Quanex Building Products Corporation (NX) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2020 Quanex Building Products Corporation earnings conference call.At this time all participants are in a listen-only mode. After the speakers’ presentation there will be a question and answer session. [Operator Instructions] As a reminder today’s conference is being recorded. [Operator Instructions]I would now like to introduce your host for this conference call, Mr. Scott Zuehlke, Senior Vice President, Chief Financial Officer and Treasurer. You may begin.

Thanks for joining the call this morning. On the call with me today is George Wilson, our President and Chief Executive Officer.This conference call will contain forward-looking statements and some discussion of non-GAAP measures. Forward-looking statements and guidance discussed on this call and in our earnings release are based on current expectations. Actual results or events may differ materially from such statements and guidance, and Quanex undertakes no obligation to update or revise any forward-looking statement to reflect new information or events. For more detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measures to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website.I'll now discuss the financial results. On a consolidated basis, revenue was essentially flat year-over-year in a quarter where we expected to see mid-to-high single-digit declines, driven by the continued shift in the cabinet industry to stock cabinets. The reality is, we reported net sales of $196.6 million during the first quarter of 2020 compared to $196.8 million during the first quarter of 2019.More specifically, revenue was down by $3.8 million in our North American Cabinet Components segment. But $3.4 million of that decrease was attributable to a single customer who decided to exit the cabinet business altogether. Spot orders were strong during the quarter, and we are seeing early signs that the market shift from semi-custom to stock cabinets may be stabilizing. In fact, the latest KCMA data market showed that semi-custom cabinet sales were only down by 0.7% year-over-year. This is the lowest rate of decline we have seen in over a year. Revenue losses in our North American Cabinet Components segment were offset by above-market growth in our European Fenestration segment and growth in the low-single digits in our North American Fenestration segment.We reported net income of $10,000 or $0.00 per diluted share for the three months ended January 31, 2020 compared to a net loss of $3.6 million or $0.11 per diluted share during the three months ended January 31, 2019. We are pleased to say that this is the first time since the company's 2018 spin-off from Quanex Corporation that we have reported net income in the first quarter of our fiscal year.On an adjusted basis, net income was $1.2 million or $0.04 per diluted share during the first quarter of 2020 compared to a net loss of $2.3 million or $0.07 per diluted share during the first quarter of 2019. The adjustments being made to EPS are for restructuring charges, certain executive severance charges, accelerated D&A, foreign currency transaction impacts, transaction and advisory fees, and adjustments related to the Tax Cuts and Jobs Act.On an adjusted basis, EBITDA increased by 30% to $15.7 million in the first quarter of 2020. The increase in adjusted earnings was driven by an ongoing concentrated focus on controlling costs, improved operating leverage, operational efficiency gains and lower medical expenses.Moving on to cash flow and the balance sheet. Due to the seasonality of our business, we are typically a net borrower in the first quarter of each year. Having said that, we borrowed 50% less cash in the first quarter of 2020 than we did in the first quarter of 2019. As a result, free cash flow improved significantly during the quarter, and we repurchased $4.6 million of our stock at an average price of $17.19 per share.Our balance sheet remains strong and we exited the quarter with a leverage ratio of 1.4 times net debt to last 12 months adjusted EBITDA, which is a full turn better than where we were a year ago.I'll now turn the call over to George for his prepared remarks.

