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Compass Minerals International Inc. (NYSE:CMP)

Q3 2008 Earnings Call

October 29, 2008 9:00 am ET

Executives

Peggy Landon – Director of Investor Relations and Corporate Communications

Angelo C. Brisimitzakis – Chief Executive Officer, President

Rodney L. Underdown – Chief Financial Officer

Analysts

David Begleiter – Deutsche Bank Securities

Michael Judd – Greenwich Consultants

Mark Gulley—Soliel Securities

David Silver – JP Morgan

Robert Koort – Goldman Sachs

Operator

At this time I would like to welcome everyone to the Compass Minerals third quarter earnings conference call. (Operator instructions).

I would now like to turn the call over to Ms. Peggy Landon, Director of Investor Relations and Corporate Communications. Ms. Landon you may begin your conference.

Peggy Landon

Thank you all for joining us this morning. In a moment I will turn the call over to Angelo Brisimitzakis Compass Mineral President and CEO and Rod Underdown our Chief Financial Officer, but first I’ll read our Safe Harbor statement.

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 expectations as of today’s date October 29, 2008 and involve risk and uncertainties that could cause the company’s actual results to differ materially. Differences could be caused by a number of factors including those identified in Compass Minerals’ most recent form 10-K.

The company undertakes no obligation to update any forward looking statements made today to reflect future events or developments. You can find reconciliation of any non-GAAP financial information that we discuss today in our earning release which is available in the Investor Relations section of our website at www.compassminerals.com. Now I will hand the call over to Angelo.

Angelo Brisimitzakis

Thank you for joining our call today. I would be proud of our third quarter performance in any economic environment, but I’m particularly proud in today’s environment to be able to put forward our results as evidence of the strength, increasing balance and the recession-resistant nature of Compass Minerals.

The increasing strength of both of our segments is evidenced in our third quarter financial results, with sales up 70% year-over-year, operating earning up to 244%, net earnings up over 10 fold, excluding special items from last year’s results and cash flow from operations up over 100% for the first nine months of 2008.

And we have a very positive outlook because most of our products are essential to daily life; therefore generally non-discretionary and non-cyclical. Certainly the least discretionary product we sell is highway de-icing salt because government will rarely compromise on issues of public safety.

Even during periods of lower tax revenues and tight budgets, most governments will find other less critical area of their budgets to cut in order to preserve public safety funding. In fact North American demand for rock salt and other de-icing products has been particularly strong this year, as governments rebound from the very severe season last winter.

Many Midwestern departments of transportation increased their overall bid sizes for the coming season after having run out of salt last season. The length and severity of last winter also affected the supply of rock salt available for the coming winter. We usually have salt inventory at our depots that carries over from one winter to the next, but last year we sold out our stock piles down to the blacktop.

And typically we begin building inventory in March for the upcoming winter season. But due to the late end of winter weather this past march, we were still selling de-icing salt to our customers as we were producing it out of the Goderich mine.

So when you add together larger bid requests from our customers, no salt inventory carry over at most of our depots, a late start to this year’s inventory rebuild, and the fact that there was already a tight capacity balance in the Great Lakes Region, you end up with a very tight supply of highway de-icing salt for this upcoming season throughout the North American market we serve.

Though it’s more pronounced this year the Great Lakes Region specific capacity issues isn’t new, and has been the catalyst for our previously announced rock salt expansion projects. As you know we have two projects currently underway at our mine in Goderich, Ontario.

Phase I will give us annually 750 additional tons of rock salt capacity, which we expect to be fully available for the 2009-2010 winter, and our Phase II expansion will add another 1 million tons of annual production for the 2011-2012 winter.

These expansions should provide much needed relief to our Midwestern customers who are currently struggling with salt supply issues. Fortunately our Cote Blanche, Louisiana mine has produced more to this point of the year than in any other year in its almost 50 year history, and we expect it to exceed its main plate capacity in 2008.

This extraordinary effort on the part of our employees comes despite two separate brief shutdowns during Hurricanes Gustav and Ike. All of our employees were unharmed and the mines sustained almost no damage.

From this mine we serve customers along the Mississippi and Ohio rivers. Thanks to the extra production from our Cote Blanche mine, and a modest amount of new production from Phase I of our Goderich mine expansion, we have rebuilt much of our inventory position, but our levels are still below normal and below the inventory that we had before the start of last winter.

