Quanex Building Products Corp (NX) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Quanex Corporation second quarter fiscal year 2005 conference call.

At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions following the presentation.

It is now my pleasure to turn the floor over to your host, Chairman and Chief Executive Officer, Mr. Raymond Jean.

Sir, you may begin.

Good afternoon, and welcome to the Quanex fiscal second quarter conference call. Thank you for joining us.

With me today are Terry Murphy, our Chief Financial Officer, and Jeff Galow, our Vice-President of Investors Relations. We'll be available after my remarks to take any of your questions.

Today's call will include a brief overview of second quarter results, a discussion of the current scrap market, the present state of our key market drivers, and an outlook for the balance of the year.

The comments I'm making today include forward-looking statements about the future prospects of Quanex. Please refer to the Company's latest 10-K report filed December 21, 2004, for our complete forward-looking disclosure statement. Our second quarter earnings release is available on our web site at Quanex.com.

During the second quarter, order entry rates in both our vehicular products and building product segments remained at generally healthy levels for this time of year. What significantly improved over the prior year's quarter were the market dynamics at our aluminum sheet business and margins of MACSTEEL, as a result of higher selling prices and reduced materials cost. These factors resulted in outstanding second quarter results for each of the operating segments.

Our vehicular product segment reported operating income of 61 million versus 13 million in the year-ago quarter, an impressive 300% plus increase.

I know many of you are struggling with how to view the segment in a more normalized operating environment. With steel scrap prices rising and falling as dramatically as they have, it makes for a difficult exercise. I believe giving you an idea of the segment's historical operating margin will be helpful.

We calculate operating margin by dividing operating income into net sales, and if you review the segment's margins by quarter for the last five years, you'll find those margins averaged in the low-teens versus an operating margin of 21% this quarter. It is our expectation that margins in the second half of the year will average in the mid-teens.

Over the same five-year time frame, it is interesting to note that on only three occasions have the segment's quarterly margins slipped below 10%, and not surprisingly, two of those times occurred last year when we saw a very sharp rise in raw material costs. We don't do well when scrap costs are spiking because of the lag in the application of the surcharge, but clearly it works to our advantage when scrap prices fall.

For the second quarter, the vehicular products segment results were also bolstered by our successful integration of MACSTEEL-Monroe into the group. The improved scheduling flexibility and productivity gains continue to accrue. We also benefited from the higher MACSTEEL-based price increase effective January 1.

Our engineered steel bar production experienced a drop of 7% over the year-ago quarter, primarily the result of customer setbacks on finished orders and to a lesser extent, order cancellations by our tier one and tier two customers who are adjusting their inventories to better match demand from their automotive customers. We look for our light-vehicle buy demand to remain a bit choppy until the new model year builds kick in, but we do expect our three plants to continue operating at respectable utilization rates.

Total North American light vehicle deals for our second quarter were just over 4 million units, down 5% over this time last year, although builds at the big three were down over 10% in the quarter. This slip in builds of the big three further emphasizes the importance of our ongoing work to gain share with the transplant automotive manufacturers, and we are making excellent strides with them.

For example, during our first half, we captured new transmission component business with both Honda and Toyota. This is a significant event for MACSTEEL as the domestic sourcing of transmission components has only recently become available to us. These components have generally been sourced out of Japan. We will continue to take advantage of each opportunity that presents itself.

Value-added sales continued to be an important element of our marketing strategy, and during our second quarter, they represented 70% of all bar shipments versus 60% this time last year.

Demand from our heavy-duty truck customers was very strong again this quarter with class A truck build up 45% over our year-ago quarter. The industry expects builds for calendar 2005 to hit 3,000 plus units, a double-digit gain, over 2004 builds.

Switching to our building product segment, they generated operating income of $31 million compared to $11 million a year ago, almost a threefold increase.

Housing starts for our second quarter averaged just over 2 million units on an annualized basis, and remodeling activity remains at healthy levels. However, our door and windows components business was adversely impacted due to harsh weather conditions in several regions.

Our aluminum sheet business greatly benefited from tight supply conditions, combined with moderate to strong demand across their market segments. Aluminum scrap remained plentiful and was reasonably priced. These factors, combined with strong operating performance, generated great margins, the best we have ever experienced.

