement, foreign exchange as well as higher revenue related to the company's CMS channel. Overall volume for the quarter was up modestly. Revenues also increased due to higher CMS revenue from both new CMS programs and the renewals and restructuring of several CMS contracts in 2007. Foreign exchange increased revenues by approximately 8% as the U.S. dollar weakened against most currencies.

Now volume growth occurred across virtually all regions compared to the prior year quarter. Increases in Asia-Pacific, Europe and South America, however, were largely offset by a decrease in North America. In North America both steel and metalworking were lower than the prior year, stemming from some softening of demand in consumer durables including automobiles.

Inventories at steel service centers in North America remain relatively low as the weak U.S. dollar has limited imports and some downtime has occurred as steelmakers continue to manage their inventory levels to boost their pricing efforts. The demand outlook for 2008 especially in North America's steel market is cautiously optimistic given the uncertain economic environment.

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 prices were significantly higher than the prior year. These costs escalations have continued into the second quarter as well. Our current estimates are that raw material price increases in 2008 will be roughly equal to the total raw material price increases of 2006 and 2007 combined. Of course, a slowdown in the global economy or changes in biodiesel subsidy levels could impact us.

As we have discussed before, we have been able to work with our customers to recover most of the raw- increased raw material costs through higher selling prices although there is usually a lag in achieving this catchup effect. I would now like to give you some data on the segment basis. As you recall, we segment the business into three areas, metalworking process chemicals, coatings and other chemical products. In our metalworking process chemicals segment, which makes up 93% of our sales, revenues in the first quarter compared to 2007 were up 18% to $137.4 million, and operating income improved 5% to $18.4 million. Sales in our coating segments, which make up about 6% of our sales, increased $1 million or 11% due to higher temporary and permanent coating sales. Operating income increased 18% to $2.2 million.

Now in our smallest business segment totaling about 1% of sales, called other chemical products, sales were up $800,000 due to the acquisition of frontier chemicals in the prior year second quarter. Turning on to gross margins, gross margin as percentage of sales was 29.5% this quarter, which represented a decrease from the 30.9% from the first quarter of 2007 and the 30.6% in the fourth quarter of 2007. Now of this 1.4 percentage point decline in reported gross margin percentage about 2/3 of it was due to the impact of high revenues and corresponding costs with only a small net shortfall in gross margin recovery in dollar terms. So in other words, it's mainly due to a [map] as opposed to a gross margin shortfall. Higher CMS revenues [inaudible[ of new and restructured contracts also impacted gross margin percentage while still contributing to the bottom line. Although there was continuing escalation in raw material cost over the past year, gross margin in dollar terms was up approximately 13% or more than $5 million for the quarter due to a combination of volume growth and pricing recovery actions.

Moving on to SG&A and other expenses, as a percentage of sales SG&A was 23.4% of sales for the quarter this year versus 25% in the first quarter 2007 and a full year 2000 SG&A rate of 25.6. In absolute terms SG&A for the quarter was up about 8% or $2.6 million with higher foreign exchange rates accounting for more than 3/4 of the increase in dollar terms. Lower legal and environmental costs and incentive compensation costs largely offset inflation and other costs. We expect our full year estimated percentage of sales to be somewhat above the first quarter rate as we continue to find key growth initiatives.

Touching briefly on operating income, reported operating income as a percentage of sales for the quarter was 6.2% versus 5.3% in the prior year, benefitting in part by the settlement of the AC Products environmental litigation in 2007. Other income is lower than 2007, primarily as a result of foreign exchange losses this year versus small foreign exchange gains in the prior year quarter. The decrease in net interest expense over the first quarter of 2007 is reflective of lower average debt balances outstanding as well as lower average interest rates.

Turning now to taxes, the effective tax rate in the first quarter was 34.1% compared to 32.9% in the 1st quarter of 2007. For 2008, we will continue to benefit from the tax holiday in China, and currently expect the full year tax rate in the low 30 percentiles. However, we also expect to continue to experience volatility on a quarterly basis due to [Fin 48] and potential changes in income mix. The company's net debt has increased from December, 2007 due to some of the seasonal factors we discussed in previous conference calls, including the relatively higher level of scheduled payments occurring during the first quarter. We still expect to show positive cash flow for the full year. The company's net debt fixed total capital ratio was 34% as of March, 2008 compared to 43% at March, 2007 and 32% at December, 2007 and that concludes my prepared remarks.

