Quanex Building Products Corp (NX) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Quanex Building Products third quarter conference call. At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder, this program is being recorded. I would now like to introduce your host for today's program, Mr. David Petratis, Chairman and CEO of Quanex Building Products. Please go ahead, sir.

Good morning and thank you 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. Our comments today include forward-looking statements about the future prospects of Quanex. Please refer to our SEC Form 10-K filed in December 2011 for our complete forward-looking disclosure statements. The earnings release is available at Quanex.com.

Engineered Products finished the quarter with sales up 8% from a year ago quarter; a very good showing. Our gains were predominantly the result of a strong performance at our vinyl extrusion business. Jeld-Wen, a major customer that produces mid to high end wood and vinyl windows has gained significant market share this year at the big box stores. They displaced a competitor that fortunately for us did not buy our extrusions, so we're experiencing significant sales growth from Jeld-Wen's actions.

EPG's operating income was a healthy $13 million in the quarter, which included $2.5 million of expenses associated with the insulated glass spacer facility consolidation. We wrapped up the consolidation project last month ahead of schedule and on budget. The total cash spend will be about $16 million once all the bills are paid, and while we expect to see some modest benefits in the fourth quarter from its completion, the $9 million in annual savings will begin in earnest in fiscal 2013. While we did leave a few pieces of equipment behind in Barbourville and the building is now being prepared for sale. According to market intelligence from Ducker Worldwide, reported US window shipments for the 12 months ended June were down 2% compared to the year ago period, while same-store sales at EPG were up 6%.

We continue to see a disturbing trend in the residential building products markets this year. While new home starts are up about 25% over a year ago, R&R activity is relatively flat. For calendar year 2012, Ducker is forecasting new home window shipments to be up about 20% year-over-year, a very good showing, but their outlook for the replacement windows is flat to downward slightly. This is obviously a concern for us because we estimate about two-thirds of EPG sales are related to the R&R window market. Also, discussions we've had concerning replacement window demand with some of our larger customers have not been encouraging. While it is difficult to pinpoint the exact causes for this weakness, we believe ongoing tight credit conditions and weak existing home prices and values continue to discourage homeowners from making big ticket improvement in their homes.

Let's now turn to Nichols Aluminum. We're pleased to report that customer demand in the quarter was strong. The strike-related financial pains we took in the second quarter to keep our customers in metal paid off, and in return, they stuck by us. However, due to an equipment outage at our casting facility we were not able to fully capitalize on the demand as we struggled for about a week to get the caster back online. We believe the equipment problem now resolved likely cost us about 5 million pounds of shipment in the third quarter.

While the reduced shipment certainly hurt our financial results in the quarter, the year-over-year decline in aluminum spread, which is calculated as the difference between our average sale price and our average raw material cost, hurt even more. With LME aluminum prices hovering around $0.90 per pound compared to $1.20 per pound a year ago and without a corresponding drop in aluminum scrap cost, our spread has been dramatically reduced from the last year. In other words, aluminum scrap costs today are expensive relative to the LME price of aluminum. And while demand for scrap today remains high while supply remains relatively tight, we just don't foresee any significant improvement in this situation between now and the end of the calendar year.

So between our reduced shipments and the lower spread, Nichols posted a disappointing operating loss of about $3 million. This loss did include about $2 million of strike-related coil purchase expenses that hit in the third quarter. As previously announced, we made a leadership change at Nichols in the quarter, Russ Brown our new President at Nichols, brings many key attributes to the job and those include a passion for lean operations, process improvements and controls, team building and employee communications.

We also announced a $6 million capital improvement project for the paint line at our Nichols Alabama facility. In our current state we don't believe we can garner meaningful improvements in either the quality or on time delivery of our painted sheet without a full replacement of that operation's drying oven. The current oven which is over 40 years old is a patchwork of fixes that will no longer support and consistently produce high quality painted sheets. If we don't take action soon, we risk the permanent loss of high margin painted sheet customers and we're not going to let that happen. So we'll do the right thing for both customers and shareholders and replace the oven in December. At this point, I'd like to turn the call over to Brent who will take you through some additional financial highlights.

