Quanex Building Products Corp (NX) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Quanex fiscal third-quarter 2014 conference call.

(Operator Instructions)

During today's conference call, Company management may make forward-looking statements about the future prospects of Quanex Building Products. Participants should refer to the Company's form 10-K filed with the SEC for a more complete forward-looking statement disclosures.

Additionally, the Company may refer to non-GAAP figures throughout today's call. A reconciliation to the most comparable GAAP figure is included in the Company's most recent earnings release, which is available along with the Company's form 10-K, at the Company's website at www.Quanex.com.

Last, participants are reminded that today's conference call is being recorded. I would now turn the call over to Mr. Bill Griffiths, Chairman, President, and CEO of Quanex Building Products for opening comments. Please go ahead, sir.

Thank you. Good morning, and thank you for joining us on our third-quarter conference call. On the call with me this morning is Brent Korb, our Chief Financial Officer, and Marty Ketelaar, our Vice President of Treasury and Investor Relations.

This has been a roller coaster year for the housing industry in general, and the window industry more specifically. It began with a high degree of optimism for a strong construction season and a recovery in the R&R market. Since the beginning of the year, however, we've seen mixed signals. Strong multifamily starts, weak single-family starts, slower existing home sales, and sporadic activity in the R&R market. Housing starts for 2014 are now expected to be up by 9% rather than 19%.

Similarly, window shipment growth forecasts have been cut in half since the beginning of the year, from 12% to 6%. Ducker recently reported 5.5% growth for the trailing 12-month period ending June 30. Disappointing, yes but a recovery nonetheless.

We continue to believe that housing starts will recover to 1.5 million, and together with a modest recovery in R&R, window shipments will recover the 65 million units. However, we also believe that this will not occur until 2018, or perhaps even 2019.

If the current forecast of 46.6 million units for 2014 holds up, then 65 million units represents 40% growth over the next four to five years, or said another way, steady growth of about 8% per year. Again, we consider this good reason to be optimistic about our long-term future.

At the end of this quarter, revenue growth for North American fenestration sales was 9% for the trailing 12-month period. This compares favorably to Ducker's reported 5.5% trailing 12-month number and their current full-year forecasts of 6%. While we expect the growth rate to slow somewhat in the fourth quarter, we still anticipate being within our full-year guidance range of 8% to 9%.

Operationally, we continue to see improvements this quarter, which helped to offset the headwinds in our vinyl profile business. Unfortunately, this offset will not continue into the fourth quarter. As we have previously disclosed, we have taken an 11% increase in resin costs so far this year, and the resin suppliers are trying to push through another 2% to 4% increase this quarter. The impact of this, together with higher operating costs, will impact profitability through the fourth quarter and into the first quarter of next year. As a result, we are lowering are full-year EBITDA guidance to $53 million to $55 million.

Like many companies, we consciously under-invested in our vinyl facilities during the downturn. As a result of higher volumes this summer, we began to stretch the capability limits of some of our older extrusion lines. This resulted in higher repair and maintenance costs, higher scrap rates, and labor inefficiencies. This situation will likely continue into early FY15.

We have recently taken delivery of, and are currently installing, five new high output lines in three of our facilities. Once these five lines are fully operational by the end of this year, we will retire some of the older high maintenance lines. Eight other lines are also scheduled for replacement by year-end. In the meantime, we will continue to see higher than normal repair and maintenance costs.

During last quarter's earnings call, I committed to provide more clarity around our mid-cycle guidance and incremental margins. However, until we finalize contract negotiations with several key customers with respect to resin costs pass-throughs, we have decided to delay that guidance. I

f we are unsuccessful in renegotiating the resin pass-through provision back into our contracts, it could mean some significant changes in the footprint and capital allocation strategy in our vinyl business. We expect to have those contract negotiations wrapped up late this year and can provide more clarity on our mid-cycle guidance at that time.

Finally, I'd like to provide you with an update on our M&A strategy. We have now fully explored the fenestration bolt-on part of our acquisition strategy, and at this time have not been able to find any targets that meet our disciplined criteria. There are, however, a number of opportunities pending that could become actionable later next year.

