Quanex Building Products Corp (NX) 2010 Q2 法說會逐字稿

Good day ladies and gentlemen, and thank you for standing by. Welcome to the Quanex second-quarter earnings release conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to Dave Petratis, Chairman and CEO of Quanex Building Products. Sir, please go ahead.

Good morning, and thank you for joining us for our second-quarter business review and fiscal 2010 outlook. Sharing the call with me today is Brent Korb, our Chief Financial Officer; and Jeff Galow, Vice President, Investor Relations.

Today's call will include a review of our current markets, a brief recap of second-quarter results, an update on Project Nexus, and a general outlook for the second half of 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 a complete forward-looking disclosure statement.

The earnings release is available on our website at Quanex.com.

Seasonally-adjusted home starts in our second quarter were 637,000, versus 524,000 a year ago, up a healthy 22%. The year-ago figure represents the low point for starts, and the industry has shown improving metrics each quarter since then. We certainly believe the worst is behind us for home starts.

Residential remodeling activity was weak in our second quarter, down 25% according to Harvard's joint housing study. We believe cold and wet weather in February and March may have played a role in this weakness.

Our end markets, comprised of new residential construction and residential remodeling activity, were down 6% on a blended basis.

As compared to these mixed signals in our end markets during the second quarter, our operating results at Engineered Products were exceptional. We experienced better customer demand each month through the quarter, as the spring building season continued to gain momentum.

The $8,000 first-time home buyer tax credit, along with the $1500 tax credit for purchasing energy-efficient replacement windows, continued to generate business for us.

For the second quarter, Engineered Products posted sales of $85 million, up 30% over the second quarter of 2009 and up 16% over the sequential first quarter.

Operating income of $5.8 million was a great deal better than the $600,000 loss we reported a year ago, before impairment charges, and 41% better than the sequential first quarter.

Our Engineered Products group has done a great job over the last couple of years driving down costs in order to reach a lower breakeven. When those efforts are combined with price increases and improved sales through new products and customers, this hard work shows in the quarter's 7% operating margin.

Engineered Products sales and income are expected to rise significantly in the second half of the year, compared to the first half. And we expect the group to report quarterly operating margins above 10% for the remainder of the year.

We formally announced Project Nexus last quarter, and I would like to give you a brief update on our progress. You may recall, Project Nexus is about profitable growth at Engineered Products and is comprised of related initiatives to get us there.

We are using the sales and marketing programs of our three businesses collaboratively to market and sell our full range of window and door products to the existing customer base. This 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 shared sales and marketing initiative will also target and secure profitable sales with existing and new regional window and door customers.

We will further bolster our growth through the development and sale of pre-engineered, fully certified systems like our new introduced energy core vinyl window system for the window replacement market, and the ImperiClad, our new jam and threshold system that is sold pre-assembled and certified.

Traditionally our offerings have been centered on the sale of uncertified components that customers would assemble and test. Engineers and designers from across our businesses are working together to create the highest performing window and door systems available on the market.

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.

Acquisitions will also play a role as we look to expand our product offerings that will enhance our value proposition to customers.

To this point, good progress has been made on the organizational side of the business, where for example we have now formed various cross business councils to help us drive innovative new product development, direct the overall sales effort, and establish the proper marketing campaigns that will raise our profile across a broad range of customers.

Through Project Nexus we've already had a few successes, and I would add that we have about a dozen regional customers in the latter stages of reviewing and approving new products like the EnergyCore vinyl window profile system.

Let's turn to a review of Nichols Aluminum. We experienced a healthy spread, saw exceptionally strong shipments, and report a very respectable profit. Spread, which is the difference between our average sale price and our average material costs, was 67% higher than a year ago -- a time you will recall when the industry had been hit hard by collapsing aluminum prices.

Our spread was off about 4% from the sequential first quarter, in part because we had to purchase higher grades of scrap due to availability issues on some of the lower grades.

Certainly the big news at Nichols Aluminum in the quarter was our outstanding shipments, 83 million pounds, up a whopping 90% from a year ago shipments, and up a very respectable 36% from just last quarter.

