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Quanex Building Products Corporation (NYSE: NX) Q2 2023 earnings call dated Jun. 02, 2023
Corporate Participants:
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
George Wilson — President and Chief Executive Officer
Analysts:
Reuben Garner — the Benchmark Company, LLC — Analyst
Brian Biros — Thompson Research Group — Analyst
Julio Romero — Sidoti and Company, LLC — Analyst
Presentation:
Operator
Good day and thank you for standing by. Welcome to the Q2 2023 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Scott Zuehlke, Senior Vice President, CFO and Treasurer. Please go ahead.
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
Thanks for joining the call this morning. On the call with me today is George Wilson, our President and CEO. This conference call will contain forward-looking statements and some discussion of non-GAAP measures. Forward-looking statements and guidance discussed on this call and in our earnings release are based on current expectations. Actual results or events may differ materially from such statements and guidance and Quanex undertakes no obligation to update or revise any forward-looking statements to reflect new information or events.
For a more detailed description of our forward-looking statement disclaimer, and a reconciliation of non-GAAP measures to the most directly-comparable GAAP measures, please see our earnings release issued yesterday and posted to our website. I’ll now turn the call over to George for his prepared remarks.
George Wilson — President and Chief Executive Officer
Thanks, Scott, and good morning to everyone joining the call. All things considered, and with a tough comp to Q2 of last year, we are pleased with our results for the second quarter of this year. As mentioned on our last earnings call, we believe we are starting to see a return to normal seasonality in our business during Q1 of this year and our results for the second-quarter further reinforce that belief. Solid operational performance during the second quarter was somewhat masked by index related pricing pressure and continued customer inventory rebalancing in our Fenestration segments.
Although volumes were down across all segments versus the prior year record levels, we did realize EBITDA margin expansion versus prior year on a consolidated basis. Our strong operational performance also resulted in improved free cash flow, which enabled us to repurchase $5.6 million of our common stock and repay $20 million of debt in the quarter. I will now provide some general comments on each of our reporting segments.
In our North American Fenestration segment, revenues and earnings were down versus prior year due to lower volumes driven by softer market conditions, weather-related softness in West Coast markets, customer inventory rebalancing for our spacer products and pricing pressures on lower raw material costs related to index pricing mechanisms. Operational performance remains strong in this segment. And we did a good job of controlling costs despite the lower volumes. And looking at the LMI acquisition, we completed in November. I am pleased to announce that we have realized our announced synergy goal. This business continues to perform very well and we are evaluating growth opportunities.
Moving onto our North American Cabinet Components segment. The decrease in revenues year-over-year was primarily a result of lower market demand and the rollback of hardwood related index pricing. We were able to realize solid margin expansion in this segment despite volume and index pricing pressures. Continued focus on cost controls, combined with capitalizing on the timing of lower cost hardwood purchases helped to minimize volume impacts.
In our European Fenestration segment, results were impacted by market softness, customer inventory rebalancing in our spacer business and foreign exchange impact, which more than offset the share gains in our UK vinyl extrusion product line.
Continued improvements in operational metrics combined with sourcing initiatives and pricing carryover, all contributed to realizing margin expansion in this segment. Having said that, challenges related to higher energy costs, higher transportation costs and general inflation are ongoing in this market and we continue to work with our customers regarding go-forward pricing expectations.
In summary, we continue to execute on our strategic and operational initiatives and we are controlling what we can control. Near-term inflationary headwinds and index related pricing pressures present challenges for revenue but the Quanex team continues to perform and we remain confident in our ability to meet the net sales and adjusted EBITDA guidance ranges for this year.
Optimizing return on invested capital and working capital remain top priorities for improved cash flow generation, which will support our growth initiatives and align well with our road to $2 billion strategy. Although macro headwinds still exist for the entire Building Products segment, we feel we’re very well positioned to execute on our strategy and create value for our shareholders. I will now turn the call over to Scott, who will discuss our financial results in more detail.
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
Thanks, George. Before, I get started. I want to reiterate that we reported record results in the second quarter of last year. So, we did have a tough comp. However, business did improve in the second quarter of this year versus the first quarter of this year. On a consolidated basis, we generated net sales of $273.5 million during the second quarter of 2023, which represents a decrease of 15.3% compared to $322.9 million during the second quarter of 2022.
