Executives
J. Neal Butler - President, Chief Executive Officer, Chief Operating Officer, Director
John V. Sobchak - Chief Financial Officer
Analysts
Daniel Rizzo - Sidoti & Company
[Michael Rumberg] - Boenning & Scattergood
David Yuschak - Smh Capital
Chris Sansone - Ribotti & Company
KMG Chemicals, Inc. (KMGB) F4Q08 Earnings Call October 13, 2008 10:00 AM ET
Operator
Welcome to the KMG Chemicals, Inc. fourth quarter and year-end 2008 conference call. (Operator Instructions)
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 and in the future may prove not to have been accurate and are subject to significant risks and uncertainties including statements as to the future performance of the company. Although the company believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.
Factors that can cause results to differ include but are not limited to the loss of primary customers, successful implementation of internal plans, product demands, the impact of competing products, increases in the prices of raw materials and active ingredients, successful acquisition and integration of additional product lines and businesses, 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.
J. Neal Butler
I would like to welcome you to KMG’s fourth quarter and fiscal 2008 year-end conference call. John Sobchak, our CFO, and I will provide information on fourth quarter and year-ending results. Our earnings release went out this morning and I hope you’ve received a copy. If not, it can be obtained from our website. We will however cover all the information in it and then open up the call for your questions. Additionally, we will provide outlook for fiscal 2009.
The first item I want to address is the fourth quarter performance against the guidance we provided in June. We forecasted the wood treating business would approximate sales and profits in 2007. Pentachlorophenol ended the fourth quarter at 93% of the fourth quarter 2007 and creosote was 117% of 2007. This business basically performed as expected for the fourth quarter.
On the year, penta revenue was down by 7%. The key driver was a 25% decrease in third quarter penta revenues. This was the result of diminished overall pole demand in early calendar year 2008 coupled with a sharp price increase in the number two oil needed to blend with penta in the treating process. A 35% increase in a key petroleum-based raw material resulted in higher production costs and lower margins although a portion of the increase has now been passed through to our customers. The combined impact resulted in a $2.5 million decline in operating profit relative to fiscal 2007.
Creosote continued to be a strong performer with sales volumes slightly greater than fiscal 2007 and an increase in revenue of 26.5% from $43.6 million to $55.2 million. This positive variance was driven by the implementation of price increases by KMG to offset [Kent] significant increases in our costs of purchased creosote. Over time we were able to pass along the majority of the cost per gallon increase although we did experience a decline in unit gross margin.
We anticipated animal health sales to rebound in the fourth quarter based upon market intelligence and forecasts from our distributors. As we reported in September we did not foresee the cumulative negative impact of a very cool spring which delayed the fly season in our key cattle markets plus dramatic input costs for cattle growers for feed, fertilizer and fuel. The net result was constriction in their discretionary purchases which for cattle growers includes ear tags, insecticidal sprays and dust.
Animal health ended the quarter at 89% of 2007’s fourth quarter sales. The decline was predominantly in ear tags which is one of our most profitable product lines. For fiscal 2008 animal health revenue was down by 17.6%. The major reason was as noted the reduced overall demand for ear tags in the US. According to USDA reports the US cattle herd has declined by about 1 million head in the last two years, and the increased cost of production appears to have been a driver in this decline.
Based upon our post-season market review at the distributor level we believe that the entire food animal ectoparasiticide market demand was down by about 25% and consequently we believe that KMG did not lose market share, that Avenger remained the number one tag in the market, and the preference going in to the 2009 season will continue to favor Avenger and Patriot which is our second largest selling tag.
The newly-acquired electronic chemicals business performed as expected in the fourth quarter in both revenue and profits. We were successful in acquiring new business with two of our large customers and were able to secure price increases in the US and Europe to cover the large cost increases we experienced in raw materials.
In the fourth quarter we made significant progress in the integration of the electronic chemicals business with a plan to move off of the transitional services agreement with Air Products by the end of September. This has been successfully accomplished and the business now operates totally under KMG systems. We have grown the electronic chemicals business from approximately $91 million during Air Products fiscal year to a current run rate of $105 million under KMG’s ownership. Electronic chemicals contributed $2.1 million in operating income in our fiscal 2008.
