Compass Minerals International, Inc.
Q3 2012 Earnings Call Transcript

Published: 29 Oct 2012

[Operator:]

Good day, ladies and gentlemen, and welcome to the Compass Minerals Q3 Earnings Conference Call. One note that today’s call is being recorded. At this time I’d like to turn the conference over to Peggy Landon.

[Peggy Landon:]

Thank you, Sarah. Good morning, everyone. With me here today I have Angelo Brisimitzakis, our President and CEO, and Rod Underdown, our CFO. But before I turn the call over to them I will remind you that today’s discussion may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the company’s expectations as of today’s date, October 29, 2012, and involve risks and uncertainties that could cause the company’s actual results to differ materially. The differences could be caused by a number of factors including those identified in Compass Minerals’ most recent Forms 10(k) and 10(q). The company undertakes no obligation to update any forward-looking statements made today to reflect future events or developments. You can find reconciliations of any non-GAAP financial information that we discuss today in our earnings release, which is available on the Investor Relations section of our website at www.compassminerals.com. Now I’ll turn the call over to Angelo.

[Angelo Brisimitzakis:]

Great, thanks Peggy, and good morning, everyone. Thank you for joining us today. First let me hope that this ugly weather on the East Coast doesn’t affect you folks too much or too badly. Hopefully everyone will stay safe. However, if a little bit of early gentle snow were to show up somewhere in our service area that would be fine with us. Certainly weather is a big factor in Compass Minerals’ story. Compass Minerals just concluded one of our most difficult 12-month weather driven periods in our nearly ten-year history as a public company, but I firmly believe that we’re now back on a positive trajectory. I realize that it may not be immediately apparent when you look at this quarter’s deicing sales compared to last year’s record-setting Q3 sales, but here’s why I say that

[Rod Underdown:]

Thanks Angelo, and this morning I would like to review the financial details of the quarter and then explain the further expectations we currently have about our businesses which give us optimism that 2013 will yield significant earnings improvements. As Angelo explained, we believe Compass Minerals is poised to turn the page on a very weather-challenged chapter of our company’s history. So beginning with the Specialty Fertilizer Segment, we reported sales of $54.9 million in the quarter up from $51.1 million in the 2011 quarter. We sold 90,000 tons of specialty fertilizer at an average price of $615 per ton. These results were very comparable to our Q2 results, although on a year-over-year basis our average selling price was down 3%, chiefly due to a slightly higher mix of international sales in the current year. Operating earnings for this segment continued to be pressured by the short-term step change in cost associated with sourcing a potassium mineral feedstock to supplement our solar pond production. Unit product costs, which are calculated a net sales minus operating earnings per sales [ton] increased to $398 for the quarter compared to $323 in Q3 2011. As a result, our operating margin declined to 24% from 38% in the prior-year quarter, and this was the driver of the $6.3 million drop in operating earnings this quarter. The step change to the higher per-unit cost level began in Q2 this year. We expect these higher unit costs to continue to constrain our Specialty Fertilizer operating earnings in the final quarter of 2012 and into Q1 2013. In fact, we’re forecasting Q4 costs similar to Q3’s results, and we anticipate selling the last of this higher-cost SOP during Q1 2013. Following that, we expect roughly a $100-per-ton product cost drop from current levels to occur in Q2 and continue through the remainder of 2013. Now to achieve the full cost improvement, our SOP plant will need to operate consistently at the Phase I design rates that it has achieved but hasn’t yet sustained. This would result in meaningful operating margin expansion for this business at current attractive prices. We expect demand for SOP to remain stable for at least the next couple of quarters for a few reasons

[Operator:]

Certainly. (Operator instructions.) We’ll go first to Ivan Marcuse from KeyBanc Capital Markets.

[Ivan Marcuse:]

Hey guys, thanks for taking my questions. So one thing about costs that you mentioned during your remarks was that there’s going to be new trainings for Goderich for continuous mining, so will that increase costs next year and then on a per-unit basis for your salt projects? And then the same thing

[Angelo Brisimitzakis:]

Hi Ivan, it’s Angelo, good morning. You know, the training on the continuous mining is going to be done adjacent to the current work. In fact, we have pretty good experience in continuous mining from our mine in the UK. I think we’ve been using that technology for about eight years now so it’s a matter of translating skills we already know in the UK – we’ve already had teams back and forth sharing some of that information and introducing it. It shouldn’t be a material change in our costs.

