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Executives

J. Neal Butler - Chief Executive Officer, President, Director and Member of Risk Oversight Committee

John V. Sobchak - Chief Financial Officer and Vice President

Analysts

Jay Harris - Goldsmith & Harris

Steven Schwartz - First Analysis Securities Corporation, Research Division

Daniel D. Rizzo - Sidoti & Company, LLC

Eric Glover - Canaccord Genuity, Research Division

Rosemarie J. Morbelli - Gabelli & Company, Inc.

KMG Chemicals (KMGB) Q4 2011 Earnings Call October 13, 2011 10:00 AM ET

Operator

Good morning, and welcome to the KMG Chemicals Inc. Fiscal 2011 Fourth Quarter and Full Year Financial Results 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 this 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 price of raw materials and active ingredients, successful acquisition and integration of additional product lines and businesses, the condition of capital markets in the light of interest rate and currency fluctuations and general economic conditions, environmental liability, 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 Neal Butler, President and CEO. Thank you, Sir. You may begin.

J. Neal Butler

Thank you. Good morning, and again, welcome to KMG's fiscal 2011 fourth quarter and year end conference call. John Sobchak, our CFO, and I will take you through the financials and provide an overview of each of our businesses. We'll also discuss the outlook for fiscal 2012. After our comments, we'll address your questions. Our earnings release was filed earlier today and I hope all of you had a chance to review it. You can access them on our website. We also plan to file our 10-K tomorrow.

We generated record revenues in both the fourth quarter and full year of fiscal 2011 driven by increased sales of electronic chemicals and higher volumes of Creosote in Wood Treating Chemicals business. We operate profitably in each quarter of fiscal 2011 and generated positive cash flow for the year while making substantial investments in our corporate infrastructure, paying down debt and increasing our cash dividend. As many of you are aware, we announced our expectations for the fourth quarter in early September. Our record revenues have in large part validated our targeted consolidation pieces in growth strategy. Our bottom line results were below expectations driven by a combination of higher than expected raw material prices, distribution cost and some lingering lucrative manufacturing costs associated with consolidation of our electronic chemicals manufacturing following our acquisition from General Chemical.

With this consolidation initiative completed, the higher cost material that was produced during the transition period is being worked down, and we expect that any consequential cost associated with those activities will be behind us by the end of this first fiscal quarter of 2012. Additionally, the pricing actions we put in place in the second half of fiscal 2011 and the first quarter of 2012 are expected to offset the raw material cost increases in both Electronic Chemicals and Wood Treating Chemicals businesses.

Fiscal 2011 was a transformative year for KMG following the acquisition of General Chemical's Electronic Chemicals business and successful integration into our operation. We've consolidated manufacturing, expanded critical capabilities necessary to facilitate organic growth and establish ourselves as a leading U.S. supplier of high purity process chemical sort of semiconductor industry. This is an important achievement given a solid demand environment for these products and the additional business associated with a more than $15 billion of customer expansion initiatives in the United States and any of which are currently underway.

We completed several important supply contracts in our Wood Treating business and have also solidified our position as a major supplier and manufacturer of Wood Treating Chemicals. This will allow us to benefit from the strong maintenance and railroad tie replacement rates that are anticipated through calendar 2013.

With fiscal 2012 underway, many aspects of our strategy are coming together. The actions we have taken and investments we have made to position KMG to capitalize on the wealth of opportunity, and here in our markets and deliver superior returns to our customers. And before I turn things over to John, I'd like to discuss the 2011 performance and outlook for the business.

Regarding our Electronic Chemicals segment. For the fiscal 2011 year, sales increased 35% to $151.5 million from $112 million last year, due primarily to the acquired business, along with increased demand due to improvement in semiconductor manufacturing. In the fiscal 2011 fourth quarter, sales increased by 10% to $40.2 million from $36.5 million in the fourth quarter of last year. The majority of our growth in the fourth quarter was organic as the 2010 fourth quarter inflated the full 3 months of sales from the Electronic Chemicals acquisition. We continue to see a healthy in-market but recognize that a recession, our significant global economic downturn, could negatively impact sales. Our customers are taking a cautious outlook, but so far we have not seen a material decline in demand. Although some European semiconductor manufacturers have advised a slowdown in the fourth calendar quarter, the European market is a relatively small part of our Electronic Chemical sales, and we have not seen that response in North America. This segment contributed $6.2 million to operating income in fiscal 2011, down from $8.4 million in fiscal 2010. In the fourth quarter, operating income was $262,000 in fiscal 2011 versus $2.8 million in fiscal 2010. This decline was due primarily to the aforementioned higher raw material cost as well as higher manufacturing and distribution expenses associated with integration of our most recent acquisition. Global price increases were phased in during the end of fiscal 2011 and additional product specific increases are planned for the second quarter implementation.

