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

Q2 2008 Earnings Call Transcript

July 29, 2008 11:00 am ET

Executives

Katie Pyra – IR, Ashton Partners

Mike Goldberg – President and CEO

Scott Stephens – VP of Finance, CFO and Treasurer

Analysts

Nat Kellogg – Next Generation Equity Research

Tim Hayes – Davenport & Company

Jason Brocious – KeyBanc Capital Partners

Heath Ritchie – Delphi Management

David Fondrie – Heartland Funds

Tim Chatard – Sterling Capital

Operator

Good morning, ladies and gentlemen, and thank you for standing by. And welcome to the A.M. Castle & Co. second quarter 2008 earnings conference call. (Operator instructions) At this time, I would now like to turn the conference over to our host, Ms. Katie Pyra. Ma'am, you may now begin the call.

Katie Pyra

Thank you. Good morning and thank you, everyone, for joining us for A.M. Castle's second quarter 2008 conference call. By now, you should have all received a copy of this morning's press release. If anyone still needs a copy, please call my office at 312-553-6717, 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. Before we begin, as usual, we would ask that everyone take note of precautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made in this morning's conference call.

We'll begin the call with an overview of the quarter, and then we'll open up the line for questions. And now, I would like to turn the call over to Mike Goldberg. Go ahead, Mike.

Mike Goldberg

Thanks, Katie. Good morning, everyone, and thanks for joining us today. I'm pleased to have Scott Stephens, our new Chief Financial Officer with me on today's call. In a few minutes, Scott will speak about second quarter results in greater detail. But first, I'd like to share some highlights with you.

In the second quarter, business activity remained firm and we reported strong revenues. Our consolidated net sales were $397.1 million, up 6.6% from the same quarter in 2007. However, compressed gross profit margins led to softer earnings.

Net income was $11.3 million, or $0.49 per diluted share, compared to $16 million, or $0.78 per diluted share in the prior year. Earnings for the second quarter of 2008 included an $0.08 per diluted share impact from the May 2007 secondary equity offering of 5 million shares.

Our end use markets held up well in the second quarter. In particular, we experienced continued healthy demand from our heavy equipment and oil and gas markets. Revenues were strong due to high sales volumes and higher seller [ph] prices driven by continuing significant price increases on carbon-related products. The aerospace market remains unchanged from the prior quarter.

Volumes in the Metals segment on a same-store basis were 9.3% higher than the corresponding quarter last year and 1.5% higher than the first quarter of 2008. Activity increased every month through May and we anticipate business levels to remain reasonably firm in the third quarter. However, as you know, in the summer months, we experience some slow down due to seasonal factors of less shipping days and customer shutdowns.

Year-to-date volumes in the Metals segment are 5.2% ahead of last year primarily driven by our carbon and alloy bar and plate products as a result of strengthening in the heavy equipment and general capital goods markets.

Our earnings in the second quarter were impacted by gross margin compression. Gross margins defined as sales less cost of materials for the second quarter were 25.2% compared to 27.5% last year and 26% in the preceding quarter. Gross margins were impacted most by changes in product mix and escalating metal costs.

In addition, in the second quarter, we recognized a change in LIFO reserves of $29.8 million, compared to $3.5 million in the first quarter and $18.6 million in the second quarter of last year. We will discuss these items in more detail later in the webcast.

Now, I'd like to give you a little bit more color on our business activity across our end use markets. Our carbon and alloy plate business continues to be very strong. Supply remains tight especially in high strength carbon and in quench and tempered products.

Demand from manufacturers of mining equipment and industrial cranes remained very firm with backlog stretching into 2009 and 2010. Customers exposed to the residential construction industry, such as aerial lift truck manufacturers, have been negatively impacted by the slow housing starts, and we have also seen a slowdown in demand from customers who make equipment for the non-residential construction market.

Activity in our oil and gas market continues to be brisk. With oil pricing hovering at record levels we expect continued strong growth within the industry through the balance of this year and into the foreseeable future.

Customer demand within our traditional bar and tubing business also remained solid through the quarter. In fact, stronger than anticipated, given the current economic climate. These products go into a number of different industrial applications which could generally be described as producer durable goods. We believe the weak dollar and the increased ability of our customers to compete on a worldwide basis is fueling this activity despite the current domestic economic sentiment.

As I mentioned earlier, the aerospace market remains generally unchanged from the previous quarter. Since late last year, we've been talking about an existing supply imbalance in heat-treated aluminum plate and saying that we expected our aerospace margins to be relatively flat until the oversupply resolved itself, which we expected to happen in the second half of this year.

Now, with the airlines feeling the pinch of escalating fuel prices and tightening capital markets, there's widespread industry speculation that they could postpone or cancel some of their new orders. However, at a recent industry gathering at the Farnborough Airshow, there was a fair amount of optimism and some large orders were announced, including the A380.

Boeing and Airbus are currently managing a seven-year backlog. No slowdown has ever generated more than 30% cancellations, which would represent about two years. Currently, cancelled slots are filled with orders pulled forward.

We believe that there is sufficient strength in the market to avoid any significant meltdown and that large aerospace build rates should remain close to current levels for the balance of this year and 2009.

Build rates for the A380 are firming up for 2009 and beyond. And the JSF program looks like it will begin to gain momentum. The general aviation markets and business aviation are thriving with backlogs approaching three years.

So our outlook for the aerospace business is that we expect the market to be neither boom nor bust over the next year, and therefore, we expect our recent pricing and margin levels to continue.

We expect further growth in our new aerospace facility in Shanghai. The location is officially open. It's fully equipped and staffed. And we have received aerospace quality accreditation and are booking locally generated business. As planned, one facility is fully functional. We'll be looking to serve Asian requirements for some of our large non-aerospace customers in the near future.

Continuing on our international scene, our Metals UK business has continued to experience real growth despite a weakening European economy. They have had particular success in the aerospace and oil and gas markets. The operation is impacted by the weaker nickel prices, which today are less than half of what they were this time last year.

Another bright spot for us internationally is Mexico, our fastest growing operation for both the sales and profit contribution. In the past four years, Mexico has delivered revenue growth in excess of 30% per annum.

To support future growth, the Castle Board of Directors has approved plans to double the operations facility and add new equipment, and this expansion will be completed in 2009.

Our plastics business had a solid second quarter. Material prices are increasing driven in large part by rising oil prices. The board builder business has been ravaged with most builders temporarily shutting down their operations for portions of the summer.

However, we're seeing continual growth opportunities in the office furniture like science markets and other industrial markets. We will also be implementing a new ERP system for our plastics business in the third quarter.

As you know, the Metals segment is also midstream in implementing an ERP system. In early April, we completed the first phase of the implementation, replacing one of the Transtar legacy systems at our domestic aerospace locations. This phase resulted in the implementation of Oracle operations functionality, including financials.

In addition, we implemented the Oracle human resource systems companywide. We experienced the typical problems in implementing new systems with a significant learning curve for all of our people. The implementation did impact our business, and Scott will give you some details on that later.

Through the process, our ERP team identified a number of actions we could take to improve subsequent implementation phases, including more comprehensive training and job shadowing in advance of the (inaudible) go live date.

These actions require additional time to execute, which pushes our phase two readiness date, the replacement of the Castle metals legacy system, from a September date into the fourth quarter.

However, rather than implement a full system that close to our financial year-end and in consideration of Sarbanes-Oxley compliance requirements, we have decided to move our next implementation date to the first quarter of 2009.

Just to reiterate, the system will be ready for implementation in November. But because of proximity to year-end, we have decided to move it to February of 2009. As a result of this move, we will incur an additional expenditure of $2 million, which will increase the capital projects spend cost to $14 million.

So in summary, we anticipate the current level of business activity will be somewhat softer in the third quarter in line with our historical seasonality patterns. All of our key markets continue to look firm. And in general, our industrial customers remain optimistic about their 2008 business.

Carbon and alloy prices are expected to move higher due to continuing surcharge increases and nickel surcharges will drift lower. Supply availability will likely remain tight in certain carbon products, keeping margins for that metal firm. Aerospace aluminum prices and margins will remain relatively flat.

We are pleased with our progress to-date in executing our strategy, but we are cognizant that our LIFO-based margins were impacted by rapidly accelerating prices and our expenses are higher than we would like as a result of higher operating and ERP implementation costs. We will increase our focus on these basic issues for the balance of the year.

Before I hand the call over to Scott Stephens, I'd like to take a moment to thank Larry Boik, Castle's CFO for the past four years, for his positive impact on the organization. He has been working closely with Scott to ensure a smooth transition.

So at this time I'll turn things over to Scott to give you a more detailed review of the second quarter numbers.

Scott Stephens

Thank you, Mike, and good morning, everyone. I'll start with a summary of our second quarter financial comparisons. I'll follow on with some six-month and year-to-date comparative results, and close with some commentary on our balance sheet and cash results through June.

Second quarter 2008 consolidated sales of $397.1 million were $24.5 million, or 6.6%, higher than the second quarter of last year. Sales in our Metals segment were $365.4 million for the quarter, which represents 6.4% sales growth year-over-year. Within the Metals segment, volume levels were strong as overall tonnage sold in the second quarter was up 9.3% compared to the prior year.

In the second quarter we experienced higher pricing for carbon products while nickel-based pricing product was lower. We also experienced a significant change in mix, which we'll discuss more a bit later.

Our Metals segment gross margin rates in the second quarter were impacted by higher metal costs, including additional surcharges in our carbon-based products. Metals segment gross margin for the quarter, which is defined as sales less cost of materials, was 24.7% of sales, compared to 27% in the second quarter of 2007.

As Mike mentioned earlier, our second quarter results reflected a change in the LIFO inventory reserve of $29.8 million, which compares to the second quarter of 2007 LIFO inventory reserve change of $18.6 million, and compares to our first quarter 2008 LIFO reserve change of $3.5 million.

In addition to the LIFO impact, second quarter 2008 gross profit margins were impacted by changes in product sales mix. A portion of the sales mix changes experienced in the second quarter were associated with the Oracle ERP implementation at our domestic aerospace locations.

Our implementation teams met the scheduled April cutover objectives. However, we did experience some typical ERP implementation learning curve issues, as Mike alluded to earlier. And as a result our customer service levels and productivity levels declined. We estimate the potential impact from these service level and productivity interruptions during the quarter to be as much as $10 million in lost sales and $3 million in operating profits.

Service levels and sales were impacted most significantly in the month of April when the system changes occurred and they recovered throughout May and June. Management is focused on remediating any remaining issues and returning customer service metrics to historic levels during the third quarter.

The third element impacting gross margins was the dramatic increase in carbon product surcharges that occurred in the second quarter. We typically experience some lag in passing on surcharge costs to our program customers.

Our Plastics segment second quarter sales of $31.2 million, up $2.5 million, or 8.5%, higher than the second quarter of 2007. Consolidated operating expenses in the second quarter were $82.3 million or 20.7% of sales, compared to $73.2 million or 19.6% of sales last year. Approximately, $2 million of the $9.1 million increase in reported operating expenses relates to Metals UK, which was acquired in January of 2008, and thus was not reflected in the prior year results.

The primary driver of the remaining $7.1 million increase in quarterly operating expenses was $4.5 million of additional transportation and warehouse costs reflecting the additional sales volumes and higher fuel costs. In addition, administrative costs increased $1.3 million over the prior year, including expenses associated with the Oracle implementation.

Joint venture earnings of $2.8 million were $1.4 million higher than the prior year quarter. As a result of lower gross profit margins and higher operating costs reflecting the items that we discussed earlier, consolidated EBITDA for the second quarter of 2008 was $26.5 million, or 6.7% of net sales, compared to $35.5 million, or 9.5% of net sales, in the second quarter of 2007.

Net income for the second quarter was $11.2 million, or $0.49 per diluted share, as compared to $16 million, or $0.78 per diluted share last year. The secondary offering of 5 million shares in May 2007 had an $0.08 per share dilutive effect on EPS compared to the prior year for this quarter.

I'll now briefly go through our six-month comparative financial results. Consolidated sales for the first half of 2008 were $790.6 million, up $42.6 million and 5.7% higher than last year. Sales in our Metals segment for the first six months were $727.7 million, or 5.5% higher than 2007. Excluding Metals UK, overall tonnage sold was 5.2% higher in the first half of 2008.

Our Plastics segment sales for the first six months of 2008 were $62.9 million, which is 4.9% or 8.4% higher than the first half of last year.

Our consolidated 2008 gross margin rate reflecting sales less cost of materials through June was 25.6% as compared to the prior year at 27.8%. The lower gross margin rate reflects the higher metals surcharge and changes in sales mix that we discussed earlier.

Consolidated operating expenses for the first half of 2008 were $162.1 million, a $12 million increase from the first half of 2007. $3 million of this increase is related to the January 2008 acquisition of Metals UK, and again, the remaining significant drivers of higher operating expenses in the first half of 2008 are transportation and plant expenses, which we discussed earlier.

