Quanex Building Products Corp (NX) 2002 Q4 法說會逐字稿

Good morning or afternoon, ladies and gentlemen, and welcome to the Quanex reports fiscal fourth quarter and 2002 earnings conference call. At this time, all participants are in a listen-only mode. Following today's 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, December 6, 2002.

I would now like to turn the conference over to Mr. Raymond Jean, Chairman and CEO of Quanex Corporation. Please go ahead, sir.

Good morning, and welcome to the Quanex fourth quarter conference call. Thank you for joining us. With me this morning are Terry Murphy, our Chief Financial Officer, and Jeff Gaylord (ph), our Vice President of Investor Relations. We will be available after my remarks to take any of your questions.

Today's call will include a review of our fourth quarter and fiscal year results, an update on our acquisition activities, the state of our key market drivers, and a review of our expectations for fiscal 2003.

As always, the comments I'm 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 complete forward-looking disclosure statement.

For the quarter, Quanex reported record (ph) diluted earnings per share of 97 cents, up 26 percent over the prior year, which reflects a healthy demand for our products. Both MACSTEEL and Nichols Aluminum essentially ran at full capacity for the quarter, while the Engineered Products group again posted excellent results as customer demand for their window and door components remain strong.

Overall, these excellent fourth quarter results came as a result of strong customer demand, new programs, along with more value-added products and lean (ph) initiatives.

Highlights for the quarter and year include, best ever fourth quarter and fiscal year sales, operating income and diluted earnings per share from continuing operations. Engineered products recorded record operating income for both the fourth quarter and the year on same-store results. Nichols Aluminum more than doubled their yearly operating income versus 2001.

We acquired Colonial Craft, which was both accretive in 2002 and earned a return in excess of the cost of capital in its first year. We successfully converted our 6.88 percent debenture to equity, and MACSTEEL and Nichols each set new productivity records for the year. Financial highlights for the quarter include sales up 7 percent year over year, cash flow from operations of 38 million, up 19 percent. Operating income was 28.4 million, up 36 percent from last year. And diluted earnings per share of 97 cents compared to 77 cents last year, up 26 percent. And for the year, sales of 994 million, up 8 percent over 2001.

Diluted earnings per share of $2.96 compared to $2.07. Capital expenditures were 34.5 million, with much of that spent at MACSTEEL to augment our value-added capacity, the so-called phase six (ph). Total debt to cap ratio was 15.2 percent, down from 44 percent a year ago. Stockholders equity increased to 421 million compared to 280 million at the end of last year, a 50 percent increase. And our book value per share rose 28 percent to $25.67.

You no doubt noticed that, for the fourth quarter, we reported fully diluted earnings per share that were actually higher than the basic EPS figure, which is clearly counterintuitive. However, the answer lies in an adjustment we made this quarter to our third quarter estimates of interest expense. As I mentioned earlier, we converted our 6.88 percent debenture in the third quarter, and the estimation had to do with what amount of interest was payable to the bondholders. While changing the estimate impacts fourth quarter net income and basic earnings per share, there was no impact to the diluted earnings because the interest expense associated with the debenture is already taken into account when calculating diluted earnings per share.

Moving the discussion to the balance sheet, we're very pleased with the progress made this year at reducing our debt. At the end of fiscal 2001, total debt to capitalization was 44 percent, and today that figure is 15.2 percent. This translates to a year over year debt reduction of 145 million, with 75 million in total debt remaining. The 75 million is comprised of 10 million in industrial revenue bonds and 65 million outstanding on our revolving credit facility, which was renewed on November 26th for another three years at favorable terms.

In our competitive landscape today, you'll find few companies that have as solid a financial footing as Quanex, with its healthy balance sheet combined with strong cash generation. For the last six years, our operating cash flow has exceeded 100 million, and free cash flow for 2002 was 53 million. This strength afford us the flexibility we need to fund organic growth opportunities, as well as acquisitions. Without an acquisition or some other use of cash, our debt level will continue to decline.

Now let me move on to the segments and talk first about vehicular products, which includes MACSTEEL, NitroSteel, Piper Impact, and Temroc Metals. The primary driver for the segment is North American light vehicle bills. As in the first nine months of the year, fourth quarter light vehicle bills remain healthy, with the latest estimate for calendar year '02 bills at 16.6 million, which would make the year the third-best build rate ever.

