Quanex Building Products Corporation (NX) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Quanex Fiscal Second Quarter 2013 Conference Call. [Operator Instructions] During today's conference call, company management may make forward-looking statements about the future prospects of Quanex. Participants should refer to the company's 2012 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 to the most comparable GAAP figures 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 conference call over to Mr. Dave Petratis, Chairman, President and CEO of Quanex Building Products, for opening comments. Please go ahead, sir.

Good morning, and thank you for joining us for our second quarter conference call. On the call with me today is Brent Korb, our Chief Financial Officer; and Marty Ketelaar, our Vice President of Investor Relations and Corporate Communications. Today's call will include a brief recap of our second quarter results and general outlook for demand and guidance for the second half of 2013. Engineered Products ended the second quarter with net sales up 15% and EBITDA was up $7 million over the year-ago quarter. Sales increases were largely driven by the inclusion of Aluminite sales. However, we did see increased sales across all of the EPG product lines. Organic sales growth was hindered by several factors: a slow start to the quarter driven by cold weather and some late winter storms; a slowdown in the Canadian housing market that negatively impacts our IG business; and pricing concessions to our fastest-growing vinyl customers that took effect in January of this year. Those same pricing concessions, as well as high material costs, partially offset some of EPG's profitability improvement during the quarter. On a positive note, we are seeing the expected cost savings from our IG facility consolidation, with $2.3 million in benefits showing up in the quarter and $3.7 million year-to-date. We are confident we will achieve the projected $8 million in savings in fiscal year 2013. According to Ducker Worldwide, the marketing intelligence firm we use to benchmark EPG's performance against the industry, total estimated U.S. window shipments increased approximately 7.5% for the 12-month period ending March 2013, with nearly 28% growth in new construction, more than offsetting the 2% decline in the repair and remodel window market. A meaningful portion of the overall market growth during the last 12 months came from low-end aluminum windows going into multifamily housing, where our Engineered Products segment does not play. For Quanex, our North American fenestration sales for the last 12 months increased 9.1%, thus outperforming the industry. Turning to Nichols. I continue to be encouraged by the operational improvements being made. On-time delivery and customer satisfaction continue to improve, and we believe our casting facility is at peak readiness and we'll be able to handle the increased demand we expect to see in the coming months. Nichols' net sales were $110 million, an increase of 24% over second quarter of 2012 results. Nichols shipped 78 million pounds, 27% better than the 61 million pounds shipped in the year-ago quarter. We estimate the 2012 strike cost us approximately 12 million pounds of shipped aluminum, meaning our organic growth was 4 million pounds during the quarter. Market demand for aluminum sheet continues to be good, although it softened a bit during the same quarter, with demand for mill finished products growing, while demand for painted sheet has declined. Nichols' second quarter 2013 EBITDA was $1.3 million, compared to a loss of $5.5 million reported in the year-ago quarter, which included the impact of the strike. The change in product mix just mentioned, as well as lower spread, continues to challenge Nichols' profitability. After adjusting for the impact of the strike, spread declined in the second quarter to $0.42 per pound versus 43% (sic) [$0.43] a pound in the year ago quarter. Spread is negatively impacted by an increased global supply of aluminum, as well as tight regional scrap material prices. The Aluminum Association, which tracks industry shipments of sheet products, reports industry volumes for the 12 month ending April 2013, increased about 3%, while Nichols' shipments increased slightly more than 13%. In May, we completed the $9 million installation of the new paint oven in our Decatur, Alabama facility. The testing has been concluded and the oven is now back in service. We expect the new oven to increase our on-time delivery of painted product and further increase customer satisfaction. Let me now turn the call over to Brent who will take you through some additional financial highlights and cover our second half guidance.