Interest expense through June was $4.3 million versus $8.4 million for the first six months of 2007. Joint venture earnings for the first half of 2008 were $4.7 million versus $2.3 million for the first six months of 2007. Consolidated EBITDA was $56.5 million for the six months ended June 30, compared to $70.4 million in the first half of 2007.

Finally, net income year-to-date in 2008 was $25.1 million, or $1.11 per diluted share, as compared to $32.2 million, or $1.59 per diluted share for the first half of last year. Again, there was a dilutive effect on 2008 earnings related to the May 2007 equity offering.

In terms of the balance sheet and cash receivable, DSO, or Days Sales Outstanding, was 45.9 days at the end of June, compared to 45.1 days at year-end 2007. Inventory DSI, which is days sales and inventory, for the six months ended June was 117 days, versus 132 days at year-end 2007.

Capital expenditures through June were $11.3 million, including $5.2 million for the Oracle ERP implementation, which compares to $8.4 million of total CapEx for the first half of 2007. Total capital expenditures for the full year 2008 is expected to be approximately $20 million.

Our total debt as of June 30, 2008 was approximately $139 million, which corresponds to a debt to total capital ratio of 25.4%, compared to the 18.3% at year-end 2007. The increase primarily reflects the funding of the January 2008 acquisition of Metals UK.

This being my first opportunity to speak with all of you about A.M. Castle since joining the company in early July, I thought I would take this opportunity to let you know that I've joined a management team that is committed to implementing the company's strategy and we're also focused on improving the operating fundamentals of the business.

Our customers demand high quality, value-added services for their specialty metal needs and we're focused on providing supply chain solutions to our targeted customer markets on a global basis.

While always striving to exceed our customers' expectations, we also will continue to invest in strategic growth areas and will focus on improving the fundamentals of margin management, productivity, and asset utilization. With this focus, we plan to win with our customers and win with our shareholders.

We'll now open up the call for any questions that you may have.

Question-and-Answer Session

Operator

Thank you very much. (Operator instructions) And our first question comes from Nat Kellogg with Next Generation Equity Research. Please go ahead.

Nat KelloggNext Generation Equity Research

Hi, guys. Just a couple of questions. I guess first of all, Scott, welcome and congratulations. We're obviously looking forward to working with you going forward.

Scott Stephens

Thank you.

Nat KelloggNext Generation Equity Research

Just a couple of things. You guys -- the Riverdale facility was closed and consolidated into your headquarters during the quarter, correct?

Mike Goldberg

Yes. The -- actually the consolidation took part in the earlier part of the year and we are out of that Riverdale lease now. I think that lease expired at the end of May.

Nat KelloggNext Generation Equity Research

Okay. So Q3 will be the first quarter we get a full quarter read on that expense?

Mike Goldberg

Yes.

Nat KelloggNext Generation Equity Research

And then, just I guess a little bit on aerospace. I mean, you sort of said you expect it to remain the same. I mean, heat treated, aluminum plated -- I guess that sort of sounds like there is still some excess supply in the channel, but it continues to work its way down. I mean, when do you guys think that things will get more in a balance that you're comfortable with, I guess?

Mike Goldberg

Yes. I think it's -- I think it's a very tough -- it's tougher now to anticipate what may happen than perhaps we thought a year or so back. As everybody knows, there's a lot of kind of -- a lot of discussion in the aerospace business about build rates. But as far as we can see and the intelligence that we've kind of gathered, we see the build rates being maintained. And I don't anticipate that we would see a significant change in the market dynamics through the balance of this year. And I think hopefully we would anticipate that it would firm up in 2009, but very tough -- increasingly tough to see too far out. And I think we would -- we truly believe that the environment that we see now will persist through the balance of this year.

Nat KelloggNext Generation Equity Research

Okay. And then, what did you guys say for ERP expenses in the quarter? I'm sorry. I missed that. You were going through kind of quickly.

Mike Goldberg

Well, we had -- I think what we said was that with the push out in the schedule, we had an extra $2 million which is going to get capitalized on the project. So that would be incurred over -- spent over the next number of months.

Nat KelloggNext Generation Equity Research

Okay.

Scott Stephens

We also -- we referenced $1.3 million of higher administrative expense for the quarter over the prior year and that includes -- that number includes the ERP implementation costs that were experienced in the second quarter.

