Quanex Building Products Corp (NX) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quanex Building Products second-quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will follow at that time. (Operator instructions). As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Dave Petratis. Sir, you may begin.

Good morning and thank you for joining us for our second-quarter review and 2009 business outlook. On the call with me today is Brent Korb, our Chief Financial Officer; and Jeff Galow, our Vice President of Investor Relations. Today's call will include a review of our current markets, a recap of second-quarter results, an update on our financial position and the outlook for the remainder of fiscal 2009.

Our comments this morning include forward-looking statements about the future prospects of Quanex Building Products. Please refer to our SEC Form 10-K filed in December 2008 for a complete forward-looking disclosure statement. The earnings release is available on our website at Quanex.com.

The condition of the Company's primary end markets, which are residential housing starts and remodeling activity, remain poor. New home starts were down 49% compared to the year-ago quarter, while our remodeling and repair activity was estimated to be down 10% to 15% over the same period.

Optimists out there keep saying that housing starts have found the bottom at these levels. We certainly hope they are right. If you assume we are now bouncing along the bottom, the question then becomes, how long do starts stay at these extremely low levels, a real concern for all of us here at Quanex Building Products.

Worldwide demand for aluminum continues to fall in the second quarter, pushing aluminum prices down to an inflation-adjusted record low of $0.57 per pound. Over the last month prices have drifted back up into the mid-$0.60 range. The Aluminum Association reported US demand for non-heat treatable sheet, what we produce at Nichols Aluminum, was off 35% to 40% compared to a year ago. So, guys and gals, it's tough out there.

At our Engineered Products segment business was slow but certainly not as weak when compared to our first quarter. On a more hopeful note, our sales in April showed meaningful improvement over prior months. So at least we do not expect -- so at least we do expect to see a seasonal improvement in demand in the second half of the year for our window and door products.

While we outperformed the broader market, we had little to boast about. For the second quarter we reported an $800,000 operating loss at Engineered Products. That was disappointing. However, these results were far better than the $4.7 million operating loss we reported in the first quarter.

We continued our efforts to educate our customers to the overall value proposition that we bring to them, especially in these difficult times, which include the benefit of having a key supplier in excellent financial strength. On previous calls I told you one way we believe we can add muscle to Engineered Products' marketing efforts is by taking a more disciplined approach to the opportunities we have blended to combine the capabilities of our three Engineered Products divisions. We believe presenting Engineered Products as one coordinated business will allow us to offer customers a more robust slate of products, systems and services that represent the very best in design, engineering and logistical skill sets.

Our progress to date includes having a joint sales meeting to bring our teams together for high-level discussions, conference calls hosted by each division sales team to enhance the understanding of their team's products, capabilities and services. We will soon launch a national sales brochure which will be used by all sales teams to push cross-selling initiatives with their customers. We have also held joint meetings with some of our larger customers to introduce them to the key players and explain the total capabilities of Quanex Building Products.

Let's review Nichols Aluminum. I'll start by saying our financial performance was very consistent with the poor state of the aluminum industry with a reported loss of $11.6 million in Nichols Aluminum. There was some good news to report as we were able to reduce inventories at Nichols by 50% in the quarter, excellent progress when you consider how slow demand was.

Today at Nichols the business is carrying 25% less inventory than at any period over the last 10 years. Nichols had finished aluminum shipments of 44 million pounds, off 39% from a year ago, which was in line with industry demand but clearly remained at low levels. On a more hopeful note, our shipments were up 22% over the first quarter.

However, as we alluded to in the past, the poor operating performance at Nichols this quarter was primarily attributable to an ongoing deterioration in our overall spread and, to be more specific, the raw material spread, as, once again, LME prices fell faster than our scrap cost. To put this in magnitude of the deterioration in perspective, our overall spread was down a whopping 33% from the first quarter. When low shipments and a lousy spread collide, the unfortunate result is poor financial performance.

At this point I would like to turn the call over to Brent, who will take you through some additional financial highlights.

Thanks, Dave, and I'd like to add my welcome to those who are listening to the call as well.

The Company reported a loss of $0.38 per diluted share from continuing operations before taking into account $0.78 a share from the goodwill impairment charge and $0.08 a share of LIFO income. There is a GAAP reconciliation table in our earnings release which shows this in more detail.

On the subject of cash flow, we had good news to report. Cash provided by operating activities for the first six months of the year was over $14 million. Much of that improvement is thanks to the significant improvement we saw in working capital this quarter, especially in the area of inventories. Nichols Aluminum, for instance, was able to reduce its inventory pounds by 50% in the quarter.

