ICO, Inc. F3Q09 (Qtr End 6/30/09) Earnings Call Transcript

Aug. 7.09 | About: ICO Inc. (ICOC)

ICO, Inc. (ICOC) F3Q09 (Qtr End 6/30/09) Earnings Call Transcript August 7, 2009 11:00 AM ET

Executives

John Knapp – President and CEO

Charlotte Ewart – General Counsel and Secretary

Brad Leuschner – CFO and Treasurer

Analysts

Jackson Spears – The Robins Group

Dan Whang – B. Riley & Company

Operator

Good morning, ladies and gentlemen, and welcome to the third quarter fiscal year 2009 earnings report conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I would now like to turn the call over to Mr. John Knapp. Mr. Knapp, you may begin.

John Knapp

Thank you. Welcome to the third quarter of fiscal ‘09 conference call. With me today I have Charlotte Ewart, our General Counsel; and Brad Leuschner, our Chief Financial Officer. Before we turn to the substantive matters, let’s listen to Charlotte.

Charlotte Ewart

Thanks, John. Please note that information reported on this call speaks only as of today, August 7, 2009, and therefore you are advised that time sensitive information may no longer be accurate at the time of any replay listening. Also I must caution everyone listening that certain matters discussed in this conference call are forward-looking statements, intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. The company’s statements regarding trends in the marketplace, potential future results, and any proposed transaction and the timing and effects are examples of such forward-looking statements.

Risks and uncertainties that could cause the forward-looking statements to become untrue or otherwise affect the outcome thereof include without limitations

restrictions imposed by the Company's outstanding indebtedness; changes in the cost and availability of polymers and other raw materials; changes in demand for the Company's services and products; business cycles and other industry conditions; general economic conditions; international risks; operational risks; litigation risks; currency translation risks; the Company's lack of asset diversification; the Company's ability to manage global inventory, develop technology and proprietary know-how, and attract and retain key personnel; failure of closing conditions in any transaction to be satisfied; integration of acquired businesses; as well as other factors detailed in the Company's form 10-K for the fiscal year ended September 30, 2008, and its other filings with the Securities and Exchange Commission.

Should one or more of such risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those indicated. Any forward-looking statements are made only as of the date of this conference call, and the Company undertakes no obligation to publicly update any such forward-looking statements to reflect subsequent events or circumstances.

During today's call, management will discuss both GAAP and non-GAAP financial measures. With regard to the non-GAAP financial measures discussed in this call, including net income, loss as adjusted, net income/loss per common share as adjusted, operating income/loss as adjusted and net debt, please refer to the press release issued yesterday on August 6, 2009, which can be found on the company's website for disclosures about these measures and for reconciliation to the most directly comparable GAAP financial measures.

And back to you John.

John Knapp

Thank you, Charlotte. Now, Brad will you review the financials.

Brad Leuschner

Thank you, John. Let me begin by discussing the comparison of the third quarter results of 2009 to the third quarter results of 2008. As a result of the global recession, lower resin prices and the translation effect of our stronger US dollar, revenues decreased 40% or $45.7 million to $70 million. Our volumes declined 20% due to a reduction in customer demand as a result of the global economic slowdown. The volume declined reduced our revenues by $25 million.

Lower resin prices reduced revenues by $12 million and the translation effect of the stronger US dollar reduced revenues by $9 million.

Our gross profit declined $5.9 million or 32% primarily from the reduction in volume sold and a $1.3 million translation effect impact from the stronger US dollar. Our gross margins improved from 16% to 18%. This improvement was caused by lower resin prices as well as a change in our overall product mix as our Bayshore segment, which has a higher gross margin made up more of the overall company's revenues in the current year quarter compared to last year, while revenues in our European segment made up less of our overall revenues this year than last.

Additionally, the cost reductions that we have made this year in response to the global economic slowdown and the optimization effort in Australia and New Zealand reduced our conversion cost per metric ton, which also benefited our gross margins.

SG&A declined $1.8 million or 17% due to the translation effect of the stronger US dollar, which reduced SG&A by $900,000 and lower compensation costs, which reduced SG&A by $900,000 as well.