The decrease was largely due to softer demand caused in part by customer inventory rebalancing, lower pricing in North America and foreign exchange translation impact. Overall, our 2Q results further enforce our belief that we are seeing a return to normal seasonality in our business.
Net income decreased to $21.5 million or $0.65 per diluted share for the three months ended April 30, 2023 compared to $26.5 million or $0.80 per diluted share for the three months ended April 30, 2022. After adjusting for one-time losses on damage to a couple of our manufacturing facilities due to inclement weather coupled with one-time transaction and advisory fees, net income decreased to $21.7 million or $0.66 per diluted share for the quarter compared to $26.5 million or $0.80 per diluted share for the same period of last year.
On an adjusted basis, EBITDA for the quarter decreased to $39.9 million compared to $45.2 million during the same period of last year. The decrease in earnings for the secon -quarter of 2023 was mostly attributable to lower volumes, decreased pricing mainly due to surcharge rollbacks and raw material index pricing mechanisms in North America, foreign currency translation and higher interest expense.
Now for results by operating segment. We generated net sales of $157 million in our North American Fenestration segment for the second-quarter of 2023, a decline of 11.8% compared to a $177.9 million in the second-quarter of 2022, driven by a decrease in volumes due to softer market demand, customer inventory rebalancing in our spacer business and lower pricing. We estimate the volumes in this segment declined by approximately 9% Year-over-Year, with the remainder of the revenue decline versus Q2 of 2022 due to a decrease in price. Excluding the contribution from LMI, revenue would have been down 21.8% Year-over-Year in this segment. Adjusted EBITDA was $20.4 million in this segment or about 22% lower than prior year.
We generated net sales of $53.5 million in our North American Cabinet Components segment during the quarter, which was 26.6% lower than prior year. This decrease was driven by lower volumes and lower index pricing for hardwood. We estimate the volumes declined by approximately 25% in this segment Year-over-Year and the remainder of the revenue declined versus Q2 of 2022 due to a decrease in price.
Adjusted EBITDA was $4 million for the quarter compared to $4.5 million in the second quarter of 2022. We did a good job of controlling costs in Q2 of this year and we realized adjusted EBITDA margin expansion of 130 basis-points in this segment compared to the second quarter of 2022.
Our European Fenestration segment generated revenue of $63.8 million in the second-quarter, which represents a decrease of 13.2% Year-over-Year, driven by lower volumes, due in part to customer inventory rebalancing in our spacer business and foreign exchange translation.
We estimate that volumes declined by approximately 10% Year-over-Year in this segment with pricing up by approximately 4% and negative foreign exchange translation impact of about 7%. Adjusted EBITDA came in at $14.9 million for the quarter compared to $15.1 million in the second quarter of 2022. From an operational standpoint, this segment continues to perform well and we realized adjusted EBITDA margin expansion of 270 basis points Year-over-Year.
Moving on to cash flow and the balance sheet, cash provided by operating activities improved to $35.3 million for the second quarter of 2023, which represents an increase of 78% compared to $19.8 million for the second quarter of 2022. We did a very good job managing working capital and the value of our inventory decreased during the quarter due to easing raw material inflationary pressures, which had a positive impact on working capital.
Free cash flow was $27.8 million for the quarter, which was more than double $13.4 million we generated in the second quarter of last year. Our balance sheet continues to be strong. Our liquidity, keeps improving, and our leverage ratio of net-debt to last 12 months adjusted EBITDA was 0.6 times as of April 30, 2023. Excluding real estate leases that are considered finance leases under US GAAP, our leverage ratio of net-debt to last 12 months adjusted EBITDA was 0.3 times. As George mentioned, we were able to repay $20 million of debt and we repurchased $5.6 million of our common stock in the second-quarter because of our free-cash flow position.
We will remain focused on generating cash, paying down debt and opportunistically repurchasing our stock. We will also maintain our focus on growing the company through organic, inorganic and innovative growth opportunities as they arise, while continuing to preserve our healthy balance sheet. The goal is always to create shareholder value.