From January through September we operated the business under a transitional services agreement between KMG and Air Products, the added cost of which had a negative impact on financial results. Additionally, we operated under a distribution agreement with Air Products in Europe and the Middle East as VAT applications in the affected countries were applied for. This process has now been completed; however it also was an extraordinary integration expense that had an adverse affect on fiscal 2008 financial results.
However even with these extraordinary expenses associated with the integration, electronic chemicals was accretive to 2008 earnings. We are now off of the transitional services agreement which effectively reduces incremental costs on an annualized basis by $1.2 million. $667,000 of third-party consulting fees were also incurred during the integration process and those also effectively ceased on October 1.
In fiscal 2009 we will see the additional costs associated with the transitional services agreement for the first two months of the year and approximately $300,000 of consulting fees associated with the integration project during the first quarter.
At this point I’ll turn the call over to John to provide details on the financials and additional information on the cut-over from the Air Products transitional services agreement. Afterward I will discuss our outlook and view of 2009 and future growth.
John V. Sobchak
Starting with the income statement, net revenues increased 118% in the fourth quarter to $51.4 million from $23.6 million in Q4 of 2007. Of the $27.8 million of additional revenue in Q4 our new electronic chemicals business contributed $26.4 million. Both animal health and penta revenues were down for the quarter by about $430,000 each for the reasons described by Neal. In creosote, revenues were up by $2.2 million for the quarter.
For the fiscal year 2008 revenues were $154.4 million, a 79% increase over the previous year. The top line growth was driven by the addition of the electronic chemicals business and strong creosote sales. The electronic chemicals business contributed $61.1 million to the $68.2 million increase in revenues for the year. Creosote revenues were up by $11.6 million for the year and we saw a $2.5 million and a $2.0 million decline in animal health and penta revenues respectively.
Gross profits increased $16.4 million for the fiscal year to $46.8 million primarily due to the addition of the electronic chemicals business. Without the addition of that business, gross profits in our legacy business would have declined by about $3.1 million. While creosote revenues increased, creosote is a lower margin product for us. Conversely penta and animal health insecticidal ear tags are among our highest margin products and they saw declines in this fiscal year.
Also, we saw a 35% increase in the cost of a petroleum-based solvent used to manufacture our main penta product. That spike in price caused a reduction in our gross profit dollars and margins for penta. The margin for the overall business declined in 2008 to 30.3% of revenues from 35.3% in fiscal 2007.
Moving to SG&A, SG&A was $35.3 million in fiscal year 2008. That’s a $20 million increase over the prior year. Most of that increase was due to the new electronic chemicals business. As a percentage of revenue SG&A was 22.9% in fiscal ’08 versus 17.8% last year. We include distribution expenses in SG&A and the electronic chemicals business is a supply chain intensive business with relatively high distribution expenses. Therefore it’s SG&A as a percentage of revenue is higher than KMG’s legacy business.
Besides the normally recurring SG&A we have also incurred an additional $667,000 of fees paid to outside accounts in IT consultants associated with the integration of the electronic chemicals business so far this year. Also, as Neal pointed out the transitional services agreement that we purchased from Air Products is based on their overhead cost structure. We estimate that our overhead cost structure would reduce that expense by over $175,000 per month or $1.2 million for the year.
SG&A in our legacy business increased by $2.5 million over the previous fiscal year. Supply chain costs increased $477,000 primarily associated with the creosote segment. Animal health SG&A was up by $746,000 associated with our sales force additions and initiatives to grow the product offerings and geographic footprint of that business.
Legal and regulatory spending overall was up by $605,000 and headquarters administrative expense increased by $700,000. Included in those numbers is $466,000 of expenses associated with our SOX 404 internal controls testing. We became an accelerated filer for year-end fiscal 2008 and that amount represents what was paid to our auditors and other third parties during the fiscal year associated with that testing.
