Quanex Building Products Corp (NX) 2006 Q2 法說會逐字稿

Good morning. My name is Henry and I'll be your conference facilitator today. At this time, I'd like to welcome everyone to the Quanex fiscal 2006 second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. [OPERATOR INSTRUCTIONS] Please note that management has asked that you limit yourself with a follow-up question and one question before being placed back into queue. Thank you. It is now my pleasure to turn the floor over to your host, Mr. Raymond Jean. Sir, you may begin your conference.

Good morning, and welcome to our second quarter conference call. Thank you for joining us. With me today are Brent Korb, our Vice President and Controller, and Jeff Galow, our Vice President of Investor Relations. We'll be available after my remarks to take your questions. Today's call will include a brief overview of second quarter results, the present state of our key market drivers and an outlook for the remainder of 2006.

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, 2005, for our complete forward-looking disclosure statement. Our second quarter earnings release is available on our website at Quanex.com.

I would describe the general business conditions of our second quarter as solid, and as the quarter progressed, we experienced a steady increase in orders. As you may recall from last year's second quarter, overall demand, particularly early in the quarter, was unusually high and as a result, both our Building Products and Vehicular Products process businesses still had some customers on allocation. For the second quarter, the Vehicular Products segment reported operating income of 40 million versus 61 million in the year ago quarter, on 1% lower bar shipments. Most of the disparity in operating income can be attributed to our raw materials surcharges which a year ago were still at very high levels while scrap costs then were in rapid decline. For us, it was a catch-up period in the scrap cycle or what we internally called hyper spread time. We did not experience a repeat of this in this year's second quarter as scrap costs traded in a far narrower band. Even so, operating margins for the second quarter remain strong at 16%.

Total North American light vehicle builds for our second quarter were off about 1% over this time last year with builds of the Big Three down 4% and up 6% at the New American Manufacturers or NAMS. The domestics continue to face significant challenges but there are reasons for optimism. GM's extensive lines of new vehicles are now in the showrooms anchored by the GMT 900 platform and customer reaction to their products is favorable. At Ford and Chrysler, light truck and SUV builds are off from this time a year ago, partially offset by a 15% increase in passenger car builds.

Ongoing challenges of the domestics underscore the importance of our work to increase bar content with the NAMS who continue to source more power train and wheel end components domestically and are also adding capacity to produce them as well. Our largest product opportunities today remain in the areas of transmission and chassis components. Additional transmission content will come from more domestic sourcing of parts. We'll further penetrate the chassis business by increasing our participation with both established and start-up producers of wheel hubs, constant velocity joints and stabilizer bars that specifically serve the NAMS. Our content with them continues to rise and for 2006, we do expect some 20% of our light vehicle tons will be sold directly or indirectly to support them.

Turning to Class A truck activity, both builds and sales remain strong. Builds in 2005 were 335,000 units while builds for 2006 are estimated to be some 360,000 units as producers sell ahead of new 2007 EPA engine emission requirements.

Our 38 million Phase 9 project at MACSTEEL is somewhat ahead of schedule and is now scheduled for completion in the August timeframe. This project will add some 50,000 tons of value-added capacity to our MAC Monroe facility which today has these services performed by outside firms. Much of the equipment is already on hand and after some operational shake down, we would expect to begin accruing some financial benefits in the project in the project in the fourth quarter. With the completion of Phase 9, some 70% of our bar tonnage will have some form of in-house, value-added processing which helps enrich our margins.

Steel scrap prices have been drifting up over the last several months due to increased demand within the industry. This year, our scrap surcharge formula is considerably more timely at MACSTEEL, with about 70% of our shipments having the scrap surcharge amount adjusted monthly.

Turning to the Building Products segment, we experienced record second quarter sales and operating income, in part due to excellent demand at our engineered window and door business, as well as from a healthy bounce in aluminum spreads and rising demand at our aluminum sheet business. At Nichols, our second quarter shipments were off 6% from the all-time record shipments in the second quarter of 2005 as customers continued to work down inventories. Spiking LME prices also caused a delay in customer purchases as they held back in the hopes the LME would fall back during the quarter, an event which did not occur. Our materials spread increased 11% compared to the year ago quarter, the result of higher selling prices and relatively low scrap costs. Order backlogs at Nichols have significantly improved, up 31% from a year ago, and are currently higher than any point since August 2004. We expect shipments in the second half of the year to be some 10% higher than the second half of 2005.

