Good day and thank you for standing by. Welcome to the First Quarter 2022 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants’ lines are in a listen-only mode. After the presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded.

I would like to hand the conference over to your host today, Scott Zuehlke, SVP, CFO and Treasurer. Please go ahead..

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 of 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 $267 million during the first quarter of 2022, which represents an increase of 16%, compared to $230.1 million during the first quarter of 2021. The increase was largely attributable to volume increases in our Fenestration segments, combined with higher prices related to the pass-through of raw material cost inflation.

More specifically, we realized net sales growth of 14.5% in our North American Fenestration segment, 15.5% in our North American Cabinet Components segment and 18.6% in our European Fenestration segment, excluding the foreign exchange impact.

We reported net income of $11.2 million or $0.34 per diluted share for the three months ended January 31, 2022, compared to $7.9 million or $0.24 per diluted share during the three months ended January 31, 2021.

On an adjusted basis, net income increased by 25.9% to $11.3 million or $0.34 per diluted share during the first quarter of 2022, compared to $9 million or $0.27 per diluted share during the first quarter of 2021.

The adjustments being made to EPS for restructuring charges, loss on the sale of a plant, foreign currency transaction impact, and transaction and advisory fees. On an adjusted basis, EBITDA for the quarter was essentially flat year-over-year at $24.4 million, compared to $24.3 million during the same period of last year.

The increase in earnings for the three months ended January 31, 2022 was attributable to continued strong demand, operational efficiency gains and increased pricing. However, the decrease in margin percentage was driven by inflationary pressures and time lags on material index pricing mechanisms.

Moving on to cash flow and the balance sheet, cash used for operating activities was $21.7 million for the quarter, compared to $3.4 million for the same period of last year. Due to the typical seasonality in our business, free cash flow was negative in the first quarter of this year.

In addition, the value of our inventory increased further due to inflationary pressures, which had a negative impact on working capital. As a reminder, we usually generate most of our cash in the second half of each year.

Our balance sheet continues to be strong, our liquidity position is solid and our leverage ratio of net debt to last 12 months adjusted EBITDA was at 0.4 times as of January 31, 2022. We will remain focused on generating cash, paying down debt and opportunistically repurchasing stock as the year progresses.

As stated in our earnings release, demand remains healthy, but the rate of inflation continues to pressure margins.

However, based on improvements in labor performance, the expected continuation of our pass-through pricing strategy, conversation with our customers and the latest macro data we are now comfortable providing the following guidance for fiscal 2022.

Net sales of $1.13 billion to $1.15 billion, adjusted EBITDA of $135 million to $140 million, depreciation of approximately $31 million, amortization of approximately $15 million, SG&A of $115 million to $120 million, interest expense of $2 million to $2.5 million, tax rate of 28%, CapEx of $30 million to $35 million and free cash flow of $55 million to $60 million.

While we do expect some level of volume growth in our Fenestration segments for the remainder of the year, note that our current expectation is that revenue growth for the remainder of the year should be driven more by price, as opposed to volume and we expect margin expansion to be second half weighted.

From a cadence perspective for Q2, we expect net sales to be up mid-to-high single digits year-over-year in each segment. However, due to inflation and the time lag associated with passing on price increases for most of our raw materials, we believe it will be a challenge to realize margin expansion in any segments in Q2.

Looking ahead into the second half of the year, on a consolidated basis, we currently expect mid single-digit net sales growth year-over-year in Q3 and Q4.

In addition, due to easier comps and the expected benefit from our pricing strategy, coupled with some volume growth in our Fenestration segments, we expect to realize some margin expansion in Q3 and Q4. I’ll now turn the call over to George for his prepared remarks..

Thanks, Scott. Prior to my comments, I would like to take a moment to acknowledge Joe Rupp for his long and dedicated service to Quanex as a Board member and as our lead Independent Director.

Joe’s guidance was key during our transition into a pure-play building products company several years ago and more recently, his mentorship and support proved invaluable as I transitioned into the CEO role. I would like to thank Joe for all he has done and I wish him all the best.

I will now discuss results for the quarter and then conclude with a discussion on the macro environment and guidance. Demand was healthy across all product lines during the first quarter of 2022.

Volume growth in our Fenestration segments and higher prices in all segments, mostly related to the pass-through of raw material cost inflation resulted in revenue growth of 16% year-over-year.

On a consolidated basis, we estimate that revenue growth for the quarter was weighted approximately 10% due to an increase in volume and approximately 90% due to an increase in price. The first quarter began with continued supply chain challenges and significant labor disruption caused by COVID absenteeism driven by the Omicron variant.

However, these issues started to subside towards the end of the quarter. The rate of raw material cost inflation remains a challenge, as we typically see a 30-day to 90-day time lag in passing these increases through to our customers. Looking at the individual segments, I will start with the North American Fenestration.