Operating income declined by $3.6 million to $11.5 million for the year, a 24% decline from 2007. The electronic chemicals business contributed approximately $2.1 million to operating income. Penta’s contribution to operating income declined by $2.5 million for the year primarily due to the increase in the cost of the solvent raw material that we discussed earlier but also due to the 7% decline in revenues that Neal mentioned. Animal health contribution to operating income declined by $2.0 million on lowered sales.
The increases in legal, regulatory and headquarter administrative expenses including our SOX-related expenses made up the balance of the difference.
Our income tax rate was 38.6% in fiscal ’08 up from 37.8% last year.
Regarding discontinued operations, in the first quarter of fiscal ’08 we reported discontinued operations associated with our MSMA segment. Accordingly the financial results of that segment have been removed from our reporting of the results of continuing operations for the current and prior years. MSMA and agriculture products used mainly on cotton in the US, which we had manufactured at our Matamoros plant, was our smallest segment with sales of $3.6 million in fiscal 2007.
Net income from continuing operations in fiscal 2008 was $5.7 million or $0.50 per diluted share compared to $9.2 million or $0.83 per diluted share in fiscal 2007. For the fourth quarter we had net income from continuing operations of $600,000 and diluted earnings per share from continuing operations of $0.05 per share compared to $1.9 million and $0.18 per share last year.
Net income for the year was $5.4 million or $0.48 per diluted share compared to $0.80 per diluted share last year. For the fourth quarter the company earned $571,000 or $0.05 per diluted share versus $0.19 per diluted share last year.
Moving to our balance sheet, we closed the year with $2.6 million of cash. Long-term debt including the current portion was $61 million. We repaid $9 million of principal on the debt outstanding at the time we acquired the electronic chemicals business using cash flow from operations. We had borrowed $9 million on our revolver to close the acquisition and repaid $3.8 million by year end and had the $2.6 million cash remaining at the end of the year.
Reduction of revolver borrowings during the last seven months was lower than anticipated due to the weakness in animal health sales in the second half of the year and the fact that the transitional services with Air Products extended through September. At year end we had $29.8 million of unused borrowing capacity on our revolver.
The year finished with working capital of $31 million in shareholder’s equity of $63.7 million.
We finished the year in a good position relative to the three financial covenants we have with our bank group. We are required to maintain a fixed charge coverage ratio of at least 1.25 and our ratio was 1.50 at year end. We are also required to maintain a funded debt-to-capital ratio of no more than 60%; ours was 49% at the end of the year; and a funded debt-to-pro forma EBITDA ratio of no more than 3.5 and we were at 2.7 on July 31.
We’re currently paying 2.25% over LIBOR on our term loan borrowings which were $31.8 million at year end as well as the $5.2 million borrowed on our revolver at year end. We have $20 million of non-amortizing notes for which we pay a fixed interest rate of 7.43% and we also have a $4 million seller note from Oxycan for which we pay a fixed rate of 4%.
Now I’ll hand it back to Neal.
J. Neal Butler
As John noted, we closed fiscal 2008 with revenue of $154.4 million up from $86.2 million in 2007 with earnings from continuing operations of $0.50 per share on a fully diluted basis, which is down from $0.83 in 2007. This was a direct result of the declines we experienced in the utility pole demand in the third quarter and the downturn in the third and fourth quarter for animal health products.
As I stated in this morning’s release, neither I nor anyone within our organization is satisfied with our fiscal 2008 earnings. We were disappointed in the performance particularly of animal health and penta, both of which as noted suffered from lower demand driven by negative economic dynamics in the markets served.
In fiscal 2009 we believe we will achieve sales revenue from about $200 million and will see notable improvements in operating profits and net earnings. A key portion of our five-year strategy is to diversify and establish a leadership position in new market sectors. The electronic chemicals acquisition represents a significant move forward in achievement of this. Diversification also includes moving into other global markets with particular short-term focus on Europe and Israel with electronic chemicals and in Latin America with animal health products.
In addition to the cost savings mentioned earlier in connection with the electronic chemicals business, we will see a $1.2 million reduction in amortization expense associated with certain intangible assets attributable to the 2005 penta acquisition from Occidental. The amortization reduction will begin in January 2009.
