Compass Minerals International Inc (CMP) 2007 Q1 法說會逐字稿

Good morning, ladies and gentlemen. My name is [Tina] and I will be your conference operator today. At this time, I would like to welcome everyone to the Compass Minerals first quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). I would now like to turn the call over to Ms. Peggy Landon, Director of Investor Relations. Madam, please go ahead.

Thank you, Tina, and good morning, everyone. We appreciate you joining us here this morning. With me here are Angelo Brisimitzakis, our President and CEO, and Rod Underdown, our Chief Financial Officer. Before they begin, I will read our Safe Harbor statement to you. Today's discussion may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the Company's current expectations and involve risks and uncertainties that could cause the Company's actual results to differ materially. These differences could be caused by a number of factors, including those identified in Compass Minerals' most recent Form 10-K The Company will not update any forward-looking statements made today to reflect future events or developments. You can find reconciliations of any non-GAAP financial information that we discuss today in our earnings release, which is available in the investor relations section of our website at www.compassminerals.com. Now I will turn the call over to Angelo.

Thanks, Peggy. Hello everyone. Thank you for joining us today. I am quite proud of our achievements this quarter and I think that you and shareholders will benefit over the long term from the initiatives we have in place. I would obviously prefer to see a more-immediate connection between our underlying results this quarter and the increased earnings per share, but you know as well as I do that it doesn't always work that way. We had a strong 21% sales improvement over the 2006 quarter and there were a number of components to that increase. The most obvious place to start is with de-icing sales, which were up over last year, though our de-icing sales were still below normal on a winter-level basis.

You will probably recall that it snowed quite a bit in certain parts of the U.S., like upstate New York and in the Rockies. But those aren't primary regions we serve. As it happens, some of our key regions barely received any snow in the first quarter, while others varied all the way from below to above average in terms of number of snow events. Specifically, we encountered some significantly mild weather in our important UK and Canadian regions, which had the effect of reducing our potential sales volume, average selling price, and margin. Because we were also adjusting to the impacts of the mild December and early January periods, we dramatically pulled back the production rate at all three of our rock salt mines and at our consumer de-icing facilities, which obviously had a constraining effect on our first quarter earnings.

By comparison, last year our rock salt production in the first quarter at Goderich, Ontario and UK rock salt mines had a favorable impact on product cost and, consequently, on earnings. Please recall that we were producing at peak levels in the first quarter of last year because of a burst of heavy snow in the prior December had depleted our inventories faster than normal and we were making up that difference. Plus, we built inventory in North America as a precaution leading into the contract negotiations with the union at Goderich. The difference between production rates in the first quarter of last year versus the first quarter of this year contributed significantly to our year-over-year earnings decline.

It should be noted that when production slowdowns are primarily in North America, we can usually reverse a good part of the product cost impact in future quarters, making the impact of these matters generally ones of timing only. However, since much of the 2007 mild winter effect was in the UK, where more of our costs are fixed, we will see some lingering effects of lower utilization rates on our product costs throughout the upcoming year.

So as we mentioned in our release, the impact of changing production schedules year-over-year was a pretty dramatic impact on our costs in the first quarter, approximately $6 million. Because our UK operation will continue to have lower production for the next several months, only around half of that impact will reverse in the second quarter. More importantly, in North America, our fuller production schedule during the second quarter and a comparable third and fourth quarter schedule will allow us to start the next de-icing season with the proper amount of product to effectively serve our pre-strike bid volumes, and we don't expect the below-normal snowfalls in the 2006, 2007 winter to have any material effect on prices or bid volumes for the next season. This is simply how our de-icing business works.

We also had some other important improvements. I am extremely a proud of our achievement in our consumer and industrial product line. In addition to our year-over-year improvements to our winter-driven consumer de-icing sales, we experienced some solid non-winter, non-seasonal growth, particularly in our water conditioning products, while the price increases that we announced in October '06 are helping to expand our profit margins. And I hope you saw the press release on our newly-enhanced pool salt product. This is still a small product line for us, now, but it is a non-winter application that gives us the opportunity to demonstrate that there are innovations in the salt industry and it gives us a chance to show off our ability to be creative and to take a leadership position. We are the first major producer to add an extra feature and benefits to pool salt.