As you have heard me say in past calls, maximizing cash flow is a priority this year, and we will remain vigilant in this critical area of the business in light of market conditions. We finished the quarter with a healthy cash balance of $85 million. During the quarter we booked a true-up impairment charge of $45 million pre-tax, which was associated with goodwill still on the books at Engineered Products. You will recall that we recorded an intangible asset and preliminary goodwill charge of $137 million pre-tax last quarter that was related to both Engineered Products and Nichols Aluminum.

At this point our remaining goodwill and intangibles balance is approximately $75 million, all of which is associated with acquisitions of Mikron and TruSeal.

Let me finish with an update on the availability of credit under our $270 million revolving credit facility. Because the facility has an EBITDA covenant of 3.25 times, falling earnings over the last 12 months will continue to impact the amount of credit that is available to us on an as-is basis. At the end of the second quarter estimated availability was $130 million, and we have no outstanding balance at this time. As a reminder, EBITDA acquired through an acquisition can be added back in the calculation of available credit. We remain focused on this issue and we'll do everything we can to maintain the existing credit facility we have, given its very favorable terms versus current market terms.

With that, I'll turn the call back to Dave.

Thanks, Brent. Moving the discussion to the outlook for our markets, the 2009 forecast for residential construction and remodeling remains discouraging. Global Insight's estimates for 2009 new home starts continue to drop with starts now expected around 530,000 units, down from 900,000 units in 2008, a 40% drop.

So what does this mean for Quanex through the remainder of fiscal 2009? While it was certainly slow in coming, we are seeing a seasonal pickup in demand and we are confident that the second half of the year will bring considerable improvements in the financial results of both operating segments. At Engineered Products we expect the segment to report positive earnings in both the third and fourth quarter. At Nichols Aluminum we know weak shipments and an especially poor materials spread have battered results during the first half of the year.

However, when you compare Nichols' first-half results to second-half expectations, we look for a significant rise in aluminum sheet shipments as backlogs improve and for a healthy jump in raw material spreads due to stabilizing aluminum prices and lower inventories. Taken together, these improvements should allow the segment to essentially break even in the second half of 2009.

However, we still believe the economic experts are optimistic in their housing start figures, given the impact of the ongoing recession, and we have little doubt that these estimates for starts for 2009 and 2010 will stay at the bottom. We are not letting our guard down, and we will continue to adjust our plans to meet that expected reality.

If, by chance, demand should surge unexpectedly, which we are certainly in favor of, we can rapidly adapt to meet those circumstances. We just don't see that happening in 2009 and remain very cautious for 2010.

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

(Operator instructions) Jack Kasprzak, BB&T.

I wanted to ask first about the improvement in demand from Q1 to Q2, a seasonal improvement. I understand the weather is better, but what else might be behind that? Because new housing activity continues to weaken if we just look at the actual housing starts. Can we assume that it was some improvement on the repair and remodel side? What would you attribute that to?

Number one, we always see a seasonal improvement as the North thaws out. Number two is, I think there was a dramatic decline in process and raw material inventories at our customer. And as those things hit bottom, they had to replenish those. And I don't want to get into some specifics, but I think our customer chain really worked extremely hard based on the economic condition to flush out inventory. So I think we are seeing that in our numbers.

And the press release mentions discussions with customers reflect a bit of optimism for the second half of the year. Why would they have some optimism?

Number one is the stimulus package. You've got the rebates that are coming from the federal government, up to $1500 for windows. And Quanex Building Products and our customers are in a good position to take advantage of that.

I would just add to that, it is not unusual even in good years to see optimism built into the customers for the second half of the year. Just coming out of the slow winter season we tend to see that anyway. So that would be part of that answer.

I would give you one other piece of color on that. I was up in St. Louis recently, here in Houston, around the country. Our big customers are really aggressive in marketing this rebate and opportunity in the energy-efficient windows, and I think our big horses and their marketing capabilities will help us in a bad economy.

David Cohen, Midwood Capital.

Have you guys experienced any credit issues with your customer base? For example, I saw headlines of a Dallas-based aluminum and vinyl window company, Atrium, that's filed Chapter 11. I don't know if they are a customer of yours. But how prevalent is that issue for you guys at this point?

Generally, it has not been extremely prevalent. We've seen it on some of our smaller customers. Atrium is, in fact, a customer of ours and we've been working very closely with them over the last few months, I'd say. And even back in the summer of 2008, in fact, we were working with them as they went through a bit of a refinancing then.