Sales at our engineered window and door components business were up 9% compared to the year ago quarter while earnings were up almost 20%. These gains can be tied back to the operating improvements we continue to experience at our newest facilities in Dubuque, Iowa and Hood River, Oregon and new programs driving organic growth. New program growth has come from several product areas, such as patio doors, thresholds, window screens, and window sill bases. Of course, supporting all of this are strong housing starts, remodeling and replacement activities.

Turning to some financial highlights, Quanex continues to generate excellent cash flow and during the first half of 2006, cash flow totaled some 67 million. Our cash balance at quarter end was 62 million and our total debt less cash to capitalization ratio was 8.4%. Cash flow is expected to be stronger in the second half of 2006 on rising earnings and reduced capital spending compared to the first half of 2006. Our strong cash generation will allow us to continue to grow our core businesses both organically and through strategic acquisitions.

Our capital programs will total some 75 million in 2006 as we look to complete two major projects at MACSTEEL and one major project at Mikron. We expect capital expenditures to drop back to more normalized levels next year.

We take the management of our working capital very seriously and for the quarter, our conversion cycle, which is a measure of how long it takes us to convert customer orders to cash, came in at 40 days, a two-day improvement over the year ago period.

Moving the discussion to the market outlook, we expect North American light vehicle builds for the second half of calendar 2006 to be down about 4% from the second half of 2005 but we're not expecting any dramatic slowing like we experienced in the second half of last year when our Tier 1 customers had to cut back in order to get inventories in line following their buying frenzy early in the year. Breaking down the back half of 2006 further, Big 3 light vehicle builds are expected to be down 8% while builds at the NAMS look to be up 2%. Our response to any fall-off in builds is to continue to increase our content per vehicle, with all the automotive players, and indeed, new programs will be kicking in during the second half of 2006, and let me underscore the importance of new program growth. For 2006, MACSTEEL expects to pick up about 100,000 annualized tons of new business which is up 10% from what we reported to you just last quarter. Some of these programs began to ramp up during the second quarter while the others will launch through the remainder of the year, the majority for light vehicle applications with some 75% earmarked for the domestics and 25% for the NAMS.

A reason much of the new programs are related to the domestics has to do with the application of our bars for new steel crankshaft consumption which continues to move away from cast iron products. This represents a new market opportunity for us. In 2005, we shipped some 10,000 tons of bars for crankshaft applications and for 2006, we expect that tonnage to reach some 40,000 tons on an annualized basis.

For the remainder of the year, we believe the industry wide steel inventory corrections, which started in the back half of 2005, are behind us. We expect bar production in the second half of 2006 to be considerably higher than the second half of 2005 with each of our three MACSTEEL facilities running above 90% capacity utilization. However, operating margins during the third quarter of 2006 are expected to continue to lag the third quarter of 2005, a period when MACSTEEL remained in a significant over-recovery situation with its scrap surcharge. You should expect third quarter margins at MAC to be more in line with what they experienced in the second quarter.

In the Building Products segment, we expect housing starts, remodeling, and replacement activities to remain at historically high levels. 2006 housing starts are expected to be off some 8% from 2005's record starts. However, the window and door industry is forecasting total window unit demand to be off less than 1% in 2006 because of very strong restoration spending. These healthy fundamentals, along with numerous new programs at our engineered window and door components business, are expected to drive top line growth some 15% over 2005.

The outlook for Nichols Aluminum remains very favorable. Supply and demand fundamentals have shifted considerably over the last couple years as the industry experienced capacity rationalization and demand has risen with a strengthening economy.

In summary, combining expected operating results of the two segments, we would expect to report diluted earnings per share from continuing operations for the third quarter in a range of $1.10 to $1.16 and for the year, $4.00 to $4.20. That concludes my formal remarks, and we are now ready to answer your questions.

[OPERATOR INSTRUCTIONS] And also note that management has asked that you limit yourself to one question with a follow-up before being placed back into queue. We will pause for just a moment to compile the Q & A roster. Your first question is coming from Barry Vogel of Barry Vogel & Associates. Please go ahead.

Good morning, gentlemen.

Good morning, Barry.

First question has to do with your stock buyback program which finally got going in the first quarter where I believe you bought almost $18 million worth of shares at an adjusted split price of about $34. Given the fact that you have the lowest leverage in the history of the Company, the best cash flow in the history of the Company, and capital expenditure requirements as you had just spoken about probably are going to go down decently next year and your depreciation and amortization will be higher than your CapEx requirements, why didn't you buy any shares in the second quarter?

