Scott Zuehlke - VP of IR and Treasurer Bill Griffiths - Chairman, President and CEO Brent Korb - SVP of Finance and CFO.

Daniel Moore - CJS Securities Al Kaschalk - Wedbush Securities Steven Ramsey - Thompson Research Group Ken Zener - KeyBanc.

Good day, ladies and gentlemen and welcome to the Quanex Building Products Corporation Fourth and Full-year 2016 Earnings Conference Call. [Operator Instructions] As a reminder today’s program is being recorded. I would now like to introduce your host for today’s program Mr. Scott Zuehlke, Vice President of Investor Relations and Treasurer.

Please go ahead sir..

Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President and CEO and Brent Korb, our Senior Vice President of Finance and CFO. This conference 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 Brent to discuss the financial results..

Thank you, Scott. I'll start with the income statement and finish by providing comments on our balance sheet, leverage and cash flow. Consolidated net sales during the fourth quarter and the full fiscal year of 2016 increased 27% and 44% to $249 million and $928 million respectively compared to the same period of fiscal 2015.

As expected the increases were driven by contributions from the HL Plastics and Woodcraft acquisitions.

We reported income from continuing operations of $5.4 million and a loss from continuing operations of $1.9 million for the three months and twelve months ended October 31, 2016 respectively compared to income from continuing operations of $9.9 million and $15.6 million for the comparable period in 2015.

Adjusted net income from continuing operations was $15.6 million or $0.45 per share during the fourth quarter of 2016 compared to $13.4 million or $0.39 per share in the fourth quarter of 2015.

For the full-year 2016 adjusted net income from continuing operations was $27.7 million or $0.80 per share compared to $23.7 million or $0.69 per share for the full-year 2015.

The adjustments being made for EPS are as follows; acquisition related transaction costs and purchase price inventory step-up recognition, the write-off of deferred loan costs, unamortized original issuance discount and prepayment call premium related to our debt refinancing in July, foreign currency losses primarily related to an inner company note with HL Plastics, restructuring charges and the goodwill impairment charge.

As disclosed in the earnings release, we recorded restructuring charges of $529,000 in Q4 related to the closings of two US vinyl extrusion facilities and the cabinet components facility in Mexico. We will have more expense in 2017 as a result of these closures for equipment relocation, lease runoff and accelerated depreciation and amortization.

Related to shedding business with a large US vinyl profile customer and closing the two facilities, we recorded a $12.6 million goodwill impairment charge and recognized $1.3 million of accelerated depreciation and amortization in the fourth quarter of 2016.

After taking this impairment charge, there is no more goodwill remaining on the books for our US vinyl profiles business. On a consolidated basis, EBITDA was $21.4 million during the fourth quarter of 2016 compared to $27.5 million during the fourth quarter of 2015.

For the full-year 2016 EBITDA was $89.5 million compared to $59.9 million for the full-year 2015. After adjustments related to transaction costs inventory step up, restructuring charges and the goodwill impairment, adjusted EBITDA increased by 14% to $34.6 million during the quarter compared to $30.4 million in last year's fourth quarter.

For the full-year 2016, adjusted EBITDA increased by 58% to $110.3 million compared to $68.7 million in 2015. Now let's move on to the balance sheet leverage and cash flow.

As a result of generating strong cash flow in 2016 and successfully refinancing our debt, our balance sheet is strong and we have a flexible capital structure that supports our business requirements. Cash provided by operating activities increased 29% to $86.4 million in 2016.

In fact, as a result of generating strong cash flow, we were able to reduce our bank debt by approximately $52 million throughout the year, approximately $32 million of which was repaid during the fourth quarter alone.

At the beginning of the year, we set forth the goal of achieving a leverage ratio between 2.0 and 2.5 times by the end of our fiscal 2016. We achieved the goal with a leverage ratio of 2.2 times at October 31.

To recap the debt refinancing, in late July we entered into new senior secured facilities totaling $450 million comprised of a $300 million revolving credit facility and $150 million term loan A.

Borrowings under the new credit facilities bear a tiered interest rate based on our consolidated leverage ratio and has average LIBOR plus 200 basis points since refinancing for approximately 2.5% reducing our credit spread compared to the previous credit facilities by approximately 375 basis point which is very accretive to EPS.

From a capital expenditure standpoint, we expect to spend approximately $40 million in 2017, which is less than what we originally planned to spend in 2016 and slightly more than the $37 million we actually spent. We will continue to invest in automation across all divisions with a heavier focus on the cabinet components segment.

