Quanex Building Products Corp (NX) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Quanex Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions and comments. Instructions on how to participate will be given at the time. I would now like to turn the conference call over to our host, Raymond Jean, the President and CEO of Quanex Building Products Corporation.

Good morning and thank you for joining us for our first conference call as the new Quanex Building Products Corporation. With me today is Tom Walker, our Chief Financial Officer, and Jeff Galow, our Vice President of Investor Relations. At the conclusion of my full comments, we'll take some questions.

Today's call will include a recap of fiscal second quarter results, a brief financial overview, and an outlook for the remainder of the fiscal year. My comments include forward-looking statements about the future prospects of Quanex Building Products. Please refer to the company's Form 10 filed with the SEC on April 4, 2008, for our complete forward-looking disclosure statements. The second quarter earnings release is available on our website at quanex.com.

I want to start by thanking you for both your patience and understanding for the additional time we needed to get our earnings release out to you. As you may know, we had to close the company's books twice during the last seven weeks.

The first closing was for old Quanex as of April 23, the date of the transactions, and the second closing was for the new company as of April 30. This was no small feat when you consider the complexity of this transaction and the burden it placed on our lean accounting staff. It was a great team effort, and the staff has earned my admiration.

The company's overall market conditions in the quarter can best be described as very weak, although we finally did see some seasonal pick-up during April, which encouragingly was sustained in May. At our Engineered Products division, we had to contend with an ongoing decline of new home starts, which were off 34% from our second quarter last year, while residential remodeling starts have been down from 5% to 10% in the quarter from year-ago levels.

We kept the decline in the division's sales to a more respectable 11% compared to the year-ago period. Our ability to generate additional sales through new customer programs and products continue to bolster us, and we remain focused on initiatives that will improve our customers' position in their distribution channel, both of new home applications and residential repair and remodeling.

For 2008, new products at Engineered Products--such as invisible window screens, composite window profiles, entry door components, advanced insulating glass spacer systems and unique solar panel components--are expected to contribute some 7% of organic growth this year, even in this weak market.

We are particularly excited about the growth we see at our Insulating Glass Sealant business. The introduction of our new Duralite sealing product continues to gain penetration, and we are winning accolades from our customers because of the product's best-in-class thermal characteristics and its ease of installation in the manufacture of their insulating glass panels.

Our growth with the leading domestic solar panel manufacturer is very encouraging, as our adhesive sales in the first half of 2008 have increased three times over the first half of 2007, and we look for this business to continue to thrive.

We just received a business license to operate in China, and we expect to have our new facility operational by calendar year end. Plans call for us to not only produce adhesives to supply our solar customer's Malaysian operation from this facility, but to also produce insulating glass sealant products that will be sold directly into the rapidly growing Chinese residential housing market, which today is being served by our facility in Kentucky.

To put the size of our solar adhesive and export sealant sales into perspective, we expect that combined sales to represent some 30% of true sales business this year.

Turning to second quarter operating income for the Engineered Products division, results were well off from year-ago results, with February being a particularly poor month. The ongoing decline in sales and the subsequent poor operating leverage continues to be a significant drag on earnings.

In an effort to help reduce operating costs during this cyclical slowdown, we are currently combining two window and door fenestration component facilities at our Homeshield division into a single, more efficient facility. We expect to have this consolidation effort wrapped up by fiscal year end, resulting in $1.2 million of annualized savings.

Second quarter operating results at our Nichols Aluminum division were respectable when you consider the poor building products environment and weak secondary markets experienced during the quarter. Our ship pounds were down 12% from the year-ago quarter but up 23% compared to first quarter shipments due to the seasonal increase in our markets following a very harsh winter in the Midwest and Northeast.

Operating income was well off year-ago levels due to the drop in volume. A 16% decrease in value-added painted sheet sales and a 7% drop in materials spread caused by relatively low LME aluminum prices early in the quarter. We are predicting a pickup in spread in the third quarter based in part on the rise in aluminum ingot prices we saw beginning in February.

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. I would also like to welcome the audience to this conference, our first one. Let me begin my remarks by commenting on our diluted earnings per share from continuing operations.

The company reported a loss of $0.20 per diluted share from continuing operations for the quarter. That $0.20 loss, however, included $13.8 million, or $0.37 per diluted share, of what was essentially non-cash after-tax transaction costs related to the old Quanex Corporation stock-based compensation programs, whose cash expense was actually paid by Gerdau.

