Eagle Materials Inc. (EXP) Q2 2009 Earnings Report, Transcript and Summary

Welcome to the Eagle Materials, Inc. F2Q09 financial results conference call. (Operator Instructions) It is now my pleasure to turn the conference over to Mr. Steven Rowley, President and CEO of Eagle Materials, Inc. Please go ahead, sir.

Thank you and welcome to Eagle Materials conference call for the second quarter of fiscal year 2009. Joining me today are: Mark Dendle, our Executive Vice President of Finance and Administration and CFO; Art Zunker, our Senior Vice President and Treasurer; and Craig Kesler, our Vice President of Investor Relations. There will be a slide presentation made in connection with this call. To access it, please go to www.eaglematerials.com and click on the link to the webcast. While you are accessing the slides, please note that the first slide covers our cautionary disclosure regarding forward-looking statements made during this call. These statements are subject to risk and uncertainties that could cause results to differ from those discussed during the call. For further information please refer to this disclosure which is also included at the end of our press release. During our last quarterly conference call, I said that Eagle would swiftly and decisively right-size our wallboard operations to best manage our marketplace presence under the current business environment. Our second quarter results reflect this change of direction. Since late June we have dramatically pulled back from secondary markets, reducing freight costs, while increasing mill nets and accepting reduced market penetration. During this quarter, American gypsum natural gas costs peaked in July at nearly $12 per MMBTU. However since then, natural gas costs have started to abate and we have successfully implemented portions of three price increases. As a result, our wallboard operations returned to profitability in August and September. Sales opportunities in cement continue to be hard to find. The Midwest and West continue to be our most difficult regional cement markets. As with our wallboard operations, we are swiftly and decisively adjusting operations at each of our regional cement companies to maximize profitability during the current economic conditions. Reduced…

Thank you, Steve. Consistent with earnings, our operating cash flow improved significantly from the previous quarter from $1.2 million to $19.6 million. The principal driver was the doubling of net earnings in Q2 versus Q1 from $8 million to $16 million with inventory and AR kept at the same level as the June quarter. DSOs remained unchanged from Q1 to Q2. Capital spending in the quarter of $0.6 million net inflows includes $3.4 million of maintenance CapEx spend offset by proceeds of $3.9 million related to the sale of the bulkhead flat rail cars in our wallboard division. During the September 2008 quarter, we also repaid the $10 million borrowed on the revolving credit facility in the previous quarter and ended the quarter with $17 million of cash on hand. As of September 30, 2008 our net debt to capital ratio improved from 49% in the June quarter to 48% in the September quarter. There was no capitalized interest in the September 2008 quarter. Thank you for attending today’s call. We’ll now move to the question-and-answer session.

Your first question comes from Garik Shmois - Longbow.

Steve, on the wallboard price increase that you mentioned that was announced for today, was this the first price increase for October?

That’s correct.

As far as your energy costs in cement go, you mentioned that you’re expecting an increase next year, particularly for coke. How much would your costs go up?

That will vary. We still haven’t finished negotiating all of our fuel contracts for next year, but it’s going to go up at least another 10%. A combination of power costs going up as well as the costs both of the coal and petroleum coke, as well as the rail cost to deliver them to our plant.

That’s estimated in the cost of energy or the total cost for production?

The cost of energy.

Sorry to be picky here -- is that fiscal ‘10 or calendar ‘09?

Fiscal.

On cement, with freight rates coming down here can you just talk about the potential risk of imports reentering the U.S. market?

Currently, we haven’t seen that happen. I don’t know that we’ve seen prices drop off that much but you never know. As far as what I’m seeing presently in the marketplace, I still see imports being less and less every month and I see more and more cement from region to region.

Your next question comes from Kathryn Thompson - Avondale Partners.

First in terms of pricing, first wallboard and then cement, where did pricing end up for the quarter? How should we think about that for the next couple of quarters?

Pricing for wallboard ended a little bit above for us, our mill net was a little bit above $103/1,000. Currently there is still a lot of upward momentum. A combination of things; the industry, I still do not believe is holding their heads above cash costs so I think there’s some momentum for further pulp price increase just to get in the industry even. As well as there’s always some fixed job quotes that just take a while for those jobs to finish and those lower costs to come off and the higher job quotes to take their place.

I wanted to check on the status of your $5 cement price increase that you attempted in Texas in the quarter. Did that flow through? How is pricing at the end of quarter for cement?

Pricing at the end of the quarter was essentially the same as the quarterly average and we have not seen a price increase in Texas.

