Core Natural Resources Inc (CNR) 2010 Q3 法說會逐字稿

Welcome to the NCI Building Systems third-quarter 2010 earnings conference call. As a reminder, all participants will be in a listen-only mode.

There will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions)

The conference is being recorded. At this time, I would like to turn the conference over to Todd Moore, Executive Vice President and General Counsel. Mr. Moore, the floor is yours, sir.

Thank you. Good afternoon and welcome to NCI Building Systems conference call to review the Company's results for the third quarter of fiscal 2010. This call is being recorded. To access the taped replay, please dial 1-412-317-0088 and enter the passcode 419727 and then the pound sign when prompted.

The archived webcast will be -- and taped replay will both be available two hours after the call through September 14. A replay will also be available at NCI's website at www.ncilp.com. The Company's third-quarter results were issued earlier today in a press release that was covered by the financial media.

A release was also issued advising of the accessibility of this conference call on a listen-only basis over the Internet. Some statements made on this conference call may be forward-looking statements within the meaning of the Private Securities Litigation Act of 1995 and Section 27a of the Securities Act.

These statements and other statements identified by such words as potential, expect, should, will, and similar expressions are forward-looking statements within the meaning of the Safe Harbor provisions of the Private Litigation Reform Securities Act of 1995. These forward-looking statements are subject to a number of risks and uncertainties that may cause the Company's actual performance to differ materially from that projected in such statements.

Investors should refer to statements filed by the Company with the Securities and Exchange Commission and in today's release for a discussion of factors that could affect NCI's operations and as well as any forward-looking statements made on this call. To the extent any non-GAAP financial measures are discussed on today's call, you may also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP on the Company's website by following the news link to see today's news release.

Information being provided today is as of this data only and NCI expressly disclaims any obligation to release publicly any updates or revisions to these statements to reflect any changes in expectations. At this time, I would like to turn the call over to NCI's Chairman, President and Chief Executive Officer, Norman Chambers.

Thank you, Todd. Good evening, everyone, and welcome to our third-quarter 2010 conference call. Joining me this evening are Mark Johnson, our Chief Financial Officer; Mark Dobbins, our Chief Operating Officer; and Todd Moore, our General Counsel. I will provide an overview and Mark Johnson will review our financial results followed by Mark Dobbins who will review our operations and then we will be happy to take your questions.

To move this Company forward from these two very tough years to generate sustainable positive results, we will need to consistently achieve balanced growth in volume and margin. This means very focused sales, commercial discipline and cost containment. While we are seeing some real improvement which I find encouraging, we still have work to do.

Third-quarter revenues and tons shipped showed solid sequential growth and modest year-on-year growth. There are other positive financial metrics worth noting.

SG&A was down year on year, comparing favorably to third quarter 2009 which had already benefited from the three-phase $682 million cost reduction program of which $121 million was fixed costs that we implemented in late 2008 and early 2009. Gross profit margin has improved each quarter this year, reflecting gains from our cost and efficiency initiatives throughout the Company.

But even though these positive results are setting the stage for us to do well under improved market conditions, we still face challenges in achieving consistent year-over-year growth in operating income and EBITDA. There are two major reasons why third-quarter operating income and EBITDA were below last year's levels.

First, there is the market which benefited from a seasonal uptick but was down 15% from last last year's third quarter based on McGraw-Hill data for non-residential construction starts measured in square feet. In other words, the volume of business in the marketplace is the lowest it has been in nearly 50 years. These weak market volumes have caused significant pricing pressure across the board and a falloff in bookings.

Second, our Buildings group did not have the benefit of shipping for its backlong in a business environment of falling steel prices as it did in 2009. Rather, steel prices have been rising and compressing their profit margins.

There are several positive points to note. Our Buildings group has more than regained the market share that it lost in 2009 period prior to our recapitalization and we are succeeding in winning important projects which Mark Dobbins will discuss in more detail later in the call.

As noted in our release, our Buildings group backlog was down appreciably from the second quarter levels. This decline is attributable to several factors.

About two thirds of the decline resulted from a slowdown in bookings related to the economic pullback that we experienced this summer combined with improving pricing discipline on incoming orders. One third resulted from a combination of two of our initiatives; the repricing of existing projects to cover increased steel costs and the scrubbing of our backlog to more closely align it with near-term shipping schedules.

