Quanex Building Products Corp (NX) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your third-quarter earnings 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 be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce David Petratis, President and CEO. You may begin.

Good morning and thanks for joining us for our third-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 our organic sales initiatives at Engineered Products, a recap of third-quarter results, and a general outlook for demand over the coming quarters.

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 statements. The earnings release is available at Quanex.com.

Last quarter we predicted the residential building and construction industry wouldn't experience much of a spring bounce, and we were right. However, despite the difficult market conditions we have experienced, I am pleased to report Quanex was able to deliver earnings after special items that were in line with the third quarter of last year. We also generated better contribution margins at Engineered Products compared to a year ago, in part because of solid execution at the facilities, productivity improvements, and better control of costs and higher pricing.

Excluding Edgetech, sales at Engineered Products were even with a year ago and I consider that sound performance given the year-ago quarter had the benefit of a $1,500 tax credit for energy efficient window purchases. There were no comparable credits available to consumers this quarter.

According to market intelligence firm Ducker Worldwide, estimated US window shipments for the 12 months ended June 2011 were down about 6% compared to the year-ago period, while EPG sales without acquisitions were down only 1% over the same period. Third-quarter operating income at EPG, excluding Edgetech, was $13 million even with the year-ago and our operating margin came in at a very strong 13%. Our Edgetech business earned $1 million on the quarter and that is after having absorbed an inventory step-up expense of about $700,000.

We continue to incur expenses at EPG related to our organic growth initiatives. We remain confident in these programs and that they will pay off in the long run by giving EPG increased sales and better margins. Because of rising raw material costs we have experienced pressure on margins all year and the third quarter was no different.

We have had some success in selectively raising prices at EPG this year, and in further support of these actions our TruSeal business instituted an oil-based raw material surcharge on May 1. The surcharge is designed to help us cover the cost of butyl, a primary raw material at TruSeal that is used in making their insulated glass spacer product. The cost of butyl, a rubber-based product, is highly correlated to the price of oil and this surcharge will help protect margins when oil prices move.

As we previously announced, Mike Hovan, formerly the President of Edgetech, assumed a lead role of our EPG sales and marketing organization. Mike is working with his senior team members to integrate Edgetech's world-class customer-focused sales and marketing infrastructure into EPG. Since taking the position, and with the help of an outside consultant, they have recently completed a full review of that organization's sales structure.

The evaluation called for changes in the way we go to market and the modified approach now has us using front-line sales people considered to be product generalists backed by a team of product specialists from each of our four EPG businesses. The new structure actually puts more feet on the street while lowering our cost.

We are making these changes to ensure we drive EPG's full value proposition, which runs the gamut from design and engineering support through logistics and customer service. The structure also positions our sales and marketing organizations for future bolt-on acquisitions.

You can get a sense of the way that we will be conducting business by stopping by our booth at the upcoming GlassBuild show in Atlanta next month. We have combined the best attributes of Quanex and Edgetech that will be showcased for you at GlassBuild. The expo not only gives us a great opportunity to highlight all the industry-leading capabilities of Quanex, but it also puts us in front of hundreds of potential new customers. I invite each of you to come see us at the show; many of our leaders of the Company will be there and available to you.

Let's now turn to a review of Nichols Aluminum. Shipments were 80 million pounds in the quarter, which were down from a strong 90 million pounds we shipped a year ago due to weaker demand for residential building and construction sheet. Compared to our sequential second quarter shipments were the same 80 million pounds, further indication of a lackluster spring bounce.

The Aluminum Association, which tracks aluminum industry shipments of sheet products, reported volume up about 4% in the same quarter from a year ago when we were off about 11% for the same period. This difference is primarily attributable to weaker building and construction demand where we have a larger presence, compared to strong distribution and transportation demand where we have a smaller presence.

Third-quarter operating income for Nichols was $7.4 million, down 16% from a year ago. While lower pounds certainly played a role, we were also hit with higher freight costs and repair and maintenance expenses. To some extent the higher repair and maintenance costs this year are a result of projects that we delayed in 2010 because of the stronger demand and investment to achieve higher process control and output.

