NX - Q3 2014 Earnings Call

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NX - Q3 2014 Quanex Building Products Corp Earnings Call
EVENT DATE/TIME: SEPTEMBER 09, 2014 / 3:00PM GMT
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C O R P O R A T E P A R T I C I P A N T S
Bill Griffiths Quanex Building Products Corporation - Chairman, President & CEO
Brent Korb Quanex Building Products Corporation - CFO
P R E S E N T A T I O N
Operator
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.
Bill Griffiths - Quanex Building Products Corporation - Chairman, President & CEO
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
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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. If
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?
Brent Korb - Quanex Building Products Corporation - CFO
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.
Bill Griffiths - Quanex Building Products Corporation - Chairman, President & CEO
Thanks, Brent. In closing let me reiterate, the current operational issues in the vinyl (inaudible) business profile 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?
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Q U E S T I O N S A N D A N S W E R S
Operator
(Operator Instructions)
, Thompson Research Group .
NEW SPEAKER
Good morning. I'm assuming 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 that strategy?
NEW SPEAKER
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 add start over again the right now, we have no visibility. That
includes some sizable transactions we have looked out. It includes both on , it includes some 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 and indexed probably 22 quarters and therefore using the cash for a share buyback makes sense
.
NEW SPEAKER
Okay that's helpful and on year end market expectations your comments about going out to 2018 or 2019 even to midcycle growth certainly that's
all helpful information there. Can you dig in a bit more and talk about what's informing that view?
NEW SPEAKER
Yes , look, I'm no smarter than anybody else on this call my opinion isn't worth it anymore than anybody else's. Clearly the trends we have all seen
so far in the housing industry would say 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 , 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. We continue to believe we 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 witness five issues we've had in our vinyl business as volumes increased we start stretching
the capability limits of our organization.
NEW SPEAKER
Okay, thanks for the color and thanks for taking my questions.
NEW SPEAKER
Daniel Moore, CGS Securities.
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NEW SPEAKER
Good morning. and Bill, thank you for the candor. Maybe just elaborate if you're unsuccessful in contract renegotiations to pursue pricing how
specifically might it impact your capital allocation strategy and your fenestration for print just trying to get order of members to degree in terms
of potential change on the strategic outlet?
NEW SPEAKER
So, look, first of all because this is a public call and there are other constituents that's will listen to this, the fact of the matter is simply the us. That
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's
we will be coming back and we need to have this back in the contract. We are not at the point yet where anybody has said no 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's customers pushed back
and say we will not accept that, 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 it 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.
NEW SPEAKER
Very helpful.
NEW SPEAKER
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 .
NEW SPEAKER
Very helpful thanks for the color. Can you elaborate perhaps print as well on the incidence of equipment failures and maybe quantify possible the
impact and cost in margins in Q3 and how much lingering impact you might expect in Q4?
NEW SPEAKER
I guess what we said we had a little bit of this in the previous quarter I mean what we're experienced is about $1 million a quarter in higher repair
and maintenance costs and then he gets a little fuzzier as to how much of this increase in labor is related to that but I think it's safe to say 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 expected this to really continue into the first quarter through the fourth quarter and into the first quarter of next
year until we can get these new lines installed and up and running.
NEW SPEAKER
And that $1.5 million to $2 million labor is quarterly as well? Correct?
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NEW SPEAKER
That's correct.
NEW SPEAKER
Got it and lastly CapEx in your expectations within the five new lines going in and potential of adding up to eight more what were looking for for
this year and if that will be a good run rate as we go into next year?
NEW SPEAKER
Yes so 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 some
of which went to Nichols before was sold included in that 30 about half of that has gone to the final 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, pay 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 midcycle 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
and the vinyl business next year.
NEW SPEAKER
Got it. Thank you.
NEW SPEAKER
Scott Levine, Imperial capital.
NEW SPEAKER
Good morning guys. So maybe following on that last or I think an earlier question about Q4 cost impact versus Q3 and take the into Q1 sticking
with the repair and maintenance costs based on what you see now which is the the level of cost impact in Q1 of 2015 been similar to what you are
guiding to for Q4 so that the tapering off at all and should we expect , based on your investment plans in the new lines, that's the increased
maintenance repair costs would effectively be access costs would cease thereafter?