Turning to the current scrap environment, the significant price volatility of steel scrap continues. But for now at least, this volatility remains in our favor.

For example, after increasing in cost some $20 per ton in April, scrap costs crashed in May by $50 per ton for us. Last year, our steel margins suffered as we experienced unprecedented increases in scrap costs quarter-after-quarter. As noted earlier, however, that situation has now reversed itself, and we find ourselves on the good side of the scrap curve.

Predicting steel scrap costs is fraught with risk, but in the near term, we expect to see continued downward pressure. Scrap exports have been modest, steel production is down due to high inventories, and the scrap yards appear to have plenty of material at this time.

Reviewing our acquisition of Mikron Industries, we remain pleased with the integration process. We acquired Mikron last year and continue to be excited by the opportunities we see, both internally with its potential for improvements and externally with its growth prospects from new programs in both PVC and composite material window profiles. Their strong presence in the vinyl window market greatly enhances the opportunities to offer complementary products to the fastest growing segment in the door and window market. Mikron's results came in above expectations for the second quarter, earning $0.06 per diluted share after interest expense. For the fiscal year, we raised the expectation of their accretion to earnings per share to be in the range of $0.30 to $0.40 versus our previous estimate of $0.20 to $0.30.

Taken together, reported diluted earnings per share from continuing operations of $1.95 for the quarter versus $0.43 in the year-ago quarter. Our return on invested capital was 16.5%, compared to 8.3% a year ago.

Reviewing our cashflow from operations, we generated about 73 million of cash in the first six months compared to just $5 million in the equivalent year-ago period. Looking at this on the basis of how long it is taking us to convert orders into cash -- that is, our conversion cycle -- we improved significantly again this quarter from 47 days in last year's second quarter to 42 this quarter, an 11% improvement.

Moving to a discussion of our markets going forward, North American light vehicle builds for calendar year 2005 are estimated to be about 16 million units, essentially in-line with 2004. We will continue to increase our content per vehicle with both the big three and the transplant companies. Add in the bullish outlook for 2005 heavy duty truck builds, which are expected to be up 20% over 2004, along with the ongoing strength we expect to see in the off-road farm equipment and capital goods markets, and you can understand why we look to be operating our businesses in the vehicular product segment at relatively high utilization rates for the remainder of 2005, though off last year's break-neck pace.

In the building products segment, we expect both housing starts and remodeling activity for the remainder of the year to continue at high levels, although off a bit from the first calendar quarter's torrid pace. For calendar year 2005, housing starts are now estimated at 2 million, slightly better than 2004's record starts of 1.9 million.

Taken together, we believe the sales and earnings outlook at our two operating segments for both the third quarter and the remainder of this fiscal year is excellent. Our expectation for the third quarter is to earn in the range of $1.35 to $1.45 per diluted share. We'll review this estimate with our mid-quarter update in July.

Providing earnings guidance remains difficult because it requires us to make accurate predictions on both the direction and timing of scrap cost inflection points. However, we are optimistic about our market drivers for the back half of the year.

At this time, we are estimating a range for full year earnings of $5.75 to $6.00 per diluted share from continuing operations, up from our previous guidance of $5.00 to $5.40, and certainly well ahead of the $2.30 we earned last year.

Let me end my discussion with a few words on the strength of our balance sheet, the priorities for our cash, and our ability to continue to grow. As for the balance sheet, we finished fiscal 2004 with a total debt-to-capitalization of 21%, which, for the most part, was our 2.5, 125 million convertible debenture.

On December 9, we borrowed 200 million from our revolving credit facility at about 3.5% to finance the acquisition of Mikron, driving our total debt-to-cap up. Since that time, however, we have repaid some 90 million and ended the second quarter with a total debt-to-cap ratio of 30%, down from the 30% we reported at the end of the first quarter. We also ended the second quarter with a cash balance of $17 million.

You can expect our total debt-to-cap ratio to continue to fall throughout the remainder of the year, assuming no acquisitions, and just like we experienced in 2004, we expect 2005 to be another excellent cash-generating year.

