Quanex Building Products Corp (NX) 2008 Q1 法說會逐字稿

Welcome to the Quanex Corporation fiscal first quarter earnings conference call. (OPERATOR INSTRUCTIONS)

I would now like to turn the conference call over to our host, Raymond Jean, Chairman and President of Quanex Corporation.

Good morning and thank you for joining our first quarter conference call. On the call with me today is Tom Walker, our Chief Financial Office, and Jeff Galow, our Vice President of Investor Relations. At the conclusion of my formal comments, we will take some questions. Today's call will include a recap of first quarter results, a brief financial overview, and outlook for fiscal 2008, and an update on the spin/merge process. Our comments include forward-looking statements about the future prospects od Quanex. Please refer to the company's latest 10-K report filed December 14, 2007, and our amended form10 filed February 18, 2008, for our complete forward-looking disclosure statements. The current earnings release is available on our website at quanex.com.

The vehicular product segment reported good financial results in the quarter as our MACSTEEL business experienced relatively strong demand from the power train customers. Our shipped tons in the quarter were 8% higher than in the year-ago quarter while total North American light vehicle builds were off about 3% over the same period. Capacity utilization for the three steel mills came in at a very respectable 95% rate and MACSTEEL was able to maintain a very healthy mix of value-added products and services in the quarter. Operating income at the segment was about even compared to the year-ago quarter, but came in below our expectations as operating results were impacted by an unexpected $90 per ton spike in scrap costs in the quarter. The scrap surcharge has since risen to cover these higher costs going forward and with scrap expected to flow more freefully the spring, MACSTEEL expects to recover some margin compression over the next couple of quarters when scrap prices drop.

The rising cost of our indirect material costs such as graphite, electrodes and refractory both used in our melting operations also negatively impacted profits in the quarter. We were able to raise contractual bar prices about 3% for calendar 2008 which will help recover these higher costs going forward but the new prices were not effective until January 1.

Turning to our building products segment, overall market conditions in the first quarter were extremely weak, exacerbated by the difficult winter in the midwest and northeast. Specifically, at our engineered products group, we had to contend with an ongoing decline of new home starts which were off some 31% from our first quarter last year. We held our sales decline to about 12% compared to the year ago period in part due to our ability to generate additional sales through new programs and product initiatives with our customers. Operating income was well off year ago results in part from the overall sales decline as well as from a unique situation that developed in which we had an obligation to deliver finished products to one of our larger customers as metal costs well below market prices for a period of about two months. More specifically, our fenestration business had a four-year contract to deliver products at predetermined selling prices and we in turn physically hedged our anticipated metal needs at the outset of the contract. However, our actual metal requirements outstripped our hedged position for the remaining three months of the four-year contract so we were forced to buy metal at prices far above those paid four years ago.

Unfortunately, we were not able to pass those higher metal costs along to our customer, so we suffered some margin compression through the end of December. We have since rectified that situation beginning January 2008 with a new three-year contract with a customer whereby we have covered our metal requirements. Our engineered products management teams remain focused on product innovation to improve the thermal efficiencies of our customers windows, make doors and windows more architecturally and structurally desirable and make door entry systems more weather resistant. This commitment to engineering excellence and industry-leading customer service is a differentiator for us. But 2008 new product initiatives that engineer products like invisible window screens, composite window profiles, entry door components, advanced insulating glass spacer systems and unique solar panel components are expected to contribute some 6% organic growth in a down market compared to 2007.

