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Executives

Linda Ferguson - VP and Corporate Secretary

Joe Carleone - CEO

Dana Kelley -, CFO

Analysts

Lee Author - Hammock Investors

Bruce Baughman - Franklin

American Pacific Corp. (APFC) Q2 2010 Earnings Call Transcript August 4, 2010 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 American Pacific Corporation earnings conference call. My name is Jasmine and I will be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today Ms. Linda Ferguson, Vice President and Corporate Secretary. Please proceed.

Linda Ferguson

Good afternoon and welcome to our review of the financial results for the third quarter of fiscal year 2010. Joe Carleone, Chief Executive Officer and Dana Kelley, Chief Financial Officer will each provide remarks. Following their remarks, we will be happy to take your questions.

Today’s call includes forward-looking statements. You can identify these statements by the fact that they use of words such as will, expect, believe and other words and terms of similar meaning. These forward-looking statements are not historical facts and are subject to risks and uncertainties. Our actual results may differ materially. For a description of the factors that may cause actual results to differ materially from our forward-looking statements, please refer to the risk factors forward-looking statements section of our earnings release furnished today to the SEC on Form 8-K and also to our most recent quarterly report on Form 10-Q and our other filings made with the SEC.

All forward-looking statements are made as of the date thereof and we assume no obligation to update these statements except as required by law. In addition, we will be referring to both GAAP and non-GAAP financial measures. Our recently published earnings release contains definitions of these non-GAAP measures and a reconciliation of these non-GAAP measures to the most comparable GAAP measures.

Our earnings release can be found in the News Release section of our website at apfc.com.

I will now turn the call over to Joe.

Joe Carleone

Good afternoon ladies and gentlemen and thank you for joining our conference call. As we expected, the fiscal 2010 third quarter was one of our weaker quarters. We expect our fourth quarter to be stronger, but not as strong as originally anticipated because of weaker forecasted Fine Chemicals sales for Q4 than previously expected. Based on this we are forced to lower our guidance.

While this is certainly a disappointment, we see opportunities in future that will allow recovery to passive organic growth. As indicated in our last two investor calls 2010 will be the year of repositioning our corporation for improved future profitability and to prepare for and take advantage of new opportunities we see emerging.

We made considerable progress this quarter towards this repositioning. More specifically we have frozen our defined benefits pension plan which affects new employees, bought back and cancelled $5 million of our outstanding notes as 2 points below par and we have launched our corporate wide cost reduction initiatives, and improving the profitability in each of our business units and eliminating certain corporate cost.

Let's now move to a discussion of our Prime chemical segment. While the future potential of the Fine Chemicals business segment continues to share remarkable promise, we continue to have several near term issues resolved. Fiscal ‘10 sales have slipped because of order reductions and delays in the approval and demand for products coming through our pipeline. In addition current quarter three delays to validate a new process have placed traditional downward pressure on fiscal 2010 revenue.

New process activities such as these provide the basis for new or increased orders. Because of this situation we now see sales of this segment to be down 20% to 25% compared to fiscal year 2009 rather than the 15% difference projected a quarter ago. Separately, we received an FDA warning letter associated with our inspection last February. The essence of this letter was an insufficient amount of detail initially submitted on our corrective actions for the observations coming out of our inspection.

We have incorporated the appropriate corrective actions and are resubmitting to the FDA. Our Fine Chemicals pool is focused on these regulatory and operational matters and we are confident that the actions being taken will overcome them. Furthermore, we have reduced work force and our Fine Chemicals segment by 10% to address the reduced production requirements. Looking to the future we continue to see strong growth in our product pipeline. As mentioned in our last call the areas of controlled substances applying biocatalysis to anti-viral building block and expanding into the Japanese market, all continued to develop positively. In addition, we are very near to signing a long-term agreement in the area to controlled substances.

Further more, we are seeing a strong emphasis for pharmaceuticals chemicals to support the efforts of the Homeland Security Department to prepare for the consequences of potential bio-terrorism incidents. Finally, during this quarter our fine chemicals team negotiated the three-year agreement with the Machinist Union at our California facility.

