Quanex Building Products Corp (NX) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Quanex Building Products Corporation first quarter 2017 earnings conference call. At this time all participant lines are in a listen only mode to reduce background noise but later we will be holding a question and answer session after the prepared remarks and instructions will follow at that time. (Operator Instructions).

As a reminder, today's conference call is being recorded. I would now like to introduce your first speaker for today Scott Zuehlke, Vice President Investor Relations and Treasurer. You have the floor, sir.

Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President and CEO, and Brent Korb, our Senior Vice President of Finance and CFO. 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 earning release issued yesterday and posted to our website.

I will now turn the call to Brent to discuss the financial results.

Thanks, Scott. I will begin with the income statement and conclude by providing comments on our balance sheet and cash flow.

Consolidated net sales during the first quarter of 2017 decreased 3% to $195 million. Compared to the same period of last year. The decrease was primarily attributable to our previously disclosed decision to walk away from less profitable volume in an effort to increase long-term returns and drive margin improvement both near-term and long-term.

We reported a smaller net loss of $3.7 million for the three months ended January 31, 2017. Compared to a net loss of $7.2 million for the comparable period in 2016. This improvement was a result of lower interest expense from refinancing our debt in July of last year.

Adjusted net loss was $1.4 million, or a $0.04 per share loss during the first quarter of 2017 compared to an adjusted net loss of $400,000, or a $0.01 per share loss in the first quarter of 2016. The adjustments being made for EPS are as follows. Acquisition related transaction costs, purchase price inventory step-up recognition, loss on the sale of fixed assets related to the closure of the plant in Mexico, restructuring charges related to the closure of three manufacturing plants, accelerated depreciation and amortization for equipment and intangible assets related to the facility consolidations and foreign currency impacts primarily related to an inter-company note with HL Plastics.

As disclosed in the earning release, we recorded restructuring charges in Q1 related to the closing of two US vinyl extrusion facilities and the cabinet components facility in Mexico. The closure of the three facilities were completed in the first quarter without issue.

Additionally, the inventory was relocated along with some of the equipment. Over the next few month we will incur expenses as we relocate the remaining equipment and displace older and less efficient equipment. Longer-term we will continue to incur lease expense until each lease ends.

On a consolidated basis EBITDA improved to $11.6 million during the first quarter of 2017 from $10.8 million last year.

On an adjusted basis EBITDA for the first quarter of 2017 was $13.0 million compared to $18.2 million last year. The decrease was largely driven by a $1.5 million increase in stock based comp expense resulting from the increase in our stock price during the quarter, combined with short-term inefficiencies as we transition away from less profitable volume in our US vinyl profiles and cabinet components businesses.

Moving on to the balance sheet. Our leverage ratio picked up slightly to 2.5 times as of January 31, 2017 primarily due to the seasonality of our business combined with the fact that we paid a one time earn out of $8.5 million during the quarter related to the HL Plastics acquisition.

Cash provided by operating activities increased to $2.0 million in the first quarter of 2017 compared to $800,000 last year. Historically, we have been a consumer of cash during the fiscal first quarter of each year due to seasonality, but the acquisitions of HL Plastics and Woodcraft in 2015 have allowed us to post our second consecutive year of positive cash provided by operating activities during the first fiscal quarter.

From a capital expenditures standpoint we currently expect to spend $35 million to $40 million in 2017, which is more or less in line with the $37 million we spent in 2016. We will continue to invest in automation across all divisions with a heavier focus on the cabinet components segment. Longer-term we remain confident that our annual capital spend level should settle in around $30 million.

We remain focused on generating free cash flow and similar to last year we expect to pay down debt as the year progresses, which will ultimately further improve our leverage ratio. As previously disclosed, we are comfortable with the leverage ratio between two and 2.5 times. As we go below the two times level, we will re-evaluate our options as how best to utilize free cash in an effort to enhance shareholder value.

I will now turn the call over to Bill.

Thanks, Brent. And good morning, thank you for joining the call with us today. In the aggregate our first quarter results came in pretty much as we expected. Growth in margin performance in our European engineer components segment was actually a little stronger than anticipated, particularly in the light of the ongoing Brexit discussions.

