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Amcol International Corp. (NYSE:ACO)

Q2 2008 Earnings Call

July 18, 2008 11:00 a.m.

Executives

Lawrence E. Washow - Chief Executive Officer, President, Chief Operating Officer

Gary Castagna - Chief Accounting Officer and Treasurer

Donald W. Pearson - Chief Financial Officer and Vice President

Analysts

Al Kaschalk - Wedbush Morgan

Rich Wesolowski - Sidoti and Company

Todd Vencil - Davenport & Company LLC

Jay Harris - Goldsmith & Harris

Operator

Good day and welcome to the AMCOL International’s second quarter 2008 earnings results conference call. Today’s call is being recorded. (Operator Instructions).

The speakers today will be Mr. Lawrence E. Washow, President and Chief Executive Officer. Mr. Gary Castagna, President of AMCOL Minerals; and Donald Pearson, President and Chief Financial Officer. At this time, I would like to turn to call over to Mr. Lawrence E. Washow. Please go ahead, sir.

Lawrence E. Washow

Thank you and welcome everybody. I thought I would make a quick note. Obviously, in the introductions you heard that Don has joined us. For those that might have missed that over the last quarter, Don Pearson has joined AMCOL as Chief Financial Officer, and Gary Castagna has taken on the role of Global President of AMCOL Minerals and I think two movesthat are really going to improve the organization a good deal. So, we will hear from both Don and Gary over the course of the call today.

Back to the numbers, by now I trust you have had a chance to look over the press release. A good solid quarter. Obviously, very pleased with the revenue growth across all of the reporting segments. Pretty solid in terms of the revenue. Profitability improvement was very good. Not as good in all areas as we would like, but we will talk about that as well.

Starting off with the minerals segment, we had revenue growth pretty much across all the product lines. Certainly international is doing well, Asia in particular. Just very strong as you can see from the breakdown, certainly the pet products, and some of the specialty areas like petroleum products, the business continues to be very strong. So, good demand and I think we are finally starting to begin to turn the corner on the margins. The sequential margin was up from the first quarter. And we expect that trend to continue. And to me, it is particularly encouraging in light of the fact that in the second quarter the energy costs again continued a pretty dramatic increase. So, we were able to overcome that and see some improvement. And as I said, that improvement will continue as we go throughout the rest of the year.

Environmental, good results all the way around. Europe continues to be a very strong contributor. And the US is doing well, particularly in the lining tech and building materials group. Again, we are looking at strong backlogs. Pretty busy just about anywhere you look around the world for the environmental activity. And we expect that to continue as well.

Of course, the star of the quarter, oil field services, just an excellent quarter all the way around. We completed an acquisition midway through the quarter. That hit the ground running and was a contributor, as you will note in the press release. But, the team is working extremely well tying these businesses together that we have acquired over the last couple of years and really creating a service organization that is getting a lot of good recognition in obviously a market that is very busy. So, we are very encouraged with oil fields and again, expect that to continue to perform very well.

Transportation is seeing the impact on margins of fuel pricing and trying to manage that and keep a relatively good business level. But, certainly the revenue side is strong. And in light of the overall slowdown in the US, we are pretty pleased with the performance there.

A quick note on overhead, I did mention it in the press release that certainly we have seen an increase there, primarily on the corporate side and with the IT spending. Benefits cost went up substantially this year. And we have increased our overhead spending projects that probably will not bear fruits, in terms of revenue here in the near term. But, we think in the years ahead it is going to be some interesting projects that we have underway.

That is a quick summary of the overall. Don, financially?

Donald Pearson-

Thanks, Larry. I will provide some further remarks and a statement of operations, financial position, and a cash flow. First of all, on the revenue side as Larry said, we have seen strong growth in all segments. What I would like to highlight here is the minerals area, where we have continued to see strong overall demand, particularly, in the Asian/Pacific area, in metal casting and specialty materials.

However, I’ll point out that in the US metal casting area, demand remains relatively buoyant. We are seeing, where we would see some fallout perhaps in the auto area ancillary markets and foundries for oil field and other areas are picking up.

Also importantly, is the freight pass through revenue. I believe everybody is aware that we are required to book our revenue pass through on freight into the revenue line. And as a percentage of our base business, that has been declining. In Q1 it is about a third of the base revenue growth, has declined to about a fourth. So, that is encouraging.

