Quanex Building Products Corp (NX) 2005 Q3 法說會逐字稿

Good afternoon and welcome to the Quanex fiscal 2005 third-quarter earnings 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 our host, Raymond Jean, Chairman, President and CEO. Sir, you may begin.

Good afternoon and welcome to the Quanex fiscal third-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 Investor Relations. We will be available after my remarks to take your questions.

Today's call will include a brief overview of third-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 a complete forward-looking disclosure statement. Our third-quarter earnings release is available on our Web site at Quanex.com.

During the third quarter, order entry rates in our Building Products segment were moderate, given the robustness of the market drivers, while activity at our Vehicular Products group show slowed significantly from the frantic pace of a year ago.

Margins, however, were up dramatically at both segments, as market dynamics at our aluminum sheet business have improved and Macsteel enjoyed higher selling prices and reduced material costs. These factors, combined with the addition of Mikron, resulted in outstanding third-quarter results for Quanex.

Our Vehicular Products segment reported operating income of 48 million, versus 25 million in the year-ago quarter, a 92%-plus increase.

Our engineered steel bar shipments were off about 15% from the year-ago quarter, reflecting sizable inventory drawdowns in our customers' pipeline and significant production cutbacks by Ford and GM. While we look for light vehicle bar demand to remain a bit uneven for the next month or so, we do expect the OEMs to rebuild vehicle stocks to more normalized levels later this year, and our bar shipments will track that activity.

Total North American light vehicle builds for our third quarter were down about 2% over last year. Builds at the Big Three were down some 8% in the quarter. This Big Three reduction underscores the importance of our ongoing work to gain share with the automotive transplants as they build on their capabilities to produce more engine, transmission and chassis components in North America. We continue to make solid progress on these fronts.

The widespread supply chain inventory reductions we saw as customers adjusted to the new reality of available steel, versus last year's allocation environment, also apply to the heavy-duty truck market. Although Class A truck builds were up 35% over the year-ago quarter, our orders were somewhat soft, as component inventories were reduced. The good news here is that we are already seeing the rebound in orders and the industry still expects to build some 340,000 units versus 270,000 units last year.

Value-added bar sales will continue to be an important part of our marketing strategy, and during our third quarter, they represented almost three-quarters of all bar shipments. Phase 9, a 38 million capital project scheduled for completion in December of 2006, will add extensive value-added capabilities to our Macsteel Monroe facility.

Switching to our Building Products segment, they generated operating income of some 43 million in the quarter, compared to 19.5 million a year ago, a 120% improvement. Annualized housing stocks during the quarter averaged about 2 million units, and remodeling activity remained at very high levels.

Our Window and Door Components businesses got off to a slow start due to cool weather, but things improved as the quarter progressed. Our aluminum sheet business benefited from relatively tight supply conditions, combined with good demand across most market segments and aluminum scrap pricing that has been relatively attractive all year. These positive factors, along with a richer mix of value-added painted product sheet and strong operating performance, generated record-setting results.

After more than a year of wild steel scrap cost gyrations, is it evidence the roller coaster ride is not yet over. For the third quarter, our scrap surcharge was higher than our actual scrap cost, which of course enhances margins. However, we look for that situation to reverse this quarter as our scrap costs have already increased by 75 to $80 a ton but the surcharge won't reflect that until October 1. As we have noted before, we recover our costs, but there is a lag.

Some comments on the purchase of Mikron Industries -- we remain very pleased with the integration progress to date. We acquired Mikron last December 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.

In addition, our major customers are outperforming the industry because of their uniquely strong positions with the big box stores, so they are hitched to stars themselves. The bigger are getting bigger and vinyl windows continue to gain share at the expense of other materials. The growth prospects are exciting.

Mikron's quarterly results came in above our expectations, earning $0.17 per diluted share after interest expense. For the fiscal year, we now expect their accretion to diluted earnings per share to be in the range of $0.35 to $0.45, up $0.05 from our previous guidance.

Taken together, Quanex reported diluted earnings per share from continuing operations of $1.71 for the quarter versus $0.82 in the year-ago quarter. Our after-tax return on invested capital was a very favorable 19.7% compared to 8.6% a year ago. We estimate that our weighted average cost of capital, after-tax, is about 10%.