At this current level, we believe that the backlog reflects active projects that will ship within the next six months or so. But there is also the possibility that some of the work that moves it to the right as a result of any of these factors will come back into the active columns and in fact our sales force continues to work on a number of those projects.

When we review forward-looking indicators, we have a decidedly mixed bag. The American Institute of Architecture inquiry index remains positive while the buildings index remains negative.

However, within the buildings index, commercial industrial work has been in positive growth territory for three consecutive months. This indicates the likelihood of improvement in new commercial industrial construction starts in the next six to 12 months.

And in fact, our industrial quoting activity and orders booked in the backlog have increased in the last couple of months. Historically, industrial commercial work has represented approximately 17% of our revenue. So that's a good sign.

While McGraw-Hill continues to forecast a multiyear recovery starting in 2011, their most recent forecast calls for further decline in new construction starts to 660 million square feet for calendar year 2010. What we find encouraging is that the vacancy rates for industrial real estate as reported by Rhys Inc. are only modestly higher at 11.8% than the bottom of the last downturn in 2003 when vacancy rates were 11%.

But the 2003 US economy supported 1.4 billion square feet of new construction and grew each year until 2007. In fact during the 41 years from 1967 to 2008, the US economy through every recessionary period still annually supported about 1 billion square feet of new construction activity with growth periods exceeding 1.8 billion.

One of the factors that we believe is holding down current construction activity is the lack of availability of financing from regional banks which have traditionally funded the types of projects our builders do. When this bottleneck eases, we expect the industry to see a positive effect quite quickly as it does not appear to be an oversupply in industrial commercial sectors.

This summer's economic pullback has caused us to become somewhat more cautious with respect to the outlook of the remainder of our fiscal year. But our basic premise remains unchanged.

Based on the current activity levels, expectations are that fourth-quarter revenues will be similar to those in the third quarter and based on those assumptions, we're looking for a modest sequential improvement in adjusted operating income. This does not reflect better market conditions but rather normal seasonal activity.

As we've said before, we are not waiting for a recovery. We are positioning the Company now for a future recovery while at the same time taking steps to ensure that we continue to outperform the market and increase our operating profitability.

Some key points. We increased the geographical footprint of our coating business with the acquisition of the Middletown Ohio paint line which will enable them to continue to grow third-party sales. Our Components group is aggressively selling insulated metal panels through our builder network and its own distribution network.

Our builders group has increased market share by greater brand focus, more compelling end market products. We continue to increase our engineering and drafting efficiency while reducing costs, improve our supply chain management and manufacturing plant consolidation. This is all designed to grow and strengthen the quality of our brands and increase the satisfaction of our expanding network of builders.

Financially our Company is generating positive cash and EBITDA and we've reduced our net debt to $83 million. The men and women throughout our Company are devoted to improving every aspect of their jobs from reducing the per ton cost of manufacturing to reducing the cost of process payable vouchers payable vouchers to making sure everyone leaves work at the end of their shift in good health.

So despite the uncertainty about the strength of the US economic recovery, we reaffirm our intermediate term objective to surpass $200 million of EBITDA that we generated in 2008. With the greater operating leverage we have as a result of the cost reductions and with continued business unit growth and efficiency initiatives, we are confident that we can generate these improved results at a level of construction activity that is significantly below the 1.4 billion square-foot market that we had in 2008. Now I'll ask Mark Johnson to review our financial highlights.

Thanks, Norm. The sequential improvement in our consolidated operating results for the period resulted from both the seasonal increase in activity and the positive impact of our sales initiatives. However, what began as a strong quarter with relatively strong bookings for our Buildings group in the April and May timeframe ended on a flat note with lower than expected bookings in July.

Revenue for our third quarter was $245.3 million, 22% above the preceding quarter and 3% above the year ago period. Similarly, Companywide shipments measured in tons increased 14% sequentially and 1% year over year.

Gross profit margin was 20.5%, a sequential improvement from the 22.2% of the preceding quarter but below the 25.8% of last year's third quarter. The sequential improvement was the net effect of increased seasonal volume on the plus side offset by the very low margin work available in this competitive market and approximately $1.3 million in special project related costs incurred during the period.

