Good day, thank you for standing by. Welcome to the Q2 2023 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Scott Zuehlke, Senior Vice President, 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.
Thanks, Scott. Good morning to everyone joining the call. All things considered, and with a tough comp to Q2 of last year, we are pleased with our results for the second quarter of this year. As mentioned on our last earnings call, we believed we were starting to see a return to normal seasonality in our business during Q1 of this year, and our results for the second quarter further reinforce that belief. Solid operational performance during the second quarter was somewhat masked by index-related pricing pressure and continued customer inventory rebalancing in our fenestration segments. Although volumes were down across all segments versus the prior year record levels, we did realize EBITDA margin expansion versus prior year on a consolidated basis.
Our strong operational performance also resulted in improved free cash flow, which enabled us to repurchase $5.6 million of our common stock and repay $20 million of debt in the quarter. I will now provide some general comments on each of our reporting segments. In our North American Fenestration segment, revenues and earnings were down versus prior year due to lower volumes, driven by softer market conditions, weather-related softness in West Coast markets, customer inventory rebalancing for our spacer products, and pricing pressures on lower raw material costs related to index pricing mechanisms. Operational performance remained strong in this segment, and we did a good job of controlling costs despite the lower volumes. In looking at the LMI acquisition we completed in November, I am pleased to announce that we have realized our announced synergy goal.
This business continues to perform very well. We are evaluating growth opportunities. Moving on to our North American Cabinet Components segment. The decrease in revenues year-over-year was primarily a result of lower market demand and the rollback of hardwood-related index pricing. We were able to realize solid margin expansion in this segment despite volume and index pricing pressures. Continued focus on cost controls, combined with capitalizing on the timing of lower-cost hardwood purchases, helped minimize volume impacts. In our European Fenestration segment, results were impacted by market softness, customer inventory rebalancing in our spacer business, and foreign exchange impact, which more than offset the share gains in our U.K. vinyl extrusion product line. Continued improvements in operational metrics, combined with sourcing initiatives and pricing carryover, all contributed to realizing margin expansion in this segment.
Having said that, challenges related to higher energy costs, higher transportation costs, and general inflation are ongoing in this market, and we continue to work with our customers regarding go-forward pricing expectations. In summary, we continue to execute on our strategic and operational initiatives, and we are controlling what we can control. Near-term inflationary headwinds and index-related pricing pressures present challenges for revenue, but the Quanex team continues to perform, and we remain confident in our ability to meet the net sales and adjusted EBITDA guidance ranges for this year. Optimizing return on invested capital and working capital remain top priorities for improved cash flow generation, which will support our growth initiatives and align well with our Road to two billion dollar strategy.
Although macro headwinds still exist for the entire building product segment, we feel we are very well positioned to execute on our strategy and create value for our shareholders. I will now turn the call over to Scott, who will discuss our financial results in more detail.
Thanks, George. Before I get started, I want to reiterate that we reported recorded results in the second quarter of last year. We did have a tough comp. However, business did improve in the second quarter of this year versus the first quarter of this year. On a consolidated basis, we generated net sales of $273.5 million during the second quarter of 2023, which represents a decrease of 15.3% compared to $322.9 million during the second quarter of 2022. The decrease was largely due to softer demand, caused in part by customer inventory rebalancing, lower pricing in North America, and Foreign Exchange Translation impact. Overall, our two key results further enforce our belief that we are seeing a return to normal seasonality in our business.
Net income decreased to $21.5 million, or $0.65 per diluted share, for the three months ended April 30th, 2023, compared to $26.5 million, or $0.80 per diluted share, for the three months ended April 30th, 2022. After adjusting for one-time losses on damage to a couple of our manufacturing facilities due to inclement weather, coupled with one-time transaction and advisory fees, net income decreased to $21.7 million or $0.66 per diluted share for the quarter, compared to $26.5 million or $0.80 per diluted share for the same period of last year. On an adjusted basis, EBITDA for the quarter decreased to $39.9 million, compared to $45.2 million during the same period of last year.
The decrease in earnings for the second quarter of 2023 was mostly attributable to lower volumes, decreased pricing, mainly due to surcharge rollbacks and raw material index pricing mechanisms in North America, foreign currency translation, and higher interest expense. Now for results by operating segment. We generated net sales of $157 million in our North American Fenestration segment for the second quarter of 2023, a decline of 11.8% compared to a $177.9 million in the second quarter of 2022, driven by a decrease in volumes due to softer market demand, customer inventory rebalancing in our spacer business, and lower pricing. We estimate the volumes in this segment declined by approximately 9% year-over-year, with the remainder of the revenue decline versus Q2 of 2022 due to a decrease in price.