As we mentioned previously, we held off on implementing this pricing actions earlier in fiscal 2011 in order to facilitate a smooth and complete requalification process for our customers. While this approach impacted our earnings in fiscal 2011, we were able to maintain virtually all of the pre-integration sales volumes of these products. These pricing actions will move us from more normalized operating margin. Our consolidation initiatives were completed in the fourth quarter, and with the exception of one product group, we've eliminated outsource production in third quarter manufacturing site, significantly increasing capacity utilization in our Pueblo and Hollister plants. We will continue to have one product group made for us in Bay Point, California consistent with our original plan.

As result of additional production volumes, our Hollister and Pueblo plants are expected to run at over 80% of capacity beginning in fiscal year 2012 as compared to approximately 50% varying the same time frame last year prior to consolidation. We're achieving the manufacturing efficiencies we anticipated and along with the pricing strategy to offset raw material cost increase anticipating the second half of fiscal year being able to regain a 15% operating margin for this business before the inclusion of corporate advocations and absent a sudden downturn in the market. In fiscal 2011, we won significant additional business from a larger customer that is expanding operation to U.S., the impact of which we expect to realize in the first quarter of fiscal 2012. We also won significant new business from a large customer building a new fabrication plant in U.S. that has slated to go on streaming on third fiscal quarter of 2012. Although the amount of these 2 expansions will generate for us is not yet certain, we expect they will initially represent an excess of $6 million per year of additional revenue with a potential to ramp up in future years.

As noted above, we encourage by the average expansion plans that our customers have in various stages of planning and development and believe we are well positioned to supply their future growth needs.

Now moving on to our Wood Treating Chemicals business. Wood Treating sales were $30.7 million in the 2011 fourth fiscal quarter, an increase of 40% over the 2010 fiscal quarter. The 2011 fiscal year, sales rose by 21% to $104.1 million. The quarterly and yearly increases was due primarily to higher sales volume in the Creosote segment. Entering fiscal 2011, a portion of the market that was using a higher grade of Creosote blended with petroleum oil to treat railroad tie shifted to our lower grade of Creosote that is not blended with petroleum oil. The shift to a pure Creosote treatment, however, does yield a better quality treated rail road tie. The shift also includes, in greater sales -- results rather in greater sales volumes of Creosote, although lower grade of Creosote employed demands at lower price and yields a lower unit margin. Overall, Wood Treating contributed $3.4 million to operating profits in the fourth quarter of fiscal 2011 and $14.8 million for the fiscal year compared to $4.7 million and $23 million, respectively, in the 2010 fourth quarter and fiscal year.

In our Creosote segment, sales in the fiscal 2011 fourth quarter rose 53% to $24.5 million from $16 million and for the fiscal 2011 year, sales increased by 27% to $80.5 million. Income from operations in the Creosote segment was $2.2 million for the current quarter compared to $3 million in the fourth quarter of fiscal 2010. Margins were negatively impacted relative to 2010 due primarily to lower average prices from the shift in product mix and renegotiated contract pricing coupled with higher average cost for purchased material. In fiscal 2011, we repositioned KMG in the Creosote marketplace following a substantial consolidation of our customer base. We've been able to execute strategic customer contracts and solidify our position as the leading merchant market supplier to the industry. While the results of the execution of this strategy has been higher volumes, it somewhat lower prices that adversely impacting our gross margins relative to year-over-year comparisons. We believe they will ultimately benefit the long term strategic position of this company and this important U.S. infrastructure market.

