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NCI Building Systems Inc  (NYSE:NCS)
Q4 2018 Earnings Conference Call
Feb. 14, 2019, 9:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Greetings, and welcome to the NCI Building Systems Operational Update Conference Call. At this time, all participants are in a listen-only mode. A brief question-and answer-session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded.

It is now my pleasure to introduce your host Ms. Darcey Matthews, VP of IR. Please proceed.

Darcey Matthews -- Vice President, Investor Relations

Thank you, LaTonya. Good morning, everyone and thank you for your interest in NCI and Ply Gem. Joining me today on the call are Jim Metcalf, our Chairman and Chief Executive Officer; Shawn Poe, our Chief Financial Officer; and Brian Boyle, our Chief Accounting Officer. Jim will lead the discussions this morning and then the team will be available for Q&A following our prepared remarks.

In conjunction with this operational update call, NCI has provided a supplemental slide presentation that includes information on our new business segments and certain 2018 pro forma information.

Please be reminded that, comments regarding the company's results and projections may include forward-looking statements that are subject to risks and uncertainties. These risks are described in detail in the company's SEC filings and the supplemental slide presentation. The company's actual results may differ materially from the anticipated performance or results expressed or implied by these forward-looking statements.

In addition, management will refer to certain non-GAAP financial measures. You will find a reconciliation of these non-GAAP financial measures to the most comparable measure prepared in accordance with GAAP in the supplemental presentation, a copy of which can be found in the Investors section of our website.

In addition, this morning, Jim will provide an update on our integration and cost initiatives and conclude with some color on what we are seeing in our end markets, before we open up the call to your questions.

And now, I'd like to turn the call over to Jim.

Jim Metcalf -- Chairman and Chief Executive Officer

Thank you, Darcey, and good morning, everyone. It's been several months since the completion of the merger of NCI and Ply Gem and we're very pleased on how the integration of two industry leaders is progressing. There are several key areas that we thought are key in bringing these companies together.

This is not just about scale, but it's about growth. It's about providing a broader product offering for our customers. It's also about industry consolidation, as we have acquired both Atrium and Silver Line over the last year. It's also about cost and synergy opportunities in a platform with complementary strength, like innovation and Lean Six Sigma.

We continue to believe that the market diversification of commercial, residential and repair and remodel is a core strength and an important part as we move through the choppy nature of the market that we see in 2019 and beyond.

Recently the acquisition of Environmental Stoneworks, which combined our existing stone business position, NCI and Ply Gem is a market leader in the stone veneer business. It also enabled us to offer a turnkey solution to our residential customers and provide considerable cross-selling opportunities to our commercial customers. This is another example of how we are creating a platform for industry consolidation and growth with products that will meet all the needs of our customers from residential, commercial and to repair and remodel markets.

Earlier this week, we filed a transition period 10-QT, where we shared our new reporting structure. In order to better represent what we do and reflect the strategic transformation of our company, we will report our results in three distinct segments: commercial, windows and siding.

Commercial encompasses the former NCI businesses, which are metal coaters, metal components, insulated metal panels or sometimes we refer to as IMP, and Engineered Building Systems. And the windows and siding segments represent the historic Ply Gem windows and siding businesses, respectfully. In terms of understanding our sales by business segment, we expect our commercial segment will generate approximately 38% of our sales while windows and siding will generate 39% and 23%, respectfully.

Historically, Ply Gem window segment's net sales were weighted about 55% to the new construction market and the remainder to repair and remodel. The siding segment sales were weighted approximately 65% to repair and remodel and the remainder to new construction.

Our ability to leverage this balance among commercial, residential, and repair and remodel and used markets is even more relevant as we're seeing some additional softness in the low-rise commercial market over the last few months.

To provide a better understanding of our combined businesses, our pro forma combined sales for calendar year 2018 were approximately $5 billion. Pro forma gross margins for the year were in the 22% range which excluded some one-time purchase accounting items.

Adjusted EBITDA was approximately $520 million or 10.4% of sales. Pro forma CapEx was $100 million or about 2% of sales with our expectations in 2019 to be between 2% and 2.5% of sales. And finally, pro forma cash flow was strong at $420 million.

We continue to focus on managing our costs and driving margin expansion across our business. Cost initiatives are already under way within both Ply Gem and NCI as well as the deal synergies that are currently expected to achieve $180 million by the end of 2020. We have a defined line of sight to achieve these operational and financial targets and have established a process to ensure our cost initiatives are realized.