For the year, MACSTEEL sales and operating income represented about 80 percent and 95 percent of the segment's results. Clearly MAC remains the flagship business within vehicular products. Compared to fourth quarter last year, sales were up 9 percent and operating income was up 17 percent. MAC operated six days per week with excellent productivity. However, MAC's '02 results were significantly impacted by the squeeze in spreads experienced from rising steel scrap prices '02. MAC scrap costs started to rise during the second quarter and were up about $20 per ton by year-end.

As we've discussed in the past, MAC's business is basically weighed to one-year contracts, which limits their ability to raise prices in the short term. However, more than offsetting this squeeze was the combination of improved operating leverage, a continuing shift to more value-added products, less outsourcing, and improved conversion costs.

The outlook for MAC in 2003 is favorable. Scrap pricing has come down a bit. There are negotiating price increases up to 5 percent, and their backlog is still very good for this time of year. In addition to these positives for 2003, there will also essentially have a full year's benefit from phase six, which added about 90,000 tons of MAC plus output to their mix. Taken together, we look for MACSTEEL to once again report higher sales and operating income in fiscal 2003 compared to '02. Like the rest of you, we're watching light vehicle sales and build rates closely.

Turning to the building products segment, Nichols Aluminum and Engineered Products both had excellent quarters, with each experiencing strong customer demand. Key drivers for this segment are housing starts, which for calendar 2002 are estimated to be above 1.6 million and remodeling expenditures. In most years we experience a slowing of demand in October, particularly from our window and door customers, but this year customer demand was pretty much sustained throughout the quarter.

Housing starts slowed a bit during our fourth quarter, but we're optimistic that starts will remain at decent levels in 2003. That optimism is centered around the Fed's ongoing interest rate policy and the encouraging demographics we see with first-time homebuyers at the lower earned of the market and the baby boomers building larger second homes at the higher end of the market. The remodeling market, which is an important component of our building products segment, makes up 25 percent or so of the segment's revenues and remains strong for us.

For the year, engineered product sales in operating income represented about 30 percent and 65 percent of the segment's results. As they have done each quarter in 2002 versus '01, Engineered Products reported record operating income. New programs, excellent operating performance, and the benefit of Colonial Craft yielded great results. The outlook for next year calls for even higher sales and operating income.

Nichols Aluminum, which produces mill-finished and painted aluminum sheet for the building and construction industries, continues to experience improved operating results compared to last year. Volume was 10 percent better than a year ago, and the operation ran at capacity for the quarter. Nichols, which has experienced improving spreads for much of the year, reported higher spreads again this quarter versus the third quarter and versus last year's fourth quarter. This improvement is a result of higher prices and their improved operating performance resulting from productivity gains.

Let me shift the discussion back to corporate issues and update you on our strategic thinking concerning acquisitions. We have purposely built in tight constraints for ourselves as to what type of business we will acquire. We recognize all too well that most acquisitions fail to earn their cost of capital. Recognizing that acquisitions carry inherently higher risks than organic growth, any acquisition we consider must be strategic to Quanex, and by that I mean it must support one of our two core businesses, MACSTEEL or Engineered Products. We must be able to demonstrate to ourselves that the acquisition can earn in excess of its cost of capital by the third year. In most cases, it should be accretive in the first year.

We won't buy businesses that are broken -- that is, in need of a difficult turnaround, although we are interested in buying businesses that have not been successful because they've been unable to fund their opportunities.

While there are potential candidates for both MAC and Engineered Products, there are more acquisition opportunities for Engineered Products. They compete in a fragmented industry with many small, regional companies. At this time we have nothing to announce, but we continue to look at acquisition candidates.

That's not to say that we are ignoring our organic opportunities. In fiscal 2002, new products and programs alone accounted for some 50 million of new business on an annual basis. We are currently looking at ways to further increase both base load and value-added capabilities at MACSTEEL, and we continue to look for ways to squeeze more painted (ph) production from Nichols with small investments.

