Quanex Building Products Corp (NX) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Quanex Building Products second quarter earnings 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 introduce your host for today's conference, Dave Petratis, President and CEO.

Good morning. And thanks for joining us for our second quarter conference call. On the call with me today are Brent Korb, our Chief Financial Officer, and Jeff Galow, our Vice President of Investor Relations and Corporate Communications. Today's call will include an update on Edgetech, and our sales initiatives at EPG. A recap of second quarter results, and an outlook for the second half of the fiscal year. Our comments today include forward-looking statements about the future prospects of Quanex. Please refer to our SEC Form 10-K filed in December 2010 for our complete forward-looking disclosure statement. The earnings release is available on our website at Quanex.com. We recognize that we're about two weeks later than usual with our earnings announcement and conference call. This issue was tied directly to the mountain of work required to get Edgetech's financials rolled into our second quarter. We expect a much smoother third quarter close. Thanks for your patience.

We announced in April that Mike Hovan, previously the President of Edgetech, assumed a senior position in sales and marketing for Engineered Products Group. Mike was very successful in his leadership role at Edgetech and was directly responsible for its excellent track record of profitable growth, even during the current economic downturn. We want that same success for EPG and I know Mike can deliver that for our shareholders. Along those lines, Mike is working with his senior team to integrate Edgetech's world class customer focused sales and marketing infrastructure into EPG. As you may know, Edgetech has a strong presence in Europe, and just last month we held a grand opening for their new facility in Heinsberg, Germany which drew about 150 customers, guests and dignitaries. Edgetech's other overseas facility is located in Coventry, England. An exciting EPG growth initiative is our first consumer targeted sales effort called ScreenItAgain, a website based store where custom replacement window screens, screen doors and window grills can be ordered. Launched just two months ago, we've already shipped almost 150 orders and initial feedback, is the site is very easy to use. So, if you're in the market for new screens, I invite you to visit screenitagain.com.

Let's turn to a review of our second quarter results. Customer demand was down at Engineered Products compared to a year ago especially at the national OEM level. When new home starts falter, our big customers really feel the impact and in turn so does Quanex. Fortunately because of our work with regional customers, who tend to be more R&R driven, we fared better. Also impacting EPG results this quarter was the absence of available tax credits that drove demand this time last year. In the year-ago quarter, the industry was benefiting from both the $8,000 first time home buyers tax credit and a $1,500 replacement window tax credit. In the sequential first quarter, the industry still had the benefit of the $1,500 tax credit so we suffered this quarter from the pull-forward effect in demand and these credits tend to generate. It really looked like the wind was out of our sails in the quarter. According to the market intelligence firm Ducker Worldwide, US window shipments for the first six months of the fiscal 2011 were estimated to be up about 3%, while EPG sales without Edgetech were up about 2% over the same period. Operating income in EPG in the quarter was $1.9 million, which included a one month loss at Edgetech of $900,000.

So we showed an improvement over the sequential first quarter loss of $650,000. However, we were still behind the $5.8 million the group earned in the year-ago quarter. We did incur ongoing expenses this quarter related to our long-term organic growth initiatives of about $600,000. And we remain confident these costs will pay off in future years with higher sales and better margins. From both a sales and earning perspective, April was a tough month at EPG, especially at our Mikron division which struggled all quarter as big customers cut back aggressively on orders. We are seeing some improvement in orders at EPG in the third quarter, compared to the second quarter. However, we will continue to closely watch the broader economy and its impact on housing. For the upcoming September 2011, GlassBuild show will be in Atlanta and we will be combining the best attributes of Quanex and Edgetech to form a single booth for Quanex Building Products. GlassBuild is a great opportunity to demonstrate the wide range of the industry-leading capabilities Quanex as well as puts us in front of hundreds of potential regional customers.

Let's now turn to review of Nichols Aluminum which reported excellent shipments and operating income in the quarter. Shipments were 80 million pounds, down from 83 million pounds a year ago. Our Nichols Alabama facility suffered a major storm-related power outage in late April, which hurt us a bit on shipped pounds and income as we recruited third party toll coaters to see us through the outage. The Aluminum Association which tracks industry shipments of aluminum sheet products was up about 4% for our second quarter, while Nichols was off about 4%. While a portion of our under performance can be attributed to the power outage at Alabama, it's more accurately reflected in the relatively weak building and construction demand where we have a large presence. Compared to the relatively strong distribution and transportation demand where we have a relatively small presence. Reviewing operating income for Nichols in the quarter, the numbers were solid despite the fact that we continued to experience higher repair and maintenance cost. While some maintenance issues were unplanned, most were planned projects that we had delayed from fiscal 2010 because of strong demand at the time, which are getting done in 2011.

