Quanex Building Products' (NX) CEO Bill Griffiths on Q1 2018 Results - Earnings Call Transcript

Mar. 06, 2018 2:29 PM ETQuanex Building Products Corporation (NX)
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Quanex Building Products Corporation (NYSE:NX) Q1 2018 Earnings Conference Call March 6, 2018 11:00 AM ET

Executives

Scott Zuehlke - Vice President of Investor Relations and Treasurer

Bill Griffiths - President and Chief Financial Officer

Brent Korb - Chief Financial Officer

Analysts

Ken Zener - KeyBanc

Daniel Moore - CJS Securities

Steven Ramsey - Thompson Research Group

Julio Romero - Sidoti & Company

Jay McCanless - Wedbush

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2018 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the call over to Mr. Scott Zuehlke, Vice President of Investor Relations and Treasurer. Sir, you may begin.

Scott Zuehlke

Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President and Chief Executive Officer; Brent Korb, our Chief Financial Officer; and George Wilson, our Chief Operating Officer.

This conference call will contain forward-looking statements and some discussion of non-GAAP measures. For a 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 will now turn the call over to Brent to discuss the financial results.

Brent Korb

Thank you, Scott. I'll start with the income statement followed by comments on the balance sheet and cash flow. We generated net sales of $191.7 million during the first quarter of 2018, compared to $195.1 million for the first quarter of 2017.

We experienced solid underlying growth in our North American and European Engineered product segment that was offset by the portfolio rationalization and divestiture actions we completed in 2017.

As you are all aware, the Tax Cuts and Jobs Act was enacted on December 22, 2017. As such, we realized $6.5 million or $0.19 per diluted share net tax benefit during the first quarter of 2018. The Tax Cuts and Jobs Act reduces the federal corporate tax rate on US earnings to 21% and moves from global taxation regime to a modified territorial regime. The lower tax will be phased in over two years since we have in October 31 fiscal year end.

Including the net tax benefit realized in the first quarter of 2018, we estimate that our effective tax rate for fiscal 2018 will be approximately 9% or approximately 24%, excluding the net tax benefit. We will continue to evaluate the impact of the tax reform through the remainder of fiscal 2018.

We reported net income of $4.9 million or $0.14per diluted share for the three months ended January 31, 2018 compared to a net loss of $3.7 million or $0.11 per diluted share during the same period of 2017.

On an adjusted basis we had a net loss of $1.5 million or $0.04 per diluted share during the first quarter of 2018, compared to a net loss of $1.4 million or $0.04 per diluted share during the first quarter of 2017.

The adjustments being made for EPS are as follows; acquisition related transaction cost, purchase price inventory step up recognition, restructuring charges related to the previously announced closure of several manufacturing plants, accelerated depreciation and amortization for equipment and intangible assets related to these facility consolidations, foreign currency impacts primarily related to inter-company note with HL Plastics and the net tax benefit related to the Tax Cuts and Jobs Act.

On an adjusted basis, EBITDA increased to $13.2 million in the first quarter of 2018 compared to $13 million in the first quarter of last year. The increase in reported earnings was largely attributable to lower stock based compensation expense and the previously referring tax benefits related to the Tax Cuts and Jobs Act.

The lower stock based compensation expense was mostly the result of moving away from stock options in two restricted stock performance units for a portion of our long term incentive compensation.

Moving on to the balance sheet and cash flow; cash provided by operating activities was $8.2 million for the three months ended January 31, 2018 compared to $3.1 million for the three months ended January 31, 2017.

We generated free cash flow of $381,000 during the first quarter of 2018, versus a negative $5.1 million during the first quarter of 2017 and we were able to repay a little more than $4 million of bank debt during the quarter of the year that we have historically been a net borrower due to the typical seasonality of our business.

We now expect to generate approximately $50 million to $55 million of free cash flow for fiscal 2018 compared to our prior estimate of approximately $50 million. The increase is mainly a result of cash reform.

As of January 31, 2018, our leverage ratio is unchanged at 2.3 times. We remain focused on generating cash and deleveraging the balance sheet and our expectation to end fiscal 2018 with a leverage ratio below 2 times is not changed.

We do expect to take advantage of the recent changes in the tax laws and plan to repatriate approximately $3 million to $5 million in foreign cash during the second quarter, which will be used to further reduce our bank debt balance.

I'll now turn the call over to Bill.

Bill Griffiths

Thanks, Brent. First quarter revenues were right on top of our expectations led by another strong performance in our European Engineered Components segment, where year-over-year growth was 5.4% excluding eliminated products and after adjusting for FX.