First quarter operating results at our Nichols Aluminum business were respectable when you consider the grim housing statistics during what is always a very weak quarter for us. Our first quarter shipped pounds were only down about 5% from the year ago quarter. Operating income was well off year ago levels due to the drop in volume, lower value added painted sheet sales and an 11% drop in spread caused by aluminum prices falling at a faster rate than our aluminum scrap costs fell during the quarter. And, again, winter came into play and slowed the flow of scrap and kept prices high. This unprecedented slow down in the building and construction market forced us to take a very hard look at the Nichols business during the quarter and, as a result of that review, we idled the mill finished kept production at our Alabama finishing facility in late January. We are however continuing to paint aluminum sheet at the facility. The suspension of the rolling mill will continue until business conditions improve. 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. Good morning to everybody on the phone. Even in the phase of these significant market head win, Quanex continued to generate solid returns and cash flow for our shareholders. The latest 12 months return on invested capital was 12.4%. Fiscal first quarter cash from operating activities came in at about $24 million down from a year ago primarily due to working capital increases in inventory at vehicular products caused by a spike in steel scrap prices as well as lower operating income and deal-related costs. Our cash balance at quarter end totaled a very healthy $215 million. Our total debt to capitalization was about 12% and our debt is essentially comprised of the company's 2.5% contingent convertible bond.

I would note that we did have a bond holder convert $9.4 million of principle during the quarter. Our balance sheet remains very strong and managing our working capital remains an important part of that process. We continue to monitor our receivables and inventories very closely. And we are now seeing, however, some customers stretching terms with us. Our conversion cycle, which is a measure of how long it takes us to convert a customer order to cash, came in at a reasonable 40 days. Let me conclude my remarks by commenting on our diluted earnings per share. We reported $0.42 per share for the first quarter compared to $0.55 per share in the year ago quarter. The $0.42 excluded $0.34 impact from a $9.2 million after tax loss associated with the premium paid on the debenture principle and 4.5 million of after tax deal costs. With that, I will turn the call back to Ray.

Thanks, Tom. Moving to discussion to the 2008 market outlook for Quanex, we expect total North America light vehicle builds for calendar 2008 to be down some 400,000 units or about 3% from 2007 builds or 15.1 million. We expect vehicular products to outperform the market through an increase in vehicle content from new programs that continue to ramp up and the 3% price increase in our contracts. Operating income guidance for the vehicular products in fiscal 2008 remains unchanged at 140 to 150 million, although we are now guiding around the bottom of that range. For our building products segment, the near-term outlook for new home construction is bleak with calendar 2008 estimates for new home starts from global insights now estimated at 900,000 units down from their recent December estimate of 1 million. Assuming the new housing starts estimate is correct, that would mean a 30 plus percent decline in 2008 starts compared to 2007.

We expect our building products sales will only be down about a third of that in part because our engineered products segment remains closely hitched to stars and these stars many consider to be the leader in the fenestration space continue to do better than market. Add to this the positive impact of new programs and engineered products, new customers and cost reduction initiatives across the board, and we look for the segment to continue to outperform the market. At Nichols Aluminum, the news is not all bad. Certainly shipments at Nichols will remain under pressure for the next couple of quarters but some good news can be found in today's aluminum prices which have risen better than 20% over the last month or so. This rise in aluminum prices and the consensus views that these higher prices will be sustainable into 2009 are expect today have a positive impact on operating income because of the high powerful positive correlation of our material spread with prices.

While we have not changed the building product's fiscal 2008 operating income guidance of 80 to 95 million, as with our vehicular products segment, we are now, we now expect to come in around the bottom of the range. However, we have not attempted to factor in any potential up side in our operating income guidance for building products due to this recent rise in aluminum prices, although this up side may be needed to help offset any additional down side at engineered products. I will close with an update on the progress of our separation process. Last week we set a record date of February 29 for the special shareholder meeting and we expect that meeting to be held on March 31. Once we mail our definitive proxy statement to shareholders of record, we will be able to share more information with you. That wraps up my formal remarks and we are now ready to answer your questions.

Okay. (OPERATOR INSTRUCTIONS). Yes, Mr. Baird, you may ask your question.

I have been upgraded to Mr. Baird, I guess.

Congratulations.

Talk to me on that one. Great. Ray, I guess if I could just start with building products, the question I had there, it sounds like you shutter or not shutter but shut off capacity at Nichols. When you look at the engineered products business, do you feel comfortable that you're right size for the current market environment or are there going to be some incremental actions in that business to right size for the weaker market?