US pricing initiatives are taking traction. In Q2 we saw increase in the margins in the gross margin level. So that effect is occurring. We expect to see continued pricing activities and improvements in the gross margins in the second half.

Moving on to gross profits, again a 25% growth over the prior year. However, the gross margin line has declined by about 50 basis points. Importantly, we want to point out on a sequential basis, that we have had an increase over Q1 of about 260 basis points. Again, a lot of that is going to be driven from the pricing initiatives in the minerals area, where we continue to see energy input costs increasing and mining costs increasing. But the pricing initiatives in minerals again are containing that.

Also in the oil field area, we had 110 basis point increase over the prior year. But, sequentially, looking at oil field is a 6% increase over the prior quarter. And I will also point out that environmental also had about a 1% increase over the prior quarter.

On the GS&A, Larry mentioned the heavy increases there of about 20%, 28%. Again, what I would like to highlight is the fact that all of the segments have reduced GS&A as a percentage of sales. So, it is really about what is happening at corporate.

Again, we see continued increases in costs in the benefit area in claims. So we do have plans in place to understand those and attempt to control those. We also have continued spending on the IT infrastructure costs as we build out global ERP systems that will benefit the company into the future.

Moving to operating profits, we had a 50 basis point decrease in a prior year. We have obviously had gross margin improvement. That was again offset by an increase’s in GS&A.

Point out again that sequentially compared to the prior quarter we had a 340 basis point increase in the operating margin, again, driven by the seasonality of some of the businesses, and profitable business growth. Particularly with oil field operating margin going from 16 to 23% and environmental improving from 10 to 16% sequentially over the first quarter.

Interest expense has increased, obviously relating to our average debt levels increasing.

An area that I would like to spend a little bit of time on is Other Net. We are starting to see minority interest become a factor in our reporting. So we have moved minority interest up to this Other Net line from Income from Joint Ventures. It has really been a non-factor in the past. But as business where we have minority interest accounting, as they continue to grow in the future, we want to have this in a line item that will be more visible.

In the Other Net, you will see about $530,000 of profit. That is really a function of gains on a currency hedge that we had on the Australian dollar for a pending mine in South Africa, offset by foreign currency fluctuations and again, the minority interest. In the future, on this line item, we will see mainly minority interest and foreign currency fluctuations.

Income taxes effective rate, generally comparable to where we would be in the prior year. As a reminder, we have a research and development credit that we would see later on in the year that would reduce our effective tax rate by about a point.

Moving on to financial position, we have had an increase in debt for the year, really a function of funding the acquisitions. Our total debt as a percentage of capital right now is about 41%. I’ll point out that working capital has increased by about $50 million. A majority of that is due to receivables. That is really a timing difference and a reflection of the growth in sales. In the month of June we saw a higher proportionate of sales for the quarter.

So, certainly, we would expect to see with both the growth we are receiving and the timing of the sales, an increase in the working capital. That said, it is something that we are continuing to look at and get our arms around on the levels of working capital, particularly in a receivables line. I think with that, I will turn it back to you Larry.

Lawrence E. Washow

Thanks, Don. And Matt, why don’t we open it up for questions?

Operator

Thank you. The question and answer session will be conducted electronically. (Operator Instructions) We will pause for just a moment to assemble the queue.

And our first question comes from Al Kaschalk with Wedbush Morgan.

Question-and-Answer Session

Al Kaschalk - Wedbush Morgan

Morning guys! An excellent quarter. Larry, just wanted to follow up on the comment about the price increases that are going to be coming through. Do you feel in terms of not necessarily a bottoming here, but you are getting close to the bottom where you have captured some of these or identified the cost increases that you may be able to pass along.

Are we really in a situation where a surcharge is just related to the transportation, or is there a quota, a markup where you are actually going to be covering more than your own cost increases going forward?

Lawrence E. Washow

I think your expectation is that the reality of what we have done so far and will see in the quarter’s ahead Al, is that we are improving the margins. We are certainly capturing the additional costs, but at the same time, we need to get the margins back to appropriate levels of the mineral side in particular. And they are not there. So, we are definitely moving beyond just trying to cover the cost elements that have increased and improve the margins back to traditional levels.

