Quanex Building Products Corp (NX) 2007 Q3 法說會逐字稿

Good morning, my name is Elsa and I will be your conference operator today. At this time, I would like to welcome everyone to the Quanex Corporation fiscal 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. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, Mr. Raymond Jean, Chairman and CEO. Sir, you may begin your conference.

Good morning, and thank you for joining our third-quarter conference call. On the call with me 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 will take your questions.

Today's call will include a recap of third-quarter results, a brief financial overview and our outlook for the remainder of the fiscal year. Our comments include forward-looking statements about the future prospects of Quanex. Please refer to the Company's latest 10-K report filed December 15, 2006 for our complete forward-looking disclosure statement. The current earnings release is available on our website at Quanex.com.

At our Vehicular Products operating segment, we again saw improved sequential demand in the light vehicle powertrain market. This pickup in demand allowed MACSTEEL to produce a richer mix of bar products with more value-added services when compared to the second quarter. After taking into account the scheduled nine-day maintenance outage we took at our three steel mills in July, MAC's capacity utilization was about 95% in the quarter.

Net sales in the fiscal quarter were up 10% versus a year ago while our tons shipped were down about 1% over the same period primarily due to a 50% drop in Class 8 heavy truck builds compared to our third quarter last year. Total North American light vehicle builds were up 2% in our third quarter versus a year ago with Big Three builds down 2% and transplant builds up 9%.

Operating income at the segment was off 22% from a year ago, the result of a sharp spike in alloy costs in the quarter and from ongoing increases in consumable supply costs. MACSTEEL uses numerous alloys in the production of its steel bars, which would include metals like nickel, moly and chrome.

We saw a broad-based escalation of these costs early in the third quarter, and while we have surcharge capabilities to cover these costs, they are on a ninety-day trailing basis that didn't adjust until July 1. As these metal costs have fallen recently, we are confident we will capture most of the higher costs during our third quarter -- during our fourth quarter, excuse me, and expect operating margins to return to their more traditional mid teen levels.

MACSTEEL is also experiencing an ongoing rise in the cost of its consumable supplies. Expenses here include the cost of electrodes, which we use to melt the scrap in our primary furnaces, refractory, which is used in both our melt and dicast furnaces, as well as flux agent costs, which include various gases, minerals and carbon used in the production of steel.

Despite our best purchasing tactics, the cost push inflation on these input costs has been relentless, and we will be looking to recover these higher costs with price increases in next year's contracts.

Turning to our Building Products operating segment, general market conditions in the third quarter experienced some seasonal pickup, but remained weak nonetheless. The positive news is we outperformed the market through both the strength of new programs and by execution, great execution on the part of our employees.

At our Engineered Products group, we again had to contend with the significant downturn in housing starts, off 22% from our third quarter last year and 23% fiscal year to date. However, we managed to hold our sales decline to some 5% compared to the year-ago period due to our ability to generate organic growth through new programs and product initiatives, a great accomplishment by our team.

Again, we did experience a seasonal pickup in demand in the third quarter compared to the second quarter, and we look for that seasonal uptick to sustain itself in the fourth quarter. Third-quarter operating income at Engineered Products was up 11% compared to the year-ago quarter as each of our businesses turned in relatively solid operating results.

More good news came from our Mikron business this quarter where aggressive restructuring efforts during the second half of 2006, combined with ongoing lean initiatives, produced healthier results compared to the third quarter last year.

For 2007, new products like invisible window screens, retractable screen doors, front door entry components, advanced insulating glass spacer systems and unique solar panel components continue to grow. These new business launches helped build momentum during the quarter, and we expect Engineered Products to report improved sales in the fourth quarter compared to both the third quarter and last year's fourth quarter.

Shipments at our Aluminum Sheet business were down 11% in the third quarter versus last year, respectable performance considering the sizable drop in the residential housing market during the quarter. Operating income was off primarily due to the reduced shipments, while material spreads remain strong.

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. Good morning to everybody on the phone. I'd like to start off by first noting that Quanex continues to generate solid returns and cash flow. Our latest 12 months return on invested capital was 14.8%, which is actually higher than our cost of capital and is a very strong metric considering the general state of the markets that we operate in.