Similarly the US Fenestration piece of our North American Engineered Components segment grew at 4.4% surpassing the latest Ducker Estimate for the calendar fourth quarter of 2017. This was especially strong as it included 5% contraction in our US vinyl profiles business due to some isolated customer operational issues and inventory adjustments.

Our Spacer, screens and accessories business grew at high single digit rise throughout the quarter. The kitchen cabinet manufacturers association indicated the growth rates for the semi-custom segment of the market for our fiscal quarter was a tepid 3.9% and flat for the stock segment.

Excluding eliminative products revenues in our North American cabinet component segment were flat year-over-year. Mainly due to a product mix shift to entry level lower price point and lower margin cabinets. This mix shift plus inflationary cost pressures impacted margins in this segment by approximately $3 million. On this amount 800,000 was related to mix and 1.5 million was labor benefits and material inflation not covered by contractual pass throughs.

For the, 700, 000 was a timing issue, related to a policy change on vacation accruals that will balance out as we move through the year. It's unfortunate that these inflationary headwinds, mass productivity improvements of close to $1 million as we begin to see traction on many of the initiatives on the way in this business.

We have completed a re-layout at one of the smaller plants, two other re-layouts are in process and we have just begun one in one of our larger plants. We still expect significant margin expansion in the second half of this year in this segment. Our longer term expectation of achieving 15% EBITDA margins in this business before corporate allocations is unchanged.

Now, fenestration businesses both in the US and in Europe also faced significant material cost pressure during the quarter, mostly in chemicals and mostly as a result of supply constraints of the hurricane Harvey. The inflationary cost not covered by contractual pass throughs amounted to $1 million in North America and $900,000 in Europe.

Silicon and TiO2 continue to be the biggest challenges, as both are in short supply and both are experiencing double digit price increases. Actions are already under way across all of our business units to offset these inflationary costs or realistically we will continue to play catch up in Q2 and then see the full benefits in the second half of the year.

Covering these costs combined with solid revenue growth across most of our businesses, plus underlying productivity improvements in our cabinet component segment, give us confidence in re-affirming our original guidance for the year of 890 million to 900 million in revenues and adjusted EBITDA of 103 million to 108 million.

Free cash flow in the quarter was positive, as Brent said earlier, allowing us to repay a small amount of bank debt at the time when we typically have to borrow. Full year free cash flow is now expected to be in the range of 50 million to 55 million, which will allow us to comfortably exit the year below 2 times leverage and perhaps even as early as Q3. There is no change to our stated strategy of improving operating margins, generating free cash flow and deleveraging.

Operator we are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Thank you, and our first question comes from the line of Ken Zener with KeyBanc. Your line is open.

Ken Zener

Good morning, gentlemen.

Bill Griffiths

Good morning Ken.

Ken Zener

We are - I guess my question is, there were some restatements that were kind of kind of seeing how this segment data comes through when you report, but in the North America Engineered realize you are not going to comment on your different businesses profitability, I recognize that. But, your spacer is obviously doing very well in terms of the growth rate that you just highlighted. And I suspect some of the recent announced consolidation merger, so Ply Gem, Atrium specifically. How does that, perhaps impact your - the extrusion business structurally, as you look at it? I mean, was there any change in your view because of that transaction? And then, if so, does that open up the possibility for further rationalization in that extrusion, which in fact I think relate to higher margin in your reported segment basis?

Bill Griffiths

So I think with respect to the Ply Gem, Atrium deal, both the customers, we don't sell extrusions to Ply Gem, we do sell extrusions to Atrium. At this point we've been told by both the organizations is, business as usual. At this point I'm not sure I would expect to see any changes as it relates to our supply to them. Of course after that deal actually gets consummated and they get their arms around it that could change, as we get into the latter part of the year, but at this point I would say, its business as usual. We don't expect to see any changes, neither good nor bad frankly with any of that products sold to those two companies.

Ken Zener

And then thank you very much for that comment. As it relates to European Engineered Component, so UK, it seems like that business is doing perhaps better than we would have thought given we have a real point to talk about down double digits volume in appliances there. Could you kind of go to what you're seeing there and visibility for the R&R side of that business. Thank you.

Bill Griffiths

Yeah, I think as we've said before, new construction which clearly is slowing down in the UK is not a big part of that business. It is mostly R&R and up until recent times, it has not been as price sensitive as other segments of the market. I think clearly in Europe, capital goods are slowly down, but if you got to replace the window, you got to replace the window. Now, having said that, because there have been significant increases in resin costs in Europe more so even in North America. And as we stated some of the other chemicals will go into that mix. We've passed on price increases, the rest of the industry has passed on price increases and we are getting to the point where we are not going to see sustained high growth rates. I don't think it's going to go negative, but I think we'll see growth rate slow down somewhat and it is going to be more difficult to pass some of these increases through, particularly into Europe where price points are so high.