Longer term, we remain confident that our annual capital spend level should settle between $30 million and $35 million. For 2017 modeling purposes it is appropriate to assume depreciation of approximately $36 million, amortization of approximately $18 million, interest expense of approximately 10 million and a tax rate of 31%.

We expect to provide more detailed guidance in the coming months as we enter the selling season and gain more clarity related to how 2017 is progressing. Lastly, it is important to mention that both HL Plastics and Woodcraft are now SOX compliance.

It takes a massive amount of effort for a private company to successfully transition into and become part of a larger public company. So thank you to all of the dedicated Quanex team members that contributed to making this happen. I will now turn the call over to Bill..

Thanks Brent and good morning everyone. Let me start by summarizing our performance in 2016. We entered the year estimating growth of 5% to 6% which at the time most people thought was somewhat conservative. The year got off to a strong start as a result of a mild winter but slowed dramatically through the summer months.

According to the latest research data from [indiscernible] on window shipments and KCMA on semi-custom kitchen cabinet shipments blended market growth for the trailing 12 months ended September 30, 2016 was approximately 5%.

In addition to lower than expected industry growth rates and foreign exchange translation impact, we experienced raw material pass through deflation across most of our businesses and price decreases primarily in our US vinyl profiles business.

We also consciously shared approximately $15 million with the business in 2016 in order to protect and enhance margins. The combination of all these factors resulted in an annual sales figure that was somewhat flattish on a pro-forma basis compared to 2015.

However, we say consistently throughout the year that margin expansion, cash flow generation and debt paydown were our top priorities and we delivered on all of these metrics despite the soft topline.

We originally guided to a consolidated EBITDA margin of 11% to 12% for 2016 and on an adjusted basis we actually achieved an EBITDA margin of 11.9% close to the upper end of that range. This was an improvement of 110 basis points compared to 2015.

And it's important to understand this improvement was primarily driven by internal operating efficiencies as we did not have any help from volume or price. The improved profitability drove strong cash flow generation and ultimately enabled us to pay down debt and improve our leverage ratio to 2.2 times which is well within our stated target.

To build on Brent’s previous comments, the successful debt refinance in this past July coupled with the expectation of continued expanded margins will help us further improve our cash flow profile in 2017, which in turn should allow us to further reduce debt absent any accretive M&A activity.

To summarize, 2016 was a very successful year with respect to our primary goals of margin expansion and cash flow generation. Looking ahead to 2017, there's clearly a great deal of post-election optimism for the building products sector.

While we share that optimism, we continue to believe that overall growth rates in the short term will remain in the mid-single digit range constrained primarily by the availability of labor at the homebuilder level and the specter of higher interest rates.

We should have greater clarity on prospective growth rates after we close our fiscal first quarter and the new administration starts to propose and enact change some of which could offset the aforementioned constraints.

More specifically with respect to Quanex, we're projecting 5% to 6% growth for the underlying business but this will be offset by us consciously exiting $50 million to $70 million of marginal business through 2017.

The majority of this is in our US vinyl profiles business were a single large customer wanted a significant immediate price decrease with a contractual obligation for further decreases over the next three years. As a result, we have initiated the process of discontinuing approximately 300 profiles for this customer.

We expect this process to be carried out in an orderly manner throughout 2017 and possibly into 2018. In addition, we have had and continue to have pricing discussions related to product lines with marginal profitability with several smaller customers mainly in our cabinet components business.

As a result of these actions, it is virtually certain that we will shed 50 million of revenue in 2017 and it is possible that this number could increase to 70 million if ongoing discussions are unsuccessful.

Long term these actions benefit us by significantly reducing complexity and allowing us to further simplify manufacturing which reduces expenses, inventory needs and CapEx thereby resulting in improved ROIC.

As we progress through the transition in the short term, the actual results will be heavily dependent upon the timing and pattern of the volume reductions.

Assuming an orderly transition, we would expect to improve margins by approximately 50 basis points in 2017 and at a minimum keep adjusted EBITDA dollars flat versus 2016 which sets us up to deliver another year of improved free cash flow likely about $10 million better year over year.

In order to prepare for this reduced volume, we recently announced internally the closure of two of our five US vinyl extrusions plants and our cabinet components operation located in Mexico. Closure of the Mexico plant and one of the vinyl extrusions plants has already been completed with no disruption to the underlying businesses.

And we expect that the second vinyl extrusion plant will be completely closed by the end of January 2017. The majority of the assets in these facilities will be redeployed to other locations to replace older less efficient equipment.

Since most of the discontinued volume will be our US vinyl extrusion business, we will use this as a catalyst to reduce our footprint, reduce product proliferation and put us in a position to better utilize our most productive assets.