Operating income declined from $6.5 million to $2.2 million or 66% as a result of the reduced gross profit, partially offset by the lower SG&A. Our interest expense declined $500,000 or 48% as a result of our lower debt levels, which were down 43% from June 30, 2008, compared to June 30, 2009. Our net debt is down even further. Our net debt at June 30, 2009, was $9.9 million compared to net debt at June 30, 2008, of $54.6 million, a decline of $44.7 million or 82%.

Our effective tax rate was 14% in the third quarter of this year. This reduced rate was the result of tax credits of just under $200,000 as well as a state credit of $90,000 that we received from the State of Pennsylvania as a result of our relocation. In the prior year third quarter, our effective tax rate was 17% primarily due to the reversal of a valuation allowance on our Brazilian tax assets.

Net income was $1.3 million or $0.05 per share this year compared with $4.6 million $0.17 per share in the third quarter of fiscal 2008. Looking at our business segments, ICO Europe's operating profits declined $2.6 million or 66% primarily due to lower volumes. ICO Polymers North America operating profits declined $1.6 million or 88% again due to lower volumes, but also due to $300,000 less benefit from insurance proceeds. Our ICO Asia-Pacific region showed improved profits from a loss of $11,000 to a profit of $171,000 as a result of the optimization changes than that have been made over the last several months more than offset the effect from lower volumes.

Now, looking at the sequential quarterly comparison. Our volumes and revenues were essentially flat. Our gross margins improved from just under 17% to 18%, which led to gross profit improving $700,000. The gross margin improvement was primarily from improved material margins in Australia as a result of having their inventory levels at improved levels at the end of March compared to December. Gross margins were also improved by the cost reductions efforts we have made throughout the company as a result of the global economic slowdown.

During the second quarter, we recognized a non-cash goodwill impairment charge of $3.5 million related to goodwill. Excluding that improvement, operating income improved sequentially by $1.1 million or 100% improvement. Operating income as adjusted was $1.1 million in the second quarter compared to $2.2 million in the third quarter.

Taking a look at the business segments, ICO Asia-Pacific stands out as the most improved, improving from a loss of $1.6 million, excluding the goodwill impairment to income of $171,000. As mentioned earlier, Asia-Pacific improved due to better inventory management earlier in the year that improved our inventory position at March 31. This allowed us to improve our material margins during the third quarter. This region also benefited from reduced bad debts expense, which declined $400,000 in Q3 compared to Q2.

Our Bayshore segment also improved its operating profits, which were up $172,000 or 11% due to an increase in volume sold at 2%. ICO Europe and ICO Polymers North America both had operating profit declines during the quarter, both primarily caused by lower volumes sold of 2% and 1% respectively.

Now turning to the balance sheet, we were again very pleased with our cash flows during the quarter, which led to the ability to reduce our net debt position. Our net debt fell from $18.1 million at March 31, 2009, to $9.9 million at June 30, 2009, a decline of $8.2 million or 45%.

At September 30 our net debt was $44.3 million. So we have reduced net debt by $34.4 million or 78%. Our capital expenditures were very light during the quarter at a little over $400,000. We would expect capital expenditures to pick up somewhat next quarter as we will spend money on the second Bayshore line that we're adding in Malaysia, as well as to fund repairs to our New Jersey building. All in I would expect CapEx to be around $1 million in the fourth quarter.

We believe our balance sheet is very strong with cash on hand of $23.6 million, total debt outstanding of $33.5 million, and with available global borrowing capacity at June 30 of $47 million. In June, we were excited to announce the acquisition of the rota molding business of Chroma Corporation, effective July 1, 2009. Essentially, we purchased their customer list and other intellectual property. The terms of the transaction are an upfront payment of $200,000 paid on July 1. If a certain volume target is met, then we will pay an additional $200,000 at the end of the first year. There is a five-year annual tiered earn out that is based on volume targets. We estimate that the present value of all the payments to Chroma for this transaction will be approximately $1 million over the five-year period, assuming we met the volume targets.