Industry reports issued by the Railway Tie Association forecast rail tie purchases to remain strong through 2013. Penta sales were $6.2 million in the fourth fiscal quarter compared to last year's $6 million. For the fiscal year, sales were $23.6 million versus $22.8 million in fiscal 2010. We've seen a modest rebound in the volume of utility post treated as compared with the downturn in treating in fiscal 2010. Income from operations from Penta was $1.2 million dollars in the fourth quarter, down from $1.7 million in last year's fourth quarter. For fiscal 2011 Penta's operating income was $6.5 million compared to $7.1 million last year. Margins were pressured by high raw material cost. We implemented a price increase in the first quarter of fiscal 2012 to offset these costs.

Now looking at our Animal Health business. Animal Health represents about 4% of our revenue. Fiscal 2011 fourth quarter net sales are $3.3 million and $10.8 million for the year compared to $4 million and $10.6 million, in respective periods last year. In the fourth quarter, sales suffered slightly from reduced [indiscernible] pressure in the Western and Southwestern U.S. as a result of drought in these geographic areas. Income from operations in the quarter was $2,000 compared to a loss from operations of $31,000. Of the 2011 fiscal year, income from operations were $61,000 compared to a loss of $86,000 in fiscal 2010. We recently obtained product registrations in some key South American markets, produced and have begun selling products into those new markets. We continue to pursue additional registrations and sales opportunities in that region. We are pursuing a variety of opportunities in this segment that are in line with our strategic growth plans.

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

John V. Sobchak

Thanks, Neal, and good morning, everyone. First, let me remind everyone that starting in the first quarter of fiscal year 2011, we changed the method we use to allocate corporate overhead cost for our recording segments. All corporate overhead is now allocated to the segments except for those amounts associated with KMG's operation as a public entity, such as board costs, audit fees, et cetera. The allocation is based on segment net sales, and we've revised prior year amounts to reflect the current method. The segment operating profits provided by Neal just now were net of those overhead allocations.

For fiscal 2011, net sales rose 28% to $266.4 million producing net income of $9.7 million or $0.85 per diluted share versus fiscal 2010 sales of $208.6 million and $15.3 million of net income or $1.34 per diluted share. Net sales rose by 19% to $74.2 million for the fourth quarter of 2011 versus $62.5 million in the final quarter of fiscal 2010. With the increase, a result of increased sales of Electronic Chemicals and higher volumes in our Wood Treating Chemicals business. Gross profits increased to $71.4 million or 26.8% of sales in the 2011 fiscal year compared to last year's $69.7 million or 33.4% of sales.

For the fourth quarter, gross profits were $18 million or 24.2% of sales in fiscal 2011 versus $18.6 million or 29.8% of sales in fiscal 2010. So the fiscal 2011 year, operating income was $17.7 million or 6.7% of sales compared to $27 million or 12.9% of sales in fiscal 2010. And for the fourth fiscal quarter, operating income was $2.7 million or 3.6% of sales compared to $6.3 million or 10% of sales in the final quarter of fiscal 2010. The decline in gross profits and operating income in the fourth quarter in fiscal 2011 year, as Neal mentioned, was primarily driven by higher raw material costs in both Wood Treating Chemicals and Electronic Chemical and cost associated with the consolidation of our Electronic Chemicals manufacturing base, following our last acquisition. Most of the additional cost related to our consolidation initiative were the result of expanded operations that both our Pueblo and Hollister facilities while our contract manufacturing location continued to be operated on our behalf by Air Products and General Chemical as production was being transitioned out of those sites. The manufacturing plant consolidation was completed in June and these extraordinary costs have been eliminated.

To provide a high level of supply surity [ph] to our customers, we built the inventory advanced of the cutover manufacturing and expect to have -- and virtually all of that higher cost product sold out of inventory in this first quarter of fiscal 2012. Fiscal 2011 distribution expenses were $29 million compared to last year's $19.3 million. As a percent of sales, distribution expense was 10.9% of net sales compared to 9.3% in fiscal 2010. Most of the increase in distribution expense can be attributed to this 28% year-over-year increase in revenues mainly from business associated with the March 2010 Electronic Chemicals acquisition and a 2011 run-up in diesel prices.

