Quanex Building Products Corp (NX) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quanex Building Products fourth quarter earnings release 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 call is being recorded. I would now like to turn the call over to your host, David Petratis.

Good morning, and thank you for joining us for our fourth quarter and fiscal year business review and 2010 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 fourth quarter results, a progress report on our initiative to broaden our understanding of the $30 billion window and door market, and an update of our cash position and a general outlook for fiscal 2010. 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 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 remain historically weak, we had a relatively strong finish to the year. Customer demand in October, often a transitional month for us as the building season begins to wane, held up well. Annualized new home starts in the quarter were down 30% compared to a year ago, and remodeling and repair activity was estimated to be down 10% over the same period.

Results at our Engineered Products business in the fourth quarter were good. We beat our internal sales forecast in part because of better than expected window demand in October, as well as from healthy growth of our solar edge tape product.

The steady demand we saw throughout the quarter was a bit of a surprise. And we believe our major customers continue to find success grabbing more share in the residential market, and in the replacement market driven in part by the $1,500 tax credit for purchasing energy efficient replacement windows.

For the quarter, Engineered Products posted sales of $100 million and operating income just over $15 million. While sales were off 12% from the year-ago quarter, they were up 7% from the sequential third quarter. Operating income of $15 million in the fourth quarter was up substantially over the year-ago quarter by some 50%, and up 36% over the third quarter.

Fourth quarter operating margins of 15% were as good as we've seen in a few years, and particularly noteworthy when you consider the industry only built 151,000 homes in the fourth quarter. We continue to make good progress on our cross-selling initiative that combines the best design, engineering, and marketing talent of our three Engineered Products divisions.

Taking a more disciplined approach to the way we seek new business opportunities will make us a more successful Company and a stronger competitor by allowing us to offer customers a more robust slate of products, systems, and services.

We recently introduced two new products that highlight this initiative, and you can take a look at both of them on our home page of our website. First is our EnergyCore product that combines a state of the art vinyl window profile from Mikron with the industry's leading insulated glass spacer from TruSeal.

Our analysis has shown that the combination of these two components produces what we believe is the most energy efficient window system in the country. In fact, Builders Magazine named it one of the best new products in 2009.

A second example is ImperiClad, a product that combines our very efficient composite door threshold from Homeshield with a full composite door jamb profile from Mikron. This product is not only rain and rot proof, it addresses a major issue customers have with the installation of door systems, which typically involve an installer cobbling together a handful of components.

ImperiClad comes fully assembled and greatly reduces the chance of poor installation and lessens the probability of compromised performance or the need for a service call-back, which is the bane of the door industry.

We continue to believe consumer demand for more energy efficient products and our ability to provide innovative window and door systems in addition to stand-alone components will fuel the organic growth of Engineered Products.

On a previous call, we mentioned the work we are doing in Engineered Products to explore additional opportunities within the $30 billion window and door market. As you know, our OEM customer base, which represents about 30% of the market, tend to be leading players in this space, and we have no plans to change the way we do business with them.

Our analysis is to provide us with a better understanding of the overall window and door market. While much work remains to be done, we are getting a better sense of the 60% of the market where we have a relatively small presence or no presence at all. EPG sees this underserved portion of the market as a potential opportunity for organic growth in an otherwise sluggish market. We'll keep you apprised of our progress.

Let's now review Nichols Aluminum. The division reported a healthy spread, strong shipments, and a respectable profit of $10 million. Aluminum prices were relatively flat through the quarter, and we were able to find more aluminum scrap to our liking, both in terms of grades and cost, which had a direct benefit on our aluminum spread.

The Aluminum Association reported U.S. demand for this type of aluminum sheet that we sell was off 23% from the year-ago quarter while our fourth quarter shipments of 78 million pounds were off only 3%. When compared to our sequential third quarter, our shipments were up a respectable 21%.

Our ability to outperform the market was in part due to our continued success in taking advantage of short lead time business that we believe will carry through for add least the next quarter or so. We believe customer demand remains strong for us in the quarter due to various issues at competitors and solid execution at Nichols.

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 would like to add my welcome to those who are listening today. The Company reported $0.41 per diluted share from continuing operations in the fourth quarter, which included $0.02 of LIFO income, primarily associated with changes in aluminum prices at Nichols Aluminum.

You might recall our reported earnings this time last year were $0.40, but they included $0.08 of LIFO income. So excluding LIFO from both periods, we are comparing $0.39 this quarter to $0.32 in the year-ago quarter. We included a reconciliation table in our earnings release, which shows this in more detail.