So you’re saying that didn’t necessarily stick, or it did and you haven’t seen an increase since then?

We have not seen an increase. We had Ike hit a little bit ago and inventory swelled so it would have been very difficult to get a price increase.

Do you anticipate idling any cement facilities in calendar ‘08 or ‘09?

We are operating Illinois Cement at a reduced capacity level. We may look at taking extended maintenance outages next year if the market continues to wane; but currently the only operation that is not at full manufacturing capacity is Illinois Cement.

Moving on to aggregates, obviously mix had a fairly significant impact on pricing. How much of the shift was mix versus slippage and overall pricing?

I think it essentially was all mix. We really didn’t see much decline in pricing. Road base is always an issue and road base usually goes for lower prices and it has much more variability than your construction aggregates. So I can say that road base, there might have been a little slippage in road base price in both markets but the other prices were solid.

Because of the big differential in that segment, is that a similar trend we should see in the upcoming quarter?

I don’t believe so. We had a couple of large jobs that went last quarter. They are completing this quarter. I don’t think we’ll see as big a change in this next quarter.

Did you have any maintenance expenses in the quarter? Any comments on the Hart-Scott-Rodino filing?

Not any unusual maintenance costs. It’s pretty normal maintenance for us this quarter in all business lines. I think we’ve said as much as needed to be said on the Hart-Scott filing in our 8-K.

Your next question comes from Todd Vencil - Davenport.

Steve, following on your comment about a couple of large aggregates jobs, can you tell us what market those were in?

Those were in Northern California.

Were those new construction or repair?

They were new construction.

Just to clarify, and I apologize for this, I think you probably answered the question but I just want to make sure on it. Except for road base, on a same product/same market basis you’re saying you’re not really seeing any slippage in price for any products?

That’s correct.

Prices are going up anyway?

No.

Switching over to wallboard, on the price increase that you said you put in today, what’s the amount on that?

The announced price was between 10% to 12%.

Is everybody more or less following along on that?

That’s correct.

In the industry as we get towards the winter months and the construction downturn seems to be deepening a little bit, are you hearing about any competitors who may be thinking about bringing some capacity in the wallboard business offline?

It’s hard for me to speak about our competitors. To date what we’ve seen, as opposed to plant’s closing we’ve seen plants run fewer and fewer shifts including some plants only running one shift. That tends to give you a much higher cost position but with the cost of freight to the market, some people believe that maximizes their profitability to the marketplace. So they just shipped a small amount very close to the plant as opposed to trying to shut a plant down and ship from the next closest plant a greater distance.

No recent announcements about closures that are public?

Not to my knowledge.

What about on the cement side? We’ve heard about a couple of closures, one up in the Illinois area. You’ve made comments about yourself obviously. Any comments on what anybody else may be doing?

I know that a lot of other people are taking long maintenance outages. I know that there are two or three other cement plants that actually have been closed; I think one in Maryland and I think there’s another one in Illinois now. There might be another one in California that has closed.

On cement also, you mentioned the fact that you hadn’t really seen freight come down that much to drive cost of imports to a critical level where they start to be attractive to the market again. What is the cost of imports into your market now? You guys are importing to Houston, right?

That’s correct. It’s still over $80 a ton.

How much of that is freight?

More than half.

Finally, on the $25 a yard concrete price increase that was announced by a lot of the competitors for October 1 nationwide, are you guys seeing any signs yet that may or may not hold?

I think a portion of it is holding but I’m not sure how much. I know from the people I’ve talked to that a portion of that is holding.

Any color on what portion that might be?

No.

Your next question comes from Glenn Wortman - Sidoti & Company. Glenn Wortman - Sidoti & Company: Are you seeing any downward pricing pressure in any of your cement markets?

You see a little bit from time to time but as you can see, sequentially our prices are flat. It’s really been more volume and so it’s really been a question of reduced imports, reduced purchased product and even reduced -- in some cases like Illinois -- reduced manufactured sales. So it’s really been less of a pricing issue, more of a volume issue. Glenn Wortman - Sidoti & Company: Wallboard, you’ve already touched on this a little bit, but are you worried that you might, if not get back any price increases at least it might be more difficult to attain further price increases due to the falling natural gas prices?