One of the year's highlights continues to be our record-setting cash flow machine. We generated about 161 million of cash, compared to 73 million in the equivalent year-ago period. This strong cash flow will allow us to continue to grow our core businesses, both organically and through strategic acquisitions. Our ongoing strong cash flow also allowed us to raise the dividend for the third time in 12 months. Last August, we raised the dividend 12%, then again in December by 7%, followed by a 15 increase this quarter. This action is consistent with both our excellent financial results and our prospects for the future.

Our conversion cycle, which is the measure of how long it takes us to convert customer orders to cash, was 42 days, a 1 day improvement over last year and in line with the second quarter.

As for the balance sheet, we ended fiscal 2004 with a total debt-to-capitalization ratio of 21%, which for the most part was our 2.5%, 125 million convertible debenture. In December 2004, we borrowed 200 million from our revolving credit facility to finance the acquisition of Mikron, driving our total debt-to-cap up to 37%. Since that time, however, we have reduced that outstanding balance by 170 million with 80 million paid down in the third quarter alone and ended the quarter with a total debt-to-cap ratio of about 21%. You should expect another drop in our debt-to-cap ratio this quarter, assuming no acquisitions.

Moving to a discussion of our markets going forward, North American light vehicle builds for calendar year 2005 are now estimated to be 15.5 million units, down about 3% from last year. Our market response to that fall-off in builds is to continue to increase our content per vehicle with both the Big Three and, importantly, the transplants. We expect heavy-duty truck builds to remain very healthy through the remainder of the year.

We ended August operating 15 turns at our engineered steel bar business, and we hope to ratchet that up toward the end of the quarter. We believe the bulk of the industry-wide inventory drawdowns and the significant production cutbacks we experienced over last six months will subside this quarter and bring our production more in line with normalized demand. In other words, rebuilding some inventory and filling the pipelines with '06 models will stimulate demand. We believe we will be gaining momentum through the end of the calendar year.

In the Building Products segment, we expect both housing starts and remodeling activity for the remainder of the year to continue at high levels. Annualized housing starts have hovered around the 2 million mark all year, which should make 2005 the best ever for starts. Given these fundamentals, we look forward to a robust quarter from our Window and Door businesses, and with Mikron's added punch, we will be ringing the bell by the end of the quarter.

We are experiencing some inventory destocking at the OEM level at our aluminum sheet business, but with a very high value-added mix and excellent margins, we nonetheless expect to have a solid quarter.

That concludes my formal remarks. We will now take your questions.

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS). Peter Lisnic from Robert W. Baird.

Good afternoon, gentlemen. A question on the Nichols business -- can you just elaborate on some of the rebalanced inventory that occurred in the quarter? Was that across the board, or was it one customer? Was it a particular market? I am just wondering if you could add a little bit of color on that one.

No, it wasn't in just one market. I would characterize it as across the board.

Fair enough. Then the painted sheet business you specifically identified in the press release. It sounds like I guess the relative mix of painted sheet versus non-painted is running at a higher rate than is typical. Is that an accurate assessment?

Correct. We've been able to ratchet up production of our painted sheet, which improves our mix.

How much higher is the relative contribution from painted versus your typical historical contribution? Meaning, you're getting a favorable mix impact but I mean, is it -- I can't remember what the number is in the press release; it's 40-something%. But is painted typically like 20% of the business or is it --?

No, it's been higher than that. I think it's been, you know, a 500 point or basis point improvement or so.

Okay, fair enough. Then, one follow-up -- in terms of cash, it was outstanding this quarter -- cash generation, debt pay down. If you look to '06, and you don't really have to stretch too much, it looks like you could be in a net cash position if I'm right. I'm wondering if you could maybe comment on what the acquisition environment looks like in terms of pricing? What's out there and kind of what you plan on doing with this cash that looks to be in the cards for the rest of '05 and '06?

Well, there's always something going on in the corporate development area, I can assure you that. We've seen prices drift north, and we remain committed to being disciplined acquirers. But you know, again, that said, there certainly is some activity going on. We have said that, for our use of cash, we like to fund our organic opportunities. You know, over the next six months, we do have a number of significant projects that are underfoot at Macsteel. We will be spending more money here at Mikron to fund some of the growth opportunities we see. Then we've said certainly acquisitions we want to keep doing, and then look at what we're doing with dividends. I mean, we keep increasing the dividend. So, we have made good use of our cash, I believe.