Thank you, Dave, and thank you to everyone on today's call. Quanex reported a net loss of $0.20 per share in the second quarter, compared to a loss of $0.34 per share in the year-ago quarter. The reduced loss was due to the nonrecurrence of the 2012 Nichols strike impact, the 2012 ID facility consolidation cost, and savings realized in 2013 from the IG facility consolidation, partially offset by lower spread at Nichols and higher corporate cost associated with our ERP implementation. Consolidated EBITDA was $2.2 million, compared to a loss of $6.5 million in the year-ago quarter. At EPG, EBITDA nearly doubled to $14 million from $7.1 million in the year-ago quarter. At Nichols, EBITDA results improved to $1.3 million, compared to a loss of $5.5 million a year ago. Corporate expenses increased $6.1 million to $14.8 million this quarter, compared to $8.7 million in the year-ago quarter. The higher expenses were driven by higher ERP costs of $3.6 million, including $1.1 million of higher ERP-related depreciation and IT-related infrastructure costs of $1 million. The remaining $1.5 million of higher expense primarily relates to stock-based compensation expense and workers compensation expense. Accounting rules do not allow us to capitalize any of our ERP post-implementation activities that we experienced in March and April following our successful go-live. And as a result, the expense we recorded in the second quarter was significantly higher than the first quarter. We expect to see a decline in monthly ERP expenditures during the third and fourth quarters of 2013. We had previously provided guidance that corporate expenses would be $12 million per quarter for the remainder of 2013, including approximately $2.1 million of depreciation each quarter. No change is being made to this forecast for the second half of the year. At the end of the quarter, we had $10 million borrowed on our revolving credit facility. We expect to increase our cash position and have the borrowings paid back over the second half of the year, as we head into our strongest cash generation period of the year. Turning to our 2013 second half guidance, we expect EPG to continue to see good revenue growth as the window market gains momentum. Second half EPG sales are expected to be $315 million, an increase of 36% when compared to the first half of the year. EPG operating income is also expected to improve significantly, growing to about $35 million to $38 million for the second half of 2013, compared to $8.7 million during the first half of the year and $26.6 million in the second half of 2012. Included in the operating income guidance is the continued cost savings from the IG facility consolidation. Second half 2013 depreciation and amortization for EPG is expected to be $16 million. Turning to Nichols, low-LME prices continue to pressure our spread, making it difficult to significantly improve profitability. Second half aluminum shipments are expected to be 160 million pounds, an increase of 15% when compared to first half 2013 shipped pounds. Second half Nichols' operating income is expected to improve with a higher volume to about $3.5 million, compared to a loss of $500,000 in the first half of 2013. We do not see any catalyst that will significantly improve aluminum pricing in the second half. And as a result, we expect our spread to remain flat at around $0.41 per pound. Nichols' second half 2013 depreciation and amortization expense is expected to be about $3 million. Second half 2013 corporate expenses are expected to be approximately $24 million, including $4.8 million of depreciation and amortization. Included in this $24 million corporate expense figures is ERP-related cost of $1.5 and $4.3 million of ERP-related depreciation and amortization. I'll now turn the call back to Dave.

Thanks, Brent. Moving to our 2013 business outlook, I continue to characterize it as cautiously optimistic. There's clear signs of recovery in the U.S. new construction market, which is refreshing. The Case-Shiller Home Price Indexes have shown double-digit growth during the past 4 consecutive quarters, also very welcome news. We continue to see good growth in Europe for our warm edge spacers and the third IG line in our Hiensberg facility is installed to help us meet the growth in demand. The outlook remains cautious for the Canadian market, which has now experienced a downturn, and the U.S. repair and remodel portion of the window market remains sluggish. With our emphasis on energy-efficient products, Quanex is much more exposed to the repair and remodel market than the new construction market, and we are not seeing that market come back yet in the U.S. in any meaningful way. This is also consistent with the analysis of our building and product peers, where (sic) [with] results and with our discussions with customers. Even with the improved U.S. housing starts and our 2013 estimate of approximately 42 million U.S. window shipments, up from 40 million units in 2012, those numbers remain recessionary from a historical perspective. We also believe that Ducker's estimate of 2.6 million unit improvement in R&R shipments is aggressive. While we firmly believe the recovery in R&R will eventually recur, we need to see continued improvement in the macroeconomic factors, led by increased home values, rising consumer confidence in spending, and more availability to credit and declining unemployment rates. Due to the big-ticket nature of window replacement, we believe we'll be at the tailwind of this recovery and could lag the recovery in new construction by 12 to 24 months. Additionally, pricing discounts and some volume loss due to our customers' loss of business to a competitor is having some impact on our vinyl business. However, due to our productivity efforts, we believe we'll be able to offset this impact in 2013. Of course, further improvements in our end markets will increase demand and improve revenue growth and profitability. One month into our fiscal third quarter indicates that the impact of the cold weather is gone and we are seeing a welcome uptick in demand. We remain well-positioned to add to our market-leading positions through organic growth and acquisitions. We continue to have a strong balance sheet and a strong, talented team ready to serve our customers, and we remain very bullish on our long-term prospects. With that, we are ready to start taking your questions.

[Operator Instructions] Our first question comes from the line of Daniel Moore of CJS Securities.

This is the second call you've mentioned pricing pressure, wondering if that's intensified and maybe, can you talk about other specific segments within EPG over the fenestration markets that are more difficult or you're seeing now that intensify at all.

I'd say the heavy part of the pricing pressure was as we entered the first part of the year, as you go through annual negotiations, so January, February. If you look at the Ducker numbers, you see an impact in the growth of aluminum windows that had been on a decade-long slide. Aluminum windows in residential installation, I believe, in 2012, picked up by 20% and are again projected to grow in 2013. So for our vinyl customers and low-end products, that's where the market's hot and the pricing intensity is severe. I would also mention the competition going on in the big box. We had a major customer lose a product set to another customer at one of the weaker big boxes and it was purely price. So there's always pricing intensity in the construction markets. But because demand remains low, it's certainly a loss [ph] .