In the area of cash generation, we continue to report good news. Cash provided by operating activities for fiscal 2009 was $60 million, the result of significant improvements in working capital, particularly better inventory control and further improvements in receivables collection. Maximizing cash flow will remain a priority for us in fiscal 2010 given the difficult market environment.

We finished 2009 with $124 million in cash. You may recall we began the year with a $67 million cash balance, so we are very pleased with this accomplishment in such a tough year.

We will use our cash in 2010 to invest in organic growth opportunities Dave highlighted earlier, make strategic acquisitions that fit our fenestration vision, continue to fund our cash dividend and may at times repurchase stock.

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, following earnings over the last 12 months has impacted the amount of credit that is available to us.

At the end of the fourth quarter, the estimated availability was $107 million, and we have no outstanding balance. We believe the amount available under this facility will increase in 2010. With that, I will turn the call back to Dave.

Thanks, Brent. Moving the discussion to our 2010 business outlook, the next 12 months looks shaky, given the soft economy, relatively high inventory of homes for sale, and growing foreclosure rates. We have little doubt that many of today's estimates for calendar year 2010 housing starts will come down. And if October's disappointing starts tell us anything, it's that we will not be letting our guard down any time soon.

Like others in the residential building and construction space, we believe end demand will modestly improve in 2010 compared to 2009. We continue to plan for weak demand, however, particularly in the first half of our fiscal year. For internal planning purposes, we are using 600,000 starts, below the 750,000 average being broadly discussed. Our more conservative outlook means we will continue to operate with reduced staff and minimal inventories until real demand tells us otherwise. Our businesses retain the ability to flex quickly to changes in demand, both up and down.

We certainly expect better financial results in 2010 when compared to 2009. We look to generate free cash flow again this year, and we will continue to fund growth, both organically and via acquisitions when and where it makes sense to do so. We shared our annual 2010 financial guidance for both operating segments in our earnings release, and we will adjust that guidance if warranted. Going forward, we will not be providing quarterly earnings guidance.

With that, we're now ready to answer your questions.

(Operator Instructions) Our first question comes from Torin Eastburn from CJS.

Good morning.

Good morning.

Could you please talk in some more detail about the various factors that contributed to the strong margins in both of the segments?

Yes. I mean, we have a number of factors.

The first I would point to is we talked quite a bit over the last 12 months on pricing realization, and I think you really see the fruits of the labor here in the fourth quarter by our efforts that really started back in August, September of 2008 of increasing prices where we could, and we continue with some strategic pricing efforts through 2009 as well.

That, coupled with, and Dave mentioned in the call, our ability to really flex down as demand really disintegrated during the year, we were quick to move to get costs out. And in all of those factors, really contributed in what was a great earnings for fourth quarter in light of the market.

Okay. And then a quick follow-up. It looks like the price of aluminum has continued to rise after the end of the quarter. How does that affect your view of the spread in the upcoming quarter?

Well, I mean, we're going to hesitate from giving just spread on a quarterly basis, but clearly, if you look at it from a long-term basis, we'd prefer higher LME prices. A slow, steady rising LME is the best scenario for us. But I would also be lying to you if I -- just because it's increased since our fourth quarter end that I know what LME prices are going to do over the next three to 12 months.

Our next question comes from Robert Kelly with Sidoti.

Good morning.

Hey, Bob.

Question on -- you talked about October coming in stronger than your expectations. What did October month look like on a year-on-year basis, and then what did -- how does November look like thus far?

I've not had any insights into November yet. We will start working on that. We've been pretty busy with our Board activities. October was -- we had some unusual strength in the solar market, and I think we saw that through the quarter. We made that comment in the release.

I think the other thing that you see happening is our big customers and this mid market that we talk about, doing pretty well in the energy efficient window space, going after the $1,500 rebate. We saw that. Our October was -- at EPG was stronger than it was in the previous year.

I think also, if you go across the northern tier of states, the weather has been relatively mild. And that tends to extend the building season, and I think we saw it in our numbers.

Great. And then just on the spread implied in your fiscal 2010 outlook for Nichols, are you assuming some sort of average? In the release you talk about a stable spread. Is that an average of what we saw in the second half or for the full year?

Bob, this is Jeff. It's more of an average for the full year. You might recall that the second quarter spreads at Nichols were pretty skinny, so we've tweaked that a little bit, but it assumes generally an average.

Our next question comes from Barry Vogel with Barry Vogel & Associates.

Good morning, gentlemen.

Hi, Barry.

You guys did a fabulous job. I must congratulate you.