Al Kaschalk - Wedbush Morgan

And then, so other than materials, which I think everybody is pretty aware of, are there other concerns that could be forthcoming on the other segments in this area? Or is it the strength is already pretty good; the need to put through price increases? Do you need to stay on top of that there? How are you monitoring?

Lawrence E. Washow

Yes. We have to see how it is doing. When you look at an environmental segment, for example, raw materials that they use for the GCL line will be nonwoven materials that are ultimately polypropylene or some derivative of natural gas or oil. So, they have certainly seen increases in their input costs as well. They do use energy in the environmental sector. So, we are definitely on top of similar situations there, fairly again, aggressively on a project basis they are moving the pricing up to ensure that we maintain the margins. There are some projects that were committed last year coming through this year where we will see a little impact on the margins in the environmental sector, but in general I think they've done a good job in keeping with, keeping on track of the cost increases and should see pretty stable margins for that group.

Al Kaschalk - Wedbush Morgan

And on the oil filled services side, and particularly on the drilling, could you help us understand, I mean, explain whether for the moment, what area do you have more geographic exposure? Or where will we be concerned if we saw some slowdown as it relates to your business?

Lawrence E. Washow

The oil field service side is really heavily dominated in the Gulf of Mexico right now and we've got a good group building and growing in Malaysia that will cover the Asian region and we've been in Aberdeen historically for quite some time so that's an element of it. And we're in Africa as well. And most of the jobs in the oil field service are projects, so if there's a big project in Africa and we get it we'll be there for an extended period of time.

For example there's one that will be starting up in Brazil in the near future. That'll go on for a couple of months so it really depends on the success of those guys in winning the projects, but given the package of services that we offer and the equipment and the support that we've got, they've really got a nice story to tell and very good results and capability to really deliver value to the customers. So, and I think in terms of the U.S., obviously this is the hurricane season coming up. That could certainly impact the oil field services. It's always one of our unknowns, about two to three for that group, but the rest of the world should continue to be strong, albeit a fairly small piece of their business.

Al Kaschalk - Wedbush Morgan

Do we have any projects that could be winding up, of a material size, that would impact the top line growth in this business?

Lawrence E. Washow

That, I mean there are the projects again, they're ongoing all the time so there's not any one project that has a material impact. It's really just making sure we're keeping a number of projects going and as one gets complete there's more in the queue to take over, so nothing, no one project of that significance.

Al Kaschalk - Wedbush Morgan

And then finally, just a little comment on the trends on lining and environmental and building, are you -- outlook here, fairly confident or have you seen any softening in markets that maybe you want to comment on? And then if there's any that are maybe overcompensating for that softness?

Lawrence E. Washow

Yes, generally the business is very strong and we do see, particularly in the waterproofing building materials group, some areas outside Ireland in particular are pretty well publicized, pretty well-known that the building boom there has slowed dramatically. And we see that in our business as well. It's really been made up though by other parts of Europe, particularly Eastern Europe, that are doing very well.

So whileSpain and Ireland and some of these places are clearly slowing down, we have found between Asia and eastern and central Europe that business has really been offset fairly comfortably. So overall I think the business is very solid and we're well positioned. A lot of projects committed on the lining tech side for the next year so it's sort of cautiously optimistic I guess, Al?

I think we see a good positive trend there but certainly if the whole world slowed down at one time that would definitely have an impact. But I think our geography is going to give us pretty good positioning to take the business wherever it might be.

Al Kaschalk - Wedbush Morgan

Great. I will look forward to seeing those mineral margins improve over the next couple of quarters.

Lawrence E. Washow

Thank you.

Operator

Moving along, we'll hear from Rich Wesolowski from Sidoti and Company.

Rich Wesolowski - Sidoti and Company

Thanks a lot. Good morning.

Lawrence E. Washow

Good morning, Rick.

Rich Wesolowski - Sidoti and Company

Larry, looking at the oil fields segment, the gross margin was better than we've ever seen even though you've got a piece of the sales growth from an acquisition, it looks like it was at least in the initial contribution, lower margin than that 38% bogey we're used to seeing. Was there a different service mix? Was it the contribution from the new regions? Was it the leverage of the sales growth? Why was it so high?