But generally speaking, we've been able to avoid the big issues that many other businesses are having to deal with.

David, you mentioned the marketing by your customers of rebates around energy-efficient windows. Is that I guess -- what portion of the market is that in terms of -- my understanding was that related to a rather expensive upper end of the window market in terms of the price points for those highly energy efficient products. Is that accurate?

It's true. The government with the stimulus package put in what we call a 30-30 spec which is effectively like an R-value that you would have in installation. You've got to have premium windows to be able to hit that and we think that plays to our strengths well.

I would just add, too, that there are, again, upper end vinyl windows that do hit that. There seems to be some scuttlebutt in the market that only a wood window will qualify for the 30-30, and that is not the case. There are more premium type vinyl windows that will hit that spec or better than that spec.

Is it safe to say that, whether or not some window hits the spec, there's probably going to be some success in generating demand, and then it's up to the consumer to figure out if they are actually going to get a rebate?

Yes, but hopefully they're getting some help from the retailer as to which units would hit and not hit the rebate.

Torin Eastburn, CJS Securities.

Your outlook in Engineered Products -- does that assume any pickup other than typical kind of a seasonal boost in the second half of the year?

I believe we understand the seasonal lift, and we've factored that in.

Have you factored in any other kind of pickup related to anything in the economy?

We were -- I'd say no. We continue to be very cautious on the primary drivers of residential housing, repair and replacement activities. We think that's going to be difficult.

And at Nichols, are you factoring in any kind of potential price increase in the back half of the year end, or is your expectation for an improved spread just based on working through the more expensive inventory that you have?

That's going to be the predominant factor is working through the high-priced inventory that we had to go through the first half of the year, and combined with stabilizing prices of LME. So, as long as things are relatively stable and we have our inventory in line with where it needs to be, we think we'll see some spread improvement there.

You've talked in the past about the scrap price tending to be a little bit stickier than the LME price. Are you seeing any stickiness in terms of the scrap price staying down as LME rises?

No, plus the movement that we're talking about, we're not talking huge movements to begin with. But generally, it's followed fairly well LME and scrap, if you really charted it.

David Woodyatt, Keeley Asset Management.

Given the magnitude of your inventory drop, I'm just wondering if digging into old LIFO layers was a factor in the high cost you had in the quarter.

Not so much. It's, clearly, a potential that we could have as we approach the end of the year. But as we've disclosed in our filings, the way we go about this is to estimate where we think we'll be at the end of the year. So there is more of an estimate involved, but at the volume drops that we have, we clearly would dig into some layers. But we have some recent layers that we would go through first before we start reaching too far back.

Well, if in fact it turned out you did have to dig into some of those real old layers, what kind of costs are in there?

That's a little much for me to just know off the top of my head, to be honest with you.

Robert Kelly, Sidoti.

First one I had was EBP in the second quarter, basically flat sales versus 1Q, big improvement in operating income. First, what are the drivers?

Secondly, is China still a drag at this point in 2Q '09?

Your first question was on Engineered Products?

Yes.

What we were able to experience that engineered products is continued benefits from some price increases from the previous year that now we've realized some additional benefits of in the second quarter, as well as we continue to get the costs down in line with volume. That, and then the third item I'd point to is we had some improvement in our material costs at a couple of the businesses, not across the board. But I think those three factors are what really contributed to some better earnings compared to where we were in the first quarter with similar sales.

Okay, and then you have China included in Engineered Products. Is that contributing positive at this point?

Well, no. Let's be clear. You are talking the Chinese facility, which we don't expect to be fully operational until, we've publicly said, the second half of the calendar year.

So it's still a drag at this point?

Yes, it's a drag, but it's a pretty small drag. It's a rounding error drag.

Secondly, you talked about the second-half outlook. Have you seen an increase in the Nichols backlog, or is that your expectation as the seasonal build flows into your order book?

We did see growth in the Nichols backlog in Q2, and we look at that as a positive sign.

Okay. I guess my question is, at the current run rate for pounds shipped and once you get to, I guess, past the higher-cost raw material, is the 40,000 to 44,000 pound ship mark the breakeven at this level spread, or is it a higher number?

We've never gotten into break-evens publicly, and so we're going to hold off trying to get into any disclosure at what pounds are we break-even because then you get into the whole sensitivity, well, what's the spread? And so we are just not going to go there right now.

I think Nichols was successful in processing through the majority of the high-priced inventory in the quarter.

Barry Vogel, Barry Vogel & Associates.