NEW SPEAKER
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.
NEW SPEAKER
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 an issue where some of your expectations are too higher their word as many prospects out there as you thought and little bit
more elaboration on when you talk about adjacent markets been an area we you can increase focus what you mean by that?
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NEW SPEAKER
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 looked at that perhaps not
surprisingly we were significantly outbid by private equity . Obviously we will not name names but we were out the altar on a couple of occasions
a loss on valuation . There are some businesses were 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 settle into peoples mind that . 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 that's the reason for delay in that. We're starting
to work more on adjacencies and so there are 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 . Quanex, fencing , decking, citing in the vinyl business is another adjacency. So we're -- because we've been heavily focused on our
own space for the last six to nine months we've done some work on adjacencies that we're ramping that up now to make that a much higher
priority . But as a result of bounce, 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.
NEW SPEAKER
Got it. Thank you.
NEW SPEAKER
(Operator Instructions) Al Kaschalk, Wedbush securities .
NEW SPEAKER
Good morning. Just won't be this M&A to death the one more is worth a shot. Could you just comment within the three buckets that you outlined
that's 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 can give on that would be great ?
NEW SPEAKER
We did look at a lot -- 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 think patients 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 out 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 been
transparent with the fact that that's where we are right now and we feel as of today 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 do not groundwork in our own space and
we'll do the same thing in adjacent spaces that I absolutely believe will get something done next year.
NEW SPEAKER
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. , pricing environment in the current quarter it looks like volumes was the main driver
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I'll let you maybe add some color on that how would you characterize the current pricing environment maybe from earlier this year and with the
changes that are going on in terms of demand? Is it more of the same or is it lasts? How would you characterize pricing?
NEW SPEAKER
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. There's not been a big enough number that's really gone and move the needle. Clearly the final 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 is 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.
NEW SPEAKER
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 may have been that didn't hold which is a good thing but could you just comment there on your production opportunities
versus the end market demand ?
NEW SPEAKER
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. We 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 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 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 and 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.
NEW SPEAKER
Very helpful , Bill. Thank you.
NEW SPEAKER
-- SunTrust.
NEW SPEAKER
Thank you. You should be able to fund the share repurchase officer with the cash on the balance sheet .
NEW SPEAKER
Correct.
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NEW SPEAKER
The question is after that. Is the board Management -- there's another share repurchase program or at that point are you willing at this point to
add debt on to the balance sheet or example another share repurchase?
NEW SPEAKER
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 in our stock price was abnormally low I think
that would be a different set of circumstances. Out 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 acquisition. and I think perhaps that's the most likely outcome as we go forward into 2015.
NEW SPEAKER
I'm sorry, you broke up? Most likely would use different acquisition for the right situation?
NEW SPEAKER
Yes.
NEW SPEAKER
Which is .
NEW SPEAKER
Yes. But unlikely to fund a second share repurchase.
NEW SPEAKER
I guess question number two, you talked about looking at acquisitions in adjacencies and you mentioned a few hypothetical at this point. But from
a synergy perspective, I assume you would be looking for something where you'd have some type of vile or other plastic extrusion seven synergies
with that late in two or not?
NEW SPEAKER
Clearly be 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 leaves. 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 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.
NEW SPEAKER
Thank you.
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NEW SPEAKER
Daniel Moore, CGS Securities.
NEW SPEAKER
Thank you. Part of my follow-up was answered it sounds like you'll have a better cents by December in terms of the pricing negotiations . Contractually
what is the earliest that you could raise prices? Is it January 1 or later if you are successful?
NEW SPEAKER
It's January 1.
NEW SPEAKER
Okay. Thank you.
NEW SPEAKER
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.
NEW SPEAKER
I want to thank everyone for joining us on today's call and just before we wrap up, I'd like you to invite you all to join us for the 2014 show in Las
Vegas at the Las Vegas convention Center. It's our single largest tradeshow of the year and gives us a great opportunity to show off our product ,
the 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.
NEW SPEAKER
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. [End of transcript]
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