While we continue to monitor these residual opportunities, we are now spending more time looking at adjacencies. But because this work is in its early stages, it is also unlikely that we will find anything actionable in the short term. As a result of this temporary hiatus in our acquisition strategy, coupled with our confidence in our long-term prospects, our Board just approved a $75 million share repurchase program, which is approximately 10% of our shares outstanding at our current stock price.

To be clear, this program does not prohibit us from pursuing our M&A strategy. We continue to have good cash flow generation, as well as available borrowing capacity to fund future acquisition opportunities. I'll now ask Brent to take you through our third-quarter results in more detail. Brent?

Thank you Bill, and good morning everyone on today's call. Consolidated third-quarter net sales increased 8.4% to $170 million while third-quarter EBITDA increased to $21.2 million compared to $17.7 million in the year ago quarter. The improved results were due to higher sales across all products, offset by margin pressure from higher resin pricing and approximately $1 million of higher repair and maintenance expenditures in our vinyl business compared to the third quarter of 2013.

The net income from continuing operations improved to $0.23 per share compared to $0.14 in the year-ago quarter. As Bill mentioned, Quanex' North American fenestration sales for the last 12 months increased 9%. Preliminary Ducker numbers have US window shipment increasing 5.5% for the 12 months ended June 30, driven primarily by new construction window shipments. Sales increases at Quanex were driven by overall growth across all divisions.

Corporate expenses were $5.6 million this quarter compared to $11 million in the year-ago quarter, primarily due to the lack of ERP-related costs and lower incentive related expenses. We ended the third quarter with a cash balance of $134 million and no outstanding borrowings on our revolving credit facility.

The share repurchase program Bill mentioned earlier will be completed through a combination of open market transactions and privately negotiated transactions, subject to market conditions and other requirements. The program is not bound by any time restrictions, and it replaces the prior program our Board approved in 2010. I'll now turn the call back to Bill.

Thanks, Brent. In closing let me reiterate, the current operational issues in the vinyl profile business are temporary, and if we are unable to renegotiate resin cost pass-throughs, we will adjust the size, footprint, and capital allocation strategy of this business accordingly. Either way, we are confident that we can maintain a steady growth trajectory and continue to improve the profitability of our core business as the recovery continues.

We have taken, and will continue to take, a patient, disciplined approach to our acquisition strategy, but remain confident that it will ultimately pay off later in 2015. In the meantime, we feel that using surplus cash for a share repurchase program at our current valuation is the prudent thing to do.

And with that, we'll now be happy to take your questions. Operator?

(Operator Instructions)

Nick Coppola, Thompson Research Group.

Good morning. I'm assuming when you're talking about it being unlikely to close an acquisition the remainder of the year, you're talking about those larger, more substantial acquisitions. Is there any update on your ability to close those deals on the extrusion assets from vertically-integrated OEMs, and any update around that strategy?

So, yes. The message is clear that right now, we do not have visibility on being able to close any transaction, probably in the next six months. Now having said that, I could get a call tomorrow from somebody we've already talked to and start over again, but right now we have no visibility. That includes some sizable transactions we have looked at. It includes bolt-ons. It includes some of the vertically integrated manufacturers. So it's sort of across the waterfront. We are not ruling out that some of these will get resurrected as we go through 2015. But I think the message is at this point, we don't have line-of-sight to anything actionable in the next probably two quarters; and therefore using the cash for a share buyback makes sense.

Okay, that's helpful. And then on your end-market expectations, your comments about going out to 2018 or 2019 even, to mid-cycle 8%-ish type growth. Certainly that's all helpful information there. Can you dig in a bit more and talk about what's informing that view?

Yes, I'm no smarter than anybody else on this call. My opinion isn't worth any more than anybody else's. Clearly the trends we have all seen so far in the housing industry would say that this is going to be a much slower recovery.

And I think it's just a multitude of different issues: credit policy, availability of labor for the homebuilders. I think it's house prices now starting to get to a level where it's freezing out first-time homebuyers. There's been a lot of talk about student loans.