As we did mention on our last call, we expect to capture between $90 million and $100 million in cost and deal synergies in 2019. Now, this includes approximately $30 million of investment to achieve these savings.

We anticipate a similar profile savings investment next year in 2020. These savings include as we've talked in the past our ongoing commitment to invest in automation in all of our plants, reduce G&A expenses, enhance our procurement efficiencies, and leverage lean manufacturing to further drive operational excellence across the Ply Gem and NCI network.

In addition to our cost savings and synergy initiatives, we believe there's an opportunity to leverage and improve our combined working capital utilization which will further enhance our free cash flow generation and de-lever our balance sheet which is a priority in 2019.

Before we open the call to your questions, I'd like to share a little information we have on the market and provide some industry observations. Consistent with current market consensus, we continue to experience market softness in early 2019 which actually began in the latter part of 2018.

We expect new residential construction growth to be flat to low single-digit this year in 2019 which as most of you know has been impacted by the tight labor market and growing affordability challenges.

The R&R market, which has softened but we do expect growth in the low single-digit range, which is a key part of our portfolio. And finally in the low-rise commercial market, we anticipate 2019 to be flat to slightly down in the overall market.

In closing, although our general market conditions have softened, our customers are still optimistic but with caution. We expect our end-use market diversification, our cost savings as well as our cross-selling initiatives will allow us to drive year-over-year performance and improvement for the company.

As we said before, we've created a market leading exterior building products company, and we remain very excited about the opportunities that this portfolio of building solutions provides to our customers.

And with that, I'd like to open it up for questions that you may have for myself or the team here. Thank you.

Questions and Answers:

Operator

Thank you. We will now conduct a question-and-answer session. (Operator Instructions) Our first question comes from Matt Bouley with Barclays. Please proceed with your question.

Matt Bouley -- Barclays -- Analyst

Good morning. Thank you for taking my questions. I wanted to ask about -- on the 10-QT, you highlighted the 5% adjusted EBITDA margin, which I believe was down from both legacy NCS and Ply Gem last year. Obviously it was slightly different in monthly timing. But could you just elaborate a little bit on the drivers of the margin decline in the two-month period price versus raw materials, volume leverage any weather related issues? Just help us bridge to that number. Thank you.

Shawn Poe -- Chief Financial Officer

Yeah, Matt. This is Shawn. I'll start and then I'll let Brian jump in as well. But what I would say is there is a fair amount of noise in the 10-QT in the margins as it relates to the purchase accounting in some of the transaction costs that are reflected in there.

Weather did play a factor in overall demand, which obviously guided down the top line, but you lose some operating leverage as well when you have that. From a cost standpoint, typically speaking costs begin to abate in the latter part of the year, but are expected to increase in terms of raw material inputs and labors and such as we go into 2019.

And on the residential side Matt, the company has already announced price increases essentially across all of our products. And I guess one point maybe I could have added to it is the residential side in terms of the weather and the pullback in the market I think you see that all the time. Maybe what isn't as out there is a pullback that has been seen in the commercial market as well. And the general market conditions I think we saw a pullback around the mid-teens to 20%. Does that help?

Matt Bouley -- Barclays -- Analyst

It does. Thank you. And I did want to I guess follow-up on that part and specifically adding on to what Jim said at the end there just around guiding toward low-rise non-residential flat slightly down in 2019. It's -- what have you seen so far this year that kind of gives you confidence in a 12-month outlook like that? Is there -- are you seeing something in your backlog order rates? Do you feel the non-res market has been kind of impacted to a similar degree that the residential market has for kind of similar reasons relating to interest rates? Just what gives you confidence in that guidance specifically? Thank you.

Brian Boyle -- Chief Accounting Officer

Yes. Matt, a couple of things. First, as Shawn said, in the fourth quarter we saw the commercial market significantly go down mid-teens. And we did outperform from an NCI commercial side of the business. And as we've done through the year, we do that with price improvement and our value proposition. There was some pull forward in the fourth quarter from the fiscal year, so there was some business that was pulled into October from NCI standpoint. If you look at early -- look at 2019, the overall market for the five-storey or less 500,000 square foot arena that we play in, in commercial we're still seeing flat to slightly down market outlook for 2019. But we plan to outperform as we've done in the past.

We have our cost initiatives as I've said. But also we've done a great job of managing the price and volume and really segmentating our business particularly in our building's business. So it is disconnected quite frankly from the overall commercial. You look at ABI, the ABI has been consistently above $50 million. But the low-rise segment that we're in has experienced a little bit of a downdraft and we just wanted to put our point of view on -- of the market to be flat to down this year. And we plan to outperform that market. But that's our view and the industry's view for 2019.