Pension fund issues are getting considerable attention in the financial press these days, and while this issue can be considered immaterial at Quanex because of the small size of our obligation, let me update you on what we have done nonetheless.

Assumptions were lowered during fiscal 2002 to accurately reflect current market conditions. Including assumption changes and the amortization of actual investment losses, year over year pension expense increased by approximately $1 million pretax.

Now let me comment on the outlook for Quanex and its markets for 2003. As a consumer durables driven company, demand for our products is determined by light vehicle builds, housing starts, and remodeling demand, and to a lesser extent, heavy duty truck builds. Our markets have been solid for several years now, and we aren't looking for any big changes in 2003. We do expect our key drivers to moderate somewhat, but to stay at historically strong levels. And given that, we expect to deliver better operating earnings to our shareholders in 2003.

Here's why. MAC will benefit from higher prices. A larger percentage of their total output will be more value-added products like the MACPLUS turn bars and cut-to-length bars. We expect some share gains, and MAC will experience lower conversion costs, a result of lean initiatives. At Nichols Aluminum, the costs will also benefit from lean initiatives. They will also have more value-added painted product to sell.

Engineered Products, with its strong customer demand, new programs, and the full year's benefit of Colonial Craft, will drive earnings higher. Leading customers of Engineered Products continue to gain market share and expand their channels of distribution. And at corporate, we expect net interest expense to be less than half of 2002's 13 million, assuming new acquisitions.

Taken together, look for improving operating results each quarter versus last year, with a possible exception for the first quarter, as we do not look for a repeat of the robust level of customer inventory restocking we experienced a year ago. Having said that, expect first quarter diluted earnings per share to approximate the 39 cents reported a year ago.

To close, we forecast our market drivers to remain at levels that will give us continued earnings growth in 2003. We clearly have the financial wherewithal to drive growth, be it organic or with acquisitions. However, where acquisitions are concerned, we'll be selective in what we do and what we pay as earning returns in excess of our weight average cost of capital remain a primary objective.

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 one on your pushbutton phone. If you would like to decline from the polling process, please press the star, followed by the two. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order they are received. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. Due to the large volume of interest in today's conference, we ask that you limit your questions to one question and one follow-up question.

Our first question comes from Leo Larkin from Standard & Poor's.

Good morning. Could you give us cap ex and depreciation for '03?

For '03 we expect capital expenditures to be in line with this year, which was about 34 million, and depreciation to be some 45 million.

Thank you.

Our next question comes from Mark Parr from McDonald Investments. Please go ahead with your question.

Yes, Mark Parr.

Good morning, Mark. How are you?

Well, thanks. I was curious to what extent you are seeing the primary sheet producers in aluminum impacting the market. Are you seeing them as more problematic, less problematic? And what -- can you talk a little bit about the outlook for spreads at Nichols over the next couple of quarters?

With regard to the big guys, I guess I'd have to say they may be foraging in our area a little less. Certainly we've benefited from Scottsborough's (ph) aluminum demise, but I'd have to say that it's a little less, Mark. As far as spreads are concerned, you know, we look for spreads to continue growing ever so slightly for us. We're not expecting a huge uptick, but we don't expect them to decrease either.

Okay, terrific. Thanks. Congratulations on a great quarter, and thank you very much for your comments.

Thank you.

Our next question comes from Michael Morrisrow (ph) from Bear Stearns. Please go ahead with your question.

Thank you. Good morning.

Good morning.

I had a question, maybe you could share your -- what you guys are modeling in terms of housing starts and new vehicle builds for '03?

Well, we're looking for both of those drivers to moderate somewhat from this year's lofty levels, but we do expect them to stay strong. I think housing starts will drop below one-six a little bit, and I would expect light vehicle builds to be in the $16 million -- 16 units area versus this year's, what, 16.6 to 16.8.

Right. Now, is there any way to factor in a sensitivity to -- let's say if we factor in a more gloomy scenario of, say, 15 million build and a 1.5 million starts, kind of what the financial structure would look like for you guys?

You're saying if we run our models using the assumptions that you have just ...

Yeah, yeah. Certainly a more depressed scenario for the outlook next year, being that those are the two main drivers for your businesses. Is there any way to derive a sensitivity ...