I’d like to give you a general overview of our business sectors as we move into fiscal 2009.
In fiscal ’09 we expect to see the penta business run at prior year levels and at this juncture anticipate sales volumes to be roughly equal to fiscal 2008. As a marker, fiscal 2007 was a record year for penta sales greatly enhanced by a significant increase in maintenance by utilities which in many areas of the US had been notably delayed. This was coupled with a volume uptick as a consequence of two major hurricanes. The market demand has now trended to a level that again we expect will be close to 2008 volumes.
Creosote demand should also remain relatively close to 2008 volumes and we will continue to work to pass along price increases to improve margins on this important product line.
As we reported earlier, both creosote and penta have been undergoing a re-registration process at EPA and both products have been successfully re-registered. These registrations represent the key franchise to do business in the US and they also provide a notable and expensive barrier to entry for potential competitors.
We view our animal health business as a fundamentally strong market and we expect to see more normalized sales in fiscal 2009 especially as we expand in the Latin American market. We have now received three Latin American registrations and shipments have been made this quarter to Mexico, Puerto Rico and Argentina. We have pending registrations in Colombia, Venezuela and Brazil and have more planned in fiscal 2009.
We are completing trials on a new ear tag which we hope to introduce to the market in 2010. It is demonstrating superior efficacy, even better than Avenger which is a current industry leader. While it is difficult to predict the spring animal health market at this early stage, we are seeing a softening of input costs for growers and a strong interest among Latin American markets. USDA is projecting beef production to be up about 1% with 2009 steer price estimates up by approximately 3.5%. So we are seeing marginal improvement in grower economics.
We’re looking for both top and bottom line growth in electronic chemicals. Net sales growth should reflect an increase in volume stemming from new and profitable business with several global customers, plus price increases implemented last spring should help increase gross profit and margins.
One of the key components of our operating strategy after integrating a major acquisition such as the electronic chemicals business is to work diligently to increase efficiencies and strip out unnecessary costs. We have an initiative underway now to do just that with the EC business particularly focusing on large expense line items such as distribution and manufacturing costs.
At the same time we are pursuing acquisition and product line extension opportunities in all three of our business sectors of wood treating, animal health and electronic chemicals.
Our organization has worked hard to successfully integrate the electronic chemicals business ensuring we provide the level of service and product quality required by very demanding customers.
We have notably enhanced our corporate infrastructure including upgrades in IT, process controls, human resource management and management and bench strength. We now have efficiencies and internal capabilities which we believe will facilitate the integration of future acquisitions.
We view the current economic situation as a potentially good opportunity to find acquisition targets that meet our criteria at attractive multiples. We have five production facilities with capacity head rooms efficient to bring in new products that are either developed internally or purchases bolt-on to our current lines.
We’ll use fiscal 2009 to prepare the way for our next acquisition which we look to consummate in fiscal 2010. Over the course of this fiscal year we’ll use cash flow from operations to pay down debt, improve efficiencies and to reload our balance sheet.
We appreciate your participation and attendance today. I’d like to turn the call over to questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from Daniel Rizzo - Sidoti & Company.
Daniel Rizzo - Sidoti & Company
You indicated that both penta and creosote were re-registered. How long does that registration last for?
J. Neal Butler
The re-registration process is from EPA. I don’t know but there’s not a definitive timeline on when they come up for re-registration again, but it’s a fairly long period of time.
John V. Sobchak
This process for re-registration was embarked on in 1986.
J. Neal Butler
That’s what I was looking for was to try and remember the date that this one was actually initiated. So that’s right, this was an ’86 initiation. It’s just now being completed. EPA is still going through the re-registration process on a number of other pesticides. The best response is that for the foreseeable future it’s re-registered. I don’t know when it will go through a second re-registration process.
Daniel Rizzo - Sidoti & Company
Isn’t that something you have to do every five years?
John V. Sobchak
No, there’s no cycle like that.
Daniel Rizzo - Sidoti & Company
Did you notice any seasonal weakness in sales in creosote in September or is it just due to poor weather?