Lawrence E. Washow

A little bit of all of the above. I mean, the for example, the nitrogen segment, which is one of the acquisition we did last year just had an excellent quarter. It's a very nice margin business when they're busy and they've been very busy. We had a business in Africa, which tends to be a high margin area for us, for everybody really.

And we had some good projects there that we think will continue for a while. So it's a little bit of a combination but the acquired business should really, the margins in the acquisition numbers certainly are even a bit lower than we expect for that business going forward as we really get it fully integrated in. So this was a very strong quarter obviously. Margin for oil field well above last quarter,a combination of things got it there. It's probably a little bit higher than an ongoing run rate than I would expect, but it depends a lot again on the mix.

Rich Wesolowski - Sidoti and Company

So is 38% still a good over under for the segment margin in any one quarter or have we moved up from there?

Lawrence E. Washow

That's probably not a bad number. You know, I think we'll see quarters like this one that it's a good bit ahead of that, so 38 plus minus whatever in that range; that's probably a good number Rich.

Rich Wesolowski - Sidoti and Company

The $4 million or so in incremental revenue from West Africa and Malaysia, what's that compared to? I mean how much business if any were you doing there last year?

Lawrence E. Washow

It varies a lot, but it's pretty small. Africa was very small in fact compared to what we did this year. Malaysia has been kind of building and growing slowly over time so we didn't even really have a business established there until mid-year there last year and we're just starting now to really get some business developed, so both of those are much stronger this year than last year. And really where we're focusing a lot of time and effort because we think the growth opportunities to diversify that business are really going to be in those areas.

Rich Wesolowski - Sidoti and Company

Okay, and in minerals, you know, we have domestic autos, heavy equipment markets, kind of sucking wind and yet you've put up an organic sales growth number here, 15% or so ex-freight charges. Can you talk about the ancillary markets that Don alluded to and maybe give the breakdown of sales within the metal casting?

Lawrence E. Washow

We're in the metal casting is a big part of our Asian business which has been growing nicely and it's a lot of growth for the metal casting related business in Asia. On the U.S. side we haven't really seen, you know, huge declines. It's certainly a bit softer but obviously we've got some pricing that's giving us a little bit of a benefit there.

But I think the other side of the coin on the U.S. is the heavy equipment guys are busy. The farm implement guys are busy so that is a nice offset while the automotive is certainly down, down double digit percentages obviously, but those other guys are real busy. So the international exposure, which has been very strong, combined counter with the U.S. activity, improved pricing, the revenue growth is solid.

Rich Wesolowski - Sidoti and Company

If you look at that 15% ex-freight charges, do you have any estimate as to how much was price versus volume?

Gary Castagna

Rich, it's Gary. I would gather in this quarter the price number was probably half of the growth. The Asia Pac side was very solid. That's basically all volume, although we will begin to see some pricing in the Asia Pac side, but that's basically volume on that end, so all of the growth in the, not all but most of the domestic market growth is price.

Rich Wesolowski - Sidoti and Company

Great. And then finally, can you talk about the enlarged credit facility, how much borrowing capacity you have?

Gary Castagna

Yeah, the new facility is $225 million. We’ve got about $65 million open right now.

Rich Wesolowski - Sidoti and Company

Great thank you very much.

Lawrence E. Washow

Thanks Rich.

Operator

We’ll take our next question from Todd Vencil with Davenport.

Todd Vencil - Davenport & Company LLC

Thanks. Hi guys.

Lawrence E. Washow

Hi Todd.

Todd Vencil - Davenport & Company LLC

Larry you mentioned the fact that you guys are working mineral margins over time. You know you think you are going to work it back to where you think is an appropriate level. What is an appropriate level in that business in your minds? Do you have with your mix of business with Asia/Pacific right now and other things of course.

Lawrence E. Washow

It should be well over 20% Todd and you go back a ways it was 22, 23% a few years ago. If you go back before that it is 25%. So I would certainly, in the near term over the next year or, so look to get above 20 and then at some point, not forever down the line, the mid 20s is still what the target is.

Todd Vencil - Davenport & Company LLC

Okay. And just in terms of the timing there it was nice to see you guys bring that margin up sequentially. At what point do you think we are going to see things flip around and see, start talking about higher margins year over year in that business? How fast do you think the price can kind of get us there?