Three-month and year-to-date cash from operating activities was strong at $50 million and $134 million respectively. Our cash plus short-term investments at quarter end totaled $144 million. We are seeing stronger cash flows in the second half of 2007 based on improving earnings and significantly lower capital expenditures primarily at MACSTEEL.

Looking at the capitalization ratio, our debt less cash and investments to total capitalization was essentially 0% compared to 8% a year ago. We have a strong balance sheet and as always managing our working capital is important and part of the overall process.

For the third quarter, our conversion cycle, which is a measure of how long it takes us to convert a customer order to cash, came in at a near best-in-class 33 days versus 44 days at the end of the second quarter.

I'll also note that we did not repurchase any common stock during the quarter due to our strategic review of Building Products. And with that, I will turn the call back to Ray.

Thanks, Tom. Moving the discussion to the market outlook for Quanex, we expect total North American light vehicle builds for calendar 2007 to be essentially in line with 2006 builds at 15.3 million units. However, second-half calendar 2007 builds are expected to up some 6% over second-half 2006. This rise in automotive builds can be seen in our current backlog at MACSTEEL where we have appliances basically sold out through October with an excellent mix of value-added products.

Given this healthy demand profile, we expect MAC's fourth-quarter shipments to be up compared to both the third quarter 2007 and the fourth quarter 2006. The margin squeeze MACSTEEL experienced in the third quarter, the result of pricing alloy costs, is expected to turn in our favor in the fourth quarter as alloy costs have dropped since the change in alloy surcharges July 1.

For our Building Products segment, we believe annual housing starts have bottomed at a unit rate of some 1.3 million plus units. However, we now expect new home construction to remain under pressure through 2008 and the aggressive incentives we have seen on the part of home builders are likely to continue.

While the near-term outlook for new home construction is not very bright, we do believe the positive impact of our new programs, along with cost reduction initiatives, will allow engineered products to post higher operating income in the fourth quarter compared to the fourth quarter last year.

Our outlook for Nichols Aluminum, as it has been all year, remains guarded with fourth-quarter volumes expected to be about even to both last quarter and the fourth quarter of '06. Material spreads, while still strong, are expected to slip a bit in the fourth quarter due to a slide in LME ingot prices.

In summary, considering the external market realities we face and our current positioning within those markets, we expect to report relatively strong performance with diluted earnings per share from continuing operations of fiscal 2007 between $3.38 and $3.46, which includes an estimated $0.13 per share LIFO charge. Our previous guidance was $3.35 to $3.60 with $0.10 of LIFO.

Before I conclude my remarks, I'd like to reiterate that the Company is reviewing its strategic alternatives with respect to the Building Products segment. We are not prepared to provide any additional information as to the review or otherwise comment on our strategic considerations at this time. We will provide an update when the Board makes a decision. That wraps up my formal remarks, and we are now ready to answer your questions.

Peter Lisnic, Robert W. Baird.

Ray, a question on Engineered Building Products. If I look at the profitability in that business, it has improved what I'd say substantially I guess. Can you maybe give us a sense as to how much of that profitability improvement is really driven by cost structure changes versus potential product mix improvement? It sounds like you have got some new products in there that potentially could be higher margin. I am just wondering how much of this is structural versus kind of new product-oriented.

I'd say that -- Peter, I don't have a percentage off the top. Certainly the new programs and product launches have, I would say, a majority of the impact versus last year. I think the structural costs certainly are substantial and will continue to benefit from that of course as we move on. And we're not done doing things structurally to help ourselves moving forward because certainly the housing market has dropped more than we had anticipated even three months ago. So it is an ongoing effort to take out the structural costs.

Okay. If you take out the product mix impact of it and realizing that you don't have a number, but if you take that out and just kind of look forward in the more normal housing environment, do you get a sense as to how much the structural profitability of the franchise may have changed relative to a year or two or three years ago? Do you think you've taken out a couple hundred basis points out of costs here?

I don't think that's an unreasonable estimate.

