Quanex Building Products Corp (NX) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quanex Building Products third quarter earnings release conference call. (Operator Instructions). As a reminder, this program is being recorded. I would now like introduce your host for today's program, Mr. Dave Petratis, Chairman and CEO of Quanex Building Products Corporation.

Good morning. Thank you for joining us for our third quarter business review and 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 brief recap of our third quarter results, and an update on our cash position. The outlook for the fourth quarter and some general thoughts on fiscal 2010.

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

While the conditions of our primary end markets, residential housing starts and remodeling activity still remain historically weak, we did experience a healthy peak pickup in seasonal business compared to our second quarter. Annualized new home starts were down 42% compared to the year-ago quarter and remodeling and repair activity was estimated to be down 15% over the same period. We believe both of our operating segments gained market share in the quarter.

At this point in the housing cycle, we feel confident to suggest that we currently are bouncing along the bottom. The next issue we face is just how long we'll remain at current levels. Today, there is a wide range of forecasts predicting what US home starts might be next year. We find ourselves planning for weak activity in fiscal 2010 and we are especially concerned about starts in the first half of our fiscal year. For internal planning purposes, we are assuming starts around 600,000, well below the 775,000 average being broadly discussed by economists. Our more conservative outlook means we'll continue to operate with reduced staff and minimal amounts of materials until demand proves otherwise.

Turning to results, our engineered products segments' business in the third quarter picked up dramatically compared to the second quarter, and we beat our internal sales forecast. We saw demand for our window and door products accelerate through the quarter, and while I don't have hard facts to directly point to, our sense is that some of our key customers picked up market share based on our sales compared to the overall market. We have also been focused on expanding our customer base and we picked up new customers during the quarter. For the third quarter, we reported sales of $93 million and operating income of $11 million.

While still off of a year-ago pace, we are well ahead of the sequential second quarter and overall quite pleased with our ability to generate 12% operating margins at a time when the industry only built 167,000 homes in the quarter. On previous calls, I said one way we can add muscle to engineered products marketing efforts is by taking a more disciplined approach to the opportunities we have to both blend the combined capabilities of our three sister companies. We believe marketing ourselves as a single integrated business enables us to offer customers a more robust slate of products, systems, and services, that represent the very best in design, engineering, and logistics. I'm pleased with our progress to date, which now includes cross-selling meetings with some of our key customers and the production of national sales brochures that are being used by our sales teams to push our marketing activities. Our efforts are opening new doors to new customers and fueling our growth.

Let's now review Nichols Aluminum. For the first time this year, we were able to show a profit. The results of relatively healthy shipments and a better aluminum spread. Aluminum prices finally saw a rally in the quarter, coming off an inflation adjusted record low of $0.57 per pound in the second quarter to the end of the third quarter, closing above $0.80 a pound. The aluminum association reported US demand for the type of aluminum sheet we produce, off some 30% from a year ago, while our third quarter shipments of 65 million pounds were only off 12% from the year-ago period. When compared to our sequential second quarter, shipments were up a respectable 49%.

We were up in part because of our ability to take advantage of short lead time business that we believe will be sustainable for the rest of the fiscal year. We also benefited from some old fashioned restocking by customers as mill backlogs moved out to six to eight weeks during this seasonally stronger period. At this point, I would like to turn over the call to Brent, who will take you through some additional financial highlights.

Thank you, Dave. And I would like to add my welcome to those who are listening to the call today as well.

The Company reported $0.22 per diluted share from continuing operations, which included $0.04 of LIFO income primarily associated with changes in aluminum prices at Nichols Aluminum. You might recall our reported earnings this time last year were $0.24, but they included $0.08 of LIFO charges, so to be fair, we're really comparing $0.18 this quarter to $0.32 in the year-ago period. We included a reconciliation table in our earnings release, which shows us some more detail.

On the subject of cash flow, we had more good news to report. Cash provided by operating activities for the first nine months of the year was $32.6 million, and is the result of significant improvement in working capital, especially inventories and from earnings. I would like to point out that our earnings release notes CapEx of $12.8 million. This is a year-to-date number. We spent $3.2 million in CapEx during the quarter. Maximizing cash flow remained a priority for us, given today's difficult market environment. We finished the quarter with $100 million in cash.

Let me finish with an update on the availability of credit under our $270 million revolving credit facility. Because this facility has an EBITDA covenant of 3.25 times, following earnings over the last 12 months will continue to impact the amount of credit that is available to us. At the end of the third quarter, the estimated availability was $121 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. And with that, I'll turn the call back to Dave.

