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Executives

Neal Butler – President, Chief Executive Officer

John Sobchak – Chief Financial Officer

Analysts

Eric Glover – Canaccord Genuity

(Charlie) – CJS Securities

Daniel Rizzo – Sidoti & Company

Alex Silverman – Special Situations Fund

Jay Harris – Goldsmith & Harris

David Cohen – Midwood Capital

Rosemarie Morbelli – Ingalls & Snyder

KMG Chemicals Inc. (KMGB) Q1 2011 Earnings Call December 9, 2010 10:00 AM ET

Operator

Good morning and welcome to the KMG Chemicals Incorporated First Quarter 2011 conference call. We would like to begin by reminding you that the information in this conference call includes certain forward-looking statements that are based upon assumptions that in the future may prove not to have been accurate and are subject to significant risks and uncertainties, including statements as to the future performance of the Company. Although the Company believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Factors that could cause results to differ include but are not limited to the loss of primary customers, successful implementation of internal plans, product demand, the impact of competing products, increases in the prices of raw materials and active ingredients, successful acquisition and integration of additional product lines and businesses, the condition of capital markets in light of interest rate and currency fluctuations and general economic conditions, environmental liabilities, the ability to obtain registration and re-registration of products, increased environmental compliance cost of products, and general political and economic risks and uncertainties.

With that, I would now like to turn the call over to Mr. Neal Butler, President and CEO. Neal, please go ahead.

Neal Butler

Thank you. Good morning, and again welcome to KMG’s Fiscal 2011 First Quarter conference call. John Sobchak, our CFO, and I will take you through the financials, provide an overview of each of our businesses, as well as update you on the integration of our recent electronic chemicals acquisition. We’ll also present our outlook for the remainder of fiscal 2011 and give you a preview of our expectations for electronic chemicals for fiscal 2012, which begins on August 1. After our comments, we will address your questions.

Our earnings release was filed earlier today and I hope all have had a chance to review it. You can access it on our website. We also plan to file our 10-Q tomorrow.

For the general summary for the first quarter, electronic chemicals performance was notably ahead of last year with the recovery in the semiconductor market and the success of efficiency measures implemented in conjunction with the previous acquisition’s integration. Performance associated with integration of the recently acquired electronic chemicals business from General Chemicals is proceeding extremely well and according to plan.

Penta performance was slightly better than anticipated, particularly as raw material costs increased. Creosote presented challenges both in terms of buy and driven by production demands, rail tie treaters, and average pricing. These issues have been addressed and we’ll expand on them in this call. Animal health, though still a very small portion of our business, delivered performance in line with expectations.

For the first quarter of fiscal 2011, net sales rose 26% to $62.1 million producing operating income of $5.6 million and net income of $3.5 million or $0.31 per diluted share, versus fiscal 2010 net sales of $49.4 million, operating income of $8 million, and net income of $4.6 million or $0.41 per diluted share for the same period in fiscal 2010. We recorded a tax benefit arising from the reversal of an NOL allowance from our electronic chemicals operations in Milan which added $0.036 per diluted share, which John will touch on later in this call.

The increase in net sales was due primarily to our March 2010 electronic chemicals acquisition. The previous year’s operating income was unusually strong, benefiting from a temporary shift in product mix and low input costs in our wood treating chemicals business. Meanwhile, the current year’s results have been burdened by the temporary costs associated with the integration of the most recent acquisition.

Now I’d like to discuss each segment and the outlook for each business for the remainder of the year. Before I do, it’s worth noting during the first quarter of fiscal 2011, we changed the methodology we use to allocate corporate overhead costs to our reporting segments. All corporate overhead is now allocated to the segment except for those amounts associated with KMG’s operations as a public entity such as Board costs, audit fees, et cetera. The allocation is based on segment net sales. We’ve revised prior year amounts to reflect the current methodology.

Now regarding our electronic chemical segment, sales increased by 60% to $36.8 million from $23 million in the prior year due primarily to the business acquired in March 2010. As compared to the fourth quarter of fiscal 2010, revenue increased incrementally with the anticipated flattening of demand. As we reported in our news release, we expect sales to continue at approximately first quarter levels for the coming quarter.

This segment contributed $3 million to operating income, an increase of 235% from $902,000 in last year’s first quarter, which reflects higher sales and the benefits of cost efficiency initiatives implemented in 2009 as part of our previous acquisitions integration project. This increase in operating income was achieved despite the cost burden associated with the integration of the recently-acquired business.