Okay. All right. That's fair enough then. And my follow-up question on the Building Products side, continuing there. With the credit market turmoil, can you give us a sense as to what you've kind of heard from your customers or their customers in terms of things that might have happened in August in terms of demand, not specifically for your top line or bottom line. You've given us fourth-quarter guidance, but just kind of what you are hearing on the ground in terms of what kind of impact the credit market is having on customers out there.

Well, to me, the most disturbing thing is even at the mid to higher end of homes, the difficulty in signing on for mortgages and to some extent the uptick in mortgage rates, I find particularly disturbing. Hopefully, that will correct itself as the financial markets stabilize. At least that is what I am hoping for.

Certainly at the high end, I don't think the housing market has been badly impacted in looking at our customer base. We know that our large wood/window customers, for example, I think have seen somewhat less of a downturn. But the credit crunch is certainly disturbing.

Okay, that does it. I'll jump back in queue. Thank you.

Steve Velgot, Cathay Financial.

Yes, I was wondering if you could quantify the impact of the metal alloy increase in the quarter and then the second question is regarding your expectation for the tax rate for the year given that it was lower in the quarter.

Yes, the metal cost that we are talking about certainly was in the double digits -- I would say low double digits. Let's just leave it at that.

Is that a percentage that it increased over the prior year or what does double digits refer to?

I'm giving you dollars like a $15 per ton --

Okay. Got you.

number. And on the tax rate, Tom, would you comment on that, please?

I would be glad to. On the tax rate, we adjusted our -- we reviewed our deferred tax accrual, which we do on a periodic basis and we adjusted the effective tax rate on that downward to about 37.5%, exactly 37.5%. That doesn't affect the current tax rate. That adjustment goes through this quarter, but next quarter, you would expect to see around a 36% effective tax rate.

Okay. Thank you.

Timothy Hayes, Davenport & Co.

Good morning. Just some more clarification on Engineered Building Products. In terms of the sales, can you break out how much is coming from pricing versus how much is volumes? If net sales were down 5% in this recent quarter, was that made up with maybe 5% up on pricing and 10% down on volume or just some help on that with those numbers, please?

No, very little of that off the top is pure price. There maybe some mix effect, Tim, that we would have benefited from. But I would say that that is minimal. So we are really talking about real growth is what we're talking about here.

And then the follow-up on the alloy costs that you just quantified, that it was a $15 per ton hit. Was that from a year ago or sequentially?

That would have been sequentially.

Okay. Thank you.

Mark Parr, KeyBanc Capital.

Thanks very much. Good morning, Ray. Market is up today, so I'm feeling a little better I guess. Your stock is doing well, too. Congratulations on all the progress with the macro headwinds that you've been facing.

Thank you.

I was wondering, and I missed the first couple of minutes of your comments, so if this is a poor question, I'll apologize in advance. I was wondering if you could give us an update on the use of bar steel to make forged crankshafts and how you expect that to influence your shipment mix in '08 versus '07.

Tough question, Mark, off the top. Certainly the opportunities continue to present themselves, and we are working hard with a number of the transplants, as well as the domestic on new programs. As a percentage of the total volume next year of our 1.3 million tons, it is very small. So I just don't have that percentage off the top, but we continue to be excited by the opportunities. But it is that amongst many others. Gears get me excited too, so it doesn't just have to be crankshafts.

Okay. So what you are saying then is that there is a number of new programs that would represent incremental organic growth opportunities for MACSTEEL in '08 that potentially could offset some macro -- overall macro weakening?

Yes, good answer.

I won't charge you. You can repeat that.

Let me just add to that. We have previously disclosed that during calendar 2007, MACSTEEL would be bringing on some 70,000 tons of new automotive business, more so leaned heavily to the Big Three versus the transplants and that's an annualized number. And we will look for some of that obviously to splash into '08 before it is all said and done.

Okay. So what I was trying to get was a number for '08. If I could just ask a follow-up, wondering what your best sense is as far as the direction and the level of scrap prices for September.

Well, there seems to be some upward pressure right now is what I am told. I certainly have some people that follow it more closely than I do, but that is the scuttlebutt.