The aluminum industry is also experiencing healthy recovery in 2010 compared to 2009, with industry shipments for our type of aluminum sheet up 52% compared to the second quarter last year.

Our ability to outperform the market was due to solid execution, taking advantage of hampered competitors, and retaining short lead time business. Give Nichols Aluminum a decent spread, reasonable volumes, and we earn a nice buck.

For the quarter we reported $7.2 million of operating income, compared to a loss of $12 million a year ago. So we remain very pleased with the ongoing turnaround in the business.

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

Thanks Dave. And I would like to add my welcome to those listening today.

The company reported $0.12 per diluted share from continuing operations in the quarter. The $0.12 includes $0.02 of LIFO expense, as well as a nonrecurring gain of $0.03 for what accountants call a bargain purchase gain. That gain is the result of having acquired certain wood extrusion assets below market value. In other words, we bought $2.9 million of assets for $1.6 million, hence the one-time gain. Those assets are being used to further expand our wood molding business at Homeshield.

Our cash balance continued to grow, and at quarter end we reported cash on hand of $153 million, a $26 million improvement from the first quarter.

Cash provided by operating activities for the six months of the year was a very healthy $41 million.

We believe this is an excellent showing, given the general weakness in our overall markets.

We expect our cash from ops balance to rise in the second half of the year based on higher anticipated financial results.

The availability of credit under our $270 million revolving credit facility continued to rise. The facility has an EBITDA covenant of 3.25 times. So falling earnings last year impacted the amount of credit that was available to us. At the end of the second quarter, the estimated availability was approximately $226 million, up from the $174 million that was available to us at the end of the first quarter. So we continue to make good progress, and the facility remains undrawn.

Possible uses for cash will be to fund organic growth programs such as Project Nexus, to make acquisitions that fit our fenestration vision, and to continue to fund our cash dividend and potentially repurchase stock.

You no doubt noticed yesterday that the Board approved a 33% increase in our cash common stock dividend, taking the dividend to an annual payout of $0.16.

As we continue to feel more comfortable about the sustainability of our end markets and cognizant of our healthy and growing cash balance, the Board and management believe this is an appropriate action for the benefit of our long-term shareholders.

The Board also authorized management to put in place a 1 million share common stock buyback program. So from time to time we will be repurchasing our outstanding shares.

We continue our important work in the area of acquisitions, which is a priority for us, and we remain interested in companies that operate in the window and door space that offer products and services complementary to ours. We are also considering companies that would accelerate our sales efforts with the regional window and door OEMs. Acquisitions that offer new technologies that improve the thermal characteristics of window and door products are also of interest.

I would describe the acquisition environment as improving, and by that I mean we are finding it easier to both establish contacts with potential candidates as well as to enter into discussions with them. While I cannot offer you a timeline on our next acquisition, I can assure you, acquiring the right company at a fair price remains a priority.

With that, I will turn the call back to Dave.

Thanks Brent. Moving the discussion to the business outlook for the remainder of fiscal 2010, our cautious optimism for a slow but sustainable recovery in our end market continues. The 22% pickup we saw in new home construction during our second quarter versus a year ago is encouraging.

Our internal outlook still calls for 600,000 starts this fiscal year, and while it's conservative, it's not likely to be too far off. Undermining our confidence was the weak Harvard estimate for remodeling spending, which was estimated to be down 25% from the year-ago quarter and likely included some winter effect. The annual estimate for remodeling is to be up in 2010 compared to 2009, and we certainly hope they are right.

If you are searching for further evidence that we are still suffering from a very weak economy, you don't have to look any further than the number of homes in foreclosures, or mortgages more than 90 days past due. The numbers are troubling and remain at elevated levels.

Recent data have the rate of foreclosures leveling off, which is a good sign, but overall they remain high at a time when many consumers are still reeling from the economic recession.

Having said that, our confidence in the markets continuing their very bumpy recovery remains. And you can see that guarded optimism in our new segment guidance. In today's economic environment we believe it's prudent to remain conservative in the operations of the business. Having said that, we are adding workers to meet growing second-half demand, and we expect temporary employees to play a role, especially at Engineered Products.