The integration and consolidation of manufacturing operations is underway and should be completed by fiscal 2011 year-end. When it happens, we will look forward to the majority of production volume shifting from third party co-manufacturers to our plants in Pueblo and Hollister, thus sharply reducing tolling fees. As a result of the additional production volumes, these plants will run at over 80% of capacity versus 50% capacity before the plant consolidation. The result is that the operating margins will increase by 200 basis points. I am pleased to report that the qualification process is moving forward and we expect all product moves to be completed by June of this year.

Following increasing sales and demand throughout fiscal 2010, we recently have experienced a leveling off in demand for our electronic chemicals consistent with trends in the overall semiconductor market. We see growing opportunities for organic growth in our electronic chemicals business with $15 billion of expansions in progress are announced for our customers in Texas, New York, Arizona and Oregon over the next few years. We anticipate that these opportunities will start to evolve into sales in fiscal 2012. Additionally, there are notable market share growth opportunities in western Europe that we are currently pursuing.

Moving to our wood treating chemicals business, wood treating sales were $24.2 million in the first quarter, down 9% compared to last year’s 25.5 million, due primarily to lower average prices for creosote. As we communicated in earlier conference calls, the first quarter of fiscal 2010 was unusually strong in our wood treating business with margins running at unsustainable levels. Overall, wood treating contributed $3.8 million to operating profits in the first quarter of fiscal 2011 compared to $8.7 million in the same period last year.

In our creosote segment, sales were $17.7 million, a 9% decrease from $19.5 million in the same period last year, the result of lower average prices. However, this was partially offset by a moderate increase in volume. Income from operations for this segment was $1.8 million for the current quarter compared to $6.3 million in the first quarter of fiscal 2010. The first quarter of fiscal 2010 was an unusually strong quarter for this segment due to a favorable but temporary shift in product mix along with improved pricing. Additionally, storage and rail car (inaudible) costs increased in the current quarter by $325,000 over the previous year. We anticipate that storage and handling costs for the rest of the fiscal year will approximate first quarter levels.

Average pricing during the quarter declined with the consolidation of our wood treating customer base coupled with the threat of offshore material finding its way to U.S. market. We successfully completed a significant supply contract with our largest creosote customer and anticipate pricing will remain relatively flat with the first quarter levels through the fiscal year.

While rail tie purchases by railroads for the 12-month period ending October 31 averaged about 19 million ties per the Railway Tie Association, treated rail tie production rates averaged approximately 16 million ties with the balance coming out of inventories, thus the reason for the notable variance between tie purchases and creosote demand. There has been and will continue to be some offsetting of this trend as the market shifts away from the blending of creosote with petroleum and moves to creosote-only treatments in 2011.

The general market consensus is that the rail tie purchases in calendar 2011 will be about 18.5 million ties and that, unlike calendar 2010, production rates will approximate purchases due to lower inventory levels. In general, we believe the reduced rail tie production demand to be temporary phenomenon, and as rail tie demand improves as the trade forecasts, so too should our sales volumes, resolving the freight and handling costs out of the equation.

Penta volumes rose over 10% due to an incremental increase in purchases of treated poles by utility companies, producing a $528,000 increase in sales in the first quarter. Income from operations from penta was $2.1 million compared to $2.4 million in the same period of last year with a reduction in operating margins due to higher raw material costs. We expect to see a gradual upward movement in demand during the balance of the fiscal year.

Regarding our animal health business, first quarter net sales rose 23.4% to $1.1 million from $933,000 in last year’s first quarter resulting in an operating loss of $397,000, on part with the operating loss of $370,000 in the previous year. The sales growth reflects improvement in the U.S. feed animal sector and the associated increase in demand for pest control. We also expect the normal seasonality of this business with sales heavily weighted towards the second half of our fiscal year to again prevail.

I will now turn the call over to John to provide additional information on the quarter and fiscal year, as well as discuss certain balance sheet and cash flow highlights. John?

John Sobchak

Thanks, Neal, and good morning everyone. A few points before beginning the discussion of 2011 results – as we announced in the fourth quarter of fiscal 2010, we are presenting distribution expenses as a line item separate from SG&A expenses in our consolidated statements of income. Also, all electronic chemical operations are now included in one electronic chemicals reporting segment, and prior year periods have been revised accordingly.