SG&A were $24.8 million for the fiscal 2011 year compared to $23.4 million in the prior year period. The increase is mostly attributable to the plants acquisition offset by a smallest SG&A reduction in other areas. As a percent of sales, SG&A declined to 9.3% for fiscal 2011 from 11.2% last year. Interest expense was $2.3 million in fiscal 2011, essentially flat with fiscal 2010's interest expense. And in fiscal 2011, our income tax rate was approximately 35.1% versus 37.5% in fiscal 2010. Net working capital at July 31 was $45.2 million including $1.8 million of cash. We continue to pay down borrowings reducing our long-term debt by $10.1 million to $49.3 million during fiscal 2011. At fiscal year end, our borrowings included $17.9 million drawn on our $50 million revolving credit facility and $11.3 million on the term loan. Currently, we pay an interest rate equal to 2% of the LIBOR on our term loan and revolver borrowing. For the 12 months ended July 31, shareholder's equity was $96.5 million or $8.40 per diluted share and cash flow from operations was $12.7 million for fiscal 2011. And now, I'll hand it back to Neal.

J. Neal Butler

Thank you, John. Now for some final thoughts and our expectations for the new fiscal year. My reasons for confidence in 2012 include the market trends we're seeing in each of our business areas are encouraging. We expect better results from fiscal 2012 and beyond to be primarily driven by improved profitability in our Electronic Chemicals business. Now that we've completed our manufacturing consolidation project and taken up pricing actions to offset raw material cost increases. We're seeing organic growth in our Electronic Chemicals business, particularly in the United States. To date, this has been driven by a solid demand environment and additional business coming on stream. We remain optimistic about this market but keep a close watch in the dynamics of the global economy recognizing that a significant downturn could negatively impact demand for electronics.

Semiconductor manufacturing forecasting indicate a flattening to slightly decline in global semiconductor market. We're seeing a minor downturn in semiconductor production in Europe but have not experienced the material effect or seen a decline in our business forecast in the United States market where we have a far greater presence. In our Wood Treating segment, we expect to see strong demand for Creosote continue to be driven by railroad maintenance programs. We have confidence in our strategy and believe it will continue to provide opportunities for sustained growth and revenue, earnings and cash flow. We have a comprehensive 5-year strategic plan and are confident in our ability to meet the objectives it lays out. At fiscal year 2011, that plan has produced a tripling of revenues since 2007, a compound annual growth rate of 21% per EPS is measured off a 5-year regression line and a 70% rise in shareholders' equity. Building upon this success is what drives each of us every day at KMG. In that regard, we're seeking ways to expand our Electronic Chemicals and Wood Treating business, both organically and via acquisitions. We have a robust pipeline of acquisition prospects in both our current businesses as well as opportunities to create a new segment platform, which we intend to establish by fiscal 2014.

And lastly, before answering your questions, I would like to point out that we will be presenting at Sidoti & Company's Fourth Annual New York Conference on November 10 and the Gabelli & Company Specialty Chemical and Ag conference on November 18. Both conferences will be taking place in New York City. We hope to see some of you there. We'll be posting our slide presentation on our website. We appreciate your participation today, and I open the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Eric Glover of Canaccord.

Eric Glover - Canaccord Genuity, Research Division

First question is on the SG&A line. That was about $2 million higher than our forecast for the quarter. I was wondering if you could explain that. And then, can we assume that goes back down to approximately high $5 million, $6 million for fiscal 2012?

John V. Sobchak

Good morning, Eric. Yes, SG&A was somewhat impacted by the manufacturing cost part of -- or excuse me, not manufacturing costs but by the increase in the duplicative plant expenses as we were ramping those down. I have to take a look at what might have been included in your total assumptions there.

Eric Glover - Canaccord Genuity, Research Division

Okay. Well on a sequential basis, it was a pretty significantly strong. Do you think it's just the increase expenses from the duplicate plant operations?

John V. Sobchak

We had some increases in the administrative costs associated with that. There were some increases in regulatory spending in our Animal Health business that increased at high couple of hundred thousand dollars also. We do expect the SG&A expenses to trend back down. In the first quarter, they still will be a little bit higher than the previous quarters trends but -- then we expect them to come back down following the completion of some of those regulatory spendings I talked about.

Eric Glover - Canaccord Genuity, Research Division

Okay. And then on the Electronic Chemicals business. Should we assume that the price increases that you've implemented will be fully in effect in the October quarter? So we should see a meaningful bump up in margins in Electronic Chemicals starting in October?

