Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2021 Quanex Building Products Corporation First Quarter Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session.

Please be advised that today's conference is being recorded. I'd now like to hand today’s conference over to your speaker, Scott Zuehlke, SVP, CFO and Treasurer. Thank you. Please go ahead, sir..

Thanks for joining the call this morning. On the call with me today is George Wilson, our President and CEO. This conference call will contain forward-looking statements and some discussion on non-GAAP measures. Forward-looking statements and guidance discussed on this call and in our earnings release are based on current expectations.

Actual results or events may differ materially from such statements and guidance, and Quanex undertakes no obligation to update or revise any forward-looking statement to reflect new information or events.

For a more detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measures to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website. I'll now discuss the financial results.

We reported revenue of $230.1 million during the first quarter of 2021, which represents an increase of 17.1%, compared to $196.6 million during the first quarter of 2020. The increase was primarily the result of increased demand for our products across all product lines and operating segments.

We reported net income of $7.9 million or $0.24 per diluted share for the three months ended January 31, 2021, compared to $10,000 or $0.00 per diluted share during the three months ended January 31, 2020.

The increase in net income was somewhat offset by a $6.7 million increase in SG&A during the quarter, $4.6 million of which was related to the valuation of our stock-based comp awards, mainly due to an increase in our stock price, and $1.6 million of which was due to higher medical claims.

On an adjusted basis, net income increased to $9 million or $0.27 per diluted share during the first quarter of 2021, compared to $1.2 million or $0.04 per diluted share during the first quarter of 2020.

The adjustments being made to EPS are for restructuring charges, certain executive severance charges, loss on the sale of plant, accelerated D&A, foreign currency transaction impacts and transaction and advisory fees.

On an adjusted basis, EBITDA for the quarter increased by 55.4% to $24.3 million, compared to $15.7 million during the same period of last year. The increase is largely due to operating leverage from higher volumes. From a margin standpoint, this increase represents adjusted EBITDA margin expansion of approximately 260 basis points.

Moving on to cash flow and the balance sheet. Cash used for operating activities was $3.4 million during the three months ended January 31, 2021, compared to $3.7 million for the three months ended January 31, 2020.

While our free cash flow was negative, this is typical for the first quarter of each year, and we did show improvement compared to last year. In fact, we did not need to borrow on our revolver during the quarter and still managed to both repay $5 million in bank debt and repurchase approximately $1.9 million of our stock..

Thanks, Scott. Demand for our products during the first quarter of 2021 proved to be even stronger than our expectations, and I am very pleased with the results in what is traditionally our weakest quarter.

We remain steadfast in our pursuit of operational excellence, cash flow optimization and improving return on invested capital throughout all segments of our business. Continued success on all these efforts will create further value for our shareholders and should position the company well for any opportunities that may arise in the future.

Prior to discussing the segment detail, I'd like to provide some color on the macroeconomic conditions of the markets we serve. Overall, we are still experiencing high demand across all of our product lines.

In North America, the new construction market remains strong and sales of existing homes, which is a key indicator for repair and remodel also remains healthy. Specific to cabinet components, the semi-custom segment, which is the main segment we serve, is starting to show growth above that of the stock segment.

As a matter of reference, there was a significant shift in market share away from the semi-custom segment to the stock segment over the past few years. So the recent KCMA data is encouraging in that it shows the semi-custom segment gaining ground over stock.

Demand for the products we manufacture in the UK and Germany remains robust despite the strict and ongoing COVID-related measures. We believe the demand is strong because many international markets remain under-built with an infrastructure that is aging, and regulatory requirements on energy efficiency align very well with our product offering.

We also believe demand in Europe and the UK is being favorably impacted by the continued shift of the discretionary income away from travel and leisure activities into home improvement projects. Although we remain optimistic on macroeconomic conditions in all the markets we serve, we also see some challenging headwinds.

We are seeing increased inflationary pressures on most of our major raw material input costs, as well as some large dollar expense items such as freight. These pressures were recently exasperated due to the severe winter weather in Texas and along the Gulf Coast, which caused delays and shortages of key chemicals, feedstocks and energy supply.

As a reminder, for the most part, we have contractual pass-throughs for the major raw materials we use in North America, but there is often a lag depending on the contract, anywhere from 30 to 90 days. We do not have these contractual pass-throughs in Europe and the UK, so our ability to pass on any increases through price becomes more important.

And for the most part, we've been very successful in doing just that..

Thank you. And your first question is from the line of Daniel Moore with CJS Securities..

Hey, George, Scott, good morning. Thanks for taking the questions..

Yes. Good morning..

Good morning..

Start with – and really solid results, obviously, start with the 17% jump in revenue for Q1.