Excluding the contribution from LMI, revenue would have been down 21.8% year-over-year in this segment. Adjusted EBITDA was $20.4 million in this segment, or about 22% lower than prior year. We generated net sales of $53.5 million in our North American Cabinet Components segment during the quarter, which was 26.6% lower than prior year. This decrease was driven by lower volumes and lower index pricing for hardwoods. We estimate the volumes declined by approximately 25% in this segment year-over-year, and the remainder of the revenue decline versus Q2 of 2022 was due to a decrease in price. Adjusted EBITDA was $4 million for the quarter, compared to $4.5 million in the second quarter of 2022.
We did a good job of controlling costs in Q2 of this year, we realized adjusted EBITDA margin expansion of 130 basis points in this segment compared to the second quarter of 2022. Our European Fenestration segment generated revenue of $63.8 million in the second quarter, which represents a decrease of 13.2% year-over-year, driven by lower volumes, due in part to customer inventory rebalancing in our spacer business and foreign exchange translation. We estimate that volumes declined by approximately 10% year-over-year in this segment, with pricing up by approximately 4% and negative foreign exchange translation impact of about 7%. Adjusted EBITDA came in at $14.9 million for the quarter, compared to $15.1 million in the second quarter of 2022.
From an operational standpoint, this segment continues to perform well. We realized adjusted EBITDA margin expansion of 270 basis points year-over-year. Moving on to cash flow and the balance sheet. Cash provided by operating activities improved to $35.3 million for the second quarter of 2023, which represents an increase of 78% compared to $19.8 million for the second quarter of 2022. We did a very good job managing working capital. 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 $27.8 million for the quarter, which was more than double the $13.4 million we generated in the second quarter of last year.
Our balance sheet continues to be strong, our liquidity keeps improving, and our leverage ratio of net debt to last twelve months adjusted EBITDA was 0.6x as of April 30, 2023. Excluding real estate leases that are considered finance leases under US GAAP, our leverage ratio of net debt to last twelve months adjusted EBITDA was 0.3x. As George mentioned, we were able to repay $20 million of debt, and we repurchased $5.6 million of our common stock in the second quarter because of our free cash flow position. We will remain focused on generating cash, paying down debt, and opportunistically repurchasing our stock. We will also maintain our focus on growing the company through organic, inorganic, and innovative growth opportunities as they arise, while continuing to preserve a healthy balance sheet. The goal is always to create shareholder value.
As stated in our earnings release, we continue to be cautiously optimistic for the second half of our fiscal year, and we believe the long-term underlying fundamentals for the residential housing market remain positive. Based on year-to-date results, conversations with our customers, and recent demand trends, we are reaffirming our guidance for fiscal 2023, which is as follows: Net sales of $1.12 billion-$1.16 billion, although we are now more comfortable with the lower end of this range. Adjusted EBITDA of $130 million-$142 million, although we are now more comfortable with the mid to upper end of this range. We previously guided to free cash flow of $50 million-$55 million for fiscal 2023.
Based on year-to-date results and the fact that we have done a good job managing working capital, we are increasing our free cash flow guidance to a range of $60 million-$65 million. From a cadence perspective, for the third quarter of this year versus the third quarter of last year, we expect revenue to be down 10%-12% on a consolidated basis. By segment for the third quarter of this year compared to the third quarter of last year, we expect revenue to be down 5%-7% in our North American Fenestration segment, down 30%-32% in our North American Cabinet Components segment, and down 2%-4% in our European Fenestration segment.
On a consolidated basis, adjusted EBITDA margin is expected to be flat to up 25 basis points in the third quarter of 2023, again, compared to the third quarter of last 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. Please stand by while we compile the Q&A roster. Our first question comes on the line of Reuben Garner from The Benchmark Company, LLC.
Thanks. Good morning, everybody, and congrats on the strong quarter.
Hey, Reuben. Thank you.
A couple of questions about the seasonality. I guess starting with the top line, I think the low end of the range would still imply a little pickup sequentially over the next two quarters, which I think is seasonally normal. Is there any risk to that? Or, I guess, what would the risks be to that? Is it further inventory reductions or just general market declines? I mean, what's kind of implied in the market, I guess, to get to those levels is probably a better way to ask it.
I'll take this. I'll start here, Reuben. You know, from a consolidated level, I would say, you know, we're very confident in hitting that low range of the guidance. If there were concerns, it would be macro-driven. I think we have some pretty good clarity now from our customer base. The order patterning, order patterns and inventory levels seem to be stabilized across the supply chain and with our customers. If there were a miss or upside to either, I think it's gonna be mainly driven by macro conditions.
