Good day, ladies and gentlemen. Welcome to the third quarter 2019 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. Instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Scott Zuehlke, VP Investor Relations and Treasurer and Interim CFO. Sir, you may begin.
Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President, and Chief Executive Officer, and George Wilson, our Chief Operating 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 a 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 will now discuss the financial results.
We generated net sales of $238.5 million during the three months ended July 31st, 2019, compared to $239.8 million for the three months ended July 31st, 2018. The decrease was primarily attributable to a weaker demand environment, mainly in our North American cabinet component segment and inclement weather in the U.S. Our European and North American fenestration segments continued to generate net sales growth above that of their respective markets, largely due to price increases related to raw material inflation recovery. We reported net income of $11.8 million, or $0.36 per diluted share for the third quarter of 2019, compared to net income of $10.8 million or $0.31 per diluted share during the same period of 2018.
On an adjusted basis, net income increased by 18% to $13.7 million, or $0.41 per diluted share during the third quarter of 2019, compared to $11.6 million or $0.33 per diluted share during the third quarter of 2018. The adjustments being made to EPS are for restructuring charges, certain executive severance charges, non-cash asset impairment charges, foreign currency transaction impacts, transaction and advisory fees, and adjustments related to the Tax Cuts and Jobs Act. On an adjusted basis, EBITDA for the quarter increased by 8% to $32.8 million, compared to $30.5 million in the third quarter of last year. The year-over-year increase in adjusted earnings was largely due to the successful implementation of pricing initiatives, combined with operational efficiency gains. Moving on to cash flow and the balance sheet.
Cash provided by operating activities was $29.9 million for the three months ended July 31st, 2019, compared to cash provided by operating activities of $26.8 million for the three months ended July 31st, 2018. Free cash flow generation was strong during the quarter. As such, we generated free cash flow of $25.9 million in the third quarter of 2019, compared to the $21 million we generated during the same period of 2018. This allowed us to repay $32.5 million in bank debt during the quarter and repurchase approximately $1.6 million of common stock. As of July 31st, 2019, we had approximately $21.6 million remaining under our existing share repurchase program. Our leverage ratio of net debt to adjusted EBITDA decreased to two times.
As a result of this decrease, the applicable margin we will pay on our outstanding revolver balance decreased by 25 basis points, which means the interest rate we are now paying is LIBOR plus a margin of 150 basis points. The next 25 basis point step-down in margin would be when our leverage ratio is less than or equal to 1.5 times. I'll now turn the call over to George to provide his prepared remarks on operational performance.
Thanks, Scott. Despite softer than expected revenues, we achieved another quarter of strong operational performance, which resulted in consolidated margin expansion of approximately 100 basis points versus prior year third quarter. Our European fenestration segment again led the way with revenue growth of 9.3% for the quarter, excluding foreign exchange impact, and we realized margin expansion of approximately 180 basis points. Results for this segment continue to be driven by above-market growth, price increases implemented late last year, and improvements in silicone costs for our spacer products. Sales in both of our North American segments continue to face headwinds. Despite the weaker demand, our North American fenestration segment still outperformed the market with revenue growth of 2.2%, compared to Ducker's latest calendar second quarter window shipment estimate of a negative 2.3%.
Ducker has recently reduced their full-year calendar 2019 window shipment growth estimate to negative 1.2%, down from a positive 0.7%. During the first nine months of our fiscal year, our North American fenestration segment reported sales growth of 3%. We also realized 180 basis points of margin expansion in the third quarter. This improvement was driven by price increases implemented early in the year, along with our continued reductions in SG&A. Moving on to our North American Cabinet Components segment. The semi-custom portion of the cabinet industry continues to lose share to the stock portion, and we expect that this trend will continue. Revenue declined $6.4 million, or approximately 10% year-over-year. As Bill mentioned in our last quarterly call, mainly due to a tough comp, we expected and realized margin degradation in this segment during the third quarter.
This was primarily driven by the timing of certain accruals, along with lower volumes. Operational improvements in the segment continue to be realized and are helping us offset the impact of a softer top line. I will now turn the call over to Bill for his commentary on our outlook and strategy going forward.
Thank you, George. Looking forward, even with the optimism surrounding lower interest rates, we expect the soft demand trend to continue through the fourth quarter. In Europe, despite the continued uncertainty surrounding Brexit, we still anticipate above-market growth, excluding foreign exchange impact, as we continue to gain share in the U.K. and expand our international sales capabilities out of our German spacer facility. We also expect above-market growth in our North American fenestration segment in the fourth quarter, largely fueled by increased customer outsourcing of screens and increased volumes in our vinyl extrusion operation as new incremental business enters full production. Unfortunately, most of this above-market growth in fenestration will be offset by a continued decline in our North American cabinet component segment as the market continues to shift from semi-custom to stock cabinets. As a result, we now expect consolidated full-year revenues to be flat year-over-year.
