ARJ Chemicals Inc. Q2 2008 Earnings Call Transcript

Arch Chemicals Inc. (ARJ)

Q2 2008 Earnings Call

July 31, 10:00 am ET

Executives

Michael Campbell - Chairman, President and CEO

Louis Massimo - COO

Steve Giuliano - CFO

Analysts

Robert Felice - Gabelli & Company

Ivan Marcuse - KeyBanc Capital Markets

Dave Woodyatt - Keeley Asset Management

Ian Zaffino - Oppenheimer & Company

Mike Harrison - First Analysis

Stan Westhoff - Waldthausen & Company

Christopher Butler - Sidoti & Company

Presentation

Operator

Good morning and welcome, ladies and gentlemen, to Arch Chemicals second quarter 2008 earnings conference call. (Operator Instructions)

This call is being broadcasted live at www.archchemicals.com and is real media player and windows media player compatible. If you wish to access the replay for this call, you may do so by dialing 888-203-1112 or 719-457-0820 from outside the US. The access number is 602 8248.

I would like to now turn the conference over to Mr. Michael Campbell, Chairman, President and CEO. Please go ahead, sir.

Michael Campbell

Thank you. Good morning. Thanks for joining us. With me today are Louis Massimo, Chief Operating Officer; Steve Giuliano, Chief Financial Officer; and Mark Faford, Director of Investor Relations.

Throughout this call, we'll make statements regarding estimates of future performance. Actual results could differ significantly from those projected, and some of the factors that could cause such differences are described in our earnings release.

Earlier today, we filed our earnings release as part of an 8-K, that's been posted on the Arch Chemicals' website in the Investor Relations section.

Our second quarter 2008 sales grew by 4% over 2007. This increase reflects our acquisition last July of the Koppers Arch Wood Protection business in Australia, favorable foreign exchange, and price increases.

We reported second quarter earnings from continuing operations of $1.33 per share, compared to earnings in the year ago period of $1.39 per share before special items.

Performance was positively driven by our core HTH Water Products, Personal Care and Industrial Biocides businesses.

Given the challenging macroeconomic conditions impacting several of our other businesses; I'm pleased with our second quarter results.

Taking a closer look at the quarter, our core Treatment Product segment posted higher sales and operating income compared to last year. Within the segment HTH Water Products sales were comparable to 2007 its favorable currency exchange rates in Brazil and Europe offset slightly lower volumes.

Lower volumes in Europe were due to unfavorable weather in France, and as a result of our strategy of improving operating margins by walking away from marginal accounts.

We benefited from good cool weather comparisons in the US, particularly in the South and the Northeast. Higher sales there, though, were offset by lower volumes in Canada due to cooler weather and in the Midwest due to floods.

Operating income for Water Products increased over last year's impressive second quarter. Operating margin expansion of 70 basis points was due to lower anti-dumping duty costs in the US, which more than offset higher isocyanuric purchase costs, freight and energy-related costs.

Results were also impacted by an unscheduled manufacturing plant outage at our Brazilian site.

Personal Care and Industrial Biocides achieved increased sales and significantly higher operating income than last year's second quarter. Sales rose 6% due to favorable currency exchange rates and higher volumes. The higher volumes were driven by record demand for our biocides used in marine paints.

In addition, we saw a strong demand for Zinc Omadine antidandruff agent, as well as other Personal care ingredients used in hair and skincare products.

Higher sales of our antidandruff related biocides helped offset decreased demand for biocides used in building products in the US. This lower demand is a result of course, of the housing slowdown which continues to adversely impact paints, coatings and wallboard used in residential construction and remodeling.

Operating income for Industrial Biocides increased by over $3 million, compared to the year ago period as a result of higher sales volumes and the benefit of our margin improvement programs, including the restructuring of our BIT manufacturing in 2007.

Wood Protection and Industrial Coatings posted higher sales as a result of the acquisition of our former wood preservatives joint venture, and favorable foreign exchange rates. Operating results were lower than the year ago period.

Our Wood Protection business continues to be impacted by the declining U.S. housing sector and the related "Do-It-Yourself" market, coupled with higher raw material costs. Copper, MEA and chrome cost increased by $3 million, compared to the year ago period.

The lower residential demand in the U.S. combined with higher raw material costs; more than offset the benefit of our acquisition and our cost containment initiatives. And, as a result, Wood Protection's operating income was over $2 million lower than the year ago period.

Shifting to Industrial Coatings, sales were ahead of last year due to favorable foreign currency rates, while operating results were slightly lower.

Coatings demand has been adversely impacted by an economic slowdown in several Western European markets due to contraction in housing-related sectors and the impact of the strong Euro on export sales. The slower demand in Western Europe was partially offset by increased demand in the Eastern European market.