To help you better understand our results in the quarter, we've provided a comprehensive reconciliation table in our earnings release that describes these various transaction-related costs by item. If you were to exclude the deal-related costs when computing the earnings, the company actually earned $0.17 per diluted share from continuing operations, or about $6.5 million.

On a comparable basis, Quanex Building Products earned $0.34 per diluted share from continuing operations in the year-ago quarter, or about $13.4 million. Our financial results this quarter were actually slightly better than we had anticipated, in part due to the seasonal improvements late in the quarter which Ray referred to.

Moving the discussion to cash, the company continued to generate solid cash flow for its shareholders, even as the housing market continues to search for a bottom. First half cash from operating activities came in at $19.5 million, down from a year ago, primarily due to lower operating income and changes in working capital.

Our cash balance at quarter end totaled a very healthy $40.4 million, which included about $28 million of the expected $52 million in true-up cash, along with another approximately $24 million of expected true-up cash receipts. We also anticipate better cash flow generation in the second half of the year due to seasonal improvements at our businesses.

Our total debt to capitalization was less than 1%, made up essentially of industrial revenue bonds totaling some $3 million. The balance sheet remains strong, and managing our working capital is an important part of that process. Our conversion cycle, which is a measure of how long it takes us to convert a customer order to cash, came in at a respectable 31 days.

With that, I'll turn it back to Ray.

Thanks, Tom. Moving the discussion to the remaining 2008 market outlook for Quanex Building Products, the near term view for residential construction unfortunately remains bleak, with calendar 2008 estimates for new home starts from Global Insight now estimated at about 900,000 units down from their December estimate of 1 million units. Assuming the new housing starts estimate is correct, that will mean a 35% decline in 2008 starts compared to 2007.

Piling on with more bad news, pundits now expect the housing trough will not occur until the fourth calendar quarter, and that elusive trough has already been moved out several times this year. We expect the company, however, to continue to outperform the market due to new programs at Engineered Products, while ongoing company-wide cost reduction initiatives improving material spread at Nichols and seasonal improvements in demand will bolster earnings in the second half of our fiscal year.

Before I close my formal remarks and open the call to questions, I did want to mention that the company's newly anointed CEO, Dave Petratis, will be joining us July 1. Dave brings with him experience in the construction markets, both residential and commercial, a culture of continuous improvement, and an outstanding track record of growing companies through both organic initiatives and acquisitions.

We all look forward to his arrival next month. And on a personal level, I very much look forward to working with Dave to provide for a smooth transition.

With that said, we are now ready to answer your questions.

(Operator Instructions.) And we'll take our first question from Arnie Ursaner with CJS Securities.

Hi. Good morning. It's Arnie Ursaner. I guess my first question is on the cash, you mentioned that you had the $28 million of the expected $52 million, and then you mentioned $24 million of cash flow receipts. I'm just trying to equate the two. Is that the difference between the $28 million and the expected $52 million?

Yes, Arnie. I can even delineate it a little bit better. We haven't gotten the cash true-up yet on the tax on the spinoff. And we're estimating now that will be around $20 million. And we also haven't gotten the cash on the bonds, the converts, the true-up. And we're estimating that will be around $4 million to $5 million, in that range.

Okay.

One follow-on point--we would expect to get the bond cash fairly soon. The tax, we are still in the process of valuing the businesses, and so that will come a little bit later.

And my second question relates to your guidance for the balance of the year, in really two parts. One is you mentioned the $80 million of operating income, you mentioned the $20 million of corporate expenses. Implied in that is a fairly sharp reduction in the rate of expense in the back half, because on a normalized basis, you were $14 million for the first six months, and it implies a pretty sizable jump in revenue and a dramatically smaller change versus last year. Can you expand on both of those, please?

If I could jump in just on the corporate and other, if I could ask you to focus on the corporate and other for the very last three months, it's $31.5 million on page 7 of the release.

Right.

And if you would back out the $25.7 million of unusual costs, that comes down to $5.8 million. So we're already at the $5.8 million running rate, moving toward that $5 million running rate. So yes, when you look at it on a year-to-date basis, it looks like an overwhelming challenge, but in actual fact, we're getting pretty close to that rate.

And in addition to that, in the $5.8 million this quarter, there were still some unusual items. We had, certainly we had stock option expense which was pursuant to the new stock options that we've issued for employees and then some other sundry expenses that will fall off as we go forward during the year.

Okay, thank you. And on the operating income side?

Well, I think on the operating income side, the seasonal uptick brought some operating leverage that we certainly needed. As we look at our margin rate performance at Engineered Products, for example, we were in the low single digits in the January to February time frame, and that has now climbed to double digits in the April to May period. So we needed to get out of the harsh winter conditions that we experienced to gain some operating leverage, and that's what we're seeing now.

