Gibraltar Industries Inc (ROCK) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Gibraltar Conference Call to discuss its first quarter 2010 Results. We'll begin today's call with opening comments from Ken Houseknecht from Gibraltar's Investor Relations department. After the company has concluded its presentation, we'll open the line to your questions.

At this point, I'll turn the call over to Mr. Houseknecht.

Thank you, Jen, and welcome to Gibraltar's first quarter 2010 conference call.

Before we begin, I want to remind you that this call contains forward-looking statements about future financial results. Our actual results may differ materially as a result of factors over which Gibraltar has no control. These factors are detailed in the company's 10-K and would be updated in the first quarter 10-Q, which will both be available later today on Gibraltar's website at gibraltar1.com. If you did not receive the news release on our first quarter results, you can get a copy on our website. The presentation slides that we will be referring to during this call are also available on our website.

On our call this morning are Brian Lipke, our Chairman and CEO; Henning Kornbrekke, our President and COO; and Ken Smith, our CFO. Thank you for joining us.

At this point, I would like to turn the call over to Brian.

Thanks, Ken. Good morning, everyone and thanks for joining us on our call this morning. Since Henning and Ken will describe our first quarter results in detail, my opening remarks this morning are going to focus on Gibraltar's strategic direction, its ongoing business, the markets we serve, our distribution channels, and our product portfolio. Following our prepared remarks, we will respond to any questions that you might have.

We have aggressively and strategically reshaped Gibraltar in recent years. Since 2006, in addition to streamlining and restructuring our Building Products businesses, we have disposed off the businesses in our Processed Metals segment which -- with the last one being eliminated in Q1 2010. The Processed Metals businesses had lower growth profiles and we had no synergistic coupling for future enhancement. We are now solely focused on the building markets, which we believe have much higher growth and performance improvement potential.

If you look at slide three in our packet this morning, you will see that we are a manufacturer and distributor of products for building markets with an annual sales capacity of $1.6 billion prior to any acquisition activity. The point that I want to emphasize here is that as demand levels in our markets continue to rebound, we have ample capacity to absorb that additional business. And given our new significantly lower cost structure, incremental sales will generate even stronger improvements in our earnings and margins.

As you can see from this slide, the combination of the repair and remodel portion of our residential market and the replacement portion of our nonresidential market comprises approximately 65% of our total sales volume. This is important due to the fact that repair and remodel and replacement activity is historically first to rebound from a downturn and that's beginning to unfold at present.

During difficult economic times, people who own homes first do whatever they can to hang to them. And then once they feel secure that they are going to be able to keep their home, then they will do repair and remodeling work before considering buying or building a new home.

And the same holds true for manufacturing facilities. Companies will first deal with survival issues, which many times include cutting back on capital expenditures and replacement activities, until they are more comfortable that their businesses are secure. Then as business conditions warrant, companies will begin spending on replacement activities and later in the rebound cycle, they will begin to add capacity and/or build new facilities.

The balance of our businesses relate to new build portions of both residential and nonresidential building markets. Current market statistics indicate that 2010 will show improved residential building levels over 2009 by as much as 30%. While that level of improvement would call for build levels far below historic norms, it is a meaningful improvement and will provide improved volume for our facilities. Any improvements in volume levered against our substantially lower cost structure and lower breakeven point will drive significant improvements in profitability.

The nonresidential new build portion of our business is focused to a large extent on industrial facilities like sewage and wastewater treatment plants, gas and oil rigs, chemical plants, and manufacturing facilities of all types. Other than for architectural and decorative applications, our products are not focused on the high-rise building market. As industrial activity continues to improve, this market, which is still depressed, will begin to rebound and provide later-cycle growth improvement opportunities for Gibraltar.

You can see from the slide, we take a broad product line to our markets and customers through a number of distribution channels, as well as going direct to some of our customers. Our streamline base of manufacturing and distribution centers, new MIS systems, which we've invested in over the last three years, provide us with improved production planning and inventory control capability. These have enhanced our ability to meet customer delivery requirements while utilizing less working capital and with far less overhead.

Our broad range of products are well established, many with strong leadership positions and the value-added component is higher than our former Processed Metals business, which enhances our ability to generate higher and more consistent margins. We have a diverse and well-established list of products with a number of our larger product categories highlighted on this slide.

