Executives
Mark Feuerbach - VP, Treasury, Financial Planning & Analysis
Randy Gress - CEO and Director
Neil Salmon - VP and CFO
Analysts
Frank Mitsch - BB&T Capital Markets
Edward Yang - Oppenheimer
Christopher Butler - Sidoti & Company
Adam France - 1492 Capital
Olga Guteneva - JPMorgan
Richard O'Reilly - Standard & Poor's
Innophos Holdings Inc. (IPHS) Q1 2010 Earnings Call May 4, 2010 10:00 AM ET
Operator
Good day ladies and gentlemen and welcome to the First Quarter 2010 Innophos Results Conference Call. My name is Leticia, and I will be your operator for today. At this time, all participants are in a listen only mode. We will conduct a question-and-answer session later in the call. (Operator Instructions) As a remainder, this conference is being recorded for replay purposes.
I would now like to turn the call over to your host for today, Mr. Mark Feuerbach, Vice President, Treasury, Financial Planning and Analysis. Please proceed sir.
Mark Feuerbach
Thanks for joining us today for the Innophos Holdings Inc. conference call to discuss first quarter 2010 results. Conducting the call today are Randy Gress, Chief Executive Officer, Neil Salmon, Chief Financial Officer, Bill Farran, General Counsel and myself, Mark Feuerbach.
During the course of this call, management may reiterate forward-looking statements made in our May 3rd press release regarding financial performance and future events. We will attempt to identify these statements by use of words such as expect, believe, anticipate, intent and other words so to note future events. These forward looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements.
We caution you to consider the important risk and other factors as set forth in the forward looking statement section and in item 1A risk factors in our annual reports on form 10K as filed with the SEC that could cause actual results to differ from those in the forward looking statements made in this conference call.
We will make a replay of this conference call available for a limited time over the telephone at the number said forth in our press release and via a webcast available on the company website.
In addition please note that the date of this conference call is May 4th 2010. Any forward-looking statements we may make today are based on assumptions that we believe to be reasonable as of this date and we undertake no obligation to update these statements as a result of future events.
Now, I would like to turn the call over to Randy Gress, CEO of Innophos.
Randy Gress
Thanks Mark and good morning everyone. I am very glad to have this opportunity to update you on first quarter results. I will start with the highlights of the quarter. Then Neil will summarize our financial results and afterwards I’ll make a few concluding remarks then we will take your questions.
First, we are pleased to achieve in this quarter our first sequential operating income improvement since the third quarter 2008, driven by increased sales volume which more than offset the impact of a modest price decline.
This performance enabled us to deliver a sequential increase in operating income of $10 million or $3 million if we exclude the impact of OCP settlement cost booked in the fourth quarter 2009.
This quarter net sales were $169 million, a 15% increase sequentially continuing the encouraging volume trend we have noted since the second half of 2009. Our core business of specialty phosphates contributed strongly and was up 8% sequentially.
Also GTSP sales were up significantly against a low fourth quarter 2009. It was particularly encouraging to see strong volume growth of 12% sequentially in the US and Canada combined with Mexico continuing its progress and restoring its market position.
In comparison to first quarter 2009, specialty phosphates volumes were up 19% and total company volumes were up 12%. This is the first year-over-year volume improvement the company has achieved since 2007. Pricing declined less than expected at 4% sequentially and as we indicated on our last call, we expect Q1 to have been the last quarter and our recent trend of price decline. Compared to pricing prior to the 2008 run-up in raw materials, we see about a 40% improvement in average selling prices in the US and Canada.
Following significant increases in commodity phosphate prices, fertilizer prices during the first quarter of this year and the impact on related raw materials such as sulfur and ammonia, we have begun to increase selling prices effective the beginning of April to help offset those higher raw material cost.
Returning to sequential quarterly sales and earnings growth, represents another key milestone for the company and is a very clear sign of the progress we have made in transforming our business and overcoming many of the challenges we have faced.
The strength and success of our US and Canadian business is very evident. Food and beverage markets were again the primarily driver of our gross in the quarter and we are clearly seeing both stronger demand conditions and also increased commercial success with our focus on improving the value we bring to customers. This is evident in the improved margins we are able to earn in these sectors.
