Quanex Building Products Corp (NX) 2015 Q3 法說會逐字稿

Good morning, everybody, and welcome to the Quanex FY15 third-quarter conference call.

(Operator Instructions)

During today's conference call, Company management may make forward-looking statements about future prospects of Quanex Building Products. Participants should refer to the company's form 10-K, filed with the SEC for more complete forward-looking statement disclosures. Additionally, the company may refer to non-GAAP figures throughout today's call. A reconciliation of EBITDA 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 and 10-Q documents at the company's website at, www.Quanex.com. Last, participants are reminded that today's conference call is being recorded. I will now turn the call over to Bill Griffiths, Chairman, President and CEO for opening comments. Bill?

Thanks, Marty. Good morning, and thank you for joining us for our 2015 fiscal third-quarter conference call. On the call with me this morning is Brent Korb, our Chief Financial Officer. And as you just heard, Marty Ketelaar our Vice President of Treasury and Investor Relations.

This has been a very busy summer at Quanex. The addition of a seasoned veteran to lead our vinyl profile business, two acquisitions, which when completed, will add $340 million of revenue. And $49 million of the EBITDA on a pro forma basis, and another solid quarter of EPS growth. Year-over-year quarterly margins improved 200 basis points on flat sales, and earnings per share improved more than 20% to $0.28 per share this quarter. We continue to see improvements in our vinyl profile business, and expect this to continue under the stewardship of Tim Reese who joined us recently from Trex.

While we saw negative year-over-year growth in this product line, it was not unexpected. All of our other fenestration product lines grew generally in line with window shipments. We continue to track to our internal expectations, and to our full-year EBITDA guidance. Which were now tightening to between $58 million and $60 million, including the transaction costs and purchase accounting FX related to HL Plastics. Revenues however, will come in at the lower end of the previous guidance, closer to $650 million. It does not include any impact from the acquisition of Woodcraft. After Brent covers the third quarter results in more detail, I will talk about the strategic rationale of our two acquisitions, and their positive impact on shareholder value. Brent?

Thank you Bill, and good morning to everyone on today's call. Reported third-quarter net sales increased 6% to $180 million, while reported third-quarter EBITDA decreased to $18.3 million. Revenue was impacted by a $14.2 million contribution from HL Plastics. Offset by $2.5 million in foreign currency translation, primarily due to the strength of the dollar against the euro.

As we previously disclosed, our third quarter reported results are complicated by several items. The HL Plastics acquisition, and the related purchasing accounting adjustments impacting their results. Transaction costs associated with both HL Plastics and Woodcraft, and the foreign currency translation impact from our European spacer operations. Included in our press release, is a reconciliation of our reported EBITDA, and earnings per share as adjusted figure, which excludes the impact of those items.

On an adjusted basis, third-quarter revenue was essentially flat for third quarter 2014 results. Revenue growth at our screen and accessory businesses was offset by the expected continued contraction in vinyl volumes and lower oil-based surcharge fees on one of our spacer products, due to lower oil prices. Third-quarter adjusted EBITDA was $22.3 million, compared to adjusted EBITDA of $21.3 million in the year-ago quarter. On and EPS basis, adjusted earnings from continuing operations was $9.6 million or $0.28 per share, compared to $8.7 million or $0.23 per diluted share.

Gross margins, adjusted for those same items, improved by 200 basis points to 25.1%, due to better labor utilization and lower repair and maintenance costs. Due primarily to the acquisition of HL Plastics, our cash balance was reduced to $27 million. And we had $84 million in outstanding borrowings on our revolving credit facility at the end of the quarter. We borrowed $92 million to fund the acquisition in the middle of June, and the first six weeks following the acquisition we paid down $8 million. And that balance has been further reduced in August, and now stands at $77 million. In our fourth quarter, we expect to recognize additional transaction costs associated with the acquisition of Woodcraft, and the related financing activities.