That's a good snapshot of what Gibraltar looks like today. I hope this makes it clear which end markets are consuming our products and how we are positioned to participate in the early and later-cycle economic recovery. Because of the strategic approach to our restructuring efforts, which focused on streamlining our operations and eliminating non-value-added steps in our process, while preserving manufacturing capacity, we are left with substantial available capacity and a lower cost structure, which will -- we will capitalize on as our markets add volume.

The building markets are large and present numerous long-term growth opportunities for us. As in the past, we expect our businesses will continue to expand through organic growth initiatives and complementary additions. This management team is confident our actions have positioned Gibraltar for improved growth, stronger earnings, margins, and returns, all of which should enhance the value of the company for our shareholders, and that's the focus of every member of this management team.

With this -- with that backdrop, Ken, I'll turn the call over to you.

Thanks, Brian. And before I begin with slide number four, I do want to point out that the P&L amounts on slides four through slide seven exclude the Processed Metals Products segment. Since that business was largely sold on February 1st, 2010, it's been reclassified to discontinued operations, and slides four through seven only present our continuing operations before special items.

We also had restated our earnings previously reported throughout 2009 and reconciled those to continuing operations, only containing our Building Products business. These reconciliations were appended to our earnings release issued last night in which we restated each quarter of 2009 and the full year 2009.

And now to our first quarter results on slide number four. There were a number of important improvements in Q1, which resulted from strong execution by the company during a period of very weak economic conditions.

First, an encouraging sequential revenue increase, even considering a wintery weather across the Southern US in January and February and amid weak end market conditions. Profitability rose, both sequentially, as well as year-over-year, benefiting from a lower fixed-cost structure that resulted from aggressive cost reductions during the past 18 months, plus the leverage that comes with even modest revenue increases.

We also continued to generate positive free cash flow, double-digits as a percent of revenues, which contributed to a further reduction of debt during the quarter. And the last bullet on slide four, importantly, we have ample liquidity to fund our growth initiatives and working capital needs as the building markets rebound. So overall, we feel good about the position of the company and its financial fitness for the future.

Now, let's turn to slide number five and talk more specifically about the sequential improvement. Starting with revenues, first quarter demand was sluggish as expected. Nonetheless, we were favorable due to wholesalers restocking for spring demand, plus selective pricing improvement and a base level of unit volume from repair and remodeling activities, despite the unseasonably cold and snowy weather in the Southern US.

We reported a notable improvement in first quarter operating income. Sequentially, operating income from continuing operations before charges rose $4 million on a near $13 million increase in sales, which is very good margin expansion. And that margin expansion was driven by unit volume and improved alignment between raw material costs and product pricing, and this operating income improvement also lifted our earnings per share.

For Q1 2010, we were not quite in the black for EPS as overall demand was below our current breakeven. But our business leaders are performing well in an environment of slack demand, rising raw material costs, and pricing that continues to be very competitive. So overall, sequential performance was good, particularly the margin expansion and the trends are encouraging.

Moving ahead to slide number six titled year-over-year profit improvement. Sales were down modestly compared to the prior-year period, which was a net result of the tail end of Q1 2009 having more favorable unit volume for larger-size commercial and industrial projects, as well as higher pricing. Even though our sales in the first quarter of 2010 were slightly unfavorable to the prior-year period, we were able to offset -- we were able to increase our profitability. And as our news release noted, this quarter's operating income on continuing operations before charges rose $10 million despite a decrease in sales of $9 million.

Behind that strong profit improvement was a much higher gross margin, increasing 750 basis points to a gross margin of 18.7%. The key drivers of the gross margin improvement were aggressive cost reduction initiatives, lower raw material costs, improved operating efficiencies, and a better alignment between inventory cost and product pricing.

So before moving to the next slide, I want to make the key point of good year-over-year and sequential profit improvement, particularly in the slack to weak market conditions, unemployment, and other macro factors affecting housing.

Let's turn to slide number seven titled net income and EPS. I spoke to the operating earnings improvement, so I'll focus on the other larger differences. Net interest this quarter shows a higher amount compared to 2009, which is a net result of higher amortization of previously deferred financing costs, which more than offset the lower level of interest costs that we settle in cash.

