Quanex Building Products Corp (NX) 2008 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Quanex Building Products Corporation 2008 third quarter earnings conference call. At this time, all participants are in a listen only mode. Later we will conduct a question-and-answer session.

Please note that this conference is being recorded. I would now like to turn the call over to Mr. Ray Jean, Chairman of Quanex Building Product. Mr. Jean, you may begin.

Good afternoon and thank you for joining us for our review of our first full quarter as the new Quanex Building Products Corporation. And as I think about it, I expect today's call to be my last conference call with you as an employee of Quanex.

I will miss you all and certainly the questions that accompany these conference calls. While at times I feel guilty for leaving the Company to our new CEO, Dave Petratis, in one of the worst housing markets we have experienced in a long time, I have the utmost confidence in management's ability to successfully navigate through these rough seas.

The process of turning the helm over to Dave is going extremely well, and I have great respect for him and for the team I am leaving behind.

There's no denying that the near-term housing outlook is grim. But Quanex finds itself in the enviable position of consistently outperforming the market it serves, and has one of the best balance sheets in the building products space.

Our balance sheet provides us the means to fully fund organic growth opportunities and to make acquisitions significantly grow Quanex. I continued we have a management team positively energized with this great opportunity to build shareholder value.

Let me turn the call over to Dave at this point.

Thanks, Ray. I appreciate the opportunity and confidence you and the Board have given me. Because of your hard work we are in a great position to succeed, and I look forward to moving the Company ahead.

To our audience today, I would like to say I am very excited to be here and I have been working hard at getting up to speed on the Company, our markets and our processes. Within the last two months, I've visited many of our facilities, met our senior business leaders, participated in Town Hall meetings with employees and have been through a [formal] and thorough strategic review of the businesses.

With a lot of help from the leaders at Quanex, I remain on a steep learning curve but am closing that quickly.

On the call today with Ray and me is Brent Korb, our Chief Financial Officer. Brent has been with Quanex for about five years and brings tremendous talent and experience to our organization. He will serve as one of the key leaders in our acquisition process. Both Brent and I look forward to meeting you over the coming quarters.

Also with us today is Jeff Galow, Vice President of Investor Relations who, fortunately, is no stranger to you.

Today's call will include a brief recap of our fiscal third quarter results, a brief Every financial overview, and an outlook for the fiscal fourth quarter. Our comments include forward-looking statements about the future products -- prospects of Quanex Building Products.

Please refer to the Company's Form 10 filed with the Securities and Exchange Commission on April 4, 2008, for our complete forward-looking disclosure statements. The third quarter earnings release is available on our website at Quanex.com.

I would describe the condition of the Company's end markets during the third quarter as cyclically very weak, but in a seasonal upturn. New housing starts were up 31% in the quarter from the same period of last year, while remodeling and repair activity is probably down more like 10% over the same period.

We did experience a healthy pickup in demand from the second quarter with overall sales up about 16%.

At our Engineered Products division we continued to contend with the ongoing decline of housing starts and remodeling activities. We kept our quarterly division sales decline at a reasonable 12% compared to the previous year.

Our ability to generate additional sales through new customer programs and product continued to bolster us. And we remain focused on initiatives that will improve our customers' products by enhancing their thermal performance as well as their distinctive features.

For 2008, we are estimating new products at Engineered Products will bring in some $30 million of incremental sales and perhaps another $35 million of incremental sales in 2009 above 2008. These are products and programs that are currently in production and include the new invisible window screen, composite window profiles, entry door components, advanced insulating glass spacer systems and thin film solar panel sealant components.

I would like to take a minute to discuss the growth we are seeing at our TruSeal insulating glass sealant business. The introduction of our new Duralite Sealant product continues to gain penetration; and we are marketing it as the state-of-the-art window insulating sealant system, based on Duralite's thermal characteristic.

Our growth with the leading domestic thin film solar panel manufacturers is also extremely encouraging, as our solar adhesive sales have basically doubled in the last 12 months. In this era of high energy cost, we believe that our solar sealant opportunity is substantial and we have the opportunity to drive significant revenue growth over the next decade.

