Quanex Building Products Corp (NX) 2002 Q2 法說會逐字稿

Welcome to the Quanex Corporation's second quarter conference call. At this time all participants are in a listen-only mode. Following the formal presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder this conference is being recorded today, Friday May 31, 2002. I would now like to turn the conference over to Mr. Raymond Jean, President and Chief Executive Officer. Please go ahead, sir.

Good morning. Welcome to the Quanex second quarter conference call. Thank you for joining us. With me this morning are Terry Murphy, our Chief Financial Officer, and Geoff Galow our Head of Investor Relations. We will be available after my formal remarks to take any of your questions. Today's call will include a brief review of second quarter results. I will discuss the state of our primary markets, then conclude with an outlook for Quanex for the remainder of the fiscal year. The comments I am making today include forward-looking statements about the future prospects of Quanex. Please refer to our latest 10-K report filed in January of this year, for the Company's detailed forward-looking disclosure statement. With quarterly earnings up 118% over the prior year, Quanex had an excellent second quarter. And our results were driven in part by ongoing customer restocking efforts within our two primary markets, vehicular products and building products. Customer orders significantly improved late in our first quarter and that strong activity continued throughout the second quarter. Results for the quarter also benefitted from a combination of other factors, including new customer programs, improved market share, more value-added products, and lean initiatives. Highlights for the second quarter include -- best ever second quarter operating income and earnings. Record-breaking operating cash flow, 6% same-store revenue growth and record operating income at Engineered Products. And new productivity records at MACSTEEL. A few financial specifics for the quarter include EBITDA of $31.9 million, compared to $21.4 million last year, up 50%. Operating income of $20 million, up 105% from last year. Inventory is down some $12 million. Diluted earnings per share of 70 cents compared to 32 cents, up 118%. And long-term debt to cap of 35% at quarter end down from 45.4%. Now, let me talk about the vehicular product segment, which includes MACSTEEL, Piper Impact, and Temroc Metals. The primary driver for the segment is North American life vehicle builds and with continued strength in this market, the segment experienced an excellent quarter with operating income up 64% over last year. A jump in heavy-duty truck production also helped results. Our MACSTEEL division had strong operating results for the quarter, volume was up 22%, clearly outperforming their market. MAC ran at 17 turns six days per week. The outlook for 2002 North American light vehicle builds has improved since the beginning of the year. Where the industry began the year with an expectation of some 15.2 million builds, the current look calls for some 15.8 million units. During the quarter, MACSTEEL also made impressive strides at further cost reductions. For instance, on a per-ton basis compared to last year, they lowered conversion costs by 6%, and reduced energy costs by 10%. On top of these excellent productivity metrics, MAC also benefitted from more value added products as a percent of their mix. Our MACSTEEL Jackson operation experienced improved earnings for the quarter, as the plant gained some benefit from the newly completed Phase Six Capital program which was completed during the first quarter. The new Mac-Plus line at the Fort Smith operation is now running limited trials as the unit comes up to speed months early, and we look for good operating gains to kick in by the fourth quarter. Piper Impact posted another profitable quarter and the division remained focused on finding viable new programs to backfill for diminishing aluminum airbag business. They continue to work closely with MACSTEEL sales and engineering staff on new product applications. Part of their long-term success will come from finding applications that call for the inherent advantages of a cold impact extrusion. That is lower cost, high strength with near net shape characteristics. Turning to the building products segment, they too had a solid second quarter. With all divisions reporting brisk customer demand. The segment includes Engineered Products and Nichols Aluminum. Key drivers are housing starts and remodelling expenditures. And as we read at the end of last week, these drivers remain strong. As they have done for the last several quarters, Engineered Products reported record sales in operating income. Key customers for the Division include major door and window manufacturers who are benefiting from strong housing starts. Seasonally adjusted housing starts remained at robust levels throughout the quarter, and demand from customers was heavy and remained so. New programs and engineered products including some exciting projects at Colonial Craft will support substantial earnings growth going forward. Nichols Aluminum, our quality supplier of aluminum sheet to the building and construction industries continues to experience an upturn in business versus last year. The Division reported a 19% rise in volume for the quarter and we expect slightly higher volumes this quarter. Nichols backlog was 57% higher than last year at quarter end, and common alloy sheet producers are scrambling to raise prices in the face of rising demand. The Division had difficulty acquiring aluminum scrap at reasonable prices during the quarter, with March and April being particularly difficult. The result was a moderate compression in spreads from last quarter and a year ago. However, there is good news here, scrap availability is improving this quarter, and Nichols is currently raising prices. They expect a modest improvement in their spread for the remainder of the year. Nichols Aluminum Golden continues to make excellent progress this year, as they have now offset the loss of a major