Similar to last quarter, the year-over-year decline in gross margin was primarily the result of rising steel prices in contrast to the year ago period when prices were declining rapidly. Selling, general and administrative costs were $48.7 million, similar to our second quarter costs and down 2.2% from last year's third quarter.

As we noted in our last quarter comments, we expect SG&A to remain at approximately this level in the fourth quarter, which means that for full fiscal year 2010, SG&A will come in about 10% lower than it was in 2009 which would be nearly 33% less than 2008. Third quarter operating income was just above $1 million compared to a loss of $9.2 million in the second quarter and earnings of $10.2 million in last year's third quarter.

If you back out special charges, the income from operations was $1.6 million compared to a loss of $8.4 million in the prior quarter and $11.5 million in the year ago period. Adjusted EBITDA was $10 million compared to $1 million in the prior quarter and $21.4 million in last year's third quarter.

Looking to our segment results, all of our divisions showed sequential improvement in operating performance in the third quarter driven in large part by sequential improvement in volumes. Similar to prior quarters, the higher margins in our Coatings segment compared to last year reflected the return to more normalized margins after selling through higher-priced inventory in last year's early quarters as well as incremental sales to external customers.

The Components group experienced an 18% decline in year-over-year third-party volume, most of which occurs in the month of July. This decrease is aligned with the overall decrease in non-residential construction starts.

Despite the significant reduction in third-party volume, the Components group was able to maintain operating profits by controlling costs and increasing intersegment sales. The Components group benefited from a 52% increase in intersegment sales as we more effectively utilized the manufacturing capability of our Components division to support our Buildings group customers.

Our Buildings group which posted a 21% increase in volume compared to the year ago quarter continues to experience margin compression primarily driven by two factors. First, the impact of increasing steel prices on this business segment which has a longer order to fulfillment cycle than Components and Coatings; and second, a very competitive market with low levels of demand.

As we have previously noted, we anticipate that this market compression will begin to gradually dissipate as steel price increases slow and as demand levels increase. I will now review some highlights from our balance sheet.

We finished the quarter with approximately $54 million in cash and an additional $2.8 million in restricted cash. In addition to the funds on hand, our $125 million ABL credit facility remains undrawn.

As we mentioned on last quarter's call, we paid down our term loan debt by $13.7 million during the quarter, bringing the outstanding balance on our term loan to approximately $136 million. Inventories increased 5% over our second quarter but were approximately 39% higher in absolute dollars than in the year ago period.

Approximately two thirds of this year over year increase resulted from higher steel costs per unit while higher quantities accounted for the remaining increase. Measured in days on hand, we finished this quarter with approximately 51 days in inventory compared to 58 days last quarter and 41 days for the year ago period.

To put this in perspective, current steel costs are 35% higher than they were at the low point one year ago but are still 27% below the peak in late calendar 2008. We recognize that steel mills are working diligently to keep prices up by putting forward additional price increases but we think their ability to get higher prices to stick is a function of whether demand levels will support higher prices. Now I would like to turn the call over to Mark Dobbins to discuss our operations.

Thank you, Mark. As Norm noted earlier, we were faced with very difficult market conditions in the third quarter but I'm pleased to report in addition to regaining share in the Buildings group, each of our operating units continues to realize benefits from the cost reductions and restructuring of 2009 while identifying additional cost saving opportunities.

During our Q2 conference call, we noted improving conditions in the quarter reflected by year-over-year increases in bookings and shipments in our Buildings division. The improved shipping trend continued into Q3 and the Buildings group posted between a 21% year-over-year improvement in tons shipped.

This improvement in tons shipped was more than offset by a market slowdown in the third quarter which resulted in mediocre bookings for the period. The markets continue to be very price competitive and higher steel costs in the third quarter resulted in compressed margins as our pricing had to be in line with the market.

However, we are competing successfully as the market begins to recognize the benefits of our improved turnaround times (inaudible) shorter delivery times and overall superior service levels. An example of continuing internal improvements in our processes is reflected by the fact that even with the shorter lead times required by the current market environment, our Buildings group continued to reduce our engineering and drafting costs through consolidation of resources and system improvements. Engineering and drafting expense per ton what was reduced by 16% over the prior year.