Okay, terrific. Thanks very much, and congratulations on the great results.

Thank you.

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

Just a couple more. Ray, is it safe to assume that as you go through the strategic review that there will be no buyback activity?

Yes, that is a safe assumption.

Okay, fair enough. And then on the $5 million worth of commercial paper that is -- there is some issue that you disclosed in the Q. I am just wondering -- I know you filed a Q this morning. Any new news on that and is that all of your exposure to anything that might be subprime-related or along those same lines? Is there anything else out there where you are a bit worried whether there might be some collectibility issue?

With regard to any update on that, we don't yet know much about it. We're going to have a conference call in the next couple of days and learn more about it. If you go back to July 30, we had about $70 million in CP, and we have sold the vast majority of that -- we are down to $15 million in CP. Our policy has always been to be the highest investment grade, A1/P1, and the tranches that we have -- we have three $5 million tranches right now, two of which are that high investment grade. The other one was downgraded as we noted. We have sold off these securities. Some of them were mortgage-backed. Some of the ones we still have are mortgage-backed. Right now, we think that our issue is with the one tranche and that we will learn more about as we go forward.

Are the other two issuers also kind of in the financial services space though? Was there any --?

Some of the paper behind the CP is mortgage paper.

Okay.

They are investment-grade.

And we just had two tranches come due this week that we liquidated.

Okay. All right. Thank you.

Leo Larkin, Standard & Poor's.

Do you have any guidance for CapEx and DD&A for fiscal 2008?

Yes, for depreciation next year, I think $80 million is a pretty good number. We are in the process of putting together our business plans for next year, and so I don't have a good number on that. I would think off the top that it would approximate what we are spending this year, which is about $30 million to $35 million.

Okay. Thank you.

Ildiko Hildreth, Waterstone Capital.

When you were talking about the $15 million CP, was that separate from the auction rate securities that are mentioned in the Q?

It is.

Okay, the auction rate securities, if they are not able to roll -- I think that these are self-liquidating, is that right?

That's right. They are vastly student loans that are backed by the US government.

And then will the issuer have to give more collateral if the underlying assets aren't worth what is due to you?

We've had no problem with auction rate securities. As I say, they are student loans that are backed by the US government. So the collateral is the US government.

All right. Thank you.

Mark Parr, KeyBanc Capital.

Ouch. Now we're worried about students not paying their loans back, huh?

Well, if the government doesn't -- we're not worried about that.

All I can say -- my kids better because if they don't, I have to. Ray, I think I heard you talk about an outlook on the housing market, thinking things have gotten a bit worse today than you might have thought they were three months ago. And I was wondering if you could just go through your thought process a little more, give a more little color on how your customers are seeing the housing market unfold here over the next say 6 to 12 months.

Well, I think right now the guys that seem to be down the most are at the lower end of things -- the track builders, so to speak. But as you go up the food chain, I think the pain has been less. But how available will mortgages be and at what cost could very well impact the higher end, which has been a little stronger I would submit to you than the lower end. So that is what has me concerned right now. Generally, people think that this is going to sort itself out in the next six months. But I think the next six months will certainly be very bumpy for the housing market and certainly I know in talking to my guys and our customers, there seems to be acceptance of that.

Along those lines, is there any universally held belief of anticipation of Fed action or any sort of macro help or is the something that people feel could get worked out without any help from the Fed?

I think everyone expects some help from the Fed is my sense of things, and I really think it is going to happen. But I'm not going to predict when.

All right.

But I'm optimistic that something will happen there. On the good side is that if you really look at the data on remodeling expenditures, home improvements, although they have softened, certainly remain strong compared to what has happened on the new housing market. And some 40% any way of our business is driven by the residential improvement market. And again, some softness there, but not as bad as we've seen in the new housing area.

Okay. Terrific. Thanks again for the additional comments.

There appear to be no further questions. At this time, I will turn the floor back over to Mr. Raymond Jean for any further or closing remarks.

For 2007, we continue to see some sequential improvement in overall demand. We remain encouraged by the resilient economy, generally 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.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.