As a result we bid on and were awarded modestly less volume than our 2007-2008 bid award volume, but this supply demand imbalance also drove an unprecedented average 20% increase in our highway de-icing bid award prices. The margin improvement from our significant pricing gains, coupled with lower than expected fuel cost will far exceed the modest volume constraints.

Assuming normal weather the net result should be a material expansion of our winter season margin dollars. It’s been a while since we discussed our highway de-icing sales process, so I’ll take just a moment to remind you that we sell our highway de-icing salt through an annual sealed bid process.

Governments award their business to the lowest bidder, and the award sets the delivered price for the entire winter so that there are no in-season price changes. The awards generally specify a volume range so that both parties have some protection from winter weather variability.

Many of our customers began taking their deliveries early this season, which is why our third quarter highway de-icing sales volumes increased 48% over the 2007 quarter. Our third quarter average selling price was up 20%, which is consistent with our increase in bid award prices and in improved mix.

Our consumer and industrial business also posted a very strong quarter, with 24% sales volume improvement and average selling prices up 7%. Now half of our year-over-year sales volume growth came from retailers and professional service providers who began early the replenishment of their depleted consumer and professional de-icing product inventory.

The other half of our year-over-year C&I sales volume growth came from new customers in organic growth in non-de-icing applications. This growth in our core non-de-icing applications helped illustrate that salt is a non-discretionary purchase in most of its applications. And because salt and the other minerals that we sell are generally are relatively low-cost in their varied applications they don’t significantly impact many of our customers purchases.

For example consumers who have installed a $700 water conditioning system in their home are not likely to stop using the system in order to save the $15 per month that they spend on a bag of water conditioning minerals. Similarly ranchers don’t use fewer salt licks in a tough economy and families don’t buy less table salt. Salt and our other minerals are often critical to our diverse customers in good times and bad and we have been their steady, reliable supplier for many decades.

Of course our most significant third quarter growth was generated by our specially fertilizer segment, with a 152% year-over-year increase in sales and a 448% increase in operating earnings. These gains were generated through 121% increase in average selling price and a 14% increase in sales volume, which was the result of continuing strong demand and the timing of the international shipments.

The price increase reflects the progressive integration of our list price into our customers’ contracts and at $752 per ton represents a 55% increase over our second quarter average selling price. We’re still expecting the fourth quarter average selling price of our sulfate of potash to approach $1,000 per ton, and we expect our fourth quarter sales to help us deliver modest full year volume growth over 2007.

Year-to-date our production was slightly less than expected primarily because of late season rains which reduced the SOP harvest from our solar pond at the Great Salt Lake in Ogden, Utah. Looking ahead to 2009 we expect the fundamentals for our specialty fertilizer segment to remain steady because of the strong dynamics of the global potash market.

First it’s important to remember that there is a global shortage of potassium nutrients. The primary driver behind the shortage is insufficient supply of standard potash or KCL caused by growing demand and limited new supply, complicated by a strike at three key Canadian mines, a sink hole near a railway that transports potash from a Russian mine and large export duties imposed on Chinese production.

In addition the Fertilizer Institute reports that North American potash producers inventory are currently about 30% lower today than in September of 2007. Our own SOP inventory is extremely low by historical standards at only 20 days of supply.

Secondly keep in mind that demand simply can’t go away. People have to eat and growers need our sulfate of potash to feed America and the world. Over the long term we expect demand to grow as populations increase and as diets improve around the world. And lastly our customers have ample access to credit. U.S. farmers are still able to obtain operating loans from smaller community banks, farm credit services or directly from the USDA.

It is important to remember that our potash is a specialty fertilizer product used on fruits, such as citrus and wine grapes, vegetables like tomatoes and sweet potatoes and tree nuts. Growers choose our specialty potash and are willing to pay more for it because it works better than standard potash and helps increase the value of their harvest. Sulfate of potash still provides a strong return on investment for these growers.

We are the only supplier to the markets that we serve who has announced capacity expansion to address the supply demand imbalance for sulfate of potash. As you know, we began Phase I with a 100,000 ton capacity expansion last year, which include maximizing the configuration of our solar evaporation ponds within our existing footprint at the Great Salt Lake, as well as expanding the capacity of our processing plant there through improved efficiencies.