Thanks, Dave. Let me add my welcome to those of you on today's call. Quanex reported GAAP operating income of $0.04 per diluted share in the third quarter of 2012 compared to $0.24 a year ago. The $0.04 included $0.03 of Nichols strike-related expenses, $0.04 of IG spacer consolidation-related expenses, $0.03 of ERP related expenses, and a $0.02 IG spacer warranty benefit. The year ago income of $0.24 per diluted share included $0.06 of special item expenses. No shares of common stock were purchased in the quarter and our $270 million revolving credit facility remained untapped. Because of certain EBITDA covenants associated with the revolver, the available balance was approximately $141 million at 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 stock. With that I'll turn the call back to Dave.

Thanks, Brent. Moving the discussion to the near term outlook for Quanex, we expect to see a continued yet modest improvement in home starts and new home window shipments. We further expect the R&R market for residential windows to remain relatively flat until we see a meaningful improvement in the economy and consumers' access to credit. Our cautious outlook was further reinforced this month by Ducker who once again reduced their 2012 window shipment estimate, this time by 2%. That reduction was prominently driven by lower expected R&R window shipments. So with that, we're ready to answer your questions.

Certainly.

(Operator Instructions)

Peter Lisnic, Robert W. Baird.

Good morning, gentlemen. First question, Dave if you could, just give us a feel for the order book at Nichols. You're looking at a fourth quarter that would imply shipments up 15% year over year. Can you maybe give us a feel as to how confident you are in that number and given some of the things that have gone on with the strike and then maintenance issues just kind of how sticky has the share or the customer base been with Quanex?

I think the order book remains relatively strong. We could shoot clearly, if we can ship more we can sell it, as we go out to look to purchase hot band on the market, it's tight so conditions remain favorable. Our challenge is throughput. We lost seven days -- six, seven days on the caster, because of electrical problems, it's an inductor system that should have been replaced years ago. When you get high electrical demand on the grid that we faced in July just because of the heat, it has effects on that system, so if the book is strong, if we can get the throughput, we can process it.

All right, and conviction in getting the throughput pretty good?

Yes, Pete, you know, if you look at the timing, I spent almost the full month of June up there in Davenport at the caster. They've got the ability to produce if the equipment hangs in there.

Okay, all right, and then if I could just switch gears to EP. The margin in the quarter may be a little bit less than we thought, but what I'm wondering there is just how should we think about mix in terms of growth in new construction markets versus this remodel market that's sort of flat, and just some of the pressure that we're seeing there.

So the growth that I was pretty pleased with in Engineered Products is clearly driven by strength at Jeld-Wen, number one, think about what's gone on over the last 2.5 years at Jeld-Wen, Onex has come in and acquired them, they were certainly on the edge. They've rebounded, that's been good for us. So that rebound and their ability to pick up or displace a supplier at Menards, which was Weather Shield, that's been a good outcome for Jeld-Wen and for Quanex, and they've been stronger across than their traditional market. So a big part of the growth is about Jeld-Wen, and then we have certainly seen uptick in the multi-family, that's been certainly across the vinyl business. What I would characterize weakness is on the repair and replacement side and a lack of high performance window sales, which really helps our IG business.

And on that IG business, presumably higher margin and that's impacting mix, is that fair to think about it that way?

We like the margins at IG.

All right. Okay, well thanks for the color. Very helpful.

All right, thank you, Pete.

Daniel Moore, CJS Securities.

Good morning. Can you quantify whether it be in dollars or margin points the sort of impact of lingering manufacturing inefficiencies at Nichols related to the strike, maybe couch it in terms of a year from now how much more efficient do you expect to be than where you're running at the moment?

Well I'm going to stop short of the year from now, but what I would tell you is in the quarter, and we had about $2.1 million worth of costs related to the strike, which is buying hot band that we had already agreed to purchase prior to the end of the strike. We are going to do some things over the coming months to really dive deep into the capital and during our December shut down to make some improvements. Dave talked about the ovens. We have some other projects that we're looking at that we are expecting to have improvements for us next year, but we haven't given any guidance, and aren't prepared to at this time to really talk through that.

