Quanex Building Products Corp (NX) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the first quarter earnings Real Estate earnings conference call. (Operator Instructions) I would now like to it turn the conference over to your host, Mr. Dave Petratis. Please begin.

Good morning and thank you for joining us for our first quarter business review and fiscal 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 including a review of our current markets, a brief recap of our first quarter results, a discussion of Project Nexus 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, 2009 for our complete forward-looking disclosure statement. The earnings release is available on our website at quanex.com.

Despite a nice jump in housing starts in January compared to a year ago, the overall condition of our primary end markets, residential starts and remodeling activity, remained weak in the first quarter. Annualized housing starts were up 2% over the year-ago quarter, the first positive quarterly improvement in several years, while repair and remodeling activity was estimated to be down 9% over this same period. As compared to the tepid market activity in the first quarter, results at Engineered Products were quite good. We saw a relatively steady demand throughout the quarter and believe our customers continue to gain share in the important repair and remodeling market.

The $8,000 first time home buyer tax credit extended through mid 2010 and the ongoing $1,500 tax credit for purchasing energy efficient replacement windows continued to generate business for us. For the first quarter, Engineered Products posted sales of $73 million, up 13% over the first quarter of 2009, and operating income of $4.5 million compared to a loss of $4.5 million a year ago before impairment charges. It is a testament to the hard work and excellent execution at Engineered Products that enabled them to earn a 6% operating margin in the first quarter.

We have not seen a first quarter operating margin that good since the first quarter of 2006, when actual housing starts were 450,000 units compared to the 117,000 actual starts we saw in this first quarter. This substantial improvement in margin on 75% lower starts is an indication of just how well the group has responded to the dramatic slowdown in housing activity. Making tough decisions on reducing expenses, driving lean process improvements, fighting for price increases and working outside of one's comfort zone has paid off for us. We will continue this good work in 2010.

We formally announced Project Nexus yesterday in our press release and I would like to add some color. Project Nexus is about profitable growth at Engineered Products made up of a related initiative that will get us there. We will take the existing sales and marketing programs at our three businesses and for the first time collectively use the respective talent on a collaborative front to market and sell Engineered Products' full basket of window and door products to our existing customer base.

This customer base represents the largest OEMs in the market and together they account for about one third of today's $35 billion window and door market. This market was closer to $65 billion just a few years ago. So this initiative should enable us to grab a larger share of a recovering market. The collective sales and marketing initiatives will also aggressively target and secure profitable sales within the regional window and door customers which we have traditionally under-served.

Be assured that we will continue to service our big OEMs with our award-winning products and services, but we believe profitable growth can be achieved with these regional players which account for an additional two thirds of the window and door market. We will further bolster our growth through the development and sales of pre-assembled, fully certified systems like our newly introduced EnergyCore Window System for the replacement market and our Impiriclad, the new door jamb and threshold system that is sold pre-assembled and fully certified.

Traditionally our offers have been centered on the sale of uncertified individual components that our customers would then assemble and test. Our highly rated engineers and designers, worked together, will collaborate to create the highest performing window and door systems available on the market. We have no intention of producing finished windows and doors. We do believe selling more certified systems will make an intriguing value proposition to regional customers. For instance, as they will be able to eliminate a sometimes long and expensive testing and certification process.

Through Project Nexus we will further our goal on becoming the leading energy efficient expert in the market, offering our customers state of the art engineering, design and marketing support for both themselves and their customers. And finally we'll continue to expand our product offerings through acquisitions that will further enhance our value proposition to both our existing and new customer base.

Project Nexus is clearly a long term growth program. Having said that, we do not expect to add to the incremental sales in 2011 as it gains traction in the market -- we do expect to add incremental sales in 2011 as it gains traction in the market. We will give you a sense of the impact later in the year.

