Good day, and thank you for standing by. Welcome to the first quarter 2023 Quanex Building Products Earnings Conference Call. At this time, all participants are in a listen only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you'll need to press star one one on your telephone. You will hear an automated message advising you your hand is raised. To withdraw your question, please press star one one again. Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Scott Zuehlke, SVP, CFO, and Treasurer. Please go ahead.
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 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'll now turn the call over to George for his prepared remarks.
Good morning to everyone joining the call. As I begin my fourth year as CEO of Quanex, I look back and realize that there is yet to be a normal period during my tenure. Shortly after I stepped into this role, we were faced with the unprecedented challenge of a global pandemic. We overcame many unknown challenges in the early stages of that crisis, only to then face a rapid increase in demand spurred on by government infusions of capital into economies around the world, coupled with a worldwide labor shortage that caused massive supply chain disruptions. Together, these factors tested the limits of every manufacturer's production capabilities and ultimately led to severe inflationary pressures over the last two years that largely continue today.
In addition, longer than normal lead times during this period created strong protectionary demand amongst our customers that has resulted in inventory rebalancing and reduced demand now that our lead times have returned to normal levels. Through all this, the Quanex team has done a phenomenal job, and I'm extremely proud of what we have accomplished. I say all this as a backdrop to the following statement. I think we may have just experienced our first quote-unquote normal quarter since before the pandemic. When comparing our first quarter 2023 results to the same period of 2019, we are able to see a seasonality pattern that is very similar. Most of our customers scheduled shutdown days during the holiday period of December 2022, and the startup periods in January 2023 were slow but began to pick up towards the end of the month.
This scheduling pattern was the norm pre-COVID, but was not followed over the past couple of years because of the abnormally high demand that everyone was seeing in the market. From an order intake perspective, the only items that I would call out as one-offs during the most recent quarter are some weather impacts on the West Coast and the impact of some customers reducing their inventory levels due to our lead times returning to normal. Looking at the overall macroeconomic environment, we still believe that in the near term, rising interest rates driven by the uncertain actions of the Fed, tight labor markets, and the ongoing war in Ukraine will continue to impact consumer confidence and create some uncertainty in the markets we serve.
However, we also believe that housing remains underbuilt overall, and with the affordability of housing beginning to improve, an uptick in both the new construction and R&R markets is not out of the question. Globally, inflationary pressures have been mixed. We have realized significant price decreases in some of the commodity raw materials we consume that are tied to index pricing mechanisms. In other areas, such as PVC resin, we saw some decreases, but those costs have stabilized and have actually started to increase slightly more recently. On the flip side, strong inflationary pressures still exist when it comes to labor and benefit costs, freight, energy, and other services. We will continue to aggressively work on productivity projects to help offset these pressures, but where needed, we will increase price to protect margins. I will now provide some general comments on each of our reporting segments.
Compared to Q1 of 2022 and excluding the contribution from the LMI mixing business we acquired in November, revenues in our North American Fenestration segment declined by approximately 7%. Having said that, the comp in 2022 was tough and seasonality was essentially nonexistent over the last two years. We believe that a return to a more normal seasonality pattern, combined with customer-initiated programs to reduce their working capitals as lead times have improved, resulted in the softer year-over-year demand. Although the year-over-year comps for the next two quarters will also be challenging, we do anticipate that volumes will follow a more traditional seasonal pattern with increases into the spring and summer months. We believe this additional volume will also result in improved margin performance as our more leveraged product lines are able to realize the volume benefits.
Operational performance in this segment has been solid, and we've been able to adjust our lead times back to normal levels. We just need the seasonal demand to return as we expect it will. Looking at the LMI acquisition and now four months into the integration, I am pleased to report that we are on track with our integration plan and fully expect to meet or exceed the synergy target of $500,000 that we announced at the time of acquisition. In our North American Cabinet Components segment, we saw a year-over-year decrease in revenues of 12.3%, which was primarily a result of lower market demand. In addition, most of our customers implemented additional shutdown days over the holiday period to lower their working capital.
We anticipate this reduction in revenue will continue near term as the pricing of both hard and soft maple are still decreasing, triggering our raw material index mechanisms. From a margin perspective, we were able to maintain our improved operational performance levels and to capitalize on the timing of the lower cost lumber purchases. As a reminder, index pricing tends to be on a 90-day lag, so when lumber prices are dropping, we tend to benefit from the timing cycle as long as the prices don't drop too quickly. Finally, revenues in our European Fenestration segment declined by 6.7% year-over-year. However, when you exclude the foreign exchange impact, revenue actually increased by approximately 4% compared to Q1 of last year. Although the macroeconomic headwinds of inflation and an energy crisis related to the Ukraine War are still present, this segment continues to perform well.