So looking at the first quarter results, gross profit margins were 28% of sales compared to 37% of sales in first quarter of fiscal 2010. Gross profit margins were unusually strong in the first quarter of fiscal 2010 due to a favorable but temporary shift in our creosote product mix, also higher creosote pricing and lower input costs in both creosote and penta. Additionally, the latest integration effort has temporarily diminished gross profit margins in electronic chemicals due to the duplication of certain (inaudible) costs as we relocate production operations from two contract manufacturing locations into the two plants that we own in California and in Colorado. As a result, gross profits declined by 6% to $17.4 million in the current first quarter compared to last year’s $18.4 million.

First quarter distribution expenses were $6.4 million compared to last year’s $5 million, but as a percentage of sales distribution expenses were essentially flat at 10.3% of net sales. Distribution expenses in our electronic chemicals segment declined this quarter to 14.4% of net sales from 18.1% of sales in the first quarter of fiscal 2010.

SG&A was kept in check at $5.4 million for both the current and prior year periods, but as a percent of sales it declined to 9% this quarter versus 11% last year. First quarter fiscal 2011 results also include approximately $176,000 of acquisition integration costs. That compares to the $663,000 incurred during the last four months of fiscal 2010.

For the first quarter, operating margins were 9%, a decline from 16% in 2010, with the decrease driven by the comparative reduction in gross profit margins from the exceptional levels of the 2010 first quarter discussed earlier.

Interest expense was $595,000 in the current quarter compared to $557,000 last year. Our income tax rate was 29.9% versus 37.3% in fiscal 2010’s first quarter. Our income tax expense was net of a discrete period adjustment of $410,000 reflecting the reversal of the NOL valuation allowance related to a foreign subsidiary.

The NOL allowance reversal is also reflected in the 38.1% effective tax rate we are estimating for the balance of the fiscal year. The lower effective tax rate for 2010 is reflective of the portion of the allowance that was reversed in that year due to taxable profits generated by that subsidiary in that year.

For the first quarter, net income was $3.5 million or $0.31 per diluted share versus $4.6 million or $0.41 per diluted share in the first quarter of 2010. Net working capital at October 31 was $43 million, including $4.7 million of cash. We continue to pay down borrowings, reducing our long-term debt by $5 million to $54.3 million which includes $17 million borrowed on our $50 million revolving credit facility, and also $17.3 million on the term loan. As of November 30, 2010, we pay an interest rate equal to 2% over LIBOR on our term loan and revolver borrowings.

Shareholders equity at October 31 was $90.1 million or $7.86 per diluted share.

Cash flow from operations was $6.5 million for the first quarter, which was relatively flat with the same period in 2010. The calculation of cash flow from operations is net of depreciation and amortization of $2.2 million versus $1.4 million in last year’s first quarter. CAPEX for this quarter totaled $1.9 million.

Neal Butler

Thanks, John. Before handing the call over for your questions, I’d like to provide you with some final thoughts and summarize our expectations for the remainder of the fiscal year. We’re extremely pleased with the progress being made to date on the integration of the acquired electronic chemicals business onto the KMG platform, and greatly appreciate the hard work that the entire KMG team has made in seeing that this transition is done on time and on budget. We’ve also enjoyed working with those that have joined us from General Chemical and equally appreciate their efforts.

As previously accomplished in the creosote and penta businesses, the execution of our consolidation strategy in the electronic chemical segment is again substantiating the effectiveness of our business model in achieving long-term growth. We will continue to see year-over-year revenue growth through our third fiscal quarter as we benefit from owning the acquired business for a full 12 months this fiscal year. We are enjoying increased market share and see the potential for significant organic growth over the next several years in this segment.

While the second quarter may be similar to the first in our wood treating business, we look for quarterly operating profits to return to more normal levels as the rail tie production rate increases to meet demand. We continue to expect fiscal 2011 to show an increase over fiscal 2010 with the second half of the year driving the expected year-over-year growth.

We will continue to stick to what we do best – that’s our proven ability to acquire, optimize, and grow niche specialty chemical business – which is maximize free cash flow from operations, allowing us to continue to fund both acquisition and organic growth initiatives plus repay borrowings and pay quarterly dividends.

We sincerely appreciate your participation today and now open the floor for questions.