I have a couple of questions for Brent, and then one for David. You mentioned in your press release the issue of aging receivables. I was wondering if you can tell us what you were talking about, because you did mention it specifically.

There's no heads up on that as to, oh, oh, there's something out there that we are trying to inform you of. That's just saying, we are fixated on that more now than you would have been two years ago. Just if someone slips by two days, we are all over it.

So there's no specific hidden message in that comment in there; it's just to let everybody know, we have not just been purely fixated on inventory. You see the significant inventory reduction that we've achieved in the second quarter. We haven't taken our eye off the ball on receivables, either.

Brent and the businesses did an excellent job of moving a higher percentage of our AR into the current category during the quarter.

Now, on the same inventory subject do you expect to lower your inventories further and generate additional cash from inventories in the second half?

Well, I want to hesitate giving specifics there. But what we will incur is that we will see some incremental improvement. But let's bear in mind, too, sales are going -- we expect sales to pick up in the second half of the year. So naturally, working capital will tend to follow. So what we're focused on doing is holding it down below what would typically be acceptable as sales pickup. Right? So we're trying not to just say, okay, things are back to normal, let's get working capital back up. So we will continue to work on getting inventory out where we can, but we also have to be mindful of, as sales pick up, you will see some increase in receivables and payables and potentially some level of inventory.

I would build on that to say, we've got aggressive programs around lean manufacturing techniques, and as part of our continuous improvement program we're trying to get more velocity around that inventory and drive that incremental improvement so that we are better.

Our operations teams have done a masterful job in the last three months of getting the inventory down, and they are not about to let up on that exercise.

I have one more question for David. You talked about acquisitions on the last call, and of course things have deteriorated since then, and of course your facility is now lower because of your lower EBITDA. Can you tell us your attitude today about taking advantage of this with your good balance sheet, despite your negative feelings about what's likely to happen over the next year?

I continue to be very bullish in our search for assets that we think are a natural fit with Quanex. I believe that the longer we drag along the bottom, the better opportunities that are going to emerge. And we continue to remain very aggressive in our inquiries and the opportunities that are out there.

I would say, Barry, we have not changed our willingness to look at something, and we will continue to be active. And while our EBITDA decreasing limits our ability to draw on our existing facility, like I said, on an as-is basis we do have room to do something under the existing facilities by way of acquisition. And we'll look; if something makes perfect sense, we'll look and see if there are other financing arrangements out there for us.

Thank you very much, keep up the good work, and let's hope this thing turns already.

Fritz von Carp, Sage Asset Management.

If you could remind me how you buy plastic resins and what exposure you might have to price changes there?

The price change we are fairly well -- I don't want to say locked in at, but we have a resin adjuster. So we pass that along based on published index pricing on, I guess, a one-month lag, effectively.

Peter Lisnic, Robert W. Baird.

First question on Nichols, I could see the raw materials costs and what's happening there and what's happening with LME. But the part I'm wondering about is the pricing dynamics, the industry dynamics there, what you are seeing and the conversion costs, whether there has been -- whether that's a headwind or not, kind of what's happening on those two fronts.

I would say we continue to be pleased with what's going on with pricing. And specifically I think you are getting at more the spread, one side of pricing and the rolling charge and what have you that if you went back eight years ago or further, you saw more aggressive pricing going on. But there has clearly been much more discipline. Even as we've seen some of our competition suffer, we just have not seen the aggressive pricing by decreasing the rolling charge.

So spread one has held up relatively well in light of what's going on all around it.

I think, if you would benchmark that, we are at historic lows during the quarter. It has moved up pretty nicely; it's just that we are coming from so far down, we are encouraged by the movement and hope that it will continue.

In terms of inventory, and you've expressed a desire to keep that under control, is that the same sort of feeling that you're getting from your competitors, that that's happening with them as well?

I would say, on both Engineered Products and Aluminum, first, from a customer perspective, as I've talked with customers, they took a lot of inventory out fourth-quarter and first-quarter calendar year, which is to be expected with the economics. I'd see out of Nichols, as we went through the quarterly reviews, some short lead time delivery opportunities that would indicate to me that aluminum inventories among the niche that we are in are low.

When you look at your cost structure, if we could think about it this way, and I'm not sure if it's the right way to think about it. But can you maybe give us a sense as to where your size in Engineered Products and Nichols relative to a macro indicator, like maybe housing starts? Are you running the business at a 700,000 start, 500,000 start? I'm trying to figure out what the risk is that all of a sudden things come back quickly and that maybe you miss it. Or, if things just stay at these depressed levels, kind of what we should expect from a profitability perspective.