packaging customer at the end of 2000. Through most of last year and into early 2002, Golden was forced to run lower margin common alloy sheet. The Division has now successfully backfilled with higher margin food packaging applications and their operating results are reflecting this higher return business. Demand in the second quarter of the year will be heavy, and the Division expects volumes to be up 35% over the first half of this year. Let me comment on the remainder of the year for Quanex. In the vehicular product segment, we expect North American light vehicle builds to be higher than last year. A concern for MACSTEEL during the second half of the year will come from higher raw material costs which began to rise midway through our second quarter. As you know, MAC uses steel scrap to produce engineered bars and the Division expects scrap costs to continue to rise over the next several months as the economy improves in the demand for scrap increases. This will cause a modest compression of spreads over the near term. This should be a temporary issue at MACSTEEL as they are raising prices to their customers now through early calendar '03 as contracts expire. More value-added products, less outsourcing and higher margin business from vehicular customers will further mitigate spread compression this year. Moving to the building products segment, we look for stronger results in the second half of the year. Engineered Products is a solid book of business, many new programs, their customers are gaining market share which in turn fuels our growth and we continue to build on very close customer relationships. Nichols Aluminum has a strong backlog and they will benefit from improved operating leverage. They will continue to raise prices wherever possible, and the Division expects a modest recovery going forward. At Corporate, we have called the the remaining $59 million of our 6.88% debentures. We look for most bond holders to convert their holdings to common stock, which will improve our equity position and put some 1.8 million additional new shares into the market. These additional shares won't affect our reported earnings per share, as we have always reported earnings on a diluted basis. An additional benefit of the debt conversion will be increased cash flow to come from the elimination of $4 million of annual interest payments. Look for capital expenditures to come down as we complete Phase Six at MACSTEEL this quarter. Let me talk about cash flow and describe for you some of the actions we are taking to further improve it. A key operating metric we track is our conversion cycle. A conversion cycle is the sum of inventory days on hand plus receivable days less days payable. This metric is symbol to tract and easy to understand and since adopting it last year, we have made significant improvement in this important area. For the second quarter, this run for cash cycle improved to 49 days versus 55 days last quarter, and I know we can do better. For comparison, our conversion cycle early last year was closer to 65 days. Cash flow further benefitted during the quarter, as we lowered our onhand cash balance by some $20 million. Our improved use of cash in part, allowed us to make $35 million of repayments against our credit facility during the quarter. For the first six months of this year, we have generated over $52 million of cash and for the year, we expect this figure to exceed $120 million. Up some 20% from last year. Our strong level of cash generation gives us tremendous flexibility going forward. Look for us to continue to pay down our debt balance with their year end expectation of reducing it to $75 to $80 million. At that level, we will have a debt-to-capital ratio approaching 15%. These figures, of course, assume we make no other acquisitions this year. In recognition of our very strong fundamentals, Moody's upgraded the Company's credit ratings across the board earlier this month. Let me say that in many respects, Quanex could be considered a stodgy company. We have a simple business model with a clearly defined strategy. We have no off-balance sheet partnerships. The revenue recognition process is conservative, debt levels are low relative to our industry and going lower. We serve markets, vehicular and building products, that are basic to the American economy. Boring as we may be, our prospects are exciting. Quanex has two very solid core businesses, MACSTEEL and Engineered Products that earn returns in excess of capital costs today and they are positioned to do so in the future. These core businesses have sound prospects and initiatives for achieving profitable growth going forward. We fully realize there are issues to address at Quanex, including businesses that don't currently meet our tests of earning returns in excess of capital costs. We are wrestling with these issues daily, and have no sacred cows as we consider alternatives. Determining and executing solutions to best serve shareholder needs isn't easy. Nor is it always a quick process. However, we know it is what we must do. Going forward, we will protect, nurture and grow our two core businesses, MACSTEEL and Engineered Products. Assuming the economy continues to improve, and consumer confidence holds, we would expect to report diluted earnings per share for the third quarter some 30% higher than the 67 cents reported a year ago and for the year some 40% higher than last year's $2.05. That concludes my formal remarks this morning. We will now answer your questions.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. If you have a question, please press the star followed by the 1 on your touchtone phone. If you would like to decline from the polling process press the star followed by the two. You will hear a three tone sound acknowledging your selection. Your questions will be polled in the order they are recieved. If you are using a speaker connect, you will need to lift the hand set before pressing the numbers. We request that you please limit yourself to one question and recue for a follow-up question. One moment, please, for the first question.