It’s a little too early to comment on this price increase that really just went into effect today. But typically in the winter even though the spot price is fairly low right now, if you look forward the price is still a little higher in the winter. So even if you were trying to hedge, you would not be able to hedge to where that would make any sense. I think you just have to watch it on a monthly basis. Glenn Wortman - Sidoti & Company: From your point of view with the wallboard pricing, you may lose a little justification for the higher wallboard prices if natural gas is coming down, you still have supply/demand deteriorating. Do you think there might be any impact on further potential wallboard price increases?

The answer to that is even though the spot price may be a little lower today, the future prices are not as low as the spot price. Glenn Wortman - Sidoti & Company: With respect to this idling in Illinois, we receive reports of about 1.3 million tons from some of your competitors. Just to give us a sense of the relative impact, how big is the Illinois market?

We really service the upper two-thirds of Illinois and the lower one-third or lower half of Wisconsin. In a normal market, that’s a 6 million, 6.5 million ton market. Current market is down about 15% to 20% from that level.

Your next question comes from Jack Kasprzak - BB&T Capital. Jack Kasprzak - BB&T Capital: There was a comment in the opening remarks about the railcar sale gain being $3.9 million helping to offset maintenance CapEx. In the press release it references a $2.6 million gain. I just wanted to clarify, is it $2.6 million after tax?

The gain is net of the basis we had in the assets. We received the full amount in proceeds of $3.9 million, but the net gain was $2.6 million. Jack Kasprzak - BB&T Capital: Could you review your debt covenants for us?

The covenants that we have are primarily a leverage ratio of 3.5:1. Jack Kasprzak - BB&T Capital: Net debt to EBITDA?

Gross. Jack Kasprzak - BB&T Capital: Gross debt. The PCA recently lowered their outlook for cement consumption for ‘09, calling for ‘09 to be basically as bad as ‘08 down around 15%. Do you guys think that your markets could do better or worse than the nationwide average? How would you have thought about that historically?

You have to look market by market. The California and Nevada markets are down; can they go down much more? I don’t believe so. So those markets I don’t think we’d see a lot of change from where we are today. The Midwest, the same thing. Even though the markets are down, we do not anticipate a tremendous change there. Where the markets have been good for us have been in Texas and in the mountain region. Those are also benefited by some oil and gas which had pretty strong sales into those markets as well. In this condition, it’s hard to look too much forward than another month or so. I can tell you October’s been a good month for Eagle but to tell you what next May or June would be, there just isn’t any visibility. Jack Kasprzak - BB&T Capital: October was a good month for cement or the whole company?

The whole company.

Your next question comes from Amy Norflus – Pilot Advisors. Amy Norflus – Pilot Advisors: Can you talk about the dividend policy and what would happen if let’s say one of the debt covenants or op earnings swell to let’s say maybe a dollar or something like that? Do you still pay the $0.80 dividend, or what’s the policy on that?

We currently have a dividend policy of $0.20 a quarter and that really is a matter for the board. That’s something that the board reviews each quarter. Amy Norflus – Pilot Advisors: It’s not in any of the covenants with the debt, it’s the earnings?

It is not in any covenants.

Your next question comes from Mike Betts – JP Morgan. Mike Betts – JP Morgan: Going back to Jack’s question on the railcar disposal gain, I think the $2.6 million -- correct me if I’m wrong, is a pre-tax number -- what was the actual contribution to earnings after tax from that in Q2?

After-tax, it was between $0.035 to $0.04. Mike Betts – JP Morgan: A point of clarification here. Your comment, Steve, about what you’re doing with cement which was going to be a repetition of what you’ve done successfully with wallboard in terms of reducing volumes and cutting off maybe some of the less profitable customers et cetera, did that already happen in Q2 or is that what you’re planning to do in Q3?

To a certain extent in Q2, with places where the economy is difficult, but it’s something that really every week and every month we look at what the opportunities are and we make the appropriate decisions. Mike Betts – JP Morgan: My final question just on the Houston freight, I’m a bit surprised but I’m sure it’s my lack of understanding that the freight cost is still so high. We all kind of watch the freight indices. Is that because your freight is under contract? If so, when are those contracts up for renegotiation?

That’s correct. It is under contract, a certain piece of it is under contract. A certain piece of it I think still has a while to go, whether it’s six to nine months to go. But not all of the freight is under contract. As we reduce the amount of sales out of Houston Cement then obviously a greater percentage becomes under contract. Mike Betts – JP Morgan: On diesel, with that coming down, were you a significant user of transport surcharges that as diesel went up you automatically got a hike for that and therefore that unwound, was that significant in either your wallboard or cement business?