Is there a certain benchmark that you tie the dividend yield or payment to?

The Board has engaged in heavy discussion on that issue, and what we're using as a benchmark is yet to evolve into a firm policy, but we're working on it.

Mark Parr from KeyBanc Capital.

Good afternoon. Congratulations on a great quarter.

I had one question related to Nichols. I was wondering if you could give us some color on Nichols' profitability and how it compares to previous cycle peaks, relative to the most recent quarter.

At least since I've been here, Mark, it has well exceeded the prior peak. I think we are setting some records is really what we're doing. You know, I think it's a combination of things. Certainly the supply/demand equation in the marketplace is far better and looking at the way we are operating Nichols today, it's a far more efficient operation. It's an operation that is shipping more value-added product. So, you know, we feel good about all that we've been able to achieve there.

Okay. One follow-up question, if I could, on the steel side? Could you talk a little bit just about what activity you've experienced thus far related to contract -- or pricing discussions for next year and what -- directionally how you think this thing is going to unfold?

The process appears to be beginning earlier than it has in prior years is what we're seeing right now. I think it's really too early to comment on how that will go.

Okay, thank you very much.

Barry Vogel from Barry Vogel and Associates.

I have a couple of little questions, first for Mr. Murphy. As far as LIFO is concerned, I know we've -- you know, you've had -- you haven't had that many LIFO charges compared to some of the other companies. Can you give us a rundown of the LIFO charge or credits in each of the first three quarters and what your outlook might be for the fourth quarter? I know it's an estimate -- given the fact that scrap is going up again.

We haven't had any year-to-date for '05 other than the -- what happened in the third quarter, which was kind of a special adjustment. We didn't have any LIFO charges at all through the third quarter. We expect, as we look into the fourth quarter, that we may have a benefit from LIFO into the fourth quarter, although just in doing some preliminary calculations, I don't have a firm number for you, but we expect that there may be some positive impact from LIFO in the fourth quarter.

Compared to last year, if you look at last year, in the third quarter, we had a $5 million charge in the third quarter; we had a $2 million charge in the second quarter and a $650,000 charge in the first quarter of last year.

So (indiscernible) did not affect -- I know you put your LIFO charges I believe in corporate expense and other?

Yes.

So basically the 28 million 083 for the first nine months has virtually no LIFO in there?

Well, that isn't exactly true. There is a special adjustment that had been made in corporate. Actually, we did a repricing of the alloy inventories at Macsteel using a three-month average there rather than a twelve-month average. What that did is it increased the vehicular products for Macsteel's inventory by about $6 million and there was an offsetting LIFO reserve adjustment in Corporate and Other. So there was $6 million that would've been a charge. The net effect on the Company, though, was pretty close to 0 for the third quarter, because it would have been an increase at Macsteel and an offset in Corporate. However, in the fourth quarter, if you look at scrap prices this year versus the last year and inventory levels this year versus last year, at least at this point in our calculations, we would expect that we would get a benefit from LIFO. There will be in increase in income as a result of LIFO benefit occurring in the fourth quarter. I just don't have a number -- (multiple speakers).

Okay, so of the 28083, which is your corporate expense line, for the first nine months, on a net basis, what was the overall LIFO impact?

On a net basis, that 6 million, that's in the third quarter for '05.

All right, so it was a 6 million negative impact in '05, so if you didn't have that, it would had been a $22 million corporate expense rather than 28 million?

You are correct.

Okay. Now, as far as your capital expenditure outlook for the full fiscal year, excluding the acquisition and the D&A outlook for the full fiscal year '05, what's the precise number right now?

Well, on the CapEx, we're looking at about 63 million for the year, but that includes about 17 million from LIFO, so 63 minus 17 would be kind of the apples-to-apples comparison for the year.

Okay, and D&A?

Depreciation and amortization is about 65 million for the year. Let me look at Mikron. Just a second, I've got it here. Mikron looks like it's about 12 million of the 65 million for the year.

All right, but the total for the Company is 65, so you're saying capital expenditures, excluding the Mikron acquisition?

(multiple speakers).

(multiple speakers) -- for about 46 million?

Are expected to be about 46 million, yes, for the quarter left.