After we close the Woodcraft acquisition, we will have purchase accounting adjustments similar to those associated with HL Plastics. And we will provide additional details on those items when we report our fourth quarter numbers later in the year. In summary, third-quarter results were solid and in line with internal expectations and we look forward to finishing the year on a strong note.

I will now turn the call back to Bill.

Thanks Brent. Ever since we divested our Nichols business now five quarters ago, our strategy has been clear. It has been transparent, and it has not changed. Priorities have shifted from time to time as business conditions dictated, but after all, that is the purpose of a well-thought-out strategy. The ability to adjust as conditions change. Let me remind you of how we articulated that strategy.

From the outset, the overall objective of our strategy was to improve the profitability of the total business from its historic 8% percent EBITDA margins to something closer to 15%. Certainly, operating leverage as our markets recover, would help. But operating margin improvement would also be required to get there. We also clearly laid out how we would deploy capital, given that we had excess cash and no leverage.

These priorities were, number one, reinvest in our existing business. In the last two years, we have reinvested almost $70 million of capital directly back into our core business. Much of it has been targeted at our vinyl profile business, and most of it in an attempt to position ourselves for greater operating leverage when our markets fully recover.

Our second priority, was to acquire businesses that gave us scale in our existing space, or broadened our customer base, or broadened our geographic reach. Although prior to the divestiture of Nichols, the acquisition of Aluminite, our entry price point screen business fits into this category. This acquisition expanded our presence in the new construction segment, made us a clear number one in the outsource screen market, and help balance our new construction versus repair and remodel position, to more closely match the overall window market.

Similarly, the acquisition of Atriums' vinyl extrusion assets also clearly fit into this category. Although small, it allowed us to expand in the fastest growing new construction market in the country. As a result, we have more than doubled the capacity of this facility. Once again, further diversifying the product portfolio to more closely match the overall window market.

The recently announced acquisition of HL Plastics also fits this category. It expands our reach in a geography we understand, in a product line we understand, and with minimal integration risks. As it is a well run, standalone business, and with 18% EBITDA margins, enhances our overall profitability.

Our third priority was to acquire businesses in an adjacent space. Here, the hurdles were clearly higher. As by definition, an adjacency had to have scale, good standalone profitability, and minimal integration risk. The announced agreement to acquire Woodcraft Industries fits this strategy perfectly. It adds $240 million of revenues as a standalone business, and will likely be a separate segment. It has 13% EBITDA margins again, enhancing our overall profitability.

Throughout the recession, it maintain low double-digit margins despite a 50% drop in revenues. It has an experienced management team, with an average tenure of over 20 years. Who will continue to run the business as a standalone unit with no operational integration. It serves an industry that on averages 400 basis points more profitable than the window industry. Unlike the window industry, it has almost no seasonality, and has 75% exposure to the repair and remodel market.

Woodcraft's business model, as a short lead time supplier to the cabinet OEMs is identical to the Quanex model supplying window OEMs. The cabinet industry structure is identical to the window industry structure, with a relatively small number of OEMs, enjoying the bulk of the industry's total market share. This results in tight, long-standing customer relationships with the OEMs at both Woodcraft end Quanex. While the product line may be different, this is a business model we understand, and makes us the largest component supplier to OEMs in the building products industry.

In a moment, I will put into perspective what this has done in terms of transforming Quanex. Let me finish the strategy and capital deployment discussion however, by pointing out that we said last year, if we had excess cash and no immediate visibility of viable acquisitions, we would look at a share buy-back program. We executed on this as well, and completed a $75 million share buy-back program in February of this year.

My message is clear. We laid out a strategy over a year ago, and we have executed against every element of that strategy. We've made adjustments in priorities along the way, but we did not deviate from it. We continue to believe this strategy is sound, and see no reason to change it going forward.

While the immediate priority will be to pay down debt, we will continue to be active in the M&A markets, but focused on smaller tuck-in deals that will not materially increase our leverage profile. We will also continue to focus on operational excellence, to continue to improve our margins. What does all this mean for shareholders?