The construction market remains somewhat hesitant with added complications from title restrictions and less availability of workable finance options for new construction projects. We've seen situations where businesses were ready and needing to expand their facilities but could not find the appropriate financing for the construction.

And while this issue has improved slightly during the year, it remains an impediment to growth in the construction industry. With that said, there certainly are opportunities and positive movement in various end markets.

We are currently engaged with a large retail organizations which is expanding their stores and distribution center network. This group has plans to build 14 projects this year with 11 of them either currently completed or in process.

NCI's building group utilizing a multibrand approach has captured all of these projects. And an important side note, these projects use our insulated panels as a product of choice for the roof and wall systems.

The Buildings group has also won 200 small outlets for another retail chain. Now this retailer works through many developers and builders.

And while we do work directly with the customer on a national level, it's the relationships with the various developers and builders that have allowed our many brands to successfully compete and win a large percentage of this work.

Other areas of meaningful opportunities for the building group include discount retailers, military and other government projects, heavy industrials such as mining and energy, as well as export projects for a number of countries. We've noted in the past that design-build construction is a mainstay of many of our builders and with cautious optimism we are seeing improving opportunities in this design-build type of construction.

The Components division had a reduction in year-over-year tons shipped for our third quarter but did report improvement over our second quarter. Now this division faces the same competitive pricing in the markets but they excel at managing their costs and maintaining their commercial discipline.

Competitors in this fragmented market have begun to sell only on price. Our Components group has always been able to operate with low cost but more importantly provide superior service in a market that demands both.

The continuing improvement of manufacturing metrics at our new insulated panel manufacturing plant is allowing us to capitalize on opportunities within the insulated panel market as well as provide product sold through the Buildings division. The Components group is focusing their new roof program which is their roof retrofit program on the educational market, addressing the needs of school districts that are feeling the pinch of tighter budgets.

This program gives school boards and school superintendents an avenue to make needed repairs while improving the functionality and aesthetics of some of the older facilities without funding a complete renovation or new construction. These insulated panels and retrofit programs are providing additional avenues to sell products in a very competitive and tight market.

The coating division external tons shipped off only slightly from the same period last year but as Components, did show an improvement from Q2. This group continues to see coating business outside the construction industry and has been successful within the lighting, HVAC and consumer electronics industries.

A focus on improved efficiencies along with updates to equipment and processes are providing opportunities to produce products for these more demanding end uses. As Norm mentioned in the third quarter we finalized the acquisition of an additional light gauge coating line located in Middletown, Ohio. This facility had been mothballed by its previous owners and provided an operating acquisition for our Coatings division.

The facility is favorably located in the upper Midwest and fits nicely within our supply chain for a significant portion of our light gauge business. This facility will be brought back online as the industry and demand returns allowing the Coatings group to be more aggressive in the southern markets where capacity has been a restriction in past periods of higher demand.

Each of our operating units is committed to not add back fixed cost as the economy and this industry rebounds. We are motivated by the opportunity to remain the low-cost producer in the industry and capitalize on an economic recovery. Thank you and now, operator, we would like to open the call to questions.

(Operator Instructions) Eric Prouty, Canaccord Adams.

Good quarter, guys, in a tough environment. Let me ask my first question on the engineered Buildings division of the Company. Any expectation about returning to being a positive from an operating income standpoint during the next quarter or do you think that will stay at a slight loss?

Well first of all, we said in the second quarter call, Eric, that we expected that the Buildings group would return to positive EBITDA for the second half of the year and that is still our view. And operating income, we should be there or thereabouts in terms of breakeven or a small profit.

It really is one of these situations that we see by the work that they have done in terms of increasing steel prices in their backlog and they're shipping schedule and their bookings that we have got -- we are on the right side of making improvements there.

Right, and then for the fourth quarter, would you expect your margins for the Coating ops and the Components ops to relatively mirror your margin percentage in this third quarter?

Well you know, we may see -- at times when steel prices are flattening or coming down, and that is the kind of uncertainty a little bit around this, because while the steel mills are really working hard, Eric, to get the steel prices up, they're struggling to get that done. So what we find in that environment, it is not as conducive for our coating group plus our Components group to kind of keep improving their margins. So if we saw a little erosion in their margins, it wouldn't surprise me but I would expect to see some pickup in the building margins.