Nat KelloggNext Generation Equity Research

Okay. And so, if I look at the back half of the year now that you've sort of pushed some of this out, I mean, the spending in sort of the SG&A line for Q3 and Q4, I mean, I assume you'll have less spending on the ERP implementation because you sort of have to put it on hold. Is that right or is that not the way to look at it?

Mike Goldberg

Again, it's a tough one to forecast, but I would assume that one of the reasons why we've pushed the ERP implementation back is to make sure that we execute on our more expensive training plan, more expensive job shadowing plan that we have. And so there will be an ongoing expense. We're not kind of freezing all that. We're -- the whole idea about extending the time was to allow us to do a more effective training and change management process. So I would anticipate there's going to be a continuing spend in that area.

Nat KelloggNext Generation Equity Research

Okay. And then, I guess just lastly -- I mean, it sounds like from what you guys are saying that there is some opportunity to see margins tick back up again in Q3. Even though it's a little bit -- seasonally slower and you lose some efficiencies that way, it does sound like that maybe some of the lost opportunities on the aero Transtar side and some -- a little bit more aggressive on the carbon pricing and carbon plate, that margins could tick up again a little bit in the third quarter. Would that be an appropriate assessment?

Mike Goldberg

I think that would be an appropriate assessment, yes. I think the one thing we don't know -- there's a number of factors which are kind of heavily influencing our reported margins. We don't anticipate such a big LIFO charge in the third quarter. We don't think the price is going to escalate as much in the third quarter as it did in the second, so that will help. Yes, we should -- the product mix balance with the aerospace should readdress itself. And thirdly, we would anticipate catching up on our carbon surcharge pass-through on our program and contractual accounts. So, all those forces worked very much against us in the second quarter. They're kind of -- they've not gone away completely, but they shouldn't be as strong. So, I think your conclusion is correct.

Nat KelloggNext Generation Equity Research

Okay. All right. I'll let somebody else get a few in here and I'll hop back in the queue. Thanks very much, guys.

Operator

And our next question comes from the line of Tim Hayes with Davenport & Company. Please go ahead at this time.

Tim HayesDavenport & Company

Hey, Good morning.

Mike Goldberg

Hi, Tim.

Tim HayesDavenport & Company

A question on the year-over-year increase in volume. You said it was up 9.3%. Did you give that figure excluding UK?

Scott Stephens

Yes, that does exclude -- that's a same-store excluding Metals UK amount.

Tim HayesDavenport & Company

Very good. A little surprised by that strength. That's a lot more than what we've been seeing in the industry.

Mike Goldberg

Yes, it's a -- well, that's a good thing, right? Yes, heavy increases in our carbon and alloy plate business and our carbon and alloy bar business. So, we're very pleased with that aspect of the business environment.

Tim HayesDavenport & Company

Next question on the program sales, could you elaborate a little more about what those are? How much of total sales do program sales represent? What kind of customers? How long those last, et cetera?

Mike Goldberg

Yes. The -- in total and it's fairly consistent across the business. About 55% to 60% of our business is what we call program business and that's a very generic term. The easiest way to describe is it isn't spot transactional business. And so, it's a variety of arrangements going from a three-month to a year and in some of the aerospace accounts even longer. And so, the typical arrangements would be you're holding a price firm for a period of time supported by the mill, and the compression in gross margins is centered around the significantly increased surcharges in -- again, in the carbon products. That's where we have the compression in the second quarter.

Tim HayesDavenport & Company

And on the carbon side, since those don't go into aerospace, what markets are those earmarked for?

Mike Goldberg

Well, it's all the industrial markets. It's the heavy equipment manufacturers. It's gears, it's general manufacturing. It's a wide range of industries that we serve in our plate and bar business. Tim, it's generally, as you know, the most of our customers are in the capital goods market, so it's equipment. And it might be directly to OEMs or through machine shops. And the other part of that, of course, is our oil and gas segment as well. So it's generally equipment going into capital equipment.

Tim HayesDavenport & Company

Okay. Thank you.

Operator

(Operator instructions) And our next question comes from the line of Mark Parr with KeyBanc Capital Markets. Please go ahead at this time.

Jason BrociousKeyBanc Capital Partners

Good morning. This is actually Jason Brocious in for Mark. How are you?

Mike Goldberg

Fine. How are you doing, Jason?

Jason BrociousKeyBanc Capital Partners

Doing okay. I just had one quick question, and then I'll let you go. I was wondering if you could speak to the timing issues in the -- that go into the gross margin in the surcharge pass-throughs? If you could speak to how quickly they pass on?