The first question is from Scott Morrison with Credit Suisse First Boston. Please go ahead with your question.

Hi, good morning. Could you maybe elaborate a little bit on your comments on the impact of scrap on MACSTEEL going forward. Obviously, as you pointed out, scrap prices are up a lot year-to-date. Just curious, one, in terms of the magnitude of any margin compression you might expect to see because of that and secondly, sort of a response to customers as you begin to go back and renegotiate higher contract pricing.

Good question. Very relevant. Let me take the second part of your question first. You know, from a customer standpoint, we are certainly not in the practice of breaking any contracts, and we do have a good chunk of our business on a contract -- contractual basis. I was reading this morning that, you know, some companies are actually breaking contracts. That is not our modus operandi. But as the contracts become due, however, we certainly will be negotiating prices that are in line with the market. The -- going to the first portion, the scrap pricing, certainly we have seen, you know, rapid escalation in the last couple months. I mean it really started early in the year, scrap has been at just incredibly low levels, and we expect prices to keep increasing over the next several months, and we are going to see a little compression at the margin, but we see that as being a very temporary -- having temporary impact, because we have got some positive things going for us as we change the mix at MAC's to more value added products and as we bring in more work from the outside, we are now in a position to bring that work in that we have been subcontracting, I am talking about the value added operations. So we think it's going to be moderate, modest, and we expect that compression to go away and in fact our margins to increase as the price -- the favorable price increases that we will be negotiating begin to impact.

Okay. And customers are sort of amenable and they understand what is happening and are amenable to seeing increases as you go forward?

Yes. I mean, we have certainly where we can, we have increased prices what we sell through small amount we sell through distribution, for example, we have increased prices. Just like the price of scrap has been at abnormally low levels, so has steel pricing been at abnormally low levels and I think our customers expect that to go up going forward.

Thank you.

Thank you. The next question is from Barry Vogel with Barry Vogel and Associates. Please go ahead with your question.

Good morning, gentlemen. I have a question on Engineered Products. Over the last few years Engineered Products has become a more important segment for the Company, and they obviously have had sone very good results. Could you elaborate on the comments that you made about new programs continuing to be a key driver in the success of Engineered Products? This year the group has over a dozen major new programs underway with its customers, could you talk to us about that comment number one? And could you discuss the 40 -- I think you have done -- you did about $40 million in sales in Engineered Products in the quarter, could you break that out in terms of the sales mix of what you are selling there and who your major customers are?

Okay, the -- you know, the new programs are how we go about achieving that is we have got what I consider to be some pretty creative people that work hand in hand with our large customers in designing new product accessories, taking costs out of a product which enables us to increase shares sometimes, and that is how we continue to -- to build our volume with those businesses. It is just an excellent -- excellent relationships and talented people working hand in hand with the customers and bringing strong value propositions. That is how that is done. The --

Barry, on the Engineered Products side as you know, as we disclosed building products, we don't break out Engineered Products. We have not disclosed the $40 million number that you had suggested, at least not that I am aware of.

I am making an estimate. Whatever the sales are, can you tell us who -- what the mix of products are in the sales of the quarter and who your major customers are.

The major customers are the large door and window manufacturers. You can include Anderson, Pella, Marvin, Colby, Caratco, and that's a good list.