J. Neal Butler

I think, if you look at the price increases that we've implemented, it was actually implemented, 2 of them. The impact of those -- they have been fully implemented. The impact of those will be seen in the second -- you'll actually see a bit of it in the first quarter, but the full impact would be seen in the second quarter. Now, we primarily as a consequence of us burning down the higher cost inventory that we talked about as a consequence of running both of the plants. So long oration, but the answer to your question is yes.

Eric Glover - Canaccord Genuity, Research Division

Finally, you mentioned the $15 billion of semiconductor plant expansions occurring in the U.S. What portion of that will be in fiscal 2012?

J. Neal Butler

Well, if you're asking what portion of that will manifest itself in 2012 in business for us, it's going to be.

John V. Sobchak

It's about half of that.

J. Neal Butler

Yes, I can add up about $8 million of it in 2012.

Eric Glover - Canaccord Genuity, Research Division

$8 million in sales?

J. Neal Butler

$8 billion, pardon me, I'm sorry, $8 billion.

John V. Sobchak

$8 billion of that CapEx expansion was planned for completion in our fiscal 2012, and we start to see the revenue from that in 2012 and more so in 2013. The rest of it is going to be primarily spent in our fiscal 2013, and again there is kind of a lag before that manifests itself as revenue for KMG.

J. Neal Butler

One of the 2 is actually coming on as we speak. The second one actually comes on stream will have a material impact on revenue in our third quarter of 2012, at least that's the forecast now.

Eric Glover - Canaccord Genuity, Research Division

Is there a way to ballpark that estimate of -- kind of impact to your Electronic Chemicals?

J. Neal Butler

We believe in 2012, we'll see an impact. We can calculate about $6 million, beyond that it's hard to guess because we won't know that until the second one really comes on stream.

Operator

Our next question comes from Daniel Rizzo of Sidoti & Company.

Daniel D. Rizzo - Sidoti & Company, LLC

Creosote sales rose 53% in the quarter and that's great. I mean, is that because of the change in the product, like to the less to the lower margin mix? It doesn't seem that, that would be sustainable?

John V. Sobchak

I'm sorry, Dan, could you say it one more time.

Daniel D. Rizzo - Sidoti & Company, LLC

The Creosote was up 53% and that just seems, like, unusually high. I was wondering, I mean, could you just elaborate on what that's from? Is it from you just selling a different type or the lower margin type of Creosote or is just increase rough insertions?

John V. Sobchak

Yes, the increase in Creosote volumes, Dan, was primarily related to that shift in the market from the higher grade petroleum blended Creosote to lower grade that's not blended with petroleum oil, so that results in an increase in Creosote volumes. We've also seen a recovery in the rail tie treating market. And if you look at the Rail Tie Association's website, the substantial increase in production volume of treated rail ties which -- we don't think that, that kind of increase trend is going to continue, but we do think that the level that we're at now does represent the level where we will be for at least through calendar 2013.

Daniel D. Rizzo - Sidoti & Company, LLC

Okay. And then with the acquisitions, I mean, it seems that you've got your debt down to a pretty nice level here, so I would imagine that you're much more comfortable doing something going forward. How is the pipeline looking these days? And is there any particular [indiscernible] you're looking at?

John V. Sobchak

Yes, we're actually very encouraged about by the pipeline as Neal mentioned, because there are some interesting opportunities in our existing businesses that we're very encouraged by, but we're also seeing some very interesting new segments, new platforms that we're looking at.

Daniel D. Rizzo - Sidoti & Company, LLC

And that would be a completely fourth platform?

John V. Sobchak

Yes.

J. Neal Butler

Yes, Dan. Today, we've probably have the most robust pipeline we've had probably ever.

Operator

Our next question comes from Rosemarie Morbelli of Gabelli & Company.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Just following up on the benefit from the extension from your 2 customers. That $6 million of revenues, is that annualized as of the third quarter level, or is that the full amount that you are expecting to see in 2012?

John V. Sobchak

That's annualized from the third quarter level. I'm sorry, the third calendar quarter. I think it's what you are referring to, right?