Regarding the lower income tax benefit, the principal driver was the much reduced level of pretax loss in Q1 2010 and also a smaller benefit this quarter. The tax rate this quarter was 47%, which included a net 600-basis point benefit for discrete tax items. The rest of the year, I expect an effective tax rate closer to 42%.

So let's turn to slide number eight, cash flow. Q1 2010's free cash flow was $17.3 million, albeit unfavorable to 2009, because 2009 was an extraordinarily strong period for generating cash, particularly reductions on working capital last year including the first quarter. And since we began 2010 with a much lower amount of working capital, there is not as much cash to generate from the balance sheet as compared to last year. However, importantly, we did generate more cash from the P&L this quarter.

Also our first quarter 2010 had its larger source of cash coming from discontinued operations. That specifically was the liquidation into cash of the accounts receivable we did not sell with the Processed Metals business. We retained those receivables and have since collected nearly all outstanding amounts.

And looking at the last row on slide eight, we believe when free cash flow exceeds 10% of revenue, it's a very good level of performance. For the full year 2010, we are expecting CapEx spending to approximate $15 million or thereabouts and any resumption of quarterly cash dividends is yet to be decided by our Board of Directors. I do anticipate that we will invest in working capital during Q2 and Q3 to support an expected rise on receivables and inventory and that short-term investment will be funded by draws from our revolver.

Turning to slide number nine, debt reduction, we reduced our borrowings this quarter, all of which was the paydown of the revolver to a zero balance from a $50 million balance on the revolver as of December 31, 2009. The debt reduction since year-end principally used the proceeds from free cash flow, plus the proceeds from the sale of the Processed Metal business. And as previously shown on slide number four, today, we have ample liquidity to support our operations at over $120 million.

Our next speaker, Henning Kornbrekke, Gibraltar's President and Chief Operating Officer.

Thanks, Ken. While the first quarter started slowly with sales down 5.3% year-over-year, business activity picked up late in the quarter as the weather improved and the larger customers began restocking for the spring selling season, which provide us with positive momentum going into the second quarter, evidenced by our sales in March and April, both of which increased compared to the prior-year levels.

Our operating income from continued operations before special charges increased by $10.4 million in spite of a $9 million reduction in sales with a 6.3-percentage point improvement in operating margin versus the first quarter of 2009. Day sales of inventory were down 18% and days working capital improved 23 days, all further evidence of the leverage we are realizing with our improved systems, new cost structure, and lower breakeven point.

At this point, I'll offer our comments on current business conditions with slide ten as a backdrop. We expect that 2010 will be a much better year than 2009 for Gibraltar, with several factors benefiting us. First, the vast majority of our restructuring activities and costs are behind us. Second, we are entering 2010 with higher levels of operating efficiency, improved business processes, and more automated systems. Third, inventory costs and selling prices are in better alignment and current pricing volatility more manageable. And finally, we have a stronger balance sheet, less debt, and much improved liquidity.

Having now moved into the seasonally strongest period for our business, together with the expected improvements in our end markets, we are anticipating a return to profitability in the second quarter and for the full year. Looking specifically at a leading indicator, one of our end markets, housing starts are up 9% from the fourth quarter of 2009. We expect continuing improvement in housing starts in 2010 to approximately 740,000 units from a trough of 552,000 units in 2009, which was the fourth consecutive year of decline.

With the more than 30% improvement in starts expected in 2010, coupled with our improved efficiency and lower cost structure, increases in demand are expected to translate into significant performance improvements, which we have now seen in the last four quarters. Even though there is mounting evidence that the residential building market is on the front end of the recovery, it is coming off of historic lows and even with an expected 30% improvement in starts, 2010 will still be the second lowest total in 60 years.

The expectation for recovery and growth in the building market is high and well-founded and we believe is now once again moving in the right direction after four difficult years. Looking further ahead, we remain confident in the long-term fundamentals of this market in light of continued population growth and other demographic trends, and our strong leadership position in the products we supply enhances our ability to grow and generate higher and more consistent margins.

Now, turning to the repair and remodel segment of the residential building market, which as Brian noted, is where most of our activity is centered, we expect with housing sales trending up home improvement spending will recover this year as forecasted by LIRA, the Leading Indicator of Remodeling Activity Index. LIRA suggests annual spending will accelerate with nearly 5% growth in 2010.