Question and Answer Session

Operator

Thank you, sir. Ladies and gentlemen, at this time we will be conducting a question and answer session. If you would like to ask a question, please press star, one on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star, two if you would like to remove your question from the queue; and for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

Our first question today comes from the line of Eric Glover with Canaccord. Please proceed with your question.

Eric Glover – Canaccord Genuity

Good morning, guys.

Neal Butler

Good morning.

John Sobchak

Good morning, Eric.

Eric Glover – Canaccord Genuity

I just wanted a clarification. You mentioned that improved capacity utilization in electronic chemicals was expected to generate a 200 basis point increase in operating margins. What level are you referring to there? The 200 basis point increase from what level?

John Sobchak

Before we had acquired the business, operating margins for the North American business had achieved a 13% level, and the 2% improvement would be on top of that when all the dust settles in 2012.

Eric Glover – Canaccord Genuity

Okay, great. Thanks. And second, I’m a little confused on this trend in the wood treatment chemicals segment where some products in creosote are being treated by petroleum. How exactly does that affect your business, and is that a long-term trend or just a temporary thing, or--?

Neal Butler

No, we think it’s a long-term trend, and it’s a volume related issue. One of the things that occurs in the rail tie treating business is the option to use one grade of creosote, which is referred to as B1, and it can be mixed with petroleum. The other is to use a grade that’s just referred to as B2 and it can’t be mixed with petroleum. And most of the B1 market now is shifting to the B2 market, and as a consequence the volumes of creosote used will go up rather significantly just by moving away from the former blending processes. And again, we think that’s long-term, not short.

Eric Glover – Canaccord Genuity

Okay. Are you anticipating sort of flattish operating margins in creosote for the second quarter?

Neal Butler

I would say right now in the second quarter, we’ll see rather flattish relative to the first quarter, and we expect to see an uptick starting in Q3.

Eric Glover – Canaccord Genuity

And then last question – now that you’re breaking out distribution expenses, is there a target level as a percentage of revenue that you’re aiming for?

John Sobchak

Well, we believe that the levels that we have achieved now are very efficient, so any improvements we might see over these levels would be incremental. I would caution also that diesel prices have an impact on our distribution expenses, so any rapid increase in fuel prices could impact our results.

Eric Glover – Canaccord Genuity

Okay, thank you.

John Sobchak

But one other thing that I would like to add (audio interference) on to the next question, is that I had misspoke in regards to CAPEX. There is a typo there. Our CAPEX for the first quarter of fiscal 2011 was $2.2 million.

May we have the next question?

Operator

Thank you. Our next question comes from the line of Arnie Ursaner with CJS Securities. Please proceed with your question.

Charlie – CJS Securities

Good morning, this is Charlie calling in for Arnie. Acquisitions are clearly an important part of your growth platform. In the press release, you indicated it would probably not be until 2013 or 2014 before you add another consolidation platform. What factors lead you to conclude that it make two to three years to find or complete a sizeable transaction?

Neal Butler

When we look at our current strategy—when we look at the five-year strategy, we anticipate today that by about the end of 2013, we will have successfully completed the majority of the acquisitions that we can make in the electronic chemicals sector, which will prompt us to move to another platform; and identifying the platform, that takes, obviously, a while to ensure that we’ve chosen the right one. We’re working on that as we speak and our expectation is that we will have that targeted again by the end of 2013 or in 2014. In the interim period, though, there will be additional acquisitions. We perceive it will be primarily in the electronic chemicals area.

Charlie – CJS Securities

Okay. My second question is you’ve previously discussed and quantified integration costs. Were they greater than you expected, and what is your outlook for future trends in gross margins?

John Sobchak

In terms of the—what we had disclosed in the past were the third party integration costs. What we had predicted in the latter part of fiscal 2010 was $250,000 a month, and we came in quite a bit below that. In this quarter, we incurred substantially less integration costs, totaling about $175,000 for the three month period. That’s all going according to plan. The costs that are not included in that that are more difficult to quantify are the duplication of plant expenses as we gear up the two plants that we own in Hollister, California and Pueblo, Colorado to accept the product moves that are coming from the two contract manufacturing locations that we had that are in Bay Point, California and Dallas, Texas. So the third quarter and the second quarter is where most of those costs overlap and we start to see the benefits of the consolidation of production in the third quarter with that consolidation being fully accomplished by June of this year.

Neal Butler

And I do think it’s important to note that the costs are absolutely running in line with our expectations.

