Quanex Building Products Corp (NX) 2007 Q1 法說會逐字稿

Good morning. My name is Rich, and I will be your conference operator today. At this time, I would like to welcome everyone to the Quanex Corporation first 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. [OPERATOR INSTRUCTIONS] Thank you.

It is now my pleasure to turn the floor over to your host, Raymond Jean. Sir, you may begin your conference.

Good morning, and thank you for joining our first quarter conference call. Participating with me on the call is Tom Walker, our Chief Financial Officer, Brent Korb, our Vice President and Controller, and Jeff Galow, our Vice President of Investor Relations. At the conclusion of my formal comments, we will take your questions.

Today's call will include a brief overview of first quarter results, and discussion on the present state of our market drivers, a few financial metrics, and our outlook for the second quarter. 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 15th, 2006, for our complete forward-looking disclosure statement.

Our first-quarter earnings release is available on our website at Quanex.com. Business conditions in the first quarter were seasonally weak, as we faced significant headwinds in our end markets. However, we did see some backlogs begin to improve in some businesses late in the quarter, a hopeful sign of things to come.

North American light vehicle builds were off about 7% in our first quarter versus a year ago, while housing starts were off some 30% for the comparable quarters. At our Vehicular Products segment, first quarter steel bar shipments at MACSTEEL just about even to a year ago, held up relatively well given the 10% drop in builds experienced by the Big 3 auto makers, compared to the year ago quarter. The Big 3 account for some 80% of our light vehicle bar shipments.

The three steel mills ran at a combined capacity utilization rate of about 90% in the quarter, as we were able to move more tonnage to the non-vehicular markets, but I will admit that not all bar sales are created equal when it comes to profitability.

MACSTEEL made excellent penetration gains during 2006 with both its Big 3 and transplant customers. Specifically, 100,000 annual tons of new automotive program work was captured last year, much of which found its way to engine components, like camshafts and crankshafts, drive line products, like wheel hub assemblies and bearings, and transmission components, like gears and splines. In 2007 we expect both automotive and non-automotive business to grow by another 70,000 annualized tons.

Turning to Class A truck demand, builds were still strong, up 9% in the first quarter versus a year ago, mainly on the strength of November builds. January truck builds were flat to last year, and we look for builds to drop from here as the OEMs finish assembling partially completed engines to the old EPA specification during the first calendar quarter.

Turning to Vehicular Products operating income, it was off 25% from the year ago quarter. As I mentioned earlier, non-automotive bar sales do not necessarily have the same profit per ton as our automotive bar sales do, nor do they typically have the same value-added content.

For example, bars sold to the service centers have a heavier mix of standard chemistries, and fewer finishing processes performed on them, in part because our service center customers want to perform these value-added services, as part of their value proposition to their customers, so they perform much of that margin enhancing work in-house. Our automotive customers on the other hand, require the alloy grades, and they often prefer to have their bar supplier handle the value-added operations.

From a market perspective, the first half of calendar 2007 will remain a challenge for MAC as North American light vehicle builds are forecast to be down 4%. The good news is that we continue to expect auto builds to bounce back in the second half of the year, and I will discuss this issue in more detail in the outlook portion of the call.

Switching to Engineered Products, we had to deal with significant market deterioration again this quarter, as demand for our window and door components fell in the face of a substantial slowdown in housing starts, and frankly, we expect the business outlook to remain unfavorable here for at least another quarter.

We continue to capture new business from quality names like Therma-Tru and the Eagle window division of Andersen, but I don't look for those sales to really break through, until housing starts begin to recover later this year. Quarterly operating earnings for Engineered Products were down 35%, compared to the first quarter of 2006 when housing starts of that time were pacing at 2.2 million units on an annualized basis. Things got worse in January with starts off 38% from a year ago.

We continue to adjust staffing levels where appropriate, and with the seasonal housing uptick in sight, we do look for improved performance from the group in the second quarter compared to the first quarter, as customers begin to build inventory in anticipation of the spring construction season. We remain confident that once the housing market begins to improve, we will see rapid financial improvement at Engineered Products, because our products tend to be consumed early in the construction of a home, and because we are well positioned with the best brands in the window and door industry. Furthermore, we will get the positive leverage from having trimmed fixed costs during this downturn.

Shipments in our aluminum sheet business were down about 14% in the quarter, an acceptable performance considering the significant drop we experienced in the residential building market. Revenues were essentially even with last year due to continued high LME pricing. Material spreads remain strong, up 10% compared to this quarter last year. We are encouraged by the pickup in backlog we saw at Nichols in January rising some 20% above December levels, as our sheet customers began to book product ahead of their anticipated spring building needs.

