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Raymond A. Jean
Chairman, President and
Chief Executive Officer
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To Our Stockholders:
In many respects, results for fiscal 2006 were impressive:
Diluted EPS from continuing operations was $4.09, our second best year; diluted EPS was $4.08, the best ever!
- Return on invested capital was 19.4%.
- Stockholders’ equity increased 15% to $759 million; return on equity was 22.6%.
- We paid a 3-for-2 stock split in the form of a stock dividend and increased the cash dividend to $0.14 per quarter, or $0.56 per year, the 15th increase in 18 years; dividends have been paid for 75 consecutive quarters.
- In down markets, we grew annual revenue and surpassed $2 billion for the first time in our history.
- Cash provided by operating activities was a strong $190 million, and after investing $72 million in our businesses, the most in a single year, we generated $118 million of free cash flow. (See reconciliation on page 18.)
- We repurchased $58 million, or 4%, of our shares outstanding and ended the year with a strong balance sheet having a total debt less cash to capitalization ratio of 3%.
Our primary end-market drivers — light vehicle builds and housing starts — weakened significantly during the second half. For the
full fiscal year, light vehicle builds were off by 2% and housing starts were down 7%. Despite this deterioration, our business vitality was very much in evidence as we again outperformed the markets we serve. This ability to outperform demonstrates the value we deliver to our customers, and the power of the Quanex Game Plan (QGP). We are confident a deeper understanding of QGP will help you more fully understand the strength of our Company.
STRATEGY — How We Grow
Over the last several years, we have shared with you a new strategic framework for Quanex, one which redefined the Company for our stockholders, our customers, and perhaps most importantly, for ourselves. Our key constituents now appreciate that Quanex is not simply a steel or an aluminum company; we are a market-driven company focused on serving the vehicular products and building
products markets.
The QGP embraces a market-centric strategy adopted to focus on customers’ needs in order to accelerate profitable growth and help
us build a stronger business franchise over time. We consciously decided to take the necessary steps to be “an inch wide and a mile deep,” rather than being “a mile wide and an inch deep.” We believe our markets provide us with abundant opportunities to grow organically and through acquisitions.
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Organic Growth
A hidden asset of Quanex is found in the way we embed ourselves into the “DNA” of our customers to identify and seize opportunities to better serve them. We believe profitable growth is the result of more than good luck — it can be actively targeted and managed by positioning ourselves to bring on product and process innovation.
We work hand-in-hand with our customers, from the creation of a new product idea through the development of the optimal manufacturing process or chemistry for that component. We then deliver those products, many with value-added operations, on a just-in-time or
line-sequenced basis.
We also seek to add value to our customers’ processes far beyond just the products we sell them, and in so doing we become a more valuable business partner. It is this full orchestration of customer service that allows us to offer innovative, often proprietary, solutions that meet our customers’ toughest applications.
Our door and window business units have developed strong relationships with the best brands in the fenestration industry. We have an impressive history of making growth happen, and we have the focus and drive to continue to do so through product and service differentiation.
We have numerous opportunities to continue to grow MACSTEEL. While the “Big Three” have lost market share to the automotive transplants over the years, we continue to increase our content per vehicle. With the transplants, we continue to increase our market penetration as they source more of their powertrain component
needs locally. The transplants currently source half of their driveline requirements in North America, and only about one-fourth of their transmission needs. It is this domestic sourcing of components that provides us the opportunity for real growth. Increasing our value-added services is another opportunity, and in September we completed a $40 million project at our Monroe plant that expanded value-added process capabilities by some 50,000 tons to meet our customers’ growing needs.
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Acquisitions
In December 2006, we announced the pending acquisition of Atmosphere Annealing (AAI) to offer additional value-added services to our customers. There is considerable overlap between MACSTEEL and AAI customers and, like MACSTEEL, AAI’s sales approach is differentiated through the application of metallurgical solutions. We believe we are acquiring a firm with strong growth prospects and very capable management.