Charlie – CJS Securities

Okay, thank you. I’ll jump back in the queue.

Operator

Thank you. Our next question comes from the line of Daniel Rizzo with Sidoti. Please proceed with your question.

Daniel Rizzo – Sidoti & Company

Hey guys. So for the acquisition you’re talking about in the out years, that’s going to be a completely different segment; like, a fifth business segment?

Neal Butler

Exactly.

Daniel Rizzo – Sidoti & Company

And we’re just looking at—like, you don’t have any idea what or where or anything?

John Sobchak

Dan, we are looking at specifically in industrial chemicals, and we’ve identified certain SIC code sectors that we feel are highly fragmented with good profit profiles that fit our requirements well, and we’re looking for opportunities in that area. I do want to add that there’s a bit of an opportunistic aspect to this acquisition search, and if we found the right acquisition sooner, of course, we would look to bring it on sooner. According to our five-year plan, we’ve targeted that 2013/14 time period as the time period that would best fit our growth outlook.

Neal Butler

And I think, just to add to that, we have run these through our initial screening process and we have several fragmented sectors today on our radar screen, so I mean, we’re a little ways down the pipe on this process.

John Sobchak

We do a lot of research in these areas before we venture into it, so. In the meantime, again to reiterate what Neal is saying, there is a substantial number of opportunities in the electronic chemical space that we’re very interested in.

Daniel Rizzo – Sidoti & Company

Okay, thanks guys.

Operator

Thank you. Our next question comes from the line of Alex Silverman with the Special Situations Fund. Please proceed with your question.

Alex Silverman – Special Situations Fund

Good morning.

Neal Butler

Good morning, Alex. How are you doing?

Alex Silverman – Special Situations Fund

I’m well, thank you. You cite $15 billion in expansion either in progress or announced by customers in electronic chemicals. How much of that 15 billion is by existing customers that you have—that you do any real business with? In other words, sort of the lowish hanging fruit.

John Sobchak

$11 billion are with--$11 billion is with customers that we do substantial business with, and about $4 billion is with a new customer that we’ve been in advanced discussions with.

Alex Silverman – Special Situations Fund

Interesting. Those are great numbers. Thank you very much.

Operator

Thank you. Our next question comes from the line of Jay Harris with Goldsmith & Harris. Please proceed with your question.

Jay Harris – Goldsmith & Harris

As you look at your performance year-to-date, what were the, if any, elements of significant variance from your budgeted expectations?

Neal Butler

The primary driver is the variance, and I’m going to back up just a second there. There wasn’t—interestingly, there’s not a huge variance between our budget and our performance in the first quarter because we had anticipated a little bit of this. But I think it’s important to note that the primary driver for the variance is creosote. It was a consequence of two things. The volumes were down a bit from what was anticipated, and as we mentioned earlier, the treaters—the demand was there but the treaters were pulling ties out of inventory instead of running production at rates that were equaling demand, so that the inventory levels have decreased as a consequence. And the other thing is the pricing was less than what we anticipated.

Jay Harris – Goldsmith & Harris

Has this caused you to alter your expectations for the rest of the year?

Neal Butler

No, I don’t—we don’t have a dramatic difference in our expectations for the remainder of the year for creosote. Now, that’s fully anticipating that the demand cycle shifts and we see the production rates go up after the first of the calendar year.

Jay Harris – Goldsmith & Harris

John, looking at the press release and trying to figure out what your earnings on an ongoing operations basis look like, I would subtract the 410,000 of benefits that lowered your tax rate and subtract the integration expenses, and I’m coming up with about a $0.13 a share penalty to $0.31. Is that an appropriate conclusion?

John Sobchak

I lost you on that. The effect of the reversal of the NOL allowance was $0.036 per share. If you want to pro forma out the integration costs, that would be $175,000 increase to operating margins.

Jay Harris – Goldsmith & Harris

All right. So it’d just be a couple of cents a share below the $0.31.

John Sobchak

Right.

Jay Harris – Goldsmith & Harris

You have in the last two press releases commented on the desire, let me put it that way, to accomplish an efficiency improvement in Europe. What can you tell us about the probabilities of such event and what seems to be the obstacles?

John Sobchak

In Europe, we were looking at—we were pursuing certain business opportunities that would increase the plant throughput there. The issue in Europe is strictly production rates and taking advantage of the operating leverage that exists there. While we haven’t been able to bring in the agreements that we were pursuing in that regard, the business team there was successful at growing the business and also implementing incremental efficiency improvement measures there.

