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A.M. Castle & Co. (NYSE:CAS)

Q1 2010 Earnings Call

April 27, 2010 11:00 AM ET

Executives

Usman Ahmed – FD Ashton Partners, IR

Mike Goldberg – President and CEO

Scott Stephens – Vice President, Finance and CFO

Analysts

Yvonne Varano – Jefferies and Company

Tim Hayes – Davenport and Company

Phil Gibbs – KeyBanc Capital Markets

Operator

Thank you for standing by. And welcome to the A.M. Castle & Company’s First Quarter 2010 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. As a reminder, this conference call is being recorded today, Tuesday, April 27, 2010.

I would now like to turn the conference over to Usman Ahmed with FD. Please go ahead.

Usman Ahmed

Thanks. Good morning. Thank you everyone for joining us for A.M. Castle's 2010 first quarter conference call. By now you should have all received a copy of this morning's press release. If anyone still needs one, please call my office at 312-553-6731 and we’ll send you a copy immediately following the conference call. With us from the management of Castle this morning are Mike Goldberg, President and CEO; and Scott Stephens, Vice President of Finance and CFO. As a reminder, this call is being recorded.

Certain information relating to projections of the company's results that will be discussed during today's call may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements are based on the current expectations and assumptions that are subject to a number of factors that could cause actual results to differ materially.

Additional information concerning these factors is contained in the risk factors section of the company's most recent Form 10-K and other reports and filings with the SEC, and also in the cautionary statement contained in today's release. The company does not undertake any duty to update any forward-looking statements.

This presentation also includes certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled to their related GAAP measures in accordance with SEC rules. You will find the reconciliation in the financial information attached to today's release, which is available on the company's website at www.amcastle.com under the Investors tab and in the Form 8-K submitted to the SEC.

And now, I’ll turn the call over to Mike Goldberg. Please go ahead, Mike.

Mike Goldberg

Thank you. Good morning, everyone. Thanks for joining us on today's call. Scott and I will review our first quarter results, give some commentary on the current business environment and the outlook for the year. First, a quick recap of our financial results.

First quarter consolidated net sales were $223 million, which is $29.2 million or 11.6% lower than the first quarter of last year. Company reported a first quarter net loss of $4.6 million or $0.20 per diluted share, compared to net earnings of $0.5 million or $0.02 per diluted share in the first quarter of last year. First quarter results this year include a $2 million charge for LIFO, which Scott will talk about shortly.

First quarter net sales in our metals segment were $199.7 million, compared to $231.1 million in 2009. Overall tons sold per day were down 10.9% from the comparable period in 2009, but increased 22% over the fourth quarter of 2009. The largest increases were in our alloy bar and nickel products, reflecting the pickup in our core and oil and gas businesses.

Sales for our plastics segment were $23.3 million, which is $2.2 million or 10.2% higher than the first quarter of 2009 and 5.8% higher than the fourth quarter.

Business activity was stronger than we had anticipated. In general, customers are more optimistic. However, we believe that the majority of the volume growth experienced in the first quarter resulted from the end of the de-stocking cycle rather than the increased customer production.

In other words, we don't believe that most of our customers made 20% more units in the first quarter. Rather their manufacturing activity required them to buy raw materials instead of depleting their inventories. We also believe the majority of our customers are keeping their inventories lean and are not restocking or building inventories.

With all that said, we see this as a first step of recovery in the industrial economy. For the balance of the year, we anticipate a slow increase in demand but at modest levels, which we would call kind of step two and then step three would be an inflection point where demand will begin to increase substantially. We do not anticipate reaching that stage until at least 2011.

Now I’d like to discuss what we are seeing in the current market environment. Overall business activity was a little stronger than anticipated and picked up sequentially each month throughout the quarter. In fact for the first time since mid 2008, we saw a year-over-year increase in volumes in the month of March.

Customer optimism seemed to increase throughout the quarter but as we said in our last call, our various end markets are recovering at different rates. Pricing -- prices are rising pretty much across the board, in carbon and alloy bar and plate, tubing, stainless bar and nickel products and aluminum, as well as, in most plastics. Scrap surcharges are also trending upwards and we anticipate that to continue for the second quarter. Supplier lead-times are steady or extended.