As stated in our earnings release, we continue to be cautiously optimistic for the second-half of our fiscal year and we believe the long-term underlying fundamentals for the residential housing market remain positive. Based on year-to-date results, conversations with our customers and recent demand trends, we are reaffirming our guidance for fiscal 2023, which is as follows, net sales of USD1.12 billion to USD1.16 billion, although we are now more comfortable with the lower end of this range and adjusted EBITDA of USD130 million and USD142 million, although we are now more comfortable with the mid to upper end of this range.
We previously guided to free cash flow of USD50 million to USD55 million for fiscal 2023, but based on year-to-date results and the fact that we have done a good job managing working capital, we are increasing our free cash flow guidance to a range of USD60 million to USD65 million.
From a cadence perspective, for the third quarter of this year versus the third quarter of last year, we expect revenue to be down 10% to 12% on a consolidated basis. By segment for the third quarter of this year compared to the third quarter of last year, we expect revenue to be down 5% to 7% in our North American Fenestration segment, down 30% to 32% in our North American Cabinet Components segment, and down 2% to 4% in our European Fenestration segment. On a consolidated basis, adjusted EBITDA margin is expected to be flat to up 25 basis points in the third quarter of 2023, again compared to the third quarter of last year.
Operator, we’re now ready to take questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Reuben Garner from the Benchmark Company, LLC.
Reuben Garner — the Benchmark Company, LLC — Analyst
Thanks, good morning, everybody. Congrats on the strong quarter.
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
Hi Reuben, thank you.
Reuben Garner — the Benchmark Company, LLC — Analyst
So a couple questions about the seasonality. I guess, starting with the topline. I think the low-end of the range would still imply a little pickup potentially over the next two quarters, which I think is seasonally normal. Is there any risk to that or I guess, what would the risks be to that, is it further inventory reductions or just general market declines. I mean, what’s kind of implied in the market. I guess, to get to those levels is probably a better way to ask it.
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
I’ll take this. I’ll start here Reuben, from a consolidated level. I would say, you know, we’re very confident in hitting that low range of the guidance. If there were concerns that it would be macro-driven. I think we have some pretty good clarity now from our customer base. The order patterns and inventory levels seem to be stabilized across the supply chain and with our customers. So if there were a miss or upside to either. I think it’s going to be mainly driven by macro conditions.
Reuben Garner — the Benchmark Company, LLC — Analyst
Okay, in that same vein on the — it looks like you’re implying that the margins are going to be sequentially lower quite a bit from where you were in Q2. I know, Q2 was a pretty impressive quarter. But what would be the reasons that you would see that sequential decline. I think historically, you see a bump-up with the revenue in the latter half of the year.
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
Maybe. I think you misheard me. So what we’re saying is 3Q margins should be flat to up 25 basis points quarter-over quarter.
Reuben Garner — the Benchmark Company, LLC — Analyst
So then, would that — wouldn’t that imply a big reduction in the fourth quarter to get to the full-year guidance?
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
No, if we’re guiding to the lower-end of revenue but the upper-end of EBITDA, that’s actually better profitability.
Reuben Garner — the Benchmark Company, LLC — Analyst
Okay, I’ll work that and get with you offline on that one. The — so then maybe last one for me, I think one that wasn’t exactly for that question, the gross margin performance in the second quarter in both Europe and Cabinets was quite strong. Was there anything kind of one-time there or is this just finally getting completely passed the price-cost Issues that you’ve had or any color on those two segments in particular would be great.
George Wilson — President and Chief Executive Officer
Yeah, I’ll give you some color on and we’ll break it down between the two in terms of the Cabinet performance, it was really as expected very much index driven. You know, last year, as we talked about almost every quarter, we were chasing the profitability because of the 90-day lag and as pricing was going up, we’re kind of — we’re paying faster than we’re able to pass it along, the complete inverse happens is it’s going down.
So it’s exactly what we anticipated as as the hardwood pricing are coming down. We’re able to buy hardwood at lower prices, faster than the index triggers. So we should be harvesting margins on the way down and we’ve kind of alluded to that in past calls. So that’s really what’s driving that. I mean the market itself is very defined in terms of pricing. So it’s index related,
In Europe, it’s a combination, operational performance has been very, very strong and we’re doing some good things from both the sourcing team and the operational teams. And then the other piece of it is some carryover pricing that we’re starting to realize as the inflation levels in certain areas have kind of panned out.