Lawrence E. Washow

I think we will be a lot closer in Q3 and maybe in Q4 we will be - I do not remember the Q4 number off hand quite frankly but I would expect that we are going to see continued improvement and certainly catch up with the previous year here somewhere over the next few quarters. We do - really a little bit hard to predict though because one of the things that surprised me this quarter should not have surprised me.

But the, again the energy impact, just from April 1 to June 30 was huge. And if you look at the price of diesel over that time it went up substantially so we did improve the margins but they would have been a heck of a lot better had the cost kind of stabilized. And that is the unknown. Is it going to be $200 barrel oil? I have no idea. But we are positioned now that we know exactly where we are. So we are much quicker to respond and we will be okay.

Todd Vencil - Davenport & Company LLC

Well that having been said, what do you see in our energy kind of since the end of the quarter? Stabilize that any at all? I mean realize everybody watches every tick on the television.

Lawrence E. Washow

Yes, I think over the last couple of weeks it has - kind of similar to where it was at the end of quarter. So it has not - we have not seen the sort of downward trend that you would expect from the oil movement down to cascade through the system yet. Diesel tends to move very, very slowly in response to that. And for us, that is a big input, so yes it is kind of stable. We will see over the next couple of months if that does start to trend down. Hopefully it does.

Todd Vencil - Davenport & Company LLC

Okay. Do you have any rules of thumb that we can look at in terms of energy impact on the minerals business? A dollar of diesel is, I do not know, x. Or how much diesel you use versus electricity.

Gary Castagna

Hey Todd. It is Gary. I do not know whether I could give you that exact number right now but I mean, in terms of the overall composition of our cost of goods. Energy, at least in the domestic market, the energy is probably approaching more than the, say the mid 20% level in terms of our total cost of goods.

When you break that down into components now. Almost a majority of it, of that 25% is diesel one way or the other through the supply chain. And that essentially is from the mine to the customer. Customer mix can maybe change that equation around a little bit. That kind of gives you an order of magnitude because the most elastic, if you will in terms of change in price to us would be the price at the pump, that’s diesel followed by natural gas and thermal cool. Thermal cool is not necessarily a published number. There is some data out there but essentially you look at those three components and you sort of look at the ticks and you look at a relative level of our cost of goods, it gives you a pretty good indication directionally what happens.

Todd Vencil - Davenport & Company LLC

Okay. Last question from me I guess this is for Don. You made a comment about the tax rate coming down a point later in the year. Do you have a feel for what the sort of full year tax rate might look like? Just kind of blend it all in.

Donald Pearson

Yes I think we are probably still in that 26 range plus or minus. It will impact somewhat on the jurisdiction. Certainly we are seeing the growth in oil field and that is at a higher rate, but unbalanced its in that 26 range.

Todd Vencil - Davenport & Company LLC

Okay great. Thanks guys.

Lawrence E. Washow

Thank you.

Operator

Just another reminder that star one for a question or comment. Moving along we will hear from Jay Harris from Goldsmith & Harris.

Jay Harris - Goldsmith & Harris

Very nice quarter. Could we get a progress report on your - mental block - the project in South Africa and sales pace on the sands that you will be selling to foundries?

Lawrence E. Washow

Sure. As you might have seen , we are buying this from an Australian lucid company whose board approved the sale June 30. And the completion of the close of the deal is pending a few regulatory issues. Some of which have been addressed and there is still one or two ongoing. So we still expect to close it certainly this quarter.

In the meantime, we do have our initial investment down there in a plant that is producing material. Certainly comfortably supplying all of the US needs. And as we get a little farther into the third quarter we will be looking to start to pre-market that material to other regions. But so far, we really have not launched that, kind of making sure that we have got our supply lines all set-up properly for long-term solid supply to the customers.

So now real major impact from that yet. We should start to see some benefit in the third quarter. We will certainly announce that deal when it is closed. And then in the fourth quarter that ought to start to become a more routine business.

Jay Harris - Goldsmith & Harris

Well, you have been selling some chrome sands being sourced by distributors. To date what has happened to the volume of that business?

Lawrence E. Washow

We have been primarily selling in the US for decades. And the business actually is pretty stable. We have not seen the big drop off. The sand is used in big heavy steel castings and even the US market has been pretty stable. We have not really seen the big drop off. So the volume in the US is good. Certainly once we get to the position we can supply other areas like China. It is growing fast there.

