Quanex Building Products Corporation — Q3 2017 Form 10-Q
Business context and period. Quanex supplies components to building-products OEMs, including window and door (fenestration) products and kitchen and bath cabinet components. This unaudited quarterly report covers the three and nine months ended July 31, 2017, in fiscal 2017. Comparatives are the corresponding 2016 periods; balance-sheet comparisons are with October 31, 2016. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $229.4m | $248.1m | $634.4m | $679.0m |
| Operating income | $17.4m | $19.9m | $18.1m | $28.3m |
| Net income (loss) | $10.2m | $(4.0)m | $8.0m | $(7.3)m |
| Diluted EPS | $0.29 | $(0.12) | $0.23 | $(0.22) |
| Operating margin | 7.6% | 8.0% | 2.9% | 4.2% |
Q3 sales declined 8% and nine-month sales declined 7%. Operating income fell 13% in Q3 and 36% year to date, despite lower SG&A. Net income improved versus losses in 2016, principally because interest expense was substantially lower: 2016 included $16.7m of refinancing-related write-offs and a prepayment penalty. Nine-month 2017 interest expense was $7.1m versus $34.3m; the 2017 effective tax rate was 31.4%, compared with a 2016 tax benefit.
For the nine months, cash from operations was $45.3m, compared with $49.1m. Capital expenditures were $27.1m; cash used in investing was $34.4m, including an $8.5m HLP earn-out payment. Cash used in financing was $20.4m, principally reflecting net debt repayments and dividends. Cash declined $9.7m to $15.8m.
At July 31, current assets were $196.3m and current liabilities $109.7m; reported working capital was $86.6m. Total debt was $264.4m, including $26.4m current maturities; cash was $15.8m. The company reported $189.6m available under its credit agreement, was in covenant compliance, and reported a 3.23% rate on credit-agreement borrowings. It repaid $10.0m on its revolver in August 2017.
Material changes and segment results
- North American Engineered Components: Nine-month sales fell 12% to $343.7m and operating income fell 49% to $15.9m. Management attributed the sales decline mainly to shedding low-margin U.S. vinyl business, with volume losses occurring faster than expected.
- European Engineered Components: Nine-month sales declined 4% to $106.1m, mainly due to currency translation; excluding foreign exchange, sales increased with volume. Operating income was broadly flat at $8.9m.
- North American Cabinet Components: Nine-month sales increased 2% to $188.4m and operating income rose to $2.9m from $2.4m, but the reported segment margin remained about 1%.
The company transferred two wood-products plants from North American Engineered Components to North American Cabinet Components, restating prior-period segment presentation. Total assets were $785.1m versus $780.4m at October 31, 2016; equity rose to $392.7m from $367.8m.
Outlook, management commentary and risks
- Management’s strategy is to stop manufacturing $65m–$85m of lower-margin business, reduce capacity, improve margins and cash flow, and pursue organic growth and strategic acquisitions. Plant closures include two U.S. vinyl plants, a Mexico cabinet-door plant, and a Lansing, Kansas plant being wound down.
- Management expected additional fiscal 2017 restructuring and closure-related costs, including approximately $0.5m for equipment moves and employee costs and $0.2m accelerated depreciation for the Lansing closure. Nine-month restructuring charges were $3.1m. Changes in estimated asset lives also increased nine-month depreciation by $3.9m and amortization by $1.6m.
- No specific company-wide revenue or earnings guidance is provided. Management cited third-party forecasts for continued growth in housing, window shipments and U.S. residential cabinet demand, while noting recent housing starts were below forecast. These are market forecasts, not company guidance.
- Goodwill for the North American Cabinet Components reporting unit was not impaired in a July test, but fair value exceeded carrying value by only about 6%; weaker-than-expected performance and reduced forecasts prompted the test. Annual testing was scheduled for August 31, 2017.
- Risks include building and remodeling market conditions, customer demand, commodity costs and timing of pass-through adjustments, foreign exchange, variable interest rates, supplier disruption, debt covenants, warranty claims and litigation. A 1% interest-rate change was estimated to affect annual pretax results by about $2.5m. Hurricanes Harvey and Irma could disrupt customers or suppliers in Texas and the Southeast, affecting demand, supply and costs.
- Contingencies include spacer-migration claims, with an accrual of $1.1m at July 31, 2017, and further commercial-sealant product claims for which no accrual was recorded; outcomes and potential liability were described as uncertain. The company also disclosed a related-party 20-year HLP warehouse capital lease, with annual cash commitments of £0.9m.
Key facts for investors to verify
- Whether the planned low-margin volume reductions and plant closures improve operating margins and cash generation, particularly in U.S. vinyl and cabinet components.
- Whether cash conversion improves as the inventory build turns; inventories rose to $94.4m from $84.3m at October 31, 2016.
- Debt, covenant headroom, refinancing terms and the effect of variable rates; also confirm the impact of the August $10m revolver repayment.
- Progress and costs of restructuring, including Lansing, and whether the cabinet-components goodwill valuation cushion changes.
- Developments in spacer-migration and sealant claims, warranty estimates, and potential hurricane-related customer or supply-chain disruption.