Assuming the midpoint of this year's guidance, and excluding transaction costs and purchased accounting FX, the addition of these two acquisitions will put Quanex on a pro forma basis at approximately $950 million in revenues and $108 million of EBITDA, or margins of 11.5%.

This compares to 2014 actuals of $595 million in revenue, and $48.6 million of EBITDA or 8.2% margins. Our mid-cycle guidance has increased to between $185 million and $210 million of EBITDA. A fourfold increase over last year's actual results. Yes we now have leverage, but at 3.2 times trailing 12 month pro forma EBITDA, it is at the midpoint of our building products' peer group and highly manageable given the cash generation profile of the business and its dampened seasonality.

While is too early to give firm guidance, our preliminary expectations for 2016, are that revenues will be close to $1 billion, and EBITDA would be in the range of $110 million to $120 million excluding any impact from transaction costs and purchase accounting adjustments associated with Woodcraft. We will of course update this on our year-end call in December, when we will have greater clarity on the magnitude of these costs.

With that, I'd be happy to take your questions. Operator?

(Operator Instructions)

Dan Moore.

You stole my thunder there a little bit Bill, in terms of spending a little bit more time on the Woodcraft acquisition. But maybe talk a little bit about, I know it will be run as a standalone, are there any -- what types of synergies, be it cost, or perhaps more relevant revenue synergies do you expect over time? And maybe describe the CapEx profile of that business and whether you'll need to do a little bit of incremental spending after having been owned by private equity for a long period of time?

In terms of synergies there are no synergies contemplated as part of the valuation our required to make this transaction work. We do have some wood-based businesses as part of our accessories operation. They are also in the Minnesota area, and we expect there may be some small purchasing synergies there. And then maybe the opportunity to manufacture some product in different facilities. But nothing major and nothing really contemplated in terms of operational integration of the two businesses. It will likely be a separate segment. In terms of capital, they clearly have been running at relatively low levels for the past several years, and our valuation model does include increased capital. They currently spend in the $4 million to $5 million a year range. And we could potentially double that number for the next two or three years, to something in the $8 million to $10 million range. Still early days yet, but we clearly, in conjunction with the management team, see opportunities for some additional automation that ought to improve productivity in their operations.

Very helpful, I appreciate it. Shifting gears a little bit, in terms of the vinyl extrusion lines that you had originally targeted for upgrade, how much -- what percentage how many of those have now been upgraded? How much additional work is left on that front?

That is just about complete. There is some trailing work that will go into the fourth quarter, but by the time we close out the year, all of that work will be finished and clearly some of the margin improvement we see today, and continue to expect going forward, is as a result of that. But we're not going to get granular and talk about how much specifically. The whole program is on track with our original expectations.

Obviously we saw that in the margins in this quarter, 24% gross margin is the best we have seen in some time. Obviously excluding Woodcraft, is that level sustainable, maybe just talk about seasonality, what puts and takes and the sustainability of that type of number on a go-forward basis.

We certainly believe it is sustainable going forward. In terms of seasonality, we pointed out that, Woodcraft will significantly impact our seasonality profile. As you know, we consume cash in the early part of our fiscal year, and then generate all of our cash and profitability in the second half. There is almost no seasonality at all with Woodcraft's business. So, it will really help in the first half of our fiscal year from this point on. Although clearly, as we enter 2016, we will see the impact initially of purchase accounting, and transaction costs. The magnitude of which we're still working on, and the timing of which is still a little unclear. And as soon as we have better knowledge there, we will go public with that information.

Lastly and I will jump back into queue, just talk about organic growth. The vinyl business as not as unexpected, when do you expect that to return to positive organic growth? And what type of near term 8, 12, 24 months type growth would you expect out of both HL and Woodcraft?