Okay, and in terms of EPG, same-store sales were up 6% and you continued to take share, how much of that increase is price versus quantity?

Yes, I would say for -- the 6% is a full 12 months, it's 8% in the quarter.

Right.

I would say that the vast majority of that is going to really be volume related for both the 12 and 3-month period. There were some incremental pick up in price, but the vast majority of that would be volume.

I would just add at 40 million window units shipped, there continues to be pricing pressure from our customers because you've got idle capacity in terms of suppliers so we, I would just reinforce Brent's point, it came on volume.

Got it. And lastly, just maybe an update on the ERP implementation, what have we learned if anything thus far and is the $35 million range still a good estimate for the total cost?

Yes, we will put definitely pen to paper come November 1. November 1 is our first big go live. We went live with payroll January 1. But where we are replacing systems at two operating locations and the corporate office targeted for the first fiscal quarter 2013 for us, it's, we will look at what the full cost will be at that point, because there's still a long tail left on this thing, so I don't want to give an updated number now. But there's a lot of work that has been done to date, a lot more left to go between now and go live. So I'm confident that we will end up with a system that will give us visibility that does not exist today. And I've talked to other companies here recently that we've talked to from an M&A perspective that have gone through this and all will talk about the pains of going through it. But the true benefit at the end of it to get profitability measures by customer, by product that we're lacking for today.

Thanks for taking the questions.

Trey Grooms, Stephens Inc.

Hi good morning guys. I've got a couple questions on Nichols. So the expected improvement in Q4 shipments, can you just talk about what is driving that, have you seen a real pick up in demand, or was there over and above the $5 million that maybe was pushed out? Is there something else playing a role there or is it just a real improvement in demand that you're seeing?

We're working through the backlog that was built during the strike. Our goal is to work that down, get our customers in metal so that we can aggressively go through the preventive maintenance down times that we need during the slow periods. I would also stress that demand is there if we can produce, and the better we can produce, we can certainly get ourselves to a position of sold out, and at 80 million pounds, historically that's about where we've been.

Well I was also just kind of pointing too to your comment on when you were buying hot band, in that market it sounds like things are pretty tight, just in the overall market over and above what you've kind of built in the backlog due to the strike and that sort of thing. Is there, are you seeing an overall improvement in the end markets there?

I would say the overall direction of our end markets is favorable, but we have over the last couple of years talked about tight capacity, and that continues to be valid and results in a tight market. There's just not a lot of capacity out there. We go out and test the market for hot band and we're looking at four to six weeks delivery if it's available.

Right, and on the oven you were talking about replacing, is that going to be completed? You said you'd started in December and forgive me if I missed this, but what's the rollout there of the timing there?

We think that's about a two week shut down. Everything points today that that will be done over the Christmas shut down, which is typically a heavy maintenance time for us at Nichols.

Okay. And then last question on the improvement in operating income there at Nichols sequentially, based on your guidance, I think that implies a sequential improvement over and above the one-time kind of costs. Is there something that's pointing to or driving that improvement there other than just the improvement in utilization?

Well, it's going to be both the utilization. That's going to be the biggest piece is the utilization getting more volume through the system which is fairly fixed cost driven, as well as some efficiencies coming, still coming out of the strike. And we're just getting better at getting metal through the process, so it's a combination of the two.

Okay, thanks a lot guys.

Jack Kasprzak, BB&T.

Thanks, good morning guys. You mentioned the two factors that drove your sales improvement in the quarter, the Jeld-Wen market share gain and uptick in multi-family. Any way to parse it a little finer in terms of the relative impact of the two, was the 8% sales gain really more the first factor than the second?

It's heavily weighted toward the Jeld-Wen recovery gains in market share. You go across the rest of the vinyl business, weakness at the big names, the mid market kind of a nice recovery that would reflect the Ducker numbers, but that's all going towards multi-family, so heavy weight towards the Jeld-Wen and then nice recovery. I would say the wood market, and as our exposure to the wood market, wood windows, is weaker than it was a year ago, which is reflected in replacement windows and the lack of construction of high end homes. When you get to the single family what's coming up across the nation is generally on the lower end, so we see weakness in that wood market and high performance windows, but the energy tax credits set an R5 standard that was very good for our IG business so to see that really start to rock, we need recovery on the R&R side. Because when people replace windows they typically will reach for a double or a triple pane and then recovery in the upscale housing market.