Do those Anderson, Pella, Marvin, Colby, and Caratco do they do the bulk of your -- were they the bulk of your customer sales?

Yes, the majority would be going to those big guys.

Okay, and as far as products, can you explain, let's say half a dozen of your products?

The big product item would be screens, for example fills, window jams, thresholds, that represents a good chunk of our work.

Okay, now when you talk about again going back to new programs, because again you had it in your press release, and I know you gave an answer, so those are not necessarily new products but they are new ways of doing business, is that what you mean?

Right. Sometimes they may represent a change to an existing product, that again changes, you know, some characteristics of it, perhaps reducing costs, taking out material costs, and, you know, it might be an item where we are enjoying 40% share, but as a result of adding value we get to increase our share. I consider that, you know, a major addition to an existing program. In some cases it is something entirely new, such as a new sill design that has been introduced in recent months.

As far as the, again, I want to stick on this one topic, that is why I am asking another question, you have been making acquisitions to build up the Engineered Products segment and the most recent was Colonial Crafts.

Correct.

If you looked at potential acquisitions for the Company going forward given the current mix of business that you have and given the fact that your two core entities, as you just suggested, are MACSTEEL and Engineered Products, is it more likely that acquisitions will be in Engineered Products rather than MACSTEEL?

Well, perhaps more likely, because it is an environment that is target-rich, if you will. There are -- it remains a fragmented business, there are many companies in -- with sales less than a hundred million dollars, many privately held. So it is a target-rich environment. But that is not to say we are not looking on the other side as well. Looking for businesses that would be natural adjacencies to MAC that would give us the opportunity to extend our broad processing capabilities.

Thank you very much.

Thank you, sir. Ladies and gentlemen, if there are any additional questions, please press the star followed by the 1 at this time. As a reminder, if you are using speaker equipment, you will need to lift the hand set before pressing the numbers.

The next question is from Greg McCowsko. With Lord Abbott and Company, please go ahead with your question.

Hi. Could you talk a little bit, it sounds like the debt paydown is perhaps a little more aggressive than you had been -- than we had been expecting earlier on, or am I wrong on that?

This is Terry Murphy. I think that what we've done, we have emphasized managing our working capital and reducing inventories, we have also looked at carrying a cash balance that is significantly less than we have carried on a quarter-to-quarter basis so we have used that excess cash as well to pay down debt. It is also true, though, to your point, that profitability is greater than we had expected and therefore we are generating more cash than we had expected relative to a year ago. The combination of those three events, plus the conversion, the conversion of the $57 million of debentures from debt-to-equity are going to put us in a very good cash position and a very good position for growth as we move forward. The 15% that Ray made reference to, the 15% debt-to-equity ratio of course assumes that we are converting that $57 million of debt to equity through conversion. That is not planned except to the extent the stock price has been significantly above that conversion price. We chose to convert -- or excuse me, chose to redeem at this time.

You give a number of 120 million cash for '02, does that include the 57? Give me a sense of that 120.

That $120 million is operating cash flow. It has nothing to do with any financing. That's just operating cash from the businesses.

So, if we are saying debt at year end is going to be 75 to 80, that could be gone by the end of '03, is that fair to say?

That is fair to say, yes.

Okay. With regard to the business, you talked about the steel business -- or the pricing and long-term contracts and naturally you don't want to break those contracts, if I were to look at the business with regard to MACSTEEL, what share of that business would be on those long-term contracts today? I realize some of them will come due. If we look, you know, in other words, or what share of your contracts, what share of business could you reprice over the next say 12 months?

Some 65% or so of MAC's business is on long-term contracts, long-term being a year, and, you know, most of those contracts will be expiring by calendar year end, so we will -- we have got some work to do.

So in calendar '04, you are saying, by calendar -- well, within --

Calendar '03, you mean.

Calendar '03. You should be able to reprice everything in MAC?

Most everything. I won't say everything but most everything, yes.

Okay. That is -- so then -- and have you locked in any scrap prices going forward at all, or any contracts with regard to scrap at this point?

No, it is a month-to-month commodity purchase.

