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#Good morning.
Thanks for joining the call.
On the call with me today is Bill <UNK>, our Chairman, President and CEO; and <UNK> <UNK>, our Senior Vice President of Finance and CFO.
This call will contain forward-looking statements and some discussion of non-GAAP measures.
For a 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 will now turn the call over to <UNK> to discuss the financial results.
Thanks, <UNK>.
I will start with the income statement and finish with comments on our balance sheet and cash flow.
We reported net sales of $209.1 million during the second quarter of 2017, a decrease of 9% compared to the same period of last year.
Similar to last quarter, the decrease was primarily attributable to our previously disclosed decision to walk away from less profitable business in an effort to increase longer-term return and drive margin improvement, both near term and long term.
Net income decreased to $1.9 million for the 3 months ended April 30, 2017, while adjusted net income increased to $3.8 million or $0.11 per share during the second quarter of 2017 compared to $3.3 million or $0.10 per share in the second quarter of 2016.
The adjustments being made for the 2017 and 2016 earnings per share are as follows: acquisition-related transaction costs; purchase price inventory step-up recognition; a onetime preacquisition employee benefit adjustment; restructuring charges related to the previous closure of the 3 manufacturing plants; gain on the sale of fixed assets related to the closure of the plant in Mexico; accelerated depreciation and amortization for equipment and intangible assets related to the facility consolidation; and foreign currency impacts, primarily related to an intercompany note with HL Plastics.
As disclosed in the earnings release and as expected, we recorded additional restructuring charges in Q2 related to the closing of the 2 U.S. vinyl extrusion facilities and the Mexican cabinet components facility in late 2016 and early 2017.
We will continue to incur operating lease expense until the 2 vinyl extrusion facility leases end as well as other employee-related costs.
EBITDA came in at $19 million for the second quarter of 2017 compared to $24.4 million last year.
On an adjusted basis, EBITDA for the second quarter of 2017 was $20.5 million compared to $24.3 million last year.
The decrease was largely due to lower volumes as we continue to transition away from less profitable business, combined with elevated legal expenses.
It is worth noting that we were able to realize adjusted EBITDA margin expansion in our cabinet components and European Engineered Components segment even with lower revenues.
Moving on to the balance sheet.
Our leverage ratio ticked up to 2.7x as of April 30, 2017, mainly as a result of adding approximately $16 million in debt resulting from a capital lease for a new warehouse servicing our U.K. vinyl profiles business.
We remain focused on generating free cash flow to pay down debt and anticipate a significant improvement in our leverage ratio by year-end 2017.
As a reminder, our long-term leverage ratio target is 2 to 2.5x.
We expect to be well within this range by the end of the fiscal year.
Cash provided by operating activities decreased to $15.7 million for the 6 months ended April 30, 2017, compared to $24.6 million for the same period in 2016.
The biggest driver of the year-over-year reduction relates to the timing of payments to suppliers.
This issue will naturally correct itself.
We continue to expect an increase in the year-over-year free cash flow of approximately $10 million.
Keep in mind that we generate most of our cash in the second half of each year due to the seasonality of our business.
For example, in 2016, we generated 82% of our free cash flow in the second half, and to take it a step further, we generated 52% of total free cash flow in the fourth quarter alone.
I will now turn the call over to Bill.
Thanks, <UNK>.
In our U.S. vinyl profiles business, the anticipated annual revenue reduction of $65 million continued on pace with a $17 million reduction in Q2 after an $11 million reduction in Q1.
We expect that the balance of $37 million will be split relatively evenly between Q3 and Q4.
And as we have said previously, this has been factored into our full year guidance.
The consolidation of this business is now essentially complete.
For the first half of this year, we successfully closed 2 facilities, relocated 13 extrusion lines, retired 23 lines and transferred 228 active tools to our remaining 3 facilities, all without any service disruptions.
We will spend the balance of this year fine-tuning and optimizing the shop floor layouts in each of the 3 remaining facilities in order to drive greater efficiencies to further improve margins.
In the rest of the businesses that make up the balance of our North American Engineered Components segment, revenues, EBITDA and margins were all flat year-over-year, impacted by a particularly soft April mainly due to weather, heavy rains on the West Coast and a storm in the northeast.