Thanks, Brent. Moving to discussion to the outlook for our building and construction markets, certainly the next 12 months still looks weak to us, given the fragile economy. Due to relatively high inventories of homes for sale and growing foreclosure rates. We have little doubt that many of the estimates for home starts in 2010 you read about today will come down, and we will not be letting our guard down any time soon.

On a near-term basis, we do expect our fourth quarter results to benefit from the better than expected increase in seasonal demand we've experienced in the third quarter. However, we will continue to operate cautiously, as we expect new housing starts in our fourth quarter to be down 28% from 2008's fourth quarter. With that, we're now ready to answer your questions.

(Operator Instructions). Due to time constraints, we ask that you please limit yourself to one question and one follow-up. You may then re-enter the queue for further follow-ups if time allows. Our first question comes from Torin Eastburn from CJS Securities.

It's actually Arnie Ursaner backing up Torin Eastburn from CJS Securities. Good morning. Quick question, can you give us a sense of utilization in both of your segments in the quarter, and more importantly, perhaps give us a feel for how it ended the quarter and even into the current environment, current period?

So this, this is, an estimate. In our engineered products groups, I would estimate utilization at about the 60% level.

Okay.

We clearly added some workers on the factory floor during the quarter. At Nichols, in the aluminum segment, we're operating three shifts at our caster with an idling on the weekends. And then our rolling capacity, I would estimate against 65%. So clearly not at full capacity by any sense.

But you certainly have a lot of room for incremental demand to be met without having to add significant costs, much more -- a little bit of variable costs without a lot of incremental expense.

That's a fair observation and I think we prove that during the quarter. I think one of the great advantages of Quanex and its companies is their ability to scale. Remember, we're scaling even in a normal economy because of the slowdown in the winter construction season.

And you mentioned frequently the idea that it's a seasonal pickup. I guess while you're not an economist or not trying to get ahead of yourself in the global view, how do you think about cyclical and secular trends in your industry versus just the seasonal pickup? You are very cautious. I'm trying to understand what are the things you would be looking for to be a little less cautious?

I still think we need to shave off a couple months of existing new home inventory. I think the unemployment rate is going to drag and that's going to be problematic for us. I think from a broader sense, you also have to be mindful, there is a Cash for Clunkers program working on a couple of things here. One is the new home purchase rebate for first home buyers. And the second is the $1500 window rebate. The new home buyer rebate ends at the end of 2009, and the window rebate runs another year. But these are some stimulus that we need to think about their effects on our overall demand. I would say on another positive side, our strong position in vinyl windows, it's clear from industry observers that vinyl is going to grow significantly faster than the traditional wood and we think we're in a good position to take advantage of that.

Thank you. Our next question comes from Peter Lisnic from Robert W. Baird.

Good morning, gentlemen.

Good morning, Pete.

I guess the first question I have is on EP and the operating margin that you put up in the quarter. Very strong, if you look at it on an incremental basis sequentially and 12%, the strongest margin you put up in six or seven or eight quarters. Can you give us an idea of what drove that high of a margin in a quarter where you did sub-$100 million in sales?

I would say number one, you heard me talk about price realization over the last 15 months, and we pulled that lever in a down economy. Number two is we've got some material price realization, especially with falling oil prices. And third, we continue to drive our lean operating activities, which we saw benefit of.

Okay, and for the follow-up, I guess can you maybe give us a sense as to what each of those three pieces contributed to the margin? Structurally, what does it mean when you're doing a 12% margin and starts are at the current level they a at, and if they improve or are up a little bit next year and then the year after, maybe markedly stronger, what does that mean for the margin profile of the business?

I'm not prepared to break out, the price volume material on the three businesses, but those things did work for us in the quarter. I believe that you've got to step back and think about the future and the numbers we put up in terms of EPG at 12%. Volume, however it comes in, will help these businesses significantly. I believe it's scalable. I believe we'll do a good job of keeping our base costs in check and, you know, where we're at from a capacity standpoint, as this thing picks up, you know, with more construction activity, we're going to perform well in that environment.

Thank you. Our next question comes from David Cohen from Midwood.

My question's been answered. Thanks.

Okay, David, thanks.

Thank you. Our next question comes from Robert Kelly from Sidoti.

Good afternoon, gentlemen.

Good afternoon.

Thanks for taking my question. As far as the EBP margin, previously you had said a double-digit margin in a recovery-type environment. Has that been proven conservative by the 3Q results?

Has the -- has our third--

Talking about a 10% EBP operating margin when housing recovers. Do you think that needs to be revised upward?

