Quanex Building Products Corp (NX) 2004 Q2 法說會逐字稿

Good morning and welcome to the Quanex Corporation second quarter earnings conference call. (OPERATOR INSTRUCTIONS) It is now my pleasure to turn the floor over to your host, the President and CEO of Quanex, Mr. Raymond Jean. Sir, you may begin.

Good morning and welcome to the Quanex second quarter conference call. Thanks for joining us. With me this morning are Rick Arredondo, our Corporate Controller, and Jeff Galow, our Vice President of Investor Relations. They will be available after my remarks to take any of your questions.

Today's call will include an overview of our second quarter results, the impact steel scrap pricing had on the quarter, the current state of our three key market drivers, an update on our recent two acquisitions, and a look at the remainder of the year.

The comments I am making today include forward-looking statements about the future prospects of Quanex. Please refer to the Company's latest 10-K report filed December 29, 2003 for our complete forward-looking disclosure statement. The Company's second quarter earnings release dated June 3, 2004 is of course available on our website at quanex.com.

During our second quarter customer demand from both the automotive and housing markets remained at high levels. MACSTEEL reported a strong 14 percent increase in volume over last year, excluding Monroe's results, reflecting ongoing strong demand from both our light vehicle and heavy-duty truck customers. Total North American light vehicle builds in our quarter were up about 5 percent over last year. Heavy-duty truck builds were up some 50 percent from this time last year.

Housing starts and remodeling expenditures remained at lofty levels during the quarter benefiting from a generally mild end of winter period and ongoing favorable interest rates. With an early start to the spring building season, Engineered Products delivered excellent second quarter sales and operating income.

At Nichols Aluminum building product sheet demand remained strong for the entire quarter, while sales to our other served markets, including capital equipment, transportation and distribution, continued to improve. This strong demand allowed Nichols to increase their selling prices.

During the early part of the quarter steel and aluminum scrap prices spiked. And unfortunately the impact of these higher prices did more than just impact operating margins at the segment level. As a result of these higher scrap prices, we recorded a pretax non-cash LIFO charge of 2 million in the quarter. Although scrap prices have dropped since then, they are still considerably higher than year end 2003 prices, which is our benchmark for LIFO. At this time we expect additional LIFO inventory charges for the balance of the year.

Taken together, Quanex's consolidated diluted earnings per share for the quarter were 69 cents, up from 58 cents we reported in the year ago quarter. MACSTEEL Monroe's and TruSeal's combined second quarter results contributed 21 cents after interest expense to our diluted earnings per share.

During the quarter our management team did a terrific job of reducing their working capital needs. One way we track our progress is by calculating our conversion cycle days, which is the sum of inventory days plus receivable days, less days payable. For the second quarter the conversion cycle improved 18 percent over a year ago as our sales declined from 55 to 45. Without this achievement, our working capital balance would be up some 45 million from where it was.

Turning to the cash flow statement, cash provided by operating activities showed a use of about 6 million for the quarter. This use of cash can be attributed to higher accounts receivables due to higher selling prices at MACSTEEL, the results of the higher scrap surcharge billings that went into effect April 1st. Higher scrap prices reflected an inventory and a change in sales mix. Offsetting part of this use of cash was an improvement in payables. As higher selling prices and following scrap costs work their way through the third quarter, we would expect cash from operations to be positive.

The cash flow statement also shows receipts of 17.3 million related to the purchase price of MACSTEEL Monroe and TruSeal. This amount represents the settlement of the final working capital balances associated with the close of the two acquisitions on December 31, 2003.

Let me move to our operating segments where I'll talk first about the results of Vehicular Products. The primary drivers for this segment are North American light vehicle builds and heavy-duty truck production. MACSTEEL shipments, excluding Monroe, were up 14 percent for the quarter versus the year ago. Our plants are in near practical capacity levels during the quarter and were struggling to keep up with very strong demand from both our light vehicle and heavy truck customers.

Demand is also strong in our non-automotive markets. A good problem that is adding to MAC's current high demand situation is the amount of new business we have captured. For instance, we continue to make inroads with the automotive transplant companies who are increasing production or sourcing more of their powertrain components in North America. Good examples of this include new camshaft program we picked up, as well as a new front wheel drive hot component. Transplant business will play an important role in our long-term success.