Thanks Scott. We are off to a solid start in fiscal 2020 as first quarter results continued to reflect our ongoing focus on operational excellence and cash flow generation.I will now provide some additional comments on each of our operating segments, starting with our North American Fenestration segment, where revenues were 1.3% higher than prior year. On a more granular basis within this segment, revenues specific to fenestration in the US grew by 3.2% year-over-year, which compares favorably to Ducker's latest window shipment estimate of 2.5% growth for the three months ended December 31, 2019.On an adjusted basis, EBITDA in our North American Fenestration segment decreased by approximately 20 basis points versus prior year. Labor inefficiencies were the primary driver of the slight margin decrease, as we built inventory ahead of a significant capital project.Our European Fenestration business delivered another good quarter as a result of solid demand in the UK market that was partially offset by the timing of spacer sales to Asia. Excluding the foreign exchange impact, this segment generated above-market revenue growth of 3.7% versus prior year, which was better than we expected.Adjusted EBITDA margin for our European Fenestration segment was approximately 100 basis points better than prior year. Timing of price increases, stabilization of raw material costs and productivity initiatives, all contributed to these favorable results.Revenue in our North American Cabinet Components segment decreased by $3.8 million or 7.1% year-over-year. As we mentioned in our fourth quarter earnings call, we had a customer who made a strategic decision to exit the manufacturing of cabinets. We stated the impact to our revenue as a result of this change would be a reduction of $10 million to $15 million on an annual basis. In the first quarter, this accounted for $3.4 million of the $3.8 million shortfall. The remaining decrease was driven by the ongoing but slowing shift in the market demand from semi-custom to stock cabinets, which was offset somewhat by an increase in spot business.As Scott mentioned, sales in the semi-custom cabinet market declined 0.7% year-over-year during our fiscal first quarter, which was the slowest rate of decline in more than a year. There appear to be signs that the cabinet market is beginning to stabilize. We will continue to monitor the market closely, but we can certainly say that the volume of quoting activity for spot buys has increased significantly, which we believe is a result of the tariffs and supply chain disruptions caused by the coronavirus.Despite the decrease in revenue for the North American Cabinet Components segment, we realized an improvement in adjusted EBITDA margin of approximately 70 basis points. This margin expansion has been driven by lower material cost, continued operational improvements and our own efforts to reduce SG&A within this segment.Finally, when looking at unallocated corporate and other costs, we realized a year-over-year improvement of $2.8 million, which was primarily driven by lower medical cost, as we have experienced a significantly larger number of high-dollar claims in 2019 than we realized so far in 2020.Overall, we are very pleased with how our fiscal year started, and we are optimistic looking ahead into the spring selling season. It is too early to increase our annual guidance at this time, but there is potential to do so later in the year if the results continue to exceed our expectations. As such, at this time, we are confident in reaffirming our guidance of between $865 million and $885 million in revenue with adjusted EBITDA between $102 million and $110 million.Going forward, our plan is to continue to use our strong cash flow to invest in high-return internal capital projects, while maintaining a strong balance sheet and opportunistically repurchasing our stock. We firmly believe that this strategy puts us in a strong position regardless of what the economy may do.And with that operator, we are now ready to take questions.

[Operator Instructions] Our first question comes from Dan Moore with CJS Securities.

Good morning. This is actually Brendan on for Dan. So I wanted to ask one quick -- first of all, George, now you've been in the role for a couple of months. Could you update us on any strategic direction or focus changes or just a general update, even subtle changes relative to the direction that Bill had taken over the past year or two?

As we said in the fourth quarter earnings call, the fact that I was an internal successor to Bill, there was going to be no substantial changes in strategy going forward. I was a part of the strategy creation with the existing team, and we are very confident that the strategy that was in places is the right one going forward. And so, there are no strategic changes. We are extremely pleased with the transition. The team has responded well, and everyone is focused on doing exactly what we have laid out to do under Bill, and we continue to do for -- on a go-forward basis.

Okay. And then, following up on that, now with the leverage comfortably below 2, what are your top priorities, would you say, over the next few years with your strong cash flow? How do you look to allocate capital?

We're going to continue to focus on internal projects that generate high returns. We're going to continue to opportunistically buy back our shares. And we'll build cash to capitalize on projects as they come forward. So those are the three priorities: internal projects, share repurchasing and building cash flow.

Great. And then, a last one with the EU Fenestration, are you seeing any changes or tangible impacts from -- I know Brexit is on the back burner now, but any impacts from there or anything else? Or is it still status quo?

It's really still status quo. We've been very happy with the performance and the growth in our EU markets, and we see no changes and expect no changes.

Our next question comes from Reuben Garner with Benchmark Company.

Thanks. Good morning, everybody. So, maybe let's start with the Cabinet business. So, you mentioned you're seeing a stabilization in semi-custom. Can you elaborate more on what your kind of outlook is for that portion of the market the rest of this year? And then, in the same segment, your margin expansion -- your margin performance in the quarter was pretty impressive in this environment. What exactly drove that? And do you have more runway over the next few quarters?

So as it relates to Cabinet revenue and what we're seeing in the market, we believe that what we're seeing is a result -- and I stated in my comments -- a result of the tariffs and the disruptions in the supply chain as a result of the coronavirus. As it relates to the tariffs, those things have been ongoing and were present in the end of -- our end of last fiscal year. We believe those things will continue and that environment stays. And what we're seeing is, our customer base evaluating their supply chain and trying to minimize risk, which has been an opportunity for us. So I see no change in that on a go-forward basis. The short-term -- hopefully short-term disruptions, as it relates to coronavirus, I think what it is, again, doing is forcing our customers to look at the risk of having such a global supply chain and making sure that they have opportunities to source and backup plans elsewhere. We're going to capitalize on that.As it relates to your question on margin expansion, we see all of our projects proceeding as expected. And the guidance that we've given, we see no reason why we won't hit those numbers on an annual basis. So we're pleased at this time with the progress we're making.