TruSeal is aggressively pursuing business worldwide with the major solar players in the market; and because of its 30-year plus adhesive experience, management believes we have a significant first mover advantage in the thin film solar panel market. The prospects for this product are very exciting.

We are on track to begin operating our new TruSeal facility in China by calendar end. Our plans for this facility will have us not only producing adhesives to supply our largest solar customers' new Malaysian operation but it will also be producing insulated glass sealant products. These products will be sold directly into the rapidly growing Chinese residential housing market which, today, is served from our facility in Kentucky.

To put the size of our solar adhesive and export sealant sales into perspective, we expect their combined sales will represent some 30% of our TruSeal's total business this year.

Turning to the third quarter financial results for the Engineered Products division, operating income was off about 29% from the year ago quarter but of note, they were up some 138% from our sequential second quarter, based on seasonal improvements in the market and the strength of new products. Quarterly sales for the group were down about 12% from this time last year, so quite credible, given the broader market weakness we saw. Compared to last quarter sales were up about 25%.

This ongoing year-over-year decline in the sales of Engineered Products and the subsequent poor operating leverage have hurt us all year. However we believe there is a real chance for better financial results at Engineered Products in the fourth quarter compared to the year ago quarter.

Ray shared with you last quarter our plan to combine two [fenestration] components facilities at our HOMESHIELD division into a single efficient facility in order to help reduce operating costs during this cyclical slowdown. We expect to have this consolidation effort wrapped up by calendar year end, resulting in some $1.2 million in annualized savings.

Price realization has become a major priority for us. Because of the steady rise we are experiencing in costs for items like energy and raw material, we are aggressively increasing prices across all Engineered Products businesses where appropriate.

Let's now turn to Nichols Aluminum. Third quarter operating results at Nichols were quite respectable when you consider the poor Building Products environment and weak secondary markets we experienced during the quarter.

In response to a very slow market, we continue to see competitors idling and in some cases closing both rolling and finishing facilities. Our ship pounds were down 11% from the year ago quarter, but up 3% compared to the second quarter because of seasonal increase in market demand.

Operating income was off last year's level due to the drop in volume and a 31% decrease in value-added painted sheet sales. Spreads in the quarter, which is the difference between our average selling price less our average material cost, was up about $0.03 per pound in the quarter compared to our second quarter, as we saw a rise in aluminum prices through the third quarter.

As of now, we are predicting fourth quarter spreads to be essentially in line with the third quarter.

At this point I would like to turn the call over to Brent who will take you through some of the Company's financial highlights.

Thanks, Dave. I would like to add my welcome to our audience as well. Over the last several years I have spoken with a few of you and I do look forward to establishing stronger relationships over time.

The Company reported $0.32 per share from continuing operations in the quarter before taking into account a $5.5 million pretax non-cash LIFO charge that equates to $0.08 per share after-tax. There is a short GAAP reconciliation table in our earnings release which shows this in more detail. On a comparable basis we earned $0.54 per diluted share from continuing operations in the year ago quarter.

Moving the discussion to cash, the Company continued to generate solid cash flow for its shareholders, even as the housing market continues to bounce along at the bottom. Year-to-date cash from operating activities came in at about $34 million, down from a year ago primarily due to lower operating income and higher working capital associated with the higher unit price of aluminum.

Our cash and equivalents balance at quarter end was a very healthy $54 million, and that figure does not take into account the estimated $20 million that [your Dow] will pay us on the tax true-up payment. We are still doing our valuation work in this area and we believe that payment will be made in early 2009.

As anticipated, our cash flow generation picked up in the third quarter due to seasonal sales improvement at the businesses. Total debt to capitalization remains under 1%, comprised of industrial revenue bonds totaling some $3 million.

The balance sheet remains strong and the process of managing our working capital has intensified in light of the existing market challenges. Our conversion cycle, which is a measure of how long it takes us to convert a customer order to cash, came in at a very respectable 32 days -- about even to last quarter.