We expect the additional business volumes from this transaction to be at least 2000 metric tons per year, and based on today's resin prices could add at least $4 million of revenues per year. We would also expect fairly attractive margins on this business. John, back to you.

John Knapp

Thank you, Brad. So, let us begin the big picture. There is being much press about the global economy stabilizing, and we at ICO would concur. At this time, we believe that our business around the world seems to have found a reasonably stable floor. There's been much press about how the emerging markets will lead us out of this recession. We concur with this as well. Our operations in Malaysia and Brazil are once again relatively robust, and there has been press about improving attitudes. We see this at ICO as well. Our July senior management call was more upbeat than it has been for many months, and our internal projections are truly encouraging.

That said, we are cognizant that the macro picture, particularly here in the US is daunting. High unemployment and huge deficits cause great concern. Last quarter I stated our core profitability was intact. And indeed it is. As Brad has pointed out, our net income rose to $0.05 a share up from $0.02 per share last quarter, if we exclude last quarter’s charge to goodwill. While the size of the earnings is not impressive, these earnings were achieved with average capacity utilization of under 60%.

We continue to state that we are proud of the work of the people at ICO during these times, and believe our record of producing solid returns on invested capital will continue in the long run. Our cash flow, as Brad points out, which is a key metric that we have been focusing on, was great. During the quarter we generated $8.4 million in operating cash flow, including $434,000 in CapEx. Fiscal year-to-date we generated $34 million of cash, including $1.9 million of net CapEx. Cash flow benefit from lower resin prices is behind us. So we would expect our cash flow in the current quarter to be minimal. In fact, we would hope that sales volumes may increase, and we would expect to require working capital for inventories and receivables.

We believe that we have a strong balance sheet with net debt of just under $10 million, which should be attractive to the best of the resin producers, for our suppliers and to wise customers, whose businesses require a dependable source of processed resins. Balance sheets are very important. Our balance sheet allows us to be pro-active in seizing appropriate opportunities to become available at times like these.

We are very active in exploring opportunities for additional acquisitions with prospects for such in each and every one of our operating divisions. This is a movement from defense as described in previous calls to offense. The Chroma noted by Brad is a good example of the type of acquisition we most prefer. We hope to announce more of these in the near future.

Volume, as you may recall and I'm often reminded measuring our business on volumes alone is not really an accurate measure of the success of our business. It is, however, the natural statistic easily measured, which we continue to follow. With the movements in prices of resins and currencies it is a better measure of our business than is revenue.

In the first quarter of 2009, our volumes were down just under 20% from the same quarter the previous year. Second quarter they were down 23% year-over-year as compared to a decline of 20% year-over-year in the third quarter. Hence our statement, we have found a floor. This quarter volumes were flat sequentially. Our April and May volumes were both down 21% compared to the prior year, but in June we saw a pickup in demand and our June volumes were up 16% compared to May. This is very encouraging.

Although we'll be impacted in the fourth quarter by the seasonality in Europe due to vacations that will affect our volumes this quarter somewhat. We will see some benefits from the Chroma transaction in the fourth quarter. So we remain cautiously optimistic. We do believe that our competitive position in the market, our nimbleness and product mix will serve to stabilize our business.

Margins, those of you who listen to our calls in the past know that I -- and I don't particularly think that we should use the word too much but, in this case, I is appropriate -- I am a margin fanatic, 20% gross margin and a satisfactory return on invested capital as reasonable objectives. This quarter our margin was 18%, up from 16.9% in the last quarter. This is also encouraging, and we are hopeful that trend will continue, and it is as we suggested it would be in the last conference call.

Our gross margin in June was the highest of each month in the quarter, which is also encouraging. Having stated all of the above, we believe there is ample room for improvement in margin over the long run. It just takes consistent work. Over the last three completed fiscal years, our average gross margin was 17.7%. SG&A percentage for the quarter, SG&A was 12.4% of revenues, down from 12.8% of revenues last quarter. At this percentage level, SG&A is higher than what we would expect to achieve in the longer run. Over the last three completed fiscal years, SG&A has averaged 9.5% of revenues. We are carefully monitoring SG&A expenses. We have made it clear that as in the past, we are incurring costs and developing several foreign markets, including India for ICO products.