We're also playing a larger role as a supplier of automotive crank shafts to the industry, benefiting from a trend to forged steel and away from cast iron. OEMs like the high strength steel because it allows them to make a smaller, lighter weight crank shaft that better meets the needs -- or meets the high torque requirements of today's smaller, yet more powerful light vehicle engines.

The second quarter operating income from that, excluding Monroe's results, was down from 35 percent from a year ago, the results of surging steel scrap costs versus a scrap surcharge recovery that lagged by three months. Fortunately this situation reversed itself late in our second quarter when scrap costs finally started to fall. For the month of April steel scrap costs were down about $45 per ton compared to March, and May costs were down another $40 per ton. June prices are expected to nudge up some $8 per ton.

Overall this drop of about $75 per ton over the last three months has been great news for MACSTEEL, whose margins were under pressure for the last several quarters as they struggled with material input costs, which seemingly defied gravity for many months. And there's another favorable development to note. Not only is MAC now benefiting from lower scrap costs, but they are also benefiting from a much higher scrap surcharge that went into effect April 1st. This surcharge is based on the high scrap cost index calculated for the month of January through March. During April we recovered some of the margin compression experienced in February and March, but we couldn't fully make up all that we had lost. We expect to do so in the third quarter.

Let me update you on our progress at MACSTEEL Monroe. The integration of Monroe into MACSTEEL is going well, as things like payroll, order entry, master scheduling and customer billing are now fully integrated. We continue to concentrate on operational improvements through a sharing of best practices and a rebalancing of production amongst the three plants in order to keep each plant in the sweet spot of its capabilities. Over time expect to see a 5 percent improvement in effective capacity from these efforts. We do see working capital as also receiving attention. In addition, the sales team is focused on enriching the mix at Monroe.

Overall we're quite pleased with the magnitude of improvements we have seen at Monroe in such a short period time. And our guys have done a great job there, but there certainly more to do. We're also very encouraged by the enthusiasm and responsiveness of the Monroe employees. We have implemented MAC type incentive programs, and employees are benefiting from that and so is their proud new owner.

As was outlined in our earnings release, Piper Impact continues to struggle against the ongoing loss of their base business. We previously announced the plan for restructuring the business, and the execution of the plan is underway and going well. We expect Piper to be operating essentially under one roof by the end of next month. This consolidation will increase efficiencies and permit a further reduction in overhead.

Let me comment on the Building Product Segment which includes Engineered Products and Nichols Aluminum. The primary drivers for our Building Product Segment are housing starts and remodeling expenditures. The segment experienced strong demand for the second quarter. Overall housing starts were robust approaching 2 million in annualized stocks. Remodeling expenditures are also important to this segment and account for about half of the segment sales. A good proxy for remodeling activity is sales of the big-box improvement stores like Lowe's and Home Depot which have remained strong.

Engineered Products delivered excellent results in the quarter. Excluding TruSeal, sales and operating income were up 16 percent and 22 percent respectively over a year ago, and customer demand remained at high levels throughout the quarter. TruSeal had a great second quarter as well, and they continue to exceed our expectations. They offer customers high quality insulated glass sealants. TruSeal's customer intimacy strategy has them working with customers in both new product development and process improvements, and they do deliver a high value proposition.

TruSeal's market strengths lie primarily with the vinyl and aluminum window manufacturers who are particularly strong in the South, Southwest and West. Historically Engineered Products market strength has been more closely tied to the window industry, with customers whose market strength is concentrated in the Midwest, East and Northeast regions.

We're excited by the opportunities for growing in all three window segments throughout the country. We will be employing several disciplines, keeping the growth we already have earned, showing up where growth is anticipated, invading adjacent markets, leveraging our relationships across customer segments, and investing in new lines of products and businesses.

Turning to Nichols Aluminum, we had a much better quarter compared to both last year and year ago results. Shipments were up 7 percent over the year ago quarter, and sales to our building and construction customers were strong. Our higher margin painted sheet capacity was essentially sold out for the quarter. Sales at our Golden facility in Fort Lockton (ph) were also robust. Customer activity in Nichols' other markets like capital equipment and transportation continued to improve, and we expect to see more strength over the next quarter or two in these markets. To their credit, Nichols also benefited from lower overhead costs during the quarter.