Let me take Nichols first. Yes, we took down some rolling capacity off at Nichols. What it permits us to do is increase the utilization rates at the other two plants where we do rolling. So it isn't like we are taking operating levels below what the demand level is in the marketplace. For us it just means we will be able to operate more effectively, just again high utilization at the mills, the rolling mills that remain open. We feel that we will be able to keep supplying the industry with what it needs. As to engineered products, we have taken the work force down close to 25% at engineered products, and I feel that we are sized to current conditions. Should those get worse, we will have to do what we have to do.

All right. And then on the, I guess the uncovered metal hedge situation that you went through in the quarter, does that account for the $1 million that you identified in the press release in terms of nonrecurring cost that EP or was there anything else in there?

This is Tom. About half of it was that and the other half were some unusual medical costs that we had.

Okay. And do you see anything else coming forward in second quarter through fourth quarter on unusual costs there or no?

There might be a little bit unusual costs in medical, probably lower amount next quarter. And then there's some offsetting things.

Okay. Thank you very much.

Okay. We will take your next question.

Hey. How are you doing, guys. Thanks for taking my call.

Hey, Bob, how are you.

Great. The timing for the idle at Nichols, that started when? Do you see it through the spring? Just maybe a little help there.

Yes, it has been off about a month is what I want to say, Bob, and as far as bringing it back up, to be determined based on market event.

Okay. Does it work in your favor having the idle capacity, as far as from a competitive standpoint, keeping pricing pretty stable based off where we are now?

Well, I think again for us it was, when you operate through the process businesses, it is always difficult to, how many shifts should you be running and so forth, and this way here, it enables us to increase the utilization rate at two of the, the other two mills. So it is just really, it is a cost-influenced decision. It is a means of lowering our cost. We feel we have adequate capacity at the remaining operations to satisfy the demand.

Okay.

So it is just, again for us, it is more effective utilization of our capacity.

Okay. Great. And then if I could, could you guys provide the DNA for each individual segment for the quarter?

I can give you the D&A for the year for the building products. That would be about 38 million.

Okay. Thanks, guys.

Okay. We will take our next question

Hi. This is Barry Vogel. Ray, you made a comment about organic sales growth of the building products of engineered products and you talked about new product initiatives and then you talked about new housing starts estimates by global insight to be down 30%. I believe I wrote down or I did write down that you might be down a third of that 30%. Does that mean that you're basically say you think sales estimates for the building products business will be down 10% for fiscal '08?

That would be order of magnitude, Barry, that's probably about right.

All right. I just wanted to, because you said it was sort of (inaudible) speak if you will. I have a question for Tom. Those charges of $9.2 million the $4.5 million associated with the spin/merge transaction, are these absorbed in the deal by [Garedow]?

The one charge, Barry, was the convert, and you may remember from our prior conversations that that is all handled by the trueup on the convert. So the answer would be yes.

Okay.

And then the other charge there were charges for deal fees, let's call them. And we have a filing with the SEC, there is a portion of those that would be carried by building products and a portion of it that would be carried by our Quanex Corporation.

Now the portion, do you consider that portion to be carried by the building products as part of your low guidance estimate of $80 million in operating profit?

No. It is not in the operating profit line.

Okay.

It is in that guidance.

Okay. So the 80 million, which is the low end of the range, does not include whatever that portion is going to be?

Right, right. And it is in terms of the year and the 80 million, it is probably insignificant.

Okay. All right. And as far as the capital expenditures for building products, are you still at that level that you talked about before, which I believe was about $15 million?

Well, yes, we ran the first quarter around 7 million in cap spending for the whole company, about half of that is building products. And so we are running at a lower rate. So we are probably a little closer to the 15, Barry.

Okay. Thank you very much. I appreciate it.

You bet.

Okay. At this time you have no other questions. A question just popped up. Do you want to take them?

Sure. We will take them.

Can you hear me now?

Yes. We can hear you.

Sorry. This is a new system a little bit confusing for me. Ray, can you just, do you mind clarifying the spin/merge timing, March 31 is a shareholder vote but it sounds like it is pushed out past the first calendar quarter now. Is that a safe way of looking at it?

