Quanex Building Products Corp (NX) 2006 Q3 法說會逐字稿

Good afternoon, my name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the Quanex Corporation fiscal 2006 third-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. Thank you. It is now my pleasure to turn the floor over to your host, Raymond Jean, Chairman and CEO of Quanex. Sir, you may begin your conference.

Good afternoon and welcome to the Quanex fiscal third-quarter conference call. Thank you for joining us. With me today is Tom Walker, our new Chief Financial Officer. Tom joined Quanex on June 12th and since that time, he's been running hard, learning the business and bringing to bear his financial acumen and business insights to our processes. Hopefully, many of you will meet Tom over the course of the coming year.

Also on the call this afternoon are Brent Korb, our Vice President and Controller and Jeff Galow, our Vice President of Investor Relations, who will be available after my remarks to take your questions.

Today's call will include a brief overview of third-quarter results, the present state of our key market drivers, some financial metrics and an outlook for the remainder of 2006.

Today's comments 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 third-quarter earnings release is available on our website at Quanex.com.

I would describe the general business conditions of our third quarter as good, not outstanding, as we did experience an increase in sales for the quarter versus a year ago. However, we also encountered slowing demand for our window an door components, which I will discuss in more detail later in the call.

The Vehicular Products segment saw strong demand in the quarter with total bar tons shipped up 12% over the year-ago quarter. The steel mills ran at better than 95% capacity utilization and we came through our planned maintenance outage in July right on schedule and with our excellent reputation for delivery performance intact.

Digging a bit deeper into the segment's results, our light vehicle ton shipments in the quarter were up 10% compared to the third quarter last year. Substantially out-performing the market, as light vehicle build rates were only up 3% over the same period.

MACSTEEL continues to make very important inroads with both the Big 3 and the transplant automotive companies this year. For calendar year 2006, we look to earn some 100,000 annualized tons of new business with 75% of those tons servicing the Big 3 and the remaining 25% serving the automotive transplants.

While we are on the subject of the transplants, our expected light vehicle shipments to these customers in 2006 will approach 20% of all light vehicle tons shipped, while just two years ago, these shipments were less than 10%. Our growth for the transplants cuts across all powertrain components, engines, drivelines and transmissions. To be more specific, we are participating with them in areas like wheel hub assemblies, crankshaft, wheel bearing, shafting and gears.

Now that doesn't mean we are giving up on the Big 3 either. Further opportunities in crankshafts applications, wheel bearings, constant velocity joints, axles and stabilizer bars are there to be gained.

Turning to Vehicular's income, at first glance at least, the figures appear to be a bit disappointing with operating income this quarter of 40 million versus 48 million a year ago. However, this quarter's lower income is attributable to a difference in raw material surcharges between the two periods. In the year-ago quarter, scrap surcharges were very high while scrap costs were in rapid decline. In other words, the surcharge recovery was in a catch-up mode and at an unusually high level.

This quarter, our scrap costs and surcharges were relatively in balance as scrap traded in a fairly narrow range and having the majority of our customers on a monthly scrap adjustment formula mitigates volatility. History tells us that we don't over or under recover the surcharge for any extended period of time. And furthermore, volume is a much better indicator of the health of a business. The segment's operating margin for the quarter remained strong at 15.5%.

Turning to Class A truck demand, builds remained quite strong with 2006 calendar year estimates of some 350,000 units. You may recall that builds in 2005 were about 330,000 units. The OEMs continue to aggressively build ahead of new 2007 EPA Engine emission requirements. Therefore, you should expect this number to fall next year with most estimates coming in at 225,000 to 250,000 units.

Our 38 million, Phase 9 MACPLUS project at MACSTEEL remains ahead of schedule. The turning equipment is installed and going through shakedown at this time. We will be operational by the end of this month and we anticipate some financial benefits in our fourth quarter. This Phase 9 adds 50,000 tons of value-added capacity to our MACSTEEL, Monroe facility, which today has these services performed by outside firms. With the completion of Phase 9, some 70% of our bar shipments will have some form of in-house value-added processing, which helps bolster margins.

I have already suggested the changes in our steel scrap costs in the third quarter were relatively minor. However, in August, you may have read about the $100 per ton drop in number one bundled scrap costs, which could give us a bit of a spread benefit early in this quarter, assuming, of course, that those costs don't jump right back up in September.

Turning to the Building Products segment, we experienced record third-quarter sales and excellent operating income, primarily due to very strong demand for our aluminum rolled products and related robust material spreads. Our aluminum rolled products shipments in the third quarter represented a new record, up 5% compared to the year-ago quarter. Sales for the quarter were 161 million, up 29% over the year-ago quarter due to improved shipments in high LME ingot prices. Material spreads increased 11% compared to last year's quarter, the result of higher selling prices and relatively low scrap costs. Order backlogs were strong through the quarter.

