Quanex Building Products Corporation — Q3 FY2018 Form 10-Q
Business and period: Quanex supplies components to building-products OEMs, including window and door components and kitchen and bath cabinet components. The filing covers the three and nine months ended July 31, 2018; comparisons are with the corresponding 2017 periods. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $239.8 million | $229.4 million | $645.7 million | $634.4 million |
| Operating income | $17.1 million | $17.4 million | $24.7 million | $18.1 million |
| Operating margin | 7.1% | 7.6% | 3.8% | 2.9% |
| Net income | $10.8 million | $10.2 million | $19.8 million | $8.0 million |
| Diluted EPS | $0.31 | $0.29 | $0.56 | $0.23 |
Q3 sales increased 5%, while operating income edged down 2%. Higher sales and cost inflation, as well as higher SG&A, offset lower restructuring and depreciation costs. For the nine-month period, sales rose 2% and operating income rose 36%; lower restructuring and depreciation costs and lower corporate compensation expense helped operating results. Net income also benefited from a $2.5 million income tax benefit, including tax-reform-related items.
Q3 segment operating income was $12.3 million for North American Engineered Components, $3.9 million for European Engineered Components and $3.3 million for North American Cabinet Components. For the nine months, the corresponding amounts were $19.4 million, $7.7 million and $0.7 million. Cabinet Components’ nine-month operating income declined from $2.8 million in 2017, while European Engineered Components’ declined from $8.9 million.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $48.5 million, compared with $46.5 million. Capital expenditures were $21.1 million, versus $27.1 million; derived operating cash flow less capital expenditures was $27.4 million, versus $19.4 million.
- Cash was $12.4 million at July 31, 2018, down from $17.5 million at October 31, 2017. Cash used in investing activities was $20.8 million and cash used in financing activities was $32.0 million; net debt repayments were a principal financing use.
- Total debt was $209.8 million, down from $239.4 million at October 31, 2017. The company reported $193.5 million of Credit Agreement borrowings, $5.3 million of letters of credit and $228.6 million of remaining Credit Agreement availability. Borrowings under the Credit Agreement bore interest at 4.08% at quarter-end.
- The credit facility matures in July 2021 and includes leverage and fixed-charge coverage covenants. Quanex reported compliance with its covenants at July 31, 2018. A hypothetical 1 percentage-point interest-rate change would affect annual pretax results by approximately $1.9 million, based on quarter-end variable-rate debt.
Changes, outlook and notable items
- Management attributed sales growth to market and volume growth, pricing and raw-material surcharges, with some offset from intentionally shedding lower-margin business and prior divestitures. Higher raw-material, freight and labor costs pressured costs; price adjusters and surcharges recover some, but not all, input-cost changes.
- Management expected the FY2018 effective tax rate to be approximately 7%, or about 24% excluding discrete items. The nine-month tax benefit included a $7.7 million deferred-tax remeasurement benefit following U.S. tax reform, partly offset by a $1.2 million transition-tax expense. Some tax accounting remained provisional.
- Management cited external forecasts for continued growth in served markets, including modest housing-start growth and approximately 3% annual growth in U.S. replacement-and-remodeling window shipments through 2020. These are market forecasts, not quantified company revenue or earnings guidance.
- On August 30, 2018, the board authorized repurchases of up to $60 million of common stock, without an expiration date. No shares were repurchased under a publicly announced program during the reported quarter.
- Goodwill at the North American Cabinet Components reporting unit had a 4.5% estimated fair-value cushion over carrying value in the March 2018 impairment test; the filing warned that weaker-than-expected results could lead to a material impairment. Quanex also disclosed unresolved claims alleging defects in a commercial sealant product; it recorded no accrual and said the outcome and timing were not determinable, while expecting no material adverse effect based on information then available.
- Other risks include housing and remodeling demand, customer concentration or purchasing changes, commodity and foreign-exchange volatility, unhedged currency exposure related to HLP acquisition debt, warranty estimates, and the ability to comply with debt covenants. Restructuring-related lease costs at closed facilities continued.
Investor verification points
- Assess whether sales growth and cost pass-throughs can sustain operating margins, particularly as raw-material and labor costs rise.
- Track North American Cabinet Components profitability and the reporting unit’s narrow goodwill valuation cushion.
- Review the tax-reform benefit, remaining provisional tax estimates and the expected FY2018 tax rate excluding discrete items.
- Confirm debt repayment, borrowing costs, covenant headroom and the use of the new $60 million repurchase authorization.
- Monitor the sealant litigation, closed-site lease obligations, warranty exposure and foreign-exchange risks.