Share gains within our vinyl profile products, price increases to offset inflation, and the launch of new products continue to offset the headwinds. On that front, we are very excited about the recent launches of our new 090 and 090R window systems, a new vented head drip for window systems, and finally, our new Genesis Spacer system, which adds another spacer product to our already high-performing Super Spacer product line. All three of these new products have generated much excitement in the market and will help address thermal and operating performance of insulating glass units and full window systems. In summary, we believe we are seeing a return to a more seasonal cadence of orders as global supply chains have improved and the world economy has become more accustomed to a new post-COVID normal.
Near-term headwinds provide challenges and make it much more difficult to be able to provide nearer guidance changes. However, we remain optimistic on the long-term outlook. The entire company remains focused on continuous improvement, serving our customers, and controlling the things that we can control. Optimizing return on invested capital and working capital remain top priorities for improved cash flow generation, which will support our growth initiatives and align with our road to $2 billion strategy. We are well-positioned to capitalize on growth opportunities as they arise or to weather any type of prolonged macroeconomic downturn if it's necessary. In short, the future of this company is bright despite near-term challenges.
I'll now turn the call over to Scott, who will discuss our financial results in more detail, and we'll finish up by providing some modeling assumptions and a cadence for Q2.
Thanks, George. On a consolidated basis, we generated net sales of $261.9 million during the first quarter of 2023, which represents a decrease of 1.9% compared to $267 million during the first quarter of 2022. The decrease was mostly attributable to softer demand, customer inventory rebalancing initiatives, and foreign exchange translation impact. Overall, we believe that our results for the first quarter of 2023 indicate a return to what was normal seasonality prior to COVID, with Q1 being the lowest quarter of each fiscal year. Net income decreased to $1.9 million or $0.06 per diluted share for the three months ended January 31st, 2023, compared to $11.2 million or $0.34 per diluted share for the three months ended January 31st, 2022.
After adjusting for one-time transaction and advisory fees, net income decreased to $6.1 million or $0.18 per diluted share for the quarter, compared to $11.3 million or $0.34 per diluted share for the same period of last year. On an adjusted basis, EBITDA for the quarter decreased to $20.5 million compared to $24.4 million during the same period of last year. The decrease in earnings for the first quarter of 2023 was largely due to lower volumes, one-time transaction and advisory fees, foreign exchange translation, higher interest expense, and increased stock-based compensation expense, mostly due to stock price appreciation.
For results by operating segment, w e generated net sales of $153 million in our North American Fenestration segment for the first quarter of 2023, which represents growth of 4.3% compared to the first quarter of 2022. The increase in revenue was driven by the contribution from the LMI Custom Mixing assets we acquired in November of 2022. Excluding the contribution from LMI, revenue would have been down approximately 7% year-over-year, driven by a decrease in volumes due to softer market demand and customer inventory rebalancing initiatives. Adjusted EBITDA was $15 million in this segment, or about 8% lower than prior year. We do expect margins to improve in this segment as the year progresses.
We generated net sales of $54.7 million in our North American Cabinet Components segment in Q1 of 2023, which was 12.3% lower than prior year. Once again, the decrease was driven by lower volumes. Adjusted EBITDA was $1.7 million for the quarter compared to $2 million in the first quarter of 2022. Margins were consistent compared to the first quarter of 2022. Hardwood pricing started to come down towards the end of fiscal 2022 and continues to decline, which will pressure revenue for the remainder of the year in this segment. Our European Fenestration segment generated revenue of $55 million in the first quarter, which represents a decrease of 6.7% year-over-year. However, e xcluding foreign exchange impact, revenue in this segment increased by 3.9%, driven by higher pricing across all products and share gains in our vinyl extrusion business.
These items were partially offset by volumes declining in our spacer product line due to some customer inventory rebalancing initiatives and softer market demand. From an operational standpoint, this segment performed well during this quarter despite additional macroeconomic headwinds, including the war in Ukraine and related increases in energy costs. Adjusted EBITDA came in at $9.7 million for the quarter compared to $10.4 million in the first quarter of 2022. Margins held up nicely, we expect continued success protecting margins in Europe as we flex our cost structure and push price to cover inflationary costs where appropriate in a softer market. As a reminder, we do not have pass-through mechanisms built into our contracts in Europe.
Moving on to cash flow and the balance sheet. Cash provided by operating activities improved significantly to $3.1 million for the first quarter of 2023 compared to negative $21.7 million for the first quarter of 2022. The value of our inventory decreased during the quarter due to easing raw material inflationary pressures, which had a positive impact on working capital. Free cash flow was negative for the quarter, which is not uncommon for our company in Q1. However, we realized an improvement of about $25 million year-over-year. Our balance sheet continues to be strong. Our liquidity position is solid and our leverage ratio of net debt to last 12 months adjusted EBITDA was 0.8x as of January 31st, 2023.
