Quanex Building Products Corporation (NX) CEO George Wilson on Q2 2020 Results - Earnings Call Transcript

Quanex Building Products Corporation (NYSE:NX) Q2 2020 Earnings Conference Call June 5, 2020 11:00 AM ET

Company Participants

Scott Zuehlke - Vice President, Chief Financial Officer and Treasurer

George Wilson - President and CEO

Conference Call Participants

Daniel Moore - CJS Securities

Julio Romero - Sidoti

Steven Ramsey - Thompson Research Group

Reuben Garner - Benchmark Company

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Second Quarter 2020 Quanex Building Products Corporation earnings conference call. At this time, all participants lines are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session [Operator Instructions]. Please be advised that today’s conference maybe recorded [Operator Instructions].

I would now like to hand to conference over to today Mr. Scott Zuehlke, Vice President, Chief Financial Officer and Treasurer. Please go ahead, sir.

Scott Zuehlke

Thanks for joining the call this morning. On the call with me today is George Wilson, our President and CEO. 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 statements 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 Web site.

I'll now discuss the financial results. We generated revenue of $187.5 million during the second quarter of 2020 compared to $218.2 million during the second quarter of 2019. The decrease was primarily attributable to softer demand in April related to the COVID-19 pandemic. Volume began to decline in late March, which is also when our two manufacturing facilities in the UK were shut down completely to comply with government orders. We've reported net income of $5.5 million or $0.17 per diluted share for the three months ended April 30, 2020 compared to a net loss of $24 million or $0.73 per diluted share during the three months ended April 30, 2019. The net loss in the second quarter of 2019 was mainly due to $30 million non-cash goodwill impairment in our North American cabinet component segment.

On an adjusted basis, net income was $6.4 million or $0.19 per diluted share during the second quarter of 2020 compared to $6.3 million or $0.19 per share during the second quarter of 2019. The adjustments being made to EPS are for restructuring charges, impairment charges, certain executive severance charges, accelerated D&A, foreign currency transaction impact and transaction and advisory fees. Adjusted earnings were essentially flat with lower SG&A offsetting volume declines related to the pandemic. On an adjusted basis, EBITDA for the quarter was $21.8 million compared to $23.4 million during the same period of last year.

Moving on to cash flow and the balance sheet. Cash provided by operating activities was $2.5 million for the six months ended April 30, 2020 compared to $143,000 for the six months ended April 30, 2019. Year-to-date as of April 30, free cash flow was slightly lower than last year mainly due to the negative impact the pandemic had on working capital during the second quarter, as it was hard to adjust inventories quickly due to the speed at which it hit.

However, we expect an improvement in working capital in the second half of the year, and have reduced our capital expenditure program. We now plan to spend between $20 million and $25 million this year, and currently expect to generate $30 million to $35 million in free cash flow in the second half of the year. As previously disclosed, we drew down our revolver by $50 million during the second quarter as a precautionary measure. We've subsequently repaid the $50 million and do not expect to have to draw on our revolver again for the rest of the year. However, we may use our Swingline as necessary in the normal course of business.

Our balance sheet is strong. We have ample liquidity and our leverage ratio of net debt to last 12 months adjusted EBITDA remained unchanged at 1.4 times as of April 30, 2020. We will continue to focus on generating cash and paying down debt in the second half of the year, which should offset the decrease in forecasted EBITDA enough to keep our leverage ratio around 1.4 time for the remainder of the year. Because of our strong liquidity position and confidence in the second half, we do not foresee a change to our current dividend policy.

I'll now turn the call over to George for his prepared remarks.

George Wilson

Thanks, Scott. Prior to giving my commentary on the quarter, I would like to take a moment to thank all of my Quanex teammates for their dedication and efforts during this global pandemic. As a group, they accepted the challenge of being an essential business and maintain production so that we could provide uninterrupted service and products to our customers. They did this in an environment where the rules and regulations seem to change daily. In addition, we witnessed countless examples of our employees giving their time, talents and resources to help others in their communities. I am humbled and thankful to be on the team with so many amazing people. Thank you.