Okay. Thank you, Mark. With that we'll turn to any questions you all may have.

Ladies and gentlemen, we would now be conducting a question and answer session. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Daniel Rizzo from Sidoti & Company. Please go ahead.

Hello?

Hi, Dan.

Hi, guys. You said that you're working with your customers to get your raw material price increases-increases due to the account of raw material growth. Are you seeing any pushback at all because I would imagine that that's getting fairly costly for them.

Oh, yeah, we're certainly seeing pushback but everybody is in that pushback mode, I'm sure not just our customers, but the reality is I think everybody looks around the world and understands what's happening. So we're having good fortune with our customers and trying to put through the price increases that we think are merited by the situation we're in. No, we don't get every one of them, and we don't get them all in the quantities we want, but over time I think we've been very successful with our customers, but not just because we're pushing our price, but because we've had the kind of delivery of services to them that they think is worth it. At least that's what I hope is happening because that's what we're focused on.

Okay. So you expect continued success with the price increases as needed?

Of course. We're going to continue to work with our customers to deliver the best result we can and ask of them the reward that we think it's worth, and yes, we have active plans to continue to do that.

Okay. And in revenue you said that North America was weak, but you're cautiously optimistic but obviously that was overshadowed by strength in any other markets. Is that kind of the mix we're looking going foward? I mean do we see any weakness in Asia or Europe or anything like that?

Well, North America revenue was actually on an overall basis pretty good in terms of its increase. It was a double-digit in terms of percent but what we were disappointed in was the volume levels in North America. So when you put that together, when you put the lower volume levels together with more success in pricing, we're still managing to realize dollar gains. But yes, I mean I think it is a shifting world around there, it is a shifting question around the world in terms of what we see happening in Asia-Pacific and South America as well as Europe, but our dollar gains in terms of growth in the first quarter I think were pretty good all around.

Okay. And finally you do have a strong presence Overseas. Do you see any attractive like acqusition or JV targets in the coming year or in this year?

Well, we may -- I mean we're always on the hunt for acqusitions, and we're always active in that area, and as always, we're working on a few things that we hope will come to fruition, but I don't want to be disingenuous and suggest there's something imminent. Where our international operations are concerned, there may be one or two places where we think we may have an opportunity not so much to create a new joint venture as it is to perhaps change our interest in the current join venture.

Okay. All right. Thanks, guys.

You're welcome.

Thank you.

Thanks for your interest, Dan.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from the line of Robert Felice with Gabelli & Company. Please proceed with the question.

Hey, guys, how you?

Hi, Bob.

A couple quick questions. Over the last several weeks we've seen pretty rapid escalation here in base oil prices and our hydrocarbon feed stock costs, and I guess I'm wondering how comfortable or confident you are here that the pricing you have in place will be enough to offset the cost headwinds or should we expect your price cost gap to widen before it gets better?

Well, the pricing we have in place is probably not going to be adequate to the task but that's why we have continuing plans to go on the pricing front to continue to work with our customers as I said earlier. Our regularly over time to try to adjust the situation we're in. We don't necessarily think the gap will widen. I mean we always have that little delay that Mark mentioned in terms of day late and a dollar short where this pricing is concerned versus our raw material costs, but our plans are to stay as steady with that gap as we possibly can, and we have plans in place to make that happen.

And what was that gap during the first quarter?

The dollar gap?

The dollar gap.

I don't think we said what that dollar gap is, but I think the reality is -- I don't know, Mark -- we realized probably 80% of the increase, maybe even more in terms of --

Yes. I think even more.

Yes. I would say we were pretty close to realizing most of that gap, realizing most of the -- not talking about a gap. Let me talk about the increase in raw material costs. I think in the first quarter, our numbers suggest that we recovered I would say in excess of 80% of that.

If it I could just add for a second, Ron, I think we had some price increases scheduled for the first quarter which we were working on with our customers, and then as you mentioned, Rob, the raw materials really took off and not just the mineral oils, but also some of the vegetable oils and animal fats as well. So in some cases where we've gone back to customers for a second round of price increases this year. So that's -- we're not a retail company, so there is discussion with customers on a customer by customer basis, but it's certainly something that's on the top of our priority list.

Yes, I think the point here, Bob, is that we realize it's an imperative here to keep a regular effort in place. It's not just kind of one and done. So that's really what our plans reflect.

