Quanex Building Products Corp (NX) 2007 Q2 法說會逐字稿

Good morning. My name is Mikaela, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Quanex Corporation second 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, Chairman and CEO, Raymond Jean. Sir, you may begin your conference.

Good morning, and thank you for joining our second quarter conference call. Participating with me on the call today is Tom Walker, our Chief Financial Officer, and Jeff Galow, our Vice President of Investor Relations. At the conclusion of my formal comments, we'll take your questions. Today's call will include a brief overview of second quarter results, a discussion on the present state of our market drivers, a few financial metrics, and our outlook for the second half of the year. I will also have a few remarks concerning our recent strategic review announcement.

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. The current earnings release is available on our website at Quanex.com.

Business conditions in the second quarter were weak, particularly in our Building Products business. However, overall demand improved significantly through the quarter. It was considerably better when compared to the first quarter, and we do remain encouraged by the prospects for the third quarter. At the Vehicular Product segment, second quarter sales were up 14% versus a year ago, tons shipped were up 5%, and more importantly, these tons had a richer mix of value added automotive bar products compared to last quarter. North American light vehicle builds were off 3% in our second quarter versus a year ago, with Big Three builds down 7% and transplant builds up 5%. We were able to outperform the market, in part thanks to new programs with both the Big Three and the transplants, and we remain on plan to win some 70,000 annualized tons of new automotive business this calendar year.

Turning to Class A truck production, builds were down 26% in our second quarter compared to a year ago, as the OEMs are now required to build new diesel engines that meet the higher 2007 EPA emission standards. Our three MACSTEEL mills ran at a combined capacity utilization of over 90% in the quarter, but we are still relying on some non-automotive bar shipments to keep us there. Vehicular Products operating income was off 12% from the year ago quarter. Non-automotive bar sales typically have a lower profit per ton as compared to our automotive sales because of their lower value-added content. I'm pleased to report that the integration of Atmosphere Annealing into MACSTEEL is proceeding well. Like MACSTEEL, AAI enjoys an excellent reputation in the automotive industry due to its ability to provide their customers with metallurgical solutions that meet demanding applications. They offer customers a great value proposition, one that melds seamlessly with MACSTEEL, enabling us to reconfigure the value chain and offer a one-stop shop sale. Reviewing Vehicular Products from a market perspective, the first half of fiscal 2007 was challenging. But the MACSTEEL team reacted well to the slower demand environment. The outlook for the second half of the year is certainly more favorable than the first half, and I'll discuss this in more detail in the outlook portion of the call.

Switching to our Engineered Products group, we had to deal yet again with a sizable market correction as demand for our window and door components in the quarter fell in the face of a 24% reduction in housing starts versus a year ago. Our sales were off about 19% in the quarter versus the year ago quarter when housing starts were close to 2 million annualized units, so we still have difficult market comparables to contend with. On the bright side, we did see a seasonal pickup in business as the quarter unfolded and housing starts are now bouncing along at about 1.4 million annualized units. More good news came from our Mikron business, where inventory and staffing issues that caused us financial heartburn last year have been addressed, and the result is much improved operating income per unit of output. Across all Engineered Products businesses today, strict cost controls remain the order of the day, and we will eventually see positive leverage from having trimmed our costs during this downturn.

I am also very encouraged by the amount of new business we continue to capture with the best brands in the industry. For 2007, new products in areas like window screens, divided light window grills, retractable screen doors and front door entry systems continue to build. This new business will be building considerable momentum during our third quarter and will place -- and will pay sizable dividends once the weak housing market turns. The seasonal housing uptick we are experiencing gives us some reason to cheer, and we do expect to report better financial results for engineered products in the third quarter compared to the second quarter. Specifically, housing starts in our third quarter are expected to be off some 13% from a year ago. But we now expect sales on Engineered Products to be within 5% of sales from the year ago quarter.

Shipments at our Aluminum Sheet business were down 7% in the quarter versus last year, acceptable performance considering the big drop being experienced in the residential housing market. You may recall that some 35% of Nickel sales are in markets other than building and construction, which is now helping cushion the blow to overall shipments. Nickels revenues in the quarter were on par with last year due to continued high LME pricing. Operating income was off due to reduced shipments and a reduction in value-added painted sheet sales as a percent of the mix. Much of our painted sheet is used in the construction and remodeling of homes. At this point, I'd like to turn the call over to Tom, who will take you through some of the Company's financial highlights.