We anticipate increased activity will be driven by stabilizing home prices and improving economic and employment outlook. Homeowners who have forced all the move, taking steps to preserve the value of their current home, investments in energy-efficient products, and the need to make improvements in foreclosed properties before they are salable among others.

Finally, in the nonresidential part of our business, we do concur with the latest forecast that suggests that modest relief is expected in 2010, particularly in the markets we are strongest and including replacement, industrial, higher education, transportation, and medical facilities.

As we said in our last call, our category-leading positions and our participation in markets that are faring better in the downturn like repair and remodel have helped to offset the impact of declining housing market. The volatility and uncertainty of the last two years and the need to focus on cash management necessitate a conservative short-term approach towards growth. We did, however, continue to work on longer-term growth platforms.

In the near term, we continue to develop new products like our new (inaudible) innovative building, framing, connecting system, metal roofing, and socket products and improved store channeling, as well as expanding into new markets including HVAC components and security products, and we have a broader geographical participation. As markets normalize, we find ourselves well positioned to deliver on our growth and performance objectives.

At this point, I'll turn the call back over to Brian.

Thanks, Henning. As a result of the many steps that we've taken to restructure the company, Gibraltar is in an excellent position to first, return to profitability in the coming quarter and for the full year and with growing volumes, to return to and exceed past levels of profitability.

With that, we'll open the call to any questions that any of you may have.

Thank you, sir.

(Operator Instructions)

We'll standby for our first question. And our first question comes from Robert Kelly with Sidoti.

Good morning, gentlemen. Thanks for taking my questions.

Good morning.

Good morning.

As far as the year-over-year trend, the down 5%, was that all volume or was there a price as a headwind as well?

Most of it was unit volume as we went through. I think pricing finally stabilized, I think we are comfortable, our inventory, as we said, was in balance. So it was mostly volume and it was specifically in two of our businesses. The one business has a very different end market for us and that business, once it rebounds, we expect to have very strong growth from it. So I think we are encouraged with the -- even though it sounds unusual with the volume year-over-year down only 5%. The other business, in fact, experienced growth -- modest growth, but the primary Building Products businesses did register growth for the first quarter year-over-year.

So the Building Product piece was offset by declines in your commercial and industrial area?

It wasn't necessarily commercial. It's a business that supplies products into a very specific market segment and that business or the market itself is going through a realignment and as that realignment is finalized, I think we will see that business pick up rather strongly. So I think we are encouraged on a year-over-year basis, looking at the results coming through the first quarter.

So -- so let me understand. It was more a matter of you being able or not being able to push volume at the door rather than a read on the end market for that business?

It was just a one business that we have and we don't want to talk specifically about the business, but it was just the one business that was, I'd say, off substantially as their -- as that market is being restructured.

Okay, great. Now, as far as your distribution areas, can you talk about what -- you talked about home improvement being a positive in 2010, what are you seeing from your kind of key retail customers in March and April?

I think there is good activity in the stores that we've noticed, certainly in retail and we see a little bit of pickup in the wholesale channels as well, I think so. That -- as we look at -- into the coming months, we are encouraged. As I said, we've seen our sales in April a little bit ahead of our forecast, we found that very encouraging. So we continue to seeing increases for about, I guess, five months with strongest increases in the last two.

And then are you adding new stores and branches in your channels in 2010?

We are not adding new stores or channels in 2010. We are expanding some of the products we have into existing channels.

Right.

That seems to be going along rather nicely. I think we are excited about the opportunities as we go forward.

Although we are always hoping and trying to add new stores and new regions to those that we are already serving. So that's an ongoing effort.

Right. And then just one final one. You had a sequential uptick in sales, I'm assuming that was mostly volume, from 4Q. But gross profit kind of slipped or at least the margin slipped quarter-on-quarter. What explains that? Was this a decline in -- ?

That was almost -- it was exclusively the realignment of our pricing of our inventory to market. Coming out of the fourth quarter and I think we had that issue most of the third and fourth quarter -- we found in the first quarter that we finally were in balance and so we looked at total material cost as a percent of sales, that was substantially lower, 8 points lower in the quarter.

I'm talking more in -- compared to 4Q, your gross margins slipped during the first quarter?

Yes, yes.