With that I will turn the call back to Dave.

Thanks, Brent. Moving the discussion to the 2008 market outlook for Quanex Building Products, the near-term view for residential construction unfortunately remains somber. With calendar 2008 estimates for new home starts from global insights now estimated at about 940,000 units, down from their December 2000 estimate of 1 million units.

Assuming the latest 2008 housing start estimate is correct, that will mean a 31% decline from 2007. And you might recall that 2007 starts were down about 25% from 2006.

The pundits, at least for now, continue to call for the housing trough to occur in the fourth quarter calendar quarter, but frankly we are not convinced of that. Let's hope they're right.

What we do know is this trough quarter has already moved out several times this year. We expect the Company, however, to continue to outperform the market due to new programs at Engineer Products while ongoing Companywide cost reduction initiatives, price realization, a healthy spread at Nichols and ongoing seasonal improvements in demand will bolster earnings in the fourth quarter compared to the third quarter. However, we don't expect to exceed last year's fourth quarter adjusted earnings of $0.44 per share.

With that said, the team is now ready to answer your questions.

(Operator Instructions). Arnie Ursaner from CJS Securities.

Good afternoon. Wanted to try to focus my questions related to the margin in the aluminum side. You highlighted a couple of factors that impacted margins in the quarter. A combination of drop and ship panels, lower payment sheet, higher freight and energy costs.

Can you give us a feel for perhaps the magnitude of some of those factors? Which if any you think may change in Q4? And also the cost or impact the shredder may have had on margin in this segment?

Thanks for the question. I would say one of the biggest challenges we have is in our [painted] sheet. The volume out there is down some 30% and we try to position Nichols with this ability to provide value add, if it generates good margins for us. And it is probably the biggest mover in terms of the variance from year-to-year.

And the cost and impact on the margin for building in the shredder?

I think that's a difficult one to estimate on a near-term basis. That's all -- scrap is all mixed together. So off the top I don't think we have an answer to that one.

And if I can ask one more quick question, the margin in the Building Products segment, last quarter you were sort of right on the bubble of operating efficiencies where you were sort of at the bubble on breakeven. You talked last quarter about some pretty good improvement in the latter months of the quarter.

Can you give us a feel for where we are now in terms of utilization and how the trends may have shifted during the quarter?

I don't think the utilization -- you are talking primarily engineered products right?

Correct. Yes.

That's what you meant. The utilization hasn't increased all that much. I mean, certainly, as we've mentioned we've seen the seasonal uptick which we've benefited from.

I think on a go-forward basis there is going to be some price realization as a result of actions that are being taken currently, and of just the ongoing cost reduction initiatives that gain traction. We just haven't let up on that front.

You know, Dave referenced the consolidation -- plank consolidation in Chatsworth. Obviously we are not going to benefit from that in the fourth quarter. To the contrary, we are spending money to execute that initiative. So there's some near-term pain on that, but I think the important thing is that we continue to take action required to position us favorably when the markets come back.

Thank you very much.

Peter Lisnic from Robert W. Baird.

Good afternoon, gentlemen. I guess, first of all, Ray, congrats and we will clearly miss your answers to some of our questions.

I guess the question I had really was the pricing comment that you alluded to, Ray, and that, Dave, you also talked about in the prepared comments in that. Can you maybe give us a sense as to what sort of price realization you are seeing in the EP business? Are you getting pushed back? And kind of what is the outlook there because with this difficult demand environment I have got to believe it's kind of tough to get price to go through?

I joined July 1 and clearly identified opportunities for price realization. So [after] three businesses within Engineered Products they've put in aggressive plans to drive prices.

From my perspective they've got the ability to flux on that. And I think customers today, even with the depressed situations, see the inflation that is coming on and they are getting hit from all suppliers. And we are standing firm.

Well it sounds like there was apparently some low-hanging fruit there if I'm reading into your answer the right way. Can you maybe give us a sense as to what the -- what sort of a blended average price raise might be or kind of what you might be realizing there?

I would say there is low-hanging fruit. I would say from my 27 years in business, the pricing lever is one of the most underutilized in business. But to be able to give you a blended factor or how that will impact, you know, haven't done that calculation.

Okay. That's fine. And then a totally unrelated follow-up and that is on the acquisition environment, if I was reading the press release. It sounds like expectations are still -- there's still a gap in terms of what sellers might be looking for.

So, A, is that right? And then, B, is there anything in the [solar] side that you might look to acquire that would complement what you're doing on the TruSeal front right now?

I think the longer this recession goes on in the building markets, the more reality that has come in to bear on potential sellers. And we think we are in an outstanding position with our balance sheet to take advantage of that.

So you know as we are looking at potential prospects, I see that realization creeping in.

Second, in terms of the opportunities in solar, we would be interested in space that would complement the position that we have. Where we will be investing is to make sure that, globally, we are servicing those customers not only from a sales standpoint, a technical standpoint and, what I would say, manufacturing standpoint, these players are going to grow pretty quickly. And I think that's a great opportunity for us to provide technical support as well as manufacturing logistical support that will help us [to run]. It is a high priority for us.

That is very helpful. Thank you and welcome.

Thank you.

Robert Kelly. Sidoti.

Good afternoon. The question on, I guess on the painted sheet. What's the biggest consumer of that? Why has that fallen off so much more than the rest of your [pound] ship?

A big piece of that has gone to transportation markets and I would say a big piece. I mean both the downturn in building products and transportation markets are having an impact. But the fact that the Revenue the market, the trailer market, the truck-trailer, specialty vehicle trailers and so forth, that has had a substantial impact, a negative impact.

Okay. Great. Then the way the [ET], you guys had the [call factor] escalators on a lot of your contracts specifically for anything plastic-related.

Are prices rising so much that they're no longer valid or -- I am just kind of confused that you are trying to get price realization.

You've got the price escalators on the blended compounds, but you've also got other factors which include transportation, packaging, labor costs and, especially, transportation with oil prices going up. It's important so we are trying to recover that.

So the materials are covered but everything else is what you are going after. Okay.

Whatever is being covered formulaicly, those remain in effect. And it's effective. It's cost push inflation on perhaps some micro ingredients. And as Dave points out, transportation, natural gas -- it's sundry other items that are starting to bite.

Thanks.

Jack Kasprzak from BB&T.

This is actually Adam Thalhimer, calling in for Jack.

The first question I had was on the guidance. For the year, guidance would seem to imply that your segmentable operating profit will increase sequentially in Q4. I'm just curious what you guys see driving that?

First of all am I reading that correctly, but second of all --?

You are reading that correctly. Yes Sir.

I think, again, the season -- in some years the third quarter is the best quarter. Right now, we are looking at a slightly stronger fourth quarter for our Engineering Products business. And we think our aluminum business, we should do a little better. I think spread may be, you know, we are saying in line.

I think they're may be a little (inaudible) side on the spread, but a little nervous on the volumes. We are saying that the aluminum might be marginally better which, in turn, you add those two up and you come up with slightly better results in the fourth quarter.

Slightly better in both segments.

Fair statement.

And then just wondering if you had any CapEx guidance you could give us for 2009, fiscal year 2009?

We haven't given anything formal yet. We are just now starting to put together the operating plans. So we'll have a lot more to say about that when we report you to on the fourth quarter.

We have indicated for this year some $15 million of CapEx and $5-ish million of that is the China opportunity with TruSeal. So for next year I will just stop with you can expect it to be a fairly skinny year, but let us put some color on that when we report to you in the fourth quarter. Because by then we would have gone through our plans.

Okay. Great. Thanks for the time.

Barry Vogel from Barry Vogel & Associates.

Ray, I'd like a hope that we have the next six years or seven years as successful as you have been, for Dave. That's number 1. It's been a pleasure dealing with you during this period.

Thanks, Barry.

I have a question for Brent. I don't know if you can answer this question, but do you have a LIFO expectation for the fourth quarter?