We continue to work the sizing of the business. But I believe we are pretty well aligned with the current forecast and current position, which take 500,000 starts. We are going to continue to keep a sharp focus on that. The one thing that's interesting about the Engineered Products side -- it has to be scalable because of the seasonality. And I believe we've got solid processes and systems that allow us to scale. I don't believe this thing is going to spike so big that we'd just be caught standing still.

Okay, I think I'm with you on that one. That does it for me, thanks for your help.

Justin Boisseau, Gates Capital.

Could you give us an updated outlook for CapEx for the year?

We haven't changed, really, off of our $18 million, and we continue to look at that. We've definitely had some things come up in the first half of the year at Nichols that were maybe a little more than we had originally anticipated. But at this point I think our guidance will remain at the $18 million.

I also wanted to make sure I understood what you said about working investment or working capital for the rest of the year. Do you think you can keep that around flat, or do you expect there to be a build in working capital through the second half?

I think if you generally look at it, you should expect to see a build in working capital. Like I said, if you tracked it over an extended period of time and calculated some ratios, what we are trying to achieve is for it not to build at the same level, same rate as it might have historically, by holding down inventory a little more than you typically would have seen. But receivables will increase as sales increase. Payables will increase, just not as much as the receivables. So right there, you would have a net increase, and then it's what actions can we continue to make on inventory.

Finally, can you again prioritize your uses of cash in the second half of the year? And should we expect cash to -- would you just build it on the balance sheet, or do you have plans for it?

Well, our first plan is to get more of it into the bank account. But as far as what to do with it, we still remain focused on looking at acquisitions, not saying that in the near term we are going to have this big announcement, but we continue to look. Right now cash is king, and we are going to be a bit more conservative than maybe in normal times. And as we feel more comfortable, then we'll look at the normal list, cast of characters on the dividends and share repurchases down the road. But right now, I would tend to see us grow that before we get too aggressive in that area, until we are really confident as to what the future does look like.

Craig Bell, SMH Capital.

Just wondering what your big difference is between your outlook for housing starts and the experts out there. Is it really more a matter of how long we are at a bottom? Is it just duration, or is it fundamentally more negative than what's out there?

A couple of factors. When you look at Global Insights, usually what's published in the paper is what would be their consensus view. We tend to lean toward their pessimistic view. We've got some other forecast on that, but I'd say generally we believe that housing into 2010 is going to remain on the depressed side, and we are trying to position the businesses for that.

We hope we are surprised with that. And I believe, based on the answer I gave to Pete, our scalability, the flexibility that we moved into this business, if there's an uptick we can take advantage of that. But I think it makes good business sense to be cautious, continue to work on our internal processes and systems and pounce on the opportunity if it comes but don't be -- I don't want to be rosy. I just want to be stone cold sober as I look at these forecasts.

Related to that, when you mentioned bits of optimism from your customers, I'm guessing that that's optimism that they are just sort of expressing to you and it's not actually showing up in orders so they can't be that optimistic about it. Would that be fair?

I think that would be fair. I think it's also regional. If you look at the West -- California, Arizona, Nevada -- no optimism. There's a healthy repair and replacement market out there. There are markets, Texas would be one of them, where we're still putting up houses. We're putting up houses in some of the Midwest cities where they haven't been as battered. So I think our customers look at optimism in there, but overall it's repair and replacement and going after that and then waiting for the day that housing will recover. And we're confident that it will come.

Lastly for Brent, you had mentioned on your focus on receivables and the aging of them that it's not really a concern for you, it's just something you are more focused on. But given that we had flat sales sequentially and the receivables were up, is that really just a timing issue?

Yes. You start getting into what were your sales at the end of the first quarter versus what were your sales at the end of the second quarter. And clearly we had -- our April was a much better month if you break it down into months than if you look back to the first quarter and the end of that period. So it is timing, yes. And it's not an aging thing.

And also, let me get one thing straight. I don't want to say that receivables aren't a concern of mine. With what is going on in the industry and the economy around us, that will always remain a concern of mine. It's just we didn't put the comment out there as a heads up to anything.

I'm showing no further questions.

Thanks for those questions today. We know that 2009 will remain a challenging year, but we also know long-term housing demographics will eventually win the day. But until they do, you can expect us to continue to outperform the market, report healthy cash flow, continue to press for cost reductions and lean improvements, raise prices where possible and keep a close watch on inventories and the quality of our receivables.

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

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect.