KMG Chemicals Inc. (KMGB)

Q1 2011 Earnings Call

December 9, 2010 10:00 am ET

Executives

Neal Butler – President, Chief Executive Officer

John Sobchak – Chief Financial Officer

Analysts

Eric Glover – Canaccord Genuity

(Charlie) – CJS Securities

Daniel Rizzo – Sidoti & Company

Alex Silverman – Special Situations Fund

Jay Harris – Goldsmith & Harris

David Cohen – Midwood Capital

Rosemarie Morbelli – Ingalls & Snyder

Presentation

Operator

Good morning and welcome to the KMG Chemicals Incorporated First Quarter 2011 conference call. We would like to begin by reminding you that the information in this conference call includes certain forward-looking statements that are based upon assumptions that in the future may prove not to have been accurate and are subject to significant risks and uncertainties, including statements as to the future performance of 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 could cause results to differ include but are not limited to the loss of primary customers, successful implementation of internal plans, product demand, the impact of competing products, increases in the prices of raw materials and active ingredients, successful acquisition and integration of additional product lines and businesses, the condition of capital markets in light of interest rate and currency fluctuations and general economic conditions, environmental liabilities, 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 Mr. Neal Butler, President and CEO. Neal, please go ahead.

Neal Butler

Thank you. Good morning, and again welcome to KMG’s Fiscal 2011 First Quarter conference call. John Sobchak, our CFO, and I will take you through the financials, provide an overview of each of our businesses, as well as update you on the integration of our recent electronic chemicals acquisition. We’ll also present our outlook for the remainder of fiscal 2011 and give you a preview of our expectations for electronic chemicals for fiscal 2012, which begins on August 1. After our comments, we will address your questions.

Our earnings release was filed earlier today and I hope all have had a chance to review it. You can access it on our website. We also plan to file our 10-Q tomorrow.

For the general summary for the first quarter, electronic chemicals performance was notably ahead of last year with the recovery in the semiconductor market and the success of efficiency measures implemented in conjunction with the previous acquisition’s integration. Performance associated with integration of the recently acquired electronic chemicals business from General Chemicals is proceeding extremely well and according to plan.

Penta performance was slightly better than anticipated, particularly as raw material costs increased. Creosote presented challenges both in terms of buy and driven by production demands, rail tie treaters, and average pricing. These issues have been addressed and we’ll expand on them in this call. Animal health, though still a very small portion of our business, delivered performance in line with expectations.

For the first quarter of fiscal 2011, net sales rose 26% to $62.1 million producing operating income of $5.6 million and net income of $3.5 million or $0.31 per diluted share, versus fiscal 2010 net sales of $49.4 million, operating income of $8 million, and net income of $4.6 million or $0.41 per diluted share for the same period in fiscal 2010. We recorded a tax benefit arising from the reversal of an NOL allowance from our electronic chemicals operations in Milan which added $0.036 per diluted share, which John will touch on later in this call.

The increase in net sales was due primarily to our March 2010 electronic chemicals acquisition. The previous year’s operating income was unusually strong, benefiting from a temporary shift in product mix and low input costs in our wood treating chemicals business. Meanwhile, the current year’s results have been burdened by the temporary costs associated with the integration of the most recent acquisition.

Now I’d like to discuss each segment and the outlook for each business for the remainder of the year. Before I do, it’s worth noting during the first quarter of fiscal 2011, we changed the methodology we use to allocate corporate overhead costs to our reporting segments. All corporate overhead is now allocated to the segment except for those amounts associated with KMG’s operations as a public entity such as Board costs, audit fees, et cetera. The allocation is based on segment net sales. We’ve revised prior year amounts to reflect the current methodology.

Now regarding our electronic chemical segment, sales increased by 60% to $36.8 million from $23 million in the prior year due primarily to the business acquired in March 2010. As compared to the fourth quarter of fiscal 2010, revenue increased incrementally with the anticipated flattening of demand. As we reported in our news release, we expect sales to continue at approximately first quarter levels for the coming quarter.

This segment contributed $3 million to operating income, an increase of 235% from $902,000 in last year’s first quarter, which reflects higher sales and the benefits of cost efficiency initiatives implemented in 2009 as part of our previous acquisitions integration project. This increase in operating income was achieved despite the cost burden associated with the integration of the recently-acquired business.

The integration and consolidation of manufacturing operations is underway and should be completed by fiscal 2011 year-end. When it happens, we will look forward to the majority of production volume shifting from third party co-manufacturers to our plants in Pueblo and Hollister, thus sharply reducing tolling fees. As a result of the additional production volumes, these plants will run at over 80% of capacity versus 50% capacity before the plant consolidation. The result is that the operating margins will increase by 200 basis points. I am pleased to report that the qualification process is moving forward and we expect all product moves to be completed by June of this year.

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