Quanex Building Products Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended July 31, 2015. Unaudited. Quanex manufactures components primarily for the window and door industry, with operations mainly in North America and Europe.
Financial performance
| Metric | Three months 2015 | Three months 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $180.2m | $170.0m | $450.1m | $431.6m |
| Operating income | $9.8m | $12.7m | $7.9m | $9.0m |
| Income from continuing operations | $6.5m | $8.6m | $5.7m | $5.3m |
| Net income | $6.9m | $8.0m | $6.2m | $24.3m |
| Diluted EPS | $0.20 | $0.21 | $0.18 | $0.64 |
| Operating cash flow | Not separately reported by quarter | $27.5m | $9.8m |
Quarterly sales grew 6%; nine-month sales grew 4%. Operating margin was approximately 5.5% for the quarter versus 7.5% a year earlier, and 1.8% for the nine months versus 2.1%. Gross margin, calculated using cost of sales excluding depreciation and amortization, improved in the quarter but was slightly lower for the nine-month period. The filing does not provide EBITDA.
Nine-month net income fell sharply year over year primarily because 2014 included a $24.1m after-tax gain from the sale of Nichols Aluminum. Continuing-operations income increased for the nine-month period; quarterly continuing-operations income declined.
Balance sheet, debt and liquidity
- At July 31, 2015, cash was $27.0m, total debt was $92.0m, and working capital was $102.0m. Debt included $84.0m drawn on the revolving facility and approximately $7.5m in capital leases and other debt.
- The $150m revolving facility had $52.0m available, after $84.0m of borrowings and $5.9m of letters of credit. Quanex reported compliance with covenants; actual interest coverage was 80.58:1 against a 3.00:1 minimum, and leverage was 1.62:1 against a 3.25:1 maximum.
- Cash declined $93.4m during the nine months. Operating activities provided $27.5m; investing used $152.1m, principally for the HLP acquisition and capital spending; financing provided $31.1m, including revolver borrowing and offset by $52.7m of treasury-stock purchases.
- Capital expenditures were $21.9m and dividends paid were $4.2m for the nine months. The company expected to contribute approximately $2.8m to its pension plan in September 2015.
Material changes and transactions
- On June 15, 2015, Quanex acquired UK-based HLP for $131.7m cash, net of cash acquired, and assumed $7.7m of debt and $10.3m of contingent earn-out consideration. Preliminary goodwill was approximately $61.9m. HLP contributed $14.2m of current-quarter sales; purchase accounting remained subject to revision.
- Quarter sales growth was more than accounted for by HLP; management cited a $3.9m decline from a specific vinyl customer, $2.5m from currency translation and $1.0m from lower oil surcharges. For the nine months, reported sales also reflected a $6.0m currency-related reduction and a $11.2m customer-volume decline, offset by other volume and pricing gains.
- Quarterly SG&A increased $6.9m, including $3.8m of transaction costs, mostly HLP-related. Nine-month SG&A included $3.9m of transaction costs. Higher debt following the HLP acquisition raised interest expense.
- The board’s $75m share-repurchase program was completed in February 2015: 3,992,229 shares repurchased at an average $18.77 per share. Treasury shares stood at 3,692,836 at July 31.
Outlook, risks and unusual items
- Management described the housing and fenestration outlook as favorable, but more conservative than third-party forecasts. It expected to grow at or above market levels beyond the effects of lost customer volume. The filing provides no company-specific earnings or revenue guidance.
- External forecasts cited by the company projected rising U.S. housing starts and window shipments. Management noted that domestic market activity slowed somewhat in the quarter, German market conditions had restrained near-term growth, and HLP offered potential UK growth and product synergies.
- On August 30, 2015, Quanex agreed to acquire Woodcraft, a cabinet-door and components manufacturer, for expected cash consideration of $248.5m, subject to adjustments. Closing was expected in Q4 2015. A $410m senior secured financing commitment was arranged to fund the deal, refinance existing borrowings, cover transaction costs and support working capital. The acquisition and financing were not completed as of the filing date.
- Key exposures include housing and remodeling demand, customer concentration, resin and oil-related input costs and surcharges, foreign-exchange movements, interest rates, and acquisition integration. A hypothetical 1% rate change on July 31 debt balances would affect pretax results by approximately $0.8m annually.
- Quanex carried a $1.0m reserve for asserted claims related to possible spacer migration in certain pre-March 2014 products; additional claims were under investigation and unasserted exposure could not be estimated. Warranty estimates are judgmental. Management said ordinary-course litigation was not expected to materially affect results.
- A reassessment of a tax position related to the 2008 spin-off generated a $0.8m income-tax benefit and a noncash $10.0m increase in retained earnings. The nine-month effective tax rate was 25.2%, or 35.7% excluding the discrete benefit. The quarter also included a $0.5m after-tax insurance-related gain from the legacy Nichols fire.
- Management concluded disclosure controls were effective. HLP was excluded from the 2015 internal-control effectiveness assessment while Quanex evaluated and planned control integration.
Most important facts for investors to verify
- Whether Woodcraft closed as expected, its final purchase price and financing terms, and the resulting debt burden, interest expense and covenant headroom.
- HLP’s subsequent operating contribution, earn-out exposure, final purchase-price allocation and integration costs or synergies.
- Whether lost customer volume, foreign-exchange effects and oil-surcharge concessions persist, and whether margins recover as management anticipated.
- Actual cash generation, capital spending and debt reduction after acquisitions and share repurchases; the filing reports $27.0m cash and $92.0m debt at July 31.
- Developments in spacer-migration claims, warranty reserves, tax matters and HLP internal-control integration.