Now I will make a few specific end market comments. And I’ll start with oil and gas. Shipping volumes and product activity trended upwards throughout the first quarter. Customer sentiment is much more positive now. For the first time in quite a while, holes are showing up in our customer inventories, leading to many requests for rapid turnaround order fulfillment. Lead-times on the supplier side are extending in both alloy and nickel commodities. Alloy-based pricing is increasing. Nickel surcharges began trending upwards in the first quarter and expected to escalate during the second quarter.

In late February, we celebrated the opening of our new facility in Edmonton, Alberta. This replaces one we have occupied since 1996 and will help us better service our Canadian oil and gas customers. The Canadian market remains a critical piece of our strategy to develop our global oil and gas business. After a brutal 2009, we were encouraged to see signs of improvement from the Western Canadian market throughout the first quarter.

Now, I’ll move on to our coil and plate markets. Activity has continued to pick up here too with current business levels completing their highest point in over a year. Customer inventories remain low, with most buying only to meet current needs. Looking across the industries served by coil and plate units, we had an unexpected bump in our mining equipment customers, which began recovering late last year largely due to out of forecast orders from China. This trend is expected to continue through 2010.

Defense continues to be strong, especially with our naval programs. The heavy industrial equipment industry such as compressors and heat exchanges are showing some signs of improvement with greater optimism about the second half.

Industrial gears and repair equipment continues to strengthen as repair parts are needed. Heavy truck, semi-conductor and general machine shop business is also improving and fluid power is seeing significant improvement with optimism for continued growth in the second half of the year. We’re seeing some signs of improvement in the construction equipment market but that market is carrying very heavy finished goods inventory and we don't anticipate this business to change significantly for the balance of 2010.

Now, I’ll talk a little about aerospace. Overall, activity for the first quarter was better than expected with more optimism in the commercial marketplace. However, customer inventories remained flush. Lead-time from aluminum plate remains short and capacity continues to exceed demand. Ingot pricing is up but due to the plentiful supply of heat-treated aluminum plate, pricing remains soft.

The commercial aircraft business is more optimistic than it was, any real recoveries likely to be next year rather than in 2010. This expectation is supported by Boeing's recent announcement from mid-March, which indicated they plan to ramp up production on their wide boarding program sooner than expected.

The business in the general aviation sector is better but remains very soft. About a quarter of our aerospace business is defense-related and that sector remains relatively strong. As you know, we recently announced the signing of a memorandum of agreement with Lockheed Martin to enter into a six-year contract extension on the F-35 Joint Strike Fighter program. We have been servicing this business since inception and are delighted to continue to do so through the ramp up of the program.

Current projections call for a slow ramp up in the next three years, escalating thereafter to near full production in 2016. We expect annual revenue from the JSF program to be between $15 and $20 million in both 2010 and 2011. Additional information about the JSF announcement can be found in the press release section of our company's website.

Finally, I want to discuss what we’re seeing in our plastics business. As we have said before, our plastics business normally runs ahead of our metal side. And we saw plastics activity trend upwards starting mid-year of 2009. We expect overall demand to continue rising this year although the market outlook is mixed. But we do anticipate continue improvement and price increases are very likely. Office furniture has been relatively quiet, general industrial business and transportation is picking up, automotive continues to be strong, but marine is weak and expected to remain so throughout 2010.

We are pleased that our efforts around working capital and cost structure improvements in 2009 has been realized in early 2010, for 2009, our average days sales and inventory or DSI was 189 days. We reduced DSI to 150 days at the end of the first quarter on a trailing three-month basis. With some exceptions, our related to some specific aerospace accounts, we expect to be close to our historical DSI levels by the end of the year.

Our average days sales outstanding, DSO, now stands at 49.5, compared to 54.8 days for 2009 and we expect to at least maintain that improved level through the balance of the year.

In terms of cost management, we said in March that we expect 2010 operating costs to be comparable to 2009, which was $238.4 million. We still expect operating costs to be approximately at that level but it could be 2% to 4% if sales levels continue to improve. We are also off to a good start with safety, in fact the first quarter this year marked a new milestone for Castle. During this time period we had a total of only six recordable safety incidents compared to 46 in all of 2009.