We currently estimate the cost of Phase I to be approximately $40 million, most of which will be spent in the next 12 months. We continue to expect to have approximately 500,000 tons of SOP capacity available to sell in 2011, weather permitting, a 22% increase from our 2007 levels.

Phase II of our expansion is more ambitious but is still approximately five years out. It calls for new permitting and construction of solar evaporation ponds on the Great Salt Lake followed by a three year solar evaporation cycle. Our expansion activities are directed at the existing potassium nutrient supply demand imbalance, increased value-added SOP marketing opportunities, as well as the historic 3.5% annual SOP growth rate.

So to summarize this is a very exciting time for Compass Minerals. Our customers are demanding more of our products than ever before. Our higher prices are commensurate with that demand and our commercial leadership. Both of our segments sales and profitability are growing and we enjoy a robust cash flow, a solid balance sheet that has allowed us to stay on strategy during this challenging economic environment.

Now I’ll turn the call over to Rod who will discuss our results in greater detail.

Rodney L. Underdown

As you read in our results and just heard Angelo discuss, our results were extremely positive this quarter and reflect the continuing strong fundamentals of both our salt and specialty fertilizer business that we’ve been talking about for quite some time.

I want to leave plenty of time for questions today, so I’m going to focus my remarks on just a few key areas for consideration. Looking first at sales Angelo already indicated our best estimate is for the average selling price of our SOP to approach $1000 per ton in the fourth quarter.

Now as a reminder every $100 of SOP average selling price increase equals approximately $40 million of additional full year operating income. Regarding highway de- icing salt prices, as you heard Angelo discuss, we achieved a 20% year-over-year increase in North American highway, bid award prices, which should be reflected in our results in both of the next two quarters as it was in this third quarter.

The percentage increase was our largest ever and reflects the tight conditions which currently exist in our markets. Because the average 20% increase includes a wider than typical dispersion of percentage increases on a customer by customer basis, the actual percent increase realized will be different; either more or less based on where it snows.

Our capacity expansion programs are designed to fully alleviate the kinds of imbalances creating this price increase in the future. Of course our sales volumes vary depending on weather patterns as we saw this past severe winter season; and since we’re the industry leader in consumer and professional deicing products our consumer and industrial sales volumes will also vary the next couple of quarters, depending on the severity of the winter.

Now while October is not one of our larger winter sales months for deicing products, I can report to you that early orders for salt have continued to be brisk in October as they were in September, following a season where salt supplies were hard to come by and some governments and other salt users have been unable to secure supply for this coming winter.

Regarding shipping costs, we’ve had a bit of a wild ride. Our highway de-icing salt bidding during the summer occurred when oil and diesel prices were at all-time highs and with no relief in sight. Following the completion of those bid awards, fuel costs have now moderated with falling oil prices. At current fuel prices we expect the full impact of our salt sales price increases to drop to the bottom line when compared to prior year.

For year-end our salt production efficiencies should be similar to prior year operating rates, leading to relatively stable unit costs, and our fourth quarter potash costs are expected to be similar to the third quarter costs, on a per unit basis. At a time when our business fundamentals give us continued optimism we’re well positioned to capitalize on the opportunities before us to use a portion of our increasing 2009 operating cash flows, to find our strategic capacity expansion plans.

As we said last quarter, we expect 2008 capital expenditures to be approximately $60 million and our 2009 capital investment to be approximately 50% higher than in 2008. These investments will help position Compass Minerals to continue its leadership in North American deicing as well as provide growers worldwide the full nutrients necessary to provide healthy nutritious food.

We have a detailed analysis process to evaluate our investment opportunities and we prioritize our spending based on both financial and long-term strategic considerations. Our financial considerations focus on the expected cash-on-cash return of the project over its life.

The dynamics of each project vary in terms of risk, strategic implications and many other factors, but we believe this approach has been instrumental to us achieving returns on invested capital of approximately 20% and likewise we expect our newly planned discretionary capital investments to deliver cash-on-cash internal rates of return in excess of 20%, consistent with our investing principles.

