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NCS > SEC Filings for NCS > Form 10-K on 23-Dec-2013All Recent SEC Filings

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Form 10-K for NCI BUILDING SYSTEMS INC


23-Dec-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
OVERVIEW

We are one of North America's largest integrated manufacturers and marketers of metal products for the nonresidential construction industry. We provide metal coil coating services and design, engineer, manufacture and market metal components and engineered building systems primarily for nonresidential construction use. We manufacture and distribute extensive lines of metal products for the nonresidential construction market under multiple brand names through a nationwide network of plants and distribution centers. We sell our products for both new construction and repair and retrofit applications.

Metal components offer builders, designers, architects and end-users several advantages, including lower long-term costs, longer life, attractive aesthetics and design flexibility. Similarly, engineered building systems offer a number of advantages over traditional construction alternatives, including shorter construction time, more efficient use of materials, lower construction costs, greater ease of expansion and lower maintenance costs.

We use a 52/53 week year with our fiscal year end on the Sunday closest to October 31. As a result, the fourth quarter of fiscal 2013 included an additional week of operating activity.

We assess performance across our operating segments by analyzing and evaluating, among other indicators, gross profit, operating income and whether or not each segment has achieved its projected sales goals. In assessing our overall financial performance, we regard return on adjusted operating assets, as well as growth in earnings, as key indicators of shareholder value.

Fiscal 2013 Overview

Third party sales in our metal coil coating segment increased 14.6% in fiscal 2013 compared to fiscal 2012. Revenue mix improved with a shift from "tolling" activities to complete packages which include the underlying steel coil. Operating income increased to $24.0 million in fiscal 2013 compared to $22.3 million in fiscal 2012. Earnings growth was outpaced by revenue growth primarily as the result of ramping up the new Middletown, Ohio coating facility, lower operating efficiency caused by an unplanned business interruption in the fourth quarter, as well as the result of operating costs for sales and marketing activities and costs related to the extra week during the fiscal year. The metal coil coating segment experienced a fire-related business interruption in our Jackson, Mississippi facility during the fourth quarter of fiscal 2013. We were able to quickly transfer production requirements to our other metal coil coating facilities, minimizing any disruption for both our internal and external customers. The damaged equipment has been repaired and the plant was fully operational by the end of the fiscal year. In addition, the ramp-up of the Middletown, Ohio operations crossed over the breakeven point and produced operating earnings during the fourth quarter of fiscal 2013.

The metal components segment produced a 30.2% increase in third-party sales in fiscal 2013 compared to fiscal 2012, primarily driven by the inclusion of Metl-Span for the full year of fiscal 2013 and a more favorable product mix. Operating income grew to $36.2 million in fiscal 2013 from $34.1 million in fiscal 2012 primarily resulting from the inclusion of Metl-Span for the full year.

Impacted by weak demand, third party sales in our engineered building systems segment increased 1.2% in fiscal 2013 compared to fiscal 2012. Operating income declined to $23.4 million in fiscal 2013 compared to $37.6 million in fiscal 2012. Operating margins were lower primarily due to competitive pricing and margin compression on projects booked earlier in fiscal 2013. In addition, we incurred approximately $2.6 million in costs for specific growth initiatives that we believe will enhance our sales effectiveness and value delivered to our customers. The foundational systems integration that occurred in the third quarter of fiscal 2013 is now forming the platform for further operational improvement planned in fiscal 2014.

Industry Conditions

Our sales and earnings are subject to both seasonal and cyclical trends and are influenced by general economic conditions, interest rates, the price of steel relative to other building materials, the level of nonresidential construction activity, roof repair and retrofit demand and the availability and cost of financing for construction projects. Our sales normally are lower in the first half of each fiscal year compared to the second half because of unfavorable weather conditions for construction and typical business planning cycles affecting construction.