Matt Bouley -- Barclays -- Analyst

Okay. That's helpful. And if I could just sneak another one in on environmental materials. The -- I think the release suggested a post-synergy EBITDA of around $30 million. And correct me if I'm wrong there, but can you give us a pre-synergy EBITDA number for them? And I guess, why there was no change to the overall company synergy target today following that deal? Thank you.

Shawn Poe -- Chief Financial Officer

Yes. That -- they -- that is not reflected in the synergy slide today since that transaction hasn't closed. And the synergy number is relatively small. It's around $6 million on that transaction. And you're right Matt, the pre-synergy EBITDA is in that mid-20s that call it $26 million range. It is a profitable business. And frankly, it's one we're excited about. As Jim mentioned in his opening remarks, it makes us a key player in the stone veneer which is the fastest-growing category of exterior cladding. Did that help?

Matt Bouley -- Barclays -- Analyst

Appreciate the details. Oh, I'm sorry.

Shawn Poe -- Chief Financial Officer

Great. No either the fact can appear good on that. So yes.

Matt Bouley -- Barclays -- Analyst

No that's perfect. Appreciate the details. Thank you very much.

Operator

Our next question comes from Lee Jagoda with CJS Securities. Please proceed with your question.

Lee Jagoda -- CJS Securities -- Analyst

Hi, good morning.

Brian Boyle -- Chief Accounting Officer

Good morning, Lee.

Lee Jagoda -- CJS Securities -- Analyst

So just starting with the -- if I look at your original EBITDA expectation for 2018 that you gave when the deal was I guess announced, it was around $520 million -- or excuse me $540 million of EBITDA. And if add in roughly $20 million, or so which would be like the pre-synergy impact from Andersen, it would get me to somewhere around $560 million. Yet, the number that I think you're reporting this morning is around $520 million. So just trying to bridge the GAAP between the $560 million that I think -- I certainly was expecting not sure what others were expecting, but -- and the $520 million that you actually reported.

Brian Boyle -- Chief Accounting Officer

Yeah. Lee the number was -- you're right in the proxy was around $538 million for 2018 and you're right. There's a pullback of about $30 million that was largely driven in really the last three months of the year or so. And it's weighted to about two-thirds on the residential side and about a third on the commercial side and it's directly related to overall sales demand. So there was really no negatives really per sequential, if you will on the margin or the pricing front. But it was really one of overall market demand. And that's why on today's call I think you're hearing Jim and us say that, we're a little bit more cautious in our view on 2019 just given kind of what we saw in the latter part of 2018.

Lee Jagoda -- CJS Securities -- Analyst

So, I guess if I'm looking at the sales of around $5 billion how does that compare to the original proxy then? Because you're right it looked relatively similar.

Brian Boyle -- Chief Accounting Officer

No. It would be down from the original proxy. Now some of that does come from the fact that in the original proxy NCI would have been on a fiscal calendar at that time Lee where the numbers are reflected in today's slide are on a calendar year and the last two months of the year were down. They were a challenging comp and you had the market pullback on the commercial side. But we wanted to level set the understanding of the business as you and others begin to think about and follow the company as we go into 2019.

Lee Jagoda -- CJS Securities -- Analyst

Sure. And then if I look at slide 6 on the synergies are the numbers you're putting in this slide cumulative? Or are they incremental?

Brian Boyle -- Chief Accounting Officer

Let me make sure, I understand your question Lee. On the $180 million is what we expect excluding synergies from environmental stone. That's the cumulative number. And I think as Jim commented on our previous call and I think we can reaffirm today that we are tracking well to those numbers. And frankly, there's probably some upside to them but I do not know that we're prepared to go above that today. But yeah, ultimately, the $180 million that you see there is the consolidated number.

Lee Jagoda -- CJS Securities -- Analyst

And the $100 million is the amount of synergies you expect to realize in 2019 not -- and that would be the run rate in 2019. Is that a fair way to think about it?

Brian Boyle -- Chief Accounting Officer

It is. That is correct, Lee. Yes.

Lee Jagoda -- CJS Securities -- Analyst

Okay. I guess that's all I have for now. Thanks.

Brian Boyle -- Chief Accounting Officer

Okay. Thanks.

Operator

Our next question comes from James Finnerty with Citi. Please proceed with your question.

James Finnerty -- Citi -- Analyst

Hi. Good morning. Just wanted to ask about the cash costs to retain the $180 million synergies, what's the total spend given what's been spent already? And what will be spent in the coming years?