So I think all of these issues combined are really just sending the signal that this is much more likely to be a long, slow, steady recovery than what was originally anticipated, I think, was a sharp snapback over the next two years.

Now, we continue to believe, we've said publicly for some time now, that quite frankly the best outcome is four or five years of slow, steady growth at 8%, 9%. That's much better than trying to manage growth of 20%, 25% a year. Some of that witnessed by the issues we've had in our vinyl business. As volumes increase, we start stretching the capability limits of our organization.

Okay. Thanks for the color, and thanks for taking my questions.

Daniel Moore, CJS Securities.

Good morning.

Bill, thank you for the candor. Maybe just elaborate -- if you're unsuccessful in contract renegotiations to push through pricing, how specifically might it impact your capital allocation strategy and your fenestration footprint? Just trying to get the order of magnitude degree in terms of potential change on the strategic outlook.

First of all, because this is a public call and there are other constituents that will listen to this, the fact of the matter is simply this. As we have said, over 60% of our current volume right now for this year, we're unable to pass resin price increases through. Nobody anticipated the magnitude of those resin increases a year ago when we entered into those contracts. We have made it very clear to the customers affected that we will be coming back, and we need to have this back in the contracts. We are not at the point yet where anybody has said no, but we're also not at the point where anybody has said yes.

I think we are just making it clear to the investment community that in the event that customers push back and say -- We will not accept that, then that our position is going to be that we can't do business that way with this kind of price level. And as we have talked to people in the industry, there does not appear to be any likelihood that pricing is going to come down.

And so our contingency plan is simply we will forgo volume and reduce the footprint accordingly. And by reducing the footprint, it will also mean we will not have to replace as many of these older extrusion lines as we currently are predicting in our plan, if in fact we get those clauses back into contracts as we expect.

Very helpful.

We are just saying, we have a contingency plan in the event that doesn't happen. It may mean our vinyl business is smaller, but it certainly will be back to its normal level of profitability.

Very helpful. Thanks for the color.

Can you elaborate perhaps, Brent, as well on the incidence of equipment failures, and maybe quantify possibly the impact on cost and margins in Q3 and how much lingering impact you might expect in Q4?

What we've said, because we had a little bit of this in the previous quarter, what we're experiencing is about $1 million a quarter in higher repair and maintenance costs. And then it gets a little fuzzier as to how much of the increase in labor is related to that. But I think it's safe to say that we probably got another $1 million plus to $2 million associated with higher labor costs related to this.

To sort of follow up on your question, Bill mentioned in his comments that expect this to really continue through the fourth quarter and into the first quarter of next year until we can get these new lines installed and up and running.

And that $1.5 million or $1 million to $2 million in labor is quarterly as well, correct?

That's correct, yes.

Got it, okay.

Lastly, CapEx, maybe update us on your expectations with the five new lines going in, and potential of adding up to eight more -- what we're looking for this year and if that will be a good run rate as we go into next year.

Yes. This year we're going to spend $30 million in capital approximately in this business in the early part of the year. That number was $40 million, some of which went to what nickel was before it was sold. Included in that $30 million, about half of that has gone to the vinyl profile business. And so we have the five high output machines being installed right now; but we also have eight others that have been ordered, paid for, and are in various stages of starting up as well. So that's already committed in this year's number.

My expectation, as we sit here today, if we're successful with the contract negotiations, we will have a very similar level of capital investment that goes into the 2015 operating plan. One of the reasons that we're going to wait before we give mid-cycle guidance is in the event it goes sideways on us, then volumes will end up being reduced; and we will not invest that level of capital in the vinyl business next year.

Got it. Thank you.

Scott Levine, Imperial Capital.

Good morning. So maybe following on, I think, an earlier question about Q4 cost impact versus Q3, and then take that into Q1. Sticking with the repair and maintenance costs, based on what you see now, would you see the level of cost impact in Q1 of 2015 being similar to what you are guiding to for Q4?

Should that be tapering off at all? And should we expect, based on your investment plans in the new lines, that the increased maintenance and repair costs, effectively the excess costs, would cease thereafter?