Similar to our first quarter, the second quarter started strong and our results were trending better than projections. However, the COVID-19 pandemic and related regulations began to impact our business toward the end of March. As such, our focus shifted to the following priorities; first, the health, safety and welfare of our employees; second, supporting our customers; and third, liquidity and cash flow management. Company wide, we have a very robust enterprise risk management process that evaluates various risk scenarios and prepares action plans to mitigate those risks. One such risk was a global pandemic and when COVID-19 hit, we were able to react quickly as we already had a plan in place.

I will now discuss results from each of our operating segments. I'll start with the North American Fenestration segment. Each of our plants in this segment was deemed an essential business and operated throughout the entire quarter. Revenue declined 5.9% from prior year Q2. But we were seeing revenue growth prior to the impact from the pandemic. In fact, revenue was trending 3.1% above prior year levels for the first five months of our fiscal year. However, revenue in April declined by approximately 25% year-over-year, due to the impact from COVID-19.

As we have stated in the past, our cost structure is highly variable in nature and as such when our volumes drop, we acted quickly with furloughs, reduced work hours and reductions in discretionary spending, which enabled us to protect our margins. In addition, SG&A reductions, lower medical expenses and lower incentive accruals, all favorably impacted results. And we were able to realize a margin expansion of approximately 100 basis points in this segment during the quarter.

Revenue in our European Fenestration segment decreased by 27.2% from prior year to $29.2 million excluding foreign exchange impact. Similar to our North American Fenestration segment, revenue was trending 2.4% above prior year levels for the first five months of our fiscal year. However, largely due to the fact that the UK was shut down completely. Revenue in April is down approximately 85% year-over-year.

As Scott mentioned in his comments, our UK manufacturing facilities were mandated to close on March 25th, and just recently restarted operations. Our German manufacturing facility remained operational, but on reduced shifts and work hours. Our North American Cabinet Components segment generated revenue of $50.7 million during the quarter, which was 19.4% less than prior year. This volume drop was driven by COVID-19 related impacts, and the previously announced loss of one customer, who exited cabinet manufacturing in late 2019.

Revenue in April decreased by approximately 37% year-over-year. After adjusting for the lost customer revenue was down 14.6% for the quarter and 34% in April. The decrease in revenue in this segment was intensified due to the fact that some of our customers are located in states were cabinet manufacturing was not deemed essential. As a result, they were forced to close for some period. While each of our cabinet component plants was deemed essential and continued to operate throughout the quarter, the rapid pace of the customer closures in other states made it challenging to manage our fixed costs, while balancing the needs and delivery requirements of our operating customers.

We aggressively managed our variable cost structure by quickly implementing temporary furloughs and shortened work weeks. But the closure of some customers nevertheless had a negative impact on the segment’s EBITDA and margins. EBITDA was also impacted by $1.8 million accrual for writing off a portion of the inventory associated with Chinese sourced products for the customer that exited the cabinet business. Absent this write off, we would have realized margin expansion in this segment as well.

As I mentioned earlier, managing liquidity and focusing on cash flow has been a top priority. As such, we are actively managing the line items that we can control. We are proactively working with our suppliers on extended terms and payments. We are also making progress in adjusting our inventory levels to match volumes. Though this process does take some time given the rapid drop in shipments.

CapEx has been reduced in an effort to optimize cash flow. However, because of our strong liquidity position, we will continue to spend capital on safety related projects and growth related strategic projects, such as the vinyl extrusion technology upgrade project that we have in Kent, Washington. We continue to be confident in our ability to generate cash and manage working capital during the second half of this year. These moves, combined with the normal seasonality of our business, should allow us to generate $30 million to $35 million of free cash flow for the full year, basically all which will be generated in the second half.

Like most other companies, we withdrew our guidance for 2020 as soon as the negative impacts from the pandemic started to become apparent. As mentioned, results for the first five months of our fiscal year through March were solid. Revenue fell quickly though in April. But we were prepared and we took the appropriate actions to minimize the impact to our business and margins. We are beginning to see signs of recovery and optimism across the building products industry.

We currently anticipate Q3 revenue will be down by 20% to 25% year-over-year in North America and adjusted EBITDA margin will be down 350 basis points to 400 basis points. For the third quarter in Europe, we currently expect revenue to decrease by 40% to 45% year-over-year with adjusted EBITDA margin contracting by 550 basis points to 600 basis points. This forecast assumes a slow recovery in Europe, no second wave of COVID-19 and no further shutdowns or restrictions on our facilities.