Sales of our window and door components were about even to the year-ago quarter, while housing starts were off about 10% in the same period. Our ability to out-perform the market is the result of new program growth, which comes from several product areas, including patio doors, thresholds, window screens, and window sill bases with both existing and new customers. We had expected sales to be modestly higher than a year ago, but we did not experience the acceleration of demand we have grown accustomed to at this time of year.

Window and door component earnings were down in the quarter compared to the third quarter 2005 due to lower operating rates and relatively high labor costs. As demand slowed, we didn't react fast enough in reducing our manufacturing costs in response to the fall-off in business. As often happens when the market begins to slow, customers continue to hope for the best -- and because we're primarily a just-in-time supplier, we are subject to getting whipsawed as their outlook and enthusiasm ebbs and flows.

For example, we had a major customer fall well short of expectations in the quarter. Yet on the assurances that order rates would rebound, we continue to carry the higher costs needed to accommodate the expected pick-up in demand. Unfortunately, the predicted jump in demand never materialized and the end result wasn't pretty as we experienced a double hit of having both lower sales and higher costs. Needless to say, we are diligently working to correct this situation across our businesses in order to regain productivity performance.

At this point, I would like to turn the call over to Tom, who will take you through some of the Company's financial highlights.

Thanks, Ray. Let me begin by saying that I'm delighted to be part of the organization. For the whole two months now under my belt, I am very pleased with what I have seen at Quanex from the professionalism of the employees, the strength of its businesses, to the conservative financial nature of the Company. It is my desire to further these agendas with my business knowledge and background.

Having said that, I am pleased to report that Quanex continued to generate excellent returns and posted a 12-month return on invested capital of 19%. Cash flow was again outstanding. And for the first nine months of 2006, cash from operations was a very respectable $129 million.

Our cash balance at quarter's end was $61 million, essentially in line with our cash balance at the end of the second quarter. What makes this figure particularly notable is the fact that in the third quarter, we'd spent some $40 million buying back our common stock. We made a $15 million pension fund contribution and we also spent $18 million on capital expenditures.

We do expect to see continued strong cash flow in the fourth quarter based on continued strong earnings and lower capital expenditures as we wind down our Phase 8 and Phase 9 MACSTEEL expansions. Our strong cash generation will allow us to continue to grow the Company, both organically and through strategic acquisitions.

Looking at the capitalization ratio, and now using total debt less cash, it was 8.4% compared to 20% a year ago. We clearly have financial strength, which means that when the right growth opportunities come along, we certainly have the wherewithal as well as the inclination to accommodate them. Maintaining a strong balance sheet is important. And the management of the Company's working capital is part of that. For the third quarter, our conversion cycle, which is a measure of how long it takes us to convert customer orders to cash, came in at 37 days, a five-day improvement over the year-ago period. From my perspective, these are very credible numbers for a manufacturing company.

On another note, Quanex has a $310 million revolving credit facility that is scheduled to renew in 2007. Today, the Board approved management's request to move forward with a new $350 million credit facility that will run five years and we expect to complete this deal this year.

Let me close my part of the call with a comment about the dividend. The Board approved a 17% increase in our common stock dividend effective September 15th, which brings us to a $0.56 annualized dividend. This initiative demonstrates management's and the Board's consensus that the outlook for the Company continues to be bright. While it is true that we could see some future impact to earnings, particularly on the Building Products side of the business, reflecting a slowing near-term view of the housing market, I believe the Company's long-term prospects are very compelling. We are confident that in any modest economic slowdown, Quanex will continue to outperform the markets, produce healthy returns and continue to generate outstanding cash flow.

With that, I'll turn the call back to Ray.

Thanks, Tom. Moving the discussion to the market outlook, we expect North American light vehicle builds for our fourth quarter to be down 7% compared to a year ago. This reduction in builds will fall primarily on the shoulders of the Big 3 as transplant builds are expected to be up in the quarter. We are not anticipating a repeat of the dramatic slowing of demand like we saw in the fourth quarter of 2005 when our customers were working down pipeline inventories.

We expect our quarterly shipments to be up some 5% compared to fourth-quarter 2005 shipments. As we have said in the past, MACSTEEL's response to a significant falloff in builds is to continue to increase its content per vehicle with all the major automotive players, and indeed, new programs continue to kick in at MACSTEEL. The importance of these new programs cannot be ignored, and remain a primary reason why MAC is able to consistently outperform the market.

In the Building Products segment, we expect to see housing starts continue to moderate and look for 2006 calendar year starts to be down some 10 to 12% from 2005. Remodeling and replacement activities still remain at historically high levels, but we do expect to see slowing in the coming quarters.