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Right. When the second trend come on streams. I am assuming that it's your third quarter not calendar.

John V. Sobchak

It's kind of approximate what we expect to see in fiscal 2012, Rosemarie.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Okay, so we will see $6 million in 2012. And do you have an estimate for 2013 since you will have only one quarter from the second trends benefit?

John V. Sobchak

No we don't, yet. We're still working on that with our customers. And really one of the main reasons is one of these new facility is a foundry, so it's a contract manufacturing for semiconductor companies that don't have their own manufacturing facility. So our sales to that foundry is largely dependent upon what kind of manufacturing contract they have, which they haven't shared with us of course.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Right. Okay, but I am assuming that they would not be building it if they did not expect to have quite a bit of business.

J. Neal Butler

Yes. The facility itself actually is just about completed. We've actually started -- begun shipping some small quantities of material to the facility for them as they're getting -- bringing equipment online, and it won't be fully operational until fiscal, I mean, until calendar 2012. But the facility itself is completed to the point that equipment has been installed and they're actually purging systems now.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And on the distribution expense, I mean, it was -- I know 9% for last year's full year but for last year's fourth quarter, it was 8.2% of revenue and this year 10.3%. How much can you get it back down? And besides diesel, does it depend on anything else that you have control over?

John V. Sobchak

Part of the shift in distribution expense, Rosemarie, was this increase in percentage of revenue that our Electronic Chemicals business represents. The Electronic Chemicals business is a distribution expense intensive business whereas in Wood Treating Chemicals, we're selling that product at our plant gate, $1.5 million savings.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

That is very helpful. And then you are seeing that you can go back to your normalized margin on the Electronic Chemicals now that you have a reachable yield capacity. Do you have some kind of a timing as to when you can get back to that 15% and I understand it is prior to corporate expense.

J. Neal Butler

What we communicated thus far is that we anticipated being back at that 15% kind of level in the second half of 2012, our fiscal 2012.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And does that imply demand at the level it is today?

J. Neal Butler

Basically, yes.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And if you could give us a better feel on what you are seeing in the cost increases on your raw material, and whether the price increases you have instituted recently will fully offset not only the dollar amount but you will -- get you back to the previous margins? Or can you just or are you just getting the dollar amount increase?

John V. Sobchak

Rosemarie, I'm sorry, would you repeat that one more time, please.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

It wasn't very clear. I apologize. Your raw material cost increases, are they going to be fully recovered by price increases, but not just on a dollar basis, in other words, you're cost is at $1, you get $1 in price increases that your margin comes down. Are you going to fully recover, not only the dollar amount but also the margin?

John V. Sobchak

Of course our intent is to recover the margin and to get back to a 15% margin. As we've said before, corporate allocations for the Electronic Chemicals business. We actually estimate that during fiscal 2011. We fell short by about $3.4 million in operating income due to raw material cost increases. We've made up a portion of that, a good portion of that would be price increases that were implemented in the fourth fiscal quarter. We have some additional pricing actions planned, as Neal mentioned, coming up in the second fiscal quarter of 2012. You can imagine, it's a bit of a moving target because some costs, some raw material costs are continuing to go up whereas others are not. So going forward, it's going to be on a much more targeted basis.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And you really held off on the price increases in order to maintain the volume. Do you think that you are not going to lose any volume as you are now increasing your selling prices?

J. Neal Butler

One of the things, Rosemarie, obviously, you always run the risk of losing business as a consequence of your pricing actions, but we really don't anticipate the pricing action we're taking having a material impact on the volume of business or on revenues. Typically, when we have cost increases, we've always been able to pass those increases along on our pricing issues within maybe about a quarter lag time. Obviously, in 2011, we consciously made the decision from a strategic standpoint to hold off on those until such time as we completed the requalification process because the requalification process was a critical element for us to ensure that we got completed and completed effectively. We didn't lose any business as a consequence, no material business. We lost maybe a few small pieces, but they were in consequential. And going forward, as we implement the price increases going forward, it's done underneath the same kind of approach we've historically taken, and we don't believe it is going to have a major shift in business now. Sometimes you do lose a bit, but you'll gain a bit but it won't -- we don't believe a material impact anywhere.

Operator

[Operator Instructions] Our next question comes from Jay Harris of Goldsmith & Harris.