Okay, that's fair. And then finally on the insulated panel side of the business, any sort of metrics you can give there as far as revenue or profit contribution or kind of growth rates, etc.? It looks like that business is doing well. Maybe you could just discuss the capacity utilization out of the new plant that you have.

Well, you know, I'll let Mark cover that. We certainly have seen and we've been both Mark and I and the team been looking at the sales campaigns that our guys have for the IPS brand with our Buildings group which is really encouraging in terms of getting more of our builders to buy that product.

And then the Eco-ficient brand that goes out through the distribution system in the Components group has -- is really getting some traction in fact with the architectural community. So, Mark, you want to speak to that more specifically?

Eric, we really did see a nice ramp up and we talked about that in Q2. Q3 continued along. There was some decent bookings and shipments.

As far as the capacity utilization there, we are still actually learning how to operate that line. It is a very complex line.

We're certainly not getting the kind of operating efficiency we would like to have. But we have a lot to learn there. I would say we're probably operating along in the 40 to 50% capacity range at that plant today but with a lot of opportunity in front of us.

Great and is that contributing to the overall corporate margin or are you -- is there still enough kind of rework and waste there that it's a bit dilutive to the overall margin?

It's probably not in a dilutive stage. We're kind of at a point now where it's not contributing but it's not really detracting either. I think Mark was saying as well that scrap rates have really come down (inaudible) Mark?

The guys have really done a good job of working down their scrap rates as they learn how to get some efficiencies out of that line.

And then on the (inaudible) opportunity you discussed, could you just talk about how you plan on approaching some of the re-roofing work, etc.? Is that going to be done in conjunction with your builders network? Is that something which is done more direct by your own internal folks? Maybe just put a little more meat on the bones of how you plan on pursuing that market.

That's a good question and we have a couple of different approaches there. Obviously the approach we have been under for years is to work this through the architectural community with the Components group.

But the Components group are going directly today to some of the school boards and working with some of the schools directly to educate them a little better on the opportunities there as well as as you just noted, the opportunity that exists with our builders group. This is a product that our builders had typically not participated in the past that we see a lot of opportunity out there for those guys. They have all the right tools in their belt. So yes, it's a multi-pronged approach.

Eric, when you think about this, the market for roofing is about $11 billion per year. And in fact the re-roofing part of that which is kind of a [continual place] is about $8 billion of that.

So we really are focused on trying to find our niche in there. And I think the guys have really done a great job on the educational side of really looking for and gaining some traction there. But like the IPS panels, it's going to be a joint approach both with the Components plus the Buildings group.

Okay, great, and then just finally one last one. Could you -- it looks like you did get your tax refund during the quarter. Could you just -- how much was that?

Sure, the tax refund was a little bit north of $26 million. And as you know, approximately half of that was contractually required to be used to pay down the term loan which we did.

Okay, great. And that's really the amount you were looking to receive. So basically you are done with receiving incremental tax refunds.

There will be some sporadic state-based tax refunds that come in over time but the bulk of the dollars are in.

Great, I'll hop back in the queue, thanks.

Arnie Ursaner, CJS Securities.

Can you quantify or give us the number of additional PIK shares that were issued in Q3?

Mark, do you want to (multiple speakers) a little bit?

Let me take that and come back.

Do you have a second question while Mark is digging on that?

I have several, not to worry. You obviously had a pretty sharp decline in July in your bookings. Can you give us a little color of how much they fell in July, give us a feel for how that trend continued in August and quantify what you scrubbed out of the backlog and if most of that occurred in July?

Well, as we said in the -- I said in my script, it was basically the difference between $259 million and the $223 million that we had in the third quarter. So that difference, that $37 million, $36 million in difference, about two thirds of that we reckon was from quite a noticeable slowdown in fact in July.

So we put about two thirds of that -- and one third of that value was a combination of price increasing to the -- price increasing was part of the first one. Part of the second one was in actual fact was both the scrubbing of the backlog to really align the active jobs and the whole notion of hitting the -- of getting the steel costs through which was the repricing.

And what were trends in August?