Thanks, Ray. Quanex continues to generate solid returns and cash flow. Our latest 12 months return on invested capital was 15.7%. Year-to-date, cash from operations remained excellent at $84 million versus $67 million a year ago. Our cash plus short-term investments at quarter end were $104 million after paying some $58 million for Atmosphere Annealing We expect to see stronger cash flow in the second half of 2007 based on improved earnings and lower capital expenditures, primarily at MACSTEEL. Looking at the capitalization ratio, our debt, less cash and investments, was about 3% compared to 8% a year ago. We have a strong balance sheet, and managing our working capital remains an important part of that process. For the second 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 34 days. With that, I'll 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 2006 builds of 15.3 million units. However, second half 2007 builds are expected to be up over first half 2007 and second half 2006. This expected rise in builds can be seen in our current backlog in MACSTEEL, which today calls for a richer mix of more value-added automotive tons in the second half of our year. Based on this improving demand, we expect MACSTEEL's third quarter shipments to be about even with third quarter 2006. The margin squeeze MACSTEEL experienced in the first half of the fiscal year due to rising steel scrap costs is expected to turn in our favor in the third quarter, as scrap prices have dropped sharply since April.

For our Building Products segment, we believe housing starts have currently bottomed at a 1.4 million to 1.5 million annualized rate, and we do expect new home construction to remain under pressure through the remainder of the calendar year. However, the market did experience a nice bounce in April, the result of aggressive incentives on the part of the home builders, a practice we will likely see accelerate as they work down high inventories. While the near term outlook for new home construction is not particularly bright, we do believe that between the positive impact of our new programs and the seasonal uptick in the construction season, Engineered Products operating income should exceed both last quarter and the third quarter of 2006. Our outlook for Nickel's aluminum remains guarded, with volumes expected to be off in the second half of 2007 compared to the second half of 2006. Material spreads, while still strong, are expected to slip in the second half of 2007 compared to the year ago period, driving down costs at Nickel's, while increasing their overall value added mix will remain priorities.

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 third quarter in a range of $0.90 to $0.98, which includes an estimated $0.03 per share LIFO charge. We raised our annual guidance to the higher end of our previous range, and we now expect to earn between $3.35 and $3.60 per diluted share from continuing operations for fiscal 2007. Our annual guidance also includes a $0.10 per share charge for LIFO.

Before I conclude my formal remarks, I'd like to comment on our May 16th press release dealing with the strategic review of our Building Products group. Some of you have asked why sell the Building Products group now. So let me address this. Remember that we have not determined we are selling Building Products. If you were to analyze our enterprise value to EBITDA multiple over the last five years, you would find that our multiple trails other steel, aluminum, and building products companies. We now believe it is an appropriate time to explore our strategic alternatives for Building Products to determine how to best unlock shareholder value. Looking at Quanex today, we have built two successful, competitive business groups in their respective industries, and we want to ensure that these businesses are as well positioned as possible to capitalize on opportunities when the cycle turns. We believe this review is timely, not only because of the strength of the business, but also because of the current strength of the financial markets, which make all the options we are considering available to us. I'll close by saying that during this review process, we will not speculate as to the timing or ultimate outcome of this review. That wraps up my formal remarks, and we are now ready to answer your questions.

Ladies and gentlemen, management has requested that you please limit your questions to just one question and one follow-up before coming into queue. (OPERATOR INSTRUCTIONS) Peter Lisnic, Robert W. Baird.

Ray, if I could ask a question on Engineered Products. The second quarter, very healthy margin there, so things turned around nicely. You alluded to Mikron. I'm just wondering if you could give us a bit more color as to what drove the sequential margin and operating income improvement in that business? And then the second part of that question is where do you see it going? Or at what point do you kind of see Building Products -- or Engineer Products, excuse me, returning to more normalized operating margin levels, if you will?

Okay. Certainly, addressing the Mikron question first. you'll recall that last year at Mikron, we were having some operational difficulties where we were not able, because of some union activity, able to adjust the size of our workforce in keeping with the drop that we were experiencing in the marketplace. And there were some other operational issues, as well, which just eroded some of our margin rates there. And that's what we're in the process of fixing this year. So we're really pleased about the progress that's being made. I don't think we're there yet, but we're pleased with the progress that the management team is making. As to returning to normalized rates with operating margins, I think we do need to see some uptick in the market to get us there. I'm pleased that we've got some nice, new program work that's going to enable us to essentially perform at nearly at last year's sales level. And that's just -- I think that's great stuff that our operating guys are delivering. But I wish the market were stronger. A rising tide will lift all boats and I need some of that to restore margin rates to normal levels.