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

Thank you. Management has requested that you limit your questions to one question and a follow-up before being placed back into the queue. (Operator Instructions). Jack Kasprzak, BB&T Capital Markets.

Congratulations on a very nice quarter. With regard to the repair and remodel market, which you mentioned was down in your second quarter, but given that you guys are adding workers and raising guidance for Engineered Products, what can you tell us about what tone to that residential repair and remodel market you are seeing so far here in the third quarter? -- your third quarter.

So I'd be limited to talk about the third quarter, but my observations on Q2, repair and remodel is an extremely broad reporting segment. We believe that the $1500 tax credit is working favorably on the window industry. And we are seeing the benefits of that.

I think second, you're seeing some early progress on our part with Project Nexus in trying to connect our sales forces to call not only on our existing customers and cross sell but open up new doors. So --

I think the third point, as you know, living in Virginia, Jack, the winter, February/March, was particularly tough. You will get some activity that goes on during that period. I think it was pent-up because of 36 inches of snow on the ground, and that will benefit as we go into the third quarter.

Is there a pretax amount to the gain? Or is it -- because I -- the press release says $1.3 million after tax. Is there a pretax amount? Or (multiple speakers)

Yes. The way that the accounting world makes you handle this gain is, it's the same, pretax, after-tax. You kind of do it on a net basis.

Very good. Thanks.

Robert Kelly, Sidoti.

I just had a question on the Engineered Products outlook, especially as it relates to op income. So I believe you said you are seeing significant volume increases for the second half of the year here. But if we kind of pull out what you've done in the first half, you are looking for about $22 million to $27 million in operating income in the second half of fiscal '10? That's still flat to down from a year ago, so how much of the costs that you're bringing back are going to hurt margins? Or is this just an attempt to be conservative?

We are investing in the business to lever up on Project Nexus. We think that makes good business sense, and I think our growth reflects it. We certainly are conservative in terms of the challenges we've got with further price realization. But we're going to continue to bang on that, especially if inflation is raging. And I think third is, we'll see how the volume comes in that ultimately will drive the profitability, but I think we've shown over the last several quarters good improvement in Engineered Products profitability, and we are working hard to stay on that track while investing for future growth.

Yes, I guess the question is, does the investing for future growth cut into the margin significantly?

To say significantly I think would be too strong. But it clearly has some impact, Bob, you know, to put a number on it, but it would be hard to do right at this point. But it does have an impact.

And then just as far as you saw in Nichols some -- I guess a little bit of moderation in the spread, 2Q from 1Q. Is the availability of your kind of preferred scrap, is that starting to come back a little bit in 3Q? Or will that be a little bit of an issue for the remainder of F '10?

Yes. I would answer it two ways. I'd probably even extend the answer a little bit beyond what you may have asked. But availability will become less of an issue. Some of that availability just gets down to the winter months, getting it off the ground, getting trucks. There's a lot that is involved in just getting scrap into our yards. So from an availability perspective, we feel okay.

I think where we will see pressure as we move forward is what goes on with the dollar, because quite frankly the dollar, at the level that it's at now does have a negative impact on LME prices, which as you are aware of, does impact our selling price and therefore our spread. So that's probably more of what we're looking at in the future than just flat availability.

Tim Hayes, Davenport Inc.

Just a real simple question -- on that $1.3 million purchase gain that you had, is that in the EP segment? Or is that in the other income line?

It's in other income.

Okay. That's all I have, thank you.

Torin Eastburn, CJS Securities.

Just a quick follow-up on the question about spread in Nichols -- it seems like your guidance implies good volumes and something like a flat spread, but I know aluminum is down about 10% this month so far. Are you assuming that the better availability will be able to offset the decline in aluminum?

Well, yes and no. Yes, we do assume that there will be more availability. We will have the ability to get into some of the lower grades, which benefits us from a spread standpoint. We do see some downward pressure in what's going on with LME prices. But if there is a dramatic change from where we are today, that is not factored in from a spread standpoint.

And have you seen or do you anticipate seeing a change in the mix of the finishing you do?

I would say no. I think we provide a better painted mix when transportation is [rocking] and we still see that transportation RV market pretty weak.