In Mexico, we are at an early stage of our transition. We have previously commented on the success the business had in dealing with the extremely challenging conditions experienced last year. And you are also aware at the decisions we took to continue investing through that period. With our OCP settlement announced during the quarter, including firm rock prices for the remainder of the contract plus the successful we’ve had in the last two quarters in restoring our market position, I am confident we are firmly back on the path to improve profitability in Mexico even if as new outline shortly, our Q1 results in Mexico was a little behind our expectation.
The successful completion as promised of our upgrade to our acid purification capability, the ongoing improvement and our Mexican specialty salts capability, plus our strategy to diversify phosphate raw material sources was substantially increasing the value of our Coatzacoalcos manufacturing facility as an integral part of our overall global network.
This enhanced capability provides both additional capacity for development of higher value market positions and also a substantial backup capability for our US sources of high-grade acid, something we’ve not had before. In fact, our Mexican facility is now our largest source of food grade acid and also by far, our most capable majored by its ability to handle multiple alternative phosphate rock sources and produce product grades tailored for multiple customer requirements.
Confirming new rock supply arrangements to succeed the existing OCP contract that will terminate in September this year. Is of course, key to the long term success of our business and here, we are pleased to report good progress also. First though, I should remind you that as part of our settlement agreement, we have some flexibility to expand OCP deliveries into the fourth quarter and accept a limited number of trial shipments from new suppliers, prior to the end of the current contract.
So we are looking at a phase transition to new arrangements, fully effective from the beginning of 2011. As we have reported in previous calls, we have been planning for this transition for almost two years after we made the strategic decision to move away from our current single source arrangement for Mexican rock supply. The initial phase was focused on sampling and testing alternative rock sources and our new pilot scale plant.
And even though, we were able previously to successfully test a number of MGA or Merchant Grade Assets, following the OCP settlement, we are now able to move more aggressively to the next phase, commercial scale testing of new rock sources and we received our second full shipment from a totally new source just a few days ago. As you would expect, we are also making good progress and negotiations on new agreements but you will understand that with discussion still at a sensitive stage on several fronts, we are not able to give any details on progress or on likely new agreements.
However I can tell you that just yesterday we signed our first new contract with a new strategic supplier. I will now turn it over to Neil for more detail on the quarter.
Neil Salmon
Thanks Randy, I’ll begin by offering some brief comments on an expected change to segment reporting from the second quarter which we hope will give investors better insight into our performance trends and also better aligns our external reporting with how we think of the business internally.
The main changes to distinguish our core specialty phosphate business which includes specialty salts and acids, purified acid and STPP or Sodium Tripolyphosphate from the non-core GTSP and other. In future we plan to report specialty phosphates in two regions US and Canada combined and Mexico.
As you are aware GTSP or Granular Triple Super Phosphate is core product of our acid purification process in Mexico and is not part of our core specialty phosphate portfolio. The other in this GTSP and other classification covers miscellaneous non core product sales also arising primarily in Mexico. In future we will report GTSP and other separately.
Volumes and revenue for GTSP and other are always likely to be more variable particularly quarter to quarter as production and sales order patterns can lead to a lumpy sales profile.
So by separating it out we hope to give investors greater clarity on what is a relatively small part of our business. And improve visibility of the underlying change for specialty phosphates. And after this change we have included additional in the press release for GTSP and other. Unfortunately in one area of the press release we got ahead of ourselves in this change and I need to advise you that in the years encountered segment results we have reported sequential variances for US and Canada combined rather than individually. We’ll correct this in this upcoming report on Form 10-Q.
Turning now to our results, as Randy mentioned net sales in the first quarter were $169 million, with the decline versus first quarter 2009 under our pricing offset by a 12% increase in volumes. The US and Canada business enjoyed a 21% volume increase year-over-year, though lower prices goes at the peak levels of Q1, 2009 resulted in a 7% revenue decline.