As a consequence of these market conditions, operating results were lower year-over-year, due to the reduced demand and higher raw material costs.

Now, to our Performance Product segment, where sales were slightly below the year ago period, while operating income was significantly lower.

Urethane sales decreased 4%, due to the slowing U.S. economy and construction industry, and the shedding of unprofitable business. Urethane's operating results declined because of the lower volumes and primarily because our price increases lagged the increased raw material costs of over $7 million.

Propylene raw material prices reached new all-time highs in the second quarter, rising almost 40% year-over-year.

Our Hydrazine business recorded higher sales, while operating results were comparable to the year-ago period. The increased sales were due to strong demand for hydrazine hydrates, particularly in the international markets.

I'll now discuss our third quarter guidance. We expect earnings from continuing operations to be in the $0.35 to $0.45 per share range, compared to earnings of $0.25 per share in the year ago period. Last year's results include a $0.20 per share impact for higher share-based compensation cost.

Water Products is expected to deliver stronger year-over-year top line and bottom line results in the third quarter. Operating income and margins are expected to improve, driven by stronger demand, lower anti-dumping costs in the US, and the benefits of our European margin improvement plan. These benefits will be partially negated by higher cost for isocyanurates, freight and energy.

Moving on to our Personal Care and Industrial Biocides business, we expect third quarter operating income to be lower than last year's strong results. This projected decrease is due to lower demand for our biocides used in building products and the antidandruff shampoos.

Turning to Wood Protection and Industrial Coatings, we expect a year-over-year improvement in third quarter sales, again due to favorable currency rates, while operating income should be lower. Wood Protection's operating income will be affected by reduced demand for our residential preservatives due to the continuing slowdown in the U.S. housing sector and the related "Do-It-Yourself" market.

Industrial Coating's operating income should be comparable to last year. The margin from higher sales into Eastern Europe is expected to be offset by higher raw material costs.

Our Performance Product segment is forecast to deliver sales and operating income comparable to last year. We expect the benefit of price increases to offset lower volumes and higher year-over-year input costs.

Let's turn now to our full year 2008 outlook.

We're confident that our HTH Water Products, Personal Care and Industrial Biocides businesses will achieve higher year-over-year profitability. We're revising our full year sales and earning guidance, however, because of higher than expected raw material, transportation and energy costs, combined with a larger impact from the depressed housing market than had been previously forecast.

We now expect Arch sales to grow by approximately 5% to 6% over 2007. Earnings from continuing operations for the full year 2008 are now forecast to be in the $2.20 to $2.30 per share range, compared to our previous guidance of $2.55 to $2.65.

Within the Treatment segment, we forecast Water Products to report full year 2008 operating margins in the 13% range, as operating income is expected to be higher than even last year's strong results.

The benefits from our European margin improvement plan, cost containment initiatives and strong demand in Latin America are expected to more than offset the higher costs for isocyanurates, freight and energy.

We also continue to forecast the 2008 operating income and margins from our Personal Care and Industrial Biocides businesses will increase over last year's excellent results.

Turning to our Wood Protection business, we expect the U.S. housing market to remain depressed. Operating income for Wood Protection is now projected to be approximately 50% of last year's results. We've announced price increases and implemented further cost reduction initiatives to mitigate the impact from the weak economy.

Our European and Australasian operations remain healthy, and we remain very excited about our new products being introduced in 2008 and in next year. The business is well positioned when the housing sector recovers.

In our Industrial Coatings business, we expect sales and operating results in the second half to be comparable to the first half. The margin from higher volumes in Eastern Europe is expected to be offset by contraction in the Western European markets. Full year results will also be impacted by higher costs for solvents and resins.

The Coatings management team continues to increase prices wherever possible to pursue growth opportunities and to cut costs.

We're forecasting lower full year sales in our Performance Product segment. Operating income is expected to be approximately $9 million lower than 2007, due to the impact of record raw material costs in our year-to-date urethane's results. This guidance projects that the second half of 2008 operating results will be comparable to last year's period.

We have forecast that sales volumes of our polyol products will decrease by approximately 10% from current levels. This decrease is due to the slowdown of the U.S. economy, including the construction industry.

Our forecast also assumes that propylene and ethylene, the major raw materials used by this business, will remain at current pricing levels in the third quarter, and then decrease in the fourth quarter by approximately 10%.

We raised prices in July, with another price increase announced for August. The price increases are expected to recover the significant raw material cost increases and return this business to profitability in the third quarter.

Our full year guidance for the Hydrazine business is that operating results will be comparable to last year.

Capital spending projections for 2008 remained in the range of $50 million to $55 million, while depreciation and amortization is still expected to be $48 million for the year.