I think we've shown that there's potential for increased margin in that business. We certainly were cautious when we went out in a down economy and tried to flex the pricing lever. And there were clearly things in the portfolio that we feel we needed to get some price realization and we've been able to do that. So that's proved factual. Brent, any thoughts there?

I would say we would look at it, but you also have to look at it from an entire full year and some of the seasonality that does go on within the year. So historically, you know, Q3, Q4's going to be a little better than our first and second quarters, but we feel there is opportunity for us to manage this business and improve our margins. So that's what we've been focused on. And in the past we might have been a little slower on recouping material cost increases that we're now all focused on Dave's price realization efforts. So I think we'll see moves quicker than we have historically done.

It's difficult right now to just project that out. We do believe there's the opportunity to reach new customers. We're proving that. I talked about price. I think there's also the opportunity to go outside the box in terms of what I call aftermarket and then window and door systems. Those are hypotheses that we threw out there and they appear to be working. I would like to get some more miles under my belt to say, we've changed the way we do business. But the trends are positive.

Okay. That's fair. And then just following on the other lever you've been pulling as far as integrating the three engineering component businesses, where are we in kind of the lifecycle of that push and what kind of contribution have you seen thus far in fiscal 2009?

So we clearly have picked up new customers from the sharing of our customer base, clear evidence of that. We're working today with a third party in a study that -- we're going out and try and validate the channels, understand the customer mix in a deeper way. The window and door industry, over 100 manufacturers, various channels, and over the next several months, we're just going in to make sure that we fully understand that. What's built the Company around EPG has been a strong focus on the large OEMs and we've done that very well. We think there's opportunity to grow the business to the second and third tier. We want to make sure we've got a good understanding of that. That's what we're working on right now.

Thank you. Our next question comes from Craig Bell from SMH Capital.

Yes, good morning. In response to an earlier question, you were talking about the home buyer credit. Are you thinking that you're going to see some forward pull of demand because of that? Is that what you were suggesting?

I believe any time you have a stimulus, it does create demand in the market that wouldn't be there. I think when a new home buyer, gets the title to that house and move in, they look to how they can improve it and the incentives out there are around. The tax credit and new windows is creating some demand out there and we could see, when that shuts off, some effects on the market.

Okay, and then as you look at the market and the concerns that you've laid out with residential, whether it's current inventory levels or ongoing foreclosures, is there -- do you have any one of those that concerns you more than the other, or is it sort of all equal on those fronts?

I think the supply of new existing homes is the one that I watch the most. Historically, that would be between four to six months. We're still sitting I think 7.7. Couple things I would also look at, in today's "Wall Street Journal," they look at the different regions of the United States. The article's titled "No Uniform Recovery For Housing". Las Vegas, Miami and California have got to come into line for us to reach normalization. With that said, we tend to be a little bit better positioned in these upper Midwest markets, which I think reflects in our third quarter numbers, but California, Las Vegas, Florida have got to recover. When I see those coming, I'll be more confident in the future as it lies ahead.

Okay, great. Thanks a lot.

Thank you. Our next question comes from Tim Hayes at Davenport & Company.

Hi, Tim.

Hi. Good morning. On the Nichols side, what's been the sequential trend in unpainted versus painted sheet?

Go ahead.

Tim, this is Jeff. The mix really hasn't changed very much. In very, very good times, we can paint almost half the capacity. Today we're probably painting something around one third of the existing capacity. Maybe it's closer to 30%. So well off of early peaks.

Okay, and then you made mention that you're taking advantage of short lead time sales. Do I read that, those are sales to distributors?

There may be some sales in the distributors. I would characterize the opportunities that we won in the quarter as traditional customer opportunities that we went in and really drove some just-in-time lower inventory schemes. We didn't take consignment, but because we were positioned geographically to lower our customer inventories, cash was important and we were able to position ourselves to give in shorter lead times and thus won the business. I would also say in the Nichols arena, we made some good decisions on capacity and our strong cash position helped us to be able to ramp up our output based on demand and we see some competitors that couldn't do that.

Thank you. Our next question comes from Jack Kasprzak from BB&T Capital Markets.

Good morning.

Good morning, Jack.

I was wondering -- I guess I was going to ask about the aluminum side and the Nichols side, your guidance of the spread being similar in Q4 as to Q3, why wouldn't it be better? I guess I was just curious why if we've had a nice uptrend in the aluminum, LME prices, why that wouldn't carry into the next few months sequentially.

Jack, this is Jeff. Let me try and help you there where I can. Certainly we saw big improvement in spread from Q2 to Q3. We ended the quarter, fiscal quarter somewhere around $0.84 a pound or thereabouts. The thing that did move up into the low 90s, which is obviously very good for us for spreads. But it's difficult for us to be terribly precise.