Now moving on to Specialty Chemicals, the Specialty Chemicals segment continues to perform well. While revenue was down as a result of reduced demand for ammonium perchlorate production is running well even with very little plant utilization. This is a significant achievement demonstrating that we have reconfigured our organization in Utah to deal with a much lower production volume in a very cost effective manner. The team is in the process of producing significantly less ammonium perchlorate products than produced a year ago with the exceptional high quality and good productivity.

You may recall that NASA’s proposed budget may remove solid rockets and hence ammonium perchlorate from its near term plans. Therefore, this demonstration is very important in that it proves we can respond to the potential of future reductions and demand. As far as the NASA budget deliberation there have been several very important and positive statements that have occurred during the quarter.

The most significant is the United States Incentive Support received Nelson's authorization bill which would authorize NASA to accelerate the development of the heavy-lift vehicle as well as to use the technology from the consolation program, including solid rocket motors. A similar bill is going through the House, which will be finally decided after the summer recess. If successful, and we believe the reconcile bill will be successful this approach will move the development of the heavy lift vehicle up to 2011 next year from the 2015 date and the administration’s proposed plan.

We look at it as a positive indication that NASA will continue to support the large solid rocket motor industrial base. Also the Department of Defense has confirmed their need for and support of the solid rocket motor industrial base. DOD’s requirements for solid rocket motors will continue for many years. Therefore, the ammonium perchlorate product line will continue to be a strong part of our corporation. The production in sale of other chemicals in this segment continued to be stable.

Let's now discuss the Aerospace Equipment segment also known as AMPAC In-Space Propulsion. Opportunities continue to grow for our liquid propulsion business. Year-to-date sales are up over 20% compared to segment sales for the first nine months of last year. We are somewhat disappointed there are profitability in this segment has not returned to expected levels. But the reason for it has been identified and actions are in place to reduce costs of manufacture and development.

The most significant event this quarter was a major competitive win resulting in the finalization of the two-year contract with OHP system of Brennan, Germany to produce 14 propulsive modules for the full operational capability portion of the satellite supported European Navigation Systems Program. This is the European version of the GPS system. They will likely purchase an additional eight units in the future. It is our intent to win these additionally units as well. Our strategy for this segment remains on track, pursue propulsion systems, built a strong technical team and grow our presence in the European Space marketplace.

In conclusion, I believe you will see the considerable long-term growth opportunities exist for AMPAC. In addition we are focusing on our cost structure and operational excellence to include margins. As we stated earlier 2010 is a year of repositioning our businesses to capitalize on new opportunities as they arrive. I would like now to introduce our CFO Dana Kelley who will discuss the financial aspects of the quarter and our guidance for the year. Dana.

Dana Kelley

Thank you Joe. For fiscal 2010 third quarter we have reported revenues of $37 million compared to $31 million for our third quarter last year. Consolidated adjusted EBITDA for the quarter was at breakeven. Our net loss was $4.6 million, resulting in diluted loss per share for the quarter of $0.61.

On Chemical segment revenue for the third quarter were $20 million compared to $15.6 million for our third quarter of last year. The quarter-over-quarter increase reflects tiny differences between the quarterly periods. As Joe indicated our Fine Chemicals segment revenue for the fiscal 2010 year will be declined in the range of 20% to 25%.

Fine Chemicals operating performance for fiscal 2010 third quarter was negatively impacted by higher than anticipated costs associated with validating a profit change. We also experienced other manufacturing inefficiencies that contributed to the cost increases.

Our specialty chemicals segment reported revenues for the third quarter of $8.2 million compared to $6.3 million in Q3 last year. While single on an annual basis this business segment can vary widely between the quarters in a fiscal year due to the size of individual orders. Also, third quarter of this year and last year are revenue volume quarters relative to the full fiscal year performance.

Smart business in this segment remained stable and strong despite the fact that we are producing at a rate that is substantially below the prior years. Fiscal 2010 margin percentages have improved a few points. This is primarily because we are currently manufacturing product and that's absorbing manufacturing overhead to support firm orders in early fiscal 2011.