Brian Boyle -- Chief Accounting Officer

Yeah. James, most of that will occur over in 2019 and 2020 as Jim said in his opening remarks. In total, it's about $60 million and its split about half and half roughly.

Shawn Poe -- Chief Financial Officer

Yes.

James Finnerty -- Citi -- Analyst

Okay.

Brian Boyle -- Chief Accounting Officer

And some of that is -- some of that's going to -- just so you know, some of that will fall into capital expenditures as they're tied to automation and such.

Shawn Poe -- Chief Financial Officer

Yes.

James Finnerty -- Citi -- Analyst

Great. And separately I think on, I guess, prior slides you had given what your expectation was for, I guess, EBITDA growth. And that, I guess, those medium-term EBITDA growth, and they're not in -- that's not in today's slides. Do you have any thoughts with regards to that guidance?

Jim Metcalf -- Chairman and Chief Executive Officer

We -- a couple of things. The market as we said has taken a pause. So we want to be realistic about the market demand particularly on the commercial side. But we still feel that we're going to grow the business as the combined business as we said. And we feel that the EBITDA will have low double-digit growth.

James Finnerty -- Citi -- Analyst

Okay. Low double-digit. And then on the M&A front, post the stone transaction given the elevated leverage and given your desire to delever, should we expect a pause in some of the M&A activity, while you do some the integration of all these different businesses and look to pay down debt?

Jim Metcalf -- Chairman and Chief Executive Officer

Well, our first priority as we said is continue to delever the balance sheet. So I want to be very clear that we've said that we want -- our goal is to get to two to three over the next couple of years. So that's basically almost a turn a year and we think working -- focus on working capital and the free cash flow are going to be very, very critical for the business. That is our first priority.

We are -- the integration of the both Ply Gem and NCI is going very well. As I said, we do expect the $15 million run rate that we put in the deck to achieve that this year and that is on a run-rate basis. The integrations of Silver Line and Atrium are going well -- going as well, and we hope to be closing the Environmental Stone here shortly.

The key is really to get those integrated and deliver the numbers. We will continue to look at from an M&A standpoint deals that are strategic and make financial sense, but do not hamper our balance sheet initiatives.

So we're keeping our eyes open, but we want to make sure we deliver the numbers. And really the key is, we're in a choppy market, and we're very focused on the base business, which from the residential side that we feel very comfortable with the integration. And from the commercial side, we have a pretty big downdraft and overall demand that we need to outperform that market. So the focus will be on delevering the balance sheet and focus on the base businesses.

James Finnerty -- Citi -- Analyst

And in terms of delevering the balance sheet, will it be mainly through EBITDA growth? Or will you also be seeking to pay down debt with the debt reduction that you targeted toward the bank debt?

Shawn Poe -- Chief Financial Officer

Well, from a financial perspective, we will have approximately $400 million in cash flow on a recurring basis. Take away $230 million of interest, you're going to have free cash flow to pay down debt just based on cash flow generation from the business.

James Finnerty -- Citi -- Analyst

Okay. So EBITDA growth as well as excellent debt reduction on top of the ...

Shawn Poe -- Chief Financial Officer

That's correct.

James Finnerty -- Citi -- Analyst

Okay. Great. Thank you very much.

Operator

Our next question comes from Reuben Garner with Seaport Global Securities. Please proceed with your question.

Reuben Garner -- Seaport Global Securities -- Analyst

Thanks. Good morning.

Jim Metcalf -- Chairman and Chief Executive Officer

Good morning.

Shawn Poe -- Chief Financial Officer

Good morning, Reuben.

Reuben Garner -- Seaport Global Securities -- Analyst

First a clarification question. The slide 5 the pro forma EBITDA that does not include the EBITDA from Environmental Stoneworks, right? So we will take that $520 million add in the $26 million to it?

Brian Boyle -- Chief Accounting Officer

That is correct, Reuben.

Shawn Poe -- Chief Financial Officer

Yes, you're correct.

Reuben Garner -- Seaport Global Securities -- Analyst

Okay. And then on top of that there's $6 million in synergies, right?

Shawn Poe -- Chief Financial Officer

Yes. That would be the -- I have said before, they're in the mid-'20s on their base EBITDA and we expect to realize $6 million. Now that $6 million may occur over 18 month, 24-month period. But ultimately, we'll realize $6 million on the synergies.

Reuben Garner -- Seaport Global Securities -- Analyst

Okay. And then the -- another clarification. The $30 million for the next two years or each -- the next two years of that investment, how much of that is a capital investment? You mentioned some of it will be capital, some of it will be in the P&L. Can you break that down for us?

Brian Boyle -- Chief Accounting Officer

The majority will be in the P&L, Reuben. But there's probably about 1/3 of it that will fall into the CapEx budget.

Reuben Garner -- Seaport Global Securities -- Analyst

Okay. And then, want to try to dig in a little bit more to the commercial markets. In the past you guys have talked about the leading indicators the LEI, ABI, new single-family housing. There was a brief -- a few months of softness in single-family. But otherwise those indicators still seem to be pretty or indicative of a positive environment. What do you think the disconnect is between what you're seeing and what those indicators are?

Jim Metcalf -- Chairman and Chief Executive Officer

Well what -- if you go back to 12 to 14 months, the leading indicator is housing as you said, it's -- as you know housing started to slow mid-2018. So we're putting forward that number. The leading indicators have been fairly positive. But the disconnect is basically most of the commercial jobs right now, are the mega jobs. The big warehouses, high-rise construction, institutional, you look at -- for example, our business the IMP business still is a good business. Bookings are strong in IMP that's the higher end.

But what our customers are seeing and-it's the shortage of labor, it's weather, it's the steel prices what -- people are wondering what happened. There's been a pause on what's happening with steel prices. And it's just been -- general labor has been an issue in that part of the business.

So at the end of the day with the market being down -- the overall market demand being down, we're really focused on our insulated metal panel business from an architectural standpoint. We're focused on our Buildings business from our segmentation and how we price from our value proposition. And really focus on our cost of margin expansion in each one of our businesses.

So we feel that the market we wanted to just -- we see the market as flat to down. If we'd rather be a little pessimistic on the market and not have market growth in our numbers and we plan to outperform that. So we feel that the second half of the year, where our customers are saying that bookings will be a little stronger, the second half of the year. But the first half of the year there's going to be some tough sliding from an outlook standpoint.

Reuben Garner -- Seaport Global Securities -- Analyst

Okay. And I'm going to speak one more in if I can. I understand the near-term pessimism. And also it looks like you maybe took down your medium-term sales growth targets some. First, can you tell me what you mean by medium term and maybe why you're a little more pessimistic from that standpoint as well?

Shawn Poe -- Chief Financial Officer

Yes. Let me -- this is Shawn, Ruben. I'll speak to that a little bit. Let me first kind of define -- the answer to your question on medium term. I think we see that as a 12 to 18-month period. And the reason maybe -- you'll note that the medium term is a sales growth number. And -- so that's going to also include pricing in it versus the market is really a volume number.

We still feel very positive on the pricing front. And long-term, the indicators are still positive for the industry. But there -- as we've seen in the latter part of 2018, there was a pullback and a number of our products had a lag effect. So that pullback is going to extend into as Jim just indicated on the commercial side kind of a softer first half of 2019. And when we think about that 12 to 18-month period, that's going to have a little bit of dampening effect on that view.

Reuben Garner -- Seaport Global Securities -- Analyst

All right. Thank you.

Operator

Our next question comes from Brent Thielman with D.A. Davidson. Please proceed with your question.

Jim Metcalf -- Chairman and Chief Executive Officer

Brent?

Darcey Matthews -- Vice President, Investor Relations

Brent, good morning.

Operator

Brent your line is live. Brent, this is the operator, your line is live.

Darcey Matthews -- Vice President, Investor Relations

I think LaTonya we may have lost Brent.

Operator

There are no further questions in queue at this time. I would turn it back to management for closing comment.

Darcey Matthews -- Vice President, Investor Relations

Thank you everybody for your interest in NCI Building Systems. We look forward to seeing you folks soon. Brian and I will be at the JPMorgan High Yield Conference on February 26th speaking to investors. And the management team will be at the Seaport Global Conference in March. So, we look forward to speaking with you then and have the first quarter some time in early May. Have a good day.

Operator

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may now disconnect your lines at this time and have wonderful day.

Duration: 30 minutes

Call participants:

Darcey Matthews -- Vice President, Investor Relations

Jim Metcalf -- Chairman and Chief Executive Officer

Matt Bouley -- Barclays -- Analyst

Shawn Poe -- Chief Financial Officer

Brian Boyle -- Chief Accounting Officer

Lee Jagoda -- CJS Securities -- Analyst

James Finnerty -- Citi -- Analyst

Reuben Garner -- Seaport Global Securities -- Analyst

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