While we have very little visibility into our fourth quarter, we anticipate volumes will improve over Q3, but will not recover to prior year levels. We will provide an updated view on the full year when we report third quarter earnings in early September. But we are very encouraged by what we are seeing and hearing from our customers. In summary, although we expect negative impacts from the COVID-19 pandemic to continue throughout this year. We are optimistic that we are seeing signs of recovery. We will stay focused on managing all items under our control with a continued emphasis on generating cash and maintaining a strong balance sheet.

With that being said, operator, we are now ready to take questions.

Question-and-Answer Session

Operator

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

Daniel Moore

George, Scott, good morning. Thanks for taking the question. And I will say congrats on solid results given all of the challenges that you certainly faced and work through. Wanted to talk about, George, you said volumes in May kind of not as soft as anticipated. I'm assuming you're referring to little bit more to the North American operations and maybe just give a little sense of the cadence of the declines that are embedded in the Q2 guidance that you gave. How were we trending kind of early part of May and now how are we looking at kind of early part of June? Just trying to get a cadence for how each of the businesses are coming back out.

Scott Zuehlke

So, Dan, this is Scott. Let me start with this answer. So we referenced April volumes in George's script. So on a consolidated basis, revenues were down in April about 40% year-over-year. And if we look at May, which we're still closing the books for, but revenue looking like we trended about down 35% year-over-year. So it improved in May from April by about 5%. Some of that is the fact that Europe started back up in April, our two UK facilities started operating pretty much mid month, started to ramp up there. Looking into June, we expect further improvement. However, when we were going into May, we thought may was going to be the low water mark for the year and it ended up being from a volume standpoint better than April. So that's what gives us some confidence going forward.

George Wilson

I think in, this is George, in North America slightly better than we anticipated. I think, we were pleasantly surprised and really not knowing what the reaction would be in the UK and certain countries in Continental Europe when they started up and demand was better than anticipated and optimism seems strong. So, I think that was probably a larger impact on our optimism. North America was better but as we expected.

Daniel Moore

And in terms of the furloughs, maybe just kind of give us a sense for how much, what percentage or how much of those have sort of come back online? Really what I'm getting at is, what level of capacity utilization are you operating at across the three businesses today, and would you expect to be back to sort of pre-COVID levels?

George Wilson

So obviously, in the UK, I'll just start by saying, the UK facilities were completely shutdown. So, we're probably right now at about 30% to 40% of our capacity. The furlough situation there is different because of their government subsidy plans. In North America, at its highest we're approximately 30% of our employees being furloughed and we're now below 10% to give you a frame of reference.

Daniel Moore

Scott, how much -- it is really impressive to see the free cash flow target staying as strong as it is. How much working capital benefit is in terms of range is implied in that guidance of $30 million to $35 million for the full year?

Scott Zuehlke

Yes, that's tough to answer. But what I can say is compared to where we ended Q2, we absolutely expect some benefit from working inventories down. And then as you may imagine, the AR and AP side of the business in Q2 suffered a bit because of COVID. We extended some terms on a temporary basis and we expect for those terms to revert back to the original terms here within the quarter. So, we expect working capital to be a benefit in the second half.

Daniel Moore

One more for me, I'll jump out. I'm just trying to get a sense for corporate, the SG&A control was up, was obviously very strong. Corporate was actually a benefit, so trying - of about $2.5 million in the quarter. So was that mostly reversing comp accruals, healthcare related, trying to get a sense for what drove the change in SG&A on the corporate side and what a good run-rate might be going forward? Thanks.

Scott Zuehlke

So, you're right. What drove the benefit was largely driven by comp accrual reversals obviously, because of the impact from COVID. Medical was lower than we anticipated. And then stock-based comp was obviously lower, because our stock price took a hit rebounding nicely today, which is good to see. Going forward. I think $2.5 million a quarter I think is what we would expect going forward and that would be an expense not a benefit.

Daniel Moore

On the corporate [indiscernible] of SG&A?

Scott Zuehlke

Correct.