A bit of a convoluted answer to that question. Clearly, we anticipated and spoke earlier in the year about one specific program that we lost. So the negative growth in vinyl was to be expected. We have replaced some of that with incremental business from other customers and some new customers. It has not fully replaced that, and in terms of the vinyl business in totality, Tim is taking a very close look at how we want to position that business in the future. So it is not inconceivable that we may shrink even a little more in the vinyl business to improve profitability and to perhaps improved the utilization of our assets in different parts of the country. Early days to be talking about that, but more to follow as we get into the early part of next year. And certainly as we firm up our operating plans here. Generally speaking, the rest of the fenestration components business, was roughly in line with the window shipments. And as you know, we don't have a direct comparison with perfect timing. What I will say is, we were all surprised by a significant slowdown in growth across the board in May and June, which is the first two months of our quarter. It picked back up nicely in July. And August looks as though it is back on track. Clearly, the summer months had a slower growth profile in shipments than was originally expected at the beginning of the year. I don't think anything serious, but once again I think it speaks to a relatively slow recovery in both the remodel markets and even in new construction. That is one of the reasons that Woodcraft is attractive. It spreads the [bed] little bit, gives us much greater exposure to repair and remodel. That market still has a long runway to recover as well, and will not be as affected by whether as the window components market.

Good color, so Woodcraft and HL, anything numerically that you care to tie to expectations for growth or leave it at that?

Not yet, we will leave it at that.

Al Kaschalk.

An easy one here first for Brent, did you -- I think what I heard was the reported gross margins of 24.1% and adjusted for some items it was 25% or 25% and change. Could you give us -- I know one was inventory, there was a fuel surcharge I think. Could you just give us the components of that?

We had the FX, we had the oil surcharge, and the purchase accounting on HL backing out the -- really just the inventory portion of the HL purchase accounting.

Is that fully -- is the inventory there fully flushed through the P&L in terms of the margin?

No, no. The way that it generally works on those purchase accounting is, is it might take us about three months on average to wash through that. We would expect it to be fully behind us once we clear the fourth quarter here.

The largest chunk of the -- in terms of basis points there, percentage point, was the purchase accounting?

Yes, definitely.

Maybe it is a fundamental question on the base business, but are we, have we anniversaried the unfavorable raw material purchases or cost components to the procurement area? Given lower energy, feed stock prices, etc.

In fact the reality is, resin prices have really remained unchanged throughout this year. I think last month they came down a penny, but materially it hasn't changed at all this year. If it goes down further or up further, as a reminder from this point on, or from actually January 1 onwards, it is effectively margin neutral. So, no effect.

Just a question on, it is good to see the leverage from the acquisitions, [I think it could] be adequately serviced by the cash flow. But a question more on the structure of the cabinet market, or your supply into that market now with the acquisition. Are you concerned at all it will have the price pressures that you've seen in your core base business come into this market as well? Or has it been something that historically the margins that they have posted have been fairly firm or steady?

First of all Woodcraft's history has been very consistent in terms of its level of profitability, and did an excellent job at getting through the recession with still some pretty healthy margins. If you pull the public company details of the cabinet industry compared to the window industry, both short-term and over a ten-year horizon, the average profitability of those in the cabinet business is in fact 400 basis points higher than it is in the window industry. It is a more profitable segment all around and while I think every segment of building products see some level of price pressure, we have no cause for concern here that there is a pent-up price push back. We feel pretty good about it going forward here, that it really is a big net positive for Quanex going forward over the next several years.

My final question if I may, from the size now of the Company in the operational changes that you made, or that are being implemented from personnel perspective, should we look for -- does this change your ability to procure raw material? Or your raw materials sourcing any differently? Whether that be scale, whether it be multiple sources, therefore helping from your perspective and obviously a margin perspective.