At this time, I’ll turn things over to Scott to give you a more detailed review of the numbers.

Scott Stephens

Thank you, Mike. Good morning, everyone. Consolidated first quarter net sales were $223 million, which was $29.2 million or 11.6% lower than the first quarter of last year. In our metal segment, we recorded sales of $199.7 million, which was $31.4 million lower than last year.

Overall average tons sold per day was down 10.9% versus the first quarter of 2009, but sequentially first quarter 2010 tons sold per day were 22% above fourth quarter 2009 levels, demonstrating the improving trend of the demand environment and our various target end markets that Mike spoke about earlier.

The MSCI reported that first quarter 2010 shipments were up 11.2% in Q1, including a nearly 20% increase in carbon sheet and coil products. Adjusted for Castle's mix of products, we estimated Q1 2010 industry volumes to be flat versus the prior year.

Our Q1 volume declined, however, which we could expect given the late cycle nature of our customer base. You may recall that our volume trends exceeded industry comps for the first several quarters of the recession, again due to the late cycle nature of our customers businesses. Similarly, we would expect to be laid out on a recovery and thus lag the industry comps for several quarters. On the plastics side, Q1 2010 net sales were $23.3 million, which was 10.2% higher than the first quarter of 2009.

Consolidated gross margin rate for the first quarter of 2010 was 24.2% of sales as compared to the prior year at 27.8%. First quarter 2010 gross margins include the impact of a $2 million LIFO charge. The prior year Q1 results included $11 million of LIFO income.

Our quarterly LIFO calculation considers a number of factors including a full year LIFO projection and a quarterly discrete calculation. At this point, we anticipate quarterly LIFO charges in the range of $2 to $3 million per quarter for the balance of this year. This of course could substantially change mainly depending on the extent and direction of metal prices.

Our gross margins realized in Q1 were lower than expected. We had expected margins to be a bit soft in Q1 and at the low-end of our normal range of 25% to 29%. However, the competitive environment was such that we were not able to increase prices as effectively as anticipated resulting in 24.2% margins or just below our Q1 expectations. As our inventory levels continue to improve and the demand environment continues to recover, we expect gross margins to improve throughout the balance of 2010.

First quarter consolidated operating expenses were $61 million, which was $7.2 million or 10.6% lower than last year. We took aggressive action in 2009 to reduce our cost structure, including a 25% workforce reduction, benefit cuts and consolidation of several operations. These actions will improve our operating cost leverage in 2010 and beyond as our volume recovers.

So far in 2010, we reinstated regular work hours, eliminated furloughs and will restore certain benefits. Although we do not anticipate a full restoration of all compensation related items to occur in 2010, the changes we have made reflect our optimism about the ongoing improvements in the marketplace.

At this point, we don't anticipate any significant changes in our operating cost environment for the balance of 2010. The consolidated operating loss for the quarter as reported was $7 million. In the prior year quarter, we reported an operating profit of $1.8 million or 0.7% of sales.

Joint venture equity income was $0.9 million for the quarter compared to a small loss in Q1 2009. Interest expense was $1.3 million for the first quarter compared to $1.7 million in the same period last year, lower due to outstanding borrowings and interest rates that were less than last year.

First quarter tax benefit rate was 34.2% compared to a full-year benefit rate of 37.3% in 2009. Fluctuations in our effective tax rate are due to changes in the geographic mix of income and loss levels.

For the first quarter, the company reported a net loss of $4.6 million or $0.20 per diluted share. In the prior year quarter, the company reported net income of $0.5 million or $0.02 per diluted share. Now, in terms of the balance sheet and cash results during the first quarter, the company's continued focus on working capital management resulted in a $9.5 million inventory reduction and a $6 million debt reduction.

The company generated $5.4 million of positive cash flow from operations in the first quarter. Inventory DSI declined to 150 days on a trailing three-month basis at quarter end, down from 189 days for the full year 2009.