(Operator Instructions). Peter Lisnic, Robert W. Baird.

I guess first question on Nexus -- it is sounds like you're gaining traction, and you mentioned that you're pretty close on a dozen or so customers, or at least they are reviewing it. Any early evidence or any early indication of what returns on some of that incremental business might be like and sort of what we should be expecting from a growth ramp perspective?

I would say it's difficult -- we've got over a dozen I think bets on EnergyCore. I'm really gassed and energized by opening up our sales force and sharing that customer base, the activity that it's generating for us. And there is a belief there that as we go into the midmarkets, there is the opportunity for better margins, but I want to put that hay in the barn before I start talking about the potential.

I would say, Pete, over the last two or three quarters we've done a good job in terms of margin improvement at Engineered Products, and we're going to continue to drive that. So if we can grow it and drive profitable growth, I think you will like the results, and as we go forward and we get some miles under our belt, we will do a better job to try and project that.

Fair enough. If you look at the -- I guess the selling proposition that you're using on the Nexus front, is it something that's really -- that hinges on energy efficiency? Is it a logistics advantage? What are customers seeing as the primary benefit of saying, let's go with the EP product from Quanex, or the EnergyCore product?

I think a couple of fundamental things have got to move in our favor, and we are trying to influence that, and it's around codes and standards. The 30/30 standard that's driving the tax rebate has been very good for us. There is discussion in the Congress right now about the Cash for Caulkers program, the -- I think it's called the Super Energy Star program. Things that -- and audits on existing homes that will drive energy standards higher.

Movement on that direction benefits for us, and we think in the midmarket the smaller manufacturers are going to have trouble moving with those higher standards, and we believe our collaboration on the engineering and sales side will help those customers move to our products at higher margin.

That is very helpful. I appreciate your time.

Good to hear from you, Pete.

Likewise. Have a great weekend.

You have one follow-up question from Jack Kasprzak, BB&T Capital Markets.

Given your current configuration within Engineered Products, how much revenue do you think you could generate in that business? And what do you think incremental margins should be?

Jack, we're going to stay away from giving that kind of guidance. We have -- it's not something we have done. As Dave says, as we go through and get more and more traction with Project Nexus, we may try to come out down the road with some way to put a way to understand that. But at the same time, I also want to couch, I'm being very cognizant internally that we don't go spend a great deal of effort trying to track every dollar and whether it's a Project Nexus dollar or not. So we're going to come up -- try to come up with a way to give a sense, put some flavor around that.

I would just add to that, Jack, we did quite a bit of work in the second half of 2009 just trying to understand the market. Engineered Products is doing north of $300 million in a $35 billion to $37 billion depressed window and door market. We think there's good opportunities for growth there, and I think it's reflecting in our numbers.

I can't recall, frankly. Have you guys commented on your -- a different way to ask the same question, I guess -- commented on your capacity utilization rate?

We have handled those questions. I would say at Engineered Products we are around the 50%, 55% range. We've got plenty of upside. Remember, this is a business that served a $2 million start market. One of the things that I think is impressive at Quanex is its ability to scale up on the seasonality and deliver on short lead times. So I'm extremely comfortable there, even with the cost reductions that we've taken out.

Great. Very helpful. Thank you.

Phil Gibbs, KeyBanc.

I just had a question on the Nichols Aluminum, the end markets. We saw a 52% increase in the volumes for the industry for a similar product of Nichols. Arguably a lot of that was restocking relative to last year, but if you had to point to areas where you may have seen a real apparent increase in demand, where would those be? And what is really driving that, aside from the supply/demand balance being more in line?

I think we said in the release, the aluminum market was up 52%. We were plus 90%. There is clearly a restocking going on. Go back a year ago and the amount of volume that was going through Nichols and the aluminum industry was scary because customers just shut down their purchases. So there is some restocking going on.

I think -- remember, about 60% of our aluminum shipment goes to fenestration, rainwear type customers, and you look at the Engineered Products side of the business, which is windows and doors -- up 19. That's where a lot of this product is going.

