Item 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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All statements, other than statements of historical fact, contained herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements relate to future events or our future financial performance, and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include, but are not limited to, the following: domestic and international general business and economic conditions; uninsured risks and hazards associated with underground mining operations; losses for acts of nature which may not be fully reimbursable through our insurance carriers; the timing of any insurance reimbursements may not correspond to the period in which the loss was incurred; governmental policies affecting the agricultural industry, consumer and industrial industry or highway maintenance programs in localities where we or our customers operate; weather conditions; the impact of competitive products; pressure on prices realized by the Company for its products; constraints on supplies and prices of raw materials and energy used in manufacturing certain of our products and the price or availability of transportation services; capacity constraints limiting the production of certain products; the ability to attract and retain skilled personnel as well as labor relations including without limitation, the impact of work rules, strikes or other disruptions, wage and benefit requirements; difficulties or delays in the development, production, testing and marketing of products; difficulties or delays in receiving or renewing required governmental and regulatory approvals; the impact of new technology on the demand for our products; market acceptance issues, including the failure of products to generate anticipated sales levels; the effects of and changes in trade, monetary, environmental and fiscal policies, laws and regulations; the impact of the Company’s indebtedness and interest rates changes; foreign exchange rates and fluctuations in those rates; the costs and effects of legal and tax proceedings, including environmental and administrative proceedings involving the Company; customer expectations about future potash market prices and availability and agricultural economics; the impact of credit and capital markets, including the risks of customer and counterparty defaults and declining credit availability; changes in tax laws or estimates; cyber security issues; and other risk factors reported in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) as updated quarterly on Form 10-Q.
In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “will,” “should,” “could,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no duty to update any of the forward-looking statements after the date hereof or to reflect the occurrence of unanticipated events.
Unless the context requires otherwise, references in this quarterly report to the “Company,” “Compass,” “Compass Minerals,” “CMP,” “we,” “us” and “our” refer to Compass Minerals International, Inc. (“CMI”, the parent holding company) and its consolidated subsidiaries.
Critical Accounting Estimates
Preparation of our consolidated financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management believes the most complex and sensitive judgments result primarily from the need to make estimates about matters that are inherently uncertain. Management’s Discussion and Analysis and Note 2 to the Consolidated Financial Statements included in our Annual Report on Form 10-K filed with the SEC on February 24, 2014, describe the significant accounting estimates and policies used in preparation of our consolidated financial statements. Actual results in these areas could differ from management’s estimates.
Results of Operations
Salt Segment
Salt is indispensable and enormously versatile with thousands of reported uses. In addition, there are no known cost-effective alternatives for most high-volume uses. As a result, our cash flows from salt have not been materially impacted through a variety of economic cycles. We are among the lowest-cost salt producers in our markets because our salt deposits are high-grade quality and among the most extensive in the world, and because we use effective mining techniques and efficient production processes. Since the highway deicing business accounts for nearly half of our annual sales, our business is seasonal; therefore results and cash flows will vary depending on the severity of the winter weather in our markets.
Deicing products, consisting of deicing salt and magnesium chloride used by highway deicing and consumer and industrial customers, constitute a significant portion of our salt segment sales. Our deicing sales are seasonal and can fluctuate from year to year depending on the severity of the winter season weather in the markets we serve. Inventory management practices are employed to respond to the varying level of sales demand which impacts our production volumes, the resulting
per-ton cost of inventory and ultimately profit margins, particularly during the second and third quarters when we build our inventory levels for the upcoming winter and earnings are typically lower than the first and fourth quarters.
We assess the severity of winter weather compared to recent averages, using official government snow data and comparisons of our sales volumes to historical trends and other relevant data. Weather affects our highway and consumer and industrial deicing salt sales volumes and resulting gross profit. The frequency of winter weather events was above average in both the first quarter of 2014 and the first quarter of 2013 in the markets we serve. The more severe winter in the first quarter of 2014 favorably impacted our sales and our operating earnings when compared to the first quarter of 2013.
Plant Nutrition Segment (formerly known as Specialty Fertilizer Segment)
Our sulfate of potash (“SOP”) product is used in the production of specialty fertilizers for high-value crops and turf. Our domestic sales of SOP are concentrated in the Western and Southeastern U.S. where the crops and soil conditions favor the use of low-chloride potassium nutrients, such as SOP. Consequently, weather patterns and field conditions in these locations can impact the amount of plant nutrition sales volumes. Additionally, the demand for and market price of SOP is affected by the broader potash market. The potash market is influenced by many factors such as world grain and food supply, changes in consumer diets, general levels of economic activity, governmental food programs, and governmental agriculture and energy policies around the world. Economic factors may impact the amount or type of crop grown in certain locations, or the type of fertilizer product used. The yields and/or quality of high-value or chloride-sensitive crops are generally better when SOP is used as a potassium nutrient rather than potassium chloride (“KCl”).