Yes. Well, just off the top here, no I can't, but clearly we are sensitive to how many units would be built and how many houses are going to be started. And we would be impacted. I think the way we look at it is, if things stay at good, strong historical levels, you know, we're going to have a good year. And with low interest rates remaining low, and obviously the big three continue to offer healthy incentives, and we -- you know, we feel good about the demographics as well. So we think we're going to have a good year.

Thank you.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press the star, followed by the one. If you are using speaker equipment, you will need to lift the handset.

Our next question comes from Bill Baldwin from Baldwin Anthony Securities. Please go ahead with your question.

Good morning, Ray and Terry, Jeff.

Good morning, Bill.

Couple of questions, Ray. Piper had a little more difficult, I think, fourth quarter probably than would have been thought a while back. Can you kind of give us a little prognosis as to how you see their 2003 unfolding from here, Ray? Do you expect them to get back in the black here in the near term, or is it going to take a little bit longer for that to happen?

Yes, it -- obviously we're disappointed with the recent results at Piper, you know, as it continues to struggle with the faster than dropoff in (inaudible) bag business from its largest customer. And the new programs that we've got in the pipeline have just been slower to ramp up than we had forecast a little while ago. But, you know, we remain optimistic about some of the programs we're working on and believe that we'll be in the black for the year and we're going to, you know, cut the losses.

I'd like to point out that Piper's returned over 7 million of free cash flow over the last couple of years, and we expect it to be cash positive in 2003, and we expect the earnings to be in the black. But right now we're going through a tough batch, no question about it.

Okay. But you'd look for improvement in the coming years as your new programs ramp up there?

Correct.

Okay. Secondly, Ray, you talk a little bit in your release about rationalization in the aluminum side of your business, on aluminum. Can you be a little more specific there as to what's taking place in the industry there as far as capacity rationalization, and if you anticipate any additional impact there?

Well, I think the big guys have rationalized some capacity. I don't have a number off the top, but there certainly has been some there. But one that has had a major impact on us, as again, has been Scottsborough Aluminum going away. That was some 250 million to 300 million pounds of capacity that competed head-on against us in our market. So, you know, we certainly have benefited from that.

You know, am I expecting more rationalization as we move forward? I guess what I expect moving forward is that, you know, as the economy recovers, that again, the big guys are going to have places to sell their aluminum sheet, so there will be less pressure on us as we move forward. The economic recovery is certainly going to be positive for Nichols is what I would expect.

Good. Just one more question, Ray. Can you tell us now what your painted rolling capacity is at Nichols once you complete the Decatur expansion?

It's about 150 million pounds, Bill.

Okay.

Our next question comes from Mike Clairefield (ph). Please go ahead with your question.

Hi. Thanks. My question was just about your outlook for next year, predicated partly on increasing market share, and I was just wondering how you guys are -- how it's going to unfold and what the size of that opportunity is going forward?

Well, certainly we are gaining share across our businesses, but what has helped us even more than that, and which is what I'd like to underscore, is our emphasis on providing more value-added products. That has benefited MAC this past year, and we expect even to do even better with value-added products in 2003 because some of the new capacity came on line late in the year.

And Nichols the same way. With Nichols we did increase our painted capacity output at one of the plants. And again, that was done in the September/October time frame. So, again we'll benefit from that next year. So I expect to benefit more from value-added capacity than share gains.

Thanks.

Our next question comes from Greg McCosko (ph) from Lord Abbott. Please go ahead with your question.

Hi, Jean. Could you talk a little bit about the capacity expansion at MAC that (ph) you're talking about the 45,000 tons of MACPLUS? And I wondered, with regard to that added capacity, would you say that, you know, in your expectations for '03, will that include -- would that mean that the percentage of the auto sales within MAC as a percentage of total will be less, more, the same?

Well, MAC's capacity, or MACPLUS (ph) capacity, has really been beefed up by about 90 million tons -- I'm sorry, 90,000 tons during 2002. Some of that did come on line in the first quarter, and the last 40,000 to 45,000 tons came in line -- came on line in the last quarter. And in total, what we have is about 290 million tons ...

Thousand.

... thousand, excuse me, thousand tons of value added capacity.

The second part of your question, Mike, was what?