Mike Goldberg

Yes. We would expect to see kind of correction in the third quarter. So it's not that big a lag. And the other issue on the surcharges, again, as most people know, is that in some -- in many of the contracts there isn't a mark up on the surcharges. And so, when surcharges take an increasingly larger part of the selling price, which in carbon products today they certainly have, then our gross margin percentage kind of gets diluted and compressed. So there's really two elements to that. One is kind of the lag aspect, and two is there's an increasing amount of the total price, which isn't subject to mark up. And so that -- both of those lead to a compressed gross margin percentage even though the dollars aren't impacted.

Jason BrociousKeyBanc Capital Partners

Okay. All right. Well, thank you very much.

Operator

And our next question comes from the line of Heath Ritchie with Delphi Management. Please go ahead at this time.

Heath RitchieDelphi Management

Hi. I have a question I guess about the pricing that you're seeing. I don't know if you gave any numbers quantifying the sort of increase in prices that you were seeing.

Mike Goldberg

We didn't. I mean I can talk generally about the sort of scale of changes. And this is kind of -- this would be kind of market pricing, not necessarily what we pass on to our customers. But if you look at where carbon prices are today, when you add up all the surcharges, they're running 60% higher. Let me correct that -- carbon kind of material costs, including surcharges, they're running about 60% higher than they would say in the -- the average of last year. That's not necessarily what we're buying at, but if you can -- went out to the general marketplace, that's a sort of scale of increases that we have -- that replacement cost would reflect. So it's an enormous -- that's an enormous delta. In terms of our business, it isn't at that scale. There's all sorts of reasons why. We don't move that (inaudible). But it is a very significant move.

Heath RitchieDelphi Management

Okay. And my other question, I was a little bit confused about the tonnage increase. You talked about a 9.3% increase. That was tons per day?

Mike Goldberg

Yes.

Heath RitchieDelphi Management

Let me ask the question in a different way. In the whole quarter, what was the tonnage up?

Scott Stephens

Tonnage was up 9.3% quarter-over-quarter.

Heath RitchieDelphi Management

That's per day?

Mike Goldberg

Yes. We measure it on --

Scott Stephens

Yes.

Mike Goldberg

On effective sales days. Yes.

Heath RitchieDelphi Management

And what was the difference in the number of sales days this quarter year-over-year?

Scott Stephens

I don't have that here in front of me.

Mike Goldberg

I mean, it should more likely be one or so, something like that. I mean, it's -- quarter-to-quarter it matter where the holidays come in.

Heath RitchieDelphi Management

So if your sales were up 6.4%, which is a lower number, then your sales dollars per ton is down quite a bit in an environment when carbon prices are 60% up year-over-year?

Mike Goldberg

Well, yes, I told you that was our replacement cost. Our prices -- selling prices aren't up that much. But keep going.

Heath RitchieDelphi Management

Well, I'm just trying to understand how much of that is a mix effect versus just a lag, if you could separate out how much that you expect to get back?

Mike Goldberg

There is a significant mix impact. Quarter-over-quarter there is a significant amount of growth and increases in our carbon products, especially, our plate products. And there is that decline in the heat-treated aluminum products and some of the other non-ferrous products. So there's been a -- there is a significant kind of shift in mix when you look at the -- when you do the quarter comparisons.

Heath RitchieDelphi Management

I mean, could you put it -- quantify that a little bit, put a number around it or how much of a price difference there is there or -- ?

Mike Goldberg

In the way this is -- there's a large number of moving parts. Again, you can -- you've got the data there. It's -- the moving parts in all products and all prices, so it would be very difficult for us to talk about a number in this situation.

Heath RitchieDelphi Management

Thank you.

Operator

And our next question will come from the line of David Fondrie with Heartland Funds. Please go ahead at this time.

David FondrieHeartland Funds

Hey, Good morning.

Mike Goldberg

Good morning.

David FondrieHeartland Funds

I wonder if you could give us a little more color on the impact of the push outs of the 787, the A380 have had? And obviously, I guess that's why you believe -- I think that is reflective of the comments that you said the remainder of the year will be relatively steady in aerospace. So what kind of improvement might we expect as we enter 2009?