I think the best way to clarify that is, the most important part is, for Q4, clearly this will continue. You now have the latest guidance. So I think that part of it is clear.

We would like to think we could get this over with by the end of the fiscal year; it's probably unlikely. It will start tapering off as we go into the first quarter of next year. But we're not at the point yet where we can give sort of definitive clarity of what the magnitude of that number is.

Okay, fair enough.

And then with regard to the M&A landscape, can you comment in general about how things played out relative to your expectations? Is this just an issue where some of your expectations are too high, or maybe there weren't as many prospects out there as you thought? And a little bit more elaboration on, when you talk about adjacent markets being an area where you can increase focus, what you mean by that.

Yes. So first of all, we looked at a vast number of businesses. Some fell into the basket of too small, not very profitable, not too desirable after we had sort of looked under the hood. And therefore sort of voluntarily walked away, as this would not be a great fit with our business after all even though the product line itself may have been a good fit.

There are also some very attractive businesses that we looked at, that perhaps not surprisingly, we were significantly outbid by private equity. Obviously, we will not name names, but we were at the altar on a couple of occasions and loss on valuation.

There are some businesses where, even before we get to that stage, valuation expectations, as you say, are still quite high. I think that's going to taper off somewhat as we go into 2015, simply by virtue of the fact that I think the expectation for a slow recovery, as we've said, is going to start to settling into people's mindset.

So all of this applies equally to the vertical integration strategy. There are still a number of our customers that are giving consideration to that part of the strategy. They need more time. So again, I think that's the reason for delay in that.

We're starting to work more on adjacencies. And so some of the examples we have given in the past would be, perhaps, aluminum extrusion profiles for commercial windows. So similar to what we do, not too far out of our space, but adjacent.

And there are a number of other examples that we could use like that. Trim, fencing, decking, siding in the vinyl business is another adjacency. So because we've been heavily focused on our own space for the last six to nine months, we've done some work on adjacencies. But we're ramping that up now to make that a much higher priority.

But as a result of that, we feel the same way. It's going to take us a couple of quarters to really analyze the attractiveness of some of those adjacencies, then make contact with the relevant companies. And then we'll start the groundwork over again.

Got it. Thank you.

(Operator Instructions)

Al Kaschalk, Wedbush Securities.

Good morning. I won't beat this M&A to death, but one more is worth a shot. Could you just comment? Within the three buckets that you outlined that were product lines were good fit, attractive business, and valuation. Was the size of businesses necessarily in one of those categories more so than another? In other words, were the larger businesses just too expensive? Any snapshot color you could give on that would be great.

We did look at a number of larger businesses. And by larger I mean greater than $100 million in revenues. They weren't all too expensive to buy or more expensive in terms of valuation. Some of them came with other issues. And that's why I said in the comments we've been patient, and we are disciplined. I mean, we do have a disciplined approach to this.

So we're not going to go out and buy something for the sake of buying it. But not all companies are as advertised once you get under the hood. So it really is a multitude of reasons. And I don't think you should read anything into that other than we are disciplined, and sooner or later the right transaction or transactions will come along.

I think all we're doing is being transparent with the fact that that's where we are right now. And we feel, as of today, a share repurchase program is a better use of our funds based on what we see in front of us.

Do I expect to get some deals consummated in 2015? Absolutely. We've done enough groundwork in our own space, and we'll do the same thing in adjacent spaces, that I absolutely believe we'll get something done next year.

I appreciate the transparency. And just a comment, I think in terms of buying what you know best, that being your own stock at the valuation level, makes a lot of sense. Great to hear from the Board on that.

On the pricing environment in the current quarter, it looks like volumes was the main driver. I'll let you maybe add some color on that. But how would you characterize the current pricing environment, maybe from earlier this year and with the changes that have gone on in terms of the demand? Is it more of the same or is it less? How would you characterize pricing?

I think it's more of the same. We have successfully taken some price increases in some product lines with some customers. We've been very selective about that. That has been successful. It has not been a big enough number that's really going to move the needle.