Jay Harris - Goldsmith & Harris

I'm going to phrase a question. I'm not sure how to phrase it. If you ignore raw material cost changes in Creosote, the switch from the lower grade, which was blended with, I would say, fuel oil to a higher grade, which has a lower margin. What does that do to your overall profits, not profitability but profits? In other words, per individual rail road tie treated, do you make less money, the same amount of money or more money now?

John V. Sobchak

Actually, Jay, the product that is blended with petroleum oil, that grade of Creosote is actually a higher grade. The market has moved to a lower grade that is not blended with petroleum oil. The pure Creosote treatment, does yield a higher quality railroad ties though, a pure Creosote treatment is more efficacious for this application. Our approach, Jay, has been that with the pricing that comes along with selling the lower grade material but higher volumes, that our operating profits would be approximately flat as a result of this transition. Now, fiscal 2011 was a bit of a transitional year, and we saw a significant recovery during the year in the rail tie treating industry, and you can see from the revenues in our fourth quarter that rail tie treatment has picked up significantly from the prior quarter.

Jay Harris - Goldsmith & Harris

What is the mix now between the 2 grades that you're selling or will sell in fiscal 2012?

J. Neal Butler

We haven't reported that blend, that ratio.

John V. Sobchak

We can't disclose that, Jay.

Jay Harris - Goldsmith & Harris

Are you eventually going to get 100% to what John has indicated as lower grade, lower-priced, lower-margin material?

J. Neal Butler

No, there are still some markets that are specific for the higher grade and the P1 level of Creosote. For instance, the utility pole market still uses Creosote. They use the higher grade and that portion of market remains at P1 level.

Jay Harris - Goldsmith & Harris

And just to delve a little further into Creosote before I go on to Electronic Chemicals. When do you know that you're -- how much advance notice you get that you're purchased materials costs are going up?

J. Neal Butler

You're talking about Creosote now?

Jay Harris - Goldsmith & Harris

Yes.

J. Neal Butler

Typically, it's about 90 days.

Jay Harris - Goldsmith & Harris

And so why -- what was there in your sales contracts that caused you not to raise your prices earlier in the fiscal year that just ended?

John V. Sobchak

There were a blend of events. One of the things that we mentioned, well today and some earlier releases in reports is that there were some notable consolidation that occurred in the customer base and in that process, we had to renegotiate some supply contracts. One of the things that occurred in renegotiating some of the supply contract was setting prices and pricing concessions made and the early portion of that and then the increases would come subsequent to that, so that had an impact on it and the other one is just mix. We have Creosote that comes from multiple sources that's not all the same price and the mix has an impact on the margin as well and the mix, during a portion of the early part of the year had a more negative impact on it.

Jay Harris - Goldsmith & Harris

If crude oil prices come down and the BTU value of Creosote declines, will you get a cheaper purchased material? And then will you have to pass that through to your customers?

John V. Sobchak

You know, we've actually looked at the correlation between Creosote prices and crude oil prices, and you can imagine it's not a very tight statistical relationship; however, directionally, in there does seems to be a relationship. And in Europe, primarily, Creosote is used not as a wood preservative but as a fuel source for carbon black production. The alternative being low-grade residual fuel oil. So it stands to reason that there would be some relationship between that residual fuel oil and Creosote cost. However, the supply and demand market for Creosote products is more complex than that. It's a by-product for one, and it's driven by -- the supply of Creosote is driven by the steel and aluminum industries, so it's tough to give a blanket comment about that, Jay.

Jay Harris - Goldsmith & Harris

If your purchase costs come down, do you have to reflect that in your selling prices? Or would you prefer not to answer the question?

John V. Sobchak

I mean, Jay, our customers are astute and understand where the market has been the value proposition we bring to the table. So it's a negotiation.

J. Neal Butler

Yes. And the process just isn't that simplistic, Jay, unfortunately.

Jay Harris - Goldsmith & Harris

Okay. Well, what percentage of your Electronic Chemical revenues are in Europe?

John V. Sobchak

It's about 20%.

Jay Harris - Goldsmith & Harris

And what is the outlook in 2012 for those revenues?