Not really. I think the only opportunity still on the table that is still currently being explored is really resin, because clearly HL gave us greater scale. They obviously buy resin in a different market than we do in the US, but we are still exploring that. There will be a little on the wood side because Woodcraft obviously buys a significant amount of hardwood, we buy relatively small amount, but our expectation is that we could perhaps get some leverage there. Being a $1 billion business rather than a $600 million business won't materially change the dynamics of what we purchased in our ability to get better purchase.

Nick Coppola.

Can you talk a bit more about your go-forward acquisition strategy? It sounds like in the near term you are more interested in smaller deals which makes sense given the HL Plastics and Woodcraft acquisitions. Can you comment on how long it will take you to work down leverage, and once you have done that where you'd be most interested?

First of all, the priority clearly is to pay down debt. The capital structure has been set up to allow us to do that. So I want to be crystal clear with everybody, that is the priority. But also the M&A business, by definition is opportunistic. We didn't plan to do these two deals within six weeks of each other, it is the way it happened. We will -- it is unlikely, very unlikely I think that we would look at another deal of scale in the immediate future, which would move the leverage profile upwards. We have stated on a number of occasions that the comfort level is really bracketing around 2.5 times, and we would like to get down to that level. But we are also aware of some smaller transactions that now could slide into potentially our vinyl business, now that it is a little more under control. There are some tuck-in deals in the cabinet market that would potentially make some sense as well. I really wanted to point out, we're not going to get out of the M&A business until leverage is back down to the low or mid-[$2's]. We will continue to be opportunistic, but we will also continue to be very disciplined. And when we have said this on a number of occasions, I think we demonstrated that. And while we have landed two pretty decent-sized fish here in the boat, we have also thrown throughout this period, a number of them back into the water. Again, don't expect a significant increase in the leverage profile, but don't expect us to abandon the M&A market in its entirety either.

In the extrusion business in the US, have you made any progress in terms of price and any update on the competitive environment?

It is still a tough price environment in the vinyl business. So we have not made a lot of progress in terms of getting back some of the price we gave up over the past two to three years with the resin freeze. It does continue to be difficult, but as we have also said, we have got a fair amount of runway on an operational improvement. We're also working on tiered pricing, and have introduced that across the board now. So while our total price may not be moving, we're actually compensating for lower prices in high-volume lines, with significantly higher pricing on lower volume lines. Because as we have talked about, the complexity of our US operations is a major difference in its level of profitability compared to HL Plastics.

Scott Levine.

This is Brian Dennis filling in for Scott Levine. Most of my questions have been answered but a quick one regarding Woodcraft, how do you plan on financing this acquisition?

We will refinance the existing revolver with $100 million ABL revolver and a $310 million term loan B.

Bill Baldwin.

Congratulations Bill to you and your team on an execution of a very focused strategy since you've been at the helm there. Is there any best practices to be achieved between HL extrusion business and your domestic extrusion business with Mikron?

There is indeed and in fact, Roger Hartshorn, who leads the HL Business is just leaving our Kent facility as we speak, and will be heading to our Richmond, Kentucky facility. And he and Tim are in active discussions, sharing best practices as well as working on resin pricing and some other things as well. That program is already underway.

Secondly, can you offer any color or talk about how you might be making progress on your warm spacer business as far as broadening out the customer base to include some of the larger OEMs in that customer base?

As you are probably aware, one of the inhibitors to doing more business with the larger OEMs, is the ability to produce insulated glass panels as fast as the production lines that the high-volume produces. There is a line at a specific customer that is being debugged as we speak, and we have another large customer that is going to take delivery of a second line from a second manufacturer that will be on display at the glass build show in Atlanta next week. After there it's going to the customer's facility. We're in the early stages of proving that out at two very large customers, and the early indications are very positive.

Is there any comment you can make Bill, as far as what runway looks like on how long it might take to get this actually up and running in production if in fact you are successful in doing that?

Realistically, it will be the middle of next year before we start seeing any meaningful volume increases. And in both of these customers, it is really a two to three-year program to slowly ramp up for volumes assuming early success.

Ken Zener.