All right, plus Mikron's -- okay. Mr. Ray Jean, you're doing a pretty good job!

Thank you! I always like to hear that.

I always like to be -- (multiple speakers). If we look at the acquisition landscape and we look at your current businesses, is it still true that the best -- the odds are that if you make further acquisitions -- and obviously you guys have done an outstanding job, outstanding job in your acquisitions over the last three or four years -- that the Building Products area would probably be the place to be, where they will occur and steel is far less likely?

Well, certainly the Building Products area is a target-rich environment, just the nature of it and so, yes. There's a higher probability that it would be on that side, but don't discount the other side totally either.

Okay. If you don't discount the steel side, what would be a logical thing for you to do, given your current operations in steel?

No, it would be looking at the steel side of things, Barry. You know, we've looked into adjacencies to the steel business that we have and have concluded that it's difficult to make good returns in that particular space, so we've been discouraged from going much beyond our core steel business. You know, you never say never to looking at opportunities that would further enhance our core steel business.

That's great. Keep up the good work.

(OPERATOR INSTRUCTIONS). Peter Lisnic.

I'm back. Mikron -- I was wondering if you could give us the sales contribution.

We really can't, Pete, go beyond what we put in the earnings release. You know, we had a separate bullet for that. You may recall, when we purchased the acquisitions, their sales were approximately 200 million, so you'll have to use that as kind of a base to work from. We would add we've grown sales at Mikron and I think Ray suggested they were running a bit ahead of our expectation.

Okay. I was just after the year-over-year organic growth for the Company, I guess, but maybe I asked it the wrong way. To your point, Jeff -- (multiple speakers) -- the performance at Mikron, it sounds like the top line is maybe running ahead of expectation, but it also sounds like Mr. Bale (ph) and everyone else is doing a good job in terms of integrating the franchise and getting things straightened out there. Can you maybe give us some more color on where you are at, maybe what inning of the ballgame or how much -- we know what the margins were when you bought the company -- kind where we're at? Is there upside to your expectations from when you bought the company in terms of profitability or accretion?

Yes, there is. In fact, there's probably still some upside accretion possibility this year. You know, we're still learning about one another. But I think Michael and his management team are doing an outstanding job of integration and focusing on the right things, and so we are very pleased with the progress they're making.

Peter, back to your question about the growth, you know, I think we say, in the earnings release, that sales were up 14% from a year-ago quarter, to give you a sense of the growth that they are enjoying.

Okay, fair enough. Then Terry, if I could, just on the corporate expense line, you've got -- there was a $6 million number in the third quarter, so we are at 14 or 15 million, whatever it was. For the fourth quarter, can we reasonably assume, assuming there's no -- just ignoring any kind of LIFO impact -- can we assume 7,8, 9, $10 million kind of number normal run rate for the fourth quarter for corporate expense?

One of the things that happened -- one of the additional things that happened in the third quarter is that we had, we had a fairly significant outlay for our Sarbanes-Oxley implementation. I don't expect the Sarbanes number to be as big in the fourth quarter as it is in the third quarter. As I mentioned earlier in response to Barry's question, we expect that there may be a benefit from LIFO. So if you take out LIFO, if we just say, on a non-LIFO basis, as we say that Sarbanes-Oxley is relatively flat, quarter-over-quarter, we're probably looking closer to the $10 million than we would be to something like -- (multiple speakers).

Okay, and your 610 to 620, do you have a LIFO credit built-in?

No, there's no LIFO charge or credit built into the 610 to 620.

Gregory Macosko from Lord Abbett.

Very nice quarter. Not a lot more to ask, but much has been covered here. I just wondered about the area of scrap. Are your relationships with your suppliers of scrap changing at all? Do you see that environment different in the future than it has been, say, when you first got there, Ray?

No, I think we have good relationships with our scrap vendors. I mean, we deal with a number of them. There's certainly a few that are larger than others, but I think we maintain good relationships. You know, the scrap market is a unique marketplace and when you think you've got it figured out, you get a surprise. It's hard giving up trying to figure it out. Certainly, exports I think factor in more than they have in prior years, given what's going on in the Far East. So, it's just very, very difficult to call which way it is going to go.

Have you decreased the number of suppliers, say, in the last few years or the last year or two?

Not that I'm aware of, no. If anything, I think we are dealing with more of them.