That had do with the inventory?

It was material pricing in inventory.

Thank you.

Welcome.

The next question is from Seth Yeager with Jefferies & Company

Good morning, guys.

Good morning.

Can you talk about -- I think in your repair and remodel, it looks like you guys are guiding up year-over-year at least from that segment. Can you talk about demand by price point and what you are starting to see?

We see the price points have held, materials have been relatively -- commodity materials have been relatively stable through the first quarter. We anticipate some pickup in the second, I think that's nationally recognized. And we think our pricing as a percent of our sales is going to remain stable as we go through year. We are not seeing the same volatility that we saw in last year.

Okay. And then as far as your working capital build, as you see it now going into the second quarter, what types of -- do you -- are you expecting a normal seasonal draw on the revolver? Can you maybe just quantify what that's going to look like as you see it now?

I think it could be in the $20 million plus or minus range.

Okay. I think that's it. I'll get back in queue. Thanks, guys.

Thank you.

Thanks.

The next question comes from Jamie Sullivan with RBC Capital Markets.

Hi, good morning, everyone.

Good morning, Jamie.

A question on the seasonality. You mentioned it's a bit stronger than your forecast. I think looking historically, you typically get somewhere in the 15% to 20% sequential uptick. Should we be thinking about that as a -- as the pattern this year if everything continues as you see it?

I think if you look back historically, that would be a good way to anticipate what might be coming this year.

Okay, great. And in the -- you mentioned some restocking in some of your customers. I guess, can you talk about at least qualitatively the magnitude of that and if inventories still remain pretty thin, your view there?

I think the inventory in most of the people that we deliver to remains fairly thin. I think that as they become encouraged with the market pickup, they are more likely to start to order ahead. I don't think we've seen that yet. I think in the retail repair and remodel part of it, I think the -- they are managing those inventories closely as well. So we are pretty well aligned with the demand. As the demand picks up, we see it initially. I think as the market starts to pick up, we would see some acceleration, because they want to increase their supply ahead of the anticipated demand. We are still hoping we see that towards the end of this year.

This is, I think, a key pattern of -- particularly our major customers focusing on working capital in their businesses. And as a result, they are trying to control their inventories as much as they can. And the good news in that is that as soon as they see an increase in sales at their stores, we will see an increase in sales from our facilities to theirs, there is a direct linkage there.

And as Henning said, as they get more confidence that the higher levels of demand will continue, then they will start to increase the inventory that they have on their shelves, which could give us another bump in sales.

I mean, it's good news because we've also -- and I think Brian mentioned earlier, with the systems we have in place, we can better manage our inventory at lower levels and still deliver pretty quickly and I think the customers know that. I think customers are trying to do the same. So there is less investment in inventory to all locations. I think that's just the way the world is today.

We've made major changes in our production planning process and major efficiency gains at majority of our plants around the country, all of which are aimed at shortening the lead time for us to produce products, which is a key element in our overall plan to reduce the amount of working capital, reduce the number of distribution facilities that we have and yet maintain top levels of service to our customers.

Right. Okay. And then just a question on the margins. From the fourth quarter, it looks like your incremental operating margins were in the 32% range, which shows the leverage there that you've set up. You had a little bit of a headwind on the gross margin line. Should -- does that suggest that the -- that's sustainable even at a higher level as revenues grow from here? I'm just wondering how to think about that.

Clearly, that's the case. And I think clearly we will start see improvements in gross margins now that we stabilized the material part of the gross margin calculation.

Okay.

Also, as we get better throughput, higher levels of throughput, we'll get better efficiencies and better spreading of the overhead. So that should also help.

Okay. So we should think about 35% plus on the incrementals?

You are talking operating or gross?

Operating.

Yes, I think we are in that range --

As volumes continue to rebound, yes.

Right. Okay. And I guess just one last one if I can ask real quick. I thought I heard you mention the price increases. If you can just talk about that there -- sorry if I missed it earlier.

Well, we have a --

We did not talk about price increases.

We talked about improving alignment of our material costs and pricing and that is one element of the management work.

I think the key thing here is that you have to go back to the fourth quarter of 2008 to understand what happened in 2009 and the difference between that period of time and our first quarter of 2010. If you recall, during 2008, raw material costs spiked, demand had risen, and raw material costs spiked, only to fall off precipitously in the fourth quarter through the first quarter of 2009 and the second quarter of 2009.