On a local currency basis revenue was up more than 11% and EBITDA margins for the segment improved by approximately 200 basis points compared to the first quarter of 2016.

As anticipated we started to see the effects of reduced volumes in our US vinyl profiles business during the quarter and originally expected that this reduction would be carried out in a slower phased manner throughout this year and into 2018. However, the transition is going much faster than anticipated and while the total number and volume of profiles to be transitioned has not changed, it is now evident that all of this volume will transition by the end of our fiscal year.

In total, revenues generated by this one customer were $11 million lower during the first quarter of this year compared to the first quarter of 2016. We now expect the full year revenue impact to be closer to $65 million rather than the $50 million we originally anticipated. As such, we accelerated our consolidation efforts during the quarter in order to further reduce the cost structure of this business.

At this point two plants have completely ceased operations and 23 extrusion lines have been taken out of service. Two lines have been relocated and are now operational. Two more lines are in the process of being moved and an additional eleven will be moved during the second quarter. Eight existing extrusion lines are being modified to accept the 86 tools that have already been relocated, 31 of which have now been qualified and are fully operational.

All in all this project has been executed very smoothly with no customer disruptions and the first phase which involves mostly high volume production assets and tooling should be complete by the end of our second quarter. The final phase of this project will be to consolidate all of our low volume accessory business into our Illinois facility. This entails relocating 194 tools, 73 of which have already been moved, but the remaining 121 will gradually be relocated throughout the year.

We are very confident that with the smaller footprint and the efficiencies gained by better utilization of our most effective equipment our US vinyl profiles business will be back to contributing to our margin expansion efforts in the second half of the year and potentially as early as the second quarter.

Our cabinet components business somewhat surprisingly realized double-digit top-line growth year-over-year unfortunately, though, at lower margins. This was primarily due to our ramp-up in volumes of the previously identified margin dilutive business as we initiated discussions around increasing the pricing or transitioning this business to ultimate suppliers.

Customers began to build inventory in preparation for the for the forthcoming changes. Negotiations continue on multiple fronts with respect to this margin dilutive business, but we do not expect a final resolution until the end of the second quarter. And as such it is still unclear as to how much of the $20 million will be lost versus obtained in bettering pricing.

Either way, however, we should start to see margin expansion in this business beginning slowly in the second quarter and ramping up significantly through the second half of this year.

While progress has been slower than we would like in our cabinet components business, we believe that we have now turned the corner and a longer term goal of 15% EBITDA margins before corporate allocation is not in doubt.

On the flip side the consolidation and restructuring of our US vinyl profiles business is moving faster than anticipated and should contribute positively to margin expansion in the second half of the year. Net/net, we now expect full year 2017 revenues to be in the range of $880 million to $900 million and adjusted EBITDA to come in between $105 million and $112 million.

The mid-point of this guidance implies EBITDA margins of 12.2%, a 30 basis point improvement over 2016 on significantly lower revenues and after a lot of transition through the first part of the year. Much of this margin expansion will clearly come in the second half of the year.

Looking ahead, all signs continue to point towards a longer, slower recovery in the residential new construction and repair and remodel markets. We feel very good about the actions we have taken this year to shrink our US vinyl profiles and cabinet component businesses while still expanding margins and improving free cash flow.

This will better position us to achieve our 15% consolidated EBITDA margin target without the aid of price or volume. And in particular, price is still very difficult to come by.

Our priority this year will be to utilize or strong free cash flow to further pay down debt and we fully expect to exit the year at less than two times net debt to EBITDA.

Operator, we're now ready to take questions.

(Operator Instructions). We'll be taking our first question from the line of Daniel Moore, from CJS Securities. Your line is open.

Good morning. Thanks for taking the questions.

Good morning, Dan.

Bill, you just mentioned the cabinet business and you did mention you expect a significant ramp in margins. Are you still confident with the 200 basis points improvement in adjusted operating margins for fiscal 2017? And, just kind of more color on progress there?