Okay. And if you kind of -- if you look at what you've done over the past couple of quarters in terms of improving the operations and streamlining the cost structure, do you look at the business now as structurally a more profitable business than it was, say two years ago? In other words, when the tide rises, will your boat be higher than it was in the previous cycle?

Yes, we'll have a stronger lever, so to speak. This is what we talk about amongst ourselves, that now is the time to take that action so that you reduce your fixed nut, and when volumes come back, you can look good.

And when you talk about that, kind of where do you shake out in terms of is there a metric that you point to? Do you think of this as being like a 15% operating margin business? Or some certain return on capital? Is there a metric out there that you think you could get to with a normalized Building Products environment?

Well, I think we can certainly get back to where we've been. I'm going to fall short of forecasting exactly where we're going to be, Peter. But we'll improve. There's lots of room to improve.

Okay. And then my second -- or actually my ninth question, probably. But my second unrelated question, I guess. In terms of the transaction, the spin-off, or however you want to phrase it, let's say nothing happens there, hypothetically speaking. I know you're not going to get into alternatives and all that. But I mean, it's in your portfolio now, you're running it. So assume nothing happens. Has anything changed there in terms of business strategy? In other words, do you still see yourselves as sort of the leading player in that Engineered Component space, and as a consolidator in that industry?

Well, I mean we certainly have not -- we're not turning down any business prospects on a go-forward basis. We're still open for business. We're running this as if it's ours, which it is. And we'll see where it takes us. We've got tough comps out there. As you know, there aren't -- I don't think there are any public companies that exactly have the makeup that we do. So we'll take it a week at a time.

And would you look at an acquisition for that franchise right now? Or is that kind of off the table?

Nothing is off the table. I mean, we're still open for business.

Okay. Great. Thank you very much.

Steve Velgot, Cathay Financial.

Just two questions from me. The first is, if there are any strategic benefit or synergy between the two Building Products companies, the Engineered Building Products and the Aluminum Sheet business? And then the second question is can you give us any help in thinking about the tax basis of those two businesses?

The first question having to do with the business relationship that may or may not exist between aluminum and engineered business units, the answer to that is there's really not. I mean we do consume some aluminum at one of the business units. And they do source from Nickels, but it is done at arm's length. As to your second question related to tax, no, we're not going to go there. I think some of that will come out as part of the process that we're going through now.

Okay. Thank you.

Robert Kelly, Sidoti & Company.

Just a question on the guidance you've given for fiscal '07, specifically the fourth quarter. If you're expecting the housing to kind of be flattish throughout the year here, what's kind of driving the improvement to the high end of the range you've currently given?

I think a couple things. I pointed out that we're building some good momentum in the third quarter with some new programs that we've got on the Building Products side. That's certainly one factor. We expect that to continue into the fourth. The other one is on -- certainly on the MAC side. You'll recall that last year, builds were down at that period of time. We are expecting a stronger second half of this year, as we pointed out, so -- to include the fourth quarter. So some of that is being driven from that side of the business, as well.

Is the mix of, I guess the more power train components, will that drive the margin structure at MAC to look like the back half of last year? Or is there still too much alternative or non-automotive dragging it down?

I would expect that we would be -- that we'd have a decent mix in the second half, and we've pointed that out. Certainly, this year's first quarter, the mix was not so good because of the need to go to secondary markets more than we like, and less so in the second quarter. The third quarter, I'm not expecting to go to secondary markets all that much. We'll go some, but not nearly as what we've done in the first and second quarters.

Okay. And then one more, if I may. With the strategic review underway, are you all -- you're still sitting on a lot of cash here. Are you precluded from doing anything with that? Dividend increase, stock repurchases?

The -- as we noted, we ended the quarter with $104 million of cash. We're not -- I guess we could engage in share repurchase or we could increase a dividend. There's no limits on that, other than it may be appropriate to keep our powder dry until the outcome of the process is known.

Okay. Thank you very much.

Timothy Hayes, Davenport.

I just had a few maintenance questions on the Vehicular Product side. First, the base pricing for '07, was that essentially unchanged from '06? Or was that -- did that end up coming in down modestly from '06?

It was pretty much in line, Tim.

Okay. And you were doing an upgrade at Monroe during the quarter. Did that -- was that completed? You were upgrading to be able to have some capacity to do higher value-added processes there?

Yes, seems to me we kicked that up in the third quarter last year. We were still in the ramp-up phase in the second half of last year. That's where we were with that.