There is certainly some opportunity for a bit better spread in Q4 versus Q3, but, if you look at the numbers, certainly inventories would suggest to you that ingot should not be $0.90. But be that as it may, there is perhaps some upside in it, but at the end of the day, it's very, very difficult to make that prediction. Right, the same way we never expected ingot to go from $1.48 to 57 cents. So we're trying to be careful there and we're using our best guesses, working with the guys at Nichols and so that's our takeaway.

Okay. That's helpful. Thank you. I was going to also ask with regard to your build, your ever-larger cash hoard that you have there, you've talked about the potential I guess to make acquisitions over time that you would be looking critically at, but if the market continues to stabilize for the next 12 to 24 months, but if you don't find an appropriate attractive acquisition target, what other things might you consider doing with the cash. Do you, for example, see doing some sort of special dividend at some point? How do you think about that?

We consider everything, all the options out there, dividends, share buybacks, and acquisitions in terms of use of those funds. We continue to believe we're in a great position and continue to be on the hunt for items that we believe will strengthen our portfolio around engineered products.

Thank you. Our next question comes from Justin Maurer from Lord Abbett.

Good morning, guys.

Hi, Justin.

Just a follow-up on the spread thing first. Was that solely a function of LME on the pricing side, or what -- what was scrap doing and how do you guys kind of feel about that as you look out next three, six months?

If you look at the progress we made in spread from Q2 to Q3 at Nichols, for argument's sake, that was all on the raw materials side.

Yep.

In that we were able to hold our raw material costs lower than the change in LME, so that's always good for us.

Yep.

As you think about the fourth quarter in general terms, I think if there is any pickup in spread, frankly it will come from, again, the raw materials side.

Right.

Of things. Going forward, as every year we just can't predict what it's going to do. We know that historically, spreads have run anywhere in this industry, $0.30, $0.35 a pound to $0.60 a pound. And we've not had anything in the middle. Right. It's either been feast or famine. So if we think about next year, we have to make a tough decision on spread. I can assure you after listening to all the experts, my guess is we want to remain somewhat conservative there, simply because we're concerned about what the inventory looks like versus where the price is. Remember, ingot has dropped down and touched, what, $0.96 a pound several weeks ago and it's back now to about $0.90. So we're going to be cautious there.

But because it's already sitting in inventory on the scrap side for the fourth quarter, then you obviously have visibility with the cost side does, just a function of what the LME does.

Yes, except keep in mind that the inventory today at Nichols, we're down to probably close to 60% from historic levels.

Okay.

So I don't have quite the swing we may have had in the old days when I might have had 40 or 50 days of scrap on the ground, so that's less of an issue today.

So why -- like if it's happening in steel, if ingot has the potential of pulling out to scrap costs, if you will, why couldn't that then -- because obviously we're thinking or hoping that there's some upside to where the quarter ended, but yet if scrap gets pulled up and you are still having to buy some of the inventory, that would have spread implications.

It would. We are watching that inventory reserve, carefully because we think -- LME aluminum stocks worldwide are record high, there's some volatility there. We're evaluating from both sides. Can we be opportunistic here, put some of our cash to work on the opportunity to buy the right mix of aluminum scrap as well as the right price, but we're also mindful that we're in a volatile time.

Yes, okay. Well, back to regular business. Is there any -- you guys talked about some cautiousness surrounding the stimulus programs and how much of that's influenced. Do you guys have any way of knowing or getting the sense as to how much kind of, whether it's the window program or certainly the, I would think that has more of a direct impact on your business than does the first time credit, but, for example, at Nichols, can you tell at all to your other, non fenestration customers, whether it's the RV guys or whoever else, has there been a divergence more recently in the demand of the window-related businesses versus non, or to get some sense as to how much is being helped by those programs?

Difficult. I think you've got to look at our strength in engineered products and be confident that those programs are helping drive some demand. I think second, though, if you look at our performance versus the broader market at EPG and at Nichols, I think we're executing at a pretty good level to go out and find new growth opportunities. Nichols, specifically we see our some competitors, having difficulty ramping up, and there's opportunities and benefits that we're trying to play. And on EPG, it's servicing this broader market with also the focus on energy efficiency.

At our TruSeal business, which is a part of EPG, we have the most energy efficient spacer on the market, and there's some changeout going on there where we offer a warmed spacer that drives that energy efficiency. The window replacement program requires a high energy standard and that displaces what we call cold ditch. So there's some things working for us and I think long-term, the country will continue to try and drive LEED standards, building standards that push towards energy efficiency and we are investing to make sure we differentiate ourselves so that we can grow EPG.