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The nonresidential construction industry is highly sensitive to national and regional macroeconomic conditions. One of the primary challenges we face is that the United States economy is slowly recovering from a recession and historically low nonresidential construction activity, which began in the third quarter of 2008 and reduced demand for our products and adversely affected our business. In addition, the tightening of credit in financial markets over the same period has adversely affected the ability of our customers to obtain financing for construction projects. As a result, we have experienced decreases in orders and cancellations of orders for our products in previous fiscal quarters, and the ability of our customers to make payments has been adversely affected. Similar factors could cause our suppliers to experience financial distress or bankruptcy, resulting in temporary raw material shortages. While economic growth has either resumed or remains flat, the nonresidential construction industry continues to face significant challenges. The graph below shows the annual nonresidential new construction starts, measured in square feet, since 1968 as compiled and reported by McGraw-Hill:

McGraw-Hill Nonresidential Construction Activity

[[Image Removed: [GRAPHIC MISSING]]]

Source: McGraw-Hill

When assessing the state of the metal construction market, we review information from various industry associations, third-party research, and various government reports such as industrial production and capacity utilization. One such industry association is the Metal Building Manufacturers Association ("MBMA"), which provides summary member sales information and promotes the design and construction of metal buildings and metal roofing systems. Another is McGraw-Hill Construction Information Group, which we review for information regarding actual and forecasted growth in various construction related industries, including the overall nonresidential construction market. McGraw-Hill Construction's nonresidential construction forecast for calendar 2013, published in October 2013, indicates an expected increase of 5% in square footage and an increase of 4% in dollar value as compared to the prior calendar year. This represented an upward revision of the 2013 forecast published in July, which indicated an expected increase of 5% in square footage and an increase of 1% in dollar value as compared to 2012. In calendar 2014, activity is expected to increase compared to calendar 2013, with an expected increase of 11% in square footage and an increase of 8% in dollar value. Additionally, we review the American Institute of Architects' ("AIA") survey for inquiry and billing activity for the industrial, commercial and institutional sectors. AIA's architectural billing index ("ABI") is a closely watched metric, as billings growth for architectural services generally leads to construction spending growth for the following 9 to 12 months. We have historically experienced a shorter lag period of 6 - 9 months when comparing the commercial and industrial ABI trends to our volume trends. An ABI reading above 50 indicates an increase in month-to-month seasonally adjusted billings and a reading below 50 indicates a decrease in month-to-month seasonally adjusted billings. AIA's ABI published for October 2013 was above 50 at 51.6 and the commercial and industrial component of the


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index was at 53.7 for October 2013. The commercial and industrial component of the index represents an improvement over October 2012, when the index was 50.1.

Another challenge we face both short and long term is the volatility in the price of steel. Our business is heavily dependent on the supply of steel and is significantly impacted by steel prices. For the fiscal year ended November 3, 2013, steel represented approximately 72% of our costs of goods sold. The steel industry is highly cyclical in nature, and steel prices have been volatile in recent years and may remain volatile in the future. Historically, we have been able to adjust our sales prices in response to increases in steel prices. Steel prices are influenced by numerous factors beyond our control, including general economic conditions domestically and internationally, the availability of raw materials, competition, labor costs, freight and transportation costs, production costs, import duties and other trade restrictions.

The monthly CRU North American Steel Price Index, published by the CRU Group, has increased 3.6% from October 2012 to October 2013 and was 9.4% lower in October 2012 compared to October 2011. For additional discussion of steel prices, see "Item 7A. Quantitative and Qualitative Disclosures About Market Risk."

We normally do not maintain an inventory of steel in excess of our current production requirements. However, from time to time, we may purchase steel in advance of announced steel price increases. We can give no assurance that steel will be readily available or that prices will not continue to be volatile. While most of our sales contracts have escalation clauses that allow us, under certain circumstances, to pass along all or a portion of increases in the price of steel after the date of the contract but prior to delivery, for competitive or other reasons we may not be able to pass such price increases along. If the available supply of steel declines, we could experience price increases that we are not able to pass on to the end users, a deterioration of service from our suppliers or interruptions or delays that may cause us not to meet delivery schedules to our customers. Any of these problems could adversely affect our results of operations and financial condition. For additional discussion please see "Item
1. Business - Raw Materials," "Item 1A. Risk Factors - We rely on a few major suppliers for our supply of steel, which makes us more vulnerable to supply constraints and pricing pressure, as well as the financial condition of those suppliers," "- Liquidity and Capital Resources - Steel Prices" and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Steel Prices."