Operations, Bayshore, it has got a prime location in the heart of the petrochemical industry in North America and its scale is one of the largest operating facilities in North America and it continues to manage well in this difficult environment. Volumes of Bayshore were down 8% from the previous fiscal year's third quarter, which led to operating income decline in the previous fiscal year quarter from $2 million to $1.7 million. Over the course of the quarter, however, we witnessed a pickup in demand and June was the strongest operating month in the quarter. We are hopeful this trend will continue. Current trials of new products, our processes for customers are encouraging.

One should note that operating income at Bayshore has averaged $13.5 million over the past three completed fiscal years. IPNA, which is ICO Polymers North America, IPNA’s third quarter volumes continued to be weak. They were down 36% from the year ago as customers drew on their existing inventories and reduced demand. While we continue to expect IPNA some incur some volume pressure from the economy, we are encouraged by current order flow.

We remain confident in the management team at IPNA and their position in the market. While it may take a few quarters to shake up, we expect to see the competitive landscape improve. I have mentioned that we are exploring possibilities for acquisitions, and in this regard note the acquisition of rota business from Chroma Corporation is just the kind of opportunity we were seeking. Chroma is a very well-respected firm in the Midwest of the USA that specializes in color concentrates, and ICO has a long-standing relationship with Chroma. It was a natural fit for ICO to acquire the rota activities of Chroma, including customer list, formulas, and process technologies.

These customers will be served primarily out of our plans in East Chicago, Indiana, and Fontana, California. While the acquisition was not material to ICO overall, it is very material to these plants. IPNA’s operating income was $210,000 in the second quarter, down from $1.8 million a year ago. This reduction certainly reflected the volume.

As stated consistently before, we remain enthusiastic about oilfield product development and commercialization, which is led for ICO by IPNA. Unfortunately exploration development for the oilfield is greatly reduced in North America and throughout the world today. Slowly, we are achieving sales in newer product lines to growing a set of customers. Please note that the averaging operating income at IPNA has been $5.6 million over the past three completed fiscal years.

ICO Asia-Pacific, in the last 18 months we have stated the business in Australia remains disappointing, while in Malaysia it is quite reasonable. We stated that we expect to see improvement in Australia and New Zealand over the course of the coming year, as the excruciating but competitive market becomes more rationale. Now we are seeing evidence of such rationality. June was the first profitable month in Australia in a long time.

As noted earlier, our Malaysian operations are performing well. We expanded the compounding capacity for Bayshore products in that market with the installation of a second production line. As previously announced, we made the decision to close our operation in Dubai, and believe we have a better means of serving the Middle East rota markets. In the past quarter, we incurred $130,000 in costs related to the closing of Dubai. We expect these costs to be further diminished in the current quarter.

The Asia-Pacific region made $171,000 in operating income in the quarter, including the Dubai losses. This compares to a loss of $1.6 billion in the previous quarter, prior to the goodwill impairment, and an operating loss of $11,000 a year ago. Volumes processed in the region declined 21% in the previous year, a portion of which is attributed to Dubai, as the weakness in Australia exceeded the growth in Malaysia.

Over the past three fiscal years, completed fiscal years, our average operating income in the region has been $3.4 million. Europe, as noted in all calls, we have great leadership in Europe with Derek Bristow, and the ability of the strong management team to support our efforts there. In fact we have such confidence in Derek that he now runs Asia-Pacific as well. The management shift will allow us to standardize products and realize savings from global supply relationships, if this is an important shift for ICO. While our numbers in Europe continue to be impacted by the slowing economy, they also reflect the strength of our position in the market. We are at $1.3 million in operating income during the quarter compared to earning $3.9 million for the same quarter last year.

Volumes were down 20% from the previous year. We suspect that we are winning market share as we think the European demand is falling more dramatically than our volumes have fallen, and we continue to see plenty of opportunities for improvement.

Over the past three completed fiscal years, our average operating income in Europe has been $9.4 million. Brazil, we were a little disappointed with the performance of our Brazilian business during the quarter as our operating income for the quarter was essentially zero compared to earning income of $224,000 last year. Volume was also down 17% compared to the same quarter last year. However, we note that our order flow in June was strong and continues to be very strong at present. If the business remains at these current levels, we would expect to increase our capacity in Brazil in the near future.

As we have consistently stated, we see opportunity to expand our business in this market so that it becomes meaningful to ICO. We expect Brazil and all of Central and South America to become significant to ICO in future years. During the last three completed fiscal years, operating income in Brazil has averaged $300,000 per year. While we remain vigilant about the global recession and anxious about the US macro issues, we have confidence in ICO’s prospects. We like our balance sheet and we're energetically pursuing the opportunities being presented to us.

We will take questions at this time.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Jackson Spears. Please go ahead.

Jackson Spears – The Robins Group

John, congratulations on making progress in a very difficult environment. John.

John Knapp

Thanks, Jack.

Jackson Spears – The Robins Group

Could you give us some color on the acquisitions? You talked a lot about it. Which size are you looking at in terms of range and you're going to use stock or is it just cash?

John Knapp

Jack, we're looking at acquisitions on a fairly wide range of size and, you know, Jack we have a strong balance sheet. So cash is available. Perhaps, we think stock prices might be more expensive for us to use.

Jackson Spears – The Robins Group

And were the acquisitions ranging up to $50 million, $60 million in revenue?

John Knapp

Jack, we are looking at acquisitions that have a variety of sizes. I guess I shouldn't be too specific, but, you know, and we are looking at acquisitions all over the globe.

Jackson Spears – The Robins Group

And who is your competition when you are looking at them? Is it other chemical companies or is it – are you in your usual position with the strength of your balance sheet and the reputation of your managers.

John Knapp

Jack, let us talk – I want to go about the – I am going to address first the Chroma transaction. That transaction came because relationships in the marketplace, not because it was brought by an investment banker. So some of the opportunities we have to look at are because of our reputation and our relationships in the business community, but Jack in general we don't talk about potential acquisitions until they get done.

Jackson Spears – The Robins Group

Okay, could you walk through the operating rates in your various units? What that implies for CapEx through the next 12 months?

John Knapp

Okay, Jack. I am going to let Brad talk about CapEx over the next 12 months.

Brad Leuschner

Well, I said in Q4, we would expect it to be about $1 million. Part of that though is to repair the New Jersey building. The second Bayshore line will spend some next quarter that's included in the million.

John Knapp

Malaysian Bayshore?

Brad Leuschner

Yes, the second – yes, the Malaysian Bayshore line will spend part of that money next quarter and that will continue into Q1 of next year. In our maintenance CapEx, it ranges between $2 million and $3 million per year. The only announced growth opportunity that we've announced that we're going to spend capital on is the Malaysia line. So, you know, we don't have our number yet for next year. It's going to depend on how the economy recovers but just now maintenance CapEx $2 million to $3 million. We'll spend some money on that second Bayshore line in Malaysia and want to go from there.

Jackson Spears – The Robins Group

And what's your operating rate at Bayshore. At one point, a year or two ago it is close to 85% or 95%, where is it today and does that give you some operating leverage going forward?

John Knapp

Jack, I imagine that Bayshore’s operating capacity usage in the last quarter was in that 65%, 68% range. Obviously, for any firm such as ICO, when we state that we have operated under 60% of capacity across the globe, and our managers by the way Jack would tell you, it's often difficult to define capacity because different processes run at different speeds on lines. Okay. We have incredible operating leverage to earn a nickel of share under 60% of utilization rate means that if we were to run at 75% to 85%, we might make a great deal of money, we should make a great deal of money. So we are like all manufacturing businesses, we have great operating leverage. We are proud of the fact that we have been operating lean, and we've been profitable at the current level that we are operating at.

Jackson Spears – The Robins Group

In the past, your inventories included some raw material and with resin prices improving, I guess it includes some raw material. How much is in the raw material component?