Operating income was $6 million in the quarter, compared to over $7 million in the year-ago quarter. While it's hard to be precise, the difficulties we experienced in Alabama with the storm-related outage did account for part of our income gap. A review of spread at Nichols, which is the difference between our average sales price and our average material cost was up 4% over the year-ago quarter, primarily due to higher aluminum prices. Spread was down 7% from the first quarter due to mix as we shipped a smaller percentage of higher margin painted sheet. I would characterize the aluminum scrap market as still tight but we have seen post consumer scrap availability arrive as winter waned. At this point I'd like to turn the call over to Brent who will take you through some additional financial highlights.

Thanks, Dave. I would like to add my welcome to those of you listening today. Quanex reported a loss of $0.04 per share from continuing operations in the quarter. This loss included $0.03 of LIFO expenses, and $0.03 of Edgetech related transaction costs. In the year-ago quarter, we earned $0.12 a share, which included $0.03 of bargain purchase gain and $0.02 of LIFO expenses. We ended the quarter with a cash balance of $58 million, compared to $182 million at the end of the first quarter. We used $104 million to acquire Edgetech, and we used $6 million to acquire the vinyl extrusion assets at a Jeld-Wen facility in Washington. We do expect our cash balance to grow between now and the end of the year, assuming no additional acquisitions. Cash used by operating activities for the first half of 2011 was about $5.4 million, compared to cash provided of $41 million a year ago. The difference is attributed to reduced income and an increase in inventory, a result of targeted opportunistic buying coupled with higher aluminum prices. Our $270 million revolving credit facility remained untapped. Because of certain EBITDA covenants associated with it, the available balance was $215 million at quarter end. Possible uses of cash include funding our growth initiatives, funding our common stock dividend, buying back our stock, and making acquisitions that fit our fenestration vision. With that, I'll turn the call back to Dave.

Moving the discussion to our business outlook, we expect residential building and construction activity to be about flat in 2011 compared to 2010. Back in December, we speculated that 2011 housing starts would come in around 600,000 units. Our estimates may have sounded a bit conservative to you at that time, but at this point we're concerned the industry won't even reach that. Much of the economic weakness that worried us in the first half persists in the second half, and then some. Which our new guidance reflects. Weak GDP growth, high unemployment, shaky consumer confidence, high inventories of homes available for sale and troubling levels of foreclosures. We still believe housing has found a bottom but at this point we can't make a case that would point to meaningful improvements in our end markets the remainder of 2011. We are, however, bullish long-term on both the economy and the building construction markets we serve. It's only the near-term that troubles us. With that, we're now ready to answer your questions.

(Operator Instructions) Torin Eastburn, CJS.

My first question is about the trend for spreads in Nichols. You said it was a mix issue this quarter. Is that an issue you think will repeat going forward?

We believe that the trend will continue going forward. If you go back over the history of Nichols, especially in the stronger years, we run a stronger flavor of painted mix, driven by stronger transportation markets and we don't anticipate a rebound in that.

Okay. And then I guess just a quick follow-up question. To the extent that it's possible to strip out the effects of the tax credit, can you say a little bit more about the trends you think you're seeing in the underlying housing and building markets in EPG? Thank you.

I think you see the trends in housing and R&R, we ran through 2 years of tax credits for window replacements as well as new home purchases. Those have expired and we saw that hit in our Q2. I believe our second quarter EPG volume was down 10% versus a year ago, so you see the effect of that. I think more troublesome is we were conservative in our new home forecast at 600,000 starts, and we have yet to hit that level and you have to stare that one down and question whether we'll see any rebound in new home constructions, and that's reflected in our guidance.

Jack Kasprzak, BB&T.

First question is related to the cost for the growth initiatives. You mentioned that in your press release. Do you think -- will there be more of those in the back half and into fiscal 2012 as well?

Yes, Jack, what I would say is -- I wouldn't expect to see a significant increase in those over the back half. We're just getting up to what we feel our run rate is. So no, I would expect those to be in the neighborhood of what we saw in the second quarter.

And into fiscal 2012 as well, will they persist, can you say at this point?

These are long-term investments that we are making. So yes, yes.

Okay.

