Quanex Building Products Corporation — Q3 2019 Form 10-Q
Reporting period: Fiscal third quarter and nine months ended July 31, 2019; comparisons are with the corresponding 2018 periods. Quanex supplies components to building-products OEMs, principally in North America and the U.K., through North American Fenestration, European Fenestration, and North American Cabinet Components segments. Figures below are in millions except per-share data.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $238.5 | $239.8 | $653.5 | $645.7 |
| Operating income (loss) | $19.1 | $16.8 | $(2.7) | $24.0 |
| Net income (loss) | $11.8 | $10.8 | $(15.8) | $19.8 |
| Diluted EPS | $0.36 | $0.31 | $(0.48) | $0.56 |
- Q3 operating margin was approximately 8.0%, compared with 7.0% a year earlier. YTD operating margin was negative, primarily reflecting a $30.0 million goodwill impairment charge.
- Q3 sales were nearly flat year over year, while operating income rose 14%. YTD sales increased 1%, but net income swung to a loss; the impairment was largely non-deductible and contributed to a $5.9 million tax expense despite a pretax loss.
- Q3 segment trends: North American Fenestration sales rose 2% and operating income rose 26%; European Fenestration sales rose 4% and operating income rose 29%; North American Cabinet Components sales fell 10%, with operating income down to $1.5 million from $3.6 million. Cabinet sales weakness reflected an industry shift from semi-custom to stock cabinets.
- YTD operating cash flow was $30.0 million, down from $48.5 million. Capital expenditures were $17.0 million, implying approximately $13.1 million of operating cash flow less capital expenditures, versus $27.4 million in 2018.
- Cash was $10.7 million at July 31, down from $29.0 million at October 31, 2018. Total debt was $192.0 million, versus $210.6 million; revolving-facility borrowings were $177.5 million. The company reported $142.7 million available under its $325 million revolver and compliance with debt covenants.
- YTD financing uses included $18.6 million of net debt repayments, $8.0 million of dividends, and $6.3 million for treasury-stock purchases. Dividends were $0.08 per share in Q3, double the prior-year quarter.
Material changes and unusual items
- The company recorded a $30.0 million goodwill impairment in North American Cabinet Components after below-plan results and a reduced long-range forecast, which management linked to the market shift toward stock cabinets. Segment goodwill fell from $113.7 million to $83.7 million.
- During the second quarter, Quanex changed certain inventory costing from LIFO to FIFO and retrospectively adjusted prior-period amounts. Management said the change better aligned valuation across operations and improved matching of revenue and expenses; the filing reported a $1.1 million increase to October 2018 retained earnings after related tax effects.
- Quanex repatriated $13.9 million of foreign cash during the nine-month period. Tax expense included charges related to GILTI/FDII and transition-tax adjustments.
Outlook, risks, and contingencies
- The filing provides no specific company revenue or earnings guidance. Management cited third-party forecasts of slightly higher housing starts through 2021, a slight decline in U.S. repair-and-replacement window shipments in 2019, 1% growth in 2020 and flat shipments in 2021, and slightly declining U.S. semi-custom cabinet demand through 2020.
- Management highlighted uncertainty around Brexit, including potential currency and raw-material cost effects on U.K. operations. Other risks include housing and remodeling demand, customer purchasing, commodity costs not fully covered by surcharges, foreign-exchange movements, interest rates, debt covenant compliance, warranty claims, and litigation.
- Quanex expected adoption of the new lease standard on November 1, 2019 to add approximately $40 million to $60 million of operating lease liabilities and corresponding right-of-use assets.
- The company disclosed ongoing claims alleging defects in commercial sealant products sold in the 2000s. It had recorded no accrual, believed the claims would not materially affect its overall financial condition, results, or cash flows, but said timing and ultimate resolution were not determinable. No material environmental matters were reported.
- Management stated disclosure controls were effective as of July 31, 2019 and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether cabinet-component volumes and profitability stabilize after the stock-cabinet market shift, and whether further impairment indicators arise.
- Whether operating cash flow recovers from the year-over-year decline and supports capital spending, dividends, and debt reduction.
- Revolver availability, covenant headroom, variable-rate exposure, and the effect of the anticipated lease liabilities on reported leverage measures.
- How Brexit, foreign exchange, and less-protected raw-material costs affect European margins and cash flows.
- Developments in the legacy sealant claims, warranty estimates, and the company’s ability to maintain insurance coverage.