Our first priority for cash is to fund organic growth opportunities of our two core businesses, MACSTEEL and Engineered Products. We love organic growth because it has a far lower risk profile than other alternatives. Our second priority is growth through strategic acquisitions that support our two core businesses. While certainly riskier acquisitions when bought right and integrated well can really propel us forward, as evidenced by our acquisitions of TruSeal and MACSTEEL-Monroe.

Using cash to grow our common stock dividend or to repurchase shares rounds out our options. Our reasonable debt to capitalization position, combined with excellent cash flow, affords us great flexibility and our best to increase shareholder value.

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

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Peter Lisnic with Robert W. Baird.

Please go ahead.

Good afternoon, gentlemen.

Good afternoon.

A question on the MACSTEEL business -- shipments in the second quarter were down, and it sounds like some of those orders were canceled, if I heard you correctly. How do we think about the third quarter in terms of what the order book might look like there?

Well, we still have a good backlog, Peter. There is certainly a little uncertainty surrounding the July shutdown period. There always is for us at this time of year -- how many days are they going to be down and so forth. But on balance, we expect to be operating the plants at good utilization rates.

Okay. You mentioned -- your quote was "respectable utilization rates." I won't ask what that means, but in terms of utilization rates or offsetting maybe what could be larger shutdown days out of GM, are you still able to produce for the heavy-duty truck market? Is there still allocation issues that could fill some demand if GM comes up short?

No. The allocation issue has gone by, so to speak. We don't have any one on allocation right now.

Okay. Okay. Thank you.

Thank you.

Our next question is coming from Barry Vogel with Barry Vogel and Associates.

Please go ahead.

Congratulations.

Thank you, Barry.

I mean, this is just incredible performance by your management team.

Thank you.

On your estimates -- I know it is very difficult when you make your guidance, and I really appreciate your forthrightness in your guidance. I think you've done a very good job there as far as investors are concerned. But when we look at the guidance for the year, if we took the midpoint of $5.75 to $6.00, you get about $5.90. In the first half, before unusuals but before discontinued operations, you earned about $3.26, I believe, which would imply if we use a $5.90 number, $2.64 in the second half. You're now giving us a guidance of $1.35 to $1.45 for the third quarter, and if I took the midpoint there at $1.40, you would earn about $1.24 in the fourth quarter.

Historically, the third quarter has always been a maintenance outage quarter, and usually it snaps back. And you think you earn more money in the fourth quarter historically than you do in the third quarter. Is there any reason why your numbers appear to call for a lower fourth quarter versus third quarter?

I think we used the word problematic in our comments on forecasting. As I've mentioned before, Barry, we have short cycle businesses to begin with, which is always more difficult than many businesses who enjoy far longer cycles than we do, and the big issue with us is, of course, the price of raw materials, which can swing our earnings considerably.

So given the uncertainty, this is not an easy exercise that we go through, but we go through it deliberately, with some thoughtfulness to it, and we give it our best shot.

And obviously, you've done a very good job in your best shot.

Now, as far as your utilization of capacity, even though the prior question -- he didn't want to ask you, but I'll ask you. If we look at the first and second quarters, and I know you've given comments about capacity -- approximate capacities -- of all your steel plants -- I think I had jotted down that the maximum was about 1.2 million ton. Is that a fair assessment? Is that the capacity of the three-year plan?

I have to put a plus to that, to some extent. I mean, we can certainly go to 1.250. So there is a little room above the 1.2.

So the 1.250 is effectively, for all intents and purposes, capacity.

Okay.

So can you give us -- can you tell us what the first quarter utilization rate was and what the second quarter was?

We're talking about running at utilization rates above 90% is where we're running now -- round numbers. I don't have it by month at my fingertips here. But round numbers, that's what we're talking about.

So the first and second quarter was about the same?

It was lower in the second.

In the second quarter?

Right.

Okay. Thanks. I'll get back in the queue.

Thank you.

Our next question is coming from James Gentile with Sidoti & Company

Please go ahead.

Good afternoon, gentlemen.

I appreciate, Ray, the historical perspective that you put -- that you attached to the MACSTEEL performance.

I guess you said that operating margins averaged in the low-teens historically. And this was prior -- mostly prior to the Monroe acquisition. You obviously added about a half million tons of capacity as a result of that acquisition. Is there going to be a more -- is that going to be a more challenging situation for you to attain the low-teens operating margin with Monroe included in your core MACSTEEL family now?