Thank you. Our next question is a follow-up question from Peter Lisnic from Robert W. Baird.

Back again. I guess, Dave, can you maybe touch on the pricing umbrella and maybe give us a sense as to where you're at in terms of accomplishing everything that you want to on that pricing initiative that you set out?

I would say we still have opportunities in the EPG businesses. There were really some stones that we had not overturned. I think we also have worked pretty hard to educate our sales and management teams and I personally have spent time with that. Second is it's a deep understanding to how we want to compete. If you take our vinyl business, I think the industry would look at it that we're selling what I call ground chuck. That's not what we sell. We sell very technical market-leading products and we need to push to get paid for that. So I would say we've made good progress in this down economy, but I would say we're, halfway home.

Is there a way that you can size or scope the opportunity for us?

I'll work on it. There's multiple forces working on it, and think about our challenge there. You've got new homes prices declining, so if you got a lot of pressure that contractors are under and the window providers, we're trying to drive that energy efficiency standard. So you got multiple forces working on this. Clearly when I sit down with our EPG general managers, price realization and our pricing opportunity pipeline is something that we're spending on. So we got a lot of fact-based to build and hopefully on a future call I can say it's worth this.

Okay, all right.

In the world I came from, I could do that. We just got to build that eighth capability here.

I understand. Jeff, is there -- can you give us a little color on conversion cost of Nichols, what the terms there are maybe?

I guess no.

Thank you.

For the rest of the audience, the one area we typically don't discuss in any detail is conversion costs for competitive reasons at the businesses. Certainly at Nichols, variable costs, labor, big issue there. Energy, of course, is a big cost for us. We over, say over the last 12 months or so, maybe over the last 18 months, certainly energy prices have come down a bit. We're a very large natural gas user. Typically spot purchase versus long-term, so we caught some benefits there, but I would not want to characterize it beyond that.

I just wonder if there's any competitive pressure that you're facing there.

Pete, I would say to be fair, whether energy or labor, I'm not sure we have in the actual cost of those thing, a distinct advantage over my three or four competitors in our space. We're all big natural gas users. It takes so many people to run a caster most of us are using scrap-based, continuous casters. What I do have, the advantage at Nichols, you won't find uniformly in this industry is our ability, because we put the dollars of infrastructure in, is to handle these very low grades of scrap that require additional handling, whether it's shredding, burning off paints and adhesives and glues, that's really the bench strength of Nichols more than anything, because certainly over the last several years, we have correctly, I believe, not put a lot of assets into grow their ability to produce sheet. It's really been on the how can I do more with my low scrap model? And we spent maybe 5 to $10 million in the last six or seven years, five or six years, in making, putting more of that equipment in, making that lower scrap available to us. That's really what sets us apart at Nichols.

Thank you. (Operator Instructions). Our next question is a follow-up question from Robert Kelly from Sidoti.

HI, guys. Thanks. Just a follow-on from someone had asked about your cash balance and what you might do with it. Prior calls, you had talked about some competitors struggling and also the book of potential I guess complimentary type bolt-on acquisitions you might do. With signs of tentative improvement in the housing situation, have you seen the multiples for those businesses change or maybe just a comment on how you perceive the multiples you might pay, should you go with the acquisition route?

Yes, this is Brent. I think we still see the struggle from the companies in the past and wanting the kind of seven, eight, nine times multiples versus what some of us buyers are willing to pay in today's market. Even with the pickup that we're seeing in the near-term, I mean, remember, we feel that we have another tough winter to go through. And quite frankly, I'm of the opinion that that's going to be a harder winter on many of these competitors, other companies we might be looking at because last winter they were able to get their working capital down and produce cash flow that's allowed them to survive.

So the key is, have they generated enough cash during this seasonal upswing to survive another rough winter? But as it relates to the pricing, I think that's all still trying to iron itself out because basically potential acquisitions seem to fall into two camps. Either they are somebody that has to sell or face bankruptcy and so that drives a lower multiple. Or it's a pretty good business and folks just aren't willing to come down to the multiples that we are willing to pay right now.

Okay. Thanks.

Thank you. I'm not showing any further questions in the queue at this time.

So I think we're done. We'll wrap this up. I've been told by long-time employees that 2009 will be our most challenging year ever and I certainly believe them, but I also believe housing demographics will eventually win the day and at some point next year, 2010 will bring us better days than 2009.

But until it does, our shareholders can expect us to continue to press for cost reductions, make further lean improvements, raise prices when we think possible, and keep a close watch on our working capital. That concludes our call today. Thanks for joining us.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.