In Mexico net sales especially cost base decreased 19% year-over-year also on lower selling prices offset by a 12% improvement in volumes. GTSP and other sales in the quarter were $10 million up from the very low $2 million in fourth quarter 2009 but still below the $18 million recorded in the first quarter of 2009. Operating income for the first quarter 2010 was $22 million; $33 million lower than the first quarter 2009 on lower selling prices probably offset by higher volumes. US and Canada operating income was flat on a sequential basis and $28 million below first quarter 2009.
Mexico returned profitability in the quarter on stronger sales and then improved cost position over the profitability fell short of our area expectations. A delay in expected GTSP shipments just into the second quarter and one-time costs related to an earlier than expected start up of Idaho production equipment both contributed to that shortfall. It should also be noted that the full benefit of 2010 prices for phosphate rock look, were not reflected in the quarter for Mexico as the business continue to sell inventory may be with higher priced phosphate sources purchased the [forward assessments].
GTSP and other operating income for the first quarter 2010 was breakeven compared to a loss of $2 million for the same period in 2009. Our effective tax rate for the quarter was 35% and we maintain our value over 36% to 38% rate for the year. Net income for the first quarter of 2010 was $10 million or $0.47 per diluted share, compared to $30 million or $1.39 per diluted share for the same period in 2009.
Net debt increased by $17 million to $130 million, primarily on higher receivables relating to sales growth. Subsequent to quarter end on April 15, 2010, we redeemed [their path], the remaining $56 million of outstanding 9.5% loans due 2012 with on-hand cash.
First quarter 2010 gross profit margin at 21% of sales was below the fourth quarters 24% excluding settlement charges as expected on a sequential selling price decline. As previously disclosed second quarter margins will improve as the raw materials contract recess that took place at the beginning of 2010 work their way through into cost of good sold, contributing additional gross profit of $8 million per quarter from the second quarter onward.
This [three] contracts we said at the beginning of the year commodity fertilizer and related raw material process such as sulfur and Ammonia have increased I know well the impact will be delayed for the portion of our input cost that are under contract with the late increases or firm prices, we will nevertheless see some increases from the second quarter.
Innophos responded with price increases in March that are effective April and we expect to offset these increased raw material costs. As you aware, an imperative rising raw material cost, the nature of our raw material contracts means our short term margins are advantage to markets as we target selling prices on the basis of market costs. We make a concrete calculation that how raw material costs would change with contracts we said based on current volume and expected market price levels.
Looking forward to next year therefore and making a reasonable assumption of some moderation from current market price levels before our contracts re-set. We would anticipate an increase in cost-of-goods sold over our second quarter 2010 base figure of approximately $5 million per quarter, taking effect primarily from the second quarter of 2011.
So in summary, an $8 million improvement in the second quarter 2010 than the first quarter 2010 that partly offset in the same quarter 2011 by the $5 million increase I’ve just described. Of course, the 2011 view is only an early estimate and will depend on the actual development of raw material costs during the year and on a number of actions currently underway that then can mitigate the impact including any additional price increases.
Finally a word on capital expenditures for 2010 which are currently expected to come in at the high end of the range we have previously disclosed or $35 million with our major items of expenditure unchanged from the fourth quarter, including the Mexican food grade asset expansion that was completed during the first quarter, incremental improvements to existing Mexican food grade source capability, completion of the ERP project, additional de-bottom [making] and expansion of food grade source capability in Canada and various US locations. And finally investment to enhance Mexico’s capability to store, handle and process multiple grades of rock consistent with the company’s supply chain diversification strategy. Also as previously disclosed we continue to make a limited investment in evaluating our Mexican phosphate rock concessions. Now back to you Randy.
Randy Gress
Thanks Neil. As we look ahead we are optimistic the condition in the second quarter will be supportive to ongoing good progress in executing on our 2010 goals. We expect some improvement in pricing ongoing strength in volumes and continued progress in our business transformation.
Specialty phosphate volume is expected to grow for the 2010 second quarter between 5 and 10% sequentially and this will represent 20 to 25% growth versus the second quarter 2009.