In conclusion, I'm confident that we are taking the aggressive actions necessary to respond to the challenging macroeconomic environment. All of us remained focused on profitably growing our company. In particular, we remain committed to improving margins and maximizing our cash generation, both keys to enhancing our shareholder value.

That concludes my prepared remarks. We'd be glad now to respond to any questions you might have. To facilitate this, let me turn the call back over to the operator.

Questions-and-Answer Session

Operator

Thank you. The question-and-answer session will begin at this time. (Operator Instructions). Our first question comes from Robert Felice, Gabelli & Company.

Robert Felice - Gabelli & Company

Hey guys just a couple of questions.

Michael Campbell

Hey Rob.

Robert Felice - Gabelli & Company

I guess first, Mike, did I hear you correctly that HTH margins for the year will be 13%?

Michael Campbell

That's correct.

Robert Felice - Gabelli & Company

And, I guess if I look at the first half, it looks like you are tracking about 100 basis points improvement year-over-year, and you mention that the third quarter will be above third quarter ‘07 levels. And I know that Louis has been aiming for that 100 basis point improvement. So what's impacting the business in the fourth quarter?

Louis Massimo

Rob, this is Louis. The one thing that you have to factor in the fourth quarter, and I agree with you the trends are very nice and they continue to be nice, but you remember we have to recoup the anti-dumping duty benefit that we had in the fourth quarter. So we're going to recoup most of it. But we feel pretty comfortable in the 13% to you know I'm not going to say that 14% is out of sight but we are comfortable with the 13% right now, based on what we are seeing on the surcharges that we are getting on the freight side.

And, as you know, when it comes to the water industry in particular, you can't, we are unable to pass on fuel charges in the mass channel. We've done a little bit on the dealer side so we are being you might say a little conservative but we're going to have a nice year-over-year improvement but it's probably going to be in the 13% to 14% and it's probably, right now, we're tracking mid-point of that range right now.

Robert Felice - Gabelli & Company

Okay. So it's really the freight, the energy that's kind of snuck up by surprise a little there?

Louis Massimo

Well, yeah, when you say surprise, we went into this year assuming that freight and distribution was going to be higher. You know that from a water perspective, it about runs about 11%, 12% of our cost of sales kind of number.

And, unfortunately in the first half, we were able to mitigate a lot of it, but as we look forward we are projecting that the fuel surcharges will continue. So that if the oil prices continue to drop and energy costs come down, then there is upside that we won't have to worry about it. But and, as you know, our pricing for the ‘09 season we start discussing that stuff with our customers in the fourth quarter. So if there's any upside in the fourth quarter that's not factored into these numbers when we get into there, but the bigger impact will be in ‘09. So we are very confident on the HTH water numbers. I just wish that it would be you know I'd be saying 14% and you'd be trying to talk me to 15%.

Robert Felice - Gabelli & Company

Now in terms of the fuel surcharges, I'd imagine those weigh on the margin there, given the fact that you'll raise prices but not by a magnitude to recoup the margin, just to cover the cost?

Louis Massimo

Well, I don't want to get myself ahead of anybody any customers or anything. Our pricing strategy has always been that we will pass on the cost and improve our margins. So I would not we're not just trying to absorb the costs. We want to absorb the costs and continue to improve the operating margins of the business while we are investing in the business.

Robert Felice - Gabelli & Company

Okay and then, I guess, flipping gears to Coatings, was the business profitable during the quarter? And to that end I was hoping you could, I guess, give a little more granularity on the profitability of Wood versus Coatings.

Michael Campbell

Coatings was breakeven for the quarter. It was breakeven for last year, and we're forecasting it to be a slight loss for the full year.

Robert Felice - Gabelli & Company

Okay and then I guess to that end, I guess big picture question, Mike. When I step back here and I look at performance during the quarter, I can't help but notice that the core biocides franchise continues to do very well despite an economic slowdown. And at the same time, the non-core assets like urethanes are struggling, and it's really this kind of environment that in one hand highlights the value of the core franchise but in the other sheds light around the fact that the non-core assets increase the volatility or cyclicality of the earnings stream, they pressure the margins and they weigh on the valuation.

So I was hoping you could I guess give your thoughts around that commentary and how the current performance changes you are thinking about the speed or the pace at which you think about streamlining the portfolio?

Michael Campbell

Well, I'd start off by saying I agree with your assessment. The projections for the year are not where we would like them to be. On the other hand, they do confirm the appropriateness of our strategy of concentrating in the biocides area and becoming the Biocides Company.

So it is confirmation that we're working on the right strategy, and you then are also right when you say, you know what can we do to get the non-core assets out of the portfolio and to reposition the proceeds from any move like that into biocides-related companies?