No, not really.

As we've been saying all along that with Monroe, we've had the ability to shift production around that has enabled us to increase our effective capacity and utilization rates at the operations. So the answer to that is really no.

And what about the average selling price? When I first met you guys a couple of years ago, it was prior to this spike in steel price and demand and what have you. And you kind of said that you had an above average sale price that kind of fluctuated around 400 to 500 a ton. Is that kind of a scenario where we can -- that can help us -- that will continue that kind of 450 per ton price tag that can attach to your value-added tonnage?

James, this is Jeff Galow. Let me help you with that a bit.

The last public discussion we had on average selling price at MACSTEEL was in fact before the run-up in scrap, so we're probably going back two years now. We suggested publicly an average for MAC -- and that's a dangerous term -- was around $525 a ton. And, again, that's a tough number to tie back to, because as you know, we had product from a base engineered bar right up through our highest engineered MAC plus turn-type product.

Since that time, we have not given any public disclosure, and obviously, that 525 now has to be very low for three reasons -- higher base price, much more value-added, just being two of those three. So we really can't go much beyond that at this point for you.

No, that gives us the -- the 500 number gives us a perspective though on the five-year operating margin then. If you take this little spike out of the situation and look out five years, perhaps we'll return to maybe a 525, 550 level as value-add improves or whatever. Is that fair?

Well, I would like to think the price is going to remain above that. Because let's face it, what has happened to metal costs over the last 18 months -- and I think it's been a recovery. Track the price of steel since 1980 through 1993, and you had a negative slope. I think that was catch-up in '04, and that will remain with us.

So that's your kind of view of the world. Thanks.

That's my view of the world.

Thank you.

Thank you.

Our next question is coming from -- a follow-up from Peter Lisnic with Robert W. Baird.

That was quick.

The wood window weather-related issues in the second quarter -- do you catch up with that in the third quarter?

You know, hard to say do we catch up with it.

Let me say this -- that we expect things to improve certainly from the second quarter and to get back to construction activity that would at least equal what we experienced last year, which would mean we would see a rebound from activity levels in the second quarter.

My experience is that the start of the real construction season tends to vary year-by-year, and this year was a little disappointing. Things just seemed to be getting started slow -- are starting off slowly in certain regions of the country.

So started off slow, but still will end up where you thought they will?

I have no reason to think otherwise, because of the macro numbers that we're looking at.

Okay.

Macro numbers are positively strong. It is just that it hasn't translated to activity for us at the plant level, but I expect it to -- I expect to see that.

Okay. Fair enough.

And then a follow-up, in terms of cash generation, which was very strong this quarter, if we just not necessarily extend what you've done this quarter, but just play with the numbers, you can basically -- outside of paying off your convertible -- you're going to be debt-free in three, four, or five quarters or something. Can you just maybe talk about the acquisition environment and what you see out there right now in terms of pipeline and pricing?

Well, we see opportunities. The pricing has certainly drifted up, no question about that. We don't like to see that, but we are looking at some opportunities, deal flow is, I would say, strong, meaning we get to see lots of opportunities.

But it sounds like you're uncomfortable with how high prices have gone, judging by your body language.

You can see me?

(multiple speakers) picture.

Remember that we keep our cost of capital in mind. We run our modeling. Using that -- what is the EVA going to be and on and on. So, yes, as pricing drifts up, it gets to be more difficult.

Okay. Thank you.

Thank you.

Our next question is coming from Bob Thatch with Lord Abbett.

You mentioned that scraps come down $50 in May, so that had no effect then on just reported quarter after the $20 increase in April, correct?

Correct.

You mentioned some nice new transmission business with a couple of transplants. What percent of the business now is with them going forward?

The transplant business now is approaching 10%, Bob.

And -- are the crankshafts included in this, or is that a separate opportunity?

The crankshafts -- that opportunity is really with the domestics as well. Because that conversion process that we've mentioned, not 100% conversion, but what is going on and going from cast iron to steel cranks, that is going on with the domestics as well. So we see it on both sides, and we have had some opportunities -- we are already logging in some sales with the domestics, having to do with crankshafts. So in answer to your question, some of it is in there.