As Neil mentioned GTSP sales are more difficult to predict for any one quarter but on average over the coming couple of quarters, we expect improved volumes. So in summary we are pleased with the first quarter results and we are proceeding according to the plans we have laid out previously for 2010.
The operating income improvement we saw in the first quarter demonstrates that the expansion of our specialty salts and specialty acids business and our focus on higher value markets is leading to growth and profitability.
We are on track with the upgrade and the capability and flexibility of our manufacturing network and we are making progress in diversifying our raw material sourcing. As we maintain our strong balance sheet and continue to pay dividends we are continuing to look for the best acquisitions of the Bolt-on variety to support our strategic goals of growth on serving profitable, specialty end markets and a wider geographic base. Thank you for listening and we will take your questions now. Operator?
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Frank Mischk of BB&T Capital Markets. Please proceed.
Frank Mitsch - BB&T Capital Markets
Good morning gentlemen and perhaps you can in future report these good results on days that the tapes not so ugly. Really nice start to the year. Randy I don’t want to put words in your mouth but I will.
It sounds to me that you got pricing up, you got volumes up and you’ve got raw’s down. It sounds to me that you are expecting the second quarter to be the second quarter on a row of improved sequential earnings. Is there any reason why is there any major factor that I am missing there?
Randy Gress
No Frank putting words in my mouth like that you are spot on. We do expect an improvement in the second quarter results.
Frank Mitsch - BB&T Capital Markets
And then you mentioned that the food grade facility in Mexico is up, I am curious as to where are you in terms of selling out that facility? How much more capacity you have available for the marketplace?
Randy Gress
Probably the easiest way to do answer that is we just completed that at the end of the first quarter here as we promised and that capital investment basically more than doubled our food grade capacity down there. We have quite a bit of capacity available at this point and I think as I pointed out earlier, not only does it provide some opportunity for grosses within the acid, it also supports some of the growth within the specialty salts since it’s a raw material with the specialty salts and acids. And then on top of that I think it provides a good backup as well as flexibility to our total network especially with supply to the US and Canada.
Frank Mitsch - BB&T Capital Markets
I see, okay. All right, fine and then lastly you mentioned obviously the new contract for a new supplier of a phos-rock and I know you are in negotiations with others as well. How confident are you and how comfortable are you that assuming that OCP goes away entirely later this year that these new arrangements are going to be able to keep you up fully sourced?
Randy Gress
I think probably the best to answer that is we are pleased with the contract we just signed so it’s an important piece of our supply. I think we’ve said before that OCP has been a reliable supplier, we’d happy to add in the mix but we’re also confident that we can satisfy our needs in the future if necessary without them.
Operator
Your next question comes from the line of Edward Yang of Oppenheimer, please proceed.
Edward Yang - Oppenheimer
Hi, good morning and congrats in the strong quarter. My questions on pricing and it’s nice to see that you started raise price again, I think in the past you’ve been able to drive a lot of profit level of a price increases, I’d like to better understand first of all, why was pricing stronger than you expected in the first quarter? Was that just a function of better demand? And could you quantify what you mean by minor price increases and is there any potential for stronger performance in that in the second quarter and beyond?
Randy Gress
For the, I guess the better performance, lesser the decline than what we had expected where before we had expected roughly a 6% in (inaudible) 4%. We did see some price improvement in some areas there in the first quarter. I think supporting that was the one up in the fertilizer raw materials weighted theme. And for the second quarter, it’s a different call to say what we’ll achieve certainly we expect to reverse this trend here and historically as you said, we’ve done a good job and been successful in covering our raw material increases and certainly targeting to do the same here, going forward
Edward Yang - Oppenheimer
And with regards to Mexico, what was the impact from the delayed shipment in GTSP and I’d like to understand the cost that were associated with the earlier than expected start up, what contributed to that was that again, just a function of demand or what have you?
Neil Salmon
Sure. The potential of one of costs in Q1 that we don’t expect to continue in Q2 was, its around $2 million and that includes the final pieces of the legal cost related to OCP arbitration. With regards to GTSP shipments delayed into the second quarter, I think that figure was around $3 million in sales but the profit impacted is relative limited given that we still have the cost paid and the hundreds of thousands profit impact on that.