I'll make a couple of comments without getting specific as to what's going on in regard to any particular business, because I don't think, I know it wouldn't be appropriate and would not benefit our negotiation position over time. But I can tell you that we have some opportunities that we are talking about in regard to non-core assets. We also have some opportunities that we're talking about in regard to adding to our core assets.

We are strengthening our internal capability to pursue both divestitures and acquisitions, and we are working with all possible speed without denigrating the value of even the non-core assets to our shareholders, without denigrating that value, we are moving with all possible speed to continue to reposition the portfolio and pursue our strategy of being The Biocides Company.

Robert Felice - Gabelli & Company

And I know it's always difficult to pinpoint a time around these things, but if you were to provide some kind of range around which we would expect to see acquisitions, divestitures, are we talking next 6 to 12 months, next 12 to 24 months, just some clarity there.

Michael Campbell

You can never guarantee the results of any transaction, because it takes two willing parties and it also takes a financing market that is cooperative. But with all of the caveats associated with that, I would hope that what we're talking about is seeing some moves in regard to our portfolio within the next 6 to 12 months rather than 12 to 24.

Robert Felice - Gabelli & Company

Great. Thanks for taking my questions.

Michael Campbell

Thank you, Rob.

Operator

We'll take our next question. Ivan Marcuse at KeyBanc Capital Markets.

Ivan Marcuse - KeyBanc Capital Markets

Hi guys.

Michael Campbell

Hi Ivan.

Ivan Marcuse - KeyBanc Capital Markets

Couple of quick questions, on the corporate expense, how much did the stock benefit you?

Steve Giuliano

For the second quarter it was approximately $0.04 per share.

Ivan Marcuse - KeyBanc Capital Markets

$0.04? And how much in the urethanes in July how much was the price increase?

Louis Massimo

Hi this is Louis. We actually announced in July 1st about a $0.10 price increase and then we followed it up with another $0.15. But for the quarter, if you're asking for the second quarter, it was about 8% price increase. And when you look at various product lines within the urethanes business, the price increases that we put in place since last year have been anywhere from a low of 25% to a high of 40%. And in dollar terms, just to help you out even more, we faced $27 million of additional raw material costs and we are passed on 20 and in our forecast of what's now, so everything is $23 million of it.

So we have been the team has been very good at passing on. And we've also done some other interesting things with our purchasing strategy. We're actually not buying some propylene in July and August so that we can finally get out in front of the propylene increases.

So I'm very confident that the business is going to do very well in the second half and it's actually in line with our expectations. It did not surprise us on the downside and, if anything, we're seeing a little bit upside from where we were at the first quarter.

Ivan Marcuse - KeyBanc Capital Markets

Are you expecting this business to get back to profitability for the full year or just the second half?

Louis Massimo

For the full year.

Ivan Marcuse - KeyBanc Capital Markets

For the full year?

Louis Massimo

Absolutely.

Ivan Marcuse - KeyBanc Capital Markets

And then including price, just not to harp on urethanes, but including the price is there more costs that you are able to take out that's going to make up for that or is it going to be all price that's going to be able to overcome the headwinds and get you back to profitability?

Louis Massimo

The team has always had -- we look at yields, and usage yield efficiencies and manufacturing guys in Doe Run, Kentucky have done a great job imbedded in there. They've delivered about $3 million of cost savings in there. So we look at every aspect.

We look at, on a daily basis, our customer base because as Michael said earlier, the propylene prices have gone to record levels and they move so quickly that a customer that we're making money on one day, we're not on the next day. So we've been doing a lot of work and the team has done a great job.

And, like I said, there has not been. I'm very proud of them; there has not been a surprise. They have come on exactly, the second quarter they were spot on what we thought they were going to do. So it's, the tools are there, they are doing everything anywhere, whether it's purchasing strategy, whether it's manufacturing cost reductions, whether it's moving price.

Unfortunately, sometimes, when you move price and you're in a competitive environment not everybody is as disciplined as Arch is when it comes to pricing.

Ivan Marcuse - KeyBanc Capital Markets

Right. And then going up to the Personal Care and Industrial Biocides, I'm not surprised that you said that wallboard is going to be a headwind going forward because it fits right in the residential. But on the antidandruff, what's causing that to be a slowdown?

Louis Massimo

Well, basically there is a major customer that's seeing some softness in their end market. Actually, when you look at year-over-year, we came in the year projecting based on guidance that we saw that it would probably be up 6% to 8% like its normal trend. It's going to be up 2% to 4%. It's still going to be up, but not as robust as some of the customers would have thought it to be in some of their end markets where the consumer is getting squeezed.

You hear about it lot in the US, but it's happening all around the world where demand is not as robust. But as Michael said, and it is going to be up year-over-year and last year it was record year. So I know Mr. Campbell loves when I say it, but we hit records last year, we are going to hit records this year, so I'm feeling pretty good about the businesses.