Yes, it is. It’s really significant in wallboard, and it’s also significant in concrete and aggregates.

Your next question comes from Todd Vencil - Davenport.

On the expansion plans on cement that you have on the boards, I know those have been delayed. Is there any official word from you guys on where they stand or what your plans are?

They just remain delayed under this current environment.

The current environment of regulatory things standing in your way, or current environment of…?

Yes.

Your next question comes from Alan Mitrani - Sylvan Lake Asset Management.

Can you tell us what your plans are for CapEx for this fiscal year? The first half on a gross basis you spent close to $10 million, is that correct?

Approximately. We’re going to minimize it.

Most of your CapEx the last few years has really been for growth anyway, right? So you can really cut it to the bone I would assume?

That’s correct.

The previous question as it relates to covenants, like you said the one is really 3.5:1. You have $400 million of debt which basically means you can’t, on a trailing basis, get below $114 million of EBITDA. Given where you are and given what we see, it’s possible that could happen. Can you tell us what levers you have to pull to make sure that doesn’t happen?

We continue to put flexibility on the balance sheet and that’s why we are minimizing capital investments and maximizing the cash on the balance sheet.

On the dividend policy -- which I know is a board issue, but really I’m sure they ask for management’s input -- do you think it makes sense to keep paying a dividend this size when your stock is trading where it is?

I would think that almost all companies in the U.S. are taking a hard look at their dividend policy.

You’re always good about telling us what you see. I realize everybody’s crystal ball is a little more cloudy but we all look at the housing starts and housing permits and it seems like given the financing situation, things are getting worse, not better. How bad can this get, in your opinion? Maybe just give us the sense of wallboard and cement. I think all of us are a little surprised that cement hasn’t come down further, given what we see as financing issues that are happening for a lot of commercial projects. Can you just give us your sense why you think that is, that cement hasn’t come down further, and maybe it is just wait and see until it does?

It’s really a function of the demand drivers for wallboard versus cement. So there still is some cement that is being consumed for larger, whether they’re public works or whether they’re privately funded roads, you still have some amount of construction that just hasn’t dropped off the cliff like homebuilding. I think that’s the reason why you’re seeing demand a little stronger, although you have seen demand come down pretty rapidly in the last few months for cement as well.

You guys are public, you have access to capital; your debt is all fixed. I have to imagine there are some smaller competitors that are not sitting in as good a situation as you are on a relative basis. Can you talk about the potential for acquisitions? I guess you don’t have much currency to do it, but your thoughts about consolidation in all the sectors that you compete in?

We’re always looking for opportunities and we remain open to that. But it really is a function of what makes sense for the company long term and what makes sense for the company as far as the capacity of the balance sheet to do something.

Also I saw this is the first time that aggregate prices have come down in a long time. Can you just give us your sense of what you’re seeing in aggregates for the California market and maybe in the Texas market too, or other markets that you look at?

The pricing was really just a function of that disproportionate amount of road base. We had a couple of very large road base jobs going in Northern California. That’s really the impact of pricing. Volumes are very slim in Northern California. Volumes are okay, but still difficult in Central Texas.

(Operator Instructions) Our next question is a returning question from the line of Kathryn Thompson.

I just wanted to get your thoughts on the status of State budgets where you have exposure?

That would be in the State where obviously California has some issues but I don’t know that we’re going to see a tremendous decline in the amount of work that’s going on in California. I know some of the projects that are moving forward in California are on a voucher basis. So if the contractor has a balance sheet that will allow him to accept vouchers, I think those jobs go forward. You just have to look and understand what’s going on in each market but clearly the declining economy is impacting the revenues in all the States that we do business.

But have you seen an impact to your current revenues, particularly bids out, as a result of this?

Not currently.

Not currently. When would you start seeing the impact? What type of visibility do you have? Is it six months, 12 months?

As far as jobs that are being bid, we still participate in the bid letting. As far as when they actually move forward, you just wait until it happens. So as of present, the work that we have on book keeps moving forward.

But still no general, I mean even directionally as far as if you bid for a job today, it could get started a year from now, two years from now, or does it vary from project to project?

It varies on each project.

But you still have some sense as to backlog, at least, over a specific time period?

That is hard for cement companies because a lot of this goes to third parties. Some of it you’re involved in upfront, but the majority of it really goes through a third party. So you have a sense for a piece of it, the ones that you’re involved in, but the majority of it goes directly through a third party so you would have a ready-mix company supplying the contractor, and you’re supplying that ready-mix company.