Turning to our two markets -- target markets -- we believe the outlook is good for the remainder of the year, and we don't expect any significant changes to occur through the end of our fiscal year.

North American light vehicle builds are estimated to be about 16 million units, down a bit from 2003. We continue to monitor light vehicle inventory levels which remain relatively high. However, light vehicle sales are still very good, with May sales up about 3.5 percent over a year ago, or 17.8 million units annualized. Clearly strong monthly sales must be sustained if the industry is to avoid a drop in production this summer.

However, if we do experience a drop in light vehicle builds, we expect new programs and growing heavy-duty truck production to help take up the slack, along with strong construction and agricultural equipment, defense and oil patch demand to keep our plants busy. Heavy-duty truck builds last year were about 175,000 units, and the expectation this year is for some 240,000 units to be built, a quantum improvement year-over-year.

Taking the current light vehicle and heavy-duty truck production outlook, together with the strength in MAC's other markets we look for MAXSTEEL to run half or above its annualized capacity of 1.2 million tons for the remainder of the year. The combination of strong demand, operational improvements, reduced scrap costs and a higher scrap surcharge significantly enhances MAXSTEEL's financial outlook in the third and fourth quarter.

For our Building Product Segment we look for both housing starts and remodeling activity to remain strong through the balance of our year. Interest rates may be going up slightly, but we believe they're going up mainly because the economic recovery is finally gaining traction and broadening out. The resulting increase in payrolls will generate more income for consumers, and thus home ownership will remain affordable for most families. We do expect housing starts to moderate in the months ahead, but we think there is enough momentum to keep the numbers strong enough through the busy construction season.

Taken together Quanex's sales and earnings outlook for the remainder of the year is very favorable. For our third quarter and full year we expect to report diluted earnings per share within a range of $1 to $1.20, and 3 in a quarter to 375 respectively. These figures do include revised earnings per share accretion guidance for this year's acquisitions, which we increased from a range of 40 to 50 cents for the ten month period to 60 to 70 cents.

Let me end my discussion with an update on our financing activity and the balance sheet. On May 5th we announced the closing of our $125 million convertible debenture. The deal was done at what we consider to be excellent terms and protects the interests of our long-term shareholders. With a 2.5 percent coupon and a $57.50 conversion price, we believe this thirty-year financial instrument is superior to our using short-term revolver money to finance long-term assets, particularly when we have growing evidence that interest rates will be drifting up. Strengthening our capital structure with this instrument allows us greater flexibility for capitalizing on future organic and acquisition opportunities. Our total debt to capitalization now stands at about 32 percent, down from 34 percent we reported just last quarter. Short of making another acquisition, we expect our debt to capitalization ratio to fall again in the third quarter.

That concludes my formal remarks this morning. We will now answer your questions.

(OPERATOR INSTRUCTIONS). Mike Harris from Robert W. Baird.

Ray, if possible can you comment or quantify the negative impact from steel scrap costs on operating income during fiscal Q2? I believe that last quarter you were able to quantify the impact on a sequential basis. Can you do that again for us?

Mike, I'm not sure how to field your question exactly. You know, scrap costs, I guess I remember them going up to some $300 a ton. They have pulled back to near $200 a ton round numbers. They will nudge up a bit, as I said in June, but you know on balance we are paying certainly $75 less a ton than we were paying at the end of March. So for us this translates, or will be translating, into a big spread improvement.

Okay. It is just that last quarter I think you were able to quantify I think the sequential impact -- negative impact on operating income on a consolidated basis of 2.5 million. I just kind of wanted to get prospective as to how that shook out for fiscal Q2 versus fiscal Q1?

Mike, I don't have that handy.

All right, I will move on to something else here. You know, staying on the steel scrap issue, you know the volatility you have seen in this area since the beginning of the calendar year I think we can agree has been unprecedented. And as everyone is now aware, MAXSTEEL is sitting in this environment with a majority of its business with a surcharge based on a trailing three-month index. I just would like to get your thoughts on the likelihood or probability in going to your customers toward the end of year and trying to negotiate a surcharge that is on more of a real-time basis, say, a trailing 3 days instead of 90 days? I think it is fair to say that it would make everyone's job a little easier in forecasting quarterly results for Quanex.