Inventory turn levels returned to near normal in the first quarter this year in most of our businesses except aerospace and oil and gas. Our aerospace business has several customer-specific programs with elevated inventory situations, primarily around the business jet area. These situations likely will not be normalized in 2010. In oil and gas, there are no customer specific inventory issues and we do expect to achieve normal inventory turns by year-end in that business. As the aerospace inventory normalizes, we would expect to return to our historical 120 day DSI or three times turn rate.

Average receivable DSO declined from 54.8 days in 2009 to 49.5 days at the end of Q1 on a trailing three-month basis. We would anticipate that our 2010 DSO rate will stay below 50. As of March 31, 2010, our debt-to-cap ratio was 20.9%, compared to 25.6% at the end of Q1 2009 and compared to 21.9% at the end of last year. Total debt at March 31 was $83.2 million compared to $89.2 million at year-end 2009.

Capital expenditures in the quarter were $2 million compared to $3.8 million in the first quarter 2009. We anticipate 2010 capital spending will be similar to 2009 levels or approximately $8 million to $10 million.

And in closing, although the market environment is better than we had anticipated, our earnings outlook as of today is consistent with what we told you on our last call. We still expect to report net losses in the first half of 2010 and if the markets continue to recover, we still expect to get back to profitability in the second half of this year.

And now, we will open up the call for any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Yvonne Varano with Jefferies and Company. Please go ahead.

Yvonne Varano – Jefferies and Company

Thanks. You made the comment in regard to the construction equipment and it seemed like there's a lot of finished inventory there and yet we have some very positive comments out of Cat. Can you just help me reconcile what might be going on there?

Mike Goldberg

Yeah. As always, it kind of varies and the area where we see the biggest buildup of inventories that customers are in cranes and the real heavy kind of earth moving equipment. We do business with Caterpillar and their subcontractors and that business has shown some improvement. So it's a bit of a mixed area, but certainly if there are certain sections which are still very, very slow and have a very sizable kind of backlog of inventory to work through.

Yvonne Varano – Jefferies and Company

Okay. And then you commented that you are having a little bit of difficulty passing through the price increases because of the competitive environment, anything more you can tell us about that? Is it a specific -- that product, is it across the board? Is it just concern on customers that we might not see price hold?

Mike Goldberg

No. I think -- I don't think it's anything specific. We transitioned from this very depressed environment in the fourth quarter and as prices escalate, I just think we were just lagging a bit in pushing those price increases through. So we have seen sequential improvement and we would absolutely anticipate our margins to recover in the following quarters here.

So nothing specific around any particular markets or in any particular products. I think it was a kind of early resistance but I believe that's behind us. And we would expect to see margin spread increasing as we go forward.

Yvonne Varano – Jefferies and Company

Are you seeing customers doing a little more shopping around?

Mike Goldberg

Well, they've always shopped around. On a transactional basis, it's pretty common. They shopped around all last year and they will continue to do so.

Yvonne Varano – Jefferies and Company

Okay. And then, I know, the tax rate is tough, but what should we be using as a tax rate going forward, Scott?

Scott Stephens

37% is kind of what we would refer to as typical.

Yvonne Varano – Jefferies and Company

Okay. Perfect. Thanks very much.

Operator

Thank you (Operator Instructions) And our next question comes from the line of Tim Hayes with Davenport and Company.

Tim Hayes – Davenport and Company

Good morning.

Mike Goldberg

Good morning, Tim.

Tim Hayes – Davenport and Company

Two questions. First on the volume side, you had a sequential gain of 22% and that was average, what -- tons shipped per day? I guess, there's more days in Q1 than Q4, correct? So the sequential change, if you did just an all-in volume figure would have been larger than 22%?

Scott Stephens

Yeah. That would be right, because the number we gave you was tons per day.

Tim Hayes – Davenport and Company

And in terms of that sequential increase, that would imply that you, I guess, would have gained share if you were comparing that figure to, say, a correct weighted-average of the MSCI data. Is that also correct?

Scott Stephens

Well, not when you really adjust for -- we try to take that MSCI data and adjust it for our mix. So for the quarter, we trailed – year-to-date, we trailed -- we would've said the industry was flat. I think yeah, though, you are right. The quarter-to-quarter sequential was something more like up -- I don't have the number in front of me, Tim, but it is upper teens or 18%, if I recall, if that's right. And we would have been sequentially up 22 on a per day basis. So yeah, I think that's correct.