There are still pressures in Europe as it relates to inflation, so there’s going to be some continued conversations with our customers, because the European inflation levels, at least at this point because of energy cost and some of the higher levels of freight and logistics costs are just ahead of what we’re seeing in North-America, we’ve we think price will still be an important factor over in Europe and we’ll see what happens there.
Reuben Garner — the Benchmark Company, LLC — Analyst
Okay, great, thanks and congrats and good luck going-forward.
George Wilson — President and Chief Executive Officer
Yeah.
Operator
Thank you. [Operator Instructions] Our next question comes from the line of Steven Ramsey from Thompson Research Group.
Brian Biros — Thompson Research Group — Analyst
Hey, good morning. This is actually Brian Biros on for Steven. Thank you for taking my questions. To start, I guess I’m pricing, can you just. You mentioned some givebacks, largely attributable to the indexing. Any specific materials there to call out and the magnitude of the declines and maybe if there is any increases to call out as well. And just how we are looking for the rest of the year kind of pricing embedded in the guidance from here?
George Wilson — President and Chief Executive Officer
So as a reminder, the indexes are primarily in North-America. So we’ll start with in North American Fenestration, the main commodities that are typically on index are vinyl PVC resins. aluminum and steel. In our screen products and then — and oil-based index for our butyl [Phonetic] base spacers. So those have obviously had downward pressures across the board. Now as we progress through the year. I think we’re starting to see that the pricing on a lot of those commodities are starting to stabilize and flatten out, in a couple of cases, maybe even showing some signs of picking back up, but they’re pretty volatile, as you know, so. We believe that the indexes are such that it will protect our margins. And, it’s fair to both LCM and our customers.
In the Quanex Custom Cabinet Components group, it’s very much hardwoods. The soft maple hard maple, cherry, Red Oak and a couple of other minor species, but those are the big ones and what we’re seeing is the same thing there is that those those hardwood species have dropped in price pretty significantly over the prior year, but we’re now starting to see that the the rate of decreases is flattening. And then, I had a couple of the species as well starting to level up to even may be bumping up a little bit.
So we think the rate of price give backs as it relates to index will start to slow-down. In Europe, it is all negotiated price and it’s very much based on the commodities. And, we continue to have discussions with our customers as to when do we give back price as well as there’s still a lot of inflationary pressures. I just mentioned to Reuben in other areas. So Europe tends to be a little more complicated and a little more specific negotiations with the customers.
Brian Biros — Thompson Research Group — Analyst
Okay, helpful. Thank you. And then second follow-up to that, can you expand on what you guys are hearing from end-markets and customers. I know you mentioned yeah demands including sequentially, orders spectrum normal seasonality. We’ve been hearing the sentiment today is better-than-expected, better than was expected at the beginning of the year. So I’m just kind of parse out. I think getting better just because of this seasonality and it’s inventory rebalancing as ever or things actually getting better on-the-ground from the final customer perspective. Thank you.
George Wilson — President and Chief Executive Officer
I think what we’re seeing and what we’ve been impacted by is definitely more of a macro-environment on. The affordability of housing becomes an issue. So if you can imagine in our Fenestration business as we’re looking at new starts, that’s an important metric, but also the size of homes, the affordability piece comes into play, then people are either building or buying smaller homes which have smaller openings and less windows. I think those have been more of an impact over purely customer demand. So, the affordability piece in the market becomes an issue. And then for cabinets and then what we’re seeing in Europe is really the discretionary income piece. I mean, those tend to be a little more discretionary or whether you redo your kitchen or your bathroom cabinets versus replacing a window and door, so. I think that’s why we’re seeing volume hit a little more, in terms of overall expectations. I think, the market is exactly where we anticipated it was and we’ve talked about that for the last couple of quarters. And I think we’ll see some normal seasonality. Again, it will be dependent upon macro conditions, what the Fed does in different things of that nature. We’ll have more impact for us, we’ve been — we’ve been pretty pleased that the year is panning out exactly the way we forecasted and saw it to come out at least at this point.
Brian Biros — Thompson Research Group — Analyst
Yes, thank you.