Okay. And then in terms of your turns per week for the quarter, usually you run about 16. Were you plus or minus that number in the quarter? And then how does that compare from -- to a year ago?

Tim, this is Jeff, let me help with that a little bit. For the second quarter, MAC, the three MACSTEEL plants combined, ran north of 90% utilization. That was probably just a bit better than third -- from second quarter last year. And if you'll remember, things were slowing at MAC a bit through the back half of last year. That's why the comps should look a little better for us this second half versus second half last year.

Okay. And can I pursue with a couple other questions?

Yes. Go ahead.

All right. The -- just to clarify your guidance on Engineered Building Products. Did you say that you expected sales to be up 5% from a year ago? Or within 5% of a year ago?

We said within 5%.

Okay. And my final question is we've heard for the last couple of years there's been a lot of import pressure on the -- on aluminum semis out of China coming into the U.S., starting with extrusions, and then more on the flat rolled products. Has that import pressure on the flat rolled products, has that accelerated over the last, say last -- since last November or so?

I don't have evidence that says it's accelerated. I think it's there, and -- it's there. I think it is a factor, but I don't think it's accelerated.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) Barry Vogel, Barry Vogel & Associates.

Ray, I have a question on the tonnage for MACSTEEL. And it's just partially a little confusion when you talk about these new programs and you mention calendar year. And of course, I look at your Company on a fiscal year basis. And so if you can just give me fiscal '07 versus fiscal '06. And then perhaps give us a little peek into fiscal '08 versus fiscal '07, in terms of the incremental tonnage from you have been using the term new programs in tons for the fiscal year.

Barry, this is Jeff. Let me help you there where I can. We disclosed -- and this is done on a calendar year basis. And I'm not going to be able to take it beyond that. If we recap some of our progress last year calendar at MACSTEEL, we talked about bringing on some 100,000 tons of new business. And that is still coming in. That's annualized tons. So I may have gotten, as we talked about, I think mid quarter a year ago, we talked about quite a bit of that coming in the back half of calendar '06. If we set that aside, let's look at new business above and beyond our previous comments. We're tracking some 70,000 tons of new automotive business for calendar '07. Again, that's annualized. So will some of this stuff mix and match and cross, the answer is yes. But we are speaking to new programs, automotive-related, annualized on a calendar basis.

So to make this clear to me because sometimes I'm not so sharp, does that mean over the period from when you started with these new programs to where you are now with the new programs, what would be the combined positive effect in tons sometime by '08? In other words, is it 170,000 tons?

Yes, let me just -- well, I can't be terribly precise. If you were -- if we were to have this conversation at the close of fiscal '07, we would have roughly the 100 and some part of the 70. If we had this conversation, hopefully at the end of fiscal '08, basically all of that 170,000 would have weighed in. The 100 certainly, and certainly the majority of the 70.

Okay. And of that 170,000 new tonnage, can you break it up between the transplants and the Big Three?

I can -- I won't be terribly specific. I would suggest to you that more than half of those new tons are coming in from the Big Three. I would add to that, however, that our growth with the transplants continues. And over time, you should look for our general mix with the transplants to continue to increase versus the mix with the Big Three. And that's from two areas. One, simply market share growth by the transplants. And then secondly, as they continue to source more components domestically, we obviously hope to capture more than our fair share of that.

All right. That's really great. Now, Ray, going back to steel, you've talked about 75% value-added mix for MACSTEEL. Can you give us some idea roughly what the first and second quarters were individually, and what you would expect the fourth quarter to be in terms of that -- looking at that 75% number that you've talked about?

Yes, Barry. I don't have those numbers off the top here. I know that our -- just looking at the MAC plus component of that, I know it was off some 600 to 700 basis points in, I think it was in the first quarter. I don't know what the second quarter was. So we're off considerably from where we were. And that -- it changes monthly. It just depends on what we're shipping.

All right. So obviously, you're optimum mix is not there right now, and you hope to get back to it in the future?

Correct.

Okay. Tom, I have some questions for you.

Shoot.

You've mentioned LIFO for the year at about a $0.10 impact. Can you give us what the impact was in the first and second quarter?

We had no impact in the first quarter. We had a $3 million impact in second quarter. And it's roughly $0.05 a share.

$0.05. And going back to the CapEx and the D&A for the year, excluding the AA1 -- or the AAI acquisition, what are we looking for in CapEx this year?

Well, we're going to be lower than last year, we're going to be in the $30 million to $40 million range, maybe $30 million to $35 million range.