Got it. And as we look back, given the sluggishness in the R&R market has continued, as we look back, do you think more demand was pulled forward by the tax credit a couple of years ago than maybe previously we thought? And is that still a factor or are we largely cycled beyond that at this point?

I believe we cycled beyond it. That was, all in, 2 million to 4 million window units. I think those were efficient buyers that took advantage of the credit installed. I believe there's pent-up demand. But the Whirlpool report was interesting to me. They see the new construction items, I mean, they see installations of washers and dryers being driven by new constructions, that people are not replacing their white goods. That's a signal to me that windows is going to be a longer stretch, at least in the short term.

And then, lastly, given -- if the recovery is stretched out a little bit, are you seeing more interest in the acquisition pipeline from sellers that maybe can't hold on as long?

Our acquisition pipeline remains rich. We are really pleased with the Alumco, like there's more like that in the pipeline. And we'll continue to move in the direction we have been, but prudently.

Our next question comes from the line of Peter Lisnic of Robert W. Baird. Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division: I guess, Brent, if I can start off with on the second quarter and corporate expense, can you give us just the absolute number for ERP costs, both the DNA piece and then the non-DNA piece? You gave us the year-over-year increase, I think, at 3.6, if I'm right. I'm just wondering what the absolute number is.

Yes. I don't have it sitting right in front of me to give you the accurate breakdown. I'll have Marty touch base with you because I don't want to give the wrong number there. Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division: Okay. That's fine. And then back to EP. If I look at the second half forecast, the midpoint looks like it's about an 18% incremental margin. And relative to what your structural incremental margins would be, I'd guess that, that's a little bit lower or weaker. So is that pricing kind of carrying through the back half of the year here? Is that the -- is that sort of the weight? And then if it is, just how do we -- how should we think about that kind of flowing through 2014 as we look out a little bit further?

I believe that, that is -- that overall margin at 18%, is driven by a lack of recovery in R&R. Where we can sell spacing products, where we have a very good position and profitability, it really -- the equation works very good for us. So we need that replacement market to recover and grow, and we need the sale of high-performance products versus what we're seeing, is this lower end mix. Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division: Okay. So it's a mix issue at this point. And that would, I presume then, that the productivity initiatives that you're implementing or have implemented are basically falling to the bottom line already and you're getting the benefits of those, and we shouldn't expect to see any sort of step function change up in those productivity settings. Is that correct?

I believe you will not see a significant uptick beyond what we've guided unless we see a robust R&R replacement. And I'm very pleased with what we're seeing fall to the bottom line with the IG consolidation. If that mark -- if we sell more IG footage, it's going to be pretty dramatic in terms of the impact on the bottom line. The second is just the low-value products. When you're selling a vinyl window with a single pane, it carries fewer pounds, less weight, lower margin. If the mix turns and that replacement market will be favorable, otherwise it's going to run about where it's at.

Our next question comes from the line of Robert Kelly of Sidoti. Robert J. Kelly - Sidoti & Company, LLC: Question on the second quarter results in Engineered Products. Could you just help us with, maybe, the margin impact, positive, negative, from higher volume facility consolidation and what the price reductions compared to the year-ago period?

I mean, we haven't discussed, Rob, what the -- what those are. But I mean, basically, what we've attempted to do, and I think have been successful in doing, are the decrease from the pricing concessions, we've more than made up in the associated volume increase. In many of these cases, these are our fastest-growing customers, and as well as the productivity that Dave talked about, but we haven't separately broken that out. Robert J. Kelly - Sidoti & Company, LLC: Okay. As far as the second half growth outlook for EDP, what are the assumptions for sales from Aluminite?

We're expecting -- they've had nice growth. If you look at what they've done year-over-year, they've had very nice growth. I'd say, if we look forward to the second half of the year, yes, I think we could safely call it about $30.5 million of sales as to how their growth is going. Robert J. Kelly - Sidoti & Company, LLC: Okay. I mean, the implication seems that the organic growth rate year-over-year is accelerating a little bit. I'm just trying to figure out where that's coming from. Is it the new construction side or are you seeing a slightly better R&R market? I mean not a good market, but not negative in the second half?

I wouldn't say that we're seeing a slightly better R&R. I mean, we're -- it's just getting our share of the new construction. But the new construction, I remind you, is a lower mix product in general. Robert J. Kelly - Sidoti & Company, LLC: Am I right that the implication for the second half '13 year-over-year is a little bit better than what you saw organically in the first half?

I think that's fair, yes.

Our next question comes from the line of Barry Vogel of Barry Vogel & Associates.