Worldwide consumption of potash has increased in response to growing populations and the need for additional food supplies. We expect the long-term demand for potassium nutrients to continue to grow as arable land per capita decreases, thereby encouraging improved crop yield efficiencies. In recent years, potash prices, including SOP, have experienced more volatility when compared to prices experienced in previous years, although our average realized price for SOP has been relatively stable over the past 3 years.
Our SOP production facility in Ogden, Utah, the largest in North America and one of only three SOP solar brine evaporation operations in the world, utilizes naturally occurring brines in its production process. The brine moves through a series of solar evaporation ponds over a two- to three-year production cycle. Since our production process relies on solar evaporation during the summer to produce SOP at our Ogden facility, the intensity of heat and wind speeds, and relative dryness of the weather conditions during that time impacts the amount of solar evaporation which occurs and correspondingly, the amount of raw SOP mineral feedstock available to convert into finished product. Due to lower raw material solar pond harvest in 2012, we purchased and consumed potassium mineral feedstock for SOP production, which was at a higher per-unit cost than our solar evaporated feedstock. The higher per-unit production costs for the inventory produced in 2012 significantly impacted our margins in the first quarter of 2013 when the remaining inventory produced in 2012 was sold. In 2013, our SOP production facility in Ogden experienced operational issues which impacted the process that converts these raw materials to finished goods. In addition, the Ogden facility began operating at production volumes which were lower than the anticipated design capacities of the recent expansion. We expect the current solar pond-based effective capacity to be up to 320,000 tons annually for the Ogden facility beginning in 2014. We are focusing our sales efforts domestically in markets which typically yield higher average selling prices, net of shipping and handling costs, due to their proximity to our facilities when compared to international markets. Beginning in the latter half of 2013, we purchased and consumed KCl feedstock at our Ogden facility for conversion into SOP. These KCl feedstock purchases helped increase production volumes, yet resulted in increased per-unit costs. As the spread between market prices for SOP and KCl has increased, the economics of producing SOP partly from KCl has improved for our unique KCl conversion process. While these KCl purchases will increase our expected full year product cost and reduce the resulting margin percentages, they also are expected to increase the amount of our gross profit. Future purchases of KCl will be based upon several factors, including but not limited to, the cost of converting KCl to SOP and SOP market prices.
In April 2014, we completed the acquisition of Wolf Trax Inc., a privately held Canadian corporation for $95 million Canadian dollars (approximately $86 million U.S. dollars at the closing date) in cash. Wolf Trax, Inc. develops innovative crop nutrient products based upon proprietary technologies. The acquisition is expected to enhance our position as a key resource for premium plant nutrition products.
General
We contract with bulk shipping vessels, barge, trucking and rail services to move products from our production facilities to distribution outlets and customers. Our North American salt mines and SOP production facilities are near either water or rail transport systems, which reduces our shipping and handling costs when compared to alternative methods of distribution, although shipping and handling costs still account for a relatively large portion of the total delivered cost of our products. Future period per-unit costs will continue to be influenced by oil-based fuel costs, a significant component of shipping and handling costs.
Manpower costs, energy costs, packaging, and certain raw material costs, particularly KCl, which can be used to make a portion of our SOP, deicing and water conditioning products, are also significant. Our production workforce is typically represented by labor unions with multi-year collective bargaining agreements. Our energy costs result from the consumption
of electricity with relatively stable, rate-regulated pricing, and natural gas, which can have significant pricing volatility. We manage the pricing volatility of our natural gas purchases with natural gas forward swap contracts up to 36 months in advance of purchases, helping to reduce the impact of short-term spot market price volatility. Our SOP production facility in Saskatchewan, Canada, purchases KCl under a long-term supply agreement, which is not based upon the market price of KCl. One of the production methods uses the brine of Big Quill Lake, which is rich in sodium sulfate, and adds the purchased KCl to create high-purity SOP.
The consolidated financial statements have been prepared to present the historical financial condition and results of operations and cash flows for the Company which include our salt segment, plant nutrition segment, our records management business and unallocated corporate activities. The results of operations for Wolf Trax Inc. have been included in our plant nutrition segment results from the date of acquisition. The results of operations of the records management business and other incidental revenues include sales of $2.3 million and $2.4 million for the three months ended June 30, 2014 and 2013, respectively, and $5.0 million and $4.6 million for the six months ended June 30, 2014 and 2013, respectively, and are not material to our consolidated financial statements and consequently, are not included in the table below. The following tables and discussion should be read in conjunction with the information contained in our consolidated financial statements and the accompanying notes included elsewhere in this quarterly report.