Even with the weaker demand environment, however, we still anticipate further margin expansion in our European and North American fenestration segments in the fourth quarter and for the full year. We also expect margin expansion in our North American cabinet component segment in Q4, which should equate to flat margins for the full year. Even with softer revenues, we are maintaining the midpoint of our adjusted EBITDA guidance at $102.5 million, but narrowing the range to between $100 and $105 million. Based on the seasonality of our business, the fourth quarter has historically been our strongest from a cash flow perspective, and we anticipate that this year will be no different.
Our objective will be to use this cash to continue paying down debt so that we exit the year with a leverage ratio closer to 1.5 times, while also continuing to be opportunistic with respect to buying back our stock. We expect to enter fiscal 2020 with a strong balance sheet and a demonstrated ability to generate more than $50 million of free cash flow per year, while also adequately funding the capital requirements of the enterprise. As we think about capital deployment in 2020, depending on the macroeconomic environment, options we are considering include further deleveraging of the balance sheet, completing stock repurchases, and possibly making additional strategic capital investments to support future growth. We are currently evaluating capacity expansion projects in the three fastest-growing portions of our business, namely our screens business in North America, our vinyl extrusions business in the U.K., and our spacer business in Germany.
We are also evaluating potential investments in new technology to improve the competitiveness and capabilities of our U.S. vinyl extrusion business and our stock cabinet components business. We believe that our strong free cash flow profile will allow us to fund all of these capital investments while still opportunistically buying back more stock and also continuing to deleverage our already healthy balance sheet. We will, of course, have greater clarity on our future capital deployment strategy when we report our fourth quarter and full-year results in December. With that, we're now happy to take questions.
Ladies and gentlemen, if you have a question at this time, please press the star, then the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, that's star then 1 to ask a question. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from Daniel Moore with CJS Securities. Your line is now open.
Hi, good morning. It's Pete Lucas for Dan. Just starting out with a quick question on the cabinets. Have you seen any volume improvement in July and August as the weather has improved?
July and August really carried the same sort of trend that we've been seeing all year. Clearly, the weather got better, and yeah, we did see an improvement. As the comps get tougher later in the summer, it's pretty clear to us now that the trend is going to be pretty much as I just said. We'll see a continued decline in the cabinet business in Q4, I think, in line with the market, generally speaking. We have strong expectations that we will do better in both North American and European fenestration relative to the market, although the market there clearly is softening as well.
Got you. Next, with relation to EU fenestration, you mentioned the growth there above the market due to price increases and silicone costs. Are you seeing any market share gains? If so, do you think those are sustainable?
Yes, absolutely. The price increases took place late last year as part of the recovery for not only silicone but resin price increases. We are continuing to gain share in the U.K. vinyl segment, and we are continuing to expand our international sales opportunities, particularly out of the German spacer facility. Evaluating whether we should look at capacity expansion in both of those operations in 2020.
Got you. Last one from me. With Brexit looming and the pound falling, what type of impact do you expect from each of these two factors on EU fenestration revenue and margins over the next couple of quarters?
It's really just translation effects. The real impact will be the relationship between the pound and the euro, which could have a direct impact on raw material input costs.
Very helpful. Thanks. I'll jump back in the queue.
Thank you. Our next question comes from Steven Ramsey with Thompson Research Group. Your line is now open.
Good morning. I wanted to hit on a couple of the growth product categories. I guess starting with the spacer business in Germany. Can you talk more to the sales and growth and margin aspirations in this business? Maybe ballpark timelines, if it's near term or long term, and then the investment needed to get to where you're hoping to go.
Yeah. One of the things that we've been doing somewhat quietly as we've gone through this year is we've transferred more and more of the international sales responsibility for our spacer business out of North America into Germany. Firstly, we have stronger capabilities there, and more importantly, on a global basis, it's actually more beneficial to trade out of mainland Europe than it is out of North America. We're starting to see increased opportunities, and if you recall, the spacer is really the only one of our products that we can manufacture and ship pretty much anywhere in the world. The rest of our products have a very limited radius. We've had an active program for some time now to develop that international business. We're seeing some benefit, as you've seen in the results throughout this year.