Third quarter revenue for our aerospace equipment segment of $8.6 million reflected slight decline over the last year's third quarter but made a solid contribution to this segment 23% year-to-date top line growth. Margins for this segment continued to be down as compared to the last year's period. You'll recall earlier this year we experienced growth on certain (inaudible) systems contracts and recorded losses.

From that point on we record revenues on these contracts at below profit. This will have the effect of holding down the segment’s aggregate margins through the completion of the loss of position contracts. Our cash flow for fiscal 2010 to date remained strong. Our operations have generated $23 million of cash flow and we ended the quarter with cash of $32 million and no borrowings against our revolver.

In June, we repurchased and cancelled $5 million of our outstanding notes, our strong cash flow and debt reduction have enabled us to reduce our net leverage during the fiscal year to 2.6. We are adjusting our fiscal 2010 guidance, primarily to reflect our updated expectation of Fine Chemicals revenue performance and the related effects on profits.

For fiscal 2010, we anticipate revenues of approximately $170 million and adjusted EBITDA in the range of $23 million to $25 million. That concludes our remarks and we’d be happy to take the questions at this time.

Question-and-Answer-Session

Operator

(Operator Instructions). Your first question comes from the line of Lee Author with Hammock Investors. Please proceed.

Lee Author - Hammock Investors

You haven’t mentioned in a while, product you were trying to do for I think was fertilizer, is that dead or is it still working?

Joe Carleone

Well, its still under evaluation by the EPA. The product is an excellent product and it works fine. We are having difficulty getting approval from the environmental protective agency for its use and the primary concern with that is any potential hazard that it may have with people performing the application. The data we have shows that its safe but it is really hung up in the quagmire of the bureaucracy of the EPA right now.

Lee Author - Hammock Investors

A little more color I mean is there any chance that at any time we want to see kind of a breakthrough or is it just.

Joe Carleone

I think right now there's a fairly low probability that that product is going to make to market in any near time soon.

Lee Author - Hammock Investors

And its not the product itself, it is just the way they would have to apply it, is that it.

Joe Carleone

Well EPA has a number of regulations as to the testing that you have to do and so forth and we have provided a lot of data. On those tests in terms of the safety and toxicity and so forth. But they still have not made a ruling on what we call the end point. And the end point is how much can a worker apply per day with the appropriate protective equipment. They haven’t made the determination.

And that determination will then dictate the financial aspects of it. Will this be financially meaningful to produce compared to competing products. Now it is aimed at replacing a product that's going off the market and so we are still waiting for that information from the EPA and at that point we would then go forward and part of it, I don't want to get too technical here but a part of it hung up on whether they consider the material a fumigant or they do not consider it a fumigant and that’s the base going on right now because for a fumigant the requirements are much more difficult than if it's non-fumigant and we’re kind of in the grey area right now, with that product.

Operator

Your next question comes from the line of Bruce Baughman with Franklin. Please proceed.

Bruce Baughman – Franklin

Question is if Nelson’s bill passes what's the timeline for related perchlorate purchases?

Joe Carleone

We believe our purchases will stay on target for fiscal ‘11 regardless of the timing of the passage of the bill. Its really whether if it doesn’t have to enter into a continuing resolution and we believe our near term orders will stay constant but right now the expectation is that it won't actually clearly become a part of the continuing resolution until after the November elections. So our expectations of the timeline is that the house will reconvene after Labor Day. They will pass a version of the Senate’s bill and then that would become part of its continuing resolution which would not really get approved until after the November mid-term elections.

Bruce Baughman - Franklin

I guess the point of the bill is to move development of the, I forgot the term, but the new space shuttle from 2015 to 2011 right?

Joe Carleone

Correct the heavy lift part of it?

Bruce Baughman - Franklin

The heavy lift, how does that affect the actual consumption of the fuel.

Joe Carleone

Well our expectations would be that there would be similar knack for demand as to what they had bought this year which is basically the equivalent of two of the Ares 1 vehicles. So that’s the equivalent, since some things would stay fairly constant for the next few years during the development which would be very good for us in terms of the production. The alternative, if that does go away altogether then Department of Defense will be then supporting the entire solid rocket motor industry and we have had discussions with the Department of Defense and they understand this and I believe are prepared to deal with the situation which would obviously cause some price increases along the ammonium perchlorate.