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Three Months Ended
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Six Months Ended
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June 30,
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June 30,
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2014
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2013
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2014
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2013
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Salt Sales (in millions)
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Salt sales
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$
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118.7
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$
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127.3
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$
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471.9
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$
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454.8
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Less: salt shipping and handling
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37.0
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35.7
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160.1
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144.8
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Salt product sales
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$
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81.7
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$
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91.6
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$
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311.8
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$
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310.0
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Salt Sales Volumes (thousands of tons)
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Highway deicing
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990
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1,157
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5,732
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5,515
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Consumer and industrial
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557
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502
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1,211
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1,037
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Total tons sold
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1,547
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1,659
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6,943
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6,552
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Average Salt Sales Price (per ton)
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Highway deicing
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$
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44.93
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$
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47.59
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$
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52.23
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$
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55.27
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Consumer and industrial
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133.27
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143.96
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142.46
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144.69
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Combined
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76.73
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76.77
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67.97
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69.42
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Plant Nutrition Sales (in millions)
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Plant nutrition sales
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$
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65.6
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$
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44.1
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$
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131.7
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$
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98.1
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Less: Plant nutrition shipping and handling
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7.8
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4.6
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15.4
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10.8
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Plant Nutrition product sales
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$
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57.8
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$
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39.5
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$
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116.3
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$
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87.3
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Plant Nutrition Sales Volumes (thousands of tons)
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98
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69
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205
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157
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Plant Nutrition Average Price (per ton)
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$
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670
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$
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638
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$
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641
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$
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625
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Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013
Sales
Sales for the second quarter of 2014 of $186.6 million increased $12.8 million, or 7% compared to $173.8 million for the same quarter of 2013. Sales primarily include revenues from the sale of our salt and plant nutrition products, or “product sales,” as well as revenues from our records management business, and shipping and handling costs incurred to deliver salt and plant nutrition products to our customers. Shipping and handling costs increased $4.5 million from $40.3 million in the second quarter of 2013 to $44.8 million in the second quarter of 2014 due primarily to higher plant nutrition sales volumes in the second quarter of 2014 when compared to same period of 2013 and higher per-unit salt shipping and handling costs for the second quarter of 2014.
Product sales for the second quarter of 2014 of $139.5 million increased $8.4 million compared to $131.1 million for the same period in 2013, principally reflecting higher plant nutrition segment product sales partially offset by lower salt segment product sales.
Salt product sales for the second quarter of 2014 of $81.7 million decreased $9.9 million, or 11% compared to $91.6 million for the same period in 2013. The decrease in the second quarter of 2014 was due primarily to lower highway deicing sales volumes, which was partially offset by higher sales volumes of our consumer and industrial products. Salt sales volumes in the quarter decreased by 112,000 tons from 2013 levels principally due to lower sales of rock salt and specialty deicing
products in our highway business particularly in the U.K. The decline in salt sales volumes contributed approximately $5 million to the decrease in salt product sales. In addition, during the second quarter of 2014, our average selling price was essentially flat in our salt segment, which was principally the result of changes in product mix for highway deicing and consumer and industrial products.
Plant nutrition product sales for the second quarter of 2014 of $57.8 million increased $18.3 million, or 46% compared to $39.5 million for the same period in 2013. This increase was due primarily to a 29,000 ton (42%) increase in sales volumes in the second quarter of 2014 when compared to the prior year. The increase in sales volumes contributed approximately $16 million to the increase in plant nutrition product sales. In addition, our average per-ton market price increased 5% in the second quarter of 2014 to $670 per ton when compared to the same period in 2013. The average selling price for SOP products in the second quarter of 2014 was essentially unchanged from the same period in 2013. The acquisition of Wolf Trax, Inc. increased both our sales volumes and average sales price in the second quarter of 2014.
Gross Profit
Gross profit for the second quarter of 2014 of $37.5 million decreased $4.4 million, or 11% compared to $41.9 million in the second quarter of 2013 due to a decrease in the gross profit in the salt segment which was partially offset by an increase in the plant nutrition segment. As a percent of total sales, 2014 gross margin decreased by four percentage points, from 24% in the second quarter of 2013 to 20% in the second quarter of 2014. The gross profit for the salt segment decreased by approximately $9 million due primarily to lower highway deicing sales volumes and the unfavorable impact of product mix on gross profit.