John Knapp

We are balanced aren’t we at the moment?

Brad Leuschner

June 30th total revenue, sorry, total inventories were $35 million, $20 million of that was raw materials, $14 million finished goods, and $1 million worth of supplies. So we are little heavy on raw materials. I don't have the exact percentage here. You know, Jack –

John Knapp

It is good. Being heavy on raw materials is good better than being…

Brad Leuschner

Go ahead, John.

John Knapp

You made a statement about resin prices increasing. You know, resin prices on a relative basis to last year are pretty stable. There has been a slight decline over the last 45 days, but we don't perceive that resin prices are going to move dramatically. We are not counting on that. We are really happy with our inventory levels across the globe. We think our team has done a great job in managing it. So that's different than a year ago.

Jackson Spears – The Robins Group

Okay, thank you, John. And I will let someone else ask some questions.

John Knapp

Okay, thank you, Jack.

Operator

Thank you. And our next question comes from Dan Whang. Please go ahead.

Dan Whang – B. Riley & Company

Yes, good morning. First question was kind of, kind of drilling a little bit more about your comment that June showed a nice you know, 60% growth on May, and with gross – good gross margins, I'm just wondering, you know, what you saw in July if you saw that trend kind of continue, if you saw kind of sequential pickup in July versus June or?

John Knapp

Let's say that what we've seen is that the trend that was established in June has continued in July. I think that that would be a fair statement.

Dan Whang – B. Riley & Company

Okay. And what do you think really is driving that? I mean is that – I know in the past you commented that you thought inventory levels at customers were fairly lean, and is it just customers trying to build their inventories up a little bit or is that may be the increasing resin prices over the last month and a half kind of helping that?

John Knapp

All right. So you have – that question is of course the question that we are asking ourselves a great deal right now. We like to tell you that we are building market share, we'd like to tell you that we are doing business with customers that are building market share, and we hope that that's the case, and we hope that is the case that there is a general improvement in the overall economy globally, okay. But we clearly understand that customers are running thin on inventories and that they are – that there is some inventory build that is kind of coming along on their part to try to remain – to restore some inventories in their businesses.

So that's, you know, that's the concern that all of us would have as we watch this happen. As to whether or not people are buying in anticipation of rising resin prices, you know, when we've asked some customers about that there might be a little of that, but people are pretty gunshot about carrying excess inventory, all folks are gunshot about carrying excess inventory. So what drives this okay, we are not out of the woods to declare a victory at the moment but we are – it shares a nice trend to see.

Dan Whang – B. Riley & Company

Right, okay. And in terms of your Asian operations, particularly Australia and New Zealand, obviously those businesses are benefiting from the restructuring actions that you've taken and in that regard are the restructuring activities complete in those regions, and do you anticipate additional sort of benefits of those moves coming in over the next quarter and therefore margins continue to benefit?

John Knapp

Well, you know, infrastructure is not complete, and maybe you incur some cost in the process of restructuring, okay. First, I think that if you just understood Australia, it went from a market that was growing consistently for a number of years to a market that boomed and then it, you know, it did with all markets that boomed us. It had a downturn to it, and so we had competitors that expanded and we had customers that expanded or all rota movers in Australia expanded, and what we've been through is the gut wrenching period of you know, excess competition and excess competition for our customers and then the falling resin prices meant that the inventories to customers held were higher than replacement inventories.

So it has been a powerful market. That – to a large degree that piece to it has – is behind us. On the macro picture, the market is becoming rationalized if that makes sense to you. That gives us a lot of comfort. We have a good reputation in the Australian market. We have got a good market share, and we see over the long run Australia is going to be a place that we're going to do well. It is just it's been rough. So I suspect that you know, we are very delighted with the June figures, and we have reason to be optimistic going forward, and I think I better leave it at that.

Dan Whang – B. Riley & Company

Great. That was very helpful. Thanks very much.

John Knapp

Yes, sir.

Operator

Thank you. And at this time, I'm showing no further questions.

John Knapp

All right. Thank you all for listening. We look forward to the next quarter call and goodbye.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.

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