Are you using more pig iron or direct (indiscernible) iron or is totally scrap, as far as you know?

No, we don't use DRI and we use -- it's a blended scrap that we come up with, with shredded being the number one ingredient. But you know, we will use lower grades and we will use number one bundles as well.

You have a lot of flexibility in there, given the flexibility in pricing in the various types?

We do. It helps us keep our blended raw material cost at as low a level as we can and we work very hard at it to achieve it.

You mentioned the transplants. Can you give us any color examples or things of how the transplant relations are progressing, anything particular to talk about there?

Well, it's across all of the nameplates that you know of, from Hyundai to Honda to Nissan to Toyota, and it ranges from a lot of work going on in constant velocity joints, a lot of work going on in crank shafts. We did have a win over the last few weeks having to do with crank shafts that will be going to Chrysler engines first, Hyundai engines second and Toyota engines third. It's kind of a phased-in approach to those crank shafts across the nameplates I just mentioned. There, the opportunity is, as they bring on more transmission component production to North America, which is going on as we speak by some of their secondary suppliers or by the OEMs themselves, you know, those are the opportunities that present themselves, and that's where we have to spend our time. The trial process just takes a long time.

Has there been anything in terms of platforms or models or anything with regard to the big three that you have not seen follow through or follow on this year, next year? In other words, you're going to be phased out in any areas?

Nothing that I'm aware of, Greg, that would be noteworthy.

No? So just the normal --?

Yes, there's always some what I call ins and outs, you know. There's always things that change obviously with different models coming on, but on balance, we've got more ins than outs and that's what you've got to play, and that's what you got to be doing if you're going to outperform the market. That's were the pressure is.

Okay, well, very good. Thank you very much.

Pete, I wanted to correct something that I said to you earlier. Going back to the corporate expenses, you asked the question, is the 9 million that occurred in '04, the 9.8 million about the run rate? That wasn't exactly your question but that was the implication of the question. That is high as well because that has a $5 million LIFO charge in it, so kind of the corporate run rate per quarter if you will is probably about $5 million. You use that as a general corporate run rate per quarter. Last year, '04, the reason it's 9 million is because there's a $5 million LIFO charge. This year, in '05, there's that $6 million LIFO charge plus the increased costs associated with the SOX implementation. Okay?

Bill Baldwin from Baldwin Anthony Securities.

Good afternoon, gentlemen. Ray, can you talk just a little bit about the new products, the important new products coming out of Mikron and maybe some of the new programs on the works there, if it's something you can chat about?

A lot of the new programs at Mikron or many of the new programs at Mikron are really supporting the growth that we are seeing through two or three of their largest customers that are (indiscernible) being driven by the growth of the big boxes. You know, people like Lowe's and Home Depot are moving more and more windows for remodeling purposes. They're also selling to the smaller contractors, and it just represents just a huge growth opportunity for them but also for us, because we are -- we just happen to be well-positioned to support those large customers that have uniquely -- as what we said in the conference call -- uniquely strong positions with the big boxes. So, that accounts for some of it and that has to do with the PVC profile on the composite materials. There, we still have growth pains there; we are still wrestling with some production issues as we try to make the processes more capable than they are today. But we remain optimistic about it. There, I think the opportunities are positively exciting because it's something that represents a breakthrough for the industry and we would have a strong, distinctive product to offer to this -- to the window market. So, again, it's just exciting, but we do have some hurdles to overcome in the manufacturing area.

Thank you, Ray.

Leo Larkin from Standard & Poor's.

Good afternoon. Do you have any preliminary guidance at least for CapEx and DD&A in '06?

We have not gone there, no. It's a little early.

Even directionally -- flat, up?

Directionally, the spend -- the dollars will be up moderately on the capital and I would say that the depreciation will also be up slightly because we will have 12 months of Mikron if for no other reason.

Thank you.

(OPERATOR INSTRUCTIONS). We appear to have no further questions. I would like to turn the floor back over to Raymond Jean for any further closing comments.

We are optimistic that our consumer durable driven markets will remain relatively strong and our secondary capital equipment markets will continue to be healthy. Our underleveraged balance sheet and great cash-generation capability gives us the ability to handily fund the growth of our core businesses and to make selective acquisitions. We love our prospects going forward.

That concludes our third-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.