Good day, ladies and gentlemen, and welcome to the second quarter 2019 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. If anyone should require assistance during the program, please press star then 0 on your touchtone telephone. As a reminder, today's program is being recorded. Now I'd like to introduce your host for today's program, Scott Zuehlke, Vice President, Investor Relations and Treasurer. Please go ahead, sir.
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. 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. Quanex undertakes no obligation to update or revise any forward-looking statement to reflect new information or events. For more detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measures to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website. I'll now turn the call over to Brent to discuss the financial results.
Thanks, Scott. I'll begin with a review of the income statement and finish with comments on cash flow and the balance sheet before handing the call over to Bill to provide some color on our performance and expectations for the rest of the year. We generated net sales of $218.2 million during the three months ended April 30, 2019, compared to $214.2 million for the three months ended April 30, 2018. The increase was mainly due to strong revenue growth in our European Fenestration segment, which was driven by above-market growth and price increases related to raw material inflation recovery. We reported a net loss of $24 million or $0.73 per diluted share for the second quarter of 2019, compared to net income of $4.1 million or $0.12 per diluted share during the same period of 2018.
The decrease in reported earnings was primarily the result of a $30 million or $0.91 per share non-cash goodwill impairment in the North American Cabinet Components segment, mainly due to lower volume expectations related to the continued shift in the cabinet industry away from the semi-custom segment to the stock segment. On an adjusted basis, net income increased to $6.3 million or $0.19 per diluted share during the second quarter of 2019, compared to $4.8 million or $0.14 per diluted share during the second quarter of 2018. The adjustments being made for earnings per share are restructuring and related severance expenses, non-cash 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 to $23.4 million compared to $21.7 million in the second quarter of last year.
The increase in adjusted earnings year-over-year was primarily attributable to operational efficiency gains and the successful implementation of pricing initiatives. Moving on to cash flow and the balance sheet. Cash provided by operating activities was $20.4 million for the three months ended April 30, 2019, compared to cash provided by operating activities of $13.4 million for the three months ended April 30, 2018. We generated free cash flow of $13.6 million in the second quarter of 2019, which is more than double the $6 million we generated during the same period of 2018. This allowed us to repay $5 million in bank debt during the quarter and repurchase approximately $2.7 million of common stock. Our leverage ratio of net debt to adjusted EBITDA decreased to 2.3 times. As of April 30, 2019, we had approximately $23.3 million remaining under our existing share repurchase program.
We are confident in our ability to generate strong free cash flow in the second half of this year and expect to continue paying down debt while opportunistically buying back stock. We also continue to expect to exit fiscal 2019 with a net leverage ratio of between 1.5 to 2 times. I will now turn the call over to Bill.
Thanks, Brent. We are pleased to report another strong quarter with revenue growth and margin expansion across all segments, combined with a doubling of free cash flow compared to the same period of last year. More specifically, our European Fenestration segment led the way again with revenue growth of more than 15%, excluding foreign exchange impact and margin expansion of almost 400 basis points. Similar to last quarter, this performance was largely driven by above-market growth and price increases implemented late last year. As you know, North America was plagued by poor weather across much of the country during the quarter. This negatively impacted results in both segments.
Notwithstanding this, our North American Fenestration segment still outperformed the market with revenue growth of 1% compared to Ducker's latest calendar first quarter window shipment estimate of negative 4%. Ducker recently reduced their full year 2019 window shipment growth estimate to 0.7%, down from 1.5%. During the first half of our fiscal year, our North American Fenestration segment has reported sales growth of 3.5%. We also realized 50 basis points of margin expansion in this segment in the second quarter. Moving on to our North American Cabinet Components segment. The semi-custom segment of the cabinet industry continues to be challenged with KCMA reporting negative 5.7% and negative 5.2% growth for the three and six months ended April 30, 2019. We outperformed the semi-custom market with growth of 0.3% and negative 1.6% for the three and six months ended April 30, 2019.