Okay. In that same vein, on the it looks like you're implying that the margins are gonna be sequentially lower, quite a bit from where you were in Q2, and I know Q2 was a, you know, pretty impressive quarter. What would be the reasons that you would see that sequential decline? I think historically, you see a bump up, you know, with the revenue in the latter half of the year.
maybe, I think you misheard me. What we're saying is 3 Q margins should be flat to up 25 basis points, quarter-over-quarter.
Wouldn't that imply a big reduction in the fourth quarter to get to the full year guidance?
No, if we're guiding to the lower end of revenue, but the upper end of EBITDA, that's actually better profitability.
Okay. I will work that and get with you offline on that one. Maybe, last one for me, I'm going to sneak one in since that wasn't exactly my best question. The gross margin performance in the second quarter in both Europe and Cabinets was quite strong. Was there anything kind of one-time there, or is this just finally getting completely past the price cost issues that you've had, or any color on those two segments in particular would be great?
Yeah, I'll give you some color, and we'll break it down between the two. In terms of the Cabinet, performance, it was really as expected, very much index driven. You know, last year, as we talked about almost every quarter, we were chasing the profitability, because of the 90-day lag. As pricing was going up, we're kind of, you know, we're paying faster than we're able to pass it along. Well, the complete inverse happens as it's going down, so it's exactly what we anticipated. As the hardwood pricing are coming down, you know, we're able to buy hardwood at lower prices faster than the index triggers.
We should be harvesting margins on the way down, and we've kind of alluded to that in past calls. That's really what's driving that. I mean, the market itself is very defined in terms of pricing, so it's index related. In Europe, it's a combination. Operational performance has been very strong, and we're doing some good things from both the sourcing team and the operational teams. The other piece of it is some carryover pricing that we're starting to realize as the inflation levels in certain areas have kind of panned out.
There are still pressures in Europe as it relates to inflation. You know, there's gonna be some continued conversations with our customers, because the European inflation levels, at least, at this point, because of energy cost and some of the higher levels of freight and logistics costs are just ahead of what we're seeing in North America. You know, we think price will still be an important factor over in Europe, and, you know, we'll see what happens there.
Okay, great. Thanks. Congrats, and good luck going forward.
Yep.
Thank you. One moment for our next question. Our next question comes in the line of Steven Ramsey from the Thompson Research Group.
Hey, good morning. This is actually Brian Biros on for Steven. Thank you for taking my questions. To start, I guess, on pricing, can you, maybe, you know, you mentioned some givebacks largely attributable to the indexing. Any specific materials there to call out and the magnitude of the declines, and maybe if there's any increases to call out as well? I just kind of way looking for the rest of the year, kind of pricing embedded in the guidance from here.
As a reminder, the indexes are primarily in North America. We'll start with that. In North American Fenestration, the main commodities that are typically on index are, you know, vinyl, PVC resins, aluminum, and steel in our screen products, and then an oil-based index for our butyl-based spacers. Those have obviously had downward pressures across the board. As we progress through the year, I think we're starting to see that the pricing on a lot of those commodities are starting to stabilize and flatten out, in a couple cases, maybe even showing some signs of ticking back up. They're pretty volatile, as you know.
We believe that the indexes are such that it will protect our margins, and it's fair to both us and our customers. In the Quanex Custom Cabinet Components group, it's very much hardwoods, Soft Maple, Hard Maple, Cherry, Red Oak, and a couple other minor species, but those are the big ones. What we're seeing is the same thing there, is that those Hardwood species have dropped in price pretty significantly over the prior year, but we're now starting to see that their, the rate of decrease is flattening, and then in a couple of the species as well, starting to level up, to even maybe bumping up a little bit. We think the rate of price givebacks as it relates to index will start to slow down.
In Europe, it is all negotiated price and it's very much based on the commodities, and we continue to have discussions with our customers as to, you know, when do we give back price, as well as there's still a lot of inflationary pressure, as I just mentioned to Reuben, in other areas. Europe tends to be a little more complicated and a little more specific negotiations with the customers.
Okay, helpful. Thank you. A second follow-up just, can you expand on what you guys are hearing from end markets and customers? I know you mentioned, you know, demands improving sequentially, orders back to normal seasonality. We've been hearing sentiment today is better than was expected at the beginning of the year. I'm just trying to parse out, are things getting better just because of this seasonality and this inventory rebalancing is over? Or are things actually getting better, you know, on the ground from the final customer perspectives? Thank you.