The increase in plant nutrition segment gross profit of approximately $5 million in the second quarter of 2014 was principally due to higher sales volumes benefiting from modestly higher production volumes when compared to the same period in the prior year. The increase was partially offset by higher per-unit production costs in the second quarter of 2014 as we purchased and consumed KCl feedstock to increase SOP production. In addition, the acquisition of Wolf Trax, Inc. in April 2014 contributed to the increase in plant nutrition segment gross profit.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the second quarter of 2014 of $24.1 million decreased $3.1 million compared to $27.2 million for the same period of 2013. The decrease in expense is partially due to a restructuring charge in the second quarter of 2013 related to a reorganization of the Company’s management of approximately $1.7 million and lower professional services expenses in the second quarter of 2014. This decrease was partially offset by costs related to the acquisition of Wolf Trax, Inc. in April 2014.
Other (Income) Expense, Net
Other expense was $7.1 million for the second quarter of 2014 and other income was $2.7 million for the second quarter of 2013. The second quarter of 2014 includes a $6.9 million charge related to the refinancing of our senior notes in June 2014, comprised of call premiums of $4.0 million, the write-off of existing deferred financing fees of $1.4 million and the write-off of the $1.5 million original issue discount on our 8% senior notes. Net foreign exchange losses were $0.4 million in the second quarter of 2014 and foreign exchange gains were $2.4 million in the second quarter of 2013.
Income Tax Expense
Income tax expense for the second quarter of 2014 was $2.5 million as compared to $2.4 million for the second quarter of 2013. Our effective tax rate for the three months ended June 30, 2014 increased from the prior year due to refinements made in the second quarter of 2014 related to the expected increase in the full-year effective tax rate. Our income tax provision differs from the U.S. statutory federal income tax rate primarily due to U.S. statutory depletion, domestic manufacturing deductions, state income taxes (net of federal tax benefit), foreign income tax rate differentials, foreign mining taxes, and interest expense recognition differences for book and tax purposes.
Six Months Ended June 30, 2014 Compared to Six Months Ended June 30, 2013
Sales
Sales for the six months ended June 30, 2014 of $608.6 million increased $51.1 million, or 9% compared to $557.5 million for the six months ended June 30, 2013. Shipping and handling costs were $175.5 million during the first six months of 2014, an increase of $19.9 million compared to $155.6 million for the same period in 2013. The increase in shipping and handling costs is primarily due to higher salt and plant nutrition sales volumes and higher per-unit shipping and handling costs in the first six months of 2014 when compared to the same period of 2013.
Product sales for the first six months of 2013 of $428.1 million increased $30.8 million, or 8% compared to $397.3 million for the same period in 2013, reflecting higher product sales in both the plant nutrition and salt segments.
Salt product sales of $311.8 million for the six months ended June 30, 2014 increased $1.8 million or 1% compared to $310.0 million in the same period of 2013. The increase in the first six months of 2014 was due to higher salt segment sales volumes, which contributed approximately $43 million to the increase in salt product sales. Salt sales volumes in 2014 increased by 391,000 tons from 2013 levels consisting of higher highway and consumer deicing sales volumes principally due to the more severe winter weather experienced in the first quarter of 2014 in North America when compared to the winter weather experienced in the first quarter of 2013 in the markets we serve, which was partially offset by lower salt sales volumes in the U.K. due to the mild winter in that region. The increase in salt product sales volume was offset by a decline in average salt sales prices primarily due to a decline in the average highway sales price as a result of lower contract pricing experienced from the 2013-2014 bid season when compared to the prior year. In addition, the exchange rates used to translate our operations denominated in foreign currencies into U.S. dollars in the first six months of 2014 unfavorably impacted salt product sales by approximately $7 million when compared to the exchange rates used in the first six months of 2013.
Plant nutrition product sales during the first six months of 2014 of $116.3 million increased $29.0 million, or 33% compared to $87.3 million for the same period in 2013. This increase was due to a 31% increase in sales volumes in the first six months of 2014 compared to the same period in the prior year. In addition, our average selling price of plant nutrition products in the first six months of 2014 increased to $641 per ton from $625 per ton in the first six months of 2013. The acquisition of Wolf Trax, Inc. increased both our sales volumes and average sales price in the second quarter of 2014.
Gross Profit
Gross profit for the first six months of 2014 of $129.8 million decreased $3.4 million, or 3% compared to $133.2 million in the same period of 2013. As a percent of sales, gross margin decreased by three percentage points, from 24% in the first six months of 2013 to 21% in the first six months of 2014. The gross profit for the salt segment decreased by approximately $10 million due primarily to lower average selling prices for highway deicing products, which was partially offset by higher salt sales volumes in the first six months of 2014 when compared to the prior year. In addition, the effects of exchange rates used to translate our operations denominated in foreign currencies into U.S. dollars in the first six months of 2014 unfavorably impacted salt gross profit by approximately $2 million when compared to the exchange rates used in the first six months of 2013.