J. Neal Butler
It can be due to poor weather but typically when you see some of these seasonal declines it’s a consequence of the ties that are in storage and being dried for treatment. If you get a really wet season, they can’t get into the woods to harvest the hard woods and it diminishes the inventory. They hold that inventory for nine months before it’s treated so it is weather related.
Daniel Rizzo - Sidoti & Company
You said that just given the current economic situation, you do see attractive acquisitions. I was just wondering if it’s going to be more limited in size going forward given your current debt level, the current credit situation in the country, and things like that. Are you looking at small bolt-on acquisitions or are you more willing to do another one of the size you just did?
John V. Sobchak
No, we’re not in a position in terms of our capital structure to do another acquisition of the size we just did at the moment. Clearly our view would be to continue to pay down debt, to look for some good add-on acquisitions to our current platforms, and position ourselves for maybe adding another platform down the line.
Operator
Our next question comes from [Michael Rumberg] - Boenning & Scattergood.
[Michael Rumberg] - Boenning & Scattergood
I’m just trying to get a better handle on the South American market for animal health and determining the size and the potential that market holds. You guys mentioned some shipments that have already taken place to Puerto Rico and Mexico you mentioned. Can you give us an idea of the magnitude of those shipments and what you can expect over the next 12 to 24 months for animal health in South America?
J. Neal Butler
When we look at that business going forward in our strategy for that business, we foresee in the next three to five years that that will be around a $10 million business. For the next 12 to 24 months it’s strictly dependent upon how quickly the countries go through their registration process and that’s a moving target. The ones that we’ve just shipped in this quarter would be in the few hundreds of thousands of dollars range.
[Michael Rumberg] - Boenning & Scattergood
I know you’ve mentioned in the past that the market in South America is much more corporate sized; they’re much larger operations comparatively to here in the US. Would these represent trial shipments to these organizations and something that could potentially be grown upon in the future?
J. Neal Butler
Absolutely. That’s probably the best way to classify them, that this initial trial product’s been put into those countries. There is a strong interest in we believe a bit of a pent-up demand for attention to be paid to these markets in Latin America. The majority of the sales would be to the larger corporate farms. And Latin America tends to be large corporate farms and subsistence. You don’t see a lot in the middle.
[Michael Rumberg] - Boenning & Scattergood
In terms of the electronic chemicals business, I haven’t seen the numbers yet for the fourth quarter but in the third quarter we saw losses on the international side of that business. I’m wondering if you can elaborate a little bit on what you attribute that to and how you foresee that turning around in the future.
John V. Sobchak
There were a couple of factors that played into that.
The business had been historically mildly profitable under the previous ownership by Air Products. The commercial management team that came over to run that business had not been running the business prior to coming on board. We had actually requested that this person be selected to run the business and he’s had some catch-up to do. He picked up the business just when raw material prices started spiking and he’s been playing catch-up in terms of our pricing strategy since then. We think we’re getting pretty close to caught up in terms of pricing relative to our raw material costs now. We’re looking at a better 2009.
The other thing that came to play there is we’ve been paying for transitional services from Air Products which a large of part of that is actually their services and business processes including their overhead structure. While we were paying for those services for supply chain and back-office support, we were building our own infrastructure. So for a period of time we’ve basically been paying for two infrastructures. We’ve moved off of Air Products transitional services effective October 1. We’re now operating fully on our own system and we’re going to be seeing some significant savings associated with that in 2009.
[Michael Rumberg] - Boenning & Scattergood
To the penta side, you’ve mentioned in the past particularly when oil was up above $130 a barrel the cost of rental between a penta pole and a CCA pole was around $75. Now that we’ve seen a significant pullback in the price of oil and you’re more highly tied into the number two oil distillate price metric, but now that you’ve seen that pullback have we seen a tightening of that differential in cost between a penta pole and a CCA pole? Have the economics improved?
J. Neal Butler
You will see a little bit of a tightening. You’ll see a little bit of an improvement. I think the thing to keep in mind with penta and CCA is that just by virtue of one being an oil-based preservative and the other one being a water-based preservative, there’s always going to be a rather notable to significant price differential. You may see it constrict somewhat but there’s still going to be a large differential.