Okay. On EPG, sales in the quarter were up about $10 million and if you adjust for a couple of the -- two one-time items, operating income was only up modestly, what factors affect the incremental margin in the quarter?

We need a stronger sales out of the IG business. That clearly is one of our profit pools, and we continue to struggle out of the engineered components because of softness in the wood market.

Okay, great. That does it for me. Thanks guys.

Keith Hughes, SunTrust.

Thank you. A question on aluminum. What quarter will we start to see the strike-related costs go away?

Well, what we would call direct strike related costs have ended, really in the third quarter we bought hot band. Now something that as we go through this fourth quarter and are planning for the December shut down, we may have some things, some actions that we take around the shut down that may impact the first quarter, I'm not going to call those necessarily strike-related. But some things that we want to insure we get some preventive maintenance completed, maybe as a catch up, that could impact the first quarter. That's a little bit of a hangover but we'll talk a little bit more about that in December if we choose to move forward with that kind of activity. But really the direct costs related to purchase of hot band and some of the labor related direct costs, those are behind us.

As you talk to people in the channel related to the spread what's sort of the channel view of what the spread is going to do over the next six months if there is a consensus?

Not a great deal of consensus. You get a lot of varying beliefs but I think they all tend to trend around not much in the way of improvement, especially over the next six months, prices have come down. You're hearing things of scrap yards have some of the metal but are unwilling to sell it today at those prices, waiting for a recovery, which is not, it's something that we've seen before as metal prices have done this, and then there eventually comes a time where the yard starts selling the scrap.

Keith, I'll give you one other perspective. What I see coming out of our flat-rolled competitors is noise around the rolling charge in an attempt to improve the spread and we will be focused in the third or in the fourth quarter and the first quarter improving our on time deliveries, and meeting our customer requirements so that we can potentially influence that rolling charge. So I think you see from the industry signals that spreads are tightening, how do we get the proper return on this metal, at Quanex we believe get our on time deliveries up, and we'll be able to fully participate in that.

Okay, thank you.

Robert Kelly, Sidoti & Company.

Good morning. Could you give us a sense of what the growth with Jeld-Wen was?

We don't split it out. It certainly had a favorable impact on us over really the first half of the year, the fiscal year.

So third quarter growth at Engineered Products, is it positive if you strip out the Jeld-Wen business?

It would be probably in line with market, it would be the best way to characterize it.

What are some of the other growth engines going on in EPG that are positive, our expansion into Europe is a plus plus for us. The UK continues to be strong, and it's because you'll see across the UK and Europe code changes that are going to benefit the IG business even in a difficult market. So we feel good about that. We see weakness in the wood market. If you look at any of the Ducker reports, vinyl continues to get a bigger share of the prime window demand and that growth benefits the Mikron business, the engineered window systems business.

Is the Project Nexus program having a material benefit as of yet?

I like our coverage. I think some of the strength that we're seeing is positive in terms of how we go to market. What we need to really lever that is the R&R side of this thing to roll. That's two-thirds of prime window demand, so when R&R is not working, you could step back and say, you know, is our realignment getting the traction that we can. I think our overall continued out performance of the market says we're well positioned.

The customer commentary that you called out as far as the weak remodel spend, does that cause you concern that maybe the Ducker window shipments is too aggressive?

I think you seen Ducker, if you follow like we do, they adjusted downward, so I think it's in fact reflecting what's going on in the window market. That would be my observation there. I think the other side of it is the advancement in vinyl materials, the big guys are only beginning to reposition themselves in the vinyl market and we see that in our number.

Okay, and then just one final one on Nichols Aluminum. The spread, it sounds like spread was negatively impacted by hot band, $2.5 million, it's about $0.03 a pound?

That's right. It's in the order of magnitude about $0.03 a pound of the spread would be related to the hot band.

So that goes away immediately or has it gone away or does it start to go away in Q4?