Our September 2008 net leverage ratio was 1.9 times trailing EBITDA compared to 3.7 times at this time last year. Given the current financial markets we don’t expect to make many changes on our capital structure in the short term. Our next scheduled maturity date is in 2012, so we’re well positioned from a debt maturity perspective and have ample liquidity with cash or undrawn revolver and operating cash flows. Our year-to-date tax rate is 31% and we think that’s the full year 2008 rate. We currently expect our 2009 effective tax rate to also be in the low 30% range.

In these uncertain times in the financial and capital markets we’ve seen evidence of fear and some that’s been panic overtake business fundamentals in investor decision-making processes. While these events cause us to pause and reflect to ensure we are pointing in the right direction companies such as Compass Minerals with our strategically advantaged assets and recession resistant attributes should be attractive to investors in any economic environment but especially now as the global economy enters more uncertain times.

As we make decisions on a daily basis we will continue to focus on running the business with the long-term goal of serving our customers and making prudent use of our cash flow to profitably grow our business and meet the needs of all of our stakeholders.

Now with that we’ll take your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of David Begleiter – Deutsche Bank Securities.

David Begleiter – Deutsche Bank Securities

Angelo do any of your highway de-icing customers ask for any price roll backs given the decline in your prices and if they did will you lower prices?

Angelo C. Brisimitzakis

Just to answer your question no we have not had that. I’m not aware of any requests for roll back in prices. This issue of pricing kind of cuts both ways. If fuel were to go up after the bids were awarded we would take that hit. If fuel costs go down, I guess the customer takes that hit.

We would like nothing much more than the customer to accept maybe a fuel surcharge mechanism but to date they’ve insisted on the supplier taking that cost risk so we take it and now the price is fixed for the entire season.

David Begleiter – Deutsche Bank Securities

Just on SOP on the August 15th price increase how much of that have you realized or are realizing?

Angelo C. Brisimitzakis

Well you saw our average for the third quarter, which is kind of a blend of some of the [lagerage] from the old price and the new $1,000 list price. We expect that for the fourth quarter to approach the full $1,000 for all of our customers on average so I think we’ve had very good success and are pointing to the continued success as we finish out the year.

David Begleiter – Deutsche Bank Securities

Lastly if MOP prices were to decline how sticky would SOP prices be short and long term?

Rodney L. Underdown

We saw a brief period in 2006 when there was a slight period of MOP pricing decline and our SOP pricing did not decline. So hypothetically if MOP were to decline, and from all that I hear from the MOP guys they’re not expecting that to happen – remember we’re a big MOP consumer – we would test the premium that normally get.

Normally we get about $150 premium to MOP. We believe that in premium should increase as the extra value of SOP is further realized by the growers and if MOP were to decline slightly we would test that premium and we would expect that premium to increase.

Operator

Your next question comes from Mike Judd – Greenwich.

Michael Judd – Greenwich Consultants

I just wanted to start off with some balance sheet related items. On the working capital side, maybe you already addressed this, what do you think the fourth quarter is going to look like? Is it going to be a use of cash there as typically it would be?

Angelo C. Brisimitzakis

Typically we have had a cash flow from operations. The last three years have actually been a generation of cash flow from operations. Now specifically, as it relates to working capital, that is significantly influenced by the timing and severity of the winter season. So last year winter happened significantly in December, which of course the receivables or the payable terms arrangements there are 30 days.

So depending on the severity of December it is really the determination of the growth in working capital or the decline. But the last three years I think the fourth quarter has had positive cash flow from operations each year.

Michael Judd – Greenwich Consultants

In terms of the freight cost, we’ve all seen the Baltic Index come down. Are you anticipating lower freight rates in the December quarter and how does that impact things?

Angelo C. Brisimitzakis

We have significant freight elements in both of our segments, salt and our specialty fertilizer. On the salt side, as I explained before, the lower freight – of course that’s all domestic sales or North American sales or within the UK – those benefits will fall to us assuming those low freight rates stay down through the course of the winter.

On the SOP side about a quarter of our sales are on the international market so we would expect to enjoy those benefits also although they’re a much smaller percentage of the revenue versus salt, which freight is a much higher percentage of the revenue.

Michael Judd – Greenwich Consultants

Lastly, with the excellent job you guys have done in terms of refinancing some of your debt or maybe that’s not the right terminology for it, but either way the interest expenses has come down fairly significantly on a year-over-year basis. I’m just wondering, I understand that you need to have capital available for some of the expansions that you’re doing within your product groups, but with the absolute interest amount down, but yet your dividend basically remains flat for more than a year here, do you think that there could be some consideration for boosting the dividend?