Ivan Marcuse - KeyBanc Capital Markets

Good to hear that, and then more of a macro question is more directed towards, probably, the Personal Care, I guess a little bit in HTH and Wood Protection. But if there is a slowdown in how much of your revenues, total firm and specifically more towards the core are linked to non-residential spending. And if there was a slowdown in ‘09 and there's just signs of slowdowns now a little bit, how would that impact your company if at all?

Louis Massimo

Well, when I look at the HTH Water Chemical business and I look at the Personal Care business, what you see is in most cases, a difference in the buying trend. It doesn't have the significant impact that you see that the housing has on wood and housing has on building products, so it doesn't have that big of an impact.

What we saw in the Water business this year is because the consumer is getting hurt a little bit, they still bought the chemicals; they just opened their pools later in certain areas. And so it doesn't really have, it's not recession proof but it's resilient.

And so our the Water business is up year-over-year and everybody who knows me, I look at numbers every single day and July, we're significantly up over last year. So things are looking good and it doesn't appear to us that the consumer spending has a lot of impact on the Industrial Biocides, on the Water Chemicals business. It has, when if you're on the equipment side, it has a bigger impact.

And on Personal Care what you do see is that people spend money on the high-end cosmetics, you see a lot of more the mass brands going there and we make a little bit less margin on the mass, what they call Mystique brand, but the volumes are still there. And so, I don't… that doesn't have a big impact on us.

The biggest impact that has been and will continue to be is on this housing issue, because people buy houses, they fix them up, they put decks on, they put pools in. So, but we're… we don't put pools in, we're not big on equipment, so we don't have that impact and we don't sell spas. So we're not equipment on that side, so it doesn't really have an impact on it.

Ivan Marcuse - KeyBanc Capital Markets

Great. And one last question then I'll jump back in the queue is, on the European business. Have you seen…? Europe, I guess is mostly attracted towards the coatings business. But have you seen throughout the quarter Europe slowdown during the quarter and are you seeing signs of more slowdown or is it just more of a factor than just demand of the export business?

Louis Massimo

Let me just handle that a little bit and because I know you were asking about coatings. We have seen slowdown in Western Europe, but I think Eastern Europe has still been pretty strong. On the water side, it was just, the start of the season was a little weak because of weather but it's been very strong in July. And I think that from the wood side I did hear that there is some weakness, a little bit from some construction housing in the U.K. and places like that. But, there's pockets that are very strong, Eastern Europe very strong, Asia is still very strong, so a mixed bag.

Ivan Marcuse - KeyBanc Capital Markets

Okay. Well, great. I'll jump back in the queue. Thanks.

Mark Faford

Thank you.

Operator

We'll take our next question, Dave Woodyatt, Keeley Asset Management.

Dave Woodyatt - Keeley Asset Management

Yes, could you give us the LIFO charge for the quarter and how it compares to the year before?

Michael Campbell

LIFO charge for the year compared to the year before.

Steve Giuliano

There's no LIFO charge this year. And there was no LIFO charge last year.

Dave Woodyatt - Keeley Asset Management

Say it again?

Steve Giuliano

There was no LIFO charge last year and there's no LIFO charge this year.

Dave Woodyatt - Keeley Asset Management

Did I understand you correctly before?

Michael Campbell

David, we can hardly hear you. Could you turn your phone up?

Dave Woodyatt - Keeley Asset Management

Well, I'll try to.

Michael Campbell

That's better.

Dave Woodyatt - Keeley Asset Management

Did I hear you correctly before saying that you would be temporarily stopping you're buying some raw materials?

Louis Massimo

Absolutely. We looked at this principally in our performance urethanes business where we buy [PO] and propylene. And based on demand forecasts, what we pre-bought in earlier months because we, like everybody else, saw our costs going up like everybody would buy. So we pre-state some, and we look like everybody else at the CMAI pricing and we took advantage of and basically mitigated about $3 million I believe it was of raw material increases that would have happened if we were continuing the buying during that period. So, we look at every tool that we have to improve the profitability of the business to stay in front of raw material costs, whether it's pricing to the end markets, the sourcing of material, so they are all part of it. But that's what we did. We did not buy in July. We don't plan to buy in August.

Dave Woodyatt - Keeley Asset Management

Well, related to that, is there any chance that bringing the inventories down in that area that you might get down into some low cost LIFO layers?

Louis Massimo

No. No, we don't have. As we sit here today and I'll let Steve answer it, that we are far away from eating into our layer. And if we actually have that and it benefits us, we fully would disclose it at that point in time. But our full year forecast assumes that we are not going to be eating into our layer.

Dave Woodyatt - Keeley Asset Management

Okay, thanks.