Many companies had higher amounts of inventory that was also very highly priced. Customers who understood raw material commodity and raw material costs were coming down were demanding immediate price reductions and that resulted as many companies were giving back selling price at a time where raw material costs had not yet fallen in their inventories and margins got compressed substantially. And that was happening to us in the first two quarters of 2009.

Coming into 2010, as Ken and Henning both mentioned, we have a much better alignment between raw material costs and selling prices and the inventory levels that we are hearing are very appropriate for the level of business that we are generating today. So we are in a totally different position going into 2010 than we were going into 2009 and that's a primary driver.

I would add, with the new business platform we have, we do price very competitively into the marketplace, we do supply excellent service and quality. That's our philosophy so that -- we watch pricing very carefully, we are sensitive too, we do everything we can to take our cost down so that we can price competitively into the market to all of our customers.

Thanks very much for all the detail.

Welcome.

Your next question is from Peter Lisnic with Robert W. Baird.

Good morning, everyone.

Good morning, Peter.

I guess if I could just follow up on that last question, is there a way that maybe you could ballpark for us in the first quarter what sort of the price commodity cost benefit was? And then as you look to the second half of the year with sort of the inflation we are seeing, what your expectations there are in terms of either margin impact or -- ?

I think in the first quarter and again, I won't talk to commodity pricing, I'll talk to our inventory levels. It was approximately 8% and we believe now we are pretty much aligned to market costs going forward. Now, we know there is a movement in some of the commodities. We know aluminum and steel are moving up, we know that some of the resin prices have -- are fluctuating as well. But I think we feel comfortable and we are in a good position to manage the situation going forward.

Okay. So basically, neutral impact as you kind of move through the year?

Yes.

Yes.

All right, all right. Thank you on that. And then if I look at your commentary on end markets, the housing start forecast up, whatever that is, 35% or 40%, the remodel forecast up 5%. I just want to understand is -- are those the assumptions that you are basically using for 2010 to kind of run the business?

I would say --

No, we've cut our cost structure back dramatically and regardless of what levels of housing starts occur, we've cut our cost back and our breakeven point to a level that we believe we've turned the corner on profitability.

No and I -- yes, that I understand. We could see that, I think, in the leverage that you are putting up last few quarters. What I'm wondering is whether -- maybe from an inventory standpoint, whether you are building inventory to serve -- ?

No, I think the comment that we made earlier, our systems are better able to manage our inventory levels. So that -- we are very much aware of what the forecasts are, we have our own forecast internally, which is probably a little bit more aggressive than the indexes that we quoted. But I think as the market continues to grow, you will find that we are very much in set with the market, we'll continue to go after market share, we'll continue to grow the businesses aggressively as the market will allow us. And we've got the capability of doing that without having to take inventory in advance.

Yes. And I -- again, I understand the operational piece of it, but what I'm wondering is, are you assuming that starts are 740,000 or more?

We believe that housing starts will be in the range of 740,000 or more, yes.

Okay, all right. That helps. And then I just -- I guess I don't understand, on the revenue or the volume down 5%, how one business could basically drive that. It must mean that that one business was basically inactive during the quarter would be my guess. So can you give us a little bit more color on what happened there structurally? Help us understand what --

Nothing happened structurally, their sales were down about 60%.

And that's just in line with the end market or -- ?

Well, it's different. I mean, they have leading market share, they have 80% of the market, so that -- they are the market for the most part. And again, that particular segment is realigning itself to some future model that's being worked on right now and when it comes online, it will pick up nicely.

Okay. So it's nothing that was structural or you lost share or anything along those lines?

Absolutely not.

All right, that is very helpful. Thanks for your time.

You are welcome.

Thanks, Peter.

Your next question is from Tim Hayes with Davenport & Company.

Hey, good morning, gentlemen.

Good morning, Tim.

First, thanks for all the detail on the end-use breakout that you've now given us. And my question is actually --

-- sure everybody understood that we are different company today and we wanted to provide as much clarity on our markets today as we possibly could to help all of you understand the business together and come up with accurate ideas on what our potential is going forward.