Clearly, the vinyl profile business is the most competitive segment we're in. And we haven't seen any change there one way or the other, primarily because we are locked into contracts. And obviously, the focus has been on the cost of resin here and what's it's likely to do in the future.

I think the next time we talk, in December, we'll certainly have more to say because by then we will have concluded, or be close to concluding, contract negotiations with existing customers. And we'll find out how big a deal the price really is.

Then finally on the volume side though, your comment I think in prior quarter was that shipment to the end market would be greater than production volumes. It seems like that didn't hold, which is a good thing. But could you just comment there on your production opportunities versus the end-market demand?

Yes. It has been a strange summer. And I will tell you that the reason we are currently outperforming the market is because we just have certain customers that clearly are gaining share.

Also, we would say that in general, the R&R market has not recovered. Having said that, we do have some customers that are doing extremely well in the R&R market. And we are enjoying the benefits of that. But there is a very, very wide disparity in our customer base between who is growing and who is not.

So I think it would be fair to say that is the biggest single reason that we have thus far outperformed the market. Now, we do believe, for a number of reasons, volumes will slow down in the fourth quarter. Some of those customers are tapering off their production. I think a lot of customers are a little concerned about potentially an early winter and not getting stuck with too much inventory. So we are seeing some signs that the fourth quarter could perhaps be slower than the rate we've seen in the last two.

Very helpful, Bill. Thank you.

Keith Hughes, SunTrust.

Thank you. You should be able to fund the share repurchase, obviously, with the cash on the balance sheet.

Correct.

The question is after that. Is the Board management, if there's another share repurchase program or at that point an acquisition, are you willing at this point to add debt onto the balance sheet as part of, well, just an example, another share repurchase?

I think it would be very unlikely that our Board would approve a share repurchase program funded by debt. Now, never say never because I think that would depend on the circumstances at the time. If debt is still readily available and very cheap and our stock price was abnormally low, I think that would be a different set of circumstances.

At the current valuation, I don't think that's necessary. I don't think there's any doubt whatsoever the Board would be very willing to take on debt to fund an acquisition. And I think perhaps that's the most likely outcome as we go forward into 2015.

I'm sorry, you broke up. Most likely would use debt for an acquisition in the right situation is what you said?

Yes.

Okay, I just wanted to --

Yes, but unlikely to fund a second share repurchase.

I guess question number two. You talked about looking at acquisitions in adjacencies. And you mentioned a few; I know it was all hypothetical at this point. But from a synergy perspective, I assume you would be looking for something where you would have some type of vinyl or other plastic extrusion synergies. Would that be the lead-in to that?

Clearly, if you look at our current portfolio of products, that would be the most likely direction to go and explore first for exactly the reasons you state. There are definitely synergies there. If, for example, we use the hypothetical I used of aluminum extrusion for commercial windows, there would not be very many synergies there.

So yes, you're correct. That's where we'll start, and we'll just keep moving around that circle of adjacency and see where it leads. I think one of the conclusions there would be the further you get away from our direct core competence, the more likely it would be an acquisition of scale. Because you wouldn't sort of step into new territory with a small deal; you would do that with a larger transaction. If there were synergies, you could do it in a smaller transaction. So I think that would be the conclusion there.

Thank you.

Daniel Moore, CJS Securities.

Thank you.

Part of my follow-up was answered. It sounds like you'll have a better sense by December in terms of the pricing negotiations. Contractually, when is the earliest that you could raise prices? Is it January 1 or later if you are successful?

It's January 1.

Okay. Thank you.

Thank you.

And I'm showing no further questions in queue. I'd like to turn the call back over to Mr. Griffiths for any closing remarks.

I want to thank everyone for joining us on today's call. And just before we wrap up, I'd like to invite you all to join us for the 2014 GlassBuild Show in Las Vegas at the Las Vegas Convention Center. It's our single largest trade show of the year, and gives us a great opportunity to show off our products, meet with our customers, and see what's new in the marketplace.

If you're interested in attending the show, which runs from today through Thursday, please give Marty a call; and he'll provide you with the details. And once again, thanks for joining us, and we look forward to updating you on our fourth quarter in December of this year. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.