Operator

We'll take our next question from Ian Zaffino, Oppenheimer & Company.

Ian Zaffino - Oppenheimer & Company

Hi, good morning. Just really quickly, I think a lot of my questions have been answered. But, on the ISO side, what's going on there? Are you starting to lock that in yet for the fourth quarter and going forward, or are you still kind of sitting on the sidelines there? Or, just give us an idea what you're thinking there?

Louis Massimo

Okay. Let me make sure I understand your question. Are you talking about where we are from a cost point of view or purchasing point of view?

Ian Zaffino - Oppenheimer & Company

From a hedging point of view.

Louis Massimo

Okay. On ISOs, we don't hedge. I guess with ISO is the question. ISOs, we don't hedge. We have, like a lot of our inputs in water chemicals. We have contracts with third-party providers that basically, our costs are locked in through the end of October and they kick back in end of September and then October 1 .So our ISO cost through basically the season has been locked in and the benefit of the anti-dumping is factored in there. And whether it's a preliminary rate now, I think the rate is 23%ish or something like that. So we'll know better in the fourth quarter if that either goes up or down. But we don't see it being a significant increase either way or decrease either way.

Now when we go, we're in as we do every time, we're currently in our discussions with our provider on what the cost increase will be for next year and I'm not at liberty to discuss that because we're still in the process. But, as everything else, it is going up. And so, but that would impact our ‘09 results. And as I said earlier to Rob is that our philosophy has always been and will always be to recover those costs and to increase our margins.

Ian Zaffino - Oppenheimer & Company

Okay. And I guess you recover that through increased pricing to the consumer?

Louis Massimo

Correct. To our --.

Ian Zaffino - Oppenheimer & Company

Yes, your customer. Okay.

Louis Massimo

Whether it's the mass channel, the dealer channel or the commercial private label re-packer channel.

Ian Zaffino - Oppenheimer & Company

Thank you very much.

Mark Faford

Thank you.

Operator

We'll take our next question, Mike Harrison, First Analysis.

Mike Harrison - First Analysis

Hi, good morning.

Louis Massimo

Good morning.

Mike Harrison - First Analysis

I had a couple questions for you on the wood treatment side of your business, particularly about micronized copper. There appears to be a debate going on about the micronized products as to how they perform or whether they even have the type of longer-term performance data, the type of performance data that you have with CCA or CAB products. What is your view of the micronized copper products and how they compare to other treatments and do you have any concerns about the performance record?

Michael Campbell

There has been, and obviously Mike you are on top of this, but there has been an attack made on micronized copper preservatives, but it was not our product. It was our competitor's product. We have a totally different technology, with different dispersants, and we have I can assure you, well tested this product before we ever put it out in the marketplace and have no reservations whatsoever about the performance of our product. The entity that was making the attack on micronized copper has not attacked our product but has attacked one of our competitor's products, and it has nothing to do with the Arch product. And I say again, we are very comfortable with the performance of our product or we wouldn't have put it out in the marketplace. That's not how we do business.

Mike Harrison - First Analysis

And, as you look at all of the competing wood treatment technologies that are available now, what is your sense of how things eventually play out among traditional treatments like CCA and ACQ on one side with maybe the micronized products and some of the copper-free products that are being introduced on the other side?

Michael Campbell

Well, I think that the trend is going to be to reduce or eliminate metals in wood treatment products, both for environmental reasons and for financial reasons. We have products now that are metal-free, that are appropriate for above-ground applications but aren't appropriate for in-ground applications if they are totally without metal. In fact, no one has a product that is metal-free that can be used in below-ground applications. Our research, I can assure you, continues to be very focused on developing metal-free products that can be used in in-ground applications. And I think that that will be the ultimate direction of the industry.

In the meantime, traditional, for residential applications, our copper azole product continues to do well in the marketplace relative to the overall demand of the marketplace. Our micronized copper I think will provide us with additional sales. But if you look out over the next couple of years, the technology direction and the market direction is going to be going towards non-metal containing products.

Mike Harrison - First Analysis

And then the last question I had is, your competitor yesterday talked about their wood treatment volumes or at least volumes to the construction-related industry is being down somewhere in the 20% to 30% range this quarter. Is that sort of in the range of what you are seeing as well in your wood treatment business?

Michael Campbell

We saw it compared to 2007, our second quarter sales for residential applications were down about 20%. So that would be construction and “do-it-yourself. And, actually, our volumes for the first quarter for these market segments were comparable to 2007, but took a sharp drop in the second quarter.

Mike Harrison - First Analysis

All right, thanks very much.

Michael Campbell

Thank you.

Operator

We'll go next to Stan Westhoff, Waldthausen & Company.

Stan Westhoff - Waldthausen & Company

Good morning guys.