Yes. We are, indeed. Because of the transition of business out of Mexico, we undertook to close that facility the day we made the announcement. We ceased production immediately in that operation. And committed to our customers that we would manufacture that product for them at least for the first 60 days, which was most of our first quarter, at Mexican prices, but of course at US costs. So, we worked and extraordinary amount of overtime in the quarter, it was very disruptive.

At the same time we had increase in volumes in other business as we started negotiations with different customers. So, high volumes all at low margins. But we clearly tracked what's going on in the underlying business excluding that and we can clearly see that our operational improvement program, some of the automation efforts, are gaining traction even though it doesn't show up in the consolidated number for the first quarter.

I just looked at the very preliminary February numbers and we had a decent February there. And clearly the trend lines are moving directionally towards better performance here in Q2 and significantly better in the second half of the year. We already have price increases on the table for all of the margin dilutive business and our awaiting decisions from customers whether they will try and source it elsewhere, or whether they'll continue to take the price.

So we expect to see better margins in Q2, but really see the effects in three and four. So we feel very good now about where that business is.

Got it. Helpful. And just transitioning to the vinyl business. What is your remaining vinyl footprint once you divest the full $65 million from that large customer? And after the two closures what does capacity look like and capacity utilization relative to -- prior to the most recent consolidations?

Yes. So, first of all, let me say the team in our vinyl profile business have done a phenomenal job in the first quarter with an awful lot of moving pieces as you heard from the prepared remarks. And much of that was on an expedited basis as it became clear that the customer was going to be able to transition faster than we would like.

So, we have three facilities. We will consolidate much of the accessory low volume business into the smaller of the three, which is in Illinois, and its capacity utilization by the time we finish is actually going to be relatively high. Probably north of 80% below, you know, some of these are still moving numbers at this point.

The Kent facility which was always pretty crowded we've moved some equipment out of there. We have moved new equipment in there. We have created some additional space by shutting down some assets that were not particularly profitable that were not extrusion lines. By the time we finish the moves there, which should be complete by the end of the second quarter, the capacity utilization of that facility will also probably be in the 80% range.

The biggest facility which is in Richmond, Kentucky, we are still relocating and repositioning equipment there. The capacity utilization of that facility will still be probably below 65% by the time we finish. And, you know, as the team there finishes the consolidation effort they're ramping up some pretty aggressive efforts to replace the lost customer with additional business from new customers or additional business from existing customers. So as we exit this year we'll start to see more and more focus there on growing that business back again after the consolidation is complete, but we're very pleased about where this business is, too.

Got it. Lastly, and I'll jump back. The overall guidance, still looking for mid-single-digit underlying organic growth, started the year obviously a little slower than that. What gives you the confidence, and I guess, what would be the delta? You know, weather may be one but what other factors give you confidence that we'll see an acceleration of underlying organic growth as we move throughout the year?

Yes. I think one of the things to keep in mind is if you look at the profile of our volume last year, the first quarter comp was pretty tough. So we had if you will recall, we had a very, very strong first quarter last year, to comp against. So if you exclude the vinyl business where most of the shrinkage was, the underlying window components business was flat year-over-year, which we actually thought was a pretty good result given how strong it was.

Then through last year somewhat surprisingly the growth rates tapered off as we went through the year. We expect this year right now, and certainly our customers do, to be more normalized so ramp up is a little more in Q2 when a very, very strong three and four, which really didn't happen last year. So that's why we still have confidence that that underlying growth rate will still be there.

Got it. Appreciate the color. Thank you.

Our next question comes from the line of Al Kaschalk, from Wedbush Securities. Your line is open.

Hey. Good morning, guys.

Good morning, Al.

I just wanted to follow up on the cabinet question. And in particular maybe a little bit more broader with -- with the guidance comment for the full year. Specifically, Q2 obviously a tough year-over-year comp plus you have business that you regrettably walked away from, but do you expect each segment to show modest growth Q2 sequentially, or is it one business is going to drive more of the lion's share of the growth?

Can you just help us talk through that because I think what we're hearing is a strong second half, but obviously you have got one more quarter to go before we start to see some of that lift. So, I just want to make sure expectations of calibrated correctly, Bill.