Angelo C. Brisimitzakis

Yes, that’s a good question. Cash is kind of king right now and we feel really good that our cash flow from operations is at a record level in our history. That gives us a lot of options and particularly with the economic uncertainty we look at the options very critically during this period.

As Rod explained our investments in our advantage assets is a strategic priority for us and we have a very high hurdle in terms of the IRR with the 20% or more hurdle so we feel really good about funding those both from a financial perspective and a strategic perspective. The dividend remains very important to us. We did raise it this year 5%.

We raised that back in February and typically the company raises its dividend on an annual basis each February and I believe, Rod, correct me if I’m wrong we’ve raised it every year for the five years we’ve been a public company.

Rodney L. Underdown

Yes. That’s correct.

Angelo C. Brisimitzakis

So the dividend remains very important to us. We raise it typically annually so I would expect it to remain important to us. Buying down or retiring the debt has also been very important to us. We’ve halved our leverage ratio as Rod pointed out. It’s now at a much more comfortable level, below two. We’ve taken advantage of our excess cash flow to retire some of our ideal 12% debt and we retired an additional $20 million just in the month of October.

So we kind of see that multiple faceted path continuing and it’s all going to be driven by how successful we are in generating that operating cash flow. I think we’re setup very well to continue to grow that operating cash flow with kind of unprecedented price increase in our highway deicing and unprecedented pricing in our SOP business.

But again, we are sensitive to weather, so we’ll just have to see how the weather effect plays out in our winter driven businesses, and there’s also a weather effect in our specialty fertilizer business; both on the selling side where the application of fertilizers is dependent on the amount of rain and the timing of rain out in the fields, but also since we operated solar evaporation manufacturing process. Whether it rains and how often it rains during the solar evaporation period does effect the amount of SOP we produce.

So I’m sorry I didn’t give you a very easy answer to follow but I think it’s kind of stayed the course with us on those priorities and any significant change in dividend at the expense of those other priorities for cash doesn’t feel like it’s the right balance for the long run.

Operator

Your next question comes from Mark Gulley – Soliel Securities.

Mark Gulley – Soleil Securities

I have a couple questions on supply. First of all with respect to ice control salt, given this tight supply demand in North America, can we assume that you’ll be able to sell out the increased production coming out of Goderich as it comes on, since you’re the only one expanding capacity in North American to my knowledge?

Angelo C. Brisimitzakis

Again, selling out the mine isn't the priority although we'd love to do it every year. The weather is going to determine whether the capacity increases actually get sold out or not. Typically the market has grown between 1 and 2% per year on a normalized basis.

So, we are putting in the equivalent of approximately 10% of the North American market with our two phase expansion. So, if the market plays out normally with our 10% expansion and a growth rate of 1 to 2%, we have between five and 10 years of available product to serve the market.

However, as we saw last year, an abnormally strong market creates a demand of approximately 10% in a single year and we were ill prepared as the industry was, to respond to that surge in demand last year. So in the short term what our expansions will give us is an ability to recover our inventory position, which was essentially wiped out last season and is only going to be partially replaced this season. So it gives us the opportunity to get our inventories back were they should be, to service our customers effectively. And will also give us standby capacity, ultimately for either that very strong winter or the normal 1 to 2% annual growth rate that we see in a normal winter.

And, again if it's a week winter those tons don't get pushed into the market because the bid volumes are set during the bidding season which occurs prior to the winter. So the volumes are set, the pricings are set, before winter even starts. So there's very little change that occurs from a selling perspective, during the winter.

Mark Gulley – Soleil Securities

I have a short term question with respect to supply interruptions and competitors. Can you tell us whether or not either of the hurricanes, particularly Ike in the Bahamas, limited Roman Haas's production there? And whether or not that was one of the reasons you were able to increase C&I prices by the 18%.

Angelo C. Brisimitzakis

That's a lot of speculating. I can tell you that both of our major sole competitors have mines very close by our mine in Louisiana and I told you about the great effort and result from our mines. I expect the teams of our competitors in Louisiana did similar efforts on Ike and Gustav. And I haven't seen any significant dislocation out of those primary Louisiana rock salt mines, all of which travel up the Mississippi and Ohio rivers.