The window and door industry is forecasting total window unit demand to be off single digits. For engineer products, we remain confident that our battery of new programs, both with existing and new customers alike, will allow it to continue to outperform the market.

The outlook for Nichols Aluminum remains favorable. Supply and demand fundamentals have shifted considerably over the last couple of years as the industry experienced capacity rationalization and demand has risen in this healthy economy. We also believe the high energy costs associated with the production of aluminum ingot will add to the competitive advantage of our scrap-based process.

As it relates to the fourth quarter, we look for Nichols' shipments and profits to be comfortably ahead for the fourth quarter 2005.

In summary, combining expected operating results of the two segments, we would expect to report diluted earnings per share from continuing operations for the fourth quarter in a range of $0.95 to $1.05, and for the year, $4.00 to $4.10. The guidance includes a provision for LIFO, which is some $0.03 to $0.06 in the fourth quarter, and some $0.13 to $0.16 for the year.

That concludes my formal remarks and we are now ready to answer your questions.

(OPERATOR INSTRUCTIONS). Peter Lisnic, Robert W. Baird.

Good quarter. If I could just ask a housekeeping question really quick. Can you give us the Nichols sales number for last year's fourth quarter? Just so we can get that into our models for modeling purposes going forward?

Did we have that out there?

We don't. Pete, we haven't released that information yet. We would probably do so when we put out fourth quarter earnings, sometime in early December.

Okay, but you have put out the second and third quarter, you're just going to wait on the fourth.

Ray, if I look at the Vehicular Products business, and it sounds like the surcharge in this quarter or in the third quarter was relatively de minimus. So we're looking at a business that generated an operating margin somewhere north of 15% in the quarter on relatively good volume. Have things changed? You have traditionally talked about this business being a 12 or 13, or maybe 14% operating margin kind of business. But you have put up a pretty good number here. I'm just wondering if the value-add is starting to add to the mix here? And should we think about this business as being a stronger profitability business than maybe what you have laid out in the past?

No, I wouldn't suggest that there has been a C change here. I think in the past, we've talked about mid-teens or so. Jeff, help me with this. Isn't that what we've put out there?

Yes, Pete, the last public disclosure we had suggests, and this was going back several quarters, that MAX returns would have been in the 10 to 13% was the number that we used. And that is going back for four or five years.

Okay, and you just did 15 though; that is what I'm getting at. Is the value add starting to improve the mix here and should we think about that 10 to 13 that you talked about quarters ago as being more like 13 to 15 or higher? I am trying to pigeonhole you, I know.

Right, well I'm not going to forecast the business going out, two years out or one year out. But I don't feel uncomfortable in thinking about this business with operating margins in mid-teens, which to me is 13, 14, 15.

That is what I was asking. And then, on my follow-up question, if I could, for Building Products, some of this, let's call it excess capacity or labor, whatever the term is that you carried in the quarter, any idea of how much that may have cost you in the quarter -- operating income or margin-wise?

Peter, we didn't quantify that. I just know that the performance on the shop floor was not what we like it to be.

Okay, and if you look at the new products that you are adding, the patio, patio doors, and thresholds etc., would those be in line with kind of your normal margin on the current product mix? Or are those potentially higher margin product, lower margin product? How do we think about that?

I would say in line.

Leo Larkin, Standard & Poor's.

Could you give us guidance for CapEx and DD&A for 2007 if you have it available?

Well, we expect CapEx to fall appreciably as we have noted before. And I would suggest in the 50% range of what we spent this year. And for depreciation, this year will be about 70 to 72, if I remember correctly. And next year, I would expect roughly between 70 and 75 at this stage of the game. We spent heavily this year, so it might be up a little bit, Leo.

And just one follow-up -- working capital, do you expect it to come down appreciably in the fourth quarter so that it is a little bit more neutral for the year?

Yes, I would say that -- I don't expect it to drop substantially in the fourth quarter. I think we had solid performance -- excellent performance, is the way I would characterize our third quarter. This is variable. I think we work real hard at controlling our working capital. And it is a function of how much we ship. And I would expect the conversion cycle to remain in line, close to that 40 mark that we have performed at.

Barry Vogel, Barry Vogel & Associates.

Ray, this year's capital expenditures I think are going to be about $75 million; is that correct?

Just a little below that is where it is going to come in, Barry, closer to 70.

All right, so let's say 70. And if your capital expenditures next year are about 50% of that, let's say we are looking at 40 million?

That is not a bad number.

And considering your balance sheet, your cash flow, your excess cash generation, your outstanding performance in most of your businesses, in particular your performance with getting more tons in vehicular builds, with a 2.7 million share authorization, I would think you're going to generate as much cash next year, again, with the drop-off in capital expenditures helping you significantly. So, were you limited to the amount of shares you continue to buy after you announced your buy-back of 1 million shares in the middle of the quarter?