And now let's review Nichols Aluminum. We reported a healthy spread, strong shipments and respectable profit of $3.6 million compared to the $8 million operating loss reported a year ago before impairment charges. Aluminum prices moved up during the quarter, a good thing for us, but unfortunately so did our scrap cost, in part due to inclement weather that reduced collection and availability. As a result our overall spread, which is the difference between our average selling price and our average material cost, was up only 2% over the fourth quarter of 2009, but up 18% from the year-ago quarter. The Aluminum Association reported US demand for this type of aluminum sheet was up 11% from the year-ago quarter while our first quarter shipments of 61 million pounds was up a very healthy 70%. Our ability to outperform the market was due to solid execution at the Business, taking advantage of ongoing competitive issues and holding onto short lead time business.

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 listening today. The Company reported $0.03 per diluted share from continuing operations in the quarter and there is no LIFO impact. We did have an $889, 000 expense in the quarter, about $0.02 per share, associated with the closing of our TruSeal China facility. You may recall we set up a small operation there last year which was essentially a leased building, a few employees and two production lines.

With the current global economic slowdown we determined our interests would be better served from TruSeal's existing US based operations. Cash provided by operating activities was almost $9 million. Not bad for our first quarter when you consider how weak the markets were. We finished the quarter with a comfortable cash balance of $127 million and about $2 million in outstanding debt. Our cash will be used to fund organic growth programs such as Project Nexus, make acquisitions that fit our fenestration vision, continue to fund our cash dividend and potentially repurchase stock.

Let me finish with an update on the availability of credit under our $270 million revolving credit facility. The facility has an EBITDA covenant of 3.25 times, so falling earnings during 2009 impacted the amount of credit that was available to us. At the end of the first quarter the estimated availability was $174 million, which is up from the $107 million available at the end of fiscal 2009. We believe the amount available under the facility will increase in 2010 and we have no outstanding borrowing at this time. With that I'll turn the call back to Dave.

Thanks, Brent. Moving the discussion to the business outlook for the remainder of fiscal 2010, optimism for a slow recovery in our market continues to grow. However, that does not mean we believe all the troubles are behind us. This is still a very soft economy, the inventory of new homes for sale is too high to suit us, and the rate of foreclosures remains troubling. Having said that, our confidence in the market stabilizing and even recovering a bit this year is reflected in our new guidance. And while January's 21% improvement in year-over-year housing starts does not yet indicate a trend, it is certainly the best improvement we have seen in years.

We will continue to plan for 600,000 housing starts, still well below the 750,000 average now being broadly discussed. I believe it's worth noting that the industry gurus continue to reduce their 2010 housing estimates while we continue to hold firm with ours. We believe it's prudent to remain conservative in our outlook which means we'll continue to operate with reduced staffs and minimal inventories until real demand tells us otherwise. We will focus on the opportunities within Project Nexus to gain share and grow Quanex in a weak market. I want to reemphasize that Project Nexus is clearly a long term growth program. We do expect it to add to incremental sales in 2011, and as it gains traction in the market, we will give you a sense of its impact later in the year. With that we're now ready to answer your questions.

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

Good morning. I was hoping to focus on the market share gains. First on the aluminum side it looks like your volumes were almost 60% better than the industry's. What's driving that and how sustainable is it?

So we made to remember that we're in a commodity market in Nichols, number one. Number two, we made some capacity decisions in the last two quarters of our fiscal year of 2009 which I think positioned us nicely to take opportunity as customers restocked their work in process inventories or their raw materials inventories that we benefited from. I would go on to say we weathered the storm well in terms of our industry competitors as the market went down. Our industry competitors have had some trouble in this space and we have taken advantage of those troubles because of the strength of our balance sheet. I think our customers knew that we would be there and we had the capacity to respond. So I really tip my hat to the Nichols team. If you have ever visited there, I believe they're the strongest team in capability in the space. We benefited from that.

Okay. And then also same question on the housing side. You've made good market share gains there as well. Other than the window tax credit, is there anything you see going on that you think is not sustainable?

I do not see anything that's not sustainable. We don't control the demand of the end markets but for the last 12 months we have been working to share opportunities within the three businesses that make up EPG. That historically had not been done. So there's been some good collaboration going on. I think it's important to note we have a good position with our integrated spacer and our vinyl market to serve the repair and replacement space nicely. Vinyl is really the driver in the repair and replacement market and from our Mikron and TruSeal businesses we've been well positioned to take advantage of that.