Our Specialty Fertilizer sales were up 16% over the same quarter last year and we feel quite good about our prospects here. The weather in California has been kinder to us this year and we have seen very nice growth in our exports. Some of our growth may be a halo effect from the strength of standard potash market, but I attribute more of the growth to producers continually improving their crop management strategy, particularly internationally.

We will announce today an additional $20 per ton price increase on our sulfate of potash product, effective June 1, which follows the $10 per ton increase we put into effect on March 1. We obviously need to recoup the increased cost of potassium chloride input and we believe that these price improvements will help get us there, but they aren't yet enough to generate margin percentage expansion.

And our record management business is growing faster than expectations, especially with the first quarter acquisition of London-based IRM. This is the first quarter that DeepStore has been a wholly-owned subsidiary for a full quarter and it already made a positive contribution to our earnings. DeepStore isn't material to our financials yet, but its growth is encouraging.

I also want to point out that it snowed quite a bit in North America during April. This year -- so during April of this year, which isn't unheard of, but it is unusual. Many of our customers used these snows as an opportunity to drain down any remaining inventory they had on hand, which bodes well for the overall volume in the coming bid season. Some of our customers took additional shipments of de-icing salt in April and we are expecting a very modest year-over-year sales improvement from the April de-icing sales. We are also continuing to work on our strategic rock salt capacity expansion at Goderich, so we should see higher capital spending in the remainder of '07 than in 2006. As we have discussed on previous calls, we expect only part of this expansion volume to be available to us for the 2007-2008 winter season. We also recently negotiated a favorable multi-year contract with our unionized employees at our Cote Blanche, Louisiana mine, positioning us well for the next couple of years.

In summary, we made some proactive inventory-management-driven operational decisions, which impacted our quarter. They were the right decisions, but when comparing results to the prior year, which also had some very good, but different operational decisions, coupled with several one-time events, our results didn't improve with our sales. But we are confident in our long-term direction and the same great advantages that have made Compass Minerals perform in the past are even clearer today. Now I will turn the call over to Rod to discuss the details of the quarter.

Thanks, Angelo. As Angelo said, our year-over-year sales comparison was positive in the first quarter, but several factors kept revenues below normal levels. Obviously, mild weather in the UK and in some parts of North America reduced our sales. And we have estimated that the weather effect, as a departure from normal winter, to between 18 and $22 million of sales for this quarter. However, I want to elaborate on Angelo's discussion of the effect of mix on our average sales prices and margins.

As you know we don't really sell our highway de-icing salt at one standard price. The prices that we bid ultimately -- and ultimately become our selling prices, vary based on our costs to produce, to ship to the nearest depot, the distance from the nearest depot to the customer, and historical competitive pressures in the area and so forth. So when you report on changes in average prices, we are reporting the change in the weighted average price of our North American bid awards.

This is normally a good proxy for the change in actual average sales price, however sometimes like this quarter, snowfall doesn't match our typical distribution. This year, unfortunately, it simply snowed more in regions where our sales prices and margins are lower and that impacted our margins by over $3 million in the first quarter. Plus, we have a different sales structure in the UK and a higher percent of fixed costs than in our North American mines, so the effect of a very mild winter in the UK had a material impact on our sales and gross profit this quarter.

The one thing I want you to take away from this is that it is very difficult to accurately estimate how weather will affect our sales and earnings. There is no way to predict which communities will or won't get snow, so forecasting our sales and earnings is difficult to do precisely. The only thing we do, and anyone else can do, is develop forecasts based on normal weather, then, as Angelo said, we are always preparing contingency strategies for any above or below normal weather.

Shipping and handling costs as a percent of sales were modestly lower than in the 2007 quarter -- modestly lower, excuse me, than the 2006 quarter, but as Angelo pointed out, our product costs were substantially higher than in the first quarter of 2006. He mentioned that about $6 million of that year-over-year variance is a result of differences in per unit inventory production costs due to production volume differences or mine utilization rates. And $4.1 million of the variance was due to the proceeds that we received last year from an insurance claim that was recorded as a rest reduction to product cost. As a reminder we collected the final $1 million of proceeds from that claim in the second quarter of 2006, so that will create a year-over-year variance in the coming quarter. We also had significant increases in the cost of calcium chloride and we use that product to extend the sulfate of potash that we harvest from our evaporation ponds in Utah.