Okay. Thank you very much.

We'll take our next question from Peter Lisnic.

Hello?

Hey, John.

It's actually John on for Pete.

Okay.

Just a couple questions. First off, when you guys look at Engineered Products, are you seeing anything on the commodity cost side there, for instance, vinyl and micron, for instance, for the upcoming two quarters or three quarters?

Yes, we've seen some increases, nothing major. We follow two indices real closely, CDI and Western Plastic News, and sometimes they are out of sync with one anther. But the good news there is that we do have adjustments in our contracts, so on a monthly basis, we adjust to whatever the price of PVC is.

Okay. And I'm switching gears from a follow-up, I guess. When you did some of the plant moves this past quarter, shuttering the Alabama mill or kind of consolidating the facilities, how much cost was incurred in the quarter? Could you break that out?

We really didn't isolate that, John. Certainly we had some, but it wasn't big. Remember, we didn't shutter that plant. What we did there is we mothballed the line, so it was more a matter of perhaps incurring some minimal severance costs and, unfortunately, laying off some people.

Let's say that it wasn't a major, like $2 million type expense, right, or anything like that?

No.

Okay. Thank you. I'll get back in queue.

And we'll take our next question from Robert Kelly.

Hi. Thanks for taking my question. As far as the second half assumptions for operating income, are you still using $1.20 per pound for Nichols?

$1.20 per pound?

You had talked about $1.20 selling price, yes.

For LME? No, I think that's been nudged up from $1.20. Right now, it's, what, $1.33 to $1.35, round numbers, without the Midwest premium. So--no, it's higher than that.

You've worked the higher numbers into your forecast?

Yes. Yes, we did.

Then as far as the plant consolidations, does this cover you for some time? Are there more opportunities to consolidate or maybe shutter some idle capacity?

No, we're getting--never say never, but given where we are with builds right now, I think we're walking along bottom, so to speak. Again, I made reference of this elusive trough that we keep reading about. No one really seems to know when we're going to hit the bottom, but the way we pick up on it in talking to our customers, I think we're going to remain at this low level for some time. But we're not looking right now and not planning to shutter another one.

Okay. And then one final, if I may. The $24 million that you expect, when will that come to you? Do you have any visibility on that?

Yes, Bob. There's two pieces of it. One is the true-up one that converts. That's about $5 million. That will be coming presently. That's supposed to be paid within 45 days of the deal, so that will be coming presently. The other, the larger portion in the $20 million or so range, is the true-up on the tax on the spinoff. And it's going to take us a while to validate that tax. We have to value all the businesses and all the assets within the businesses in order to do that. And we have a valuation company in here as we speak doing that valuation. So it will be a little bit later, a little bit later.

Okay. Thank you.

We'll take our next question from John Kasprzak.

Oh, thanks. Good morning, everyone.

Good morning.

Could you give us some idea of within Engineered Products, what your utilization rate is, even now with the seasonal pickup in the spring?

It's low. I don't have one number to throw back at you, but we're probably in the 50% to 60% range.

Okay.

I'm sorry, I was just going to add that the pickup has been very recent. It's an April and May kind of phenomenon.

Right. And that's just a seasonal issue, right? There's no, I mean, obviously we've been saying the housing market is still weak, so there's no underlying--?

No, there's no secular upturn at all.

I was going to ask, too, just in terms of getting an update on D&A, run-rate, is the numbers in that $38 million range still a good number?

Yes.

It is. And how is CapEx also? Is $15 million or so still a good number?

I think I'd use both of those. We might shade up a little bit higher than that on the capital. We've been saying $15 to $20 million, but it's probably going to be closer to the $15 million, maybe a little bit over that. And yes, the D&A is $38 million a year, so we've got another $19 million to go.

Okay. And finally, on acquisitions, in this severe market downturn, are you seeing more opportunities? Are prices coming down to more reasonable levels? Maybe you could talk about the landscape for acquisitions.

Yes, there's certainly a pickup in activity. I like to think of acquisitions as kind of a five-step process. You've got identification, you initiate, you negotiate, you close, and then you integrate. And we're certainly well along on the identification. We've got our roadmap, so to speak, we're making approaches, we've initiated a number of discussions. So we're very encouraged by the opportunities that we believe will be there for us in the next year.

Great. Thank you very much.

We'll take our next question from Craig Bell.

Yes, good morning. In your press release, you talked about higher overall sales in third quarter for the Engineered Products? Is that just a purely seasonal uptick?