I agree. And certainly conceptually that is what we would like to see. I mean we view the surcharge mechanism as a way to recover our costs. We certainly don't view it as something that you profit by. So it would clearly be in our advantage, or to our advantage, if we could have that adjustment on a 30 day basis as opposed to the current 90 day.

You know this is going to be a function of negotiations as we near the end of our year. And you know we will be putting some priority on doing just that. At the end of the day, however, market sets the price to some extent. Certainly what is going on with the market dynamics at that point in time will certainly have a big influence on the outcome, but it is something we're going to be pushing for.

James Gentile at Sidoti & Co.

Could you comment on the competitive environment for MAXSTEEL, just where Timken and Republic and the Canadian competitor lie?

Well, Slater, I guess let's just start with the Canadian company. I assume you're referring to Slater. And as far as I know they are still operating. I don't know at what utilization rate, but that is what I know. And I must say that we have actually picked up some business from them over the last six months, certainly their long-term prospects were in doubt for quite awhile. Timken and Republic certainly remain viable competitors.

And what is your view -- what scrap price do you have forecasted in this range, like maybe around high and low per ton that we can correlate to your earnings guidance that you have issued for the balance of the year?

James, every time I think I have got that thing figured out the market proves me wrong. I can tell you that. Right now, as I have said, we are in the low 200 range. We are expecting it perhaps to bounce up and down within, hopefully, in much narrower range that it has the past six months. So roughly that is where we are. We were not surprised by the little push-up in June. And in fact I wouldn't be surprised to see prices nudge up a bit again in July because of the big automotive plants, or some of them -- the big scrap generators so to speak will be shut down for a period of time. And so it is going to be interesting. I think there is a concerted effort on the part of the scrap people to keep prices high. And so time will tell.

John Emerick (ph) from Bright Color Capital (ph). Mr. Emerick? Okay, we will move on. The next question is going to come from Mike Parr at KeyBank Capital.

It is Mark Parr. My brother Mike is on vacation this week. I was wondering, first I just wanted to congratulate you guys for the foresight of having scrap surcharges in place for many years. And I just think is a testimony to the kind of management team that Quanex has put together over the years.

Thank you.

Secondly though regarding the Monroe facility, could you share with us what capacity utilization rate Monroe was running at in the April quarter, and how you see that emerging over the next, say, twelve months or so?

Well, they were operating at -- over their rated -- so-called rated capacity, or what we had rated them at ,publicly which was about 500 tons. I'm sorry, 500,000 tons a year. Obviously that varies some quarter to quarter because of the number of days and so forth. And the second quarter is pretty good with number of days. But as I said, in total with the three plants we see the opportunity to increase our effective capacity some 5 percent, and Monroe is clearly part of that. And we will be developing some -- as part of our strategic planning process, which we are initiating during this month -- we will be looking at making some capital expenditures to further raise that effective capacity.

I just had a follow-up question regarding Nichols. I know that you have officially stopped providing quarterly guidance on revenues and contribution from Nichols, but it does seem as if that operation really had a nice pickup in the April quarter and the outlook for that pickup to continue is fairly good. Is there any additional color you could give us on Nichols' performance in terms of how they impacted the April quarter and what the delta on that performance might be for the July and October time frame?

They did have a very nice pickup operationally. The market dynamics have been very helpful. Demand is way up in frankly all market sectors that we serve. And you know capacity is being trimmed back further. You probably saw that Alcoa intends to shutter their San Antonio facility, which is going to give us a further boost, if you will. But operationally last year we had been -- we were struggling with one of our finishing plans in Alabama. And this year they have been performing very well, and that clearly is helping the results.

Joanie Jensen from McMahon Securities.

As far as your working capital, you were able to reduce your cash cycle significantly this quarter. What is your long-term target for working capital, both for the cycle and individually? It looks like most of improvement was due to inventory declines. And can you also address if this is seasonal, or if it is pretty constant during year?

Well, as we continue on our lean journey, we are finding ways to permanently reduce working capital needs. And I haven't just handed out a number out there for us to meet. I think it is up to each of our businesses to figure out an optimum level of working capital that we can live with. But we certainly knew that what we have been living with was not necessary. And so it is a work in progress. I think we can continue to improve as we go forward. The improvements may not be as huge as we have experienced in the last year. It will be difficult to squeeze things down, but we all recognize that we still have some good opportunities.