Operator

Our next question comes from Julio Romero with Sidoti. Your line is open.

Julio Romero

I wanted to start on North American fenestration, saw margins rise nicely even with the sales decline. Could you maybe break that out for us from maybe there's structural cost reductions versus more shorter term expense management?

George Wilson

As we look at that, Julio, I mean the majority of what we saw is structural you know the short time, and we will have to get back to you on details with the breakout. Obviously, as volume dropped we managed some of the discretionary spending just as you would expect. And it's really hard to determine exactly those pieces when you bridge it out. But I would tell you and I think you've seen this in prior quarters under Bill's guidance and what we were doing. The majority of the things that we've done operationally in cabinets, as well as NAF are structural in nature and we expected these types of improvements.

Julio Romero

I was totally surprised by the margin improvement there. And I know last quarter you guys called out some labor inefficiency in that segment and be related to a specific project. But it sounds like maybe those inefficiencies are [under] [ph] at this point?

George Wilson

In that specific one that we talked about, we believe that we have that headed in the right direction. Not completely fixed but we saw significant improvement. So yes.

Scott Zuehlke

Now, Julio, to be fair, what you're seeing in year-over-year improvement for North America Fenestration and EBITDA margin that does include some incentive accrual reversals as well that did help.

Julio Romero

And I guess, as we begin to see kind of in market stabilizing, how are you thinking maybe longer return on capital allocation? I know you're focused on debt reduction. But do you maybe have any update on some of the internal projects you're considering, especially considering the cash flow that you expect in the back half of the year?

George Wilson

So we talked about the debt reduction, the dividend policy will stay as is. But in terms of our CapEx, we're going to continue to prioritize it based on safety projects. And then there is three or four strategic projects that will continue on. The Extranet vinyl extrusion project, which I mentioned in my script, as well as we'll continue to spend money on screen expansion in the regions where we're underserved right now. So anything related to strategic growth projects we will continue to spend money on.

Scott Zuehlke

And just to add to that, Julio with the screens business, we are moving forward, opening a new screens plant here in August-September timeframe.

Operator

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

Steven Ramsey

I guess on the UK plants being shutdown now operating again. How much backlog was less sitting and how much of that has been cancelled, or do customers still desire that product? And is there a time lag for those orders to be fulfilled?

George Wilson

We think that the initial demand that we're seeing is backlog related. But the good news that we have in the UK is that their order and opening up did not prohibit people, installers and salespeople from going into the homes and that continues to be remained unknown. What's the consumer sentence confidence and allowing others into their house. But what I would say is short term feedback is that that remains pretty strong and people are investing in projects in their own homes.

Steven Ramsey

And then on cabinet business, I know a mix of the decline with the customer exiting the business, and then you talked about in the last quarterly calls in the custom stabilizing. I guess is there any way to get a feel for some of custom, how it trends from here, will it kind of remain in a stabilized state or could this accelerate decline in the coming quarters?

George Wilson

So we're trying to digest the new KCMA numbers. There was such a rapid change across a lot of the segments. It's really hard to determine what was causing any sort of drop. And so I think that for us to be able to determine the shifts between stock and semi custom and getting balanced, we're going to need another quarter of look to be able to determine what is that true impact. We anticipate that the conditions are such that people will start looking at the R&R projects and we're seeing signs of that. And we think with wood pricing starting to stabilize that the semi custom market that we participate in will be a good place to be.

Steven Ramsey

And then lastly for me, I guess to circle back to the inventory question. You talked about in the last quarterly call, how you had built up inventory ahead of large capital investments in North America Fenestration. I guess, how does that play out as the quarter moved along? Is that kind of that factor passed this, or is that part of the inventory work down that you're in the process of?

George Wilson

It is definitely part of our inventory work down. Obviously, you try to build and level load those plants to be able to manage the peaks in the busy time. Right now as our forecasts we're trying to evaluate what that peak will now be, we are bleeding down inventory. So that is part of this process.

Operator

Our next question comes from Reuben Garner with Benchmark Company.