And then I see that you have put down -- you assumed a 15.8 million vehicle build for this year, I have heard higher, what if we were to see, let's say, just for argument's sake, 16.5 million builds, let's be aggressive, what could that mean to that 40% estimate for the earnings growth for fiscal '05, or fiscal '02, excuse me?

We like to be conservative with our assumptions, and, you know, I like to think there is some upside.

But I mean I would assume that the increase -- every incremental increase at MAC is -- I mean, is there -- could you give me a sense of the incremental profitability for an added dollar of MAC sales sort of at this point?

No, I don't want to take that one on. Off the top like this. But, you know, we were operating MAC at better than 90% of capacity in the second quarter, so, you know, there is -- you know, there is a limit. You know, I think there is lots of runway left in terms of profitability, but, you know, just sheer tonnage, you know, there is a limit to that. What we would be doing is changing out lower margin work with higher margin products going forward.

I believe you have a Phase Four --Six plan for MAC going now, when do you figure that that will add capacity?

Well, --.

To the 90% you talk about in the second quarter?

That won't happen until the fourth quarter of this fiscal year. It is undergoing a shakedown as we speak. We don't expect to benefit from that in the third quarter.

And Greg, let me add to that. The Phase Six, which is a third, basically a third MAC plus line at Jackson and Fort Smith, does not add to base capacity at MACSTEEL. What I am really doing is I am taking lower margin hot roll bar and converting more of it to a value added product. So that in and of itself will not allow me to run more product through MACSTEEL. That is fairly limited at 720,000 tons. So Phase Six is more value added, not a change to the base.

And given your outlook in, say, going forward, say into the first quarter of '03, would you say that you could maintain at least maintain this capacity levels you had on a sequential basis, whatever they happen to be in the fourth quarter, based on demand for that higher margin product?

Yeah, I think that's a reasonable assumption.

Okay. Thank you very much.

Thank you.

The next question is from Bill Baldwin with Baldwin Anthony & Securities. Please go ahead with your question.

Good morning. Ray, can you offer a little color to us on the types of applications that this cold extrusion impact from Piper, where it could be -- where it could have a competitive position in the marketplace, kind of, you know, some of the applications that make sense for that?

Well, again, you know, the benefit of that extrusion process is that it gives you good metallurgical characteristics with near net shape and where we were working with MAC on vehicular applications is looking where those characteristics are needed where duct-to-line castings may be used today, which would require more machining to get the properties and the surface characteristics that you want, and where strength is important. So, you know, we have got a job for example that we are working on where it is called a yolk, and that stands as example I guess of where we have got solid potential going forward.

Would that be an example of some of the new business that you alluded to in your release where Piper's picked up new business?

Correct. And some of that is undergoing accelerated testing as we speak.

Can you speak, Ray, and give us a bit of an idea of what kind of utilization we are seeing in Piper's manufacturing operations right now, what utilization rates are there?

I don't have a percentage off the top. But I -- you know, round numbers, we are in, you know, 50 or 60% range. It is low. I mean, in fact, even though Piper's profit was up some 10% versus last year, their volumes were down this quarter by, you know, several million dollars, and third quarter will not get any better because one of their large customers lost a program which is going to decrease sales a little more than we had expected, but we expect to remain profitable. We are in a squeeze play a little bit here as, you know, the process of bringing on new work sometimes takes a little longer, but we fully expect to get there and we remain very excited about the prospects.

I was trying to get some idea of what the -- you know, the current facilities at Piper could support in terms of a business.

A lot more.

No, I gather that. And also, would it be safe to assume that the new business that is likely to come in to Piper over the next several years will be a more value added product than what you currently have in the cannister area?

Yes, absolutely.

Thank you verry much.

Thank you, sir. Mr. Jean, there are no further questions at this time.

Please continue.

Well, thanks for your interest today. Our commitment is to remain customer-driven, return focused and passionate about lean manufacturing. I am confident we will continue to improve shareholder returns because of it. This concludes the Quanex second quarter conference call. Thank you.

Thank you, sir. Ladies and gentlemen this concludes the Quanex Corporation second quarter call. Please dial 800-405-2236 with access number 4721-10. If you would like to listen to a replay, please dial 800-405-2236 with access number 472110. Thank you for participating. You may now disconnect.