Okay. Thank you.

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

Thanks. Good morning, everyone.

Hey Jack.

Hey. My first question has five subparts. Actually just modeling questions. Can you give us an update on fiscal 2010 expectations for CapEx, D&A and where you think the tax rate will be?

Yes. I mean we've really left the CapEx, D&A the same as where we were at the end of -- or in December, but basically CapEx of about $22 million, D&A of $30 million and then your tax rate -- we had an unusually higher rate in the first quarter. We still expect that to be closer to 38%, 38.5% for the full year.

Okay. And just with regard to the cash balance that is building nicely for you guys and I realize we're maybe not entirely out of the woods yet from the housing downturn, but as things hopefully continue to stabilize can you talk about the preferred uses of the cash, would you consider raising the dividend, special dividend or anything else you might want to add?

I would say we continue to make sure that there is a strong focus on cash generation with the business. Our first quarter historically we have not been able to do that so we're pleased with that, but our focus continues to be around acquisitions and then we will consider the other options that we've got, share buybacks, dividends. And we're mindful of where we're at with our cash balance and want to make sure that we make good decisions that will deploy that cash in the best use and returns to shareholders.

Okay. Great. Thanks very much.

Hey Jack?

Yes?

Get rid of the snow in Virginia so the Cavaliers can start playing baseball, will you?

And they're rated number one so we need to get them on the field.

Thank you, sir.

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

Good morning, gentlemen.

Hey Pete, Morning.

I guess first question can you maybe give us a little bit of color on the spread at Nichols maybe talk about spread one and two.

Pete, this is Jeff. I can help you with that a little bit. As David said in his formal remarks, the LME rose through the fiscal quarter. It was probably up $0.08 or $0.09 which is always a good thing for us. The scrap thing had a setback there. It was very -- it was difficult to collect the types of scraps we wanted so prices went up. We were perhaps buying some better grades of scrap simply because we couldn't get the best mix of scrap that we wanted.

So as you think about spread one and spread two -- for those of you not quite as familiar with that, the spread one would simply represent the market fabrication spread and that has been and has remained relatively flat. So where we got hurt is on what we call spread two, which is simply the raw material spread between our average raw material costs and the price of aluminum. So we got squeezed there a bit. All other things being equal, the first quarter for us is typically the toughest for the collection of this scrap and so all things being equal we would expect the spread two to improve a bit as we push into spring, summer.

That's helpful. If I switch gears a bit and talk about -- or ask about Nexus, I guess. You made it clear that this year there will be some contribution from the program or the initiative and presumably that will accelerate as we progress through the years, but I'm wondering how this factors into the return or margin profile of the business if you're all of a sudden selling a system. Is that something that your customers are going to find more value added or is it going to be comparable to typical Quanex EP margins and then along a similar line sort of as you start to migrate into more this, call it middle tier customer base what impact that might have in terms of profitability the business as well.

We think the system approach is targeted at the right time because we see the standards around windows and doors continuing to increase, and I'm talking weatherization standards. The current tax credit requires a 30/30 window. We think in some discussions that we've had with the Department of Energy and new programs coming around EnergyStar that that will move upward and our technology strengths from our vinyl extrusion business, Mikron, and our leadership position at TruSeal with the most energy efficient spacer will track well to that.

The -- what Project Nexus helps us build on is bringing those technologies together in what we call a window and door system and I believe that our customers will pay a premium for that technology and it's not something that I would give away. Think about the Toyota Prius when it first came out was selling for a premium. We're going to be providing high technology and weatherization that I don't believe -- we're a bit unique in our ability to provide that and certainly will not be able to be matched in the mid market. I expect to be rewarded for it.

Second --

What was your second part of your question.

It was the profitability of the systems and then profitability as you kind of try to tap the middle tier of the OEM group.