I would just chime in just to say, if you go back to sort of the summertime of last year and look at what really occurred even during that time, the team at Nichols did an excellent job to -- and we made the call to really step on the accelerator while the competition was hitting the brakes still, and managed to pick up significant volume at that time that we continue to do an excellent job of retaining. So you just see the continuation of job well done for the last -- going on 12 months here.

No, I mean, I fully recognize that you guys are doing a tremendous, tremendous job within the organization. I'm just curious as to -- and you are taking market share. I'm just curious as to what your sense is of the real demand change. It has had -- how much of the demand change for the actual product?

I think that 50 number is a good one in terms of demand, and we'll take that. Remember, there is some -- there was some capacity take-out, which was relatively minor, but it played into some shifting by our competitors that has benefited Nichols. And so we're taking advantage of that, and we got on the accelerator early, I thought. Tom Brackmann's and the Nichols team decision to ramp up last April/May was timely, and we continue to benefit from that.

Peter Lisnic, Robert W. Baird.

Just one follow-up on Nexus. As you pursue that growth opportunity, how should we think about the product mix vis-a-vis vinyl, fiber, and wood? And then Brent, I know you touched on acquisitions a bit. Would that be something that we should think about from an acquisition perspective? In other words, expanding some of your exposure to what I will call non-vinyl markets?

I look at our vinyl and IG business really as the leader in Nexus. Remember, the vinyl market that -- is going to grow at twice the rate of the wood market. So that's really the opportunity that we have with Nexus.

I would add to that though, we think that the wood business, the Homeshield business, also has great opportunities because, again, they've been focused on some very large OEMs with some great capabilities.

I also like our potential -- remember, we are one of the largest screen manufacturers, divided light. There is an untapped repair and replacement market there that we've not been serving. And the more we drill down and understand that, Brent, in his comments said around acquisitions where we can help ourselves in the channel -- if an acquisition opens some doors for that, we will consider that.

Yes, and I would say on the acquisition front, specific to -- I think your question was really, are we -- is it all about vinyl? It's a lot about vinyl, but I would tell you, we will and are looking at things, both existing technologies and technologies in development, of other materials. So it's not solely about vinyl.

If you really think long-term, Pete, and think long-term down the road, ideally, we find ourselves in a position where we are providing customers with a slew of options on every component. So different materials on a profile, different materials on a spacer, that run the whole gamut, and then you can pick and choose and come up with 1200 combinations, when you really only have four options in each of the components.

I really like our vinyl position, though, as a catalyst for Nexus, because it's the medium that provides the structure for a window and door, and as you pre-engineer those systems to meet higher codes, you can add accessories, you can add hardware, you can add specific types of AG that qualify that system, and that's what we are trying to develop here with Nexus.

Okay, and I guess the thing that I'm wondering is, as these higher standards are implemented and you go from R3 to R5 -- or whatever the numbers are -- is there a risk that you are not as well-positioned with some of your larger wood customers or with other non-vinyl products? But it sounds like no is the answer to that. So that's -- just wondering if you could clarify that a little bit.

I think your answer's right there. Let's be candid, an Andersen, a Pella, a Jeld Wen -- the top 10 guys are driving R&D. We are at the table there, helping them from a component standpoint. We'll be there. It's the second tier that's not going away, where we can use our same engineered capability in a collaborative way. Historically it's been used individually to grow our business.

That helps. Thank you very much.

Robert Kelly, Sidoti.

Could you give us the breakout on fixed versus variable costs within engineered building products?

No, we haven't done that, Bob, and not going to do that right now.

Can you ballpark it?

No.

I had to try.

I know. That's just details we haven't given historically.

Gentlemen, there are no further questions in the queue.

Thanks for your questions. Quanex outperformed its end market in the first half of 2010. You can expect us to do the same in the second half of the year, and Project Nexus will help. You should also expect us to report higher sales and operating income in the second half of 2010 compared to a year ago period.

As we efficiently manage for profitable long-term growth, we will continue our important work in the areas of safety, cost reductions, lean improvements, and price realization, while keeping our working capital under control.

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

Ladies and gentlemen, thank you for your participation. You may all disconnect at this time. Everyone have a great day.