RESULTS OF OPERATIONS

The following table presents, as a percentage of sales, certain selected consolidated financial data for the periods indicated:

[[Image Removed]]        [[Image Removed]]      [[Image Removed]]       [[Image Removed]]
                                                  Fiscal year ended
                           November 3, 2013       October 28, 2012        October 30, 2011
Sales                            100.0 %                  100.0 %               100.0 %
Cost of sales,
excluding gain on
insurance recovery and            78.9                     77.8                  79.0
asset impairments
(recoveries)
Gain on insurance                 (0.0 )                      -                     -
recovery
Asset impairments                    -                      0.0                   0.1
(recoveries)
Gross profit                      21.1                     22.2                  20.9
Engineering, selling,
general and                       19.7                     19.0                  21.1
administrative
expenses
Acquisition-related                  -                      0.5                    --
costs
Restructuring charges                -                        -                  (0.0 )
(recovery)
Income (loss) from                 1.4                      2.7                  (0.2 )
operations
Interest income                    0.0                      0.0                   0.0
Interest expense                  (1.6 )                   (1.4 )                (1.6 )
Debt extinguishment               (1.6 )                   (0.5 )                   -
costs, net
Other income, net                  0.1                      0.0                   0.1
Income (loss) before              (1.7 )                    0.8                  (1.7 )
income taxes
Provision (benefit)               (0.7 )                    0.4                  (0.7 )
from income taxes
Net income (loss)                 (1.0 )%                   0.4 %                (1.0 )%


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SUPPLEMENTARY OPERATING SEGMENT INFORMATION

Operating segments are defined as components of an enterprise that engage in business activities and by which discrete financial information is available that is evaluated on a regular basis by the chief operating decision maker to make decisions about how to allocate resources to the segment and assess the performance of the segment. We have three operating segments: (i) metal coil coating; (ii) metal components; and (iii) engineered building systems. All operating segments operate primarily in the nonresidential construction market. Sales and earnings are influenced by general economic conditions, the level of nonresidential construction activity, metal roof repair and retrofit demand and the availability and terms of financing available for construction. Our operating segments are vertically integrated and benefit from similar basic raw materials. The metal coil coating segment consists of cleaning, treating, painting and slitting continuous steel coils before the steel is fabricated for use by construction and industrial users. The metal components segment products include metal roof and wall panels, doors, metal partitions, metal trim, insulated panels and other related accessories. Metl-Span is included in the metal components segment. The engineered building systems segment includes the manufacturing of main frames, Long-BayŽ Systems and value-added engineering and drafting, which are typically not part of metal components or metal coil coating products or services. The manufacturing and distribution activities of our segments are effectively coupled through the use of our nationwide hub-and-spoke manufacturing and distribution system, which supports and enhances our vertical integration. The operating segments follow the same accounting policies used for our consolidated financial statements.

We evaluate a segment's performance based primarily upon operating income before corporate expenses. Intersegment sales are recorded based on standard material costs plus a standard markup to cover labor and overhead and consist of: (i) hot-rolled, light gauge painted, and slit material and other services provided by the metal coil coating segment to both the engineered building systems and metal components segments; (ii) building components provided by the metal components segment to the engineered building systems segment; and (iii) structural framing provided by the engineered building systems segment to the metal components segment.

Corporate assets consist primarily of cash but also include deferred financing costs, deferred taxes and property, plant and equipment associated with our headquarters in Houston, Texas. These items (and income and expenses related to these items) are not allocated to the operating segments. Corporate unallocated expenses include share-based compensation expenses, and executive, legal, finance, tax, treasury, human resources, information technology, purchasing, marketing and corporate travel expenses. Additional unallocated expenses include interest income, interest expense, debt extinguishment costs and other income (expense). Segment information is included in Note 22 of our consolidated financial statements.