Tim Hayes – Davenport and Company

Right. Okay. And then in terms of your guidance for the first half of this year, can we at least assume that -- or least not rule out that Q2 could be profitable, say, if you do a nickel per share in Q2, that would still give you a first-half loss. Is that -- or do we expect another loss albeit smaller in Q2 versus Q1?

Scott Stephens

Well, we're not going to get that specific in terms of quantifying expectations for Q2. We certainly expect an improvement from Q1. We see demand continuing to improve. We see margins as Mike was just talking about continue to improve. And we see expenses comparable to Q1, so we do expect improvement for Q2. Precisely where that's going to come out on an EPS basis, we would expect it to be certainly better than Q1.

Tim Hayes – Davenport and Company

Right. And just to be clear, a profit or an EPS gain no larger than $0.20, right?

Scott Stephens

No longer than $0.20 and we're standing by the -- by our comment that we would still expect to have a reported loss for the first quarter.

Tim Hayes – Davenport and Company

Very good. Thanks for answering those questions.

Operator

Thank you. Our next question comes from the line of Phil Gibbs with KeyBanc Capital Markets. Please go ahead.

Phil Gibbs – KeyBanc Capital Markets

Hi, guys. I had a question about the gross margins and kind of the trends through the first quarter and whether or not in the metal segment that the margins in the March, the month of March were materially higher than that of the January quarter, meaning were we ending the quarter much higher than where we started?

Mike Goldberg

We would say the margins sequentially improved. I would say they were much higher at the end, but we see -- the trend both in volumes and pricing and margin improved month-to-month and certainly, we would expect that to continue.

Phil Gibbs – KeyBanc Capital Markets

I know we are coming off of the lows so that the second half of '09 and the second half is normally from a seasonal perspective for you guys a little bit weaker than the first half. But given what we are seeing in the supply chain, would you continue to expect topline, sequential topline recovery as we move through the year, given what we are seeing in the inventory channels?

Mike Goldberg

That is a key, kind of key question -- we kind of comment on the seasonality. Yeah, typically the second half of the year with less shipping days is weaker than the first half. But not necessarily all the time and in fact, even last year our volumes in the fourth quarter were higher than the third quarter as the recovery just about started for us during that time period. So in a recovering economy, we have seen in the past and we actually anticipate in this year for the second half to be stronger than the first.

And your comment around the lack of inventory in the supply chain, kind of feeds that. So as we kind of said in our prepared comments, we expect the demand to improve throughout the year, not greatly. It's going to be a long, slow recovery but we do anticipate it to keep moving up and to kind of offset any reduced shipping days which we typically see in the second half of the year, especially in the fourth quarter.

Phil Gibbs – KeyBanc Capital Markets

Great. Then just to follow up here on the commercial aerospace side. How are you seeing things based on what your customers are telling you set up from a demand standpoint in '11 versus '10? We know the inventory issues on the heat treat side are still relatively, let's say an oversupply but how is the actual demand setting up relative to '10?

Mike Goldberg

I'm not sure anybody has really seen that trickle through yet. The increase in the wide-body production rates does make a fairly significant kind of shift in consumption of product. And I think that's what we are anticipating but we certainly haven't seen that yet and nor would we expect to see it at this stage of the year. So we see that as a good sign, a good indicator of the market improving. But at this stage, I don't think anybody has actually seen that or reacting to that.

Phil Gibbs – KeyBanc Capital Markets

Okay. Thanks very much, guys.

Operator

Thank you. (Operator Instructions) And at this time, I would like to turn the conference back to management for closing remarks.

Mike Goldberg

Thanks, everybody, today for listening in, asking the questions. Again as we said, we do think that the environment is improving albeit slowly. And we look forward to speaking to you three months from now and hopefully with some improved results to reflect that marketplace. So until then, we will thank you for your attention.

Operator

Ladies and gentlemen, this concludes the A.M. Castle and Company first quarter 2010 conference call. If you would like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4284169, followed by the pound. Thank you for your participation. You may now disconnect.

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