So is it Toyota and the Honda business you talked about -- is that separate from these crankshaft programs or a part of that?

I'm not separating the crankshaft tonnage from Honda and Toyota opportunities, Bob.

Okay.

You had, last year, characterized the opportunity there of about 75 to 100,000 tons. Is that still the best guess?

Best guess.

You also last year had increased your authorization on repurchase to a million shares. How much is outstanding?

It is still a million.

Okay.

On the dollars you're going to be spending on phase nine -- $38 million might represent how much in terms of incremental tonnage or value-added sales dollars?

Phase nine is for value-added. It isn't for capacity expansion.

It will hopefully just be a mix-up grade then?

Correct.

For phase eight is a capacity in terms of about 40,000 tons.

It will represent about 40,000 ton?

Yes.

Then that should be then at higher-than-average selling prices -- by definition?

Yeah. Let’s make sure we're clear, Bob.

Phase eight is a base capacity project at Ford Smith. It is base-engineered bar.

Phase nine is an upgrade, if you will, at Monroe, where today they have no value-added processes, and we're going to bring in essentially MAC plus turning, straightening, testing lines there. So we'll convert part of Monroe's base capacity to value-added.

Remember, much of those sales we already have, and this would be an opportunity to bring those inside.

Okay.

And -- CapEx is $22 million in the first half. What do you think it may end up being for the year and next year -- if you have a best guess, Jeff?

This year it could be some 660 million, Bob.

Okay. So is a lot of that phase nine spend going to end up this year? Is that what that represents?

The big chunks are phase eight and nine in that 60 million I'm giving you. Both of those won't be done until next year, so some of the spending -- like the 38 million we've said we'll be spending for phase nine -- some of it is this year -- I believe more than half is this year -- a little more than half, next year will be the remainder.

Okay, but you haven't accelerated spend relative in the second half relative to the first half?

No -- yes.

At this time would you expect an absence of, let's say acquisitions, CapEx to be lower next year?

We're about to undertake our planning process in the next -- through the next 60 days, so I'll better sense of that a little later.

Okay.

And some of your window customers and doors have been supplying Home Depot. Are you just benefiting from continued penetration by some of your customers directly?

No question about it. It isn't just -- I don't know if you said wood -- I think you just said window, didn't you?

Well, and doors.

The answer to your question is yes. I think we are definitely hitched to some stars here, no question about it. They've got great programs and are doing very well with the big boxes.

I think last time you mentioned that the industry had improved their forecast for the year of shipments being down five, to down three to four. Are there later numbers that you've received?

I think we've mentioned two. We're talking about housing starts?

Right.

Which would be slightly above last year. So I think it's gone from minus five to minus two to slightly above -- subject to change, of course.

Right.

And with the new wins that you're getting at MACSTEEL, whether it is from transplants or from the -- just evolution towards -- away from cast iron, I guess basically what we're experiencing is just a continuing broadening in your customer base -- both light and heavy-duty vehicles -- that should smooth things out from a demand perspective as you move through future cycles?

That's what we would like to see.

All right. Thank you.

Thank you.

Our next question is coming from Bill Baldwin with Baldwin Anthony Securities.

Yes, thank you.

Ray, would you care to come up with a normalized margin for Nichols Aluminum such as you have for MACSTEEL?

There is no such thing as a normalized margin.

Now, Bill, you know I won't let him do that.

Nice try, though, Bill. We report in two business segments, building products and --.

Okay. I understand. Then we'll break it down to building products.

I guess another way to ask is what color insight can you offer as far as what you think the longer-term outlook is for the aluminum sheet biz. Do you think there have been some fundamental changes there in the supply-demand, that as long as the drivers to the markets are in reasonably good shape, that business is probably gone to a new threshold -- maybe not where it is right today, but it is certainly above where it was a few years ago?

Certainly the dynamics are a lot more favorable than they were, and in answer to your question, yes, there has been some changes. There has been some capacity taken out, as you well know, over the last two or three years. Somebody who does play at the margin in this area, remains on strike. There are certainly some factors that have dropped the capacity, and demand across all markets has improved. So it is just a healthy business environment in the aluminum sheet area.

Not withstanding the company on strike, has some of the other capacity reductions, in your mind, been permanent? Have plants been scrapped?