Despite the slow start, there's a great deal of optimism throughout our customer base for a strong summer selling season.
In our cabinet components segment, margins improved slightly year-over-year on flat revenues even though we continue to face strong operational headwinds.
We were able to negotiate acceptable price increases on about a half of the $20 million of margin-dilutive business we previously identified, and we agreed to walk away from the other half.
This is also being factored into our full year guidance.
While this will have a positive impact on our results in the second half, it was still a headwind in the second quarter as most of the price increases did not go into effect until late April and we continue to work excessive overtime for customers building safety stocks for products that were in the process of transitioning to other suppliers.
This resourcing effort took much longer than anticipated but was finally completed as Q2 closed and, therefore, should have no ongoing negative impact in Q3.
We believe that these actions, along with productivity improvements from some of our automation projects, will drive margin expansion of approximately 200 basis points in the second half of this year on what is expected to be relatively flat revenue levels.
In our European Engineered Components segment, we realized 4% revenue growth on a local currency basis during the quarter, which was lower than the double-digit growth rates we have seen over the past year but really not a surprise given the political turmoil throughout the quarter in Europe.
Brexit was officially triggered.
There was a contentious election in France, and there is still a surprisingly uncertain pending election in the U.K. Despite all these moving parts, the European Engineered Components segment continues to be our most profitable, and margin improved by a further 30 basis points year-over-year in this second quarter.
We still expect solid mid-single-digit revenue growth for the remainder of the year in this segment.
As <UNK> mentioned just now, our leverage ratio increased slightly this quarter to 2.7x as a result of the new HL Plastics capital lease.
As a reminder, most of our free cash flow is generated in the second half of our fiscal year.
Last year, we generated approximately $42 million of free cash flow during the second half, and we remain confident that we will surpass that number in the second half of this year.
This cash will be used to pay down debt as it is very unlikely that we will close on any acquisitions during the balance of this year, thus, we should end the year with a leverage ratio close to 2x.
In summary, we came into this year expecting materially lower revenues, but with improved margins and stronger free cash flow.
In order to achieve this, we needed to do 2 things: one, rapidly restructure our U.S. vinyl profiles business; and two, stop the profit leaks in our cabinet components business and reposition it for profitable, sustainable growth over the next several years.
Through the first half of this year, we've successfully completed the consolidation in our U.S. vinyl profiles business and turned the corner in our cabinet components segment, thus, setting us up for a strong second half.
As such, we are confident in reaffirming our prior guidance of $880 million to $900 million in revenue and $105 million to $112 million in adjusted EBITDA with a leverage ratio closer to 2x.
And with that, operator, we're now ready for questions.
Yes.
So as far as comps go, if you recall, the first half of last year was pretty strong, mostly for the ---+ because of the warm winter.
So we\
Yes.
So the ---+ I'm not sure that we actually disclosed the amount that we have left.
It's no longer material.
They would no longer, at Mikron, fall into our top 5 customers, although, of course, we sell them other products elsewhere.
We're now in a position where, as a result of the consolidation and the loss of that business, that we have a pretty stable footprint where we can start regrowing the business.
Frankly, the restructuring went better than we anticipate, and as a result, perversely, we actually increased capacity.
Even though we have 2 fewer plants and 23 fewer lines, our actual realized capacity went up somewhat.
So through the second half, we're going to be doing a combination of 2 things.
We're obviously actively out pursuing other business, and I'm not going to talk about the specifics of that because there are some ongoing negotiations, but we are confident we can start regrowing this business with better profitability going forward.
But more importantly, as we start getting efficiencies up with the existing footprint, we're doing a fair amount of fine-tuning to make sure that we're fully utilizing our most productive equipment.
And it is possible, as we go through the second half of the year, that we'll end up retiring more extrusion lines to further reduce our capacity, more in line with our production expectations.
Yes.
So generally speaking, prebuys are unusual because most of the product line is highly customized.
This was very specific to product that we expected to exit the building much, much sooner.
But one particular customer had a lot more difficulty than anticipated in getting the business resourced, so we ended up in a spot where we were tight on labor and we worked excessive overtime.
In fact, in the second quarter alone, the overtime premium compared to the second quarter of the previous year was $0.5 million greater.
So absent that ---+ and the majority of that overtime was really working for customers.