You know, I think what we're seeing and what we've been impacted by is definitely more of the macro environment. The affordability of housing becomes an issue. If you can imagine in our Fenestration business, as we're looking at new starts, that's an important metric. You know, also the size of homes, you know, if the affordability piece comes into play, people are either building or buying smaller homes, which has smaller openings and less windows. I think those have been more of an impact over purely customer demand, the affordability piece in the market becomes an issue. For cabinets, what we're seeing in Europe, it's really the discretionary income piece.
I mean, those tend to be a little more discretionary of whether you redo your kitchen or your bathroom cabinets versus replacing a window and door. I think that's why we're seeing volume hit a little more. In terms of overall expectations, I think the market is exactly where we anticipated it would be, and we've talked about that for the last couple of quarters. I think, you know, we'll see some normal seasonality. Again, it'll be dependent upon macro conditions, what the Fed does, and different things of that nature, will have more impact. For us, we've been pretty pleased that, the year is panning out exactly the way we forecasted and saw it to come out, at least at this point.
Got it. Thank you.
Thank you. One moment for our next question. Our next question comes in the line of Julio Romero from Sidoti & Company, LLC.
Thanks. Hey, good morning, George and Scott.
Morning.
Good morning.
Hey, good morning. Maybe to continue on price for a little bit. You know, can you talk about price aside from anything on an index or anything surcharge related? Maybe speak to the efforts to maintain price across the three segments, and has that gotten any more or less challenging than maybe three months ago?
Yeah, I think we work very hard to be a fair supplier to all of our customers, and so we're open and transparent and continue to have those discussions with the customers. I think in areas that are non-indexed, the biggest impacts in most cases tend to be freight, and then, you know, packaging, supplies, things of that nature. We continue to go after price where we can, you know, cognizant of the fact that, you know, we're also trying to support our customers in the market. I think in North America, let's step back. Globally, there's much more pressure right now on either repealing price or at least, you know, holding prices flat.
I think we're seeing the customers in the market begin to really start pushing back on further price increases. To answer your question, it's absolutely much more of a challenge today than it was six months ago, there's no doubt. I think our efforts to continue to be transparent and work with our customers to make us all successful has worked for both sides.
Got it. That's helpful. Maybe just turning to the cost side. You guys obviously did a good job, you know, controlling costs in the quarter. You talked about, you know, some of the things that helped you were some favorable purchases, while the index figures hadn't happened yet. Were there other levers you were able to pull on the cost side within the quarter? Would those levers on the cost side be able to benefit you in the back half of the year?
Yeah, absolutely. Great question. And, and the answer to that is yes, there are other triggers that we've pulled, and I think it highlights what we've said all along, that, you know, that our cost structure is built in such a way that when we do go up or down, we have the ability to be ahead of the game, probably more than most. I think so, for example, in cabinets, I would tell you know, they're not easy discussions, but when volume starts dropping, the team was ahead of it and controlled our labor costs, controlled our supply costs, and really focused on managing their inventory levels. We have those kind of things in place in all the divisions. We have triggers that we pull.
We test our different models. If volume were to do this, here's what you do. They were prepared, and all the groups reacted very well. It's really cost structure across the board that we're managing.
Got it. Then maybe turning to the LMI integration, it sounds like that's going well. Maybe just talk about that, if you could, and would there be potential of maybe additional synergies beyond the target?
Yeah. No, we've been extremely happy with the acquisition of that business. One, from a culture perspective, it fit in very, very, very well. The teams are working well together. It's opened us up to new and additional markets. You know, we're servicing not only the fenestration markets, you know, it's through vertical integration supplying us, but we're now supplying a little bit into the automotive business, wire and cable. We actually, you know, they supply materials into, like, dog toys and things of that nature. It's allowed us to get a view into a lot of different things. We've been very, very thrilled with their performance and continue to be. In terms of growth, and more synergies, I think the answer is yes.
I think that there's an opportunity to use other materials that we currently make, for example, in our spacer business, maybe, expanding their sales team and giving them offerings in silicone and butyl types of rubbers, and allowing them to be a full service, compound provider of not only EPDM, which is currently what they do. I do believe there's both cost synergies as well as potentially new sales, opportunities, which will help us improve, the utilization of current assets. We'll be able to do some of that without investing in any more, CapEx. We're pretty excited about the opportunities that lie within this business.
Got it. Well, thanks very much for taking the questions, and good luck in the back half of the year.
Thanks, Julio.
Thank you. I would now like to turn the conference back over to George Wilson for closing remarks.
We'd like to thank you all for joining. We look forward to providing you an update on our next earnings call in September. Have a great day.
This concludes today's conference call. Thank you for participating. You may now disconnect.