Yes, that's the way we view it. I think we're benefiting from some of the things that we've mentioned in terms of new program initiatives and so forth, but there certainly is no--unfortunately, granted that six months ago, we thought that the trough to the housing downturn would have been--initially it was going to be the first quarter, and then it was the second quarter, and now it's the fourth quarter.

So there's just no secular uptick whatsoever. So we're seeing seasonal, and we're seeing the growth, certainly, of our new initiatives. We continue to do better overseas. We've had some solid programs there, and of course, we've got our solar panel business which is growing by double digits. So on balance, we remain optimistic that we're going to have a stronger second half.

Okay. And then you were talking about receiving your business license in China. You said that you're supposed to have that operational by the year end. Was that fiscal year end or calendar?

Calendar.

The calendar. And how long do you think that will take once you're up there, to get that ramped up?

I would think some four to six months, we should be making a good amount of product--after the start-up, of course.

That investment is secured by a long-term contract with a major, maybe the leading solar panel producer for their plant in Malaysia. And so we would get very quickly into supplying that contract need. Operationally, we should be able to get up to speed fairly quickly.

Okay, great. Thanks.

We'll take our next question comes from Justin Boisseau.

Yes, thanks. Quickly, if you go back to the acquisitions for a second and talk maybe a little bit more about the specific sectors or types of acquisitions you're thinking about, maybe the overall size you'd be considering?

Well, certainly, I'll take the latter here. In terms of size, I think we've got great flexibility. You know the cash we have on hand, we've got a $270 million line of credit ready to go, and $100 million to $200 million we can certainly do. In some ways, I prefer the $50 to $100 million than the smaller ones, but we'll certainly entertain the smaller ones as well.

We haven't ruled things out. If it makes good, strategic sense, love bolt-on acquisitions to our current business platforms because it's far less risky. You can put together some very strong integration teams and you can do it fairly quickly. So bolt-on acquisitions is what we're giving first priority to but certainly stand-alone businesses that play where we play, we certainly have a good appetite for $100 million to $200 million.

And these are all being (inaudible)?

I'm not ruling out something bigger. I'm just saying that I would view something like that as in our sweet spot.

This is Tom. I'd just add to that when we did the spinoff road shows, we were very open with--our financial objective is to kind of keep our leverage at two times EBITDA. It might go a little bit higher than that. And of course, we'd be acquiring EBITDA, so that would give you a sense of the order of magnitude of what we might be looking at.

And these would all be in Engineered Products, right?

That is definitely our first priority, absolutely.

And then given the issuance of options at the time of the spin, could you tell me how many options you have outstanding and what's the weighted average strike price?

Well, the average strike price is kind of easy. I think that's $15.02. That's being very precise. The number off the top--Tom, do you have the number?

I don't have the number, but what I can help you with, if you're trying to get to dilution going forward, if that's your question, the dilution from those will be probably a little bit less than $0.5 million. We didn't have any dilution this quarter because we ran at a loss all-in, and you don't dilute when you do that. But going forward for the options, it will probably be around, a little bit less than that $0.5 million, depending on the price in the marketplace, of course.

Right. And then finally, on receivables, the absolute dollar number looked maybe a bit high, although I don't have great year-to-year information. Is there anything going on there that might be unusual timing issues?

No, receivables, there's no issues. The one thing--there's no issues. The conversion cycle's 31 days, which is really, really good. But the one thing in the balance sheet that I could point out that's really unusual is that we have very significant swing in deferred income taxes.

When we did this transaction, we went through a process of reorganization that allows us to step up the basis in our assets so that we'll be able to amortize a significant amount of those assets over the next years, 15 or more, and that gives rise to a $60 million tax benefit. And so you see a huge swing in, we go from a deferred income tax liability of $34 million last year to an asset of $28 million this year. That's the biggest move--other than the cash, of course--in the balance sheet.

Perfect. Thanks.

We'll take our next question from John Tumazos.

It's very impressive that you had a 7.3% or 7.5% operating margin with the $15.3 million in income in the tough climate. I see just $3.4 million of eliminations, so there's no double counting. The two businesses basically run separately. I just want to congratulate you. It's a good margin. How much of the costs of $195 million were purchased scrap and purchased raw materials for the Engineered Products?

We'll have to talk, John. I'm not sure if I can help you all that much.

It looks like you have a 25% margin excluding purchased materials.

Well, in Engineered Products, we don't have any scrap purchases. That would be on the aluminum side.

But you're buying finished product? You're buying the ingredients for the window.