Fortunately for us a very healthy spread helped to mitigate some of the impact of these higher costs. A review of spread, which is the difference between our average sales price and our average material cost, was up 13% over the year-ago quarter, primarily due to aluminum prices moving up at a faster rate than our raw material costs. As we look to the fourth quarter, we know aluminum prices have drifted down from the third quarter, potentially putting some pressure on spread if we don't see a corresponding drop in scrap cost.

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 on the call today. Quanex reported earnings from continuing operations of $0.24 per share in the quarter. Our earnings included $0.06 of special expense items, like LIFO and acquisition-related costs, while year-ago results included $0.02 of special items. The earnings release has a table that gives you more specific information on these items.

We ended the quarter with a cash balance of $62 million and we expect our cash balance to grow in the fourth quarter based on higher income and lower working capital. The stock buyback program was active in the third quarter with the Company purchasing 169,600 shares common stock for $2.8 million. And because the stock remains at what we consider to be an extremely attractive price given our long-term view of the Company, we purchased an additional 239,050 shares so far in the fourth quarter at an average cost of $12.21.

Since the program commenced in May 2010 we have repurchased about 745,000 shares, and as the stock price remains around its current range we will continue to be buyers. Further supporting these efforts, yesterday the board authorized an additional 1 million shares to the program. We don't believe the market is acting very rational at this time, so you should expect us to continue to take advantage of this opportunity.

Our $270 million revolving credit facility remains untapped. Because of certain EBITDA covenants associated with it, the available balance was $204 million at the quarter end. Possible uses of cash include funding our growth initiatives, making acquisitions that fit our fenestration vision, funding our common stock dividend, and buying back our stock.

With that I will turn the call back to Dave.

Thanks, Brent. Moving the discussion to our business outlook, we expect residential demand to remain under intense pressure for the next 12 months. Our outlook has recently seen support from companies like Ducker which lowered their outlook for US window shipments for the coming year by the over 10%. IHF Global Insight, an economic forecasting company, also lowered their housing start forecast for 2012.

Much of the tepid economic data that worried us in the first half of the year remains. At Quanex we are sharpening our game and looking to grow earnings from our own growth, productivity gains, and innovation. We still believe housing is at the bottom, but at this point we simply can't make a case for meaningful near-term improvement in our end-markets. However, we remain bullish on Quanex.

The economy and our building and construction markets in the coming quarters are going to be a challenge. We will take the opportunity to continue to build our business.

With that we are now ready to answer your questions.

(Operator Instructions) Torin Eastburn, CJS Securities.

Good morning. My first question is about the buyback. Quanex at $11 seems awfully attractive; is there a reason you are not actively buying back shares at a bit faster pace?

Torin, what I would tell you is we put in a program that we have been executing on and we have not done anything to change that as of yet.

Have you contemplated changing it?

I contemplate things all the time. Obviously, there is things that we are not allowed to do during blackout periods when we are around earnings and things.

Sure.

So we have had a program in place that is intended to kick in should we find ourselves in that situation.

All right. And my follow-up. Are you willing to talk about what you think Quanex could earn on an EBITDA or earnings basis, or even a revenue basis at some kind of mid-cycle level, say 1 million housing starts?

I am going to hesitate to give you that right now, Torin, but clearly it's something that we continue to try to think of the best way to provide some way to think of some Quanex with Edgetech under our belts, with the organic growth activities, and the like. So nothing at this time to give you, but maybe we can come up with something in the future here.

Torin, I would say we look forward to the day of 1 million homes starts, but I would say our history may give some view of the future. You go back to 2008 significantly stronger drivers in the economy; third quarter of 2008 some 900,000-plus new homes being built. Our revenues are in the same range and we are significantly more profitable.

I think we are discouraged that housing is in the place it is, but we are very optimistic as we position the business for success in the midmarket and sharpening our manufacturing facility.

All right, thank you.

Peter Lisnic, Robert W. Baird.

Good morning, gentlemen. Dave, I guess first question, your comment in the press release and at the end of the call about the flat to reduced demand in coming quarters. Can you give us a sense as to how much of that is new construction or what you are seeing in new construction, because it looks like most of the forecasts there at least are calling for some growth over the next, call it, 12 months versus remodel where I guess pressure on the consumers may be causing that market to be down or down more significantly than you thought?