Edward Yang - Oppenheimer
And finally just on the expected cost increase from the lag supply contracts. Is that coming on the rock side, is that acid or sulfur?
Neil Salmon
Its combination of all of those and timings vary depending on our different contract, but as we’ve mentioned in Mexico we have firm rock pricing through September and then our US and Canadian contracts we set according to different conditions. So we are partly sulfur prices as they come through with partly on lags crossing 4 million.
Edward Yang - Oppenheimer
It’s interesting that you are calling that out though because wouldn’t you be able to with the better pricing department. Is there any chance that you could offset some of those expected price increases with selling price increases or better Mexican fixed cost absorption.
Neil Salmon
I did mention that we do, we are looking to mitigate I think. And Randy may comment further but we are little cautious at this stage as to what pricing we can achieve a year ahead as we have greater clarity or we wanted to give you an idea what we see as the potential resets in our cost of goods sold that’s why we have more than a idea at least based on current market pricing. So I’d agree that this is not the final word on this figure but we just wanted to give you an overview over cost reset that we see coming.
Operator
(Operator Instructions). Your next question comes from the line of Christopher Butler of Sidoti & Company, please proceed.
Christopher Butler - Sidoti & Company
I was wondering if you could give us any indication of whether there is still higher cost inventory in your system that’s going to come through in the second quarter at all?
Neil Salmon
Sure. In US and Canada we are betting those reset prices from the beginning of year that I’ve already mentioned. In Mexico, we did see some higher costs still related to purchases made before the OTT settlement and that will reduce during the second quarter, but it will be offset in the second quarter by increased raw material costs though at this stage we don’t see an improvement in margins in Mexico on the second versus first quarter.
Christopher Butler - Sidoti & Company
And looking at your industrial end markets, I was wondering if you could give us an indication you are seeing any improvement there and with the strengthening in the US overall or Asian imports becoming an issue or do you see them as an issue down the road at all.
Randy Gress
Yeah, Chris. In a couple of areas there, couple of questions there I think. One on the industrial side, we have seen some continued improvement in that area of the business also with some recovery I think you may recall that we were seeing that area down a 30% or so, last year, so yes we are seeing some recovery there and then as far as imports from the Asian area, they are pretty much still within the historical range but at the low end they have decreased some specially in the acid area going into specially the U.S. and Canada for this year.
Christopher Butler - Sidoti & Company
And switching gears to acquisitions, could you first up give us an idea of how much, what percentage of your sales was to South America, would this be your first choice of geographic expansion or with is Europe more appealing to you and just give us a little more color overall?
Randy Gress
I’ll ask Neil to address some of the breakouts there a little bit later. But first I’d like to say that what we have been targeting with our strong base within the North American zone to grow the business especially within our specialty salts and specialty acids area outside the North American zone that would include Europe but especially Asia Pacific as well as Latin America especially with what we’ve seen in Latin America and the strong base we have in Mexico. And Neil if you can add to that with the.
Neil Salmon
Yeah, so I think export sales in total especially phosphates, this excludes GTSP which is also predominantly export. But export sales were 12% full year 2009 and were 16% in the first quarter. So they continue to increase in our mix. 11% of the 16% were to South America. This is our largest developing market but we’re also going to stun Asia Pacific as well as we mentioned previously.
Randy Gress
And as it relates to any of the Bolt-on acquisitions that would be in support of our core business specialty salt, specialty acids especially and also, as that would support our growth geographically.
Operator
(Operator Instructions) Please stand by while the questions register. Your next question comes from the line of Adam France of 1492 Capital. Please proceed.
Adam France - 1492 Capital
Yes, good morning guys. Thank you for taking my call and not being an expert in business here, could you speak to when you talk about trial in various different rock suppliers? Just what are the variances that you see as you go through this process and how does it affect the quality of the end product?