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The following table represents total sales, external sales and operating income attributable to these operating segments for the periods indicated (in thousands, except percentages):

[[Image Removed]]   [[Image Removed]]     [[Image Removed]]      [[Image Removed]]     [[Image Removed]]      [[Image Removed]]     [[Image Removed]]
                           2013                    %                    2012                    %                    2011                    %
Total sales:
Metal coil          $        222,064                 17          $        210,227                 18          $        201,098                 21
coating
Metal components             663,094                 51                   534,853                 46                   437,655                 46
Engineered                   655,767                 50                   643,473                 56                   548,594                 57
building systems
Intersegment                (232,530 )              (18 )                (234,543 )              (20 )                (227,770 )              (24 )
sales
Total net sales     $      1,308,395                100          $      1,154,010                100          $        959,577                100
External sales:
Metal coil          $         92,970                  7          $         81,106                  7          $         75,394                  8
coating
Metal components             581,772                 44                   446,720                 39                   353,797                 37
Engineered                   633,653                 49                   626,184                 54                   530,386                 55
building systems
Total net sales     $      1,308,395                100          $      1,154,010                100          $        959,577                100
Operating income
(loss):
Metal coil          $         24,027                             $         22,322                             $         17,944
coating
Metal components              36,167                                       34,147                                       20,643
Engineered                    23,405                                       37,596                                       13,011
building systems
Corporate                    (64,411 )                                    (62,376 )                                    (53,225 )
Total operating     $         19,188                             $         31,689                             $         (1,627 )
income (loss)
Unallocated other            (40,927 )                                    (22,692 )                                    (14,720 )
expense
Income (loss)
before income       $        (21,739 )                           $          8,997                             $        (16,347 )
taxes

RESULTS OF OPERATIONS FOR FISCAL 2013 COMPARED TO FISCAL 2012

Consolidated sales increased by 13.4%, or $154.4 million for fiscal 2013, compared to fiscal 2012. This increase resulted from higher tonnage volumes in each of our segments, driven primarily by the inclusion of Metl-Span in the current period and improved demand in the end use sectors we serve compared to the prior year. These increases were partially offset by lower sales prices related to competitive pricing pressure and lower steel and input costs in the current period.

Consolidated cost of sales, excluding gain on insurance recovery, increased by 15.1%, or $135.4 million for fiscal 2013, compared to fiscal 2012. Gross margins were 21.1% for fiscal 2013 compared to 22.2% for fiscal 2012. The decrease in gross margins was the result of lower sales prices due to competitive pricing pressure and lower steel costs, the additional costs associated with the integration cost for our Metl-Span acquisition, the ramp-up of the new Middletown, OH coating facility and our decision to retain and train skilled manufacturing workers in order to capture additional efficiencies in the seasonally stronger second half of our fiscal year which did not materialize. The decrease was partially offset by higher tonnage volumes in each of our operating segments due factors discussed above.

Consolidated gain on insurance recovery for fiscal 2013 was $1.0 million. On August 6, 2013, our metal coil coating segment facility in Jackson, Mississippi experienced a fire caused by an exhaust fan failure that damaged the roof and walls of two curing ovens. During the fourth quarter of 2013, the ovens were repaired and we received insurance proceeds of approximately $1.0 from claims submitted to date. These insurance proceeds have been classified as a "gain on insurance recovery" on the consolidated statement of operations. There was no amount recorded for fiscal 2012. See Note 5 -- Gain on Insurance Recovery to the consolidated financial statements for more information.

Metal coil coating sales increased by 5.6%, or $11.9 million to $222.1 million in fiscal 2013, compared to $210.2 million in the same period in the prior year. Sales to third parties for fiscal 2013 increased by 14.6% to $93.0 million from $81.1 million in the same period in the prior year, primarily as a result of a 8.7% increase in external tons shipped and a higher package sales mix compared to toll processing sales mix.


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Package sales include both the toll processing services and the sale of the steel coil while toll processing services include only the toll processing service performed on the steel coil already in the customer's ownership. Metal coil coating third-party sales accounted for 7.1% of total consolidated third-party sales in fiscal 2013, compared to 7.0% in fiscal 2012.

Operating income of the metal coil coating segment increased to $24.0 million in fiscal 2013, compared to $22.3 million in the same period in the prior year. The $1.7 million increase resulted primarily from the previously discussed insurance recovery and the increase in external volume, partially offset by the additional costs associated with the ramp-up of the new Middletown facility.