Your next question comes from John Emrich - Ironworks Capital.

What is the right tax rate to use for the company on an annualized basis?

30%.

Are you a cash taxpayer at those same rates?

That’s correct.

Could you just clarify what you meant by putting flexibility on the balance sheet to avoid triggering the debt covenant of 3.5X?

That’s why we’re keeping cash and we’re not spending a lot of cash and we’re trying to build the cash balance on our balance sheet.

Your next question comes from Justin Boisseau - Gates Capital Management.

It looks like the inventory dollars were up a bit year over year and maybe a bit up in days as well. Can you talk a little bit about what’s going on there in inventory?

It’s just a function of we had a real slowdown at Illinois Cement, it took us a while before we realized what was going on with the customers and we ended up with a little extra inventory relative to last year. Then with sales slow, although we are producing at a rate that we’re selling, we just ended up with a little extra cement in inventory.

I think you previously said the company thought about the imports required to meet U.S. demand in cement should be about 10%. Is there any update on that? Do you still expect there to be some imports for the full year?

There are some natural imports that will come in from Canada and Mexico. I believe Canada is the largest importer into the U.S. right now and those cement plants were built to supply markets across the Great Lakes. I would anticipate that we’re going to see cement continue to come in. It’s more of a natural market to come from either just across the border in Canada or just across the border in Mexico.

Got it. What about your expectations? Do you have any of what your net debt might look like at the end of the year? I think it’s about 383 now. Do you expect it to be higher, lower or about the same at the end of the year?

We expect it to be slightly lower.

Your next question comes from Trey Grooms - Stephens Inc.

On the natural gas pulling back you guys had mentioned that will be something that you’ll benefit from going forward. I know over the last few years you haven’t been very active in hedging. Now that we’ve got pricing, natural gas prices down, are you guys taking advantage of that by hedging to any degree? If so, can you give us an idea of what percent of your natural gas needs are being met by hedging at this point?

We are about 40% hedged going forward for the next 12 months.

Can you give us an idea of roughly about the cost of that hedge, where it’s set?

In the $7 range.

You’ve mentioned that coal costs, you expect them to be up next year. Can you remind us when your coal contracts re-price on cement?

It varies from plant to plant. We have one operation that still has another year, year-and-a-half left on pricing, another one that is just pricing up right now. The other plant uses all petroleum coke and we’re not seeing as dramatic a price increase in the petroleum coke market as the coal market. The other one, the coal mine is very close to our plant and it’s not on rail so it’s shipped direct by truck so it’s not as volatile.

On the one that’s pricing right now, can you give us an idea of what level of increase you’re seeing?

That’s close to a 50% increase.

Looking at wallboard, whenever you’re looking out into ‘09 where do you see utilization rates going before we start to see any kind of improvement? How far do you think we can go? How low do you think the utilization rates could go in wallboard?

I think utilization rates can go as low as they want where we are at. I don’t think you’re going to see any difference. We saw pricing bottom regardless of where utilization was earlier this year. So even if utilization continues to go down with the industry, as I perceive it to be just below cash costs, I don’t think further deterioration in capacity utilization would have an impact on pricing. So it’s really a question of, can you still cover your costs in the current environment? In fact, if you’re actually losing cash costs and you have lower volumes that is probably a good thing.

What I’m trying to get at is where do you see the industry demand or consumption in the industry shaking out into ’09, roughly?

I believe the demand will be off another 10% from this year. This year is going to be about the 25 billion level.

With everything we just talked about with costs coming down, diesel coming down, your outlook for another 10% off in volume in wallboard, under those scenarios, assuming that the wallboard pricing that we’ve seen you guys get traction on recently holds, are we in a position now in wallboard where we can stay in the black, even in assumption of another 10% down in volume?

I like our position.

Your next question comes from John Emrich - Ironworks.

What was cash flow from operations and depreciation in the quarter?

Cash flow from operations?

Yes, sir.

The depreciation was about $12 million. One moment. The cash flow from operating activities in total was $19.6 million for the quarter.

Your bank facility is LIBOR-based. I’m just interested, given the wild swings that have been ticking on there, did it reset at the beginning of this month? What level did it reset too? I’m trying to figure out what interest expense is going to look like going forward compared to the quarter?

On the revolver, we really don’t have anything on the revolver currently.

That’s the one that’s LIBOR-based?

That’s correct.

There are no further questions from the lines at this point in time. I’ll now turn the conference back over to you.

Thank you. I look forward to seeing you again in another three months.