I think the large OEMs are the most intense part of the market and the mid tier guys are more responsive to the technology and services that we're providing. In a market that's growing -- this final replacement market is really the sweet spot in terms of replacement and that's where we want to be.

Okay. That's helpful. I will jump back in the queue.

Thank you.

Our next question comes if Robert Kelly of Sidoti.

Good morning, guys.

Hi Bob.

Question on the (inaudible) guidance particularly for EBP. You had talked in the past about housing starts in that range of 600,000 or so. So assume that that's better or worse, what kind of sensitivity does EBP have to $50,000, $100,000 change in that kind of outlook?

Yes. Bob, we stopped short of going that far with sensitivity and it's really hard to get into if housing is up 200 -- 625, 650 what's that impact going to be because it's a lot more driven off of our customers and their impact on new housing versus repair and remodel. So we stopped short and I don't really have some sensitivity to give you at this time.

Okay. You had been successful in the past year raising prices, as you deed yourself more as a solution provider rather than a widget or component provider. Should we expect further price increase in the next few years? How are you feeling your ability to pass price along?

Results are always -- say a strong statement about our abilities. I see environment where material prices are increasing and I think its imperative that we're able to stay ahead of that, number one, and that's going to be an important priority for the business. Number two, coming in from the outside of this business 18 months ago, I see that the suite of services, product quality that we're offering, should command a premium and in a weak supply chain environment I think we can hold our own at the negotiation table and so that's our focus. We'll rest on what we've done year-to-date and we're going to continue to fight because the opportunity is there.

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

Good morning, Tim.

Good morning. My question is relating again to the spread two and the scrap market. We certainly know that it's tight, it's hard to know is it just weather related, also cyclically related with the uptake in the economy. My question is do you have any concerns that maybe the scrap market is tighter for structural reasons? We've heard that from some other aluminum players and if it is do you -- have you had to use any more primary in your mix or is that still almost entirely scrap based and if there is a structural tightness in the market, do you have to -- might you have to use higher grade scrap in your mix?

We are not using higher grade scrap. We're still 99% scrap based. Typically in the winter availability becomes tough because the stuff gets frozen, people aren't out collecting. I think it's very -- behaved traditionally. I think we've got one advantage here, though. Think about the scrap dealers that we deal with. Our guys got paid. Our financial strength solidified some relationships with these dealers and I think that will serve us in the years ahead.

Tim, this is Jeff. Let me just for clarification the -- Dave is referring to -- we did not add into the mix ingot.

Right.

Right? So that we predominantly are not an ingot user and (inaudible) scrap tightness in the first quarter it didn't change the ingot scrap mix at all. To that point we did have to use some higher priced scraps in order to get the job done, but we just don't know. We think it's more weather sensitivity than it is to some structural change.

Okay. Good. Good to hear. Thank you.

Our next question comes from Phillip Gibbs of KeyBanc Capital Markets.

Hi gentlemen, good morning.

Hi Phil.

I just wanted some more clarity on Nichols Aluminum, the shipment momentum that you have going into February and March for one, and what you see as far as your sense of customer inventory levels and what types of potential product applications are stronger and which ones are stable to weaker right now.

The back log of our business at Nichols is solid. It's hard to see where that -- is it true customer demand or is it the rebuilding of inventories that are needed to make this go? I have not personally been out talking with customers, but I think our year-over-year performance at Nichols shows how hard our customers shut down their buying of the aluminum a year ago. So there is a rebuilding of that supply chain. There was another point. Supply chain. Yes. Where is it going. I guess that would be my comments on it.

So you would expect stronger shipments in the April quarter here?

Phil, this is Jeff. We haven't guided to that. If you were to look at our traditional shipments at Nichols just through any given fiscal year we typically have higher shipments each quarter. There are times when Q4, because remember my year end is October, there are times where my shipments at Nichols in the fourth quarter may be relatively flat to the third, but generally speaking you would expect higher shipments through the fiscal year. Just a note speaking to the Nichols demand. One of the things that does take place if you -- if the market believes -- the customer base believes that LME for instance for aluminum will be rising that does tend to put a little fire in their belly, but certainly the bulk of what we have seen as far as versus the industry and versus competitors is just from good old fashioned hard work and good execution.