Thank you.

Now I want to ask you a question. I know that it's hard to be optimistic in light of what has actually happened and what is happening.

However, if you look at your operating profits in a very difficult environment in your last two quarters, and particularly Engineered Products, I think that you are being ultra conservative in your guidance that you're attempting to give us.

I mean, you earned $26 million in Engineered Products in the second half of this fiscal year, and there's no way you can say, or anyone can say this has been an easy environment. So could you give a little more color on what might be too conservative an estimate in Engineered Products in particular in the next year?

Barry, I think if you have listened to me over the last year, I'm sure you have, I've been -- we were bulletproof. Extremely reluctant, as we went into this, and I think you gave us credit for that. I have lived in seven states, traveled the world.

As I travel around, look at the economy, it's extremely hard for me to get optimistic, even to get to the economists in terms of home starts. I think right now there are like 780,000. We saw global insights come down by 10%. Then you look at the October change in starts that I think dropped down to 530,000.

I think there's an argument for conservatism, and our next two quarters are our toughest ahead of us. When we see better signs, we'll give an indication. As we understand the market, this is why we're focusing on this 60% of the market that we don't serve. We think there's opportunities there in this $30 billion space. We've just got to go out and farm that and see what we can do. And I hope for us, and for the entire economy, that we're wrong.

Now, as for as new products, I remember you had this excellent presentation awhile ago with a table projecting incremental product sales. Can you give us an idea what the incremental products sales were in fiscal 2009 and in your estimate for fiscal 2010, what you believe they might be? These are new products now.

Exactly. You've seen those in our road shows. We're really in the infancy of that. So it's hard to make projections.

We'll be meeting with new dealers and customers this month that will put those into the marketplace. The EnergyCore would be an excellent example.

We've really to have go out and develop the markets for that, so it's hard for us to give projections. And we've chosen not do it.

I would say, Barry, going back to some of those presentations, if you looked historically, we would say $25 million to $30 million has been our historical add each year from those new products.

We continue to develop and innovate and introduce new products. But clearly, just to give an order of magnitude, the amount of contribution from new products was significantly less than that historical $25 million, $30 million, just with the underlying demand being so poor.

So we hesitate to give what that number is. As we move forward, more of this systems approach, and we get further and further into that, we may revise sort of that information when it proves helpful.

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

Hey, Jack.

Good morning, guys, it's actually Adam Thalhimer calling in for Jack. Wanted to ask about the repair and remodel market a little bit. You guys kind of talked about what you expect for the new construction market in 2010. Could you elaborate on repair and remodel, and I guess maybe also comment on what you're hearing from your -- from your primary customers, the Anderson's, the Pella's? What's their outlook on repair and remodel in 2010?

Our view is from 2009 to 2010 R&R will be flat. We still have the $1,500 stimulus. You've got the first time home buyer. Obviously, if that's on an older home, we think that will help drive the economy.

I would point you to Pella, who is a big customer on the vinyl side, has been extremely aggressive in going after this R&R market. Because frankly with that rebate, it's one of the better games in town.

As we have tried to go deeper into [prime] window demand and understand it, R&R has held up much better over time than new construction. And, because Americans continue to want to invest in their homes, that stimulus helps drive that. So we're projecting flat, and we're going to go out and try and gain share in that space.

Great, thank you. And then I guess my follow-up question would be on the solar market. There's an awful lot of solar projects on the drawing board for 2010, 2011, and 2012 in the U.S. Would you care to revise your outlook for that business for you?

We really are focused on the commercial solar panel side. It's global. We've got a very strong customer in that with First Solar, but no revisions. We like the way that that's moving, but it's in the expectations that we've been going with.

Our next question comes from Mark Parr from KeyBanc Capital Markets.

Good morning, Mark.

Hey, good morning. Couple of questions. Regarding the positive delta of your business compared to your end markets, some competitors had some operational challenges. Can you give us an update on your view of how long you expect those challenges to remain in force?

I didn't pick up a lot of color on the competitive landscape around Nichols. I'm hesitant to comment on it. The public information is out there. And I think you've got to look to that, and help to explain why we've been successful at Nichols.

You've got bankruptcy. You've got some other issues, and I think we've benefited from that. The Aluminum Association is pretty clear on its output, and our numbers are pretty clear, and I think a great execution by the Nichols team and difficulty in bringing capacity on line because of a variety of challenges. So I didn't learn anything more than I knew.

Okay, all right. It is going to be an interesting dynamic though, as the year progresses. Companies with capital and access to capital, and then there's a lot of companies that don't.