The consideration, if we want to continue to grow that business as we go into 2020 and 2021, it looks as though capacity expansion in Germany would be a smart thing to do. Secondly, the other fast-growing portion of our business, again, as you'll see in Europe, is our U.K. vinyl profile business. We've been taking share as some of our competitors have struggled a little bit in that environment. Again, we may consider a capacity expansion there in 2020 going into 2021. In North America, we have talked before about as our customers in the window business run up against capacity constraints, one of the easiest product lines to outsource is screens. It's labor-intensive and takes a lot of floor space. We've been seeing increased opportunities to take additional screen business.
That may require some selected expansion in regions of the country where we're currently underserved, and that's under evaluation. I think to tie a ribbon around the whole thing, it's pretty clear from a macroeconomic environment right now, 2020 is likely to be overall relatively slow growth in the residential segment. At least that's the indications we're seeing right now. There are bright spots that we want to take advantage of, and our focus through this year and certainly going into next year, is going to be on the things we can control. The segments of our business where we do see growth, we'll make investments there, and anticipate to following the market with the rest of our product lines.
In terms of cost. If we funded every one of these growth projects to the full, our CapEx of normalized around $25 million could reach $40 million. No higher than that. It's not likely that we would do that all at once. That may get spread out over the next two years. A lengthy answer. Hopefully that covers what you asked.
Yes, very helpful. Thank you. I'm sorry if I missed this, but wanted to get a little more clarity on the pricing front. More in the cabinets business with the shift in product categories, how are you approaching pricing and, given the shift in end market dynamics and the shift in your own capabilities to serve?
Since we put through price increases last year, late in the year, and some in the early part of this year in our cabinets business. Because of all the dynamics that are going on in cabinets now, consolidation, and this shift, we have not pushed for price increases for the balance of this year. Quite frankly, I'm not sure we'd be very successful at getting price as we enter 2020. Again, we're focusing on what we can control and going to work on our cost structure and capabilities, particularly so that we can be more competitive in the stock cabinet segment, which is a relatively small portion of our business right now.
Great. Thank you.
Thank you. As a reminder, ladies and gentlemen, that's star then one to ask a question. Our next question comes from Julio Romero with Sidoti. Your line is now open.
Hey, good morning, everyone.
Morning.
Morning, Julio.
Just on that last point, Bill, you had talked about evaluating options for 2020 and potentially for the stock cabinet segment. Could you possibly convert some existing manufacturing to service that stock cabinetry, or does it take a greater undertaking for a new facility or something along those lines?
It wouldn't be a new facility. We're looking at some technological investments in existing facilities, and you're right, some potential conversion of capabilities elsewhere. Still in the early stages of evaluation, but at least wanted to get it out there. We recognize this trend looks as though it's going to continue and clearly a high priority for us strategically is to figure out a way to make that an integral part of our business at similar levels of profitability, and enjoy the growth prospects.
Okay. Very good. I wanted to ask about how tariffs are affecting the industry and consequently Quanex. I would assume that tariffs on cabinet components coming out of China would be driving some increased quoting your way. Can you talk about if that's happening and how that should flow through your P&L in the coming quarters?
We are seeing increased quoting activity. In all fairness, I think it's driving the business to other low-cost countries outside of China. A lot of it is really going to move, I think, to Mexico, to existing cabinet manufacturers' facilities. A lot of it is moving towards Vietnam and Indonesia. As of yet, we have not been successful in being awarded any of that business. Frankly, right now, I think it's unlikely as this goes to other low-cost countries.
Understood. Appreciate the detail there, and best of luck in the rest of 2019.
Thank you.
Thank you. Our next question comes from Ken Zener with KeyBanc. Your line is now open.
Good morning, everybody.
Morning.
Morning, Ken.
Wow. Bill, this is one of the more dynamic calls, I think, not only because your businesses are performing well, perhaps better than expected on certain levels, but you're also talking about reinvesting. If I could just take a broad picture, what hesitations do you have given the slowdown in housing growth? Obviously, our view is that it'll be flat modestly, both new and R&R. What concerns do you have given your experience last cycle with investing at this point of the cycle? Are you basically saying with your German expansion, U.K. extrusion, that you're running at 100%, or just about? How do you balance those incremental sales that you want with what would be perhaps more of an incremental margin drag as you add capacity and fill it out?
Trying to take this piece by piece. It's been very clear, I think, through this year that Europe in general has been a positive surprise all around, given the political chaos, the fact that that business continues to perform. I think it's going to continue to be insulated from many of the things we see in the U.S. We've talked in the past about if there were acquisition opportunities, that's a jurisdiction we will probably look at. Our view now is that investment in expanding capacity there is a better way of continuing to grow those markets. We're not talking about bricks and mortar. We're not bumping up against 100% capacity at this point. Yes, this is a forward-looking view.