Reuben Garner

So, maybe on the margin front. So is there anything structurally different maybe from a fixed variable standpoint between the North American Fenestration segment and the Cabinet's business? Or was the margin kind of, I guess performed -- relative margin performance in the quarter solely tied to those issues going on with some of your customers on the cabinet side, not being able to be open in the quarter? In other words, you were able to expand margins year-over-year in windows despite everything going on, but you had some pressure on Cabinet side?

George Wilson

Without the write-off of the accrual for the customer that left, the inventory accrual, we would have had margin expansion in cabinets as well in the quarter. However, the difference between the two that we called out is truly managing that fixed cost piece when we have certain customers that did shutdown for cabinets, and we didn't see that in North American Fenestration. So that's really the difference. Our customer base on the NAF side, almost every customer was deemed essential and in the cabinet side, we did have some. So you had to continue running the plants and the cabinet side at less than ideal run rates and levels to support the ones that are still running. So that's the biggest difference, Reuben.

Reuben Garner

And then maybe on the, let's see, on the guidance for Q3. So I think if I'm reading it correctly, it's implying somewhere the quarter being down in 25% to 30% range. So, a little bit better than the trend you're seeing in May. I'm a little surprised that you're still seeing that or expecting that type, or those types of declines. Do you have any way of breaking down what your new business looks like relative to your R&R? I know that might be difficult. But the reason I'm asking is a lot of the builders seem to be pretty optimistic and I think in fact even already started to bounce back in May. Is it the new construction site is going to fare a lot better and the R&R side might not, because people are hesitant to have contractors come in their home to do things like replace kitchen cabinets. Can you just talk to us about maybe what you're hearing and seeing there?

George Wilson

I think we are seeing, or we are hearing optimism from our customers as well. So I think what we're dealing with right now is where we're at in the supply chain. You have our customers also trying to work through inventory levels and adjust. So where we're at in the supply chain, it's just delayed. So we won't see the impact of some of is for a little longer than those builders and some of the OEMs. But we're definitely hearing optimism, Reuben. And we think as people reduce their travel and some of the larger expenses on that type of thing, they're going to invest and we're seeing more of that type invest in their homes and living spaces and we see more of that optimism. There's a lot of comments that housing will lead to recovery and we are hearing that.

Reuben Garner

And then last one from me, I mean obviously, some of the states that were shut down, you're going to see it. But any notable regional disparity in your markets that’s worth calling out other than New York? Anything that you've noticed trend-wise that certain markets are bouncing back stronger or faster than others?

George Wilson

I think, you know for us and it goes consistent with what we were seeing in quarters before. For us, the Southwest, South Central, and Southeast continue to remain strong or stronger. From the cabinet side, the shutdowns were primarily Northwest. Washington did not deem their cabinet customers as essential and neither did Pennsylvania. So, that was where we saw some short-term hits in those regions for the cabinet side.

Operator

We have follow up question from Daniel Moore from CJS Securities. Your line is open.

Daniel Moore

Just on capital allocation, I guess number one, any thoughts, like M&A has sort of been on the back burner for quite a while. Any thoughts that the disruptions might shake loose a few tuck-ins and opportunities, or was it just too sort of short-lived, number one. And number two, obviously you took very prudent action of focusing on cash preservation as this was going on. What would you need to see to be more comfortable, more confident in maybe allocating capital or returning cash to shareholders more aggressively once again? Thanks.

George Wilson

In terms of the M&A, my comment is, listen, we'll listen and we'll continue to look at opportunities as they come to us. We think there will be a pause for, in that area as everyone's going to be trying to understand what true valuations are all about and where that should be. So, I think both the selling and the buying are going to be very cautious and as will we. So not that we wouldn't look anything, we just think that there will be a natural pause. And we're going to put ourselves in the position by the tactics that we're doing now and building and protecting our balance sheet to be ready when that does break.

In terms of providing cash back to the shareholders, I think we're really going to need to see, at least another quarter. I mean, it's constantly talked at the Board level and they're very cognizant of doing things to provide value to our shareholders. But we want at least another quarter to see what we, and some look into 2021, I think, before we really make that decision permanently.

Operator

That concludes today's question-and-answer session. I'd like to turn the call back to George Wilson for closing remarks.

George Wilson

Thank you all for joining. And we look forward to providing an update on our next earning call in September. Thank you.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.