The increase in plant nutrition segment gross profit of approximately $7 million in the first six months of 2014 was principally due to higher sales volumes when compared to the same period in the prior year. Both periods were impacted by higher per-unit production costs as we purchased and consumed KCl and mineral feedstock to increase SOP production although costs in the first six months of 2014 were elevated when compared to the same period in 2013. In addition, the acquisition of Wolf Trax, Inc. in April 2014 contributed modestly to the increase in plant nutrition segment gross profit.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first six months of 2014 of $49.4 million decreased $1.6 million compared to $51.0 million for the same period of 2013. The decrease in expense is partially due to a restructuring charge in the second quarter of 2013 related to a reorganization of the Company’s management of approximately $1.7 million and lower variable compensation in the first six months of 2014 when compared to the same period in 2013. This decrease was partially offset by costs related to the acquisition of Wolf Trax, Inc. in April 2014.
Other (Income) Expense, Net
Other expense was $4.0 million for the first six months of 2014 and other income was $3.1 million in the first six months of 2013. The second quarter of 2014 includes a $6.9 million charge related to the refinancing of our senior notes in June 2014, comprised of call premiums of $4.0 million, the write-off of existing deferred financing fees of $1.4 million and the $1.5 million write-off of the original issue discount on our 8% senior notes.
Income Tax Expense
Income tax expense of $18.0 million for the six months ended June 30, 2014 decreased $1.5 million from $19.5 million for the same period in 2013 partially reflecting a decrease in pretax income in 2014, partially offset by a higher effective tax rate. Our income tax provision differs from the U.S. statutory federal income tax rate primarily due to U.S. statutory depletion, domestic manufacturing deductions, state income taxes (net of federal tax benefit), foreign income tax rate differentials, foreign mining taxes, and interest expense recognition differences for book and tax purposes.
Liquidity and Capital Resources
Historically, we have used cash generated from operations to meet our working capital needs, to fund capital expenditures, to pay dividends and to repay our debt. Principally due to the nature of our deicing business, our cash flows from operations are seasonal, with the majority of our cash flows from operations generated during the first half of the calendar year. When we have not been able to meet our short-term liquidity or capital needs with cash from operations, whether as a result of the seasonality of our business or other causes, we have met those needs with borrowings under our $125 million revolving credit facility. We expect to meet the ongoing requirements for debt service, any declared dividends and capital expenditures from
these sources. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
Cash and cash equivalents of $304.0 million as of June 30, 2014 increased $144.4 million over December 31, 2013 resulting from operating cash flows of $161.8 million generated in the first six months of 2014 and additional cash received related to the refinancing of our $100.0 million 8% senior notes with $250.0 million 4.875% senior notes. We used a portion of those cash flows to acquire Wolf Trax Inc. for $95 million Canadian dollars ($86.1 million U.S. dollars on the closing date and subject to customary post-closing adjustments), fund capital expenditures of $49.0 million and to pay dividends on our common stock of $40.4 million.
As of June 30, 2014, we had $628.3 million of principal indebtedness consisting of $250.0 million 4.875% senior notes due 2024 and $378.3 million of borrowings outstanding under our credit agreement. No amounts were outstanding under our $125 million revolving credit facility as of June 30, 2014. We had $7.8 million of outstanding letters of credit as of June 30, 2014, which reduced our revolving credit facility borrowing availability to $117.2 million.
Our debt service obligations could, under certain circumstances, materially affect our financial condition and impair our ability to operate our business or pursue our business strategies. As a holding company, CMI’s investments in its operating subsidiaries constitute substantially all of its assets. Consequently, our subsidiaries conduct all of our consolidated operating activities and own substantially all of our operating assets. The principal source of the cash needed to pay our obligations is the cash generated from our subsidiaries’ operations and their borrowings. Our subsidiaries are not obligated to make funds available to CMI. Furthermore, we must remain in compliance with the terms of our credit agreement, including the total leverage ratio and interest coverage ratio, in order to make payments on our 4.875% senior notes or pay dividends to our stockholders. We must also comply with the terms of our indenture. Although we are in compliance with our debt covenants as of June 30, 2014, we can make no assurance that we will remain in compliance with these ratios nor can we make any assurance that the agreements governing the current and future indebtedness of our subsidiaries will permit our subsidiaries to provide us with sufficient dividends, distributions or loans to fund scheduled interest payments on the 4.875% senior notes, when due. If we consummate an additional acquisition, our debt service requirements could increase. Furthermore, we may need to refinance all or a portion of our indebtedness on or before maturity, however we cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all.