Okay. And D&A I think is right on, it's still at $78 million.

Yes.

Can you tell us a little bit about accretion from AAI? Because obviously, from based on your press release, it did well or better than you expected. So was there accretion in the quarter?

It generated $1.6 million of profits, operating profits in the quarter.

And that was for the whole quarter, three months?

Yes. And you'll see that in our Q.

Okay. Fine. Ray, I have one more question for you. You talk about elaborate new programs for Building Products, but you never give us any details. Can you give us some color on these new programs for Building Products?

Well, the -- the biggest actually has to do with door entry systems. And those are largely thresholds. And that's a big one. Another one has to do with screen doors, a different type of screen door. Another one has to do with TruScene, which is a new screen product that's marketed by a big wood window manufacturer. You've probably seen the ad on "Dancing With the Stars" and so forth. It's been featured on a number of commercials. We're the exclusive manufacturer of that product. And so just some good things in the pipeline.

Can you tell us some of the brand names we're talking about upon mentioning these different products.

Just think about the brand names in the industry.

By the way, what makes you think I watch "Dancing With the Stars?"

Barry, that's what people do in North Carolina.

Oh, really? Now as far as -- one more question. As far as the stock buyback program, considering you didn't buy shares at $30, why would you consider buying shares at $50?

We've been -- we've been in a blackout period for some time, Barry.

Right. So you're not -- .

So we couldn't buy at $30, I guess is what I'm telling you. But I think our stock price remains attractive.

Okay. So then you mean you're not closing the door on possibly buying shares in these price -- where it is -- approximately where -- around this area?

We haven't closed the door. I think I indicated earlier that given our situation, that we certainly have an inclination to keep our powder dry until we decide on the outcome of our process here. But time will tell. We've used that option in the past. And we will not hesitate to do that in the future again, if we think it's appropriate.

Thank you very much. You continue to do a great job. I appreciate it.

Thank you.

James Gentile, [Newlin] Capital Management.

Ray, you mentioned twice that you wanted to keep your powder dry during the divestiture -- during the strategic alternative process for Building Products. And I can't common sensically find the relationship as to why you need to keep the cash on the balance sheet during this process.

Well, it -- again, depending on the outcome, let's just go down -- well, you can imagine a scenario where you would want to pass off that dry powder to a new entity, for example.

Okay. So -- okay.

And I'm not -- we haven't said we're not going to. I was just kind of opening up with you a little bit and indicating the inclination right now.

I got you.

But it could change.

Because I guess prior to the announcement of the portfolio review, I guess conventional wisdom was that that cash would perhaps be used to expand through acquisition the Engineered Products piece of the business. That's always been kind of structurally part of the story. So I was just making sure that in the event, for example, that the strategic review does not result in anything, and that Building Products remains part of Quanex's portfolio, would you return to the -- an acquisition environment in the Engineered Products business?

Well, as we indicated earlier, we haven't shut out the acquisition possibility under the current situation. So we remain open to doing acquisitions. It remains certainly a high priority item with us. But we've also used dividends and stock buybacks to return cash to shareholders. At the end of the day, it's all about shareholder returns, and we're very, very mindful of that.

Great. Thank you very much. Excellent job so far.

Thank you.

Leo Larkin, Standard & Poor's.

Could you give us any preliminary guidance for CapEx and DD&A for fiscal '08?

Leo, you're just a little early. We're going to be going through our strategic review planning process in the next six weeks or so. And I'll have a better answer for that at the next conference call. So I can tell you this, that we don't have any major maintenance-type programs or big expenditures for organic growth purposes. I think we've got -- given what's happening on the -- what has happened on the housing side and so forth, we've got I think adequate brick and mortar. So it would be certainly maintenance or franchise spending and new growth opportunities, say, that I'm not thinking of right now. But generally, I think the level would remain below certainly what we spent last year, for example.

Okay.

But in line with this year.

Okay, so it might not be -- might not be very different from where it is this year?

Correct. Again, without having gone through the planning process.

Okay. Thanks very much.

Thank you. There appear to be no further questions at this time. I would now like to turn the floor back over to Mr. Jean for any closing comments.

For 2007, we continue to see a sequential improvement in overall demand. At the same time, we continue to make the tough decisions relative to staffing levels and other cost control measures on the Building Product side of our business to position it to meet the current market environment. Overall, we remain encouraged by the healthy state of the economy, low interest rates 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.

This concludes today's Quanex Corporation conference call. You may now disconnect, and have a wonderful day.