Operator
Thank you. [Operator Instructions] Our next question comes from the line of Julio Romero from Sidoti and Company, LLC.
Julio Romero — Sidoti and Company, LLC — Analyst
Thanks. Hey, good morning, George and Scott. Maybe to —
George Wilson — President and Chief Executive Officer
Good morning.
Julio Romero — Sidoti and Company, LLC — Analyst
Maybe to continue on price for a little bit. Can you talk about price aside from anything on index or anything surcharge related. Maybe speak to the efforts to maintain price across the three segments and how they guide and any more or less challenging than maybe three months ago.
George Wilson — President and Chief Executive Officer
Yeah. I think we worked very hard to be a fair supplier, it’s all of our customers. And so, we’re open and transparent and continue to have those discussions with the customers. I think in areas that are non index, the biggest impacts in most cases tend to be freight. And then packaging supplies, things of that nature. And we continue to go after price where we can cognizant of the fact that we’re also trying to support our customers in the market. So I think, in North America there has been — all right, let’s step-back globally, there’s much more pressure right now on either repealing price or at least, holding prices flat. I think we’re seeing the customers in the market begin to really start pushing back on further price increases. So, to answer your question, it’s absolutely much more of a challenge today than it was six months ago. There’s no doubt, but I think our efforts to continue to be transparent and work with our customers to make us all successful has worked for both sides.
Julio Romero — Sidoti and Company, LLC — Analyst
Got it, that’s helpful and then maybe just turning to the cost side, you guys obviously did a good job controlling costs in the quarter. And you talked about some of the things that help you were some favorable purchases while the index triggers hadn’t happened yet. Were there other levers you were able to pull on the cost side within the quarter. And would those levers on the cost side be able to benefit you in the back-half of the year?
Scott Zuehlke — Senior Vice President, Chief Financial Officer and Treasurer
Yeah, absolutely. Great question. And the answer to that is yes. There are other triggers that we pulled and. I think it highlights what we’ve said all along that our cost structure is built-in such a way that when we do go up or down, we have the ability to be ahead of the game, probably more than most and. I think, so for example in cabinets. I would tell you, they’re not easy discussions. But when volume starts dropping. The team was ahead of it and controlled our labor costs, controlled our supply costs and really focused on managing their inventory levels and we have those kind of things in place in all the divisions. So we have triggers that we pull. We test our different models, if volume were to do that here’s what you do and they were prepared in all the groups reacted very well.So it’s really cost structure across-the-board that we’re managing.
Julio Romero — Sidoti and Company, LLC — Analyst
Got it and then, maybe turning to the LMI integration, it sounds like that’s going well. Maybe just talk about that, if you could, and would there be potential of maybe additional synergies beyond the target?
George Wilson — President and Chief Executive Officer
Yeah, We’ve been extremely happy with the acquisition of that business, one, from a culture perspective that fit-in very, very well. The teams are working well together, it’s opened this up to new and additional markets on we’re servicing not only the Fenestration markets. It’s through vertical integration, supplying us, but we are now supplying a little bit into the automotive business wire cable, we actually — they supply materials in the like dog toys and things of that nature.
So it’s allowed us to get a view into a lot of different things and we’ve been very-very thrilled with our performance and continue to be. In terms of growth and more synergies. I think the answer is yes. I think there is an opportunity to use other materials that we currently make. For example, in our spacer business maybe expanding their sales team and giving them offerings and silicone and beautiful types of rubbers. And allowing them to be a full-service compound provider of not only EPM, which is currently what they do, so I do believe that both cost synergies as well as potentially new sales opportunities, which will help us improve the utilization of current assets, we will be able to do some of that without investing in anymore CapEx. So we’re pretty excited about the opportunities that lie within this business.
Julio Romero — Sidoti and Company, LLC — Analyst
Got it, well, thanks very much for taking the questions and good luck in the back half of the year.
George Wilson — President and Chief Executive Officer
Thanks, Julio.
Operator
Thank you. I would now like to turn the conference back over to George Wilson for closing remarks.
George Wilson — President and Chief Executive Officer
We’d like to thank you all for joining and we look-forward to providing you an update on our next earnings call in September. Have a great day.
Operator
[Operator Closing Remarks]
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