Our costs for energy, particularly natural gas, were about the same year-over-year and we are hedged for about 60% of our expected needs for the rest of 2007 and don't currently anticipate any large fluctuations in our natural gas cost when compared to 2006. SG&A costs increased $1.4 million over the 2006 quarter. Now, we changed our vacation policy accrual, which created a $1.6 million charge this quarter. The effect of that accrual will gradually reverse throughout the year as employees use their previously-earned vacation, but it isn't likely to be a meaningful factor in SG&A in the upcoming quarters.

DeepStore, which we acquired in November of 2006 and integrated with our London-based records management acquisition in January of 2007, resulted in the consolidation of another $600,000 into SG&A costs and we will continue to consolidate this business into our results going forward, of course. Angelo discussed how we flexed our production down in response to the mild winter and while that impact had an unfavorable year-over-year impact on results, we also reduced discretionary SG&A spending by about $1.4 million, which somewhat mitigated the effect of our change in earned vacation accruals. The remaining net increase in SG&A is typical for what we expect for the remainder of 2007, as there are inflation effects and investments we are making in personnel to drive us to the next level with our operational excellence model.

Before we leave our discussion of operating earnings, it is worth taking time to reflect to consider the impact of the mild weather, particularly in the UK. We estimate that milder than normal weather reduced our salt operating earnings by 8 to $12 million from a normal weather quarter. For the full winter season, that is including last year's fourth quarter combined with the March quarter of 2007, we estimate that mild weather suppressed operating earnings by over $20 million when compared to a normal weather year. We have sold less de-icing tons over the course of this winter than in any other full winter season since we have been a public Company.

We have experienced three mild winter quarters in a row, starting with March 2006. In our trailing 12-month period, we have the unusual scenario of two different production curtailments and 15% lower highway de-icing sales, which, of course, is our very firm foundation in the Company. And yet with all these factors, I think we have shown some good resiliency and we have positioned ourselves well for the upcoming highway de-icing bid season this summer and have great pricing momentum in our consumer and industrial Salt and Specialty Fertilizer product lines.

Turning to the rest of our results, our interest expense increased $400,000 quarter-over-quarter, as a lower average debt balances were offset by increases to non-cash accreted interest on our discount notes. Income tax expense came in at an effective rate of 26%, which is what we expect our full-year tax rate to be. Net earnings were $2.5 million lower than the 2006 quarter and adjusted EBITDA was also about $2 million lower for the reasons we have discussed.

Our total debt declined $18.3 million this quarter, which reflects a $10 million principle paydown we made on our term loan and the repayment of $16 million that was outstanding on our credit facility at year-end. These reductions were just partially offset by accretion on our discount notes. There is not currently any change in plans for the discount notes. The 12.75% senior discount notes will be callable this coming December at their face value plus a call premium of 6.38%, which comes to a total of $131 million.

We continue to evaluate whether we should tender early for these notes, but given the tender premium we would pay in addition to the call premium and the non-cash nature of the accreting interest, plus our outlook for interest rates, we have not found that the early tender is extremely compelling right now. However, we do believe that we can obtain a far better interest rate than our current 12.75% rate, so I would not expect us to still have those notes outstanding in a year. The other notes, the 12% senior subordinated discount notes, are also callable, but in June of 2008.

Our debt net of cash at the end of the quarter was $531.8 million, which is approximately 3.4 times trailing EBITDA. As important is that when you factor in an estimate of the mild winter from the last 12 months, the net debt ratio would be less than three times EBITDA. Depreciation, depletion, and amortization was very similar to the prior-year quarter and we expect our full-year 2070 DD&A to come in around the same level of last year.

Operating cash flow is for the 2007 quarter were just over $80 million, compared to $112 million in the 2006 quarter. The primary difference between the two quarters was cash collected from receivables from the preceding December quarters. Our CapEx in the quarter was similar to last year. Our current plans call for full-year capital spending to run between 40 and $45 million for 2007. The 2007 expenditures include the previously announced capacity expansion of our Goderich mine and a couple of million dollars of capital needs related to the continuing growth of our expanding DeepStore business and our UK mine.

Another important use of cash flows this quarter was the $7.5 million investment we made in the London storage business, which is now part of our DeepStore subsidiary. That business contributed modestly, but positive earnings. EBITDA for the whole DeepStore business approximated $500,000 during the first quarter and we still believe the acquisition to be modestly accretive in this first year of ownership. So now, Tina, will you please open up the call for questions?