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, and good morning to all on the phone. Quanex continued to generate excellent returns and cash flow. Our latest twelve months return on invested capital was 17.4%. Cash from operations remained robust at $66 million, versus $39 million a year ago. Our cash plus short-term investments at quarter end were $158 million, a 49% improvement from a year ago. We expect to see continued strong cash flow in 2007, based on healthy earnings and significantly lower capital expenditures. The combination of our strong balance sheet and excellent cash generation positions us to continue funding our organic growth opportunities, and to pursue strategic acquisition targets.

On February 1, we closed the acquisition of Atmosphere Annealing Inc., a $46 million end sales heat treat business that we will bolt-on to MACSTEEL. We paid cash for the acquisition. AAI serves both the Big 3 and the transplant automotive companies with cut piece heat treat processes, a service that MACSTEEL could not provide internally.

Like MACSTEEL, AAI enjoys an excellent reputation in the automotive industry, in part due to their ability to provide customers with metallurgical solutions that meet their most demanding applications. They offer a great value proposition to their customers, and this melds very well with MACSTEEL's approach to the market.

Looking at the capitalization ratio, our debt less cash was about 2%, compared to 10% a year ago. We clearly have the dry power, so that when the right growth opportunities come along, we have the capacity as well as the inclination to accommodate them.

Maintaining a strong balance sheet is critical to our long-term prospects, and managing our working capital remains an important part of that process. For the first quarter, our conversion cycle, which is a measure of how long it takes us to convert customer orders to cash, came in at a very competitive 36 days.

With that, I will turn it back to Ray.

Thanks, Tom. Moving the discussion to the market outlook, we expect total North American light vehicle builds for calendar 2007 to be essentially in-line with last year. Digging a bit deeper, we expect 2007 builds at the Big 3 will be down 4% from last year, while builds at the transplants are expected to rise 10%.

Based on an improving backlog, we expect MACSTEEL's second quarter shipments to be about even with the second quarter of 2006 shipments. One of MAC's responses to a fall-off in builds is to continue to increase content per vehicle, and we have new programs coming on in calendar 2007 for automotive steering yokes, wheel bearing hubs, and gears for continuously variable transmissions, to make that happen.

We expect to remain active in non-automotive markets as well. For our Building Products segment, we believe housing starts have currently bottomed at a 1.4 million annualized rate. We expect new home construction to remain under pressure through the first half of calendar 2007, then begin to rebound somewhat in the second half.

This outlook means another tough quarter or two for Engineered Products, although we expect to see some benefit from the relatively better remodeling market, as well as from new programs with existing window and door customers.

The outlook for our Nichols Aluminum remains cautiously favorable, in buying scrap at the lowest possible price and increasing their overall value-added mix remain priorities. We are encouraged by the strong pickup in the January backlog which continues to build. Shipments for the second quarter are expected to be near year ago levels.

In summary, considering the external market realities we face, and our current positioning within those markets, we expect to report diluted earnings per share from continuing operations for the second quarter in a range of $0.70 to $0.78. Guidance for the year remains unchanged pending greater clarity in both the timing and magnitude of improvements in the Company's primary markets. That concludes my formal remarks.

We are now ready to answer your questions.

[OPERATOR INSTRUCTIONS] Your first question is from Mark Parr of Keybanc Capital.

Good morning, guys.

Good morning, Mark.

How are you doing? Hope it is warmer down where you guys are.

It is a mid-70's day. Nothing like the south this time of the year.

I can tell you it is mid-70's in Cleveland, but I would be lying to you. [laughter] I was wondering if you could give a little more color on the fixed cost cutbacks that you have made, and how much of a benefit you derive from that, or how much cost you have incurred as a result of it?

I don't have a number off the top as far as what we have achieved, but we are pruning back our fixed expenses, and at one of the Engineered Products businesses in fact, we are looking at some substantial reductions this week again, so the process continues. I think one has to take advantage during these tough times, to take the tough actions that position or will position us very well, when we start coming out of this, so again, I don't have a quantitative response to you, but it is an ongoing process.

If I can ask one follow-up. In the bar steel area at MAC, you had indicated second quarter would be looking flat from a shipment basis. Could you give us an idea of what base price realizations are looking like heading into the seasonal strength of the period, and also what you are expecting as far as scrap costs for the March buy? Then I will pass it on. Thanks.