[Ivan Marcuse:]

Great. And since you’ve been using it, what do you expect the benefits to be from the continuous mining? So where do you ultimately [see] the unit production costs going for salt once training is up and the miners are going?

[Rod Underdown:]

Yes, hi Ivan, this is Rod. The continuous mining technologies, so just to get everybody on the same playing field here

[Ivan Marcuse:]

Great. And then your Chile investment, what kind of costs would be needed to get that asset up and going or is it ready to go once you make a decision? And what sort of spending would be required to get it going, and what would be the timing on that?

[Angelo Brisimitzakis:]

Yeah, I think you need to look at Chile as a long-term option that any mineral-based mining company needs to consider in order to keep its product line and its asset base vibrant and moving forward. Those assets in Chile are some of the highest-quality, lowest-cost salt in the world. We actually have two competitors that currently exploit that salt so we know it can be brought to market cost effectively and competitively. But right now it sits in the middle of a desert, and it’s basically on the surface so it would require a surface mining operation which tends to be much easier and lower-cost to –introduce than underground mining – significantly lower-cost to introduce although we don’t have a specific estimate for you today. The other thing that has to be done is roads and ports would have to be secured. Again, this is a very isolated area in Chile. Once that’s secured, you can take that salt really anywhere in the world. There’s some really effective logistics both to North America, both East and West Coasts, into Europe or even into Asian markets. So it certainly provides us a backup supply to our current mining operations in the US, in Canada and the UK and that’s very important as we saw last year when we had a tornado that affected our primary Goerich Mine. It also opens up those new markets I mentioned, and another point to recognize is we currently serve for example our C&I business, consumer and industrial, we currently serve customers on the East Coast in a very disadvantaged way; meaning we have to ship product for example from Lyons, Kansas, where we have our closest evap facility or Chicago, Illinois, where we have our closest packaging facility. Giving us ability now to ship product directly onto the East Coast to serve existing customers could really drive some productivity in the future. So I would look at this as a step-by-step approach. We secured what is probably the essential piece, which is the mineral rights. We’ll develop logistics over the next couple of years as well as a mining plan. We’ll assess market and then we’ll have more to talk about as we go forward. But certainly don’t look at this as a short-term opportunity; look at it as a long-term option that really any good mining/mineral company needs to be developing as they develop their current assets as well.

[Ivan Marcuse:]

Great, and my last question

[Angelo Brisimitzakis:]

Yeah, that’s a great question because we have seen some choppiness in MOP. I think many of you have probably heard the others’ calls, and I think as Rod has pointed out, MOP is a little bit different in the sense that since it is a primary fertilizer for many growers that the dealers tend to load up on inventory and there’s really a different cycle. Ours is more of a just-in-time, plus the crops that we serve tend to be more stable than some of the volatile commodity crops. So we see perhaps a little bit of disconnect right now going on between MOP and SOP. What we see on SOP is both the demand and the pricing showing a little bit more stability than you might see on some of the international MOP pricing discussions. So it might result in a slightly higher spread but we don’t think that’s going to be a material difference, and we do think that all pot ash is predicted to strengthen as we approach the spring of next year.

[Ivan Marcuse:]

Great, thanks for taking my questions.

[Operator:]

Thanks. From Oppenheimer we’ll move to Edward Yang.

[Edward Yang:]

Good morning. On the guidance for deicing salt, you mentioned that the volumes are going to look a lot like 2009. But do you expect it to be distributed differently between Q4 and Q1? Is it going to be more heavily skewed towards Q1 as customers work through their inventories?

[Angelo Brisimitzakis:]

Yeah, I think we typically think about it as about a 45/55 split just roughly, and there’s probably a minor expectation for a shift there but probably nothing more than 5%. So you could think about it in terms of a relatively normal split.