A couple things that I see in the environment. Number one -- I think this is my 13th conference call. The forecasters have always been more optimistic than maybe Jeff, Brent, and I. Unfortunately, they tend to come our way. So I think you got to be cautious as you look at the forecasting community because we are in a time that we have never been in before.

Second is we had two years of window tax credits. Trying to understand what demand that drove in the market, but I think it feels like about 3 million windows. As we look at the Ducker forecast, Ducker has come down 10% as we stated. They are looking at 28 million and 38 million windows; you got to be a little careful with that.

Ducker is not extremely precise but it shows at 38 million windows we are at the lowest point that we have been as we have hit the down elevator. I think it's another indicator.

I think the third is existing homes structures you have got 2 million, 2.5 million in excess. It's going to take a period of time, years to work through that, and put on top of that no improvement in unemployment. I think you have got to be cautious. So that is kind of where we see it.

Okay, that is a perfect color. Then for the follow-up question. I guess if you take out Edgetech and the purchase accounting, and you alluded to this a little bit on the call, the operating income at EBP or EP was basically flat even with the some of the things identified like butyl pressures.

So I am wondering if you could give us a little bit more color on how you are -- what sorts of levers you are pulling there. You mentioned pricing and productivity, but I am wondering if there is some more granular details that you can give us on kind of how you are generating that profitability, even with some of those headwinds.

We made a very strong Lean Six Sigma effort and investment in the business; I think some 95% of our employees across the Company with the leadership team's involvement to try and drive Lean Six Sigma improvements. We have gone through some pretty significant downsizing. If you look at our headcounts across the Company from 2008 to where we are at today, we are significantly more productive. So the pricing productivity we have lowered our footprint and we are going to continue to push on that. That is where we are getting the gas.

Okay, thank you.

Keith Hughes, SunTrust.

Thank you. Just wanted to get any sort of feel you have had on recent trends the last three to four weeks given the news and the headlines. Have you seen any behavior changes for any customers in terms of ordering patterns?

I think our customers see the lack of spring pick-up. First indicator would be our Nichols business. A year ago we were sold out and I think it's clear -- it's the canary in the mine in terms of that. Where our customers on the Nichols side would be typically strong at this point we are just not seeing it.

I step back and say, okay, are we losing share in this environment and I am confident we are not. It's that economic uncertainty, the lack of confidence that we are seeing.

The other thing that we have got to be mindful of is we come off of two years of window tax credits that certainly helped us in 2009 and 2010, and we are in an absence there. So don't see -- we see a weakening environment.

All right, thank you.

Rich Glass, Lockwell Investments.

Nice job in a tough environment there. Can you guys talk about Edgetech and what that acquisition does vis-a-vis Project Nexus in terms of their exposure to that market you are trying to make some headway in?

I am excited about what Edgetech brings in terms of our customer exposure. For -- I would say they bring some incredible marketing and customer relationship strength and culture to Quanex which was sorely needed, number one. Number two, when you think about Edgetech, and we competed with them historically with our TruSeal business, most customers were either Ford or they were Chevy. They were Edgetech or they were TruSeal.

So Edgetech brings us an additional 500 customers that we can expose our vinyl, our window accessory products in terms of the growth of the business. So the other leg that Edgetech brings is -- and it's really two.

They had developed a commercial presence for high performance glass. We have got some great products developed at Micron to be able to go into the commercial arena. We would have had to invest in feet-on-the-street marketing efforts to do that. The Edgetech team can pick that up.

And the last is international sales presence. When you think about IG spacer, about 60%, 65% of the world market uses metal spacer and it's very energy inefficient. The opportunity for growth because of Edgetech, its international position, our position at TruSeal in warm edge spacer gives us the opportunity to convert that market. So it brings some very nice opportunities.

The other thing that I think is really impressive at Edgetech is the ability of that team to embed their marketing message in the regional window fabricators and the regional window dealers. Again, it was an opportunity we were trying to develop on our own. We are able to move faster because of their experience.

Okay. In terms of those international markets you were referring to, is that more the Western Europe developed or is it in other areas as well, or instead of I guess?