In total, the restructuring in our US vinyl profiles business will involve relocating approximately 200 tools and 13 extrusion lines to our other facilities which will then allow us to retire 26 older and underutilized extrusion lines. Overall, we will reduce our capacity in this business by about 35%.

All of the closures should be completed by the end of our first fiscal quarter but as Brent said some of the restructuring related charges such as residual lease obligations will continue to flow through our results during the rest of the year.

So some of our expectations for 2017, we are projecting underlined sales growth of 5% to 6% offset by the planned volume reductions previously discussed and with the potential negative foreign exchange translation impact which could be approximately $20 million based on current exchange rates.

However, more importantly in our opinion, we expect that the combination of continued margin expansion and reduced cash interest expense will drive a further improvement to our free cash flow profile in 2017.

With respect to the longer term outlook, the actions taken now will enhance our ability to reach our 15% mid-cycle EBITDA goal and while we may fall into the lower end of our mid-cycle revenue guidance, EBITDA of roughly 200 million and free cash flow of roughly 120 million is eminently achievable.

We will continue to provide more detailed guidance as the year progresses. So operator we’re now ready to take questions..

Certainly. [Operator Instructions] Our first question comes from the line of Daniel Moore from CJS Securities. Your question please..

Bill, maybe just talk a little bit more, a little bit more color or granularity on the decision to walk away from some of that business.

Is there a competitor or competitors that are being particularly aggressive or under pricing as a customer? What other options or alternatives does the customer have and is there any other additional revenue beyond that the bulk of the 50 million with that customer after we walk away from it?.

So there's really two separate things going on. The bulk of the business we're going to walk away from in 2017 is in fact that one customer in the vinyl profile business and they are in fact going to place that business with a competitor who is incredibly aggressive on pricing.

We had the opportunity to keep that business but the price reduction of our current price level is in excess of 20% with a contractual obligation to further reduce prices over the next three years and hold any resin price increases as well and that was just unacceptable level for us.

And more importantly was really a positive move in that walking away from that much business allows us to really reset the footprint of our vinyl business which will take it to another level of profitability. So all in all that was a very positive move and not a difficult decision given the magnitude of the price reduction we were looking at.

The other part of this is there is - we are identifying and this is mostly in the cabinet components business as we have a new team in there looking for margin opportunities. We've identified a significant amount of business that is marginally profitable some of it in fact is not profitable at all.

And we're in multiple discussions with multiple customers on individual product lines to either assist them in moving that business elsewhere or to increase prices such that it's beneficial for us to keep that. So there's really sort of two things going on simultaneously. I think the vinyl profile situation is a one-off..

Very helpful and you mentioned that you would reduce your vinyl capacity by about 35%. Remind us how much you did - roughly speaking, in rough terms your market share. Trying to get a sense of how much that would reduce the overall market capacity..

Our market share in the aggregate including vertically integrated is probably in the low 20% range of the total market and keep in mind about half is vertically integrated. It's a significant move and we certainly have more or had more excess capacity than most everybody else in the industry..

Got it. A quick follow-up. I think you mentioned you would expect the adjusted EBITDA to be at least flat.

If we were to come in a little better than that next year, what would be some of the drivers?.

I think, when we’re moving a lot of equipment, we’re closing and relaying out plants, things can go wrong. So I would prefer to err on the more conservative side. If all that goes well, there is upside to the numbers there.

And I think notwithstanding what's going on at Quanex, I think what happens to the general economy and what happens in the residential construction sector next year is still a little bit of an unknown. Right. I mean I think there is a lot of optimism. And if things really go as well as most people believe, I think that's upside to that number as well..

Last one and I’ll jump back in queue. Generating a lot of cash, you probably tick down below two times this year.

Just remind us in terms of capital allocation, M&A still preeminent and would you consider maybe being a little bit more aggressive on returning cash or share repurchase as well?.

Yeah. The current credit agreement gives us some limitations on doing that. The M&A pipeline, look, we're still active in the marketplace. There's not a lot out there that meets the criteria we need. Hence, no action at all in 2016 and 2017 quite frankly could shape up the same way.

And I think if we continue to pay down debt, that's not a bad outcome, but as we've said before and I think as we've demonstrated, we're open to whatever makes the most sense at the time when it comes to deploying capital..

Thank you. Our next question comes from the line of Al Kaschalk from Wedbush Securities. Your question please..

Good morning, guys. Nice job and appreciate the additional details for fiscal ‘17. So my question, I guess, I just want to focus on a little bit around the margin topic. You mentioned the takeout or the exiting the vinyl business; you've been very vocal about the lack of pricing in that business.