Randy Gress
Yes Adam. I could give you a little bit on that. Basically, when they’re bringing in some different rocks, the rocks will have different quality from a I guess the base chemical, the phosphate content within the rock as well as some of the metals or quality of the content within the rock and what we do within our Mexican facility is convert that rock to MGA which is merchant green acid which is fertilizer grade acid and there is performance differences in taking that step but more importantly is we have technology to convert that MGA to purified acid for applications in the food as well as industrial side. And the technology and trials we are doing are to ensure our ability and performance in converting that MGA in the purified acids. I hope that answers your question or not.
Adam France - 1492 Capital
Okay, in terms of initial inputs there is no standardized specific phosphate content. It will vary depending on where you are getting the rock as well as the metals that might be in the rock as well. Am I understanding it correctly?
Randy Gress
That’s true.
Operator
Your next question comes from the line of Jeff Zekauskas of JPMorgan, please proceed.
Olga Guteneva - JPMorgan
Good morning, this is Olga Guteneva listed in for Jeff, how are you? I have a question on your Mexican attrition. So given the fact that you are transforming it into food grade. Do you think in the future you can get the profitability of the margins to the North American levels or there are some fundamental differences which would prevent you from getting there?
Randy Gress
Neil would you like to address that?
Neil Salmon
I think long term that direction although certainly, I think we have been clear on that and but clearly it does take time to build the kind of value added position that we enjoy in North America, we already increased resource in Latin America as it provides stronger customer support, technical service but the position we enjoyed US is, a result of a very long customer relationships as you are aware and also the facility is build that position in Mexico, but it will take a very little time to get back.
Olga Guteneva - JPMorgan
Okay, thank you and what was the capacity utilization in Mexico during the first quarter and if it changed over the course of the quarter, like what’s the entry level for the current period.
Neil Salmon
This is Neil again. This is always a difficult question to answer because we have many different units within the part as we discussed before, but broadly to give you an idea as we said before last year we are operating well below 50% capacity and in the first quarter I don’t think that was a significant exit rate change, but we were operating around just over that 50% overall for the plants full on some areas and bit different on some additional capacity as we have already talked on this call and others.
Olga Guteneva - JPMorgan
Thank you and lastly the house keeping question. Was the debt repayment, what’s the expectations for the interest expense for the year and going forward.
Neil Salmon
Yeah, well I think we said that the random saving from that debt repayment would be $5 million as there were some small rise up with the advanced cost on that previous facility. So I think on a P&L basis to this year, we’re looking at about $17 million to the year is that right or not?
Randy Gress
May be a little more from the first quarter may be 18 but on the manual, going forward basis $17 million.
Neil Salmon
Yes, $17 million annualized from the second quarter on it.
Operator
Your next question comes from the line of Richard O'Reilly of Standard & Poor's, please proceed.
Richard O'Reilly - Standard & Poor's
Asked about Mexico. The alternate supply, are you looking at receiving asset from other suppliers or you’re just looking at rock as a replacement.
Randy Gress
Richard, for I think what we had done historically prior to last year, was focused on rock because that’s by far our best way to operate the plant down there but the type of integration we have in the sulfuric production. As far as going forward, our plans are to source rock all though we do have the option to source MGA but the desire is to again go with rock as our base raw material.
Operator
You have a follow-up question from the line of Adam France please proceed.
Adam France - 1492 Capital
Yes, thank you. Randy with the balance sheet in great shape and business improving any thoughts on tying the dividend more directly to your bottom line EPS?
Randy Gress
Let me ask Neil to answer that.
Neil Salmon
Yes. I mean I think our focus on the moment is on investment potential and we’ve talked about some what high level of capital expenditure this year. We also expect a high level next year and also bolt-on acquisitions as Randy has mentioned.
So, we need to get further and understand the amount potential before looking at any alternatives on dividend policy that of course, we do plan to maintain the current level of dividend payment.
Operator
At this time, there are no further questions. I would like to turn the call back over to Mr. Randy Gress for closing remarks.
Randy Gress
I would like to thank you for joining us for the call this morning and I look forward to updating you on our further progress again next quarter. Good bye now.
Operator
Thank you for joining today’s conference. This concludes the presentation. You may now disconnect. Good day.
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