Well, barry, thanks for commenting favorably on our cash flow results. It's a question of timing, Barry. We've said that stock buybacks are very much a means of getting cash to shareholders that we will employ from time to time and the window opens and closes on us periodically and that was a factor in the second quarter.

Would you say that you're more inclined to take this great balance sheet, this great cash flow and the great positioning that you've done here and be more aggressive going forward in your share buyback program?

I think that's a possibility.

One other question. You mentioned in your press release something about a LIFO charge due to rising income prices may occur. Could you explain that?

Well, I'm sure you know the math behind the LIFO charge. It's just, as a result of rising LME pricing at Nichols, that's where the concern is more so than MAC. But it is a factor at MAC as well, what will happen to scrap prices as the year draws to an end and we may be faced with a charge there as well or perhaps a pick up depending on where the price of scrap is vis a vis at the end of 2005. So it's just something that we have to consider at the end of the year.

All right. So you won't know that until the end of the year?

Correct.

Thank you very much.

Thank you. Your next question is coming from Mark Parr of KeyBanc Capital. Please go ahead.

Thanks very much. Good morning.

Good morning, Mark.

First, I just want to say congratulations on the great results.

Thank you.

And I had a couple of questions. First of all, related to MACSTEEL, could you give us a sense of your exposure to the Class A truck market and how you're anticipating managing the expected slowdown in truck production next year?

Yes. Our exposure, we've said that truck, I mean our tonnage to the heavy duty truck market can be 10 to 15% and next year we certainly expect to be closer to 10% is probably what's going to happen given the expected drop in builds that we're going to see in 2007, and the answer to that is again more to increasing content in light vehicles and increasing content in the heavy duty trucks as well. So that's the only answer to that one.

Okay. And just as a follow-up, if I could, could you -- you've talked about the shift from cast iron to forged crankshafts creating a 30,000 ton growth benefit for you in '06. What's the opportunity for this market in '07 and are there any other programs or new product or content situations that you could disclose to us?

Just the crankshaft opportunity. I guess in total we look to be some 100,000 tons is what I would say off the top here, that kind of opportunity. I think the big opportunity for us continues to be some of the wheel hub components with the transplants and we have captured some of that business and more in the future.

All right. If I could just, I realize, if I could just ask one more, how much of a LIFO charge have you incurred year-to-date?

None, year-to-date.

Okay. Thanks very much.

Thank you. Your next question is coming from John Hoshelter of Robert W. Baird. Please go ahead.

Good morning, guys.

Good morning.

Could you just kind of walk through what you're seeing on the acquisition front and then kind of valuations and do you expect valuations to get better as the home building market slows a little bit?

Well, we are continuing to look at things. There's always something in the pipeline. Multiples have gotten rich and we are determined to remain disciplined acquirers. Certainly, multiples of 8, 9, are not unusual and to me some of those deals at that lofty pricing, I find it difficult to get to a return on capital that we find acceptable, so there's nothing wrong with keeping powder dry and I would expect as the building area tips down some that we might be finding more attractive opportunities.

Okay. And then kind of turning to Nichols, could you kind of comment on what you're seeing in kind of peripheral markets there, like not your typical construction market but other markets for common alloy sheet, and could you sell there if the market starts to weaken in construction?

I'm not sure if I picked up the end of your question, but let me address the beginning which is the secondary markets. Those are strong, and certainly, the pick up in non- residential construction does help there immensely as well as other secondary markets, including capital equipment. The economy is doing well across just about every industry segment and so aluminum demand is just robust.

Okay. Thank you.

Thank you. Your next question is coming from Bill Baldwin of Baldwin Anthony Securities. Please go ahead.

Good morning there, gentlemen.

Good morning, Bill.

A couple of questions. Ray, could you give us some insight into the capital, those capital projects you mentioned? The one at MAC about the additional MACPLUS there at Monroe, I'm familiar with but the second project at MAC and the project at Mikron that you're spending money on this year?

Yes. The second MAC project, of course, is the Ford Smith $20 million project which has to do with some capacity addition as well as improvements in quality level. That's why that was done and that one remains on schedule as well. At Mikron, it was pretty much a capacity expansion. We did purchase some high speed extrusions and a lot of the money was spent at the Kentucky facility so it was pretty much for capacity, just to increase the velocity of product through the operation.

No new Greenfield plant at Mikron then at this point?