Just how much of that was pricing reflecting pass-through of raw materials and kind of similar question for the increase in revenue guide for the year?.

I'd say, as a general statement, most of the increase in revenue was really related to increased demand and volume. Pricing started to play a role toward the end of the quarter and will likely play a role along with the raw material increases going forward through the year. But in Q1, it was mostly volume..

Got it. That's helpful. Scott, I think you said a number for the increase in medical claims for the quarter. I missed it.

If you said it, can you repeat it? And what are the expectations kind of on a full-year basis?.

Medical first quarter year-over-year is $1.6 million higher. What we're forecasting is kind of a return to what we would call somewhat normalized. So if you take 2019 and average that with 2020, obviously, 2020 was a lot lower due to the COVID restriction. We're expecting somewhere in the middle there..

Got it. Okay. And George, you gave a lot of great color. Just in terms of EU demand, obviously, remarkably strong and continues to be.

Just if you had to rank order those factors that you described in terms of what's driving the underlying growth, is it COVID restrictions? Is it interest rates remaining low? The efficiency, the standards? Or is it just a combination of all those? Just any more color on what's driving that strong demand would be helpful..

I think, Daniel, what we're seeing is really a balance between the two of the main items. One, the infrastructure is old, and the need to replace windows from the R&R side continues to be there.

And the fact that across all of Europe, there are some very strict regulations as to energy efficiency requirements when you replace anything on the home and our products fit very well into that application better than most. That is a significant benefit and it is unrelated to COVID.

The COVID piece, as it relates to the restriction on travel, I do think that that's playing a significant piece, and will in the near-term because I don't see the travel opening up. So across the board, you're seeing people with the discretionary income with the inability to travel and go places or putting money back into their homes.

And we absolutely are seeing a benefit from that. Those are the two main factors..

Very helpful. Okay. I will jump back in queue if I have any follow-ups. Thank you..

Thank you..

Your next question is from the line of Julio Romero with Sidoti..

Hey, good morning..

Good morning..

Good morning..

Hey, I just wanted to ask a follow-up to that last question about the demand drivers in Europe. You called out kind of improved consumer demand for renovation because there's less – kind of just less spend on travel and economic recovery, increasing vaccination rates.

But just trying to help me think about the differences between what's driving demand in Europe and what's driving demand in North America? Because all those things fit the North American profile as well, right. So I don't know if you could help us think about what's a key difference between both geographies..

I think they do. I think the big difference between Europe and North America is that in North America, the new construction activity is – competes with R&R in terms of installation labor, whereas in UK and Europe, it's much more focused on R&R. So the European growth model is building into that fact. We tend to be heavily weighted to R&R.

So in North America, any resources that go to new construction, I guess, comparatively, that's where you'll see the difference..

Okay. I guess, on your cabinet segment, you saw some good margin improvement there, I think, 330 basis points.

Can you maybe try to quantify the benefits of the new assets? And how much that benefited the margin versus volume leverage? And also, when do you anniversary those new assets?.

In terms of the asset, it's hard to break it down because of plant-by-plant. It gets rolled into general operational improvements. There are three or four assets that we put into our rough mills that are showing yield improvements. So we haven't split that kind of detail out. So I think it would be inappropriate.

And I don't have the proper numbers in front of me to give you that information, Julio. Could you repeat the second part of your question? I apologize..

Sure. If you benefited from not just volume leverage in this quarter, but also improvement on your manufacturing capabilities, when did you put that in place last year? Just trying to think about when you anniversary that..

That was – those assets were more back half. So we'll see full year of benefit, probably end of third into our fourth quarter. They were end-of-year asset installations..

Okay. And I guess, just my last one is a little more broad. Just you called out some labor constraints in terms of your company. But I've always thought about labor constraints is also helping your company, right, on the – from your customer base because I would think increased labor tightness drives additional demand for your type of products.

So if you could speak to that and maybe what you're seeing there..

No, you're absolutely correct. That the labor constraints are also a driver of increased share and demand for us. So it's a balance that we're trying to fight and create. As I said, it's not a problem unique to Quanex. So it is creating opportunities.

But at the same time, we're fighting availability of labor as they continue to approve extended unemployment benefits. It is difficult to get labor in almost every market that we're in, and it's the same thing. So not a simple problem to solve, but you are correctly stating that it is an opportunity for us as well.

And we're trying to capitalize on that. We're working hard with our Human Resources department to put in different programs to be more forward-thinking in terms of attracting labor..

Okay. That's it for me. Thanks very much..

Thank you..

Your next question is from the line of Steven Ramsey of Thompson Research..

Hey, good morning..

Good morning..

Good morning..

I guess, I wanted to continue on the labor constraints and maybe more how it impacts you guys.