Mike Goldberg

Yes. The current build rates for the A380 are about one per month. And we expect that to double in 2009, and then increase perhaps 2.5 planes a month subsequently. So we do see a positive impact from that, not only directly for us, but on the whole market. So that push back we now see happening in 2009. Now, our involvement on the 787 is actually more in our titanium products, which aren't a big part of our business. And again, we haven't enjoyed what we'd anticipated in that -- for that business in this year. And again, we would expect to see that recover in 2009. So the push backs have had an impact in the general market. I think it's been discussed in too many quarters. The pushback of the A380, the JSF programs, really were the major contributors to the oversupply of product and until we see those planes ramp back up in their production, or those programs ramp up a production, we're not going to see any major shift in the marketplace. And the same would be true for the 787, but obviously has less impact in the metals market than many other platforms.

David FondrieHeartland Funds

Thank you. And then, also on inventories, obviously LIFO-based inventory you're putting through higher costs. But, inventory actually has increased each of the last two quarters. So, I presume that means that there is a higher LIFO reserve. When that -- would you expect inventories to come down? And if they do come down, does that release part of their LIFO reserve into earnings?

Mike Goldberg

I'll answer the first part of that, and then I'll pass on to Scott for the second part. Yes, we would anticipate that our inventories would reduce between the end of the second quarter and the end of the year.

Scott Stephens

Yes. And then, corresponding with that reduction, then the inventory -- the LIFO release would occur accordingly.

Mike Goldberg

And there were a lot of moving parts in that calculation as well.

David FondrieHeartland Funds

But generally speaking, I mean, all other things being equal, the release -- part of the LIFO reserve would be an improvement for earnings.

Mike Goldberg

Yes.

Scott Stephens

Correct.

Mike Goldberg

That would be true.

David FondrieHeartland Funds

So you've taken that brunt of it in the first half and maybe we'll see some benefit of it in the second half.

Mike Goldberg

I believe that's -- that would be true, yes.

David FondrieHeartland Funds

Very good. Thank you very much.

Mike Goldberg

Okay.

Operator

And our next question is a follow-up question from Nat Kellogg.

Nat KelloggNext Generation Equity Research

Hi, guys. Just two quick things. On the tax rate, it seemed relatively high. Is there anything going on there and can you give a little guidance -- I mean, what we should expect for the rest of the year?

Scott Stephens

There were a few nonrecurring sort of situations -- audits, basically, that were settled and paid in the quarter. And those in total were approximately $800,000 of additional tax. So those would not -- we would not expect those to reoccur at that level in future quarters.

Nat KelloggNext Generation Equity Research

Okay. So then, we should see back to that sort of 39% to 40% level in the rest of the year?

Scott Stephens

Yes.

Nat KelloggNext Generation Equity Research

Okay. And then, just -- I guess people [ph] question about -- I mean, is it fair to say when I look at volume's up and then obviously the revenue wasn't up as great as that, I mean, that's basically due because stainless and some of the alloy prices are going down and the carbon, but that's obviously more than sort of half of your business. And then, the carbon prices are going up and that's only about 20% or 25% of your business. And that accounts for the difference between price and volume. Is that -- that's probably fair to say, correct?

Mike Goldberg

Yes. Again, you've got a lot of moving -- you're right. You've got a lot of moving parts. You've got the carbon influence of our business. The prices are going up and the volumes are going up. And then, counter to that, if you look at really all the nonferrous business, whether it's nickel, stainless, and to some part on the aluminum, we've got prices going down and actually some volumes going that way as well. So that's what makes kind of reconciling these numbers very difficult, because we've got things moving in very significantly in opposite directions. And so, hence the questions on the numbers here today.

Nat KelloggNext Generation Equity Research

And then, I guess just a last one. I mean if I look at your volumes and I look at the margins, I mean, were you guys too aggressive in pricing in the quarter? I mean, should you guys have been priced higher on some of your carbon products that you were?

Mike Goldberg

You mean that we didn't charge enough?

Nat KelloggNext Generation Equity Research

Yes. I mean, if I look at the margins and I look at the volume you guys did, it seems like you gave away some margin. I realize a lot of this is the LIFO-based stuff. But that said, you guys have said yourselves that the higher prices pinched the margin a little bit. And then, I look at the volumes you did, which were very robust, I realize there's a lot of demand for that product right now and it's very tight. But because it's tight, and I assume you guys are getting it decently because you're a big buyer, I mean, if you look back, should you have been a little bit more aggressive on where you were pricing the product?