We did purchase some land in Arizona for potentially coming up with a fourth plan, but we have not moved on any structure.

And the second question, Ray, on the MACPLUS capacity at Monroe, is the outsourcing volume pretty much sufficient, you think, to fill up the 50,000 ton capacity coming on stream?

Yes, very much so. In fact, the way we did the planning on that, Bill, is that we're still going to be subcontracting some. It won't be a big amount but it was planned that way.

Okay, thank you very much.

Thank you. Your next question is coming from Timothy Hayes of Davenport. Please go ahead.

Good morning.

Good morning.

Just to clarify on the annual guidance of $4.00 to $4.20, I think that that actually is effective of what you raised your guidance from your original or your initial guidance once I do the adjustment for the 3 for 2 stock split?

Correct.

Okay, and so if I do the math right, and adjust your initial guidance, it was roughly 3.60 to almost 3.90?

Brent, can you confirm that? Was that -- ?

That's correct.

That's all I had, thank you.

Thank you. Your next question is coming from Mark Parr of KeyBanc Capital. Please go ahead.

Thanks. Could you give us some guidance regarding expected share count, primary and diluted, for the balance of the year?

Brent, could you help me on that one? I know it's around 40 million, but I'm --

It's expected share count for the end of the year?

Yes.

Yes, we would expect, I guess, something for the end -- the full year average is what we use. I suspect that's what you're asking but something in 38 million for basic and north of 40 million for diluted. But again that's a full year average.

Okay. Do you have a preliminary expectation for '07 at this point on share count?

No. We haven't gone through that process yet.

All right. Another thing you had mentioned in the release related to the outlook for aluminum scrap prices to perhaps stay strong but maybe not as strong as aluminum ingot. I was wondering if you could update us regarding your view of that situation for the next couple of quarters, provide some additional color?

Well, we do expect LME pricing to remain certainly higher than it's been historically. And scrap pricing, there's a high correlation between LME pricing and scrap pricing, and so they will move in tandem. Sometimes when LME goes up, shop lease, scrap lags in the increase. Sometimes and the reverse can happen going the other way. We have the ability with our scrap processing facility to bring in some pretty low level scrap which gives us the benefit in the marketplace to keep buying low often, so I'm not going to forecast precisely on that but we certainly enjoyed a nice spread between LME and scrap pricing.

Would you think that the spreads could widen further in the second half?

I would not bet a lot of money on the further widening of spread, Mark. I wouldn't be surprised to see some tightening.

Okay, thanks very much.

Thank you. [OPERATOR INSTRUCTIONS] Your next question is coming from Dan Whelan of Bear Stearns. Please go ahead.

Hello everyone.

Good morning, Dan.

Quick question. Just given the trends for pricing in the M&A market, have there been more discussions internally about internal expansions?

You're talking about to fund organic growth?

Yes, exactly.

Well, that's clearly what we're doing with, we're spending 75 million this year.

Yes.

Some of it is value-added and the other two are really capacity to meet what we expect will be the demand out there.

Right, right. Your balance sheet seems to be getting leaner by the quarter. I guess alternatively, given where your balance sheet's going, are you more open to making larger acquisitions than you have in the past?

We certainly have the capacity for that and would for the right opportunity, I'd love to be making a big deal or a bigger deal. It's, small deals take as much time and so forth, so the right deal, we will step up.

Okay, great, and one last question. Can you just remind us where the CFO search stands?

Well, we hope to be getting to the finish line real soon, but still have nothing to announce.

Okay. Are you down to a few candidates or -- ?

Yes. Our standards are very high.

Good. Okay, thank you very much.

Thank you. There appears to be no further questions. I'll now turn the floor back over to your host.

During the first half of 2005, we benefited from a favorable steel scrap surcharge and very high end demand making first half 2006 comparables tough for us. However, during the second half of 2005, scrap cost volatility moderated, surcharges dropped, although they still remained in a catch-up mode, particularly in the third quarter, and customer demand dropped off as they found themselves with too much inventory. Because of this, we do expect our results in the second half of 2006 to become increasingly favorable when compared to the second half of 2005. We are optimistic that our consumer durable driven markets will remain healthy and that our secondary capital equipment markets will continue to be strong. Our under leveraged balance sheet and great cash generation capability gives us the ability to fund the growth of our core businesses and to make selective acquisitions when appropriate. It's a good position to be in. That concludes our second quarter conference call. Thank you.

This concludes today's Quanex conference call. You may now disconnect.