Great. Thanks George. And then, your capex -- I don't know if you want to call them announcements -- but your capex descriptions last quarter and your planned investments, can you update us on those investments, what the benefits that you're seeing so far, if any? And I know that you're doing some work to grow your screens business at least into new geographies. Can you talk to us about what kind of growth opportunities you see for that part of the business outside of just the housing environment?

In terms of the capital projects that we have in place that we highlighted at the end of our last fiscal year, what I can say -- because we won't get into that level of detail, but what I can say at a high level is, all of our projects remain on time and as expected. So we're very pleased with the progress, and we believe that the benefits and the returns that we predicted as a result of those projects will come to fruition. So, everything is on time and as planned.In terms of screen expansion, again, on time and as planned. We expect, as we talked about, to expand into the Northeast market operationally. We expect the timing of that to be the end of our fiscal Q3. And everything is, again, on time and to plan. So we're pleased with the progress. We think that the market will continue to look at opportunities to outsource components as labor remains tight in almost every region. And we'll compare our footprint and our opportunities to the opportunities being presented with those outsourcing activities.

Great, thanks. Congrats on the quarter and good luck for rest of the year.

Thanks Reuben.

Our next question comes from Steven Ramsey with Thompson Research Group.

Good morning. I have a handful questions on German spacers. I guess, to start with, where are we at, again, on the new line or lines coming online? And if we're already -- if they're already in place, how fast you expect that to ramp up?

The equipment is in place. It's being launched, again, on plan and on target. Our continued efforts now to fill that capacity up with revenue is on steam and on progress. We don't give that level of detail as to the revenue per line or anything of that nature. But the revenue growth that we'll see and what's been -- the opportunity presented by that equipment is, again, as expected. And we're hitting all our targets that we forecasted in our numbers.

Excellent. And I guess, on the margin impact, just given EU margins are very strong and yet you're still investing heavily in German spacer growth, I guess, is this diluting margins to a significant degree? And just any commentary around the current margin impact and maybe once this investment kind of matures, how it impacts margins.

The spacer that we produce in Germany fits a very specific high-end market. So we see very good growth opportunities for the spacer market. And the fact that it serves a relatively specific niche and high-end types of projects, we don't expect nor anticipate any sort of degradation in margins.

But as it hits a more mature phase and sales staff has ramped up and products are delivered to customers, I guess, ultimately, it would be a positive for margins over time.

As we continue to grow that segment, it could have a favorable impact on our margins, and that's our plan.

Excellent. Thank you.

Thank you.

Our next question comes from Julio Romero with Sidoti & Company.

Hey, good morning, everyone. I wanted to ask about your cost control initiatives. You saw essentially no corporate costs in the quarter. Can you just talk about what you're doing there, what's driving that and if this quarter changes your full-year SG&A expectation at all?

As we've made the transition -- there's really two pieces in the corporate SG&A. As we've made the transition to a new leadership team and have reevaluated what we're doing and how we're going it, there are some synergies and some cost benefits to those changes. But the main driver this quarter has really been on the medical cost. And what drove that is, in 2019, we had a significant number of one-time large medical claims that we just haven't seen that level of significant activity this year. So there has been a pretty large benefit in medical cost quarter-over-quarter.

And then, Julio, as you know, it's almost impossible to be able to accurately forecast what those medical claims may or may not do going forward.

Got it. I wanted to switch over to the Cabinet segment. One thing you guys had talked about a couple of quarters ago was potential conversion of capabilities in the Cabinet business to potentially service some other price points within the market. Can you give us maybe an update on any progress there and any takeaways from whether a conversion of those capabilities maybe makes sense for Quanex?

We've launched a new process on a small scale to test out operational capabilities. But really, before we make a decision in terms of investing heavily in that segment going for a lower price point, we really feel that we're being prudent by allowing the market to settle and not making rash decisions in a volatile time. So we're preparing in both steps. We're operationally testing our capabilities and then we're preparing and monitoring the market to determine when we'll make that final decision on how much in what to invest.

Okay, that's fair. And I appreciate the color there. Just last one for me is on the North American Fenestration segment. You called out some labor efficiencies there -- inefficiencies. Was that concentrated in maybe a certain geographic area? And do you still see that segment is having the greatest opportunity for margin expansion in fiscal '20?