Yes. We will see some margin improvement in Q2 and certainly sequentially. But it's slow. And because there's still a lot of moving parts to take place in Q2 I don't want to get too aggressive in our forecasting. Clearly, by the end of Q2 as we get into the second half we feel very good about margin expansion there, but my expectation right now is we'll start to see it in Q2.

The underlying window components business in North America will not see a lot of margin expansion there. We will certainly see some at Woodcraft and I think we'll start to see some further improvement again in the vinyl profiles business.

I appreciate the color on margin. I guess maybe I was hoping to probe a little bit into the revenue side given a lot of the moving pieces.

We expect to see pretty strong sequential revenue growth, even in Q2, and then a similar amount again in Q3 and then as I said, we expect sort of normal growth so an even better fourth quarter. So, steady incremental growth as we go through the year.

Got it. And then finally if I may, the $20 million that's under discussion on the cabinet side, what assumption have you made on that $20 million as it relates to the $880 million to $900 million of revenue.

The reason for the big spread, you know, it's not coincidental that that's $20 million, right? So, we clearly internally have our own thoughts about how these negotiations are going. For obvious reasons we're not going to talk about that publicly at this point. You know, I don't think you'd go far wrong by looking at the mid-point as where we're most likely to end up, realistically. I mean it could be on the low side. It could be on the high side. But I think at this point I would say if you have to nail down one number I would guide you to the mid-point of that range.

Okay. Great. Thank you and good luck and let's keep pushing the pedal on that pricing formula.

Yes we will. (inaudible). Thanks, Al.

Our next question comes from the line of Nicholas Coppola, from Thompson Research. Your line is open.

Good morning, guys. This is Steven Ramsey on for Nick.

Good morning, Steven.

I had a question regarding CapEx and automation investments. Does the exit of the low margin business being faster this year along with the potential ongoing situation in cabinets exiting that business, does that speed up the pace of your automation investments? Long-term?

Not really. The gating item on automation is physically getting the equipment made and delivered. The robotic's guys are busy and the reason for that is we're not the only people or the only industry with labor issues. So, I think there's been a ramp-up in automation activity across general industry so that the real gating item, we can't go faster because we just can't get it fast enough.

Excellent. That's helpful. My second question, switching gears to Europe, the strong volume growth. Can you go into detail a little bit more on that strong growth and how we should think about volume growth there throughout the year? Thank you.

Well, the reason it was a surprise to us is that segment grew on a local currency base at that rate in 2016 compared to 2015. Or, just a little under that rate. And then, if you recall at the beginning of this year, you know, the whole rhetoric around Brexit started again, you know, with the alleged uncertainty of what parliament was going to do whether Theresa May would have a mandate or not. So, our expectation was that that growth rate would actually drop off in the first quarter, and it really didn't happen.

As it turned out, I think the UK is exactly where it expected to be at this time with respect to the negotiations of Brexit. So, I think the only uncertainty I would say in the European segment would be if everybody continues to ignore the noise around Brexit, we could potentially be looking at 10% growth on a local currency basis throughout the year. If there's a period of nervousness again, maybe it slows down, but right now we haven't seen it.

Excellent. Thank you.

Our next question comes from the line of Ken Zener from KeyBanc. Your line is open.

Hi. Good morning everyone. This is actually Adam on for Ken today.

Adam, good morning.

Good morning. I was wondering, and I apologize if I missed it, but on the free cash flow guide, do you guys still expect to (inaudible) cash by around $10 million this year? And, if so, if you could provide some color on the allocation of the roughly $60 million or so that would be cash so that would be for the rest of year. And how you guys plan to allocate that capital and maybe rough percentage terms such as buying back debt or stock repurchases? Thank you.

Yes. I mean, Adam, I think our guidance earlier in the year was for about $10 million increase. We would be close to that. You know, is it sort of eight to ten-ish. From a debt pay down perspective, last year we paid down $52 million of debt. I think something in that neighborhood would be expected again this year with the bulk of that taking place in the second half of the year. I think we pay down close to $35 million in the fourth quarter. So look very similar to last year in that regards.

Okay. Great. Thanks a lot, guys. Good luck.

Thanks.

Thank you. Our next question comes from the line of Bill Baldwin from Baldwin Anthony Securities. Your line is open.