Excluding real estate leases that are considered finance leases under U.S. GAAP, our leverage ratio of net debt to last 12 months adjusted EBITDA was 0.4x . Previously disclosed, we did borrow $92 million to acquire substantially all of the assets of LMI on November 1st, 2022. We were able to repay $5 million of it towards the end of the first quarter because of our free cash flow position. In the near term, we will remain focused on generating cash, paying down debt, and opportunistically repurchasing our stock. We will maintain our focus on growing the company through organic, inorganic, and innovative growth opportunities as they arise, while continuing to preserve our healthy balance sheet.
As stated in our earnings release, we are now prepared to provide official guidance for fiscal 2023, albeit with wider ranges than prior years, which is based on current macro fundamentals coupled with ongoing conversations with our customers. The near-term outlook for our business is cautious. Softening market demand, lower raw material pricing and related surcharge rollbacks offset in some ways by inflationary pressure in other areas and weaker consumer confidence, in part due to rising interest rates, are all causing near-term uncertainty. However, we are cautiously optimistic about the second half of our fiscal year and our long-term view of the residential housing market remains positive.
Guidance and modeling assumptions for fiscal 2023 are as follows. Net sales of $1.12 billion-$1.16 billion, adjusted EBITDA of $130 million-$142 million, depreciation and amortization of approximately $42 million-$43 million, SG&A of $120 million-$125 million, interest expense of $8 million-$8.5 million, a tax rate of 25%, CapEx of $30 million-$35 million, and free cash flow of $50 million-$55 million.
Looking to the second quarter of this year, we expect market volume to improve versus the first quarter of this year, which follows normal seasonality. From a cadence perspective, for the second quarter of this year versus the first quarter of this year, we expect revenue to be up 2%-4% on a consolidated basis. By segment for the second quarter of this year compared to the first quarter of this year, we expect revenue to be up 3%-5% in our North American Fenestration segment, down 6%-7% in our North American Cabinet Components segment, and up 12%-14% in our European Fenestration segment. Adjusted EBITDA margin is forecasted to improve by 350 basis points-450 basis points on a consolidated basis in the second quarter of 2023. Again, this is compared to the first quarter of this year.
Operator, we are now ready to take questions.
Thank you. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. One moment while we compile the Q&A roster. Our first question comes from the line of Daniel Moore with CJS Securities. Your line is open. Please go ahead.
Thank you, George, Scott. Good morning. Thanks for taking the questions.
Good morning.
Start with North American Fenestration. Give us any sense for the magnitude of the impact of customers rebalancing inventories, you know, last quarter and in the current fiscal Q2 so far, and any sense for kind of where we are in that process nearing the end, likely to continue for a couple of quarters? Any deep color there would be great.
In terms of the magnitude, you know, I don't think we're prepared publicly to break that out versus the volume drops. In terms of where we're at in the process, we started seeing that destocking or inventory rebalancing initiatives really starting to take hold at the beginning of December, has gone into January and early February. Knowing where we're at within our customers and during our visits, we think that that should start coming to an end here, very soon, probably within this month and going into the next. I think we'll see an end to that in this quarter, because at some point here, they're gonna have to start repurchasing inventory. We're starting to see some signs of that.
That's helpful, George. You gave good color, you know, full year and then Q2 kind of outlooks. What can you say about the expectations for the trajectory of margins, you know, across the segments embedded in your fiscal 2023 guide, given some of the moving parts with index pricing, and, you know, how should we think about margins year-over-year in each of the three segments for the full year?
Yeah, I think for the full year, for our fenestration segments, year-over-year EBITDA margins, flattish to maybe slightly down. I mean, again, we're trying to protect margins in all segments, but I'd say for the cabinet component segment, there's gonna be a little more pressure on margins for the full year. I think as we look at margins, and I hope what came across through our comments is, you know, going even back to 2019, you would see some fluctuations just based on seasonality, because we do have a couple product lines that are more highly leveraged, such as spacers in the vinyl profiles that the profitability is very much correlated and tied to volume because of the fixed cost structure.
As we start seeing that seasonality, volume ramp up, we would expect, as in the past, to see the profitability improve. In the Cabinet segment, you know, I think what we saw in the first quarter and what we've said all along is, you know, on the backside of index pricing, as wood prices go down, the ability to get ahead of those pricing mechanisms gives us some short-term benefits. You know, I think, we'll be working really hard, even with the drop on revenue, to be able to hold and sustain margins as much as possible in that segment.