John V. Sobchak

From our perspective, we're looking at fairly flat revenues in 2012. Our team there has made some, I believe, impressive progress at winning additional business. That's going to be offset by the slowdown that's being signaled to us by our customers there for the fourth calendar quarter.

J. Neal Butler

Sans a significant downturn in the market, we forecasted our business to be up slightly out of our European facility in 2012.

Operator

[Operator Instructions] Our next call comes from Steve Schwartz of First Analysis.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Just back on this Creosote dynamic, can you guys give us an idea of why the market has made this change to pure Creosote versus blended?

J. Neal Butler

There are a myriad of reasons for that and I guess I'll just maybe isolate on a couple of them. One was there was a lot of material available at the P2 level. So it was available to the marketplace, that's the first thing. The second thing is there were a number of the treaters that were promoting the pure P2 treated tie as a better quality tie and a higher quality tie than one that was blended with the P1. I mean, that was 2 components, but there are a number of factors that went in to the market shifting over to the P2.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Got you. And, John, tell me if I've got this wrong, the pure Creosote is of higher value to the railroads, yet it's not reflected in higher value to you guys as the Creosote supplier because you noted a negative mix impact, is that right?

John V. Sobchak

Well, let me rephrase it for you. The treated tie that's a result of a pure Creosote treatment is actually a more efficacious, a better quality tie for the railroads. The Creosote that we sell into that tie is actually a bit of a lower quality Creosote than the one that's blended with petroleum oil. The reason why the pure Creosote tie results in a higher quality tie is because the petroleum oil dilutes the effectiveness of the Creosote treatment.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Okay. And then I did see one thing put out by, I think, the Progressive Railroading magazine or something like that and they had noted the RTA data and, Neal, you talked about the RTA forecast through 2013. But if we could just look at the short-term, it looks like the trailing 12-month purchase rate is like 21 million ties, yet the RTA is maintaining their calendar '12 forecast for about 20 million ties, which kind of implies that these last few months of this year could actually be weaker year-over-year? Is that kind of a dynamic you're expecting to play out?

J. Neal Butler

Well, I think one of the things to keep in mind is that last year, last calendar year, the demand and the production rate were not in sync. The demand was higher than the production rate, which was -- and the reason being that the railroads were actually pulling down inventories of rail ties, and I think last RTA report I showed -- saw that the ratio was about 0.7:1, so they keep somewhere around anywhere from 3 quarters to a year's worth of inventory, and they were pulling down the inventories, so the production was running behind the demand. So I think a portion of it is a little bit catch-up and building inventories back up. I mean, that's the reason right now you sort of seeing the demand and production rate a bit out of sync in the other direction.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Okay. So really need to kind of discount that RTA purchase forecast relative to the type of demand you're seeing. Okay. And then just my last question and again in railroad and the Creosote related to the 45G tax credits. If I recall your customer base has a stronger mix of sales to the short line railroads, and you can correct me if I'm wrong, but I think there are some strong demand being created there by this 45G tax credit which would expire at the end of the year. Do you expect that, that could be an impact on your business in '12?

J. Neal Butler

We don't see that and what we're operating off of and what we've done historically, and this probably proven to be the best leading indicator are the forecasts from the RTA.

Operator

[Operator Instructions] It appears there are no further questions at this time. I'd now like to turn the floor back to management for closing comments.

John V. Sobchak

Before we embark on the closing comments, I would like to go back to the question that Eric Glover had raised about SG&A cost. In the fourth fiscal quarter of 2011, SG&A was $7.7 million versus $7.2 million in the fourth quarter of 2010. We did incur some additional administrative expenses associated with the ramp-up of the transition of manufacturing relative to the consolidation strategy that's behind us. We also saw -- excuse me, approximately $220,000 of additional regulatory spending in the Animal Health business associated with a data calling for some registrations as I had mentioned in my response, Eric. So that accounts for the difference. And then, Eric, if you would like to talk to me later on about those costs, I could perhaps give you further insight after we file our 10-K tomorrow. We'll have more information on that.

J. Neal Butler

Okay. With that, we appreciate your participation today. We equally appreciate the continued support of all our investors, and we look forward to seeing some of you at the upcoming conferences. Have a good day.

Operator

This concludes today's teleconference. You may now disconnect your lines at this time, and thank you for your participation.

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