Unfortunately, we expect negative sales growth in this segment for the remainder of the year as comps get more difficult and the shift from semi-custom to stock continues. Not surprisingly, this was the biggest driver of the impairment charge and the revision to our revenue guidance for fiscal 2019. On a positive note, however, efficiencies continue to improve, resulting in margin expansion of 110 basis points for the quarter. Assuming we do see a continuation of negative single-digit growth in revenues in this segment during the second half of the year, we would expect margins to remain flat for this combined six-month period, with margin degradation in Q3 due to the tough comp, but margin expansion again in Q4.
Despite the revenue headwinds in cabinets, on a consolidated basis and excluding foreign exchange impact, we reported revenue growth of approximately 3.2% for the quarter, with a margin expansion of approximately 70 basis points. As Brent mentioned, free cash flow for the quarter was solid and more than doubled year-over-year to $13.6 million. Revenue growth for the six months ended April 30th, 2019 was approximately 3.4%, excluding foreign exchange impact, which is below the low end of our original revenue guidance. We expect a stronger second half in our North American Fenestration segment and continued strong growth in our European Fenestration segment. Revenue headwinds are expected in our North American Cabinet Components segment.
Our first half sales growth performance, combined with our current expectations and outlook for the second half, mainly in our North American Cabinet Components segment, have caused us to revise our fiscal 2019 revenue guidance down slightly to between 2% and 3% growth. Despite the lower growth expectations, we remain very confident in our original adjusted EBITDA guidance of $97 million-$107 million. We also expect to generate enough free cash flow in the second half to continue paying down bank debt and still expect to exit the year well below two times leverage ratio. We also expect to continue to opportunistically buy back stock at a similar rate to the first half repurchases. Now operator, we're ready for questions.
Certainly. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch-tone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Daniel Moore from CJS Securities. Your question please.
Good morning. Thanks for taking questions.
Good morning, Dan.
Bill, Brent, why don't we start, George, start with European Fenestration. Obviously continues to be really strong in taking share. Last quarter, we thought maybe a little bit of inventory building going on ahead of Brexit. Is your sense that's still the case this quarter? Maybe just talk about the underlying drivers there, then if you could just break out the 7% growth FX between volume and price.
Similar to last quarter, about half of the growth is really driven by the price actions we took late last year. We do continue to take share, particularly at HL. We do not see any change in inventory build as a result of Brexit. I think that's finished. We did not see inventory drawdowns, hence the strong growth profile there. We're very pleased. We expect to see that continue through the balance of the year at this point.
Helpful. Shifting gears, the North American Cabinet Components, obviously you gave good color there on the shift towards stock. Maybe you can give it a little more detail of what you're seeing in the market and what, if anything longer term you can do to kind of shift as tastes and mix shifts there?
Yeah. Clearly, if you look at the KCMA data adjusted for our fiscal year, for the first six months of our fiscal year, the semi-custom market is down 5.2%, and the stock segment's up 6%, and the full custom is about flat year-over-year. Clearly the industry is trending in that direction. The forecasts for the second half of the year are for similar numbers. While we continue to look at how can we do better inside the operations, it's prudent to at least flag. We could see mid-single-digit decreases in revenues, particularly against some stronger comps, as we go through the second half of the year. We're clearly looking at longer term strategies as to how to get better positioned in the stock segment. The challenge, of course, is the price points and the margin profile is not necessarily as attractive.
We don't have an answer yet, it's very much front and center of our long-term plan, particularly as we start getting into next year's operating plans.
Very helpful. Appreciate it, Bill. One more and I'll jump out. Wood prices clearly coming down a little bit. Maybe just talk about raw materials trends in general and how much of an impact they may have had on gross margin in the quarter and the outlook going forward.
I wouldn't say that raw materials in total had a material impact in improving profitability. It didn't hurt us, but it didn't help us significantly either. Most of the improvement is productivity and efficiency gains that are finally flowing through the P&L.