(OPERATOR INSTRUCTIONS) David Silver, JPMorgan.

Hello, this is Ben Richardson sitting in for Dave Silver from JPMorgan.

Great. Thanks Ben.

So, a question on your Salt segment, so per unit costs by our estimate were up roughly $5.00 a short ton year-over-year. So what is your outlook for cost going forward and have you flushed this higher cost inventory out of your system?

Yes, I would say on the Salt segment, you know, the significant impact, issues that impacted us in the first quarter are behind us. We do have some lingering effects of some production costs in the UK due to lower '07 production volume requirements, but we also have higher production that we are planning in the second quarter of this year in North America, as I mentioned. So I think the items that we are talking about are expected to maybe just slightly put pressure margins, however, the thing that should be considered is that if we have a normal fourth quarter in terms of weather, the impact of that would almost help restore full-year margins in the Salt segment.

Okay. All right. And switching over quickly to potash, you mentioned that potash costs were rising faster than your sulfate of potash prices and that that led to some margin squeeze. So what is your outlook for SOP prices going forward?

Yes, this is Angelo, you know, I think the majority of our SOP is produced organically ourselves from the evaporation process. A portion of potash is used to extend the harvest and we source KCl to do that. That material has inflated tremendously and has compressed our margins. We have used price increases as a way to offset that, so the underlying market for fertilizers is pretty good and we will announce today an additional $20 a ton on price and our prospects are pretty good. You can see, historically, we have had good results in terms of announcing a price increase and achieving it in the market. So I am quite optimistic we will be successful in implementing our both March price increase, which is behind us, and the one that we are looking at now for June 1.

And, Ben, I just want to point out the change in the potash margins aren't inconsistent with what they have been the last couple of quarters. I think we mentioned last year in the third quarter that we had kind of seen a step change down of around 5% on operating margins in the potash business. And that is about what we saw in the first quarter this year, as well.

It's Angelo again. It's a two-edged sword. Basic potash prices, KCl prices, is kind of a foundation for strong SOP prices, so the fact that they are inflating just gives us more opportunity to create more value above that floor. And I think we have shown a good ability to do that. So it probably is not a bad problem to have, but we have to stay vigilant to make sure we recover as much of that inflation as we can as quickly as we can.

All right. Thank you. I will get back in the queue.

(OPERATOR INSTRUCTIONS). Nils Wallin, Credit Suisse.

Good morning. I had a question with regard to the gross margin, the compression there. Now other than the, I guess, higher fixed cost per unit, there was also a, you said, concentration of sales in other regions. Am I to believe that most of that effect was due to the UK?

Well, I think we talked about it. We had a couple of key markets that were significant to us that had milder weather. One was the UK and the other one was Canada, and so the combination of those two both had an impact on that. In the US around the Great Lakes, it was pretty good and even in what we call our southern section, it was really good. So I think we did have an interesting mix effect, with the UK and Canada contributing negatively to that.

Now, is that -- since those margins tend to be below average, is that a structure of the contracts, a structure of the fact that maybe there is more spot sales? Is there anyway you can prevent something like that happening in the future?

Yes, this is Angelo again, you need to step back and recall the comments that Rod mentioned about how the price structure and the margin kind of fit together. Each one of the counties is a unique price and there are literally thousands of unique ship-to locations that we have a cost of getting the product to. We have a cost of shipping from our depot to the customer and we have competitive factors that are quite different county by county. And then there is obviously historical pricing of presidents that have been set so really the margin at any particular county is different than another county. Now what we report to you is a weighted average. When it snows in a different way than what we have assumed a weighted average to be, our normal distribution, we will either benefit if we had a greater concentration in the higher-margin regions or counties or areas, or we won't benefit, as happened in the first quarter.

Some of our Canadian business and some of our UK business tends to be very attractive to us. And they got disproportionate amount of the snow, in a negative sense, in some of our lower margin regions. So it kind of cuts both ways in the first quarter, the mix. It's a customer mix kind of issue. Didn't -- was not in our favor.

Did those -- I mean, are those margins in those regions fairly stable year-to-year?

Yes.

Okay.

Yes. What is not stable is the number of snow events year to year.

Right. Okay. Thank you very much.

Robert Koort, Goldman Sachs.

This is Amy (inaudible) sitting in for Bob Koort.

Hi Amy.