Very good. And actually to that, I was now curious what does your raw material needs look like? How have those changed now that steel processing is gone? What kind of products are you buying and how much of different ones? I just want to get up to speed on that.

I mean, fundamentally what it means in a broad sense is that we have higher value-added -- it means that material costs as a percent of sales are considerably lower now than they used to be before, which means that we have more leverage inside of the business, particularly on profitability, which has been our challenge and our strategy for --

Quite awhile.

Brian and myself are probably -- I'm going to say seven or eight years. This is not new, we like to say that the period we are going through has accelerated what we already started a long time ago. So we were well prepared -- even though we hoped it didn't happen, we were well prepared for the downturn in the economy. And I'd say, if nothing else, we just accelerated what we already had in place.

To get a little more specific on that -- two points. One, the Processed Metals business' raw material percent of selling price was in the 70% to 75% range. So when you pull that out, it drops the percentage of raw material -- selling price made up by raw material costs. We are still buying steel, we are still buying aluminum, we are still buying some stainless steel and some -- and resins just as we were before, but --

But less of it.

But less of it. We are -- one of the ways that we've improved our working capital is that while we still do buy some of our products direct from aluminum and steel mills, producing facilities, we are buying a larger portion of our business from service centers, which helps us maintain lower levels of inventory, higher inventory turns, and have more stable pricing.

So it's another -- kind of a structural change that moving away from the Processed Metals business has allowed us to making the business -- putting us in a position where we think, as a result of this, we are going to be able to have more consistent margin performance than we were able to able in the past when Processed Metals was part of the business.

Right. So is it fair to assume that all the additions with iron ore you referred to size that any of the hassle of changing from annual contracts to quarterly contracts given that those were all probably residing in the steel processing to the extent that there were any.

Yes, I couldn't fetch through. We found that in fact two years to three years ago, almost everyone run away from annual contracts, that was a thing of the ancient past, which only increased the volatility on a day-by-day basis. You never knew at what price you are going to line in with. As Brian had said I think for the most part, that's a much smaller part of our business today than it ever has been.

And then in terms of your supply contracts and customer contracts are you pretty much all now spot, are you buying the spot raw materials and selling spot or is it from clearly --?

We've a centralized supply chain management group and they're doing good job of helping all of the businesses line up the best prices and not just on a spot basis.

The key thing that we've always tried to do is match our purchasing terms with our selling agreements from a time perspective. If we're selling at a spot market basis, we'll try to buy on a spot market basis. If we're selling on a longer-term contract basis we'll try to buy on that, but even within that we found that utilizing a blend of short-term and long-term pricing mechanisms gives us better stability.

Right. Not on steel processing I was just curious, what percentage of your business is on a spot basis?

Let me just back a bit. We're no longer in Processed Metals, we don't buy and mine of the way we did with steel, and we're now selling products to large retailers. We're bringing in material, we're buying labor, and we have a standard cost data system. The business now is configured very different than Processed Metals. We don't have the same nor do we need the same alignments on material costs and selling prices. It's a different business. We're in a Building Products business, you know the products that we sell, just not done that way --

I think what Henning is saying is Processed Metals business was really a spread business.

Exactly.

The spread between raw material cost and selling price. We always did as much as we could do to keep our operating expenses as low as we could but the real nature of making a profit in that business is based on the spread. In the Building Products business with raw material cost being so much of a lower factor compared to the Processed Metals business, it's a value add business with a host of different components that drive the --

We don't have fluctuations in pricing on a monthly basis like a Processed Metals business. When we sell -- we sell a mailbox, a mailbox is a mailbox and I don't think the price changes very much for the entire year.

Right. In terms of passing on any changes in raw materials cost would that be pass-through much easier when it goes through distribution whereas OEM or retail would be a little stickier? Is that fair to assume that or do I --

We have good arrangements with the customers that we have. I think there's only one business that I know of today that that has a kind of arrangement with the customer tends to be a long-term arrangement. We put into place one particular commodity had enormous fluctuations. We've not seen that, we've not worked at particular policy with that customer in over six months. I think in general we're saying that that's not an issue for our business going forward, we're pretty good stability both in pricing and we're finding better stability in our material supply side as well.

We're little hesitant to say too much about that area too because that's a very competitive area and I know competitors are listening out on this call so we hope you understand our reluctance to get into too much of detail on that.