It is kind of publically known that the Bahamas were hit more severely, but that is not rock salt mines. That’s a solar evaporation and solar evaporation above ground facilities are a lot more vulnerable than underground mines to these kind of wind effects.

So, I suspect there was more impact at the Bahamas mine. I have no ability to directly correlate it to pricing or demand, whether it's in C&I or our highway [DA].

Mark Gulley – Soleil Securities

Another question, I'll get back in queue, if I'm doing the math correctly on the million ton ambitious goal for Ogden, if I'm doing my math right it sounds like that capacity wouldn't be available until beyond 2015. Am I correct there Angelo?

Angelo C. Brisimitzakis

Yes, to be honest with you, the path to a million isn't even clear yet. What's clear right now is the first piece which is 100,000 tons, and that's clear through 2011; we'll get there.

The next chunk which is phase two, which was the expansion of the ponds, is much more ambitious. That should give us another 200,000 tons approximately, but that's approximately five years out, because we have to get the permits and that's a very detailed process, with the Army Corps of Engineers, environmental impact study. Then we have to truck these massive ponds and then the solar evaporation process is a three year cycle. So you just add up those pieces and you're five years out.

The other pieces that go from 750 to a million are still under development and have different time horizons. But it's unlikely that we get from the 750,000 tons before 2013 or 2014. And again that market is growing approximately 3.5% a year. We need about 15,000 tons in our own capacity just to stay even with the market. And the market currently is underserved. So there is SOP demand that is not being served that we believe that if we had that capacity today we'd have that demand.

Operator

(Operator Instructions). Your next question come from the David Silver – JP Morgan.

David Silver - JP Morgan

A couple of questions, and I guess I'll apologize in advance this will be kind of a hopscotch, but I wanted to ask you about your SOP shipment volumes first. So, I guess with this three year phase in 100,000 ton expansion, I thought you were going to have maybe an additional 25,000 tons available in calendar '08. In the release you pointed more to maybe 425, 430, in other words very similar to the shipment levels last year.

So, I'm just wondering, is there an inventory shift? Or why might the shipment levels given the strong demand low inventories, why might the shipment levels be relatively stable instead of up 25,000 tons.

Angelo C. Brisimitzakis

In my prepared remarks I highlighted that our solar evaporation season was a little bit less than we predicted because of some rains that had occurred at Ogden, Utah. So our production it’s kind of not like a chemical plant where you just dial in the knobs and the plant produces. We actually really on Mother Nature and a certain amount of evaporation to occur over our 33,000 acres, to give us a harvest, so it's strictly production constrained. Now those production times should occur next year assuming the weather for evaporation is normal.

But our inventory right now is at maybe an all time level; we're down to 2 days of inventory. And, so therefore we're constrained by production and inventory to just have a modest increase year-over-year.

But, I would say that in our financial model the improvement in selling price far outweighs the impact of a few thousand tons of volume on SOP. So we're much more excited and much more focused on achieving that approaching a $1,000 a ton goal for the fourth quarter. And, as Rod pointed out, for every hundred dollars of SOP selling price, that translates to about $40 million of operating income at today's volumes. So really our focus is there. Sure we'd love to have that last incremental couple tons of sale and production. It’s just not going to happen this season.

David Silver - JP Morgan

Ok, then also on the SOP side of things I had a marketing question. So you're indicating for the fourth quarter an average selling price of close to $1 thousand a short ton. Again you reiterated how low your current inventories are. Can you give us an idea of how far out your selling now? So in other words if and order comes in, I'm assuming that you really don't have any product to sell on the spot basis.

But, are you telling people that you can't get a shipment until February, until March. How filled up is your order book, or what's your backlog look like there?

Angelo C. Brisimitzakis

Yes, we've seen a little bit of compression in terms of how far out customers are placing orders. I think that in this economy people have pulled back their [horizoning] and it's kind of become more, kind of hand to mouth.

So our orders are really fourth quarter focus right now. Our pricing is typically 90-day validity. So we're kind of going quarter to quarter. And what we've seen in the month of October is good acceptance of our selling price. So we feel pretty good about the $1,000 guidance we gave for the fourth quarter and our customers are really taking it quarter by quarter right now. And frankly, without a lot of inventory at hand, it matches up pretty well to our production.