Okay. And you mention, though, in terms of the raw material costs cumulative, you expect them to be equivalent to the amount you experienced in '06 and '07 combined. How much pricing would you need on the top line percentage terms to offset the cost? And what should we look for?

Look for in terms of -- I don't know what you mean by look for, Rob.

Percentage pricing, to offset that headwind. Do you need 6%, 8%, just want to get a sense?

Well, I'm not sure we have that number exactly at hand, and the reason for it is it varies dramatically by region, and that's really the way we tend to look at this as each of our businesses is looking to maximize our position in a particular region. So I think for me to give you one number would be a little bit misleading, although probably if we are able to achieve a 5% increase or so for the year, we'd probably cover most of it.

And what was pricing up during the first quarter?

About 5%.

Yes, about 5%.

Okay. So you're pretty much there right now?

Well, we think, I mean we've got plans in place to try to stay ahead of this game or at least try to stay with the game. I shouldn't talk about staying ahead. Just to stay with the game and we're out there with our customers regularly on this. Because understand the constraints, they understand the constraints, and we're all fighting the aim battle.

Well, I think to clarify your question the 5% we realized in the first quarter compares to the prior year third quarter, and obviously raw materials escalated throughout the year. So we've been looking and obviously some of the price increases we realized in the first quarter this year are a build-on and continuation of stuff we did last year as well.

So that pricing will fade out as the year progresses.

Right. We definitely need to go back for more price increases.

Okay. And if it I look back over the last several years, your second quarter gross profit is usually a bit higher than your first. In light of the higher costs, would you expect that relationship to hold? Are you looking for higher gross profit on an absolute basis in the second quarter versus the first?

Well, we expect to be making improvements in each quarter, not so much in the margin, but as long as our revenues move along, we expect our gross margin dollars to move along.

And certainly the second quarter historically has been a stronger volume quarter for us than the first quarter.

Okay, great. Thanks for taking my questions.

You're welcome. Thanks for your interest.

Thank you. There are no further questions at this time.

Okay. I'm just give people a few seconds more if they have something in mind. I don't want to cut them off early.

(OPERATOR INSTRUCTIONS) One moment, please, while we poll for questions. Our next question is a follow-up from Robert Felice with Gabelli. Please go ahead and ask your question.

I figured I'd ask another. Ron, if I think back 24, 36 months ago when raw material costs were really on the rise, probably about the time of Katrina and Rita, Quaker had a much more difficult time then preventing margin compression and really staying on top of the cost curve and if I compare that to today, it seems as though it's not -- I don't want to say as much of an issue, but you're really on top of it to a much better degree. So I guess I'm wondering what changed? What's Quaker doing now as an enterprise that it wasn't doing then?

Well, of course, the kind of volatility that we've seen in the last few years kind of gets your attention. I mean that was the kind of volatility we had about back, say 36 months ago, as you pointed to, Rob, is -- came from an environment where prices were relatively steady for a long time. We had developed a corporate strategy, which we still pursue, that the real conversation we want to have with our customers is about value. What do we deliver to you in value and how can we get paid for value, not just price per gallon or something of that sort. With raw materials having the experience they've had over the last three or four years, obviously, we have to readjust that discussion so that we focus more on purely price, although we never want to walk away from the value equation because that's the way that we can get premium prices from our customer when they realize we're delivering a premium result.

So you say what happened? One is that the emphasis on pricing wasn't as great then because our raw materials were steadier. We had actually put in place a corporate strategy that said we wanted to move price as long based on value, not just selling as I said units of stuff, and I think the experience we've had over the last few years has forced us to reevaluate some of the balance in that but not walk away from the value equation. So it's really -- I guess if you ask me what's the single thing, it's learning. You've got to adjust to the environment you're in and, I guess, the visibility of price increases or the visibility of what's happening in the world is great with our customers today. So that makes a conversation not easier, but certainly people understand the basis on which we need to have it.

Well, it seems to be having the right effect.

We hope so. We're going to stay at it.

Great. Thanks for taking my follow-up.

Thank you.

Thank you. There are no further questions at this time.

Okay. Then I will thank everyone for their participation unless someone has a last thing they need to say because I know I one time got one objection about stopping too early, but I trust we've given everybody a chance to ask whatever questions they may have. We certainly appreciate your interest, and we look foward to continuing to deliver for you as we have done so far, and we look foward to a good 2008, and I will look foward to talking to you again next quarter. Thanks, everybody.

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