[Edward Yang:]

Okay. And on consumer industrial, why the different trends there? I mean you’re still expecting volumes in Q4 to be down year-over-year?

[Angelo Brisimitzakis:]

The buying patterns, the buying habits of customers are a bit different in the retail area than they are in the highway deicing area. So yeah, I think we are expecting a flattish to down volume and that that would be a Q4 expectation. However I think assuming normal Q4 weather we would certainly expect to see a lift in that sub-segment in Q1.

[Edward Yang:]

Okay. And what’s your assumption for the tax rate in 2013?

[Rod Underdown:]

Yeah, we haven’t introduced that yet. We typically think of a normal year as being somewhere around 30%, so that would be the right longer-term rate to use. But as I mentioned, there are several factors influencing us this year and we think of our full-year rate as being in the low 20%s.

[Edward Yang:]

Alright, thank you.

[Operator:]

Next we’ll hear from Bob Koort with Goldman Sachs.

[Bob Koort:]

Thanks, good morning. Angelo, I was wondering if you could just review for us the spread of contract terms in terms of the upside volume obligation if we do get a better or even a normal winter in light of reduced bid volumes going into the season? Is it pretty standard across your customer base or are there varying percentages that you’re obligated to meet?

[Angelo Brisimitzakis:]

Yeah, good question. I mean kind of the marquee, large, primarily US states that we depend heavily on, the typical arrangement has an upside of 20% versus the targeted volume at which we’re obligated to supply, under penalty if we can’t, at the predetermined price. So we typically store added safety stock to meet those obligations. Beyond the 20% we’re not obliged to supply, there are no penalties if we can’t, but that provides us with a tremendous opportunity for upside because the pricing is then renegotiated at whatever the market will bear in that high-demand scenario. And we believe our inventories going into this season are not only adequate to support the plus 20% requirement but also a spot that might be above that. Again, it might be wishful thinking but there was actually a study that Weather Trends International put out that said about 90% of the time following an exceedingly warm winter that’s well below normal snowfall, that the following winter is 10% to 25% more snow than average. So again, I’m not a big fan of weather forecasts – they’re often wrong – but this was kind of statistically based and it certainly provides for a hopeful winter for Compass Minerals.

[Bob Koort:]

And can you help us with, you mentioned the bid sizes were down. On average how much down were they?

[Angelo Brisimitzakis:]

Yeah, and that’s kind of the other variable. We kind of had an unusual buildup to our winter season for this year because we’re going to have the normal bids that we receive plus whatever bids weren’t fulfilled last season. And we think the combination of those two will give us a volume around 7 million tons over the winter which is slightly down from our ten-year average of about 7.5 million tons. So we think net-net with average weather we’re going to end up pretty well. However, we got there really through a much larger than normal carryover effect and smaller bid sizes. Bid sizes, if you read some of the public available, some states, some areas were down almost 50%. Others were actually flat; some were slightly up. Maybe on a weighted average basis something around 15% smaller bid this cycle than typical but again, what we look at is what do we expect to sell and we benchmark it against an average winter; and we expect to sell something slightly less than our average sales in a winter.

[Bob Koort:]

And my last question, I appreciate your time

[Angelo Brisimitzakis:]

Well, the last one we had was a few years back, and actually a good winter sustains itself for two years. You actually benefit in the cycle that you’re in, in the winter that you’re in, and then you can imagine it sets you up for a pretty positive and dynamic bidding cycle thereafter. Unfortunately, a mild winter also gives you two years of effect – the mild winter that you currently go through, and it sets you up for a fairly boring and somewhat depressed bidding cycle. What we saw in the last year, which was the 2008-2009 winter where we had a severe winter, we had a price increase on average on bids of 20% which is super-sized versus our typical 3% to 4% price. And then the following year we had an increase of 8%, so that was the two-year effect where we achieved 28% pricing over a two-season period. And in fact, during that winter of 2008-2009 spot prices in places in Illinois, for example, reached over $100 a ton; and I believe at the time, Rod, correct me if I’m wrong – prices were normally around $50 a ton.

[Rod Underdown:]

That’s about right.