So in other words, the current level is sustainable to improving?

There will be some volatility surrounding that from quarter to quarter, but a lot of the improvement is definitely sustainable.

Okay. And then lastly, you discussed the outlook for the rest of this year in light of a rising interest rate environment, but typically if we are going into a rising interest rate environment for the next couple of years, how would you see that affecting demand over that cycle?

Well, I think the housing market is being stimulated just by the demographics in household formations. There is just some good things going on there. The numbers are big and they should propel the housing market forward. Interest rates will have a dampening effect as they rise. The question is how high will they go?

Clearly some will tell you that it will take double digits to really turn back the demographics in the household formation push, if you will. I'm not sure if I'm that optimistic, but I would think that we can -- that interest rates can rise certainly above current levels, but given the demographics, I think we will have a healthy environment.

We do expect the demand to moderate to some extent, or the stocks to moderate. It doesn't have to stay at a $2 million level to have a good strong market, and one in which we will do very well in.

And is your Vehicular Segment at all impacted by the interest rate cycle?

Well, it all depends what the OEMs do about it. Thus far they seem to be absorbing the increased interest rates through the incentive schemes that they keep coming up with. I think their objective is to keep plants running. So they have certainly mitigated the impact of a rising interest rate.

Amy Narquist (ph) from Pilot Advisers.

It is Amy Narquist. You said that if there's a slowdown in the auto build that there's enough of the backlog to pick up the slack in the steel business. Can you talk about that backlog and where else you are seeing your strength? I know it is in heavy truck, or some of it is heavy truck.

Right. Well, backlog -- we don't have huge backlogs. Remember that we are really a short cycle business. When you look at Quanex that's what we are all about. Our demand is hinged to the OEMs' build rights. But what we do have going for us is that we do have new programs. For example, we have picked up some 40,000 tons of demand for crank shafts this year where in our forecast, or in our plan, we had 12,000 tons forecast of new programs for crank shafts. It is just a wonderful opportunity for us to -- I often say that we will outperform our market as a result of the penetration that we can make in our served markets, and that is just one example of it. So I expect that our new programs would offset a moderation of the auto build.

And is this strong enough to carry into next year too?

I believe it is.

So even if we have a lower build rate next year, you have other things that can kind of offset the lower build rate?

Correct.

And that would be in Ag and heavy truck also?

Yes, heavy-duty truck. A good forecast for heavy-duty truck for next year. In fact, the forecast is for us to be up over this year.

Barry Vogel of Barry Vogel and Associates.

I have a couple of questions. One, Ray, can you tell us where you are at this time in terms of Piper finally being gone? And can you give us some idea of how much money they made in the black in the quarter?

We have a good process underway. We have -- we're dealing with a strategic buyer and we are engaged in negotiations, time will tell. There's no end date on this, but I'm optimistic that something will happen this fiscal year. Piper was black this quarter in a range of $500,000.

Okay. Let's assume that you do this transaction at the end of year. Do you expect then with the current situation to be in the black in the third and fourth quarter?

The backlog right now would indicate that our new programs that they have would not quite back fill for the expected loss of further airbag business. So it is going to be a struggle.

Okay. Now as far as Capex for this year, can you give us an updated figure given that all your different things that you're trying to upgrade?

We still expect our capital expenditures this year to be in in the range of 30 to 35 million.

And how about D&A?

D&A this year will be about 55 million. Next year on an annualized basis that will be closer to 60.

You have no idea about Capex at this point for next year, am I correct?

No, as I said, we're just initiating our strategic planning process this month.

All right. When are you going to do another great financing?

You liked that, uh?

The best.

Yes, it was a coup.

Anyway, congratulations. You're doing a fabulous job.

Thank you.

Rajis Chalapera (ph) from Verdom (ph) Asset Management.

Could you give us an idea of the levels of cash flow from operations that you're likely to generate under the current conditions for this fiscal year?

I don't have a precise number, but last year our EBIT was over 100 million, and it will be well above over 100 million. We're picking up 10 million in depreciation alone, for example. So we are going to have a good year.

Greg Macosko from Lord Abbott.