Metal components sales increased 24.0%, or $128.2 million to $663.1 million in fiscal 2013, compared to $534.9 million in the same period in the prior year. This increase was primarily due to a 22.4% increase in external tons shipped and higher sales prices, mainly driven by a more favorable sales mix, partially offset by lower steel costs during the fiscal 2013. The external volume increase was primarily driven by the full year inclusion of Metl-Span in the current period. After completion of certain operational integration activities, Metl-Span contributed an incremental $125.5 million of sales in fiscal 2013 compared to fiscal 2012. Sales to third parties for fiscal 2013 increased $135.1 million to $581.8 million from $446.7 million in the same period in the prior year. The remaining $6.8 million represents a decrease in intersegment sales. Metal components third-party sales accounted for 44.5% of total consolidated third-party sales in fiscal 2013 compared to 38.7% in fiscal 2012.

Operating income of the metal components segment increased to $36.2 million in fiscal 2013, compared to $34.1 million in the same period in the prior year. The $2.0 million increase resulted from an increase in external tons shipped as noted above due to the full year inclusion of Metl-Span, which contributed an incremental $8.6 million of operating income during fiscal 2013 compared to fiscal 2012. The increase in operating income was partially offset by costs related to certain growth initiatives and investments in our sales force. Additionally, the prior year comparative period was favorably impacted by the collection of a significantly aged account in the prior year comparative period.

Engineered building systems sales increased 1.9%, or $12.3 million to $655.8 million in fiscal 2013, compared to $643.5 million in the same period in the prior year. This increase resulted from a 5.5% increase in external tons shipped. This increase was partially offset by lower sales prices as a result of competitive pricing pressure and lower steel costs in fiscal 2013 compared to the same period in the prior year. Sales to third parties for fiscal 2013 increased $7.5 million to $633.7 million from $626.2 million in the same period in the prior year. The remaining $4.8 million represents an increase in intersegment sales. Engineered building systems third-party sales accounted for 48.4% of total consolidated third-party sales in fiscal 2013 compared to 54.3% in fiscal 2012.

Operating income of the engineered building systems segment decreased to $23.4 million in fiscal 2013, compared to $37.6 million in the same period in the prior year. This $14.2 million decrease was driven by competitive pricing pressure, lower steel costs and increased labor costs from personnel retained in anticipation of higher demand, which did not materialize during the second half of 2013. The decrease in operating income was partially offset by the increase in external tons discussed above.

Consolidated engineering, selling, general and administrative expenses, consisting of engineering, drafting, selling and administrative costs, increased to $256.9 million in fiscal 2013, compared to $219.3 million in the same period in the prior year. As a percentage of sales, engineering, selling, general and administrative expenses were 19.6% for fiscal 2013 as compared to 19.0% for fiscal 2012. The increase was primarily driven by the full year inclusion of Metl-Span in fiscal 2013 which contributed an additional $15.7 million. In addition, the increase in costs over the prior year was driven by unique expenditures incurred to improve our distribution channels, manufacturing capabilities and customer responsiveness, higher non-cash stock compensation charges, the extra week in fiscal 2013 and variable costs on the increased activity levels.

Acquisition-related costs for fiscal 2012 were $5.0 million. These costs represent various services to enter into a definitive agreement to purchase Metl-Span LLC for $145.7 million in cash. There was no amount recorded for fiscal 2013. See "Liquidity and Capital Resources -- Acquisition of Metl-Span LLC."


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Consolidated interest expense increased to $21.0 million for fiscal 2013, compared to $16.8 million for the same period of the prior year. Interest expense increased due to a higher term loan balance which increased from $128.5 million to $250.0 million on June 22, 2012 as a result of and in connection with the Acquisition and the Company entering into the Credit Agreement which provided for a term loan credit facility in an aggregate principal amount of $250.0 million.

Consolidated debt extinguishment costs for fiscal 2013 were $21.5 million, compared to $6.4 million in the same period in the prior year. During our third quarter of fiscal 2013, we entered into an amendment to our Credit Agreement and recognized a one-time debt extinguishment charge of approximately $21.5 million related to the write-off of non-cash existing deferred debt issuance costs, non-cash initial debt discount write-off, prepayment penalty and fees to the creditors. During our third quarter of fiscal 2012, we recognized a non-cash debt extinguishment charge related to the deferred financing costs of the amended and restated credit agreement, due April 2014, of $5.1 million. In . . .

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