Do we have a LIFO expectation? Yes. I would say we would expect there to be probably in the $2 million range in the fourth quarter.

$2 million charge?

Yes, $2 million charge; but that of course is an estimate based upon what we think LME prices are going to do. So it's as good as our ability to forecast that LME in the future.

Okay. And as far as the issue of further cost-cutting and higher price realization, do you have some idea of what the improvement might be for the third quarter to the fourth quarter on those two items?

I think that's a tough one, Barry, in that some of this is still ongoing. Some of it the effective date will vary to some extent. So I think we really hesitate to put a number on that.

Okay. Thank you very much.

[Al Sebastian] from Iron Bound.

Just a couple questions. Can you give us a hand with the working capital? It seems for the first nine months, there was a significant increase in accounts receivable and inventory, despite lower sales. Can you explain that?

Yes. The thing that's really pushing both of those up is the price of our aluminum scrap. You know as closer inventory just it's an increase for us roughly 20% from the end of last year to where we are now. So just even if you kept your level of receivables and your level of inventory flat, you would see your receivables and your inventory pick up as we are seeing here.

Okay. So, you are saying I guess if you didn't have an increase in aluminum scrap, you are saying that -- where would this be? Would it be you would actually have a decrease in accounts receivable and inventory?

Yes. It is too hard to tell. I would say we would be at least closer to flat. But I don't know the exact number.

And a good metric for that, of course, is our conversion cycle in days. That neutralizes the unit cost impact of aluminum, and that has stayed within reasonable bounds. I mean we don't show that we are deteriorating on the working capital management side.

One last question. In terms of your corporate overhead at $20 million. That is a run rate you think is sustainable?

Yes. That's our best guess for right now, but we do believe that sustainable. You know, we are just going into our budget process for 2009. And we will see what we come out of that with as for 2009.

But yes, clearly, $20 million to us seems like a very reasonable run rate.

Okay. Thank you.

Craig Bell from [SMH] Capital.

Yes, just quickly on the pricing. When did you really start implementing that? Sort of getting aggressive on the price increases.

You know, there was momentum. You know when I hit the door July 1 we announced price increases at (technical difficulty) effective September first. HOMESHIELD is increasing prices with customers that are not on long-term contracts and we had increased prices effective May 1 at TruSeal.

So there was some action in place. As I said I believe this lever sometimes underdeveloped; and I would like to think out in the future that we can be noted as a company for our pricing excellence and applying the signs of pricing to our business.

I think you know the pricing mastery at Nichols is really pretty noteworthy. And we are going to try and develop that expertise in engineered product.

Great. In looking at the acquisition front, obviously, given your balance sheet, you're well-positioned and if you can the right people at the right price helpful. But are you seeing any kind of competition out there or do you think that your balance sheet is putting you in a pretty unique position right now?

I think you have always got to anticipate that there's going to be competition in the M&A process. I think what's impressive here, Ray, Paul Hammond have some strong long-standing relationships that is important in the acquisition process. We feel that we are a bit unique when you look at the building products based with our ability to have dry powder in reserve to go out and pursue the prospects that we think make sense.

David Cohen from Midwood Capital.

Most of my questions have been answered. But what are you suggesting that folks thing about as far as a normalized tax rate for the company?

For this year?

And beyond.

For this year we would expect it to be about 40.5% because of transaction related items. For going forward, for next year, probably closer to the 36.5% range.

Okay. Thanks.

[Mark Parr] from KeyBank Capital Markets.

I just wanted to toss a weigh in with you, Ray. You've done a great job building a business and leading the charge here and hoping that the pass off you are doing here is equally as positive.

So congratulations on a great career here at Quanex.

I appreciate those comments.

I would say to the mentorship from Ray that the hand off here has been outstanding and he thinks he's going away, but he's only a phone call away and I am going to take advantage of that.

One question I did have and I know you guys attempted to give some color on the call regarding how you are offsetting the end market weakness. But could you just try to summarize for me new programs the new product areas, kind of to date in '08 and then, incremental opportunity you are seen in '09?