Helpful. Appreciate it. I'll jump out with any follow-ups. Thanks.
Thank you. Our next question comes in the line of Reuben Garner from Seaport Global Securities. Your question, please.
Thanks. Good morning, guys.
Morning, Reuben.
Just a follow-up on the cabinets question. Or I guess your outlook. You guys, I think you said in the first half, the cabinets data would've been down something like mid-single digits, and you guys clearly outperformed that. Is your expectation that the market may be down mid-single digits in the second half, and you can outperform that? If so, what's driving that outperformance on your end? Is there a difference in exposure between you and the overall industry data or something you're doing that's driving that outperformance?
Well, it is a little bit of both, actually. It isn't as clear cut that we're 100% semi-custom and zero stock. We clearly participate in that stock segment, but on a limited basis. I think our ability to outperform the raw statistics is partly because of that, and partly some of it is driven by pricing actions that we took earlier in the year, that are helping sort of improve our revenue profile over the market in general.
Okay. That's helpful. I guess outside of the secular pressures, if you will, on the cabinet side, what's your general outlook for the next 6 to 12 months as you're talking to customers just on R&R and new construction growth going forward?
We're actually optimistic and most of our customers, I would say are perhaps even overly optimistic. Clearly, weather impacted the first half of the year. There's a high expectation that both new construction and R&R is gonna recover in the second half. Next year is kind of too far out to tell right now. I think if we see interest rates either falling or at least remaining static here, I think we're gonna see a groundswell back towards the whole residential sector here. We actually feel very good about where we are and what the outlook is for the second half, and we're optimistic for next year.
Okay, last one from me. The margin expansion you talked about, some of your internal efforts starting to flow through. How much of the margin expansion in your guidance for the second half is kind of items within your control, whether it's savings from reorganization or things you've been working on in the cabinets business. How much is within your control and how much is price cuts, volume growth, et cetera?
It's essentially the outlook for the balance of the year. Any margin improvement is completely within our control. The only thing that we're nervous about is if, in fact, the cabinet business in semi-custom continues to deteriorate. And for whatever reason, we can't beat the market, those volume declines are severe enough, it's going to be hard to continue to get expansion. We probably can tread water, although, as I said in the remarks, the third quarter comps are pretty strong compared to last year. I think it's likely we could actually see some margin shrinkage in cabinets, but we'll recover that in Q4 when the comp's a little easier.
Perfect. Thank you.
Thank you. Our next question comes to the line of Steven Ramsey from Thompson Research. Your question please.
Good morning.
Hi, Steve.
Thinking on cabinets, if we were to kind of think two years out from now, are you still working to get into that position where you can be equally as profitable on stock as semi-custom? Does the looming potential consolidation in the space, and even tariffs now in Mexico, does that change where you think you can take the business over a one to two-year timeframe?
No. We are still very confident and very optimistic about the profitability level in that business, particularly if we look out over the next two or three years. We will adjust the mix shift accordingly, and we are working on plans to do that. I think the whole tariff issue could end up being a positive for us. I think the worst case scenario we see is this is a slightly smaller revenue business, but more profitable.
Excellent. Can you share more on how tariffs end up being a positive for you?
Yeah. I think if the tariffs end up sticking or if there's no immediate end in sight to tariffs, it will drive more business back to the U.S., which is clearly a benefit for us because, I think you understand, most of the cabinet manufacturers don't have a lot of excess capacity. I think we would be a beneficiary, and we have clearly seen increased quotation activity, particularly as it relates to the Chinese tariffs and the anti-dumping case.
Great. Last from me, stock, movement, your stock that is, not stock cabinets, but your stock, moving up a good bit today, clearly on good results. At what zone does the stock price get less attractive for a buyback? If that happens, do you build cash to maintain leverage, or do you increase the ongoing dividend, even consider a special dividend? If the stock stays a little more permanently elevated here, how does that change your view on the buyback?