[Angelo Brisimitzakis:]

So we saw in effect a doubling of pricing in those few areas. Now, some of those regressed back to the average but that 28% really was never given back. So this industry tends to move in chunks and normally chunks forward after harsh winters. It rarely moves back, and when it does move back like it will this season it moves back very little. We look at (-)2% and say following a historically mild winter with bids down 15% and probably near record customer inventories, to only give back 2% selling price? I struggle to find another industry in the materials space that can boast those kinds of dynamics.

[Bob Koort:]

Great, thank you for the help.

[Operator:]

And next we’ll hear from David Begleiter with Deutsche Bank.

[David Begleiter:]

Thank you, good morning. Angelo, back on the Q2 call you referenced that pricing was trending flat in highway deicing for this year; obviously you finished (-)2%. So basically what happened in the back half of the bidding season? What really drove the price decline versus the first half?

[Angelo Brisimitzakis:]

Yeah, I think you’re correct. I think when we gave guidance this time three months ago we were looking at flattish. I think Rod updated it last month at a conference to slightly down and now we’re able to put clarity around it, now that the whole season is finished. You know, bidding… Imagine a process where there was essentially thousands of prices put in and thousands of reactions by multiple competitors to each subsequent price offered; and you start out probing for the appropriate level that will sustain the market and get you the volume that you seek. In a strong market, for example that year we talked about, 2008-2009, when you probe your normal pricing you end up achieving more volume than you intended, so your next bid tends to be at a higher price in order to manage your volume. And that continues to go forward until you end the bidding season at the targeted volume and whatever price you get. And we ended up in that year 20%. Unfortunately this cycle it started out differently. Some of the early bids actually had higher prices, and as we went along those higher prices were not achieving the targeted necessary volumes to support our asset base to maintain our market share. So the only response we have in order to continue to maintain share is to respond price accordingly. It’s kind of like a game of musical chairs – when you get down to one or two chairs it gets pretty dicey. So I would say the end of the bidding season was a lot dicier than the beginning was, but again, we look at it overall and we look at the volume that we achieved plus the carryover, plus an average net price only down slightly; and we look at it following what we would call an historically mild winter – certainly milder, with fewer snowfall events than the last 15 years at least. And we feel pretty good about what we achieved, and we feel really good that the structure of the industry maintains itself. And that’s why we always say this industry resets itself after every subsequent winter because there really isn’t a cyclicality to weather. This winter may be the harshest ever just like last winter was one of the mildest – there is no pattern. It’s a random event. Weather is a random event and therefore people react to what’s in front of them and not necessarily what happened the season before.

[David Begleiter:]

Understood. And Angelo, what is your highway deicing market share right now for the upcoming season?

[Angelo Brisimitzakis:]

We really don’t disclose specific market shares but I think it’s fair to say that it’s relatively unchanged from last season. And again, in a cycle where demand is down it’s important that we keep that share and it probably will not be a very smart time to be going after additional share.

[David Begleiter:]

And just lastly, given the good solar evaporation harvests how much more volume would you have to sell in next year, 2013, versus this year?

[Angelo Brisimitzakis:]

Yeah, and this is where we really need to separate the harvest from the SOP production. The SOP harvest is merely the raw material that has the various minerals in it – the salt, the magnesium chloride, and the potassium sulfate – that we then process through an SOP plant in order to have sellable SOP. That SOP plant is constrained currently at around 350,000 tons per year plus we have about 40,000 tons available to us from the Big Quill acquisition in 2011. So our total SOP capacity is around 390,000 tons to date regardless of the amount of harvest. So even though our harvest is increasing we don’t have a plant that can utilize it yet. Our Phase II expansion would allow the plant to grow to potentially 570,000 tons from its current approximately 350,000 tons. So between now and the beginning of the SOP Phase II expansion we are constrained between that 350,000 tons and 390,000 tons range that I gave you for our SOP facilities.

[David Begleiter:]

Very good, thank you very much.

[Operator:]

And next we’ll move on to Joel Jackson with BMO Capital Markets.

[Joel Jackson:]

Hi, good morning. Congrats, Angelo, on your upcoming retirement. I want to just poke around on a couple things here. On your cost guidance you gave for Q4/Q1, just going back to something Rod said a few minutes ago

[Rod Underdown:]

Yeah, the $2.50 is a real cost. There is no mix. There is zero mix in that number.