No, that goes away immediately. We've cleared through all of the previous hot band that was purchased, so everything on the ground is just the current spread.

And the spread compression is completely tied to the metals?

Yes, it's comprised, LME prices falling much more significantly than what we've observed on the scrap side.

And so, this is a dumb question. If the metal side of the equation is compressing, how come the price discipline side of it doesn't expand to compensate? Aren't we down to just a couple players in aluminum rolled sheet or is it volumes are too weak, that's not happening.

Hi Bob, this is Jeff. Let me help you with that. So what you're seeing on the OEM side is manufacturers are trying to raise what we would call spread one to fabrication spread, for instance Solaris went out publicly with a $0.05 per pound increase in the fabrication spread; whereas you had Jupiter going out with a $0.05 energy surcharge. At the end of the day it's all in so the industry is certainly trying to get more on the fab side. I don't think all of it's sticking but there is certainly a push to get that done.

Thanks a lot.

(Operator Instructions)

Tim Hayes, Davenport & Company.

Hi, good morning. Just wanted to go through the how much hot band was purchased or how much hot band affected the $2.1 million of strike related costs, was that all hot band or mostly hot band?

That was entirely hot band.

All right, and was that to the hot band purchased because of the -- strictly because of the outage, the one week outage?

No, the hot band is related to when we were on strike, in order to get hot band during the strike we had to commit to certain poundage, certain volumes. And so that really was inventory that had been purchased during the strike, and had yet to be sold as finished goods so you don't recognize that cost until it's sold. So it's really just carryover to commitments that were made during the strike.

Okay, that makes more sense. All right. Thank you.

John Collier, Oppenheimer.

It's Oppenheimer, close, good morning, gentlemen. Quick question, this might be a little difficult, so just want to preface it. It sounds like reading between the lines that Nichols is going to require a step up in maintenance CapEx and I just want to get your comment on the magnitude of that, if I'm reading it correctly and any other projects that you think you might have to put in the works next year, thanks.

So yes we believe that Nichols will require a step up in capital maintenance as well as preventive and predictive maintenance. Our expenditure on the paint line would be an example of that. As we're preparing the 2013 budgets we're taking a three and five year cut at those expenditures. It's been a trend that we've been on in addition to the $6 million at the paint line, we just completed a $2 million upgrade of our annealing system, and we would -- we'll give you a number as we go into 2013 on how we see that, but we will step it up, we think it makes sense. Throughput at Nichols will help us grow this profitably.

Okay. And then just to make sure I understand it, the maintenance, you're not actually looking at any significant capacity improvements. This is just to keep the business going as is?

That's correct. I do believe that we can capture untapped capacity that's existed in Nichols with higher reliability. So you'll see us really flexing our lean Six Sigma and what we call standard work and preventive maintenance at the operator level and get more process mastery around the caster.

Okay, any opportunity to go after some higher margin business while you're doing this or is that still not really in the works?

I think when we think about Nichols, it's commodity business. Historically, Nichols accepted that they were in this commodity space and have not flexed their ability to service customers with high levels of on time delivery outside a few. Our goal is to raise our reliability of our system and our on time delivery, and participate more aggressively in some of the rolling charges that are being exhibited by our competitors. But we feel this reliability in on time delivery is an important step in that.

Great. Thanks a lot.

(Operator Instructions)

And this does conclude the question-and-answer session of today's program. I'd like to turn the program back to Management for any further remarks.

As some of you already know, Jeff is retiring later this year, and like many of you, we're certainly going to miss him at Quanex and I would put a double underline under that. We will miss him. We did find a good person to take his place. His name is Marty Ketelaar from Memphis based Service Master. Marty joins us next week and he and Jeff will be working closely together to insure a smooth transition for all of us. I, along with Brent, wish Jeff the best in his retirement and he's going to be right here in Texas, so if we need him we'll get him back here on the call.

Thank you, Dave.

We would also like to extend an invitation for you to join us at this year's Glass Build Show in Las Vegas, Nevada on September 12 through 14. Like last year, we'll have many of our EPG business leaders available to meet you so we hope to see you there. That concludes today's call and I want to thank you for your interest in Quanex Building Products. Have a great day.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.