Jay Harris – Goldsmith & Harris

When you say growing the business, was that a market share increment?

John Sobchak

They’ve added about 5% to revenues in the photovoltaic industry, which was a business that they had no position in at all when we first acquired it back in December of 2007, so I think they’ve done a very good job of expanding their presence there. Also, they’ve been effective at getting some additional new customers in Europe. And I’d like to say the supply chain group in Europe was just as effective as the U.S. side at driving down supply chain as a percentage of revenue. They saw the same kind of efficiency improvement on distribution expense that the North American team was able to achieve. So they’ve been able to drive that business into a very profitable position even without the additional (inaudible) that we were looking for.

That being said, there are some significant organic growth opportunities in Europe that they are pursuing, and I think we have a very talented team there that’s running that business.

Jay Harris – Goldsmith & Harris

A couple more, if I might. The $15 billion of additional capacity, IC capacity that you expect to come on-stream in, I guess, 2012 and 2013 fiscal years. What does that represent in terms of a potential revenue increment for you?

Neal Butler

As much as I’d like to give you a number, that would be extremely difficult to draw some conclusion from. One of the things that we do know is that as they move into these new facilities—as these new facilities go to greater miniaturization, where you’re looking at the 32 nanometer, maybe 22 nanometer, one of the things that we do know is that the requirement for high purity process chemicals goes up; but it’s hard for us to estimate what that’s going to mean because, again, the addition—the CAPEX addition itself, obviously, provides significant opportunity. What we don’t know is what their processes are, and until we learn what the processes are, you don’t know what the demand is going to be for particular lines of chemistry.

John Sobchak

I’d like to add that it’s likely that, with this kind of an investment, the customers are likely to not want to rely on sole source, so I believe that the high purity process chemicals will probably be awarded to a couple of suppliers, and of course we’re trying to become the major supplier to all of them. But we’ll have to see.

Jay Harris – Goldsmith & Harris

Finally, without that increment, it occurs to me that you’re driving the Company to become, I don’t know, 70% electronic chemicals or some much larger number than that. Is that a reasonable conclusion?

Neal Butler

I don’t know that I would say we’re driving the Company to that. I will say that that’s the way the math is working out. But our intention is to take that particular sector, which is high purity process chemicals, and grow that sector to the point where we’ve met our basic criterion. One of them is to have a leadership position in that market, and once that’s accomplished – and you don’t always know what the absolute threshold is – but once we feel like we’ve done a very good job and have achieved what we need to achieve, we’ll move to another platform which, again, by virtue of math, is going to decrease the percent of our business that that will constitute. But again, we’re not driving to do that but that is the way the math works.

Jay Harris – Goldsmith & Harris

Are there any opportunities for you to establish a base of operations in electronic chemicals in Asia that interest you?

Neal Butler

We are looking very seriously at opportunities in Asia today. We recognize that some of the higher IP production will move to the Pacific Rim—or some of it has moved, but probably some of it will continue to move there. We need to be in a position, we believe, to participate in that market over there, so yeah, we’re looking very seriously at opportunities over there today. We don’t have anything teed up but we are taking a look at it.

Jay Harris – Goldsmith & Harris

Thank you, gentlemen.

Operator

Thank you. Our next question comes from the line of David Cohen with Midwood Capital. Please proceed with your question.

David Cohen – Midwood Capital

Yeah, actually my question about the margin improvement in North American chemicals was actually answered a lot earlier. Thanks.

Neal Butler

You bet.

John Sobchak

Thank you, David.

Operator

Thank you. Ladies and gentlemen, as a reminder, if you’d like to ask a question, you may do so by pressing star, one on your telephone keypad at this time. Our next question comes from the line of Rosemarie Morbelli with Ingalls & Snyder. Please proceed with your question.

Rosemarie Morbelli – Ingalls & Snyder

Good morning, all.

John Sobchak

Good morning.

Rosemarie Morbelli – Ingalls & Snyder

Just following up on Jay’s last question. Neal, are you planning on acquiring a business in Asia or do you think you go via a green plant?