Ken Zener

Okay, and if may I ask one more question gentlemen. If we were to look at your - kind of waiting for the - you're obviously giving EBITDA guidance for the total company. Is there any guidance you could kind of give us for the three different segments in terms of profitability, not by quarter, but just - when we look at the end of the year, your expectations in FY18 versus FY17, is cabinets up or down, engineered components - is there any color you can give us on that, that was my last question. Thank you.

Bill Griffiths

Yeah, I think generally speaking without being too specific, it will be a challenge to get margin expansion in Europe this year, but I would not expect to see significant contraction. In North American Engineered Components, again significant margin expansion could be a challenge, but I would expect them to be closer to flat. We do expect margin expansion in the cabinet component segment. It will be a challenge to get expansion in Q2, but definitely in Q3 and Q4.

Ken Zener

Thank you very much.

Operator

Thank you. And our next question comes from the line of Daniel Moore with CJS Securities. Your line is open.

Daniel Moore

Good morning, thanks for taking my questions.

Bill Griffiths

Good morning, Dan.

Daniel Moore

So, want to drill in a little bit on the cabinet business, and roughly half of, I guess the 3 million in mortgage margin degradation reflecting higher input costs, may be break that out that labor versus raw materials and you mentioned in Europe at least getting more difficult to pass through price increases, you're confident around - over the next few quarters being able to recover those.

Bill Griffiths

I think in Europe it's going to be tough because we've had a number of price increases in the past year in Europe. That's not being the case in North America, as we've said before it's definitely a challenge with our customer base here in North America that becomes somewhat easier when you're try to cover highly publicized inflationary costs. And that's what this is about; hence our confidence level is much higher. To the first part of the question, because of the way hardwood prices have increased, and because of the way some of our customer contracts are structured, we did find ourselves in a position this quarter where there were a few hundred thousand dollars of material costs that did not get pass through and it's kind of that inflection point issue and the color issue with some of our contracts. That price is stabilized and start to full, that will correct itself; if they continue to increase at a steady rate that may not correct itself without some further discussions with said customers. So, that was part of it, part of the increased is we transferred the Woodcraft employees to the Quanex benefit plan and the Quanex 401K Plan, which is something we had to do this year, knew it was coming. And that increased their labor costs by a material amount that we still expect to recover as we go through the year here. But, that was the bulk of it.

Daniel Moore

Got it, and then just in terms of corporate, you mentioned obviously the switch to RSU's away from options, what would be the full year impact in '18 and may be just guidance in terms of what corporate expense should look like for the full year?

Bill Griffiths

Yeah, I mean the full year impact of the RSU, the move from options to RSU's is kind of in a million and a half range. In terms of overall corporate momentum, [ph] inflationary increases offset by that benefit moving from the options to the performance restricted stock units.

Daniel Moore

Got it and lastly little housekeeping, but so for now should we be thinking about 24% in terms of tax rate on a go forward basis?

Bill Griffiths

That's safe assumption, yeah, that's how we tried to present it, just think of it as a 24% run rate.

Daniel Moore

Got it, thank you again.

Operator

Thank you. And our next question comes from the line of Kathyrn Thompson with Thompson Research Group. Your line is open.

Steven Ramsey

Good morning guys. This is Steven Ramsey on for Kathryn. On Woodcraft, you had previously mentioned more push into cross selling initiatives. Can you update us on how that is going and how we should think about that impact for 2018 guidance?

Bill Griffiths

Actually, that's not quite the case. It wasn't Woodcraft, that - the cross selling initiatives really relate to North American fenestration and frankly that's one of the reasons why the screen, spacer and accessories business is growing at a faster rate than market. As those cross selling initiatives start paying off, we are obviously utilizing our strong contacts, add some customers to get increased outsourced screen business which is the easiest product for a customer to outsource particularly in light of tight labor markets. It's easy for them to outsource that product line to someone like us, and then utilize that labor for other things. And then the spacer business, the cross selling initiative there was the development of the high speed lines which are going in steadily across the board, limited somewhat by the ability of equipment manufacturers to supply those lines.

Steven Ramsey

Excellent, thanks for clarifying that and that color. My second question relates to progress in replacing the loss in business. Over the last year, you guys said you were active and had a solid pipeline there, just wondering the progress in converting the pipeline to customers and if any of this is baked into 2018 guidance or if we should be thinking 2019 and beyond impact?

Bill Griffiths

This is nothing baked into 2018 and we continue to make progress, there is a very slow sell in cycle and because of the sensitivity of some of those discussions we are not going to comment specifically, but at this point there is nothing baked into '18 numbers.

Steven Ramsey

Great, thank you.