So my question is this, we should probably expect volume and/or further cost reductions to add to that margin, but are you seeing any signs on the pricing side that you have it going in the right direction or at least a more favorable direction for Quanex and Quanex shareholders..

Unfortunately, in the vinyl profile business, the answer to that is no, we've taken price decreases this year. This particular case, as I just mentioned, the price decrease required was just over and above. But we have not seen price increases in that sector at all and I'm not sure that that’s likely to change in 2017.

We may get some very selected price increases on specific products with specific customers in our other businesses. But I think I would say overall it's still a tough environment for us to get price, even though, our customers continue to get price from their customers.

So there's really no price increase expectation built into our future numbers here for 2017..

That’s helpful. And while there's a lot of work still to be done, do you take off the table or lean on the table, the view that there could be further business that if it doesn't meet the return profiles, you find ways to exit that as well. Hence the high, continued high focus on ROIC..

Yes. That's clearly going to be the continued focus of the business. I think this 50 million to 70 million is pretty much the end of it. I mean we've now identified I think almost all of the bad business.

The only thing I think that would change that is if we had another or the same competitor take a very aggressive view with another customer and forces to decrease prices significantly that that could cause us to walk away from more business. But based on what we see and know today, I think this 50 to 70 is the end..

Right.

And just another part to that and then maybe you could shed some color on Europe, but first on the, are you seeing anything on cost inflation or areas there that would maybe by the headwinds in the margin story? And then second, to what extent has there been any update or thoughts on Europe and in particular the BREXIT impact?.

Yes. On the cost side, as you know, almost all of our significant raw material costs are passed through up or down, which leaves labor, healthcare, benefits, those kind of things as big costs that are on their inflationary pressure. One of our stated goals is to continue to invest heavily in automation, which helps offset that.

Labor is still difficult to come by. It's getting progressively more expensive and I don't think that's likely to change. So replacing that with automation is a key part of the strategy, but we don't see anything on the cost side that we don't have a view to offsetting as we go through the year or to impact our margins negatively. .

Yeah. And I think, Al, you're asking also on Europe and really in the UK where I think some of the risk was from a BREXIT standpoint, where some of the raw materials are, though we pay for it in pounds, ultimately if you follow it upstream, it does originate in mainland Europe. So it’s euro based.

So we have seen some pressure on that to date and during 2016 after the vote, the industry as a whole did raise prices, us included as a means to offset some of that inflationary pressure and we’d really expect to the extent that continues that the industry would react similarly..

Thank you. Our next question comes from the line of Nick Coppola from Thompson Research Group. Your question please..

Good morning, guys. This is Steven Ramsey on for Nick. Looking at North America engineered components; there was only the 1.6% growth in volume.

What's the delta there versus the core underlying 5% to 6% growth you've talked about and how does the exited business impact that along with inventories and customers?.

So first of all, the 5% to 6% was the projected growth. It looks as though industry growth is going to come in closer to 4%. And that's a blended cabinet and window components number.

I mean look I think the takeaway is we’ve said growth is difficult to come by, particularly in this environment when we're evaluating product lines and customers for profitability, overall 15 to 16 was about flat and overall 16 to 17 could be flat to slightly down.

But as long as margins continue to improve, profitability improves and cash flow improves. We're happy with that outcome..

Thanks. And then on Woodcraft, I’d be interested to hear sales trends in Woodcraft on a year-over-year basis and then how the progress is in improving operations there and potential margin improvement in fiscal year ‘17..

So again, Woodcraft overall, year-over-year pro-forma, they were pretty much flat. They had material deflation as hardwood prices dropped and that got passed through to the customer.

We exited some business in 2016 and we're going to escalate that program in 2017 as the new management team is in there and as you exit some of this loss making or bad business, it gives you the opportunity to better utilize the assets, better utilize labor, gives you the ability to relay out equipment on the factory floors, all of which were in the process of doing and we remain very, very confident that the margin profile of that business, not only will meet our original acquisition expectations, but now I think we have a line of sight over the next few years to exceed the margin expectations when we bought that business..

Thank you. Our next question comes from the line of Ken Zener from KeyBanc. Your question please..

Good morning, gentlemen. I think it's very good day. You're making the difficult decision in the extrusion business. I wonder if you could give us a little more guidance. I think you said for the year FY17 EBIT would be up 50 basis points.

Did I hear that correctly?.

The EBITDA margin is what we were saying..

The EBITDA margin. Now, could you perhaps, just given the pressure that you have from some of these exited businesses, just we don’t want to misinterpret, let’s say, the first half margin pressure, because it exits versus second half or is it even throughout the year.