[Joel Jackson:]

Okay. So if I look to your Q4 and Q1 salt guidance, you’re obviously guiding for a little bit below average Q4 and Q1 highway deicing volume – what would be a normal Q4 and Q1 salt cost if we sort of assumed a normal Q4/Q1 volume and not any more impacts from the Goderich tornado?

[Rod Underdown:]

Yeah, I think, Joel, you might have heard us talk in the past about kind of going back to the 2009-2010 period, recognizing we have a structural increase of about $1.00 and then adding inflation for that, which kind of gets you from the ’09 cost to the current expectation of… Across a full year it would be somewhere between $33 to $34. I can walk you separately through the quarterly some other time off the call, but that would be the general way that I would encourage you to look at it.

[Joel Jackson:]

So ’13 may be closer to $34, but ’14 might be closer to $33 – something like that?

[Rod Underdown:]

Order of magnitude that doesn’t sound incorrect but you know, we really haven’t introduced anything for 2014.

[Joel Jackson:]

Okay. On your highway deicing price outlook, I know you said bid season pricing is down about 2% and you’re guiding to highway deicing prices in Q4 and Q1 to increase because of improved sales mix. Can you walk us through a little bit how you will go from (-)2% to a little bit of an increase when we talk about rollovers and multi-years and the chemical salt base load?

[Rod Underdown:]

Yeah, sure. Well, as you probably remember, our chemical bas load is not seasonal at all. It’s very consistent. And while sometimes chemical plants produce more or less there’s not a huge variation in demand over the course of a year. So last year when our highway deicing sales were constrained, the chemical sales became a larger portion of our sales mix. And so when you factor that in, last year in Q4 we actually had prices that we reported down almost $3.00 versus the prior year while the pricing last year was flattish. So the effect on chemical, a bigger portion of chemical sales last year was seen in our Q4 2011 results. When you factor in normal weather expected for Q4 this year we would expect to report a higher average selling price for the exact opposite reason.

[Joel Jackson:]

Okay. Let me ask a question as well

[Angelo Brisimitzakis:]

Yeah, this is Angelo. That’s obviously a hot topic of all the business journals these days. We’re in the process of talking to our key investors to understand what their preferences are. Certainly the dividend is extremely important to Compass Minerals and many of our investors. We’ve made no definitive decision yet. It’s being evaluated but we’ve made no decision.

[Joel Jackson:]

Okay. Maybe if I can just go into SOP a bit, too

[Angelo Brisimitzakis:]

Yeah, that’s a good question. Again, you can imagine across 40,000 acres there’s a lot of things going on in solar evaporation, so we look at certain key performance indicators

[Joel Jackson:]

Okay, and finally just furthering the discussion on SOP prices

[Angelo Brisimitzakis:]

Yeah, that’s a good question. I mean our typical contract duration is 90 days or less where we guarantee pricing. Now of course we guarantee supply for longer periods, and if you look at our customer base we typically supply customers year after year, but we have the opportunity to look at price at least every quarter. We also sell to different crops than the MOP guys do, and a lot of our sales are concentrated in the West where KCL or MOP isn’t that dominant as it is in other parts of the world. So we believe we have a different crop base, a different geographical base, a different customer base; and again, as I said in my comments before we don’t sell as much to dealers that keep large quantities of inventory so we tend to not get into that rollercoaster of our dealer customers having too much SOP and really pushing the price down to move it; or having too little SOP and pulling the price up to get it. We’re not in that cycle. So we like this price stability. We like the boringness of prices in the low $600’s because based on our costs and our improving costs, $600 a ton for SOP is a very attractive margin for Compass Minerals.

[Joel Jackson:]

I might sneak in one more question if you don’t mind. Can you just maybe comment generally if there were any trends this year from your bid season contract portfolio versus last year? For example are there any geographical areas that you may have gained overall share in or lost share in, just so we can get an idea of how things trended year-over-year?

[Angelo Brisimitzakis:]

Are you back to salt?