When people purchase the penta poles, they’re not purchasing them strictly for the purchase price economics; they’re purchasing for the physical characteristics and long-term their issues with disposal with penta poles where penta poles are actually easier to dispose of than a number of our competitors’ poles. There are some long-term advantages to penta, and as I said the physical characteristics of penta are preferred by lineman as well.
So yes, we are seeing a little bit of tightening in terms of the differential between us and CCA but that’s not ever really been a driver for the reason you purchase the penta poles.
[Michael Rumberg] - Boenning & Scattergood
I know that you guys have some lines of credit with Wachovia. I’m just wondering if you could tell us a little bit about the security of those lines and what affect if any this has on you guys.
John V. Sobchak
We actually have a bank group that’s led by Wachovia. Bank of America is also in the group as is Prudential Capital. Of course we’ve been keeping close relationships with all three. Right now it seems like it’s business as usual over at Wachovia. They seem to be happy with the credit in the business. We always have a fallback position and Plan B in the works.
Operator
Our next question comes from David Yuschak - Smh Capital.
David Yuschak - Smh Capital
Just a couple things on the quarter on a sequential basis, maybe you can help us out in getting a better grasp of the numbers and the impact in the quarter as well as how this could play out the rest of 2009 fiscal year. Your gross profit was impacted by about $200,000 in the quarter but your actual costs were up about $1.5 million more than the third quarter.
Could you just give us an explanation? You came in with some pretty decent revenue but that cost side of it was comparatively high compared to the third quarter. I’m just wondering if you can give us a breakdown as to how much might have been SOX, how much might have been higher commodity prices we weren’t able to pass through? Can you give us a better delineation of how that may have played out with higher costs versus the third quarter sequentially?
John V. Sobchak
In terms of gross profits, SOX and some of those other operating expenses wouldn’t come to play. Product mix is an important consideration. The creosote sales and electronic chemicals sales being up; those are two segments that have performed relatively strongly but they also have the lower margins. So the overall effect is dilutive to the business.
David Yuschak - Smh Capital
I’m just wondering though, given the higher input costs because of commodities, how much that may have impacted the quarter not being able to raise the prices fast enough to overcome those input costs. Can you give us a sense as to how much that may have affected results?
John V. Sobchak
There was significant impact in the electronic chemicals business because although we had raised prices in the fourth quarter they weren’t in effect for all of the fourth quarter but we had not quantified what that impact would be.
David Yuschak - Smh Capital
Would you say that in addition to the animal health this was the second biggest impact then?
John V. Sobchak
Raw material prices? Yes.
David Yuschak - Smh Capital
For electronic chemicals?
John V. Sobchak
Yes.
David Yuschak - Smh Capital
Everybody anticipated the animal health issue being what it was I think as far as the decline and after you pre-announced. But the impact on the electronic chemicals was really one of the key drivers because of that. Looking into next year then, given what’s happened with commodity prices, how are you guys seeing that play out as far as your impact on input costs into next year relative to the kind of price increase that you implemented? And is there some issues that may result and maybe having to take back some of this price increases if in fact from these commodity prices hold up whether as currently compared where they were the first half of the year?
John V. Sobchak
We’ve been pretty aggressive with price increases to try to keep up with these raw material prices and as we mentioned it’s a little bit of a catch-up game with the newly-acquired business. It was just bad timing that commodity prices took off just about the time that we closed the business. But we had major price increases that went into effect on May 1; others went into effect July 1; and then we had a dramatic price increase for some of the products in the Mideast on October 1, specifically Israel. We think we’re well positioned going forward to recover those cost increases. Given the economic conditions, I don’t know if we’re going to be seeing the same kind of commodity price escalations in our fiscal ’09 that we saw in this year that we just finished.
David Yuschak - Smh Capital
You also indicated in the electronic chemicals business about focusing a lot on the distribution and manufacturing expenses. Could you help us out and maybe give us a better idea of where that might come from as far as where you can get those efficiencies, maybe how long those efficiencies may have to take place to get it through the system to get you where you feel you’re comfortable on both of those factors?