Could you talk a little bit about the summer shutdown for automotive? I know you have talked about MAC and being kind of at capacity. Do you expect to build inventory or sort of get ahead a little bit this summer when some of the auto plants slow down a little bit?

Well, the automotive shutdown I think remains in a state of flux. We know that some GM plants, for example, are going to be shutting down an extra week to gain inventories. I think the Chrysler plants, given I think the pretty good selling rates of some of their new automobiles, they may be running -- they may be not be shutting down at all from what I understand. So there are some pluses and minuses.

The data is not all in, so we're not really sure. And that is -- part of the uncertainty surrounding the third quarter for us all the time is this what is going to happen in July? I can tell you that we plan on shutting down for a week at MAC for needed maintenance. And this is program maintenance that we do on a yearly basis. And it is all scheduled and we do plan to execute that.

But you, in other words, will run the plants very close to what you hear from the auto companies, and don't expect to sort of build inventory other than for the shutdown that you expect to have?

Correct. We do have -- a slight inventory build may happen. It just depends again on how many plants they shut down and how will they pick up their orders in the month of July. Some of them have their own trucking capability and they pick up the steel, but if they're down, they don't pick up the steel.

I see. Okay, and then with regard to the accretion, clearly things came through nicely, better than we initially expected. But if we look at the run rate for fiscal '05 are we talking order of magnitude something about $1 or so for the two operations that were acquired, TruSeal and Monroe?

Well, I think if you annualized our current guidance of 60 to 70 cents for ten months, I think you may fall short of $1, but you're getting close to it.

I see. And my guess is you continue to be conservative on that with regard to what is out there?

Well, I am of the under promise and over deliver school of management.

Very good. And then you mentioned finally with regard to the debt to capital and bringing that down. With the exception of possible acquisitions, is it as busy as it has been over the last 12 months right now?

As far as the number of companies we are looking at?

Yes, and the candidates' possibilities? Does there continue to be interest as much as ever or not?

Yes, absolutely. I think there are some opportunities out there, and we continue to work at it.

(OPERATOR INSTRUCTIONS). Bill Baldwin of Baldwin Anthony.

Just a couple of questions. With the improvements in the operations at Nichols and the better margins there, Ray, is that business beginning to earn its comp to capital at this point in time?

Well, they are certainly getting closer to it, but they're not there.

Not quite there yet?

Not quite there. But we have seen --.

But it is getting within sight of it, Ray?

I'm sorry, Bill, I didn't hear that?

I say it is getting within sight?

Within sight. Within sight, but it is still a reach for them.

Okay. Secondly, with this pick up in demand at MAC, are you having to out source more product at this point in time for MAC?

We've had to outsource a great deal from the Monroe operation as they typically did in the past. They did not have finishing capabilities the way the other two MAC plants have. So it has picked up there. And -- but from the other two plants, most of it as a result of our lean improvements we have increased the effective capacity of our finishing area, and we have been able to handle most of it in-house.

When you talk about the finishing capacity, Ray, is that -- are you talking about finishing into an MAC Plus product?

Yes, MAC Plus or MAC Prime. MAC Prime being the bars cut to length.

Right. Is that we might see some Capex in fiscal '05?

Could be.

Thank you very much. And congratulations on doing an outstanding job.

Thank you.

Mike Harris from Robert W. Baird.

You know when considering the very strong and robust outlook for both heavy-duty trucks and trailer, can you just remind us again, when you look at MACSTEEL what percentage of MAC's sales can heavy-duty truck represent in a very strong environment? And also from Nichols, can you just comment on what heavy-duty trailer exposure could be as a percentage of Nichols' revenues?

At MACSTEEL heavy-duty truck in a good year can get to 20 percent. And I think clearly we will be approaching that next year. And related to Nichols truck trailer, I would say it is in the 10 percent range, Mike.

Gentlemen, there appear to be no further questions at this time.

Our long-term business strategy is directed at protecting and growing our two core businesses, MACSTEEL and Engineered Products, and we're doing just that. MACSTEEL Monroe, TruSeal and Colonial Craft are excellent examples of how or acquisitions when well integrated can complement the organic growth of our core businesses, thereby fueling earnings and returns. Both MAC and Engineered Products earned in excess of their cost of capital again this quarter, and we see nothing on the Horizon to change that. That concludes Quanex's second quarter conference call. Thank you.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day.