Bruce Baughman - Franklin

Let me ask you this way then if Nelson’s Bill doesn’t pass and the status quo remains which is development in 2015, does that make any difference in terms of the amount of perchlorate that's actually consumed?

Joe Carleone

Yeah, the amount of pounds will go down roughly by 40% of what we are producing this year but we do have a contract and DOD understands this that we will necessarily increase our unit price to cover our fixed cost.

Bruce Baughman - Franklin

And how long does that pricing matrix remain in place.

Joe Carleone

It runs in place right now from 2013 and we are negotiating, we are in the middle of negotiating a potential two-year extension to that or perhaps even longer so we’re in discussions with our customers right now on the extension of that.

Operator

(Operator Instructions) Your next question comes from the line Greg (Limple). Please proceed.

Unidentified Analyst

I saw the freeze of the defined benefits plan for new employees and just wanted to get a clear understanding of the additional cuts to G&A that are able to be made given the performance of the business. And then the second question, I would just like to understand the rationale for the buyback of the bonds instead of just purchasing stock given the bond maturity of 4.5 years away.

Joe Carleone

Well on the first question, we closed as of I think it was July 1. We closed retention plans for new employees, which reduces our long term liability and we probably don't see any immediate savings which reduces the liability as we had new employees and we are adding new employees in parts of our business. So I don’t see that affecting our G&A rates or costs immediately in any way.

Unidentified Analyst

Are there any additional cuts that are able to be made?

Joe Carleone

Yes we are looking at our corporate cost and we’ve launched our corporate wide cost reductions and we are targeting all the operating costs not only at our corporate level but at all of our individual businesses. And we will be, we could get off about a month ago and we would be working diligently intelligently to reduce a lot of expenditures that we see that we can do especially in the areas of travel and other fixed types of costs.

Unidentified Analyst

In terms of the reduction what's the outcome that you expect to see in terms of the reduction level in cost, as a final result.

Joe Carleone

I don’t have a specific number to give you but we've planned it to be significant. Its not just going to be a few hundred thousand dollars, its going to be significant number and we will be getting those plans in from our division. We do our, we are in the process of doing fiscal ‘11 planning right now and the divisions we will be reporting in mid-August with the plans and we will be looking at reducing their activities. So I'm reluctant to give you a number until I see the plans coming in from our divisions, but we should be prepared to say something next quarter about that.

Unidentified Analyst

Okay. And then could you give me a little bit of color on the decision to buy back the bonds instead of doing the share buyback.

Joe Carleone

Again we looked at our cash position and we had the opportunity. These bonds came up on the open market. We didn't buy them back under our buy back plan or under our current. We bought them up on the open market as anyone would and we were alerted that these bonds were available and they were available at a good price basically at the price we were carrying them on our books, so we are able to remove that debt which helps our leverage as well in those small amounts and will reduce our interest payments on an annual basis of roughly $450,000 per year. So we felt that that was a better use of our cash at that point in time because the opportunity arose and we've talked to a number of people about it and felt that was the best use of our capital at that time.

Unidentified Analyst

Well I appreciate you answered my question and I look forward to following up in August to understand further about the G&A cut. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of (inaudible) with Wells Fargo. Please proceed.

Unidentified Analyst

The new contract that you won in the aerospace equipment segment, the two-year contract, can you give us kind of a level of magnitude, a ballpark figure for a revenue number on that, or is that like a $5 million number or a mid-teens or.

Joe Carleone

Well, let me try to help you along with that, our customers has not allowed us to disclose the value of that contract at this point in time. We have asked for permission for that and we don’t have that. So I can't give you a specific number but we were able to get at least 14 propulsion modules and I think if you track what propulsion modules for satellite tend to cost you can come up with an estimate that’s pretty close.

Operator

At this time there are no further questions. I would now like to turn the call back over to your host for today, Mr. Joe Carleone. Please proceed.

Joe Carleone

Well, I certainly want to thank everyone for interest in our company and taking time out of your precious schedule to listen to our call. We will look forward to seeing you and hearing from you on our next call. Thank you.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: American Pacific Corp.Q2 2010 Earnings Call Transcript
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