Clearly, we'll give you more about 2012 later in the year, but, yes I think it's fair to say.

Second question is on Edgetech, just looking at some of the numbers you gave in terms of guidance, sales of $80 million, 12-month run rate and operating income of $5 million. That margin looks a little low versus maybe some of the numbers that were in the pro forma filing. Is that -- can we expect over time or do you expect Edgetech margins to ramp back up maybe beyond the next 12 months?

We're still working through really the purchase price allocation and how much goes to intangibles and, therefore, amortization. So it would be too early for me to give any guidance. We'll look to give a better sense later in the year when we give 2012 guidance. But, yes it's lower than what we would have said before, only because more is going to intangible assets, therefore being amortized.

Trey Grooms, Stephens.

First off, on [E&P] business is in line with -- pretty close to in line with some of the industry numbers you gave us. Can you tell us kind of what kind of progress you're seeing or what kind of progress you're having there with Nexus kind of I guess -- last time we got an update on the specifics there was a few quarters ago. Could you give us a little more color on what's going on there, what kind of traction you're getting there, because you did outline some of the costs, kind of the long-term investments you're making there, if the you could just give us some color, please.

I think if you reflect back on Quanex, we were 70% new construction, 30% R&R. If you remember my comments on Ducker, that we're running even with Ducker, we're a point less, we made a big transformation, I think in terms of our servicing the R&R market with work to do. We still see a big dependence on new construction in our big customers but we're in the process of making that shift. We're 10 months into it and feel good about what we're doing in terms of branding our movement on opinion leaders for energy efficiency and our overall view of the market. Believe that will be enhanced further by the addition of Edgetech, which for the size of the Company had a very nice presence with mid-range customers and the opinion leaders in the industry.

Okay. Can you tell us -- there was some -- you mentioned some changes with the Edgetech management, as far as the role that they're playing within Quanex. Can you tell us kind of what that will mean for Project Nexus and if there are any other changes that will take place there.

We named Mike Hovan, the former President of Edgetech, as leader of our Engineered Products Group, sales and marketing initiative. He is heading up a front office integration project that will take what we've done right with Project Nexus, we're really taking a time out and saying as we bring these 2 organizations together, how can we improve our presence in front of customers, grow the business, and drive efficiencies. We'll be able to give you updates on that at the next conference call. But Mike's the guy, 20 years experience, a great track record, and we're really -- with the close April 1, we're ahead of schedule in terms of those integration activities.

Peter Lisnic, Robert W Baird.

First question I guess back to Edgetech, can you give us a sense of what the -- what I'd call the cyclical profitability profile of the business is? Looks like your number for -- on a pro forma basis, around 6%. I'm just wondering how much incremental leverage we might see as the cycle improves for that business and then on top of that the synergies that you've identified at $2 million to $3 million.

Pete, I'm going to stop short of giving additional guidance around Edgetech. As we go through the integration efforts, we might gain some further insight on that. I'm going to stop short on that one. What was the second part you were --

I'm just wondering historically what has this business done from a profitability perspective, what was the previous peak and kind of where it's troughed out at.

I'm going to stay away from giving the historical information. Clearly, it looks differently without the higher depreciation and amortization from the step-up, so -- but I would just say, it was a very profitable business and really point out the growth that occurred at Edgetech each year, under its existence. So it's a strong marketing machine and that's what we're attaching our sales and marketing organization to.

Okay. That is fine. Let me switch gears, then, and talk about I guess the base business at EP. Any sense as to what inventory levels might be like at OEMs or distributors. It sounds like that may have been a piece of what hurt the volume numbers in the second quarter.

I would say, think about how the rebates went through the first half of the year. Remember, we started the year in November. So they were buying ahead to try and get last minute shipments and those inventories were squeezed down through the summer months and I think continue at that level, based on uncertainty of how demand will be after the rebates and weak construction. So I would characterize our customer inventories at a light level, characteristic probably over the last 2, 3 years.

Okay. And then you identified Mikron I guess as having some pretty severe pressure. I'm also wondering about commodity costs and whether you had any pressure there. I know there's pass-through clauses but I'm just wondering whether there's anything sort of that you couldn't recover in the second quarter especially at Mikron with oil price inflation.

CDI covers us well on the base material. There's micro ingredients, TI02 would be an example that is significantly up and we are working on price increases to stay in step with that. I would say something we did during the quarter that was interesting, effective May 1 we put in surcharges related to oil. It's the first time it had been done in the spacer business and it's just an example of what we're trying to do to stay ahead of inflation.