Edgetech has a very nice presence that complements what we were doing in Europe. So you had Edgetech, extremely strong in the UK and what I would call old Europe. You had TruSeal that was pretty successful in the Eastern countries, the Eastern Block of Europe, so that comes together nicely.

The opportunity exists in the world where you need high-performance windows, so think about Japan, South Korea, think about Australia, New Zealand, to some extent Brazil. But where you have the need for energy performance, energy efficiency, sound deadening that is the opportunity. Again, 65% of the world use cold edge application, which are not as energy efficient, that is our opportunity; I like it very much.

All right, thanks.

(Operator Instructions) Robert Kelly, Sidoti.

Good morning. Just had a question on Project Nexus. A year ago or when you first announced your long-range plans you talked about $150 million in, I guess, a normal housing market. Is that type of expectation still valid? Is Edgetech part of that $150 million calculation and where are we today with Nexus?

So let me say it this way, Bob, the $150 million -- the addition of Edgetech doesn't whittle down that amount. They don't occupy some of that. What Edgetech does is allows us to ideally accelerate to achieve that $150 million. Actually that $150 million, I think when we talked about it a year ago we did say that we assumed some level of return towards a more normal market.

So obviously sitting here today with the market continuing to be flat on its back it's hard to get at some conversions, but I would tell you we have some -- we see some success, early success in this organic growth effort. And as Dave touched on earlier, the expertise that Edgetech brings will help us further accelerate our goal on the Project Nexus.

But we have innovation, we have energy core, and ImperiClad, and various products that have been developed as a cross Quanex development that are in the market today that are growing today. But a solid spring building season would be nice to be able to point to some stronger traction.

As far as your use of excess cash are we to read -- with you diving into the buyback so aggressively are you off the acquisition hunt at this point?

Not at all.

No back off off the acquisition hunt. I believe the perspective that Mike Hovan, Larry Johnson from Edgetech brings in terms of our acquisition pipeline enriches it. We took Gus Coppola, a 30-year TruSeal Quanex employee, and put him solely focused on acquisitions that can build our fenestration offering.

So we think there is an opportunity the longer this depression in housing holds on that it will continue to pop up nice opportunities like Edgetech and extend our value proposition.

Have you seen multiple expectations come down with this recent round of, I guess, cold water on growth expectations?

I think our acquisition pipeline is more enhanced by the focus and expertise of Gus, and what Edgetech Europe brings to the game it opens up our views.

But let me say, to your point about multiples, clearly with all the fear or whatever that is going around currently that has spooked some sellers, so I think there is some level of people concerned about what does the next 30 days hold. But I believe this too will pass.

We continue to focus on those that we feel are part of our dream team, which Edgetech was top of the list on that. We are very focused on those; we are not going to get distracted on other things. But acquisitions do remain a priority, but clearly looking at a share price that we have today there is a good return in buying that stock.

Great. Thanks, guys.

Justin Bossieau, Gates Capital Management.

Was just wondering if you could talk a little bit more about Edgetech and sort of your outlook on margins there. I think you have quoted it as $24 million in sales in the quarter and about $1 million of EBIT, which seems to be maybe less than what it did in the prior years or some one-time stuff in there associated with the integration. And what is the outlook going forward? Thanks.

I think we have given a run rate in the last quarter when we gave a run rate. I think we said about $5 million of OI with $8 million of depreciation and amortization. When you look historically the big change is really all the purchase accounting that gets layered on to these things these days, so significant amount of intangibles that get amortized on an annual basis.

So I would say to continue to use that run rate level that we have provided before until we update you in the future, if we have another update.

Okay, terrific. Thanks.

If there are no further questions, I would now like to turn the conference over to the speakers for any additional remarks.

The growth initiatives we are implementing will pay off for our shareholders in the long run and our vision for long-term profitable growth remains on track. So until our end-markets decide to give us some help we will continue to push our lean process initiatives, drive for productivity improvements, lower cost, work safely, invest in our people, and expand our customer base, and judiciously raised prices as needed to help protect our margins.

That concludes today's call. Thanks for joining us and have a great weekend.

Ladies and gentlemen, this does conclude today's conference. You may now disconnect and have a wonderful day.