And then could you maybe get a little more in to the segment guidance as well, just so we can understand the impact on the vinyl versus the cabinets?.

So first of all, because of all the moving parts here in the first half of the year which as you will notice generally a slowest as well, you can clearly expect the margin expansion to be back end loaded. You're absolutely right. We're not going to see a whole lot of that, particularly in the first quarter, but it will be back end loaded.

As you know as well, absent the vinyl profile business, the rest of the North American engineered components business, we've been at the margin improvement game now for three years with good results and there's not a lot of juice left in the rest of that business to really move the needle on margins.

There's still a big opportunity in the vinyl business, but clearly as we exit a significant portion early on in the year, close two plants, move equipment and tooling around, I think it will take a while into the second half of the year before we get traction on further margin expansion there, but there is opportunity and then clearly in the cabinets business, that's where the biggest margin expansion opportunity exists.

The new team is really starting to get traction there, starting to take some actions that again we won't see too much of in the first quarter. But as we get into Q2 and then certainly the second half, we should see a ramp up in their margins that will be pretty visible with the way the segments are reported..

Appreciate that. And I will ask a question I’ve asked you before, I think I didn’t know the answer, but within the engineered components because you have such the screens, the spacers and then the extrusion are three very different EBIT profiles. I don't assume you're going to eliminate us in terms of what those spreads are.

Would you?.

That is correct. We are not, but I appreciate you asking the question..

Related to that is the fact that I kind of, I would have assumed perhaps that the bold move to get rid of that, the lower margin business would have resulted in EBIT margin uplift and I’m not trying to be negative at all, so I think there are, other two businesses are very good and obviously you needed to do this in the extrusion side, but I’m just trying to understand if you walk away from the lower margin, why isn't there a net benefit I guess to the margin?.

Well, to be clear, right, the business historically has been at, call it, average margins. It's in the future, in the extrusion business, correct. Right. So in that case, we're not walking away from that, because it is currently margin dilutive because it's not. It would have been margin dilutive significantly with a 20% to 25% price decrease.

So it’s a little bit of a different situation than what we're facing with some of the other business, which clearly is margin dilutive, but much smaller numbers.

Does that make sense?.

Understood. It does and that was an assumption there on my part.

Would you like to give the location of these closed facilities by chance?.

Yeah. No reason not to. We closed the Yakima Washington vinyl extrusion facility. We closed the Guadalajara, Mexico cabinet components facility and then we will have the Greenville, Texas facility closed by the end of January..

Good. And I appreciate this. One more if I may. What was the stock’s cost in cabinets? Is there a number that we could think about so we could understand how much that burdened the business, burdened by non-operating cost? Thank you very much..

Yeah. I mean, so I put it this way, Ken. It's difficult. We don't have like a bucket where we track it at, but it’s definitely in the high hundreds of thousands of dollars of cost when you really step back and think about the distraction that it caused and some additional labor we had to bring in as a result..

Thank you. Our next question comes from the line of Bob Wetenhall from RBC Capital Markets. Your question please..

Hey, guys. This is actually [indiscernible] on for Bob today. So on the, and you’ve spoken about this a little bit already, just the automation investments that you've made. I think in the past, you talked about potential for 200 basis points improvement in cabinets.

Is that still a reasonable estimate longer term and what is kind of the pace of the realization of that and I know you talked about some more improvement in the back half of ’17 than first half, but is that 200 still accurate..

Yeah. That’s still a good number and I think the additional color I would have is that based on what we're now seeing, we believe that the opportunity longer-term, now 18, 19 is in excess of that..

Okay. Great. Thank you. And then just quarter-to-date, I don't know if you all could provide any sort of update the way you've seen, you may be in and around the election demand following the election and I guess given until maybe up until this week, it's kind of been a milder November again. .

Frankly November follow the trend of the end of our fiscal fourth quarter. So September-October and into November very similar story line, steady. Not off the charts, but not fallen away either. So just continued steady growth..

Thank you. Our next question is a follow-up from the line of Daniel Moore from CJS Securities. Your question please..

I’m covered. Thank you, again..

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to CEO, Bill Griffiths for any further remarks..

So thanks everyone for joining us. And to recap briefly, we successfully accomplished all of our stated goals in 2016. We will continue to focus intensely on margin expansion and strong free cash flow generation in 2017. We will not be focusing on growth.

So thanks for joining us and we look forward to another successful year ahead of us and we'll see some of you at some upcoming conferences in the New Year. Thanks and happy holidays to everyone..

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day..