Well, I think very clearly the number one priority in the second half of the year when we start generating some pretty serious cash is to continue to delever with a target of getting ultimately down to around one and a half times. Depending what happens to the stock price here, if it continues to be strong, I think you'll see us buy back limited amounts of stock in preference to paying down debt. Assuming we do close the year as we expect, closer to one and a half times, certainly below two, if the stock is performing as we think it should, at the levels we expect to close the year at, then I think we'll have a nice problem to worry about next year in terms of what we do with our excess cash.
I would say it's unlikely, based on what we know today, that we'll do anything more with the dividend in the short term. If 2020 looks like it's going to be a strong year relative to 2019, with a strong stock price, I would expect us to hoard cash for a period of time. That'll be a very nice problem to have to worry about.
That's right. Okay, thank you so much.
Thank you. Our next question comes from the line of Julio Romero from Sidoti & Company. Your question please.
Hey, good morning.
Morning, Julio.
Wanted to start off with the screens and insulated glass spacer products. Can you just talk about the trends you're seeing there and how that kind of squares away with your expectation for revenue in the North American Fenestration for the year?
Yeah. Certainly in screens, we continue to take share. I think one of the reasons we're outperforming the fenestration market is, as we have mentioned before, we're taking on some additional screen business. The spacer business continues to improve, not as rapidly as the other segments. The other portion of the outperformance to market in fenestration is really additional business that's now in production in vinyl extrusions. Hence our confidence level that we'll see a stronger second half of the year. Our customers are pretty optimistic that we'll see a bounce back here, both in new construction and R&R once the weather clears. We feel pretty good about where growth goes. It's just not going to be enough to offset potential negative growth in cabinets.
Okay, understood. Just switching gears over to cabinets, I guess. You saw some nice margin expansion despite the flat sales. Maybe talk about some of the underlying efficiencies you're seeing there. I know you've done some layout improvements. Is the improvement in margins driven by layout improvements or just any further color on what's going on in that segment?
Yeah, it's a combination. As you well know, we've put a lot of effort into productivity in general. Layouts, automation, and just general efficiency gains, along with some pricing we put in place in the earlier part of this year. That combination has really driven that margin expansion. We've, I think, been pretty transparent about the opportunity that still exists in cabinets to improve the profitability. We've been slow getting there, but I think we're finally starting to see it. It's kind of unfortunate that we may have negative growth in the second half of the year, but I think even with that, we'll be able to hold margins flat. I wouldn't expect a complete second half margin shrinkage. We may not be able to expand margins much further, though, and that's the second half combined. As I said, Q3 has a pretty tough comp.
I doubt we're going to be able to beat that.
Okay. Maybe just more broadly, piggybacking on the question earlier about the potential divestiture activity from the OEMs and the consolidation there. Just how are you guys thinking about the potential changes in the value chain and potential opportunities and threats that can come from that?
Yeah. I don't want to talk too much directly about our customers. Obviously, we're very close to all of them. Like we've seen in windows, our expectation is, for the most part, that as consolidation continues to take place, we will not be harmed by that. I think you have to look at it in terms of the current capacity at our customers' facilities, combined with our ability to produce more product, simply because we've continued to drive down our cost structure, improve productivity. We're actually freeing up capacity as we get more profitable. We have the ability here to take on incremental business, whereas even with a consolidation, most of our customers do not. Now, there may be some exceptions to that. We'll see how it plays out, but we're obviously monitoring it very closely. It is not something that keeps us awake at night.
I think by the time all is said and done, there'll be as many opportunities as there will be risks. We're not concerned about it. We still think this is a good space to be in over the next several years.
Okay, very good. Just lastly for me, the SG&A outlook. Can you just talk about the outlook for the year and what the cadence might be for the next two quarters? Thank you.