Well, I was just asking, the share of the total output of MAC. Would it be -- is it -- what share is going to be auto this year versus last year, would you figure?

Auto share would go up this year, you know, if for no other reason that I expect heavy duty truck builds to decline somewhat. And we're looking in the 65 percent to 70 percent, you know, light vehicle -- or let me restate that, some 65 to 70 percent of their output will be going to light vehicles.

So if we put it all in truck and auto -- I'm just trying to get a sense of what portion of the output might go to, shall we say, lesser engineered levels of utilization for that, and to get a sense of where pricing might go within the MAC area.

I would expect some 75 percent to 80 percent of our output would go to vehicular, with the remainder going to aerospace, distribution, oil patch.

And so -- I mean, that mix is what it's been in the past and you expect it to -- I mean, is it around what we've seen in the past?

Yes. Fair characterization.

Our next question comes from Kathy Muldune (ph) from Sage Asset Management. Please go ahead with your question.

Hi. I think my question was just answered, but of the percentage of your share that goes to vehicle, that's 80 percent. How are the other end markets doing -- the aerospace, oil, whatever else, MACSTEEL ...

They haven't been particularly robust. We haven't detected much change, you know, in the last six months. You know, we really don't do much in the aerospace area. I think the defense business has picked up a little bit for us. Some of our product is used for making munitions, as well as tank and armored carriers. So we've seen an uptick there. But otherwise, it's been somewhat steady state.

Okay. Thank you.

Our next question comes from Leo Larkin from Standard & Poor's. Please go ahead with your question.

Yes. Getting back to Piper, how long will you give Piper -- if Piper does not meet your expectations this year, how long will you continue with it?

Well, if Piper, by the end of the year, shows no signs of improvement and the future doesn't look bright, obviously we'd have to consider other options.

Okay. Thank you.

Our next question is a follow-up question from Mark Parr from McDonald investments. Please go ahead with your question, sir.

Thank you. I had -- my question relates to MACSTEEL. First of all, could you give us some sense of what your outlook is for scrap prices over the next couple of quarters? Also, I believe you had indicated an outlook calling for 5 percent price increases at MACSTEEL, and I was wondering if that was including or excluding the mix enhancements with the MACPLUS lines?

The -- scrap pricing has nudged down over the last four to six weeks. and looking at the future, I have a hard time with forecasting scrap pricing. In fact, I can't do it. So, I'm just -- you know, we're not expecting it, from a planning standpoint, we're not baking a reduction in scrap pricing in our assumptions, I can tell you that.

Okay.

Yes. The price increases that we're negotiating, believe I said that it goes up to 5 percent. I mean, it clearly varies by the type of product, the volumes involved and so forth. So I'm not trying to say that we're getting an across the board 5 percent increase. It really does vary. And some of it is the result of more value added, so it's somewhat of a composite number that I'm giving you there.

Okay. Very good. Thank you very much again.

Our next question is also a follow-up question from Michael Morrisrow from Bear Stearns. Please go ahead with your question.

Thank you. I just wanted to touch on first quarter. You listed quite a few favorable factors for next year, higher prices and more value added, the Colonial Craft acquisition in the first quarter as opposed to last year, lower interest. Seems like they're all going to be offset by the - by, I guess, lower volumes. Can you quantify -- are you expecting MAC to run significantly below capacity, or what utilizations are you expecting? It just seems there are more positive factors, certainly, going into the first quarter.

Yes. We feel good about the backlog at MAC, certainly through year round. I think right now, what the build rates will be by the automotive guys going into January, you know, we're hearing -- we're looking at it. We just don't have the answer to that one yet. But we expect demand to remain strong.

Okay. So it sounds like this is a conservative type of estimate that the bottom line would be flat with last year?

This certainly is uncertainty in the economy and, you know, we want to remain somewhat cautious, you know, about the outlook. Let's see what their first quarter build rates call for when they come up with them.

Thank you.

Ladies and gentlemen, as a reminder, if you do have a question, we ask that you please press the star, followed by the one. If you are using speaker equipment, you will need to lift the handset before pressing the numbers.

At this time, we have no further questions.

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 fourth quarter conference call. Thank you.

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