I know you said some of that, but maybe I'm asking you to repeat yourself. But I would just like to get that clear in my head if I could.

I would describe that as some of our new product programs. We've got a program called DP 40 that drives new door threshold. Really some exciting products in what we call enhanced visiability screens.

I don't know if you've seen this offered by companies like Andersen, but clearly the premium product that makes the screen transparent. In our micron business we have what we call micron wood which gives the ability of a PVC extruded vinyl windowsill to be coated with a wood product that is stainable. And clearly progressive in terms of the market acceptance and capability.

The last that I comment on would be our promotion of the TruSeal products. One is Duralite which gives a window producer a level of efficiency that is unparalleled in the marketplace.

We clearly are setting the market standard and we think this will as this nation in the world moves towards green solutions, that we are in a position by ourselves.

The last is the thin film solar relationships that we've got in the Commercial Solar segment. We think we've got the opportunity to exploit that worldwide now.

You take those five or six headlines, we think that is going to impact are topline by about $30 million this year and $35 million in 2009.

So that's an incremental $35 million in 2009 or an incremental $5 million?

Incremental $35 million.

Terrific. Thanks again for all the color and look forward to continued progress.

Justin [Bousseau] from Gates Capital.

Thanks. You talked a little bit about using cash for acquisitions and you do have a small dividend. Is there any other type of uses of cash you might anticipate? I don't believe you have a stock buyback authorized at this point, but is that anything that you have considered?

Yes, that's definitely something that we will consider in the future. We do not currently have one authorized, but clearly as we go look into the future, I mean it's acquisitions, (technical difficulty) share buyback.

So it's just a matter of figuring out what our cash flow claims look like in the near-term.

I would say there's a bias to grow through acquisitions. We clearly are going to be disciplined buyers and we like the space that we are in and see opportunities in that space. And we would like to believe that we can execute on them.

Then, kind of directionally how should we think about building products and the profitability their stabilizing, given what you talked about what price increases and cost-cutting vis a vis the housing market? In other words what do you need to have happen in housing next year to be flattish on the operating income line for building products?

We are going through the budgeting process in the next eight weeks. Have I think said very realistic expectations on what the market may look like in 2009, and we are going to work hard to get a sense of that. So it's a little ahead for me but to comment on that but I think we're taking a very hard realistic look at what '09 will be like and then will draw our conclusions on what we've got to go get in terms of price and productivity.

I would emphasize on both of those front price and productivity, we are going to be driving our business hard because we feel it's a great time to sharpen the edge. So when this recovers we can take advantage of the new products, the enhanced capabilities that we have.

At this time there are no additional questions. I'd like to turn the call back to Dave Petratis.

Thank you. Having spent two months with the Company I can tell you without hesitation that I have been impressed by the people I meet, the facilities I tour and the processes that I have come to know.

I am particularly fortunate to have the mentorship of Ray Jean and to depend on as I take on my new responsibilities. Financially, my hat is off to Ray for putting Quanex in such a strong position and executing the spinoff of the business.

Today we are sitting with a comfortable cash balance, basically, no debt and an untapped $270 million revolver and minimal capital expenditure needs. The uncertainty surrounding today's current economic conditions obviously remains.

Yet we are convinced the long-term prospects of our end markets are excellent. And during this time we will take advantage of our financial capabilities to add to our business profile.

The vision for Quanex Building Products is to become one of the world's leading manufacturers of engineered building components that will be recognized for their leading-edge products and process technology, best-i -class customer service and excellent shareholder returns. Our purpose is to provide systems and components that seal, protect, and improve the energy efficiency and architectural appeal of building envelopes.

We will grow faster than the served markets through robust technical capabilities that drive new programs initiatives and products. We will increase the size of our footprint by pursuing product, process and distribution adjacencies, and global building product markets, through our proactive acquisition process.

This concludes today's call. Thanks for joining us. I look forward to working with you in the future.

Thank you for participating in the Quanex Building Products Corporation 2008 third quarter earnings conference call. This concludes your conference for today. You may all disconnect at this time.