[Joel Jackson:]

I’m back to salt, sorry, yes.

[Angelo Brisimitzakis:]

Well you know, every year it’s kind of like the duck on the pond – it looks very calm at the top, looking down. As I said our shares is essentially unchanged; our pricing off 2% considering the low demand and you think that nothing’s happened. There are literally thousands of bids and within those there’s probably multiple hundreds in which we’ve lost or we’ve won. So there’s a lot of noise under the surface but in general we remain in those areas that are critical to us in those large states. We sell a lot less in places where we have disadvantages – for example, in the state of Ohio where we have a 5% barrier to sell, it’s kind of protectionist there for Ohio and we don’t participate as much. We don’t necessarily get to the East Coast because our logistics are disadvantageous. We tend to do very well in Ontario; we tend to do very well around the Great Lakes in Wisconsin and Illinois and Michigan. Those haven’t changed in a material way.

[Joel Jackson:]

Thank you.

[Operator:]

And next we’ll hear from Jeff Zekauskas with JP Morgan.

[Jeff Zekauskas:]

Hi, good morning. In a typical Q4, what’s the distribution of your monthly shipments? In other words, in a normal quarter what percent is shipped in December, what percent in November and what percent in October?

[Rod Underdown:]

Yeah, a really good question, Jeff. October is almost always the lowest by far. November, there’s typically a step up in the 2x range and in December it’s 2x again. So just order of magnitude December is by far the largest month in our quarterly dispersion.

[Jeff Zekauskas:]

So by 2x again you mean 2x November.

[Rod Underdown:]

Yes, that’s correct.

[Jeff Zekauskas:]

Okay. Secondly, in your SOP shipments you said that you shipped more to the offshore markets. What percent do you usually ship to the offshore markets, how much did you ship and which are the key offshore markets for SOP?

[Rod Underdown:]

Yeah, sure. Historically Q3 is the quarter where we do more of our international shipments. That’s because we have a number of customers that are more Southern Hemisphere and so the growing cycle is obviously different, and our export shipments there tend to focus – for those specific customers tend to be Australia and New Zealand area. But we do sell a fair amount into Latin America and so some of our export sales were there. As I look at the percent change in domestic and export, last year was an unusual mix in that we had very low exports last year and they were almost doubled this year. So the mix was just slightly different but not all that unusual from a typical Q3.

[Jeff Zekauskas:]

So do you usually ship, I don’t know, 25% offshore in Q3?

[Rod Underdown:]

Yeah, more like a third in Q3 typically.

[Angelo Brisimitzakis:]

So for the year 20%, 25% is a good proxy, right?

[Rod Underdown:]

For the year yeah, 25%.

[Jeff Zekauskas:]

Why was the tax rate 9% in the quarter?

[Rod Underdown:]

Yeah, so as I had mentioned we had a couple of factors that came into play which affected our outlook for the full year tax rate. So where we had previously expected it to be in the mid-20%’s and we’re now expecting it to be in the low 20%’s. And when we record our tax expense for any quarterly period we’re always truing up the year-to-date to match what we expect it to be for the full year absent any kind of special items.

[Jeff Zekauskas:]

So these adjustments relate to prior years or to the current year that have decreased your rate?

[Rod Underdown:]

It’s all related to current-year events, Jeff.

[Jeff Zekauskas:]

Okay, thank you very much.

[Operator:]

Ladies and gentlemen, this does conclude the time allotted for our question-and-answer session. Mr. Brisimitzakis, I’ll turn the conference back over to you for any additional or concluding comments.

[Angelo Brisimitzakis:]

Oh, you said that very well, Sarah. Thank you. [laughter] With our essential products safely produced from our advantaged assets, with our large moats selling into attractive, highly-structured markets that enhance life – whether it’s public safety or nutrition – Compass Minerals has a very bright future ahead of it. I’ve been honored to have been its CEO for these past seven years and to have worked with each of you; also with our 2000 or so employees and a Leadership Team and Board of Directors that are both very supportive and world-class. I am most proud of what we have accomplished together for our shareholders

[Operator:]

Ladies and gentlemen, that does conclude today’s conference. Thank you for joining.