This segment generated revenue of $146.6 million in Q1, which was $18.5 million or 14.5% higher than prior year Q1. Strong demand in our IG spacer and screen product lines, volume growth in vinyl fencing components and price increases across all product lines were the main drivers of the growth.

We estimate that revenue growth in this segment was weighted approximately 45% due to an increase in volume and approximately 55% due to an increase in price. Adjusted EBITDA of $16.3 million in this segment was essentially flat versus prior year Q1.

Improve pricing, volume-related efficiency gains and productivity-related improvements were more than offset by inflationary pressures on raw materials, which cause margin erosion of approximately 170 basis points for the quarter.

However, our current expectation is for margin expansion in the segment later in the year, assuming that the rate of inflation subsides. Our European Fenestration segment generated revenue of $58.9 million in the first quarter, which was $9.8 million or 20% higher than prior year.

Excluding foreign exchange impact, this would equate to an increase of 18.6%. We estimate that revenue growth in this segment was weighted approximately 20% due to an increase in volume and approximately 80% due to an increase in price.

Strong demand in both IG spacers and vinyl extrusions combined with material-related price increases accounted for the strong performance year-over-year.

These favorable volume related impacts and pricing actions were more than offset by inflationary pressure on raw material costs and by inefficiencies caused by the COVID-related absenteeism early in the quarter.

As such, adjusted EBITDA came in at $10.4 million for the quarter, which was $300,000 less than prior year and yielded margin compression of approximately 420 basis points. Similar to our expectations for other segments, we do anticipate that margins will improve as the year progresses, again, assuming that the rate of inflation subsides.

Our North American Cabinet Components segment reported net sales of $62.4 million in Q1, which was $8.4 million or 15.5% higher than prior year. Volumes decreased in the segment year-over-year, mainly as a result of customer’s decisions to reduce overtime hours worked in their plants.

Increases in hardwood index pricing, as well as discretionary pricing actions offset the volume and resulted in revenue growth year-over-year. Adjusted EBITA was $2 million for the quarter, which was $1.2 million less than prior year and resulted in margin compression of approximately 280 basis points.

Improvements in lumber yield and labor efficiency were more than offset by a significant increase in hardwood lumber costs during the quarter. Weather-related challenges in the Appalachian Wood region, as well as increases in Maple demand were the main drivers of the increases in lumber costs.

As a reminder, we have material index pricing mechanisms in place, but they typically have a 90-day lag and we will require a period of flat or declining wood pricing before we’re able to catch up on our emerging performance in this segment.

As we look forward through the remainder of the year, we feel good about the demand environment across all of our product lines. In North America, the housing market remains strong and our customers continue to have high levels of backlog, which we anticipate will slowly dwindle throughout the year.

The rate of inflation and the potential for further interest rate hikes could impact demand at some point in the future, but we do not expect this to occur in the near term due to the high backlog levels. In Continental Europe and the U.K., the demand environment remains healthy.

Although, consumer confidence could ultimately be impacted if inflation continues to ramp and energy costs continue to increase.

From Quanex perspective, we have seen enough improvements in our supply chain and stabilization in our labor force to say that the main challenge we now face is the rate of inflation and the ability to pass-through price in an expedited manner.

As Scott mentioned earlier, we have enough data points and adequate visibility into our customer’s backlog to give us confidence in providing full year guidance. Again, we expect to generate revenue of $1.13 billion to $1.15 billion and adjusted EBITDA of $135 million to $140 million.

If we execute the plan and are able to post results within these ranges, it will mark the third straight year of record performance for the Quanex team. Moving on to a more recent and tragic subject, which is the Russian invasion of Ukraine.

It is difficult to see these events unfold in real-time and watch what you believe to be unfathomable turn into reality. We have employees and business partners with personal ties to Ukraine and our hearts are with them, their families and all the Ukrainian people being affected by this pointless and horrific war.

At this point, it is too early for anyone to accurately predict or estimate the impact that this war will have on the European or global economies or what supply chain disruptions or other impacts this may have on our industry. We anticipate there will be challenges, especially if the situation worsens substantially.

However, at this point, it is much too early to predict or forecast those impacts. Nonetheless, our team has managed through COVID and numerous global supply chain challenges over the past few years and we are very confident in our ability to navigate this event as well. And with that, Operator, we are now ready to take questions..

Thank you. And our first question comes from the line of Daniel Moore with CJS. Your line is open. Please go ahead..

Thank you. Thank you, George and Scott for all the color and taking questions..

Thanks, Dan..

In particularly around price and quantity that’s really helpful.

Maybe talk, obviously inflation is the kind of the remaining challenge, as you described, just talk about looking across each of the segments, the cadence of what you’re seeing, whether prices are flattening, reaccelerating kind of in real-time and just trying to get a sense for your confidence around the trajectory of margins recovering in the back half of the year? And I’ve got a