It was concentrated within one specific line, being driven by one very specific capital project. So it wasn't geographical. It was project-related.In terms of margin expansion, we still think, as we said, that the NAF segment will hit their operational performance that we forecasted on a go-forward basis. So we think it will recover and provide the expected margins that we anticipated at the beginning of the year and we've guided to.

Got it. Appreciate the color. Thanks very much and best of luck in fiscal '20.

Our next question comes from Ken Zener with KeyBanc.

Good morning, gentlemen. The cabinet bidding process as customers seek to shorten supply lines/risk, could you just give us a little more flavor for kind of how that is? Is that coming from builders? Is that coming -- where do you think -- obviously, the manufacturers. But where is your sense in terms of where it's coming from? Is it really the components that you've had already in place? Are they seeking actually expanded dialog? And what type of lead time do you feel that they are talking about?

So what we're seeing, obviously, the information is coming from our customer, which is the OEM. We feel like there has been no significant change, and there's actually demand on the builder side of the business.Our customer supply chain, which can be heavily weighted to overseas suppliers is just at risk. And so, we see a lot of opportunity, both from our existing customer base and some new ones, about trying to minimize that risk and looking at internalizing and bringing in their supply base to a domestic more convenient supply. As you know, Ken, and we've talked about openly, our route to market is very short lead times, enabling our customer to carry low inventories and have significant less risk in terms of carrying inventory. And that's what we do and that's what we're focused on and selling on.

Right. And within that short cycle turnaround then -- so we've seen obviously it's been a very volatile market, right, for stocks. But we've really seen some stocks get hammered because people think their supply chains are potentially shutting down coming out of China. So it seems as though your customers might be, with such short lead times, actually prone to be very, not just interested but perhaps panicky if their product is not available, right, on the two -- they're kind of just -- they can't do anything without coming to you. So have you seen really an increasing rate of concern from your customers in terms of these orders? It seems like their inventory could dry pretty quick if they weren't using you and now they're interested in using you. That's why I'm pursuing this line of questioning.

No, I understand the question. And again, I can't speak with certainty...

Are they getting more panic basically? If their inventories disappear because you can't come in, are they coming to you with an ever-increasing rate of interest/panic at all?

I don't have visibility into that, Ken. All I can say is that the rate at which we're seeing different opportunities on a spot basis have increased. So for me to make presumptions on why that is the case, I would be guessing.

Fair enough, George. Who thought Brexit would be such a high -- post-Brexit Europe would be such a high margin business. For the UK, can you talk about now that that's -- it's been done, is the business stable? How is the UK kind of working? Does it just continue to chug along and pricing was through to cover the deflation in the pound? How has all that worked? Has it been pretty steady in the UK?

The market itself has been very steady. What we see in the product that we serve in terms of vinyl profile and to the extent spacers, they go into obviously windows and residential homes. Majority of the market is R&R there because the infrastructure is old. There is a constant demand to replace old windows. As windows fail, they have to replace it. So it's a relatively stable market. And we've done a very good job, I think, capitalizing operationally on delivering and servicing our customers in a market that will continue to be very stable for those reasons. It's an under-built and under-served markets that we like being in.

And then, Ken, I can add a little to that on the top line side, which obviously we're converting well. We're selling more products to existing customers, but we've also been successful last year, which is paying dividend this year, in acquiring new customers, specifically in our vinyl profile business in the UK. So that's translating well for us.

Appreciate that, Scott. And then my last question. George, you mentioned that you're not revising up your guidance for the year. I think that's appropriate. But that commentary, is that predicated upon the first quarter being a positive net income number? And then -- for example, and specifically, where would you see that upside? Is your upside confidence probably in Cabinets, given margins and given potential demand trends? Or does it lie within Fenestration North America?

So, Ken, this is Scott. I'll take this one. So obviously, the first quarter being a good quarter gives us some optimism going into the spring selling season. Conversations with our customers adds to that optimism. We're sitting here in early March, and we can say that February gives us some optimism. And I think the upside, if there are, is upside to our guidance later in the year. First, it would probably translate to the top line as we're seeing some good spot business in Cabinets. And then on the bottom line, it will translate but not to the extent that we're seeing revenue growth above that of our original forecast.

And I'm not showing any further questions at this time. I'd like to turn the call back over to George.

Thank you, everyone, for joining. And we look forward to providing an update on our next earnings call in June.

Ladies and gentlemen, that concludes today’s presentation. You may now disconnect, and have a wonderful day.