In terms of pricing, I think our price for our contract work as we have indicated is pretty much in-line with last year. The spot market continues to move in that scrap pricing has rebounded certainly over the last 60 days, and so prices have drifted up, but as I have indicated, our margin on a per-ton basis is not as good on that work, has not been as good.

Near term I expect scrap pricing to keep drifting up. In fact, I was just reading this morning a big jump in bundles for March of some $53, so there is a lot of pressure in the scrap market, I think paced by iron ore pricing and demand, so there is certainly upward pressure on scrap pricing.

Okay. Terrific.

Thank you. Your next question comes from [John Halshultzer] of Robert Baird.

Good morning.

Good morning.

Can you guys just kind of elaborate on the other markets that you're finding for MACSTEEL's products, and just if you're seeing particular pockets of strength that could last kind of past 2Q if necessary?

Yes. I guess, you know, we are going to service center outlets more than we normally do. We certainly have some customers that are focused on oil patch, and we are pushing hard in that particular segment. Agricultural equipment remains strong.

I know our Nitrotech business and quench and temper products were doing very well there, strong demand, and construction equipment remains pretty well, so in defense I would say where we don't move an awful lot of product, I think it has been steady for us, but so on balance I would say that the secondary markets where we tend to go to are just a little stronger, are displaying a little more strength than our automotive customers.

Okay. And then I guess as a follow-up, just because of the mix issue, and that these aren't as value-added, is it safe to say that the investments you made at MACSTEEL Monroe you are really not, aren't really kind of showing up in margin yet?

No. Some of that is showing up in margin is what I would have to say. In fact, we are not quite up to capacity, but we're very pleased that the way we have been able to ramp that up, so some of that work was being done outside. Remember that, and is now being done in-house, but we will be operating that plant at capacity very shortly. I am talking about the secondary operation.

The value-added. Okay. I will get back in queue.

Thank you. Your next question comes from Robert Kelly of Sidoti.

Good morning.

Good morning.

Good morning, Robert.

Had a question on the backlog jump at Nichols. Is there more to that than just seasonal pickup and volume? Can you elaborate on that?

No, I think it is pretty much the seasonal pickup. That is the way we read it. You know, the big guys that support, that are driven by the housing market always start early, and they do build some inventory in anticipation of the spring construction season, so we believe that that is what is going on, and so we have just been encouraged versus, you know, the low backlogs that we have had during the fourth calendar quarter, so just an encouraging sign.

And then a follow-up, are you expecting I guess for 2Q for us to bounce along this 1.4 million annualized start level?

Q2 calendar?

Yes.

I would expect to see a slight uptick from there, but not much. Are we going to get to 1.5? I am not sure.

Okay. I appreciate it.

[OPERATOR INSTRUCTIONS] Your next question comes from Barry Vogel of Barry Vogel & Associates.

Good morning, gentlemen.

Barry, how are you?

Good, good.

Good morning.

First question I have is for Mr. Walker about the amount of goodwill on the AAI acquisition.

Yes. We didn't actually break that out separately.

Can you give it to us on the phone, on the call?

Not our policy to do that.

Aren't you going to have to put it out, it is going to be in your public information, won't it?

Well, we are going through the final valuations now, and when we fine tune that, we will put that in your disclosures going forward.

Okay. And Mr. Jean, I have a couple of questions for you. Is there a phase 9 in your future?

Not, it would be phase 10, Barry.

Sorry.

But is there a phase 10 in our future? I would have to say there will probably be a Phase 10, but it is not on the drawing boards right now.

Okay. As far as the commentary about new business for MAC, it gets a little confusing to me. Last year you talked about 100,000 tons of new business, and I know it didn't happen right at the beginning of the fiscal year, and so if you can elaborate, how much on the 100,000-ton comment, how much tonnage in fiscal '07 do you expect to get, versus what you had already received in fiscal '06, and then you have made a comment about 70,000 additional new business, and could you explain to us, you know, in fiscal '07 if that is a separate item from fiscal '06, you know, from the 100,000, what would we be likely to see on that additional 70,000 tons in fiscal '07?

Yes, well, certainly let me take the easy portion first. The 70,000 we do expect, that is distinct and separate from the 100,000 that we talked about last year. And of the 70,000 for this year, a good portion that far will be realized this year, because some of it is non-automotive, for example, and some of it is automotive, and we will get a good chunk of that is the way it works out for this year. I don't have precise percentages on this and going back to '06, I don't have the answer off the top of my head, Barry, on of the 100,000, the effective rate that we captured in '06 of that 100,000.