Trends in August were certainly not -- we didn't see a marked improvement. The slowness that we saw in July is pretty much still there.

It doesn't seem to be worsening but it certainly isn't getting a whole lot better except for some discreet markets that we talked about. We're still seeing some good opportunity.

In fact with the industrial side, some mining work plus some energy work. So we're seeing some things occur that are a bit on the positive side. But it's really difficult to see a true market improvement yet.

Was the backlog higher at the end of August than it was at the end of July?

I don't know that (multiple speakers) it probably was higher. It probably was higher. It certainly wasn't appreciably less. Let's put it that way.

I'm sure this is one you are going to respond to off-line because it's a reconciliation question. But if I look in the adjusted EBITDA table on page 13 of your release, you showed EBITDA of [$22.458 million] for the first three quarters and in your cash flow statement, it shows [$26.017 million].

I'm sure there's an incredibly simple answer for the $4 million discrepancy. If you have it now, I'll take it. If not, we can do it off-line.

Mark (inaudible)

Sure, the non-cash amortization of deferred financing costs is accumulating and how that's classified between the two statements looks a little different. That's the basis for that difference.

And that is the entire difference?

That is the entire difference.

Okay, my final question -- well maybe one more. In your original bank filings, you had hoped to achieve $36 million of EBITDA this year based on the nine-month trends and your view of Q4. Roughly speaking you're going to be at about half of that level. Does that cause any issue at all with the banks or does it restrict you in any way from executing on your turnaround plan?

First of all, we are not saying -- I think we said in our comments that we expect that the fourth quarter will be somewhat better than the third quarter. So again, we'll see where that comes out. But, Mark, do you want to address the covenant issue or anything with the banks?

Sure, that has no bearing on any covenant issues. There are no covenant requirements under any of our facilities. The first time they begin to apply would be October of next year and that would be at a five times net EBITDA ratio.

Net debt to EBITDA.

Net debt to EBITDA.

Again, I guess I'm still trying to understand a little bit about what's happening in your underlying business. You have 21% tonnage increase, prices are higher and yet your revenues were materially -- were flattish, if you will. And I guess I'm trying to reconcile (multiple speakers)

Flat with what, Arnie? Flat with the second quarter?

Well, a little bit up year over year despite a 21% volume improvement and prices of the underlying raw material are also higher.

Right, that goes in large part to what we really spoke about with the Buildings group continuing not to be able to pass on all the steel price increases immediately.

I mean, I think you had also said in your prepared remarks that you thought the worst of the margins issues to win back business was behind you. I'm not sure I fully -- maybe I'm missing something?

I think there's a difference between what we see that we're booking and the margins and the spread in that. I think when we look at what we were able to do with the backlog in terms of the shipping schedule and work through with our builders the steel price increases, I think that has us encouraged.

So I think that the backlog gives you some sense of topline. But as you know in the past, we would generally expect to see in the following six months a number in revenue that exceeds that backlog number and we are seeing and expect to see a level of seasonality while being modest to some extent, still pretty normal in percentage terms for the second half of this year versus the past year. So what we are expecting is that our Components and our Coating group will truck along maybe with a little bit of erosion and then we'll see some improvement with the Buildings group.

Thank you very much.

Wait a minute, Arnie. I think that Mark has that -- has the answer to the first question.

Arnie, the PIK dividends accrued in the quarter were approximately $8 million. That would be approximately 1.2 million common share equivalent.

Thank you very much.

Eric Prouty, Canaccord.

Just one final follow-up on the inventory levels. Would we expect that to fall in the next quarter as you work through material from inventory into sales or is that expected to remain flat?

We finished this last quarter with 51 days worth of inventory and we would generally expect that we would finish the year around 45 days worth of inventory. So approximately six days less inventory would be the typical pattern to expect.

Okay, great, thank you.

It turns out we have no further questions at this time. We will go ahead and conclude the question-and-answer session. I will now turn the conference back over to Norman Chambers, Chairman, President and CEO.

Great, well thank you very much for participating in the call. And we look forward to speaking at the end of next quarter. Thank you very much.

Thank you, sir, and thank you, gentlemen, for your time and we thank you all very much for participating in the NCI Building Systems third-quarter earnings conference call. This concludes today's event.