I have a couple quick questions. Can you give us some sense as to how much production have you cut to adjust the inventories in North America? And also a little bit more color on the magnitude of the unit price increase as the result of the inventory adjustment?

Well, the adjustment that we had to production volumes year-over-year, it was about 50% across the Company in terms of our highway de-icing minds, so it was pretty substantial. We cut production by about 1.2 million tons during the first quarter, which, as I said, is almost 50% of what we did last year. I think last year would be viewed as a high year for the first quarter. This year being an unusually lower year. So, you know, that is kind of the order -- that is the kind of order of magnitude and hopefully that is helpful.

In terms of the effect of that, there was $6 million effect of having costs that basically were not absorbed, or a difference in the amount of costs that were absorbed by the production of inventory in that first quarter. And that was the dollar impact of the decision. I want to make sure everybody heard Angelo, the quarter-over-quarter, year-over-year production decisions were both of the right decisions. Last year, we were doing a couple of different things that included setting ourselves up for a good contract negotiation. And this year, we were doing some proactive inventory management. So they were the right decisions, but it is unusual to have two production curtailments in a 12-month period. The production curtailment last year being the eight to 10-week strike that we had at our Canadian mine.

Okay. My second question is do, in fact, the inventory level will come back to the level you really want before the bidding season, before the upcoming bidding season?

Yes, this is Angelo. I think the way we manage the fourth quarter -- first quarter and fourth quarter position us well to be exactly where we want to be in terms of inventory and give us, really, the opportunity to re-establish kind of our pre-strike levels on our bids, so we are very optimistic that we positioned ourselves exactly what we need to do. And, again, we play this game for the long-term. It is unfortunate when you compare a quarter to a quarter. With unique events in both quarters, you get some pretty tough comparisons, but, again, we wanted to set ourselves up for the long term and we think we have done that.

Great. And my third question is the potash margins were obviously challenged by the raw material headwinds over the past few quarters and I was wondering what is your expectation for those raw materials constraints going forward? And then given that you already have your new pricing actions on the table, and how quickly do you think you can restore the margins to the levels we saw before?

That's a good question. You know, if I knew exactly what was going to happen to potash prices and margins, I would probably make a lot of money somewhere else speculating on it. I mean it is a very, very large global industry, potash, and, as you know, China and India play huge influence and factors on it. What I can tell you is it appears the supply-demand balances on potash favor producers right now and we are seeing a surge of all fertilizer demands with some knock-on effects on potash, particularly driven by what is happening in corn and ethanol conversion, things like that. So I would expect potash to stay strong and that is why we have chosen to be very aggressive on SOP pricing, with a price increase first in March and now one for June. And we will continue to push that as potash stays strong, so I guess I am optimistic, to answer your question, I'm optimistic on our SOP pricing, but I'm --

But how about the raw materials, you know, cost rents going forward? Do they go back to higher?

And I believe that if I had to predict, I would think that basic potash prices will not go down in the short-term, and are more likely to stay flat to increase.

And then, I think --

But I am not the potash expert, you know. You might want to see what others have to say, Mosaic and others are much more heavily involved than we are.

Actually my question relative to the SOP, than the specialty potash you guys produce. And then actually I think essentially my question is related to the raw materials outlook, because your comment over the past few quarters, you know, the margin of your SOP business were challenged by the higher raw materials, so I was wondering, going forward, do you expect some relief on the raw material side, or you continue to expect higher raw materials and that will impact your SOP margins going forward?

Yes, Amy, I am sorry if I confused you. And it gets confusing, because the word potash is kind of used twice. The raw material is basic potash and that is KCl, potassium chloride. We sell a product, SOP, which is sulfate of potash. So it gets confusing, because potash is used by both times. The KCl raw material, muriate of potash, has been inflating now for the last year and it put a lot of pressure on our costs. We have responded by increasing our selling price of the sulfate of potash, SOP, and we expect both of those to continue to be strong going forward.

Okay. Thank you.

And we have no further questions at this time. I would like to turn the call back over to Angelo.

Thank you, Tina. And, again, once again, I would like to thank everyone for joining us this morning. We look forward to talking to you again at the end of July and when we will have preliminary update of our next winter's commitments and average prices. So everybody, have a good day. Thank you for your attention.

And this does conclude today's Compass Minerals first quarter conference call. You may all disconnect.