Yes, the window did close on us, Barry.

So would it be safe to assume that now that the window is going to be open again, given your 8% net debt to capital and your prospects, that you probably will be fairly aggressive buying shares going forward? With the stock price where it is today?

Well, as we have indicated before, our first priority is to fund capital expenditures. That is going down as you so correctly pointed out. And then we do look at acquisitions and we do have some items in the pipeline. It doesn't mean that anything is going to be consummated, but we continue to look at it. And it is something that we have to keep in mind as we move forward. Share buybacks is certainly a way to return money to shareholders as well as dividends. We haven't hesitated to use all four for mechanisms and we will continue to do that in the future.

Timothy Hayes, Davenport.

Two questions -- first could you speak to building sheet conversion prices and what they have been doing say year-over-year? And what you have seen in the last month or so?

And then also, could you just repeat your outlook for the window and door market again? I just could not hear that clearly.

Yes, your first question is conversion price or cost -- oh, price, okay, I'm sorry. I was thinking cost. Conversion price over the last six months has drifted south a little bit. But spreads have remained healthy in total. So it is good operating margins on balance.

And the window and door outlook -- we have indicated that we expect housing starts to be down some 10 to 12% for the year. And that of course, suggests that at this time and going into the fourth quarter, the number to me is well north of 15%, actually, in terms of just single-family housing starts in order to get to that 10 to 12% number for the year.

And we would expect just the window and door demand now looking at it from a unit standpoint, to be down less than that; we suggested single digits. And the reason for that is better than half the units, door and window units, service the remodeling market and that, of course, we don't expect to be down nearly as much. So that is the outlook that we threw out there, Jim.

And just on the conversion prices again, are they slipping a little bit, recently, the last month or so, with the weakness that we're seeing in housing?

The answer to that is no. I think the weakening was several months ago.

Bill Baldwin, Baldwin Anthony Securities.

With the significant improvement in the last couple of years that we have seen out of Nichols Aluminum, Ray, has that at all changed the way that you kind of define or look at that business internally? It used to be that it was kind of described as a non-core operation. I just wondered if this improved fundamental environment and return on capital that we've seen has caused you to look at it a little bit differently?

Well, I think it is probably fair to characterize Nichols right now as an [earning protector] versus Building Products. We have looked into its possible sale, no question about that, to the point of holding discussions with potential acquirers. Those discussions generally were not satisfactory. In our mind, we're going to be walking away with multiples of EBITDA short of what we think that business is worth. We don't see ourselves as a metal consolidator though. And our priority remains to Building Products, to grow Building Products, as an acquirer and one who grows organically as well of the fabricated components businesses that make up Building Products.

We look at the cash generated by Nichols to be used to further these efforts.

(OPERATOR INSTRUCTIONS). Peter Lisnic, Robert W. Baird.

I guess I am back again. I forgot to welcome Tom to the conference call. So I figured I would do that.

And then if you could, Ray, I guess, the third quarter came in a little bit stronger than you were anticipating, based on your mid-quarter update. Can you just give us a sense as to what was stronger relative to your expectations there?

It was the vehicular side. We shipped more tons than we had forecast. It is always a little bit of a -- not guessing game, but we are always forecasting what our customers will pick up or what they will accept at the end of the month and we just did a little better than we had expected. I think spread was a little better as well for the month. So overall, vehicular did the trick for us.

And then on the acquisition side, as I guess this doomsday scenario plays out for the housing sector, are you starting to see multiples come down at all to where you might be able to pull the trigger on anything near-term?

We are in the process right now of looking at some things. So I think I will have an answer to that in the near future. I am just hesitating to respond favorably to that one right now. I don't have a sense of whether they are going to drop. You would expect some drop, because certainly the outlook is not as bright as it was a year ago.

And just one other quick one -- the percentage of volume or shipments that you have on a one month lag basis -- now, I think the last number we heard was around 70%. Is that still the right number?

It is.

(OPERATOR INSTRUCTIONS). There appear to be no further questions. I would like to turn the floor back over to Mr. Jean for any closing comments.

During the fourth quarter of 2005, demand for our steel and aluminum rolled products fell as our customers found themselves with too much inventory. For this fourth quarter, overall demand is expected to be better and we look to report higher sales. But we will have to remain vigilant to both rapid and unexpected changes in our markets.

There is little doubt that our markets are cyclical. And I believe we are going to get a demonstration of that over the next couple of quarters. However, no one is suggesting end of world changes in our markets. And the expectation of soft landings continues to be the order of the day.

And keep in mind that the long-term outlooks are indeed positive for both operating segments. That concludes our third-quarter conference call. Thank you.

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