So would it be fair to say some of the shipments that you may have seen over the last couple quarters could have been pulled forward given restocking and your customers' sense that prices were going up.

Yes. I can't without -- I mean I don't have a lot of hard data to point to. I would generally agree with that and of course one of the best proxies we have is how are we doing versus the Aluminum Association and of course we have been -- Nichols has been well ahead of that certainly for the last 12 months and obviously have really broken through in this quarter. So the indication from the Aluminum Association is a rising demand for the types of products we produce. Now they don't forecast and certainly we don't either, but the outlook is certainly looking better.

Okay. Okay. And just lastly the decision to take the TruSeal line out of China can you talk a little bit about that?

Clearly the economic drivers have changed dramatically since we made that deployment, number one. Number two, the demand for what I would call high end spacer, not that robust in China. We think we can serve that market from Barbourville, Kentucky, our plant there, and bottom line made a good decision for us. TruSeal's ability to really run a global manufacturing business, you had to look at the pluses and minuses of that. We feel we can service this market adequately. Remember too extrusions does not have a high labor content. This is rubber, in this case through a machine, so your cost advantages are not huge. We felt that was a good decision from a cost savings standpoint and simplification standpoint and that's why we executed it.

Okay. And I just have another one. I'm sorry to do this. But what's your view of the solar market opportunities going forward?

Our solar opportunity is clearly around the commercial solar panels. That continues to being a good growth opportunity for us. We're a niche player. Remember we're providing what we call the sealing tape that makes sure that there's a high level of integrity between the glass that's protecting the thin film photovoltaic, and we're pleased with the performance of that business. Overall solar is certainly not hitting the high expectations of growth that they expect for that, but there's still a lot of movement going on in terms of the world's drive for energy efficiency and we'll do okay in that part of it.

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

Back again with a couple, I guess. Brent, I guess I heard share buybacks as potential use of capital. Can you give us a sense -- I think you have what, 2.7 million shares out there that you kind of use to buyback. Sort of how -- where is that trade off relative to what the acquisition pipeline might look like?

Yes. Pete, let me first clarify something. At this point we do not have a formal authorization so I think the 2.7 you're referring to was still -- goes back to the Quanex Corp point.

Okay.

And that did not carry over. So in order for us to actually pull the trigger on a share repurchase we would in fact have to get Board approval in advance of that. So I mean I guess that gives you a little sense of -- our priority currently is clearly focused on acquisitions and I would just shed a little light to just say activity -- I'll call it phone activity has really picked up over the last six plus months. And so we continue to focus on acquisitions in the fenestration space and look to that as our first option for deploying the capital.

Can you give us a feel for multiples and quality of companies that are calling or being called to you from -- whoever it might be?

Well, I mean it's all over the board. If you want to talk about both quality and multiples, right? I mean phone conversations about those that are slipping closer and closer to bankruptcy to -- it's probably more on our end calling out some very good companies and the multiples obviously are quite different for both of those. So I hesitate to give a guess as to what any sizeable acquisition multiple would be right now. But clearly we're looking for a good value but at the same time with what we're able to do in our performance and in outperforming the market we're not going to get just absolutely so cheap that we miss a good opportunity for the future.

Okay. And then just one quick clarification I guess or comment on EP. Is it safe to say that basically the systems revenue that's being derived from that business right now is de minimis?

Yes.

Okay.

You know, it's in its infancy. We are leading with that EnergyCore system. We kicked that off December 17th, and we're pushing hard to drive customers.

Helpful. Thank you very much.

Thank you, Pete.

I'm not showing any additional questions, sir.

Fiscal 2010 will be more profitable for Quanex Building Products compared to 2009, and the long term growth potential of Project Nexus should reinforce our ability to outperform our end markets. So as we manage for profitable growth in 2010 and beyond, we will continue our important work in the areas of safety, cost reductions, lean improvements and price realization, all the while keeping our working capital under control. This concludes today's call. Thanks for joining us.

Ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day.