Neal Butler

I don’t know the answer to that. I think what we’re doing right now, it would be very premature for us to make that kind of comment. What we are looking at is what the opportunity actually is. That traditionally has been a very low cost to serve market, so we have not participated to a significant degree there. Understand, we do business in the Pacific Rim today. We don’t have physical presence in the Pacific Rim with a manufacturing facility. Now, that is what we are looking at today to try to quantify what that opportunity is over the course of the next four to five years, and then make the determination do we acquire an existing operation? Do we put in a green field operation? Those are all options that are on the table but we really haven’t targeted either one of those as the appropriate one to take.

Rosemarie Morbelli – Ingalls & Snyder

And is the business you are doing in Asia with your current customers who are expanding there, or do you have a whole different group of customers there?

Neal Butler

The majority is with current customers.

Rosemarie Morbelli – Ingalls & Snyder

Okay. So you—one could argue that you actually need to follow them?

Neal Butler

To a degree. You know, they have a desire for you to do so which, obviously, we’re certainly willing to do and pleased to do. But that is a portion of it, yes.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And then if I may, you have talked about the game plan in order to grow the electronic chemical. You have talked about the (inaudible). Could you talk a little bit about your other areas and what are your expectations there, or is it just the creosote business, more or less, what it is today and just getting the cash and the profitability out of it. Could you address that question for the wood treating, for animal health? What are we going to be looking at three years down the road, or are they going to disappear?

Neal Butler

When you look at—take them one at a time. If you look at the wood treating business, we’ve made a number of acquisitions over the course of the last eight to 10 years in both creosote and penta, to the point that when you look at our definition of wood treating – and our definition of wood treating is confined to industrial treatment, which basically ends up being railway ties and utility poles – at this point, we’ve made just about most of the acquisitions, not all of the acquisitions, we believe we can make in that sector.

So you know, back to the original question – yes, it is a business now, but the consolidation strategy has worked the way it’s supposed to work. We’ve been able to maximize the free cash flow out of those businesses and we’ll continue to operate those and try to maintain maximum cash flow out of them. I don’t see us making significant acquisitions in either of those businesses. We’ve already talked about the electronic chemicals business and it’s very obvious, I think, to everyone that our intention is to continue to make acquisitions and grow in that sector.

The animal health business is a very small business, as you’re aware of. It’s probably running something slightly below—right at or below 5% of our total business to date. We are continuing to look at some acquisition opportunities, but we recognize that the acquisition growth in that sector is not as significant as it is in the other sectors, and we’re going to look hard trying to do something over the course of the next couple of years and then we’ll make a determination if we’re successful at consolidating; and if we’re not, then we’ll do something else with it.

Rosemarie Morbelli – Ingalls & Snyder

All right. Great. I appreciate the input.

Operator

Thank you. Ladies and gentlemen, our next question comes from the line of Eric Glover with Canaccord. Please proceed with your question.

Eric Glover – Canaccord Genuity

Just a couple more questions. Should we assume that the tax rate goes back to the sort of more normalized rate for the rest of the fiscal year?

John Sobchak

The effective tax rate for the rest of the fiscal year should be 38.1%.

Eric Glover – Canaccord Genuity

Okay. And what were inventories in the quarter?

John Sobchak

Inventories were fairly stable for the quarter and came out to $41.2 million as of October 31.

Eric Glover – Canaccord Genuity

And then finally, this potential new electronic chemicals business that you’re thinking of expanding into beyond fiscal 2012, is that product something that can be run through any existing facilities with expansion, or does that require use of acquired manufacturing plants?

John Sobchak

Eric, if you’re referring to the—are you referring to the new platform that we were discussing for the 2013/14 time frame?

Eric Glover – Canaccord Genuity

Yes.

John Sobchak

Oh, that would not be in electronic chemicals.

Eric Glover – Canaccord Genuity

Oh, did you say industrial chemicals?

John Sobchak

Yes, it’s industrial chemicals.

Eric Glover – Canaccord Genuity

Okay, sorry.

John Sobchak

It’d be pretty unusual if we’d be able to run that business through the existing facility.

Eric Glover – Canaccord Genuity

Okay, I misheard that. Thanks.

Operator

Thank you. Ladies and gentlemen, at this time we have no further questions; and I’d like to turn the call back to management.

Neal Butler

We sincerely appreciate everybody’s participation today. We also appreciate the questions. Since this is our last conference call of the year, we want to wish everybody on the call still a Merry Christmas and happy holiday season for the coming year. So thank you.

Operator

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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