That's really helpful. Maybe one more and I'll jump out. In terms of revenue, you know, at the midpoint, looking at sort of a low double-digit decline o rganically year-over-year. H ow much of an impact is pricing in that? Is that kind of low single-digit headwind versus volume? Just trying to get the breakout of those expectations. Thanks.
Yeah, that's tough to answer. I'd say so far year-to-date, it's mostly been volume driven only because year-over-year, specifically in the first quarter, pricing was actually still up year-over-year. Obviously, as raw material costs come down, pricing is gonna be impacted more going through the year. I think it'll start balancing out between volume and price probably more in the second half of the year.
Makes sense. I will jump back with any follow-up. Thank you.
Thank you. One moment for our next question. Our next question comes from the line of Steven Ramsey with TRG. Your line is open. Please go ahead.
Hey, good morning. This is actually Brian Biros on for Steven. Thank you for taking my questions. I wanna start on cash generation. A lot of companies this year are taking time to highlight their cash generation abilities, especially compared to last year, which was a tough year. I know you guys touched on it a little bit in the prepared remarks and in the guidance. Just expand on how you're thinking about the free cash flow for the year, maybe cadence through the year, and items to keep in mind that are different from last year.
I think if you look at last year, there was a pretty large hit to working capital mainly because of what was going on with inventories and the inflationary pressures there. Obviously, that subsided, we do expect that to benefit us this year. Historically, we generate most all of our cash in the second half of each fiscal year, I don't think this year is gonna be any different.
Gotcha. Thank you. Follow-up, I guess, would be just on the labor front. I guess, how are you guys thinking about labor through this, kinda, call it a trough period here? You know, it's easy to fire and protect margins, tough to hire then. How are you guys thinking about the labor dynamic of protecting margins versus keeping that labor for, you know, the long term, even the second half when things are expected to pick back up?
Yeah, you know, as we look at labor, and I think your point is spot on, it is difficult to get labor back when you lose it. I think we've been very cautious on, you know, reducing our labor workforce, and our teammates at any of the facilities. We've worked very hard to offset any sort of inflationary or margin pressures in other areas through continuous improvement in other activities. We've deployed them in terms of really getting caught up on some of those activities that we've done in preparing for the increase in volumes that we do anticipate. If we get to a point where we feel that, you know, a permanent reduction in workforce is needed, we'll obviously pull that trigger.
You know, our confidence level on where the market can go has really pushed us to look to find ways to offset costs in other areas before going to labor.
Thank you. I'll pass it on.
Thanks.
Thank you. One moment for our next question. Our next question comes from the line of Julio Romero with Sidoti. Your line is open. Please go ahead.
Thanks. Hey, good morning, George and Scott.
Good morning.
Yeah. You know, how do you feel about the prospects to achieve price gains ex index rollbacks across the portfolio compared to, say, three months ago?
I think we've continued to have success, and that's because we're being very open and transparent with our customer base. You know, areas such as we notated in our script that are still very, very real. Labor and benefit costs, you're not seeing rollbacks in those areas. Freight is very much in everyone's face, and it continues. I think, you know, there's obviously pushback, but we go with data that's justified and being able to justify it in all means. I think we've had continued success, and we'll continue to work and keep the dialogue open with our customers. The other thing, you know, it helps when we're showing that we are focused on productivity and finding ways to offset.
You know, we're also, I think, doing a very good job of trying to minimize what price increases we have to go and working with our customers to get the best value possible. To this point, we've been successful. It's not just a gimme, but I think our performance and our continued transparency gives us confidence that we'll continue to be successful in pricing.
Okay, that's very helpful. Then, George, I think you touched on it earlier. Just trying to think about product lines in the North American Fenestration segment from a leverage standpoint, I think. Are spacers and vinyl profile on kind of equal footing from a leverage standpoint? If you could just dig into that at all, if you could.
Yeah, I think they're very, very similar in the fact that they're both extrusion processes, although they extrude different materials. You know, it's one of those things where the machines like to be run and taking things down for changeovers or even shut down during delays. Startups are expensive, scrap levels are high. They're profitable when those extruders are running. I would say the impact on leverage is very, very similar when comparing those two product lines versus, you know, a screen product, which tends to be much more labor-paced.
Really appreciate the color there. I'll hop back into queue. Thanks.
Bye.
Thank you. I'm showing no further questions, and I'd like to turn the conference back over to George Wilson for any further remarks.
I'd like to thank you all for joining the call today. We look forward to providing an update on our next earnings call in early June. Thank you.
This concludes today's conference call. Thank you for participating. You may now disconnect.