John V. Sobchak
On the distribution expense side, distribution expenses for the electronic chemicals business is about 19% of revenues is what we’re budgeting going forward. We’re looking at total distribution expenses in excess of $20 million for the electronic chemicals business in the coming year to give you an order of magnitude.
The distribution chain, the supply chain, for this business is very complex in terms of shipping, warehousing; there’s a process that takes place called dip tubing where tubes are added to the drums. Again these are products that sometimes need to be kept in environmentally controlled conditions. They’re shipped in drums and five gallon buckets, bulk containers, in some cases totes.
So there’s a lot of opportunity to streamline the distribution chain. What we did with the business because of the complexity, we made the decision to just bring over the supply chain as it was as we were integrating the business. It would have been too complicated to try to integrate the business into our system at the same time of trying to streamline it.
Now that we have it in our system and fully operated by us, we’re now going to take a look at what efficiencies can be gained. Clearly a $20 million supply chain cost, if you could just achieve a 10% savings on that, that’s $2 million. The supply chain that Air Products had that was used for this business was used for a much larger electronic chemicals division. This business just kind of slipped into their existing supply chain so it’s not necessarily the optimum configuration for this much smaller product line we have acquired.
David Yuschak - Smh Capital
What kind of timeline do you think you’ll need to review that and make changes that you can potentially like you said get a 10% reduction in those total costs?
John V. Sobchak
We haven’t completed the analysis so the 10% number there was just a for instance.
David Yuschak - Smh Capital
Right. I’m just wondering what kind of timeline you think you may need to achieve some of these potential opportunities.
J. Neal Butler
We’ve initiated the process now and we’re going through now looking for places to improve the efficiencies and strip out some unnecessary costs. We’re identifying those and the timelines associated with them will be attached to them, but I can’t tell you now specifically what that timeline is. We have some specific goals set for completion in 2009 though.
John V. Sobchak
Clearly moving inventory from one warehouse to another perhaps or changing delivery methods, those aren’t changes that can occur overnight. So this is savings that we’re really kind of focused on in fiscal 2010 when we would expect it to really start to show some considerable fruit.
David Yuschak - Smh Capital
You mentioned manufacturing expenses as well. Where do you think you see opportunities there?
J. Neal Butler
It’s the same thing. We’re going through the analysis process now that we’ve done the cutover and now that the entire operation is within KMG’s systems we have the ability to go in there and scrub some of these expense numbers and take a harder look at them. When we were operating on transitional services with their products, there really was not the ability to drill down in detail and figure out what all these incremental or these individual costs were.
We now have that ability but the ability is weeks old because we just cut over on the first of October. So it’s difficult for us to quantify what that is. I think the most accurate statement we can make is that again one of our operational norms is as soon as we do finish an integration, the first thing we do is start looking at places to strip out the costs.
John V. Sobchak
That being said, I think our plants particularly Pueblo are very fine organizations and they were very well operated, very well configured by Air Products. Some of the manufacturing expenses, the low hanging fruit we’re going to look at, are some of the contract manufacturing agreements that are in place for some of the products that are coming in. Are we getting the best price for the service there? Also opportunities on raw material purchases and packaging costs. Some of the packaging, the low particle shedding containers that we need to use in these high purity products are very expensive.
David Yuschak - Smh Capital
On the debt side of it, do you have any expectations about how much you can lower your debt levels in fiscal 2009 as a minimum maybe?
John V. Sobchak
We hadn’t set that target yet. We’re clearly very focused on paying down the debt. We’re now moving into a period of time where we’re starting to build inventory for some of our seasonal sales.
We’re also going to benefit in the coming months of moving off a transitional services. There was considerable receivables, an $11 million receivable, that we had from Air Products just by virtue of operating under the transitional services agreement. There’s also a payable that we have to them that offsets that to a certain degree but they just weren’t perhaps paying as much attention to the receivables situation as we might. We think there’s going to be some additions to cash flow from operations just by reducing working capital in the business, and that’ll go right to paying down the debt.