Certainly one mothballed and the other one has been disassembled and shipped overseas, from what I know.

Okay.

So permanent elimination then. So how many capacity would fall into that category, would you estimate that has been mothballed and/or dismantled? Is it 5, 600,000?

Bill, round numbers -- 6 to 700 million pounds per year. The bulk of that was from two shutdowns and then some smaller facilities closing in some other firms.

Would you care to estimate what the total capacity rolling or casting capacity is in the sheet business, domestically here? In other words -- 6 to 700 million -- what percent would that be, do you think, of capacity that's been shut down?

Bill, I can tell you that the market that we serve is about 3.5 billion pounds. I don't know what the industry rolling capacity is.

There's not much imports, though, in this business, is it. That would be almost all domestically produced product?

It is typically domestic.

Thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS]

Our next question is coming from Barry Vogel from Barry Vogel & Associates. Please go ahead.

On the $38 million project that Mr. Thatch had talked about, he didn't ask you what the value-added rate would be when phase nine would be completed. You're now at 70%. Last year, you were at 60%. Can you give us some idea where you would be when that is all said and done?

It will not change from where it is, at least on day one. And the reason for that is a lot of -- when we say 70%, some of that we're doing ourselves, some of it we're subcontracting to have done elsewhere. The plan with Monroe, of course, phase eight that is -- phase nine, I'm sorry -- is to bring that in-house.

So when that is brought in-house completely, would that get you to 70%? Would that keep you at 70% without going out of house?

The capital addition of phase nine does not plan to bring it all in-house. Even with phase nine, we'll still be subcontracting some of that work.

So would 70% still be the number?

Correct.

Now, if you bring in a significant amount of that, that obviously is going to help profitability.

That is a correct statement, very much so. Again, what we do when we take these investments is, we bring in state-of-the-art equipment to do that, far better than the way they are doing it currently. So yes, we do intend to improve our operating earnings.

Terry, in terms of depreciation this year, what are you looking at -- depreciation and amortization?

60 -- about 67 million.

On LIFO -- I know with scrap going up and down, this thing is all over the lot -- did you have a LIFO charge in the first quarter?

We had no LIFO charge in the first or second quarter of this year. We had a $2 million charge in the second quarter of last year.

With scrap going down and certainly not spiking up the way it was in recent quarters, the odds on having a LIFO charge this year are probably slim, is that correct?

That's correct.

What was the LIFO charge all of last year?

20 million.

You had a $20 million LIFO charge in fiscal '04, and if you have a zero LIFO charge in fiscal '05, you're picking up $20 million in terms of P & L effect.

No cash, but P & L effect, you are right.

That's one of the reasons -- one of the many reasons -- why you're having such an incredible year.

Yes, it is.

Thank you very much. Keep up the good work. Thank you.

Thank you.

Thank you.

Our next question is a follow-up coming from James Gentile with Sidoti & Company.

Hello. Ray, I was just wondering if you can give us one more statistic. If you look at the range say between 11 and 15% of operating profit margin historically in MACSTEEL, could you give us kind of a plus or minus unit production in North America that correlates us to that -- those levels of profitability?

This is not an exact science. Off the top, I don't have one, James.

Okay.

So, I mean, at which point then, looking at the 16 million expected for '05, say we see a 5% decline in North American builds next year. At which point does unit volume concern you in terms of absolute number of unit declines?

You tell me where the scrap costs are going to be, and I'll have a chance at coming up with the answer perhaps.

All right. So you're more concerned obviously then with the scrap cost volatility then than the absolute --?

It just makes answering your question somewhat difficult.

I agree.

Certainly volume is a key variable, but sticking with the volume side, we have to look at the mix as well. So there's a lot of factors that enter into the equation.

Okay. Thanks.

Thank you.

There appears to be no further questions at this time. I'll turn the floor back over to you for any further or closing remarks.

Thank you.

We remain optimistic that our consumer-durable driven markets will remain relatively strong, and that our secondary capital equipment markets will continue to be healthy. We also believe we will continue to out-perform our served markets.

Our strong balance sheet and excellent cash generation capability will continue to support the growth of our core businesses. We like our prospects going forward.

That concludes our second quarter conference call.

Thank you.