Couple questions for you. Woodcraft, since it is not in the window area, probably requiring its own segment, could you talk about how the deal -- how you got comfortable? I understand the OEM side and I looked at a lot of the old filings for this Company. So, I understand who its customers are. How did you get comfortable with this kind of entering that space? And how did the deal come to? I just want to get a sense of how it developed.

Probably I should say this isn't the first time we looked at Woodcraft. In fact, Brent was on the team obviously prior to my time back in 2007, when it was last sold to a private equity. And at that time, Quanex was a very serious bidder, but was outbid by the current owner, and some other private equity players at the time. It wasn't completely new to us. That was point one. That was one of the reasons we got a look at this business. The business model is eerily identical. So the similarities are really pretty astounding between the cabinet industry in the window industry. As I articulated in the prepared remarks, there are a lot of good things to like about this. And not a lot of bad things to walk away from. But once we met the management team, and the way we handle these transactions is we made it very clear to the bankers on the other side, we're not particularly interested in sitting in a meeting room going through a 50 page PowerPoint presentation. We want to get out into the operations. So, Brent and I toured 10 of their 13 operations throughout North America, in a relatively short period of time. And just looking at the manufacturing process, the order intake process, the way the business operates, it is so similar to ours that it didn't take very long for us to get comfortable with this at all. We feel very good that this is going to be another big platform for Quanex over the recovery cycle here. Diversify the product portfolio somewhat, spread the risk a little bit too. We feel this is a very positive addition, not too far out of our comfort zone, different product line but identical business model.

With this business, could you talk with the customer concentration component and how you got comfortable with that? It's obviously been a very steady operating history in terms of EBIT, but how it to comfortable with the customer concentration if you're willing to describe that?

It is a little more concentrated than the window industry, but not significantly more so. It has the same dynamics in that almost half of doors and components are vertically integrated inside customer operations. But just like windows, very difficult to switch. High costs to switch and such long, deep relationships, some that go back 20, 30, 40 years even. As that market continues to expand, and as I know you are aware, like the window industry a lot of capacity was taken out. So there has been a clear, steady trend of more and more outsourcing. And the expectation is, that will continue. Albeit at slow pace. But it is likely to continue as we go forward here.

Since you touched on FY16, appreciate that, you said $110 million to $120 million? Correct? For EBITDA?

That is correct excluding any purchase accounting, or transaction cost from Woodcraft.

If I take the [LTM] sells for both of those acquisitions, I get an EBIT contribution of almost $50 million. It seems that -- on a base let's say $60 million this year. It would seem to suggest roughly $6 million to $7 million increment EBITDA on your legacy business. Could you talk to that and that would seem perhaps relative to the passing in the vinyl business of the $20 million hit in FY14. Some portion of that was obviously the maintenance which would seem to be subsiding relative to the price. So is that a correct interpretation of your organic EBIT expansion based on that $110 million to $120 million?

Let me say this, typically we would never give guidance for 2016 this early. Secondly, there is absolutely categorically nothing in it for me personally, for us as an organization to be aggressive in what we think 2016 will look like. Only bad things will happen. With that as a backdrop, the rest of your comments are in line. Does that make sense?

It does. You're saying there's no reason for you to talk about much EBITDA expansion outside of the M&A is what I heard.

Yes, why would I at this point? You guys collectively will put pen to paper and you will come up with your own view. What I wanted to do was put a stake in the ground and say, at the end of 2014, this was a $48.5 million EBITDA business, and as we go into 2016, it's run rate ought to be in the $110 million to $120 million EBITDA range. As you tried to push me into saying it could even be better.

I just wanted to clarify the for the record. I'll talk to you soon. Thank you.

(Operator Instructions)

I'm showing no further questions from the phone line.

Thanks everyone for joining us on today's call and we look forward to talking to you again at the end of our fourth quarter, which we will report in early December. Thank you.

Ladies and gentlemen this concludes today's conference. Thank you for your participation and have a wonderful day.