Brent, I just want to -- I know you didn't have all those numbers at the tip of your fingers. But can you go back to this ERP cost situation and corporate expense situation? Because it gets a little confusing, and I know it's hard to explain.

Yes. I hear you.

If you could, and I don't know if you can do this, at the minimum, give us an idea what, in fiscal '13, the ERP costs are going to be and what the corporate expenses are going to be for fiscal '13? And your best guess for ERP costs in fiscal '14 and corporate expenses in fiscal '14?

Yes. So I don't have, clearly, all that. What I would tell you is, trying to make this clear for folks, the -- what I have off the top of my head in terms of the ERP cost in the second quarter was about $3.7 million of just non-depreciation related costs. And I think we had depreciation of about $1.5 million. Now that's -- I've got to confirm that with the accountants that I didn't just give incorrect numbers. And then, I think, we gave the guidance of what the second half was on those numbers, so...

But what was the number for the year? ERP?

For the year, what I'm lacking is the first quarter. I would say we're going to be in the range of about -- combining both current expense, as well as the depreciation and amortization, around $14 million, roughly.

Okay. And corporate -- if you use $24 million for the second, which you did make a statement about that, you have about $51 million for the year for corporate, including the first half. So do you have some idea of the fiscal '14 expenses for ERP and corporate?

For '15 -- for '14?

Yes.

Yes. We're not going to '14 yet.

You're not going -- you have no idea what the range would be?

We have idea, we're just not giving guidance for '14 yet.

The reason I'm questioning you there is because these are big numbers.

Yes. Agreed.

In that sense, it's disappointing that they've had such a deleterious effect on your profitability.

Yes, I mean, the objective here is we went live with our first 2 locations in the corporate office in March. It was successful. Now we ramped down the cost as we move forward quite a bit, and we're going next to our IG facility. And once we go live with that facility, then we can more greatly reduce those costs going forward. So I think by the end of the year here, we'll be able to give solid guidance for '14 and beyond as it relates to that, what that effort looks like, what the stream of expenses look like.

Okay.

I want to be helpful here as well. It's been heavy lifting. We went live, no disruption to our plan for our customers. We've got clear numbers out there for '13. And as we move into '14, our costs will be declining.

[Operator Instructions] Our next question comes from the line of Daniel Moore of CJS Securities.

Anything you're seeing in terms of input costs both on EPG, as well as Nichols, in terms of ethylene or others? And maybe just update us in terms of scrap pricing, have any movement in direction there?

I would say, I haven't been tracking ethylene, but CDI appears to be softening. Ti02 has taken a nice step down. When I to talk about driving productivity, we've worked in the face of some pressure with vinyl pricing. Our teams have worked pretty hard to capture productivity in the market and ride those trends. I feel good about that. Wood seems to be coming down. Aluminum scrap continues to be tight. And with overall LME prices coming down, I would say we've got scrap here, it's sitting on aluminum, not willing to bust those out. So that would be my view on it. Again, we've been very aggressive with the movement in low-end products to go out and find pockets of productivity in our purchase spend.

And any -- like just focusing on one -- additional market, in terms of commercial, do we expect that to be a needle mover over the next year or 2? Do you see any acceleration in opportunity or penetration there?

We've got some investments to try and grow that, but I don't see it as a huge catalyst. Our investments there are in developing warm edge spacing for the commercial IG market. It's on markets in its infancy actually does better in Europe. I continue to be very encouraged in a very ugly European market for our growth. And then vinyl applications in ribbon wall storefront and tilt/turn windows for commercial applications, which is undeveloped in this country. You go to Europe, commercial applications of vinyl PVC and IG is much more common and we think there's opportunities there.

[Operator Instructions] I have a question from the line of John Koller from Oppenheimer. John Jay Koller - Oppenheimer & Close, Inc.: It's Oppenheimer & Close. Quick question, I wanted to go over again, if I could, the maintenance CapEx figures for -- if they have changed materially since the last quarter?

No. Our CapEx has held relatively consistent and specifically, the maintenance as well. And I would say even the maintenance expense, which is predominantly at Nichols. John Jay Koller - Oppenheimer & Close, Inc.: Right. The paint oven, the $9 million expense -- that seems a little high or is my memory and my notes off?

I mean, over the last 6 to 9 months, that's what we would have been talking about.

And I'm showing no additional questions in queue.

So we'll go ahead and close.

As 2013 progresses, we will continue to drive efficiencies through the operational improvements at Nichols through our lean process initiatives and preventive maintenance approach. We are confident we will deliver the savings from last year's IG facility consolidation, as well as drive productivity improvements, improve customer service and grow our customer base across Quanex. All of this will benefit our shareholders in the long run and allow us to achieve our vision of profitable growth. That concludes today's call. Thank you for joining us and have a great day and a great weekend.

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