Operator

Thank you. And our next question comes from the line of Julio Romero with Sidoti & Company. Your line is open.

Julio Romero

Hey, good morning everyone.

Bill Griffiths

Good morning, Julio.

Julio Romero

So just wanted to touch further on the cabinet re-segment, first hoping to get some granularity on those said layout improvements, may be, you can talk about what you did specifically at the plant. You mentioned you completed the relay out in Q1?

Bill Griffiths

Yeah, there were four big projects on underway that effectively re-layout four separate facilities such that we can reduce the number of touch points. So the product literally will start up, run into the factory and flow with some resemblance of order through various machine cells and come out at the back end without a lot of material handling, a reduction in working process inventory and a much more efficient and balanced flow. That was completed in Q1 in one facility, we have two other small facilities where the work is still in progress and will be completed in Q2. And then our largest facility is really just starting and will take all of the second quarter and into the early part of Q3, before that is completed. And that's a pretty significant project in and of itself, we're seeing benefits already from––that's where a lot of the productivity gains came from even though it was disguised by inflationary costs. So and that's one of the biggest reasons we have a high degree of confidence in the second half of the year, picking up some significant margin improvement.

Julio Romero

I understood, and can you talk about - you've talked about how in Q1 is the idea of kind of do the relay out, due to the relative downtime resist the back half of the year. Can you just talk about how much of the work was accomplished relative to your expectation at the beginning of the quarter?

Bill Griffiths

Yeah, we were - we got everything done that we had planned to do, it's unfortunate that we couldn't kickoff the big project sooner, so that's actually going to run through a busy period for us, which is not ideal, but it was held up because we needed some new equipment for a separate facility, that needed to be installed before we could move some from one factory to another and then it was just a domino effect. So, the whole program got delayed for that reason, but we will manage through it in the quarter here.

Julio Romero

Got it and then lastly you mentioned the product mix shift, towards entry level cabinetry from some of your customers. Does that impact how you think about the permanent - the long term headroom you have on margins for the cabinet segment if the circular trend, towards more there will be star cabinets and use in the long run?

Bill Griffiths

Yeah, we do see that as a continuing market trend and we are evaluating margins and evaluating how lowest product lines are manufactured or balanced in the factory. At this point, we do not expect it to change our expectation of our 15% EBITDA margins in that business before corporate allocations. We do not expect that to change going forward.

Julio Romero

Understood and then just lastly, I wonder if you can touch on the decision to some of that repatriation and should we expect for the repatriation of cash going forward?

Brent Korb

No, I mean, really we have about $10 million of cash, not a huge number that's outside of the US. So our intent is to keep the safety net cash there, so we're not constantly moving back and forth and creating a lot of administration there. So we'll bring back what we feel is the safe amount during the second quarter. And then under the new tax act we can begin to take cash on a regular basis instead of cumulating and the good news is our tax strategy HL, our most recent acquisition, unwinds itself in 2018 naturally with its inter-company note, so the timing was good for us.

Julio Romero

Got it, appreciate it. Thank you for taking my questions.

Operator

Thank you and our next question comes from the line of Jay McCanless with Wedbush. Your line is open.

Jay McCanless

Hey, good morning everyone. Thanks for taking my questions.

Bill Griffiths

How are you Jay?

Jay McCanless

Good morning. The first question I had just thinking about the business rationalization last year and the comps as we go for this year. When should we fully lap that and when should especially North America, you think maybe the sales comps turn positive.

Bill Griffiths

We should see more direct comps in Q2 for sure in the second half of the year. There was still a fair amount of overlap in Q1 though.

Jay McCanless

And then the second question I had, just kind of building on what was asked earlier. If oil prices continue - oil and other inputs continue to move higher, are there some other business that you guys might be thinking about exiting or walking away from, just because you can't raise prices fast enough to make up for the material cost inflation?

Bill Griffiths

No, I don't think we see anything on the horizon that would cause us to walk away, but I do think because most of these inflationary costs are highly public. It will be easier to pass them through and in most cases many of our customers are buying the same stuff at elevated prices, right. So a vertically integrated window manufacturer that's extrude in their selling profiles, they're paying higher prices for TiO2, so a lot of this - that makes it somewhat easier to have the discussion, right. I mean, it's never easy to get a price increase, but a whole lot easier under those circumstances than if you're just in there on January 1saying, hey I need 5% increase.

Jay McCanless

Okay, great. Thanks again.

Operator

Thank you. And I'm showing no further questions at this time. I would now like to turn the call back to Mr. Bill Griffiths for closing remarks.

Bill Griffiths

Thanks everyone for joining us today, particularly as some of you I think are suffering from some inclement weather and we look forward to talking to you next quarter. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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