We feel Europe's going to settle down, and we think all the pieces are in place for us to continue to get growth there. We just want to be ready for it in terms of production capability. In the U.S., almost the same thing applies. Any potential acquisitions to fuel our growth in North America are few and far between. As we look at the horizon, it actually makes more sense for us to increase capacity in those segments where we know we can get growth. The labor issue isn't going to go away. I think we can continue to enjoy increased screen business. That will require setting up at least one, if not two, and possibly even a third screen manufacturing plant. The capital investment there is minimal. It's a few hundred thousand dollars in a leased facility.
We may utilize existing facilities to do that, but there's opportunities for growth there. The harder ones are investments in technology to better position our vinyl extrusion business, which as you know is one of our more competitive product lines, and the stock cabinet business. We will monitor the potential investment against what's likely to happen in the residential markets in 2020. We concur with your view. We think starts will be flat or flat-ish next year. We're not convinced that there's a downturn on the way, and when you put all the pieces together, it's not a bad time to invest in the business and really take advantage if things continue to slow down.
Very fair answer. I appreciate that. Within that outlook, now that we have 2019 guidance pretty much done by quarter, is there a way we should think about growth relative to incremental margins in each of your segments? Usually companies offer 20% or 30% incrementals. Has your base business stabilized enough that we could hear from you some type of guidance in that regard?
Yeah, that'll be more appropriate, I think, on our December call. As we've talked about before, the reason it becomes difficult is the business product lines, as you know, are completely different. As we've said, the screen business, which is where we are seeing growth, kind of has the lowest drop-through rates. Clearly, we've been awarded some new business in our vinyl business. That will change that a little bit. We will attempt to do a better job at clarifying that as we guide towards 2020 in December.
Thank you very much.
Thank you. Once again, ladies and gentlemen, that's star then one to ask a question. Our next question comes from Reuben Garner with Seaport Global Securities. Your line is now open.
Thanks. Good morning, guys.
Morning.
Morning, Reuben.
I had some technical difficulties, so excuse me if this was already asked, but I just want to try to understand your top-line guidance a little bit. What changed for you guys from your last guide? Was it predominantly the secular pressures in cabinets, or are you seeing a softer consumer and housing outlook? Is it a combination of the two? What really was the difference between what you guided a few months ago and what you're guiding today?
I think the biggest change is that in the fenestration segment, that we have not seen the bounce back in mid to late summer that was originally anticipated, particularly by our customer base. I think the housing sentiment has clearly sort of weakened as summer has gone on here. The benchmark we use, Ducker forecasts window shipments at the start of the year. That marketing group forecasted window shipment growth in the low single digits and is now forecasting the full year to be negative year-over-year. We're seeing that. The good news is, because of the things I just talked about, we're actually doing much better than the market in that case. In case of cabinets, the KCMA numbers continue to show about a 5% decline in semi-custom compared to a 5% increase in stock cabinets. We're seeing a continuation of that.
Really, the change since our last guidance is the continued softness in primarily the North American fenestration segment, which of course is our biggest.
In the fenestration segment, forgive me for not knowing this, but is it possible that your customers built up some inventory in anticipation of demand being better, and that's leading to them not necessarily ordering as quickly as they otherwise would have?
I don't think so. I think the channel remains as it always has. I think overall demand is there. If you recall, we talked earlier in the year that really the constraint on whether we would see a pickup in the second half to recover from the weather in the first half was really going to be labor. I think that's what we're seeing now. There's just not enough labor, even for renovation projects, as well as new construction, to pick up the business that was lost earlier in the year.
Okay, last one from me. This past quarter, we heard some good orders commentary from some of the builders. Has anything changed in the last month that you would think that that wouldn't ultimately flow through to you guys? Mortgage rates have come in. I know that there's broader macro concerns, the consumer seems to be doing okay. Is there anything that would lead you to believe that that trend may not continue or eventually lead to business for you guys as we look into your next fiscal year?
All I think we can say is these numbers we just reported are as of the end of July. We're in the process of closing our month of August, and the trend we saw in June and July continued into the month of August. Right now, the expectation is we'll see that trend continue into September as well. The answer is no, we are not seeing it. That's why I said on the remarks here, there's a lot of optimism around interest rates, and mortgage rates continue to fall to an all-time low, driving a lot of refinancing, but it does not seem to be driving an increase in new construction, at least not yet.
All right. Thank you, guys.
Thanks.
Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Bill Griffiths for any closing remarks.
Thanks, everyone, for joining us on the call today. We look forward to updating you in early December. We expect a strong close to the year as we continue to focus on the things that we have direct control over. Once again, thanks, and we'll see some of you as we hit the road here in the next few weeks. Thanks, everyone.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.