So anyway, good luck with continuing to be able to take advantage of that, and also hopefully we'll see some improvement from the end markets as well.

I had one other question. As far as the taxpayer funded tax credits on new homeownership, do you have any color on how long you think that might last?

I don't. Clearly, they extended it on new homeownership, the window rebate also runs out in 2010. But there's some discussion in the government circles. McKenzie has weighed in. They believe that a dollar spent on energy efficiency across not only homeownership but commercial businesses is a good stimulus investment for our economy.

Number one, it reduces energy consumption. Number two, these are industries that generally benefit the United States. And number three, when a taxpayer can reduce his energy bill, he gets some stimulus with that.

So we like that type of thinking, but we're not drafting the legislation. So we're watching it.

Our next question comes from Tim Hayes from Davenport & Company.

Hi, Tim.

Hi, good morning. My question are on Nichols. What was the operating rate during the quarter. And then on the shipments, how much of that was painted sheet?

Tim, this is Jeff. Let me help with you that. On the question of the mix, we probably painted about the same as we did in the third quarter, somewhere around 30% to 33% of the mix was painted. So no real change pretty much through this year. I'm sorry, the other part of your question?

The operating rate at Nichols in the quarter.

Yes. It's -- I'm going to stay fast and loose. It was probably comfortably above 75%.

And if I could, on a follow-up, can you quantify in dollar terms what the benefit from the spread was during the quarter?

No, sir, we can't do that.

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

Good morning, gentlemen.

Good morning, Pete.

I guess first question on the margin at Engineered Products, the 15%. I know you talked a little bit about pricing and productivity. What I'm wondering is, on the productivity side of the equation, clearly have become more productive.

Can you give us a sense as to -- as you ramp up production, how significant maybe the structural changes are in the business and what that might mean for a relative margin profile as we look at a more normal housing environment?

Pete, I would say especially on the Engineered Products side, our ability to flex up, remember, we're really scaled from a capital standpoint to support 2.1 million housing starts. So when it comes down to the labor side, I think we have the ability to scale up as well as we have the ability to scale down.

So we don't view the structural changes to be dramatically significant. Now, of course, that's tempered by how quickly does it happen. If you go overnight from 600,000 starts to a million starts, there's going to be a little lead time to get fully up and running. But in many of these cases, we're talking a week, two weeks to get labor trained.

And remember also, based on our seasonality, we're used to bringing on temps at the peak building cycles. So we're used to really bringing in short-term labor and getting them up and running very quickly.

Pete, I would just add, you think about what drives productivity. We look at it as material, we look at it as variable, then you've got price productivity. As you look at the structural footprint of Engineered Products, we took out one facility, which was at Chatsworth. That's really about it.

The rest of the drivers continue to be incremental, human productivity improvements. And if you go back to 2007, with the exception of taking out that facility, we're doing better but it's -- I wouldn't say it's dramatically different.

Okay, fair enough on that. And then on that 60% of the market that's relatively untapped. Can you give us maybe a sense of the competitive lay of the land there? Is it serviced by relatively small competitors there?

Will it be -- I don't want to say relatively easy, because nothing's easy, but the opportunity sounds large. How quickly and how effectively do you think you can penetrate the opportunity, I guess, is really what I'm wondering?

I would describe it as, it's a big part of the opportunities in the vinyl space, and we'll be going after that.

As energy standards rise and the Department of Energy, if you go in and look at windows standards, they're trying to set efficiency standards on vinyl windows for DOE type projects and try and bring some sense to how windows are measured in terms of their efficiencies. They would like to have an R-5 standard. Our EnergyCore is R-6.5. The rest of the market is R-3.

So that opportunity, it's not easy for what I would call that 60% of the market to move the energy standards up. These are guys that buy PVC compound, and they extrude it through a press. They're not involved in the engineering. So that's our opportunity, number one.

Number two would be on our Homeshield business, where we've got divided light, and screens. We've not been even going after that market, knocking on doors, so we think there's a good opportunity there. We leverage that versus our TruSeal business that's very adept at serving this space.

So I think there's some nice capabilities that we have that are going to be needed by this customer base.

Our next question comes from Gregory Macosko from Lord Abbett.

Hey, Greg.

Hi. Yes, thanks. Again, I echo Barry's points on being conservative on your outlook, but could you talk about the expectation of, I think it was $23 million on the corporate side. That seems like a little high relative to the current run rate, or am I not looking at it the right way?

Well, yes, I mean the current run rate, off the top of my head, I think was about $20 million for 2009. But we have several -- what's in that number is we add on -- remember, coming out as Quanex Building Products in 2008.