Okay, thank you.

(Operator Instructions)

Our next question comes from the line of Mark Parr with KeyBanc Capital Markets.

Hey, guys, good morning.

Good morning, Mark.

Good morning, Mark.

I don't know if you want to provide more color along these lines, but Brian, I was wondering if you could give some color on what you expect overall input costs to rise in '10 versus '09.

Input cost rise in '10 versus '09.

Steel, aluminum, et cetera, all your basic raw materials that you're buying.

I think there's an upward trend but it's small and since the first of the year pricing has come up a little bit but as we go out or the balance of the year I think it will get to a certain level and then plateau.

I mean steel is at [630], we think it will go to [720], that's after in the marketplace and it will come back down to [680] so we're talking about may be on steel 7% or 8% of the year, I think aluminum we see less than that. And I think the same is true for resins, I think, resins have moved around a little bit, but I think it had come back down in the $0.80 to $0.90 category. So, we don't see a lot of movement as we go from this year. As we said earlier we think there is going to be more stability.

Okay. All right, that's helpful. And then as far as how you're buying material, are you buying it on a longer-term contract basis or more on a spot basis?

Some of the businesses do buy in a longer-term, I think they do a good job of recognizing what's the movement. If we see volatility in there, they might back walk and go shorter term on it, but it's -- for us, it's business as usual. We have good coordination between all of our businesses. If one business' volume is off, we have the ability to transfer that material to another business that might have volume that's up, we've seen that during the year, that's help provide both pricing and quantity and inventory balance for the year.

So I think we're encouraged going forward. I think we're starting to see a long lasting stability. I think even we'll see some stability. I think you see that also, Mark.

But the thing too is now that we're focused on our Building Products exclusively, raw material volatility is less of a factor in our ability to generate margins than it was when we had Processed Metals.

Right.

That's my desire. We wanted to get to a place where we could generate not only higher margins, but more consistent margins. You'll recall we've been saying that for a long time. Well now we think we've come a long way towards being in that position. So while we don't expect major volatility this year in the input cost, the impact of whatever volatility there is, is going to be muted because of the new position we put the business in.

I know you comment about expecting things to level off. We're looking at iron ore prices now that are moving up significantly more than a 100% from last year in the global markets and current iron ore pricing is higher that it was in '08. We haven't seen the demand fall through on pricing for steel yet. We're still on a cost push environment. There's certainly there is no visibility into the second half yet, but some of the raw material indicators are certainly suggesting that there's more upside risk to pricing than downside risk. I just --

Looking at first the volume in the marketplace will drive an awful a lot of that, Mark --

Right.

Most importantly though we think we're in a good position to manage through whatever comes.

Okay. All right. Is -- are you seeing -- I mean, again, are you expecting a modest increase in cost, I mean, you're seeing pricing power adequate to offset that?

Sure. Again, as we said before, we price very competitively in the marketplace, we've done a great job in controlling our costs, we think we'll stay competitive with our customers which will help us build market share in expanding that to some other geographies. I think we're focused on that.

Okay. I really appreciate all these conversations, very helpful. If I could just ask one more question, as far as new products, is there any change in the mix of your new products for 2010 versus '08 or '09? Approximately, what is the mix of new products for this year?

I think this year we'll have a total of -- I think it's -- the last time I looked at a 11% or 12% with the new products I think we're heavily focused on the repair and remodel part of the market. We've got some new products going in there which are going to be very helpful.

We've got some new innovative products that are going to help in home construction. That will help take the total cost of home construction down by utilizing some of our products. It will strengthen some of the framing components that are used. We got some new codings that we use and some of the products which will lengthen the life of the product. I think we've got a host of opportunities and our folks have done a great job of pushing those forward. Again, we're very encouraged with both rest of this year and as we go forward.

Okay, terrific. All right, thanks again for all the color. Congratulations.

Thank you.

Thanks, Mark.

Ladies and gentlemen, this will end our Q&A session for today. I will now like to turn the call over to Mr. Brian Lipke for any closing remarks.

Thank you. Thank you all for joining us on the call. I can tell you very simply that sitting here today it feels a whole lot better than it did sitting here at this time last year and we have a much more optimistic outlook from this point going forward. Thanks for your participation. We look forward to talking to you next quarter.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a good day.