David Silver - JP Morgan

And then one question on your salt production side, so I have a little model here trying to get to margins based on different shipment volume levels, and I try and tinker with it over time, but when I look at the third quarter I have to say the per ton margins actually seem to have declined from 3Q to 3Q, and given the 20% price increase on the deicing salt and the very large volume increase, I mean, I'm kind of wondering why the per ton margins weren't meaningfully higher than a year ago instead of below those levels?

And I admit the cash production cost per ton has shifted down too, but is there a way that we could kind of think about translating these stronger volumes, much stronger volumes, into kind of reported operating income?

Rodney Underdown

Yes, Dave, this is Rod. When you look at it on an operating income per ton basis, which is I'm assuming sort of a stat you're looking at, is that the right – well, I'll just assume. It was relative; it went up 4% on a per ton basis. Remember there is a difference between the operating income per ton of a ton of highway deicing salt, which sells for an average $45, roughly $45 a ton, versus an operating income per ton of a consumer industrial ton of salt, which sells on average for in that $140 plus range.

And so when you have a period like this year where our tonnage increased on highway deicing was close to 50% and we had good strong volumes in C&I but the percentage increase wasn't as high, when you look at that on a per ton basis across the whole salt segment you'll end up with a different mix just across the whole salt segment. Now the increase in the operating income per ton was about 4%, and that was principally a function of mix.

But what I will say is that during the third quarter it's really the oil prices started to decline fairly rapidly about midway through the quarter, but all during the quarter we were still delivering product at fuel prices that were more commensurate with what would have happened the first half of the year than what we expect to happen now the last three or four months of 2008.

So our fuel prices were as high, almost as high as they were in the second quarter, and while our price increases had taken affect, especially on the highway deicing side, it was probably the last quarter we expect to see the high fuel prices that partially offset the increase in selling price.

So it will, as we look at the fourth quarter, it will be somewhat dependent upon what oil does and the impact of fuel on our shipping and handling costs, but we currently believe that as we look into our production expectations for the fourth quarter that our unit cost in both our segments, but specifically in the highway segment, will be relatively consistent with what we saw last year in the fourth quarter on a per unit basis, which with higher salt prices should increase the margin and operating income per ton.

But the third quarter was significantly influenced by 50% higher volumes on highway deicing side, which just carried with it a lower per ton margin.

Operator

Your next question comes from Robert Koort – Goldman Sachs.

Robert Koort – Goldman Sachs

Could you guys talk a little bit about the composition of your delivery costs? In other words is the predominant share of the cost getting it from the mines out to your own depots, or is it getting it from your own depots and warehouses to the customer site?

Rodney Underdown

Well, Bob, that's a good question. It of course varies by customer, so to the extent we have a customer in Detroit where the salt is a short delivery from the Goderich mine and we service it out of the Detroit depot and we're serving it all the way into central Michigan. Well the bigger percent is going to be on the delivery side versus getting it to our intermediate storage sites.

Whereas if we're serving it because of customer inventory, then the – and I'm just using this as an example – then the bigger cost is going to be getting it to the depot. I would say that on average the biggest cost is getting it to the depot, and that our delivery costs to the customer are typically 50 to 150 mile range of truck delivery, and that even though the water delivery is cheaper on a per ton basis, it's really getting it into the depot that would be the larger share of the logistic cost.

Robert Koort – Goldman Sachs

And then I think you mentioned you've got a different customer base, a tight customer base, in your specialty potash, but we're hearing quite a bit about demand destruction in commodity grade potash. Do you not see that amongst your customer base on the specialty potash?

Angelo Brisimitzakis

Yes. This is Angelo. Demand destruction is kind of a word that goes around a lot. Most of the sales that we have are to growers of crops like fruits and vegetables or wine grapes or tree nuts that have to get planted every year. They don't get replanted. They're perennial crops, so demand destruction in that sense would mean to basically abandon your vineyard or abandon your almond tree for a subsequent year.

So I think it's a different sell and the customers are using SOP because they have to, because if they use MOP or KCL, that chloride hurts the root system of a perennial crop. On an annual crop like corn or wheat, you don't care about next year because you've got to replant it every single year. I'm not a farmer, so that's as far as I can go on that one.