I would be curious, you know, if Jeff can get that, it would be helpful, because if you had gotten 170,000 of new business in the last year-and-a-half, that's pretty [darn] good.

Yes. I think we can lend some clarity to that. Jeff, do you want to add something to this?

Yes, Barry, let me just add on the 100,000 new tons last year, that was of course, primarily automotive, and my recollection is a bit more than half of that came in the back half of calendar '06, but let me pull some numbers, and I will get something a bit more precise on that.

That's great, and Ray, I know you didn't buy back any shares in the quarter, and the question is, it didn't have to do with the AAI acquisition alone, or could it be some other reason?

There was certainly that was the big one for most of the quarter, and then we got close to the end of the quarter, so we got it our quarter pretty well closed, for AAI and other reasons.

And, Barry, this is Tom. In a general sense, though, we are an inquisitive company. So it would not be unreasonable to expect that we would be, that it would avoid, that feature would avoid our ability to go to the capital markets and acquire stock. We have authorized a little over 2.5 million shares to repurchase.

Thank you.

Thank you. Your next question is from Timothy Hayes of Davenport.

Good morning.

Good morning, Tim.

Just to clarify the guidance for Nichols volume in Q2, did you say you expect it to be flat from a year ago?

Yes, that's right, Tim.

Okay. Just looking at some of the macro data, we are seeing housing starts year-over-year remaining down some 20%, whether you look at the first quarter '07 versus a year ago, or the second quarter of '07 versus a year ago, so I was surprised to see that kind of guidance for Nichols. Is that due to any customers restocking inventory, or is that more or entirely due to market share gains?

Yes. Well, let me address the latter first. No, I would not consider this to be market share gains. I agree with you on your characterization of the market, in terms of where it is at today, and the fact that it is going to keep rocking along this level, perhaps with a slight uptick in the second quarter, but I am certainly not anticipating much, so no, I think it is our customers, you know, building in anticipation of the season, and certainly we are under the impression that inventory levels are pretty far down, given that aluminum pricing has been up, people were anticipating late last year that it would drop, so I think the pipelines are pretty well bare bones, and so there is clearly inventory restocking going on, and should builds not develop to expected rates, to me it would mean that we wouldn't see a strong third quarter, things would be, you know, more flat or down or whatever, you see, so there could be inventory adjustments moving forward if indeed sales are not realized, in accordance with their expectations.

Great. I guess what I am still puzzled on, is that if they're rebuilding inventories for seasonal reasons, they would have done the same thing last year. I am just, and if so, then how can you have flat shipments, if housing starts could be down some 20% from a year ago? It just seems -- ?

Might have to do with inventory levels. They could have had heavier inventory levels at this time last year.

A follow-up question on, if you could help us out with some corporate expense guidance for the second quarter, and then out quarters thereafter?

I think the way I would approach that is just to tell that you we have about 2.5 million of unusual items this quarter. They were stock option related and deferred comp related, pursuant to the increase in our stock price as a company.

We also at the SG&A line enjoyed last year a reversal of about 2 million of an accounts receivable write-off. We were able to collect it, so on a comparative basis, it is 2 million more difficult year-to-year, so with that, I think you can just pull those unusual items out and then trend it on that basis.

Okay. Thank you.

Thank you. Your next question comes from Bill Baldwin of Baldwin Anthony Securities.

Good morning.

Hi, Bill.

Hi, Bill.

Good morning, gentlemen. Can you comment on what you are seeing in the marketplace on aluminum pricing, here recently, say in the past few months, what the trends are?

I would say flat to down slightly, no real big change, Bill.

So spreads are holding up pretty good, then at this point, versus where they were in the first quarter, then?

Correct.

Okay.

Some of that has to do just to give a little more explanation on that, you know, certainly some of that has to do with the difference between LME and what we are paying for scrap, so--,

Right, right.

But in total spreads remain very strong.

Thank you very much.

Thank you. There appears to be no further questions at this time. I would like the turn the floor back over to management.

For 2007 we are confident that quarterly demand will improve sequentially for us through fiscal 2007. Our markets are both seasonal and cyclical, and our businesses are also very short cycle, so our ability to quickly make mid-course corrections to changes in the marketplace is a key success factor for us.

Overall, we remain encouraged by the healthy state of the economy, low interest rate, and wage and job growth. We believe the long-term prospects of our consumer driven markets are excellent, and we are well positioned to outperform them. That concludes today's call. Thank you for joining us.

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