How much did labor constraints, maybe did it reduce sales, even though demand was higher for you guys in Q1? And if that was the case, what segments or products is – are the labor constraints impacting you the most?.

So I think where you would see the biggest impact for us is really on our labor cost and significant increases in overtime usage. I don't think – in very rare circumstances, has it impacted a reduction in shipments.

The area that currently is most impacted would probably be our cabinet components plants, primarily up in the Minnesota, Wisconsin area is the toughest market right now..

Okay, great. And then, maybe I missed this in the prepared remarks, but how much then is our automation investments of focus right now for CapEx? Maybe if there are automation investments are being stepped up, is that in North America cabinets or other segments? And then, maybe if this is a meaningful portion of the CapEx guide..

CapEx – automation has been a focus for us for multiple years, and it will continue to be so. We have active projects in place to try to reduce labor and ease that burden of our labor demand.

The problem that we have and everyone will have in CapEx is that most of the equipment suppliers for automation have long lead times because their demand has increased and they're having the same issues.

So we're actively working to implement processes that improve our existing process, but I will tell you that all CapEx projects are being extended in terms of their timing based on lack of supply and equipment across the globe..

Got it. That’s it for me. Thanks..

Thank you..

Your next question is from the line of Reuben Garner of The Benchmark Company..

Thank you. Good morning, everybody..

Good morning..

Good morning..

Maybe if we could talk about the – so we've heard ocean freight and just transportation, in general, I guess, globally has become increasingly an issue. Are you guys finding that – I know this last year, you got some benefit from some of the cabinet manufacturers looking to do in-source production.

Are you guys finding that to be increasingly a trend in this environment? Or is there some other offset that might negate that factor?.

No, it's still – we still see it as a – that is a tailwind for us. Internationally sourced freight, the ability to find containers and the surcharges being applied to containers is a significant cost to those that heavily rely on importing of products. So that is an opportunity for us.

Our challenge will be, as you know, is we do a very good job of trying to source and supply locally. So it's the inter freight between our plants and trying to minimize the freight cost between us and our customers that we're focused on right now.

We don't have a huge impact on the cost side of us from international freight, so that piece is an opportunity..

Okay. And then, in North American Fenestration, obviously, a big quarter there and the outlook is very strong. I mean, is there any way to gauge – I think you guys have been doing well on the top line with some of your initiatives like screens, for example.

But is there any way to gauge what the, I guess, the market's growing versus how fast you guys are expecting to grow? And then also, I guess, windows is one of the things that we've heard is the most constrained product in the industry.

Is there – is that leading to an increased backlog for you guys in the coming quarters? In other words, maybe you would have even had stronger results in Q1 had the industry been able to keep up with the demand?.

Let me take the first part of that on the U.S. versus market in North America fenestration. So as you know, we track a few different sources and Ducker is one that we track for window shipments. And I think their latest forecast showed an expectation of about 6% growth this year.

Obviously, with the revised guidance that we just provided, that would indicate that we're growing meaningfully above market. I think to your point, screens is definitely a main – one of the main drivers there. And I'll turn it over to George for the other element..

Yes. In terms of the backlog with the windows customers, I think that this, again, Reuben, goes to the pace setter being installation labor versus new build.

From what we're hearing from our customers, demand is strong, backlogs are there, and it's really the installation of windows into the opening holes, that's the pace setter for the flow-through to our industry. So I'm not sure we could have provided any more windows, and I don't think my customers can make anymore.

It's really being paced on the installer end..

Okay. And then, if I could sneak one more in.

Any updates or anything new on the energy efficiency front? I know that you guys, your spacers are efficient and would benefit from any kind of new regulation from the administration? Have you heard or have any updates there?.

No, I think it's too early into the new administration. I mean, we anticipate, over everything that we're seeing, that it will be, at some point, have a renewed focus that we tend to be behind the Europeans in that realm. And we anticipate it will be addressed, but it hasn't at this point, and we haven't heard anything on the near-term horizon..

Great. Thank you, guys, and congrats on the good start to the year..

Thanks, Reuben..

Thanks, Reuben..

Your next question is from the line of Ken Zener of KeyBanc..

Good morning, gentlemen..

Good morning, Ken..

Oh, what a quarter. Let's see here. I'm just looking at your January presentation, 55% thereabout, North American Fenestration.

Can you just update us on the mix of your three businesses there? Is it about a third, a third, a third still, would you say, for IG screens and profiles?.

I think really based on some of the comments we made on screens and accessories. That piece is probably growing to a little bit more than a third..

Yes..

IG is doing well, too. And I would say, vinyl is probably on the lower end of the three..

Now is that – I appreciate that. It's getting to the actual questions about the quarter and the year, but I ask that because it seems like you're obviously – if the industry is up six.