We have been able to manage our cash flows generated and used across the Company to permanently reinvest earnings in our foreign jurisdictions or efficiently repatriate those funds to the U.S. As of June 30, 2014, a substantial portion of our cash and cash equivalents was either held directly or indirectly by foreign subsidiaries. Due in part to the seasonality of our domestic business, we experience large changes in our working capital requirements from quarter to quarter. Typically, our consolidated working capital requirements are the highest in the fourth quarter and lowest in the second quarter. When needed, we fund short-term working capital requirements by accessing our $125 million revolving line of credit. Due to our ability to generate adequate levels of domestic cash flow on an annual basis, it is our current intention to permanently reinvest our foreign earnings outside of the U.S. However, if we were to repatriate our foreign earnings to the U.S., we may be required to accrue and pay U.S. taxes in accordance with the applicable U.S. tax rules and regulations as a result of the repatriation. We review our cash balances and tax positions on a regular basis with the intent of optimizing cash accessibility and minimizing tax expense.
The amount of permanently reinvested earnings is influenced by, among other things, the profits generated by our foreign subsidiaries and the amount of investment in those same subsidiaries. The profits generated by our domestic and foreign subsidiaries are, to some extent, impacted by the values charged on the transfer of our products between them. We calculate values charged on transfers based on guidelines established by the multi-national organization which publishes accepted tax guidelines recognized in all of the jurisdictions in which we operate, and those calculated values are the basis upon which our subsidiary income taxes, profits and cash flows are realized. Some of our calculated values have been approved by taxing authorities for certain periods while the values for those same periods or different periods have been challenged by the same or other taxing authorities. While we believe our calculations are proper and consistent with the accepted guidelines, we can make no assurance that the final resolution of these matters with all of the relevant taxing authorities will be consistent with our existing calculations and resulting financial statements. Additionally, the timing for settling these challenges may not occur for many years. We currently expect the outcome of these matters will not have a material impact on our results of operations. However, it is possible the resolution could impact the amount of earnings attributable to our domestic and foreign subsidiaries, which could impact the amount of permanently reinvested earnings and the tax-efficient access to consolidated cash on hand in all jurisdictions, as well as future cash flows from operations.
Canadian provincial tax authorities have challenged tax positions claimed by one of our Canadian subsidiaries and have issued tax reassessments for years 2002-2008. The reassessments are a result of ongoing audits and total approximately $83 million, including interest through June 2014. We dispute these reassessments and plan to continue to work with the appropriate authorities in Canada to resolve the dispute. There is a reasonable possibility that the ultimate resolution of this dispute, and any related disputes for other open tax years, may be materially higher or lower than the amounts we have reserved for such disputes. In connection with this dispute, local regulations require us to post security with the tax authority until the dispute is resolved. We and the tax authority have agreed that we will post collateral in the form of a $31 million performance bond (including approximately $6 million of the performance bond which will be cancelled pro rata as the
outstanding assessment balance falls below the outstanding amount of the performance bond). As part of the additional required collateral, we have previously paid approximately $30 million and we have agreed to pay an additional approximately $2 million during the remainder of 2014 with the remaining collateral balance to be paid after 2014. We will be required by the same local regulations to provide security for additional interest on the above disputed amounts and for any future reassessments issued by these Canadian tax authorities in the form of cash, letters of credit, performance bonds, asset liens or other arrangements agreeable with the tax authorities until the dispute is resolved.
In addition, Canadian federal and provincial taxing authorities have reassessed us for years 2004-2006 which have been previously settled by agreement among the Company, the Canadian federal taxing authority and the U.S. federal taxing authority. We have fully complied with the agreement since entering into it and we believe this action is highly unusual. We are seeking to enforce the agreement which provided the basis upon which the returns were previously filed and settled. The total amount of the reassessments, including penalties and interest through June 30, 2014, related to this matter is approximately $104 million. We have agreed to post collateral in the form of a performance bond for approximately $22 million and have previously made cash payments of approximately $2 million. We are currently in discussions with the Canadian tax authorities regarding the remaining required collateral of approximately $44 million.
In December 2009, a surface salt storage dome which was under construction collapsed at our mine in Goderich, Ontario. We are involved in construction litigation and other contract claims relating to the dome’s collapse. Claims asserted against us total approximately $13 million. We have also counterclaimed for damages.
While these matters involve an element of uncertainty, management expects that their ultimate outcome will not have a material impact on our results of operations, cash flows or financial position.