Okay.

I would say this. Volume was weak, inflation raged, and we're battling every day to hold our prices and make sure that we're staying in pace with inflation.

Robert Kelly, Sidoti.

Just a question on the Edgetech pro forma numbers that you gave. When you announced the closing, you talked about 2010 being in like a $10 million range, unaudited. What is the difference between that and the $5 million that Quanex would generate from Edgetech being a part of their organization?

In 2010, you're saying?

Yes.

I don't have the reconciliation just off the top of my head, but we have some -- clearly, the costs, there were costs included in their 2010 that don't continue forward, some parent charges. We have under Quanex, and some different costs for benefits and things of that nature, but I think the predominant difference is really the depreciation and amortization from the step-up. If you're looking at from an OI perspective, that's going to be 95% of the difference.

So the bulk of the difference is non-cash things?

Yes, clearly, our depreciation and amortization is currently estimated to be significantly higher than their 2010 unaudited.

Okay. Great. And then just, one of the strategic rationales of acquiring Edgetech was to get further penetration of the regionals. Can you just update us, how that is going?

It's in its infancy. Mike Hovan is leading a project that will help rationalize our face in front of the customers, but I think the key thing here is they bring 400 plus new regional customers to Quanex and its capabilities and complimenting a very nice position that we had with Truseal. In the IG business, you are either Truseal or you were Edgetech, if you were -- or others. And there was no overlap in those customers, so it really opens up some new doors for us.

Justin Boisseau, Gates Capital.

First question revolves around the corporate expense which was $10.3 million in the quarter. You guys are guiding towards a $26 million number for the year which would imply about $6.5 million a quarter. What's the delta between the $6.5 million a quarter sort of expected normal rate.

Justin, first off, there's $2 million of LIFO in there, as well as our guidance of $26 million, we're saying that's $26 million excluding transaction costs and so we also had transaction costs in the quarter as well. So if you really back out the LIFO and the transaction cost, transaction being related to Edgetech, then we're going to be closer to that run rate that you talked about, the $6.5 million.

Right. And so would the run rate -- should we think about increasing corporate on a run rate once Edgetech is included. Will it add $1 million or $2 million a quarter?

No. On a go forward basis, no. These are specific to the closing or the integration of Edgetech. But not adding long-term cost to corporate.

Got it. And then the follow-up, as it relates to the guidance for Engineered Products, you're talking about $30 million of operating income for the year and that's apples-to-apples with the $1.2 million or I'm sorry -- yes, $1.3 million year-to-date? Am I thinking about that right? That's implying almost $29 million in the second half.

Yes, that is the way to think about it; correct.

Plus another $2 million from Edgetech, which is included in that segment; right?

Correct.

Barry Vogel, Barry Vogel & Associates.

I have a question of David. I noticed you made an acquisition of this Jeld-Wen Yakima facility. Can you tell us why you did that?

We have a relationship with Jeld-Wen that provides over 80% of their extruded material. In the down economy, they were having difficulty utilizing that facility. We had gone through some pretty major down-sizing and felt it was a good opportunity to get them out of the self extrusion business and be the sole supplier for them for PVC extrusions.

So would that be for their entire operation, nationwide?

Yes.

How big of a business could that be?

It's better if it is in a healthy economy, but we have not given numbers on that customer size, but Jeld-Wen would be the top 3 window producers in the United States and we've had a long relationship with them from Mikron and from Homeshield and it's building on that relationship.

Okay. And then a second question. Given the desultory environment that you have, and I know you're busy acquiring Edgetech, doing all these things, integrating them, et cetera, et cetera, is it fair to say that you still believe that one of the things you should concentrate on, for shareholder value, and given your fine balance sheet and cash generation capability, despite the terrible environment, that we should expect you to continue to buy back stock?

Yes, Barry, I would just say, we have the program that was approved last year that we continue to look to, when it's sensible to be buying stock, we will do so.

Okay. I guess the lower price today will give you a better opportunity.

We will always look at it, yes.

(Operator Instructions) I'm showing no further questions in the queue.

Obviously, 2011 is going to be a tough year for the housing market, Quanex and its customers. But we know that our rock solid balance sheet, we can ride out the continuing economic storm. The growth initiatives we are developing across the Company will pay off in the long run and our vision for long-term profitable growth remains on track. That concludes today's call. Thanks for joining us and have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Have a great day.