And what was Ducker saying FY2020 was up for the industry? Scott, if you have that?.

For 2021, they were expecting 6% growth..

Versus what in FY2020, please? I'm just trying to see, was this share gain? Yes, may have got where I'm going?.

Yes, about – a little over 2% in 2020..

Right.

So would you say the share gains you're seeing in screens is really a function of your strategy to help manufacturers improve their businesses? Is that a new function that we're seeing in 2021? Or was that kind of evident in the back half of 2020 or 2019? Is this a new event is what I'm getting at because it's real success you're having, obviously?.

Yes. I would say the success on the screen side is really working with our customers to show the benefit of outsourcing that process. And allowing them to focus on using their labor to manufacture and sell windows. The other thing that it's starting to see, and if you remember, we opened up a new plant at the very end of our fiscal 2020.

And so we're gaining some growth on an area that was underserved in prior years. That's the two impacts on the screen side..

Okay. So when you're saying underserved, just to explore this because I think about these businesses all different. Underserved, I mean, so you opened up a new plant and I could Google this, I guess, but you're opening up a plant next to an existing customer or new customer, basically.

So it's actually a greater share of that person's screen business is what I'm assuming you're saying to me..

Yes. As we said in the past, the screen product line and if you look on our investor presentation and see our footprint, the screens are, in terms of weight very light, and they can be easily damaged. So the location of a plant is really based upon a freight radius. We know our optimal radius to be able to ship a screen.

So when we locate a new plant it tends to be around a cluster of customers that we think we have an opportunity to get new business on. And that's why we chose Allentown, PA..

Excellent. Really appreciate that. So going back to the other piece, if you guys don't mind this question because fenestration is the fascinating industry.

Your profiles, would you say your profile shipments have been in line with the industry growth rate? Or are there kind of share gains that we're seeing in your guidance? And related to that, obviously, the price pass-through, or are you seeing any disruption there relative to your ability to capture price on the underlying input? Because all that stuff is under contract, right? I mean, it's not a lot of supply.

Is it on the extrusion side per se?.

Yes, that is correct. I would say, in general, our growth has been in line with what we're seeing in terms of the market. As we've said in the past, we've been very focused on understanding what we do and do well. So as we've quoted and gone after and retain specific pieces of the business, it's based on SKUs that we feel that we can run effectively.

And the other piece that we're doing is we're looking at areas in non-fenestration, and it's just starting, but being able to look at other things that use extruded vinyl profiles and utilizing the assets.

So we're really – our focus right now is on OEE, keeping the equipment up and running and optimize all runs, to be able to effectively improve profitability. And so that's what we're working on in that area..

And where would you say your capacity is pre – having that big shutdown two or three years ago? Are you running at about 60% of the capacity you did at the peak three or four years ago?.

I would say, roughly, that's correct..

Excellent. And then, last question, sorry. But the comments from you, consistent with KCMA data, showing cabinet sales up 10% in January, but semi-custom, up 17%, and that's one month. And I have to look at the comms and such. But wow, what a turn.

Can you comment as to the 5% growth, if you think that's reasonable? Obviously, I think it's reasonable as your guidance. But I mean, do you think there's upside there? Or do you have installation constraints like you do in windows? Or do you think there could be something bigger there because semi-custom homeowners' equities at a record level.

Do you think there's – that's a really favorable turn for you. That's my last question. Thank you very much, gentlemen..

No, thanks, Ken. To answer that question, I think really the biggest pace setter for us is labor availability, which I talked about. So if there is any upside, it will be on any loosening of available labor in the areas where we have our door and our components plants..

Thank you..

Your next question is from the line of Daniel Moore with CJS Securities..

Yes, thanks again. Most of my follow-ups are covered, but just a quick one. Maybe a comment on your proclivity to be more aggressive in terms of buybacks with the remaining $9 million authorization, just given rising EBITDA and strong expected free cash flow and obviously, all the gains that you've made on the balance sheet..

Yes, good question. I think that, to your point, we are operating well, we're putting up good numbers. We did repurchase about $1.9 million in the first quarter. I think the average price was were around $25 or so, which sends a message that we still continue to believe our stock is undervalued even at these levels.

So we will be opportunistic with repurchasing stock going forward..

That is helpful. Thanks again..

Yes..

Thank you..

Thank you. And at this time, we have no further questions. I will turn it back over to our CEO George Wilson for any closing remarks..

Thank you. Before we sign off, I'd just like to take a brief moment and thank Bob Buck for his service on our Board and to Quanex. Bob's contributions over the years were invaluable, and his guidance will be missed as he enters his retirement.

I'd like to thank you all for joining the call, and we look forward to providing an update on our next earnings call in June. Thank you..

Thank you. This does conclude today's conference call. You may now disconnect..