That was product we really didn't want or need, and it was certainly dilutive to margin.
But absent that, the margin improvement would have been probably closer to 80 basis points better.
So I wouldn't take that to mean that preordering is something that is common.
And then we're not going to speak to specifics on the individual price increases for obvious reasons, but suffice to say that with the exit of some of the other business and the productivity improvements, gives us confidence that in the second half, we should see about a 200 basis point margin improvement in that business.
So the short answer is it's being adopted slowly, and slowly because of the inability of the equipment manufacturers to produce enough lines fast enough.
That's really the chokepoint on that project.
The customer on the West Coast that had the first line installed very, very successfully and subsequently ordered 2 more.
The customer on the East Coast that's moved a little slower has 1 working very successfully, about to take delivery of a second, with a third pending order.
And we have a number of other customers that are actively looking at the project.
The short version of the value proposition is, for the first time ever, we can now, on an automated line, using flexible warm-edge spacer, produce insulated glass units at about the same production rate as the metal bar spacer, but we do so with significantly less labor.
Typically, the metal bar lines, mostly because they are old now, run with 8 to 9 people, and a super spacer line will run typically with 3 people.
So net-net, even though the cost of the spacer component itself is more expensive, the total cost of the insulated glass unit for the customer is about the same with significantly better quality.
And labor, as we all know, is difficult to come by, so they can utilize their existing labor much more efficiently.
So hopefully, that answers the question with enough color.
Yes.
Look, the biggest issue really was a lack of margin improvement in the vinyl profile business.
As we sort of closed that out, their margins sort of held, I would expect to see some improvement here as we go into the second half, and certainly, next year.
Awful lot of moving pieces in that business, so it's sort of difficult to pin down here the detail of any one or single set of components.
Suffice to say, I think given all the moves that took place, given that there was a very soft weather-related April, coming out of the second quarter flat, we considered a victory, and we now have a stable platform to build on for the second half of the year.
Well, no, there ---+ really, it's 3 things that we talked about really through the first half of this year.
One, the margin-dilutive business will be corrected.
Half of it will go out of the door, which will be a benefit.
Half of it, we got price increases that were acceptable to us, which clearly will be a benefit.
Neither of those 2 factors had any positive impact in the second quarter because it really took us all of the second quarter to get both of those things accomplished satisfactorily.
And then the automation projects that are being initiated through the course of the last year, some of those are really kicking in as expected.
So we'll see 3 things: better margins through price; better margins because some dilutive business will exit the building; and three, productivity improvements are actually starting to take hold.
So those are really the 3 components that will drive the expansion in the second half.
Yes.
I mean, we basically halved the growth rate.
I mean, we were running in the low double digits quarter-over-quarter, year-over-year through last year and through the first quarter, and clearly, the level of uncertainty is having an impact.
But we got 4% on a local currency basis, and the expectation is that will be the growth rate here as we go forward.
There is a surprising amount of uncertainty regarding next week's election.
It's gone from the polls saying a landslide victory to a Reuters report today that actually said she could lose her majority.
And of course, based on recent experience in elections, who knows what the polls really mean, but it creates a level of uncertainty that's certainly slowing investment, but certainly not to the point of panic here.
So I think it'll still continue to move in mid-single digits.
No.
We will, towards the end of this year, start looking more aggressively at some of their very specific product lines that we feel may have a niche position in the U.S. market, and we may, in fact, start test marketing some of those products with a view that if it's successful, we'll actually start manufacturing them here in our vinyl profile operation.
But still very much in the early stages, and frankly, that would be a relatively long, slow process.
I wouldn't expect to see any benefits from that until, certainly, the second half of 2018.
But given that we've sort of cleared the decks of a lot of other issues here, that's now starting to become a higher priority.
There are, and there are a couple of new products that are being introduced in our vinyl profile business that are appropriate for low rises, storefronts and light commercial.
And that's an active part of their growth initiative to rebuild the volumes in that business.
So yes, there are active programs underway.
It's a little bit higher in the vinyl business than in the spacer business, but not significantly so.
Thanks, everyone, for joining the call, and we look forward to updating you at the end of the third quarter, we hope with a much stronger performance as we look forward to a very strong close for the year this year.
Thanks.