In August 2011, a tornado in Goderich, Ontario, struck our salt mine and our salt mechanical evaporation plant. There was no damage to the underground operations at the mine. However, some of the mine’s surface structures and the evaporation plant incurred significant damage which temporarily ceased production at both facilities. We expect to be reimbursed by our insurers for substantially all of the replacement and repair costs for our property, plant and equipment and associated clean-up costs incurred. However, there can be no assurance that all losses will be fully or even substantially reimbursed. We had approximately $10 million of capital expenditures (including expenditures for improvements to our existing property, plant and equipment which are not fully reimbursable) in the first six months of 2013 due to the tornado.
We also have submitted a substantial business interruption insurance claim to compensate us for lost profits and certain additional expenses incurred related to the ongoing operations. We estimate that the effects from the tornado were immaterial in the first six months of 2014 and 2013. We believe our losses, including the impact of estimated lost sales, lost production and additional expenses that have been incurred related to the tornado will be substantially covered by our insurance policies as business interruption losses. However, the amount of actual business interruption recoveries may differ materially from our current and future estimates and the ultimate collection and timing of any insurance recoveries could materially impact our short-term or long-term financial position and liquidity. Since the tornado occurred, we have received insurance advances totaling $100.0 million, including $13.7 million and $18.5 million in the first six months of 2014 and 2013, respectively. We have approximately $70.4 million of deferred revenue recorded as of June 30, 2014 in our consolidated balance sheets. The actual insurance recoveries related to the replacement cost of property, plant and equipment are expected to exceed the net book value of the damaged and destroyed property, plant and equipment and the related impairment charges. We expect to settle our insurance claim in the third quarter of 2014 and recognize a gain as a reduction to product cost in our consolidated statements of operations of more than $80 million.
For the Six Months Ended June 30, 2014 and 2013
Net cash flows provided by operating activities for the six months ended June 30, 2014 were $161.8 million, a decrease of $14.0 million compared to $175.8 million for the first six months of 2013. We had a reduction in working capital items of $57.6 million in the first six months of 2014 compared to a reduction of $74.8 million in the first six months of 2013. These reductions provided a portion of our cash flows from operations, and reflect the seasonal nature of our deicing products and will vary largely due to the severity and timing of the winter weather in our regions.
Net cash flows used by investing activities of $123.3 million and $41.2 million for the six months ended June 30, 2014 and 2013, respectively, resulted from capital expenditures of $49.0 million and $55.5 million, respectively. Our capital expenditures in 2013 include expenditures of approximately $10 million (including expenditures for improvements to our existing property, plant and equipment which are not fully reimbursable) for the replacement of property, plant and equipment damaged or destroyed by the tornado. The remaining capital expenditures were primarily for routine replacements. In April 2014, we acquired Wolf Trax, Inc. for $95 million Canadian dollars ($86.1 million U.S. dollars on the closing date, and subject to customary post-closing adjustments). In addition, we received $8.7 million and $11.9 million of insurance advances that were presented as investment activities during the first six months of 2014 and 2013, respectively.
Financing activities during the first six months of 2014 were a source of cash flows of $104.7 million, primarily as a result of the refinancing of our $100.0 million 8% senior notes with $250.0 million 4.875% senior notes. We also paid dividends of $40.4 million in the first six months of 2014. During the first six months of 2013, we used $30.2 million of cash flows, primarily to
make $36.5 million of dividend payments and $1.9 million of debt payment. Both periods were partially offset by proceeds received from stock option exercises.
Sensitivity Analysis Related to EBITDA and Adjusted EBITDA
Management uses a variety of measures to evaluate the performance of CMP. While the consolidated financial statements, taken as a whole, provide an understanding of our overall results of operations, financial condition and cash flows, we analyze components of the consolidated financial statements to identify certain trends and evaluate specific performance areas. In addition to using U.S. generally accepted accounting principles (“GAAP”) financial measures, such as gross profit, net earnings and cash flows generated by operating activities, management uses EBITDA and EBITDA adjusted for items which management believes are not indicative of our ongoing operating performance (“Adjusted EBITDA”). Both EBITDA and Adjusted EBITDA are non-GAAP financial measures used to evaluate the operating performance of our core business operations. Our resource allocation, financing methods and cost of capital, and income tax positions are managed at a corporate level, apart from the activities of the operating segments, and the operating facilities are located in different taxing jurisdictions, which can cause considerable variation in net earnings. We also use EBITDA and Adjusted EBITDA to assess our operating performance and return on capital, and to evaluate potential acquisitions or other capital projects. EBITDA and Adjusted EBITDA are not calculated under GAAP and should not be considered in isolation or as a substitute for net earnings, cash flows or other financial data prepared in accordance with GAAP or as a measure of our overall profitability or liquidity. EBITDA and Adjusted EBITDA exclude interest expense, income taxes and depreciation and amortization, each of which are essential elements of our cost structure and cannot be eliminated. Furthermore, Adjusted EBITDA excludes other cash and non-cash items in other (income) expense. Our borrowings are a significant component of our capital structure and interest expense is a continuing cost of debt. We are also required to pay income taxes, a required and ongoing consequence of our operations. We have a significant investment in capital assets and depreciation and amortization reflect the utilization of those assets in order to generate revenues. Consequently, any measure that excludes these elements has material limitations. While EBITDA and Adjusted EBITDA are frequently used as measures of operating performance, these terms are not necessarily comparable to similarly titled measures of other companies due to the potential inconsistencies in the method of calculation. The calculation of EBITDA and Adjusted EBITDA as used by management is set forth in the table below (in millions).