Michael Campbell

Hi Stan.

Stan Westhoff - Waldthausen & Company

Hi. I had a question about the 13% margins in the water business. Does that include the anti-dumping rebate possibly for the fourth quarter?

Louis Massimo

Yes. It does. And it represents half of what it was last year.

Stan Westhoff - Waldthausen & Company

Right. Yes. I think I got that part. Okay. And then, I thought you mentioned that you were buying propylene in July, but you are not.

Louis Massimo

Not in July and not in August.

Stan Westhoff - Waldthausen & Company

Okay. Now is that more of a natural gas based product or is it petroleum?

Louis Massimo

Petroleum.

Stan Westhoff - Waldthausen & Company

It is petroleum?

Louis Massimo

Yes.

Stan Westhoff - Waldthausen & Company

Okay. And are you doing any pre-buying of any sort for any other raw materials or any other opportunities you might see on the raw materials side?

Louis Massimo

I won't go into a lot of detail but where there is an opportunity to pre-buy, we do, we do hedging for copper and natural gas and stuff like that. So where there's an opportunity, if we see it, we do it. But the biggest challenge we've had is the rising cost in PO and propylene, and so it was a good opportunity to do some pre-buying before the stuff went up. And then at the same time because of some softness in the end markets, we didn't have to eat through our inventories that quick. So it benefited us very well.

Stan Westhoff - Waldthausen & Company

Have you seen any of the prices come down since petroleum has come down here a little bit in the last week or so, couple weeks?

Louis Massimo

Well, we'll say that the nominations are a little bit lower than they used to be in the past. There are some trends that as I talk with the team and maybe because I'm relatively new to the urethanes business over the last year is that it's the first time I saw the nomination actually go in place at the beginning of the month versus the end of the month, which basically for me, it's only data point but does signal to me that the producers believe that costs and prices are going to go down because they want to lock them in a little early. So that it's one data point and it bodes well. There is a lot of publications out there that predict what prices are going to do. Unfortunately, they've been as good as the weathermen.

Stan Westhoff - Waldthausen & Company

Yes.

Louis Massimo

So hopefully, hopefully we've seen a trend but it seems that it's going to break in our favor.

Stan Westhoff - Waldthausen & Company

Okay. And then just one last question. You mentioned an unscheduled plant hours in South America. Has that been resolved?

Louis Massimo

Yes. We had a minor de-comp down there that had the plant shutdown for about a week or two.

Stan Westhoff - Waldthausen & Company

Is there something maybe take advantage of? Maybe is there a little bit of weaker season or something like that?

Louis Massimo

Unfortunately, the Latin American/Brazilian business is doing so well.

Michael Campbell

No, fortunately.

Louis Massimo

From a manufacturing point of view that we are shipping products and we have been shipping products from North America down there and we are in the process of doing our expansion down there to meet the needs.

Stan Westhoff - Waldthausen & Company

Oh, that's right.

Louis Massimo

So, the good thing is that the issues that we had were short and were fixed pretty quickly, but it did cost us a little bit of money from shutting it down and having additional freight of shipping product down there.

Stan Westhoff - Waldthausen & Company

All right, and thanks a lot.

Michael Campbell

Thank you.

Operator

We'll go next to Christopher Butler, Sidoti & Company.

Christopher Butler - Sidoti & Company

Hi, good morning guys

Michael Campbell

Hi Chris.

Christopher Butler - Sidoti & Company

I wanted to get a feel on the water products business, as far as what the purchases were like from customers going into this season. I mean, did we see cautious buying due to concerns on consumer spending, and is that something that we could help us in the second half of the year as they have to restock or but sell-back?

Louis Massimo

Chris, let me break it down by channel. When it comes to the mass side, we really didn't see, from our customers, a different trend in the ordering patterns. We did see from the POS, point of purchase the sales data coming off the shelves, a little bit of a different buying pattern than last year. But it wasn't that significant. It's mostly weather-related when you have those things.

We did see a significant change on the dealer side, where the dealers were very concerned on the upcoming season. They were seeing softness on their equipment end and they didn't want to get stuck with a whole bunch of inventory. So we did see a slower start to the season from a dealer point of view, because in that industry you do have an early buy in the fourth quarter, so they did buy so that we're seeing nice volumes and order trends, July.

And, if you recall, last year, we had an outstanding July. And right now, our July is stronger than last year's July. So it bodes well that the order patterns, as you said, would pick up. We did get a lot of input from our dealer base that people were opening their pools later, which was the reason that chemical sales were off in the beginning. And now they are seeing the strength now.

So, I think that, yes, it's going to bode well and now our increases in South America and South Africa will show strong, we're going to continue to show stronger third and fourth quarters based on history.