No, I am not prepared to say that at all. Right now our best shot at it, at the close date is the March 31, April 1, whatever. But it would be at the close of the first calendar quarter which is what we have been saying all along.

So you can effectively have that shareholder vote in the morning and then handle the spin and everything else.

The spin comes first and then the merger would be second.

Okay. All right.

It is kind of, nearly a simultaneous transaction, but from a legal standpoint the spin comes first is what I am saying.

Okay. And then if I could just ask a question on Nichols again, the painted sheet business I am guessing that is just a function of the housing market or was there anything else there that was one-time in nature where you for whatever reason, maybe a production issue or loss of share or whatever or is it just simply a function of the market?

It is a function of the market, and you mentioned housing and clearly, that is the big one. But, we also serve secondary markets and those are not particularly robust.

Okay. And then have you, I mean with what you are doing on the capacity front in Nichols, have you seen competitors in this space kind of take the same approach? In other words, is anyone else kind of idling capacity at this point?

Yes, Alaris announced within the last ten days that they were taking down a facility as well, a rolling mill facility. So, yes, the industry is adjusting to the market which is a good thing. We got smart businessmen out there.

Yes, I guess that's one way of putting it, yes. Okay. Thank you for your time.

We will take our last question.

Hi. This is Lee for Arnie at CJF Securities. You had mentioned cost savings. I was wondering if you could detail, we noticed the corporate has been falling rather dramatically from '06 to '07. I am wondering what kind of trend is sustainable through '08 given the plant closures and decreased throughput.

Are you addressing primarily the corporate decrease, Lee? Or are you going elsewhere with this?

Yes, definitely the corporate when you look at just building products and aluminum together.

Well, we have -- back our corporate spending. And we would continue to see a lower trend there. We do have, not the segment level but at the corporate level, significant transaction costs that went through quarter which are unusual. But we have been watching very closely our overhead spending, both at corporate and in the operating units and we would continue to see those trend down through the year in a tough market against the prior year.

Ray, I am going off of the filings and it looks like you did about 31 in '06 and 21 in '07. Is there still room too go down in '08 or have you kind of bottomed out or is there any more opportunity for savings kind of an on underlying basis?

Probably to the too much more on an underlying basis.

So we are pretty much there at the bottom now or maybe a couple million more max down?

Over time.

But for '08.

For '08, the it would be difficult to --

Squeeze anymore out?

Well, and I don't want to commit to a number.

Do you guys have the split on kind of the under lying corporate for the quarter, what it would be between building products and vehicular?

We don't have that.

Okay.

At this time.

Okay. That's great. Thanks.

And that was our last question.

Well, there's no doubt that we will continue to face strong headwinds in our markets given the weakening economic fundamentals and the ongoing housing recession. Many experts hold out hope for a turn around later this year which is certainly heartening to us, but in the meantime we must continue to carefully and effectively navigate our way through today's seemingly deteriorating economy, but we will not be victims to the environment. We believe now is the time to sharpen the saw, the time to make investments in our future. We have made tough calls to ensure operations are sized to the existing business conditions and to spending. But as to investments, it is full throttle. Capital projects that have a good return are not being deferred. We are not laying off engineers. We are looking to add more.

I am excited about 008, not because of the market which stinks, but rather because of the opportunities that I believe will come along and the fact that we will be positioned to take advantage of them. This is where discipline and dry powder pay off. Experts will tell you that more homes will be built in the next ten years than build over the prior ten years. Housing is a pillar of the U.S. economy. It will be back and when the market does come back we will be ready to very effectively leverage our lower cost structure and take advantage of the more favorable economic wins. Our vision for Quanex building products is to become North America's leading manufacturer of engineered components sold to OEMs and distributors of building products. We expect to grow faster than our served markets through engineering excellence, to drive new program initiatives and products. We will increase the degree of integration for engineered products by pursuing to tight product and process adjacencies while striving to be the low cost provider to the industry. That concludes today's call. Thank you for joining us.