Mike Goldberg

I think we -- my philosophy is that we should always be a bit more aggressive, should always push on higher price. We've had a look into this and we've kind of tried to look back and compare our non-LIFO margins and see whether that was the case. But we think we've actually passed the increased prices kind of through. I think there's always room for improvement. So -- but I don't think there's any kind of overlying kind of strategy here which kind of says we've gone for more volume at less price. I don't -- I'm certain that's not the case here. And again, the surcharges are the ones which -- are the ones of the issue here I think in terms of price. So the way that our systems work and the way that our pricing philosophy works here, we're pretty aggressive in passing those prices through. And as we've analyzed the business through the quarter, it appears that way and I think the compression is around the surcharges rather than our ability to pass-through base price increases.

So the other thing to look at is the relative difference between base price increases in the second quarter and surcharge increases in the second quarter. I mean, it's -- there's an enormous amount on the surcharges and a relatively small amount on the base price increase.

Nat KelloggNext Generation Equity Research

That's a little bit semantics, right? I mean, the end price is the end price. I mean, I guess --

Mike Goldberg

It's semantics in the transactional world, but not in the program world. And that's the difference.

Nat KelloggNext Generation Equity Research

Okay. All right. That's helpful. And then, I guess just one last thing. I mean, you guys are able to get plate. I mean, I know people talk about it being polite, but I would assume that you guys are a relatively sizeable buyer and you guys have had no problems with supply. Is that correct?

Mike Goldberg

Well, it's been -- well, we'd like more. So, it is a constrained product, has been all year, and it looks like it will continue to be. And so, we've got our -- we certainly got our share and -- but we could have gone with some more. It's been a great product for us this year and we're investing heavily in terms of processing equipment to participate in that market more so. So, yes, we've had our allocation, but it is a constrained product.

Nat KelloggNext Generation Equity Research

Okay. All right, great. That's all I've got. Thanks a lot, guys.

Mike Goldberg

Okay, thanks.

Operator

And our next question comes from the line of Tim Chatard with Sterling Capital. Please go ahead at this time.

Tim ChatardSterling Capital

A question on the program business just really what you said. Can you go back to your program customers and say, the price is -- essentially rewrite the contracts and say, we're holding the price from except for surcharges, therefore allowing you not to have the lag on that business. Is that something you can do? Is that something you have done? Is it strategically something that's interesting to you?

Mike Goldberg

I think the answer to the last question is, yes. I think -- we're in a -- I think we have to do that. I think if we go back into traditionally how the industry has worked and how our company has worked, surcharges have not -- especially on carbon they never existed -- they didn't exist and if they did, they were de minimis. So this was kind of a non -- kind of bit of a non-issue. As -- the world has changed significantly in the last kind of six months in these products. So, we have to go back and look at these and talk to our customers and come to some sort of mutually (inaudible). So I think this is a change of foot, because the market has substantially changed the way that the mills price the product. The environment has changed. We almost have to kind of go back and look at these things differently.

Tim ChatardSterling Capital

Yes. I mean, I'm not in the business, so all of this interesting to me. But presumably, the mills are operating in a new environment and they slap on the surcharge. And have you ever said to a mill, no, that's not what our deal was, I'm not paying the surcharge? It seems like your customers have contracts with you where you're held to a fixed price. On the other side of that, you're sort of at the mills kind of disposal to do what the mill wants to do.

Mike Goldberg

We -- the issue becomes margin rather -- we pass it on. There may be a lag in terms of an inventory turn, but not much -- not more than that. So we pass it on. And so, we're not kind of -- we're not caught in it. We may take a month or a quarter to get back to equilibrium. But we'll get there. The issue really is now because of the size of some of these surcharges, this is now starting to impact our margin. And that's the difference today. And so, I agree with you that as a business and as an industry we've got to go back and look how we structure our deals with our customers as well.

Tim ChatardSterling Capital

Good luck. Thank you.

Mike Goldberg

Thank you.

Operator

And gentlemen, there are no further questions at this time. Please continue with any closing comments that you may have.

Mike Goldberg

Thanks, everybody. We appreciate the questions and the interest in the business and it's an interesting market out there and we're endeavoring our very best to work and to manage the fundamentals of margin and expenses. And we look forward to speaking to you third quarter, if not before. Thanks very much.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference call for today. We do thank you for your participation. You may now disconnect your lines at this time.

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Source: A.M. Castle & Co. Q2 2008 Earnings Call Transcript
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