Jay Harris - Goldsmith & Harris

Okay. I did not write the question down and it has escaped me. Let me get back in queue.

Lawrence E. Washow

Okay.

Operator

We do have a follow-up from Todd Vencil of Davenport. Please go ahead.

Todd Vencil - Davenport & Company LLC

Hey guys. Just wanted to ask about India. Anything going on there? How is the business going? Anything going on between yourselves in Ashapura that we ought to know about.

Lawrence E. Washow

Ashapura is doing okay. The numbers they reported pretty similar quarter over quarter. Have not seen a big drop off in their boxide business, which is their primary business. But have not really seen any big steps upward either in terms of growth. So it seems like that is kind of at a stabilizing point.

Our joint venture Bentonite business. One of those is related to bleaching earth and that Bentonite ends up being used in edible oil. That business uses a lot of sulfuric acid and the price of that has sky rocketed in the last few quarters. So that has had some impact on margins over there but as much as it here, it is just an element of pricing and getting that passed on through. So a little bit of impact on some of the margins but generally, the business is okay. It is doing fine. India has kind of gone through its ups and downs a little bit but certainly the growth prospects, in my mind, are excellent there. And we are seeing developments from iron ore companies that have used Bentonite as well as refineries that will use the bleacheners. So I think over time India is going to be a real contributor as it has been.

Todd Vencil - Davenport & Company LLC

Right, thanks.

Operator

Just a final reminder that star one for a question or comment. We now have a follow up coming Jay Harris of Goldsmith & Harris.

Jay Harris - Goldsmith & Harris

This is hardly a follow up. It is the initial question. What kind of visibility do you have going forward on those areas of business that have traditionally been cyclically sensitive? How far in the future can you feel comfortable about the aggregate demand worldwide for your environmental product lines, your metal casting product lines?

Lawrence E. Washow

Metal casting is probably a little bit easier because you can see the kind of the industrial pace and cars and trucks and the traditional uses for metal casting products in developing areas. So it gives you some visibility as to the metal that is going to be poured and things like that, Jay.

Environmental is a little bit more difficult. The plus side is as more of the developing areas kind of embrace the environmental need that the Western world has adopted. We see lots and lots of opportunities particularly in some areas, mining areas, for example where they are using bleaching ponds or things or just trying to protect ground or soil - ground water or soil. Some substantial projects in those areas that are coming. And given the commodities boom we think that is an area that we expect to continue to grow in the years ahead. Landfills are fairly stable in the US but again growing outside the US. As other countries figure out ways to deal with waste.

In terms of the projects, commercial projects there is probably the most difficult from one standpoint in that even though a project may be specified and we are on it. If it does not get funded next year, it gets pushed off a year. It is hard to know for sure if that is going to really happen, but that is kind of offset by the numbers of projects we are on.

We have a great number of projects. They are not huge but every building uses several elements of our building material products typically. So we have lots of opportunities as long as there is building going on. And between the infrastructure and the commercial building and government building, somewhere in the world there is a lot of building going on.

Jay Harris - Goldsmith & Harris

Is the geographic spread in the environmental business and the strength in the developing economies such that the fear of recession or business slow down in the industrial world just would modulate your growth? Or would you know if the risks are higher than that?

Lawrence E. Washow

It is, again really depends on the magnitude of the decline. But I think the geographic risk certainly does provide kind of that buffering effect. If the US is slow as it looks like it might be, certainly China is very busy. If you look at the breakdown Europe and the Middle East represent a substantial portion of our environmental business and actually a fast growing piece. And that includes central Europe in there obviously, which is doing extremely well.

So overall I think the environmental business, the diversity both terms of product and geographic, gives us some comfort but it is not a guarantee we will not be hit by a slow down around the world. But I think it will be ameliorated somewhat.

Jay Harris - Goldsmith & Harris

Thank you.

Lawrence E. Washow

Thank you Jay.

Operator

At this time gentlemen we have no further questions in the queue. Turn it back over to our host for any additional or closing remarks.

Lawrence E. Washow

Okay. Thank you very much for joining us. Look forward to the call for Q3. Thank you.

Operator

Once again this does conclude today’s call. Thank you for joining us and have a great weekend.

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