Hey. Thank you. Good morning.

Good morning, Bill.

A couple items here. Could you bring us up to date on what's going on with your spacer program with your larger OEM IG customers and how that's progressing?

Yes. Very similar story actually to the automation question earlier. The program is going very, very successfully with the equipment that's up and running. Progress is slower than we originally anticipated because of the difficulty in getting the equipment built and installed. So we continue to see interest from new customers and the existing customers that have bought lines already are getting great productivity out of the lines that are in place and they are anxiously awaiting new equipment deliveries. I think we expect some later this year and then several more installations next year. It's going well. No issues.

Oh, very good. Very good. And I guess this equipment delivery then will stretch out over a couple of calendar years?

Yes. This is -- you know, for some of these bigger customers their plans run out over a three year period of time.

Three year period. Okay.

Right.

Now, the last time, I think at least I remember on this, Bill, you had two customers, I believe, for this -- you know, utilizing this new equipment. Is that still the number you're working with are or there additionals?

We have two. Those two are both working very well and expecting deliveries of new equipment over the next two to three years. And we've had two others initiate new lines. One of which is just replacing -- We already sell spacer to that customer and it's just replacing it with a high-volume line, replacing a low volume line. But it's -- so there's some cannibalization there in that one customer's case, but we still expect incremental business as a result.

Kind of broadly, Bill, can you kind of give us a little color on what's transpired in the cabinet component markets? Are you seeing any kind of a pickup in repair and remodeling area? And if so, does that take your demand into the higher priced, higher priced component business there?

We're really not seeing that. I mean that is still one part of this recovery that we haven't seen happen yet. I think if you look at Duckers window shipment, the year-over-year growth, their estimates for R&R were in the very low single digits. So that still has not happened. My broader view of the way the world is going to unfold is I think that labor constraints will still put a governor around new housing starts, which is why many of the economists are now forecasting one and a half million starts being further out than any of us would have expected.

I think that's going to be a governor but the (inaudible) of that is likely to keep prices higher. So, with new homes at high prices, potential increases in mortgage rates I think we will see more people make the decision they're going to stay in their existing homes because it's more cost effective and then as prices continue to escalate make the decision to renovate their existing properties. So I think there is still pent up demand there. We are not seeing it now and I'm not sure we'll see it this year, but I believe it will happen as the cycle gets deeper and deeper.

I kind of thought, Bill, and tell me if this has been correlation in the past, but existing home sales have been reasonably strong in the US here in the last year or so. I kind of thought that would have some kind of correlation with spending on repair and remodeling as people move into new homes -- not brand new but new homes to them that they bought in the existing home market.

Historically, that's been --

Has there historically been a correlation there between the two?

Absolutely. It has been. This cycle, it doesn't seem to be happening to the same extent. Now, I think it's happening -- if you look at the big bucket of R&R spend, it's doing very well, but you know, it's paint, it's appliances, it's carpeting, it's the big ticket items, particularly windows. It's difficult to get a pay back and that's the -- people don't pay attention to that when they're buying a new home.

Right. And then lastly could you give is us a little color what's going on with the spacer market over in the UK and Germany plants? How that business is going in Europe and UK?

It's going very well. You know, they were a big part of the revenue growth and the margin expansion in Europe. We're very happy with our European business all around.

And HL, have they completed their warehouse expansions and are they are in pretty good shape from a capacity standpoint to continue to grow over the next several years?

Yes. They are, indeed. They're starting to move into the new warehouse now. And then the old warehouse will be converted to a manufacturing space in the second half of this year.

Now, remind me, Bill. They sell almost all of their products in the UK's, don't they?

Absolutely. All of it. They don't export at all.

And will that continue to be the case as far out as you're looking right now?

Yes. We do not expect to see that change.

Thank you very much.

Thanks, Bill.

Thank you. I'm seeing no other questioners in the queue at this time so I would like to turn the call back over to Bill Griffiths for closing remarks.

Thanks again everyone for joining the call and we look forward to updating you at the end of the second quarter where we expect to show some more incremental improvement. Thank you.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may now disconnect. Everyone have a great day.