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
Net earnings (loss)
|
|
$
|
(0.7
|
)
|
|
$
|
10.6
|
|
|
$
|
49.5
|
|
|
$
|
57.0
|
|
Interest expense
|
|
|
4.5
|
|
|
|
4.4
|
|
|
|
8.9
|
|
|
|
8.8
|
|
Income tax expense
|
|
|
2.5
|
|
|
|
2.4
|
|
|
|
18.0
|
|
|
|
19.5
|
|
Depreciation, depletion and amortization
|
|
|
18.8
|
|
|
|
18.1
|
|
|
|
37.2
|
|
|
|
35.4
|
|
EBITDA
|
|
|
25.1
|
|
|
|
35.5
|
|
|
|
113.6
|
|
|
|
120.7
|
|
Other non-operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (income) expense, net
|
|
|
7.1
|
|
|
|
(2.7
|
)
|
|
|
4.0
|
|
|
|
(3.1
|
)
|
Adjusted EBITDA
|
|
$
|
32.2
|
|
|
$
|
32.8
|
|
|
$
|
117.6
|
|
|
$
|
117.6
|
|
Our operating earnings were favorably impacted in the first quarter of 2014 and to a lesser degree in the first quarter of 2013 by the winter weather in the markets we serve.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance to provide a single, comprehensive revenue recognition model for all contracts with customers. The new revenue recognition model supersedes existing revenue recognition guidance and requires revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration an entity expects to receive in exchange for those goods or services. This guidance is effective for fiscal years and interim periods with those years beginning after December 15, 2016 and early adoption is not permitted. The guidance permits the use of either a retrospective or cumulative effect transition method. We are currently evaluating the impact that the implementation of this standard will have on our consolidated financial statements.
In April 2014, the FASB issued guidance which changes the requirements for reporting discontinued operations and requires additional disclosures about discontinued operations. Under the new guidance, disposals that represent a strategic shift that have or will have a major effect on an entity’s operations or financial results should be reported as discontinued operations. The guidance is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2014. We do not expect that the guidance will have a material impact on our consolidated financial statements.
In January 2014, the FASB issued guidance related to service concession arrangements. The guidance states that entities should not account for certain service concession arrangements with public-sector entities as leases and should not recognize any infrastructure as property, plant and equipment. The guidance is effective for fiscal years beginning after December 15, 2014. We do not expect that this guidance will have an impact on its consolidated financial statements.
Effects of Currency Fluctuations
We conduct operations in Canada and the U.K. Therefore, our results of operations are subject to both currency transaction risk and currency translation risk. We incur currency transaction risk whenever we or one of our subsidiaries enter into either a purchase or sales transaction using a currency other than the local currency of the transacting entity. With respect to currency translation risk, our financial condition and results of operations are measured and recorded in the relevant local currency and then translated into U.S. dollars for inclusion in our historical consolidated financial statements. Exchange rates between these currencies and the U.S. dollar have fluctuated significantly from time to time and may do so in the future. The majority of our revenues and costs are denominated in U.S. dollars, with British pounds sterling and Canadian dollars also being significant. Significant changes in the value of the Canadian dollar or British pound sterling relative to the U.S. dollar could have a material adverse effect on our financial condition and our ability to meet interest and principal payments on U.S. dollar denominated debt, including borrowings under our senior secured credit facilities.
Although inflation has not had a significant impact on our operations, our efforts to recover cost increases due to inflation may be hampered as a result of the competitive industries in which we operate.
Seasonality
We experience a substantial amount of seasonality in our sales, primarily with respect to our deicing products. Consequently, sales and operating income are generally higher in the first and fourth quarters and lower during the second and third quarters of each calendar year. In particular, sales of highway and consumer deicing salt and magnesium chloride products vary based on the severity of the winter conditions in areas where the product is used. Following industry practice in North America, we seek to stockpile sufficient quantities of deicing salt in the second, third and fourth quarters to meet the estimated requirements for the winter season.