Robert Koort – Goldman Sachs

And the last thing is you're switching over to more solar pond-based SOP. What do you guys expect in terms of margin progression if everything else was held constant other than your sourcing or production method for SOP over the next year or two years?

Angelo Brisimitzakis

Yes, I mean, we have two main manufacturing processes as we've outlined in the past. The process that relies on the source material is a higher cost one and is the one that is more susceptible to changes in raw material intra cost. The solar evaporation process is a more stable process for us because basically we control it and we rely on the sun.

Currently about 65% of our margin comes from pond based production, solar evaporation pond based production, and we expect that to grow to something close to 90% by 2011 as we add more of the pond based capacity. So it should help us lower our costs and it also should help us increase the amount of control we have over our costs and make us less vulnerable to fluctuation in the cost of sourcing raw materials.

Operator

Your last question is a follow-up from Mark Gulley – Soleil - Gulley & Associates.

Mark Gulley – Soleil - Gulley & Associates

Yes, a couple follow-up questions if I may. Rod, you talked about CapEx projects that seem generated 20% internal return over the life of the project. But I'm aware of another project, another investment, that generates even higher than a 20% return in terms of free cash flow yield, and that's you're own stock.

Do you factor in purchases of your own stock as a base case relative to expansion projects as you prepare your capital expenditure request for the board?

Rodney Underdown

It's something where of course we don't exclude it from consideration. I think we've chosen to – where we've had purely financial transactions – what we've chosen to do this year is to take the guaranteed kind of favorable interest arbitrage return on reducing, using our cash to repay our 12% note.

I think obviously in the environment we're in I think we've seen some pretty dramatic shifts in our share price, and as it gets lower that becomes more attractive, but what I would say is that those purely financial transactions probably take a second seat to our strategic investment alternatives that we really view as driving Compass over the long term, and are more certain than whatever the return could be from a share repurchase.

Angelo Brisimitzakis

Yes, this is Angelo. Just to add something on to that, I mean, if the market and the share of our price was trading on fundamentals and outlook into the future, if we're trading where we're trading and we were sure of the fundamentals counted we would be very bullish on buying back our stock, but I don't think anyone right now can explain what the market is trading on and where the bottom is.

There have been a few players out there that are in similar industries that made what looked like very good decisions to buy back their stock with excess cash, maybe three or six months ago, and are now looking at stock prices half of what they bought their stock back at. So I'm sure a financial play on our stock, while it should be something that is important and to be considered, we're just so uncertain about where this whole thing is going in terms of valuation.

And when we compare it against transactions such as our strategic investments, which are both strategic and have good financial returns, we kind of opt for that. Plus as Rod explained, the retiring of our 12% high yield notes is a certain financial return and lowers our interest expense and there's really no uncertainty in the benefit of that transaction. So maybe call us too conservative right now, but I think during these times preserving cash and making those correct strategic/financial decisions is our priority.

Mark Gulley – Soleil - Gulley & Associates

I'm going to challenge you, Angelo, with an agronomy question if I may. And that is the concept used in row crops is mining the fields, that is that farmers can – growers – can reduce their application rates of a fertilizer for a year if they have already built up enough fertility of the various nutrients. Given your specialty crops against citrus and all the rest, can growers, have they in the past, delayed or let's say reduced application rates for a year to avoid the high cost in a given year?

Angelo Brisimitzakis

Yes, and again I'm not an expert, but from the research I've done, that opportunity is there. They could blend in MOP, they can reduce the K. Just remember that K is typically the least applied nutrient versus the optimal level. So the potassium is the nutrient of the big three that really requires the biggest increase in application just to catch up to optimal, and it's a one-year phenomena.

But again, we've been in the SOP business for 40 years, so we'll wait. Whatever timing games – and maybe games is the wrong word – that might be played by the growers, we'll wait those out. Our inventory is extremely depleted. It's at historic lows. So if a small percentage of our customers decide to miss a season, we're a small player in the global market, there are a lot of international markets. Potassium is an underserved oversold nutrient. We don't think it will put a lot of pressure on our demand.

Operator

And at this time there are no further questions.

Angelo Brisimitzakis

Thank you very much everyone.

Operator

This concludes Compass Minerals third quarter Earnings conference call. Thank you for your participation.

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Source: Compass Minerals International Inc. Q3 2008 Earnings Call Transcript

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