Yeah. I think when you look at last year's, last year's SG&A is about $103.5. We're kind of in that level. Is it $103-$105 range? In terms of how that flows over the back half of the year, pretty consistent Q3, Q4 levels in the $25 million-plus range. Pretty even in those back two quarters.
Okay, that's helpful. Thank you for taking the questions, and best of luck on the back half of the year.
Thank you.
Thank you. Our next question comes from the line of Kenneth Zener from KeyBanc. Your question please.
Good morning, gentlemen.
Good morning.
Morning.
I think that SG&A guidance you just gave was a bit down from what you guys had before, being dollar value. I assume that's associated with your lower revenue and/or are there cost actions that you guys are taking?
No, it's slightly down. I think we talked about 105 before. It's kind of 103 to 105. We took some actions-
Okay
in the first quarter that obviously we've seen some benefit from here in Q2, and then would expect to continue in the back half of the year.
Okay. Sorry, I said it was the one attender. E.U., very impressive, what's happening there in terms of margins. I believe, and I could be mistaken, but I think you guys beat your margin guidance that you gave back on the last quarter. Could you talk about what the factors were there, and why you think that business is doing so well given all the noise, I don't know if that's the right term, that we're hearing from the U.K.?
A good part of it is, we put price increases through at the end of last year that kind of caught up with rising input costs, both in the spacer business and in the vinyl profile business. Since then, in Europe in particular, both of those cost increases have abated. In fact, some of the costs are coming back down, but we've maintained price levels, because if you recall, Ken, there are no contractual passes throughs in Europe. We've enjoyed some margin expansion as a result of that. I think the reason that this business outperforms the general economy is, when a window fails, you have to replace it. Because the infrastructure's so old and the replacement cycle continues there, it's a little bit insulated from the general economy.
In addition of which, remember, almost all of our business in Europe, particularly in the U.K., is repair and remodel. Almost none of it is tied to new construction. I think the combination of all of those things, plus there are a couple of competitors that are having some challenging times in the U.K. in particular, and we are gaining some market share. In this case, we have all three things working in our favor. That's why the exceptional performance.
Thank you for that. That's very useful. Sticking with that, could you give us, I don't know, where your share is now versus, let's say, at the time of acquisition? If you think about it that way, we can understand how your success is relative to peers.
Yeah. There are about six of us, all that started out a couple of years ago with very similar market share. All in the low to mid-teens. We've improved by 1% or 2% relative to some others over that period of time.
Okay. It sounds like it's really your pricing and it's okay. In the U.S., obviously, cabinets has taken companies that are in the space larger than yourself by surprise on this mix shift. In terms of the fenestration and I believe recent share gains with some old customers on the extrusion side, could you maybe update us there in terms of how oil might be flowing through your input costs and your customers coming back to you and how that's helping your utilization? Thank you very much.
Yeah. We haven't seen much in the way of raw material price escalation. If we do see, particularly on the resin side, it's a pass-through anyway, that shouldn't have a material effect on us. I think we are now in full production with one customer that started ramping up at the beginning of this year. We'll see that continued utilization through the back half. We have another customer that's not yet in production. We're still going through pre-production trials. We'll see some improvement in Q3, but a full ramp-up in Q4. That clearly will help us on the fenestration side as well. The screen business, we continue to get awarded, but relatively small dollar amounts. Those two combined really put together the bulk of our share improvement in the fenestration side. We feel pretty good about where that's heading for the future.
Thank you very much.
Thank you. Our next question comes from the line of Daniel Moore from CJS Securities. Your question, please.
Thanks again. Just housekeeping. Obviously confident about cash flow coming in really strong in the back half. Are we still looking at cash flow from ops in the $50 million-$55 million range and CapEx $25-$30? Any changes there?
No changes. Free cash flow in that level. Yes. CapEx, no changes to any of those forecasts at this point.
Right. Perfect. Okay. Thank you.
Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Bill Griffiths for any further remarks.
Thanks everyone for joining the call. We look forward to speaking to you next quarter. Thank you and goodbye.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.