Christopher Butler - Sidoti & Company

And shifting gears to whether last year you had some difficulty coming out of Texas and Oklahoma. This year we're looking at sort of later openings in North America and you had point to Europe. How do these weather-related difficulties compare last year to this year and could we under normal circumstances see a good uptick for the second quarter in ‘09 from that?

Louis Massimo

Well, I would say that last year's weather patterns were a disaster. This year we had one pocket, basically. It was the floods in the Midwest. So every region is up. And even actually the Midwest is catching up. It's not like where it never stopped raining in Texas and stuff like that. I've been around long enough that I'm not going to predict ‘09 yet. But I will say that the only weak spot we saw really on the weather pattern is in our Canadian operation. And it's, as they keep reminding me, it is a very, very short pool season up there. So it cost us about $2 million of pre-tax in the second quarter and we'll get about half of that back in the third quarter. But, it kind of just basically shuts down after July. There's no real August. Everything starts to get really cool so you don't have a long season to catch up.

So, the answer to your question is, the weather patterns this year from what I've seen is, and our sales show us that its stronger than last year. We obviously didn't know how to pocket but it's nothing dramatically hurting us other than, like I said, the impact in Canada.

Christopher Butler - Sidoti & Company

And shifting over to performance urethanes, I think we talked about on the cost side, but looking at the demand environment there, can you give us some feel for how much of this is leveraged to residential construction versus sort of overall weakening of the U.S. economy? And similarly, can you give us sort of a feel for the geographic mix on this business?

Louis Massimo

Well, Chris I'll do the easy one first. It's a North American-based business, so we don't do much outside of the United States. As to the housing; not so much, it doesn't have that much of an impact it has. It's just the general economic conditions. And if housing has an impact on general economic conditions, it impacts the business.

What we saw in volumes is, if we break it down into basically two key areas, we believe that the business when you look at the volumes, about 25% of our volume decrease was related to the general economic conditions. The rest is basically competition.

Earlier in the year and during the year there are people out there that want to buy volume, and we're smart enough to figure out that if you're losing at the variable margin line, increasing, you can't make that up on volume. And so the team has done a very good job of walking away from business at the same time.

So, hopefully I answered your question that basically, round numbers, one-third of the decrease in volumes was related to the economy. The rest is walking is that away from business. It doesn't make sense to be paying the higher propylene cost and then to be selling at a loss.

Christopher Butler - Sidoti & Company

Thank you for your time.

Michael Campbell

Thank you.

Operator

We'll take a follow-up, Robert Felice, Gabelli & Company.

Robert Felice - Gabelli & Company

Hi guys, just one last quick question. I wanted to go back to your comment earlier on the weak demand in Industrial Biocides into wallboard and other residential applications. It's my understanding that you're starting from a pretty low base there in terms of penetration in the market. And originally you had anticipated that you'd be able to continue to grow despite the slowdown. So I'm just trying to get a sense as to what you're seeing there. Is it delayed acceptance of the product because of weakness in the market or is there something else going on?

Louis Massimo

Let me frame this out for you, no pun intending for building products. The year-over-year, we're up. We are not to where, you call me the sandbagger? We think there was significant upside to the Industrial Biocides, principally in the building products area because of the, in particular, the strength in the wallboard application.

Wallboard is going to be up year-over-year, it's not going to be up to the extent. And basically what's happened is that while it's still being incorporated significantly into the final product, they are not being sold right now, and so there was basically a down-tick. But the volumes, the year-over-year profitability year-over-year are up significantly.

Robert Felice - Gabelli & Company

Okay that's helpful.

Louis Massimo

I don't want to you know it's not doom and gloom. It's been great. It's just that, as you call me sandbagger, going into last quarter's call there was a heck of a lot more upside than there is now. There's still upside but it's not as robust as it was.

Robert Felice - Gabelli & Company

Okay, great.

Operator

As there are no further questions, I will now turn the conference back to Mr. Campbell.

Michael Campbell

Thanks Operator. Let me make a few closing comments. Unprecedented high costs for raw materials, transportation and energy face the entire industry. Despite that, we remain excited about Arch's future. We have a focused portfolio of core biocides businesses, and we are well positioned to accelerate profitable, global growth opportunities.

Earlier in the call, we made reference to possible acquisitions. Let me say in that regard, consistent with our track record we will be disciplined in pursuing these acquisitions and making sure that from a financial point of view they are very attractive to our shareholders.

And the entire management team is committed to our goal of delivering strong, top line and bottom line results, while maintaining an attractive dividend yield. We're certain that our strategy and the pursuit of that strategy is the best way to deliver those results.

That's all for now. Thanks again for your participation and thanks for the opportunity to provide you with this update.

Operator

Thank you. This concludes our conference call for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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