Acquisitions will continue to be very much a part of our growth strategy. We are continually evaluating business development opportunities to grow our core businesses or to build upon our competencies to extend our reach within Building Products. For a disciplined acquirer with high return expectations, the rich valuation environment we experienced during 2006 proved difficult, but we believe we will find more sensibly priced acquisitions to redeploy
our strong cash flow.
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Operational Excellence - How We Execute
Continuous improvement — of products, processes, and employee skills — is the most important factor underlying Quanex’s growth expectations for 2007 and beyond. Some maintain that both productivity and growth are incompatible. We maintain they are
interdependent. As we grow, we become more productive, and as we become more productive, we grow!
“Lean thinking” is the cornerstone for continuous improvement throughout Quanex. It is the mindset we have for executing all forms of process improvements on the shop floor, in product engineering and within the office environment. It is done through the application of lean tools such as Six Sigma methodology, Kaizen events and demand flow techniques. As proxies for improvement over the last five years, sales per employee increased by 35% and our conversion cycle has been reduced by eight days.
As proud as we are of our current successes, we fully recognize that “what was is not what needs to be.” In today’s increasingly competitive environment, your leadership team knows full well we will not thrive and grow through linear process improvements alone — we must also achieve breakthrough improvements by reconfiguring or radically improving our existing processes or products.
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Project Breakthrough - How We Lead
As an extension of the Quanex Game Plan, and to reach for bold innovation in process and product development, Project Breakthrough was launched 18 months ago and is building momentum. The initiative recognizes that a disciplined approach to continuous improvement is critical to leveraging our resources and places a premium on
developing people. Project Breakthrough acknowledges that in business, people are the ultimate differentiator!
The initiative began with a Developmental Assessment Process of the top 60 leaders in the Company, and is now focused on
sharpening leadership skills and deploying training throughout the Company to develop more “lean” practitioners. Also, education
on Personal Accountability and Change Management is directed at creating a healthy dissatisfaction for the status quo, an environment of candor and constructive conflict, and a culture of speed, decisiveness and teamwork. The elements of this major change initiative are highlighted in this report.
OUR PEOPLE
This annual report features our employees, and for good reason. It is our people who develop the strategies, create new products, increase productivity, and ensure that we operate safely and ethically. They are the key to Quanex’s success!
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Governance
This is our second financial report covered by section 404 of the Sarbanes-Oxley Act of 2002 (SOX). The first report was costly to complete on schedule, but we have since applied lean control disciplines to our financial process. Compliance and testing this year was far less expensive and the excellent results are testimony to the quality of our financial team!
From a leadership standpoint, a number of changes have occurred. Tom Walker joined the Company in June 2006 as Chief Financial Officer. Tom came to Quanex with a wealth of financial management and M&A transaction experience. Regrettably, Michael Bayles retired in January 2007 due to personal health reasons. Michael contributed immensely to Quanex with his strategic guidance and passion for operational excellence.
Russell Flaum recently left our Board of Directors and Vince Scorsone will retire at the 2007 Annual Stockholder Meeting. Each has been a valued resource throughout their tenures, and on behalf of the Board and the Company, I thank them for their service.
Joe Rupp, Chairman, President and CEO of Olin Corporation, a manufacturer of metals and chemicals, joined our Board in January 2007. Joe brings with him over 30 years of experience
in industrial markets and we look forward to his insights in our Board deliberations.
Outlook
Although we enter 2007 with considerable headwinds in our primary markets, we do expect some recovery as the year progresses. Over the long term, we believe the vehicular and building products markets have bright and vibrant futures. They are, after all, the pillars
of the U.S. economy!
With great core businesses and a strong balance sheet, this is an opportunity for us to again demonstrate we can outperform the
markets we serve. We will redouble our efforts on cash flow generation, assume a conservative posture on costs and continue our commitment to Project Breakthrough. These efforts will allow
us to emerge from this market correction stronger than ever.
I deeply appreciate the hard work and dedication of our employees, and the guidance, encouragement and support of our Board of Directors.
Raymond A. Jean
Chairman, President and Chief Executive
Officer
* Click here
for Non-GAAP reconciliation.
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