Each year we add on a layer of option expense. So until we're three years out, we add on a tranche of that.

So the combination of that and estimating incentives at more of a target level than the lower depressed level really adds on $2.5 million. So that takes us from the $20 million to $22.5 million, $23 million is kind of how we get there.

Then relate that a little bit to the -- you are going to go out there in the building products area, or Engineered Products, with windows, et cetera. Are you looking for a sales force, and does this include any sales force ramp, or maybe that's in the numbers with Engineered?

We have a bit of money that -- the sales force directly, some of those numbers are going to be within the divisions themselves. We do anticipate having some additional costs, making some investments both from expense and capital at the corporate office line for this organic growth potential.

Whether it's sales -- we'll probably spend quite a bit of money on the marketing side to really go after this regional OEM focus that Dave was mentioning. So, yes, there are additional costs assumed in that $23 million to capture those expenditures.

Our next question comes from Justin Boisseau from Gates Capital.

Hi, thanks. Could you talk a little bit about the acquisition pipeline, what you are seeing in terms of sellers' expectations today versus maybe six months ago and how active that pipeline is?

The changes in our acquisition strategy, I would say we've narrowed the pipeline down. If you went back six months, a year, it was really the building products universe around residential homes.

Today we think that opportunity is very focused on fenestration related components that will help us better go after this underserved market. From a Quanex perspective, add to our capabilities to put together components and systems that will complement the Engineered Products businesses. So that's how I would say the change is.

In terms of -- we believe the longer housing starts remain at these historically depressed levels, the more opportunistic it will become. And we see signs of that. Customers questioning their vertical integration strategies, as well as competitors that were able to flush cash out of their system for survival in the last 24 months that aren't going to have the ability to do that in the next 12.

And then can you talk a little bit about what your expectations would be in terms of the top line, if and when the housing market comes back. So on the way down, you all have performed better in terms of your top line. Would you expect that to continue on the way up, or would that trend not necessarily hold then?

I fully expect us -- if you look at Quanex over the last five years, we have outperformed in our markets. I think, number one, our strength coming out of this will give us the ability to outperform. I think you see that at Nichols.

At EPG, we have worked, over the last 12 months to bring our sales forces together to talk about opportunities, talk about leads, understand this $30 billion market more deeply. And we've got some pretty exciting new products out there that I think will continue to give us the ability to outperform.

(Operator Instructions) Our next question comes from Robert Kelly with Sidoti.

Hey, yes, just a follow-on for the untapped market you're going after. Is there a timeline for impact? And then can you just discuss your return goals and margin goals? Do they line up with what you're doing in Engineered Products right now?

I will take the timeline and let Brent think about the return goals. We just concluded, and I made a presentation to the board of directors on what we see in terms of this untapped market. As we went through our 2010 business plans, lining up investment, we're at our infancy and starting on the implementation phases.

So the rollout of our EnergyCore really gives us the opportunity to pull these resources together, and I think from my perspective, this is something I need to talk about quarter-to-quarter and how we're getting traction on this. So I look at it as a 24 to 36-month realization. And I believe we can organize ourselves to be able to go after that, and we'll talk about the results as they come in. But I can't stress enough, we're at the infancy.

Our three businesses worked very well independently when the market was strong. In this depressed market, to grow this thing, we've got to go out and target the markets that we don't serve.

I think we're very happy with the work of the three businesses and our ability to bring together technical resources to roll out market recognized products, like the EnergyCore and ImperiClad system. Brent?

Yes, and, Bob, I would just say we don't have all the finished business plan put together, but from our preliminary assessment we feel there is a good opportunity here to make some good returns, and we're definitely excited about what the picture looks like. And we think there's clearly an opportunity for maybe some improved margins at this 60% regional OEM level. But we still have some more work to do to really button down the numbers but we really think there's good potential here.

Thanks.

Our next question comes from Tim Hayes with Davenport & Company.

Hey, Tim.

What tax rate should we be using for 2010?

For 2010, off the top of my head, I want to say we're in the 38% range.

Thank you.

(Operator Instructions) I'm showing no further questions at this time.

So we're going to wrap up here? Like many of you, we are happy to put 2009 behind us. While we are proud of the many achievements, like growing our cash and picking up market share, they were certainly hard fought gains.

2010 will likely be a better year, but still no walk in the park. We will continue to manage for profitable growth, cost reductions, lean improvement, and price realization, all the while keeping a close watch on working capital. That's our pledge to you.

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

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the conference, and you may now disconnect.