Correct, we're buying wood, we're buying resin, PVC resin. We're buying steel, stainless, hot roll, and we're buying butyl rubber, so it's a wide range, if you will, of raw material sources.

Are raw materials two-thirds of the cost?

No, no, they're not. It's closer to 50%. But on the aluminum side is where you get into a higher raw material and that is all, our aluminum business--I know that you know that--it is all scrap-based, or at least 95% of our molten metal is recycled aluminum. So there the raw material cost as a percentage of sales are in the 60% range.

Well, congratulations on holding the good margin in a tough climate. How much will your corporate and other be going forward when the reorganization is complete?

Well--this is Tom--one of the things I focused on earlier was, in the current quarter, we ran $31.5 million at corporate. And about $26 million of that is transaction related. So if you back that out, we're already down to that $5 million to $5.5 million or a little bit more running rate.

When we did the road shows, we said we'd, on a pro forma basis, get to $20 million on the year, so we're pretty close already. We'll have some drips and drabs as we go forward and there's some things we still have to do. But I'm pretty confident that we're going to get down to that rate pretty soon.

Should we allocate about half of that to each segment?

Well, we actually don't. It's kind of like half of Tom Walker. It's really corporate expenses, so that's why we don't allocate it to the business units. We show those separately. But I guess you could if you needed to.

Thank you.

And we'll take our last question comes from Bill Baldwin.

Thanks, gentlemen.

Yes, good morning.

Just some questions here on the numbers for some clarification. On the consolidated statement of income, it shows other net at $4.242 million. Tom, can you kind of indicate what that's comprised of? Over on page 8.

Yes, I've got it. It's the rabbi trust. There are a lot of unusual things going on. This is probably the most unusual. We have a rabbi trust that had stock of Quanex Corporation as its assets, and that's set up for (inaudible) and some retirement kinds of things. It received on the merger and spinoff, just like the shareowners did. It shared the stock in BP Spinco and $39.20. That represents $4 million plus of unusual income for the company.

Okay. And so that will pretty much be down to zero, I guess, for the--going forward.

Indeed. Yes. From a cash flow standpoint, we'll actually be able to potentially remove some of that cash into the BP Spinco statements.

Okay, okay. So not all of that will accrue to the rabbi trust?

Right.

So some of the cash will accrue to--?

It will initially go to the rabbi trust, but we will have to make a decision as to whether we pull some of that out, which we could do.

Okay. And the second question, Tom, in looking at your recurring numbers, the $0.17 a share, can you indicate what your tax accrual rate was to come up with that $0.17, what would have been the pro forma tax rate?

The tax rate, as you might imagine, is another very unusual thing--unusually high because there were so many costs that were non-deductible pursuant to the transaction, banker fees being the most significant. And so our full-year effective rate will be 39.5%. 3% of that is for the transaction cost, so on a running rate basis, we'll be at 36.5%.

And for the second quarter, what would that rate have been to come up with the $0.17?

Well, what you do is you look at each quarter and then you use an average for the year. We don't disclose the particular quarter, but the way you account for it is you take every quarter and average the whole year, and that's the number you use. In actual fact, we lost money so we wouldn't be paying taxes in the first quarter here all in. But when you look at the whole year, then you have to account for it on that basis. So I guess the direct answer is 39.5%.

Okay. So to arrive at the $0.17 recurring number, we roughly have a 39.5% tax rate was utilized.

Yes, that's correct.

Okay. Thank you very much.

Thank you.

And that is actually your last question.

The uncertainty surrounding today's current economic conditions--including the health of the credit markets, the reduction of home equity values, the severity and length of the economic contraction, and the significant impact on all of us by energy cost increases--leaves little doubt that we are going to be put to the task over the coming quarters.

However, our new company is sitting with a comfortable cash balance, essentially no debt, an untapped $270 million revolver, and very small capital expenditure requirements. Although the housing market has yet to stabilize, we know the long-term prospects of our end markets remain excellent. And we are well-positioned to not only out-perform them, but to take advantage of our financial capabilities to add to our profile.

The vision for Quanex Building Products is to become North America's leading manufacturer of engineered materials and components sold to OEMs and distributors of building products. It will grow faster than the served markets through leading-edge capabilities that drive new program initiatives and products.

It will increase the size of its footprint by pursuing product, process, and distribution adjacencies in building products markets through its proactive acquisition process. And it will grow shareholder returns through a combination of organic growth and strategic acquisitions, always mindful that return on invested capital is a key financial metric that holds a strong correlation to value creation.

That concludes today's call. Thanks for joining us.