Quanex Building Products Corporation — Q2 FY2014 Form 10-Q
Reporting period: Three and six months ended April 30, 2014. Unaudited results. Quanex supplies engineered components for window and door manufacturers, with operations primarily in North America and facilities in the United Kingdom and Germany.
Business context and material change
On April 1, 2014, Quanex sold Nichols Aluminum to Aleris for $110.0 million, subject to a working-capital adjustment. Nichols is reported as discontinued operations, and prior-period income-statement comparisons were reclassified accordingly. The sale generated a preliminary after-tax gain of $24.6 million; Quanex also expects to continue purchasing aluminum from Nichols in the ordinary course.
Quanex acquired vinyl-extrusion assets at Greenville, Texas, for $5.2 million in December 2013. Its reported continuing business is presented as one reportable segment.
Financial performance
| Metric | Three months ended Apr. 30, 2014 | Three months ended Apr. 30, 2013 | Six months ended Apr. 30, 2014 | Six months ended Apr. 30, 2013 |
|---|---|---|---|---|
| Net sales | $135.2 million | $125.1 million | $261.6 million | $231.3 million |
| Operating loss | $2.8 million | $8.6 million | $3.7 million | $17.6 million |
| Loss from continuing operations | $2.0 million | $6.9 million | $3.2 million | $12.0 million |
| Net income (loss), including discontinued operations | $20.1 million | $(7.3) million | $16.2 million | $(15.5) million |
| Basic EPS | $0.54 | $(0.20) | $0.44 | $(0.42) |
Continuing-business sales rose 8% in Q2 and 13% for the first half. Higher demand for insulating-glass spacers, improved European sales, vinyl profiles, and engineered components contributed; Greenville and the prior-year Alumco acquisition also supported growth. Cost of sales increased faster than sales, and resin price increases that could not be fully passed through, labor inefficiencies, insurance and benefit costs, repairs, and freight weighed on margins. Operating losses nevertheless narrowed, chiefly as SG&A fell following the ERP implementation shutdown, lower IT and compensation costs, and headcount reductions.
Discontinued operations reported net income of $22.2 million for Q2 and $19.5 million for the first half, including the $24.6 million after-tax Nichols sale gain. Excluding that gain, Nichols incurred losses of $2.4 million and $5.1 million, respectively. Thus, consolidated net income and EPS principally reflect the transaction gain, not profitable continuing operations.
Cash flow, balance sheet and liquidity
- Cash and cash equivalents were $127.0 million at April 30, 2014, up $77.3 million from October 31, 2013. Cash includes short-term investments.
- First-half operating cash flow was negative $11.0 million, versus negative $20.8 million a year earlier. Investing provided $87.9 million, principally from Nichols sale proceeds of $110.0 million; capital expenditures were $18.6 million. Financing provided $0.4 million, including $3.0 million of dividends paid.
- Total debt was $0.8 million, with no revolving-credit borrowings. The $150 million facility had $143.0 million available, subject to covenant-based limits; letters of credit were $6.2 million. The company reported covenant compliance and substantial headroom.
- Total assets were $531.9 million, total liabilities $95.9 million, and stockholders’ equity $436.0 million. Working capital was $185.3 million.
- Quarterly cash dividends were $0.04 per share; first-half dividends were $0.08 per share.
Outlook, risks and unusual items
- Management described improving U.S. housing activity and expected seasonal strength in the second half of the fiscal year. It cited external forecasts of 1.1 million U.S. housing starts in 2014 and continued growth in window shipments; these are market forecasts, not company earnings guidance.
- Management expected European warm-edge spacer demand to benefit as customers adopt new vapor-barrier technology in response to regulatory standards. It also noted that U.S. new construction was increasingly weighted toward multifamily housing, often with lower-cost, less energy-efficient windows.
- Resin costs and contractual limits on customer surcharges remain a margin risk. Other stated risks include housing and remodeling demand, customer concentration, foreign exchange, energy and other input costs, warranty estimates, taxes, environmental rules, litigation, and execution of operating and acquisition plans.
- Quanex expects approximately $8.1 million of insurance proceeds related to a Nichols facility fire and estimates a $5.7 million gain on involuntary conversion, including $4.8 million of remaining gain expected in Q3 when proceeds are received. These amounts remain dependent on collection and timing.
- A $2.8 million warranty-accrual reduction benefited first-half cost of sales. The company cautioned that warranty estimates involve uncertainty. It also disclosed a possible need to establish a valuation allowance against deferred tax assets if it records three years of cumulative adjusted losses.
- Management said it believes cash, operating cash flow, and credit availability will be adequate for foreseeable needs. Operating cash flow was still negative in the first half. No quantified company revenue or earnings guidance was provided.
Important facts for investors to verify
- Final Nichols sale working-capital adjustment and the cash actually received or paid in settlement.
- Collection and timing of expected insurance proceeds and the resulting gain recognition.
- Whether pricing actions can offset resin and other cost inflation without further margin pressure.
- Continuing-business operating cash generation after seasonal inventory investment and capital expenditures.
- Tax-asset recoverability, warranty claims experience, and continued compliance with credit-facility covenants.