David Yuschak - Smh Capital
On your outlook for sales in 2009 given what’s happened with the markets here in the last two months, credit issues and everything else and everybody’s concerned about the outlook for just about anything, you guys are still maintaining the $200 million expectations for revenue. What gives you some optimism that that may still be a very achievable goal for you right now?
J. Neal Butler
As we look at our budgeting process for fiscal 2009 when you look at this $200 million, we believe that we’ve taken a realistic approach but on the conservative side of a realistic approach to putting the forecast and the budget together for this year. As with any market I guess anything can go south on you but as we look forward now and with the market research that we’ve done going forward in the three sectors we’re in, at this juncture we still feel pretty comfortable that that $200 million number is going to be there.
Operator
Our next question comes from Chris Sansone - Ribotti & Company.
Chris Sansone - Ribotti & Company
Just to go back to the electronic chemicals segment, is your expectation that you’ll be able to increase volumes in 2009 compared to 2008?
J. Neal Butler
Yes. We believe we’ll see a volume uptick. It won’t be a huge increase in volumes because some of the volume uptick we’ve already experienced in fiscal 2008 and that carries over of course in 2009. But yes, we believe there is still some areas that we’ll pick up additional business and this is an additional volume business and it’s additional business that we pick up that’s profitable business.
Chris Sansone - Ribotti & Company
I guess that’s what I wanted to hear more about. Is your expectation based on KMG picking up new accounts to potentially offset weakness that you’re maybe expecting from your existing accounts?
J. Neal Butler
If I understand your question, some of the volume that we’ll be picking up is from current customers with some new product offerings, new SKUs. So that volume is an uptick as a consequence of being qualified and picking up volume in a product that we, it’s sometimes an SKU, it’s not necessarily different chemistry, but picking up a new product for sale with those customers. Does that answer your question?
Chris Sansone - Ribotti & Company
I think so. So that gives you some visibility because you’re already doing business with these customers and now they’re saying, “Okay, we can do more business in these other product lines.”
J. Neal Butler
Certainly. And that’s a key focus of ours, to try to pick up additional product lines with the customers that we do business with today.
Chris Sansone - Ribotti & Company
If you look at those customers and if they’re publicly traded, no doubt their stock prices are lower. So obviously the expectation is I think for all of us that the economy’s going to be weaker in 2009. Holding your existing customer base and account base constant and in tying that back to your 2009 revenue expectations, and I’m just referring to the electronic chemicals segment, what level of activity are you expecting from your existing accounts in 2009 compared to 2008? You don’t have to give me a particular percentage, but are you expecting lower volumes from those existing accounts you’re doing business with presently?
J. Neal Butler
Not notably lower volumes, no.
Chris Sansone - Ribotti & Company
Why is that? You would think that fewer semiconductors are going to get sold next year.
John V. Sobchak
The last week in particular has been a very tumultuous week and I think it would be foolish for us to say we fully analyzed that and we know where the economy’s going next year of course. What we’re relying on right now is input from our customers. As part of the qualification process, they’ll talk to us about what kind of volumes they need in the coming years. Of course something unexpected can come up and things can change, but at the moment we’re going by what our customers and what the distribution channel is telling us.
Operator
Our next question comes from David Yuschak - Smh Capital.
David Yuschak - Smh Capital
I’m just following up on that question as far as your business from your existing customer and what you’re hearing. How much are you looking at fiscal 2009 in electronic chemicals for new business opportunities and how much do you think you can depend upon landing newer customers longer term to grow the top line for that division other than continuing to get more with the existing customer base?
J. Neal Butler
In 2009 particularly, the majority of business that would be incremental to 2008 will be with existing customers; not new customers. There is some new customer opportunities that we’re pursuing now; probably more in Europe than the US. Success in those would manifest itself probably more in the 2010/2011 timeframe. And I’m talking about new customers or new market sectors.
Operator
There are no further questions. I will now turn the conference back to management.
J. Neal Butler
We want to thank everybody for taking the time to get on the conference call today. As we said, I know the earnings release is out today and I’m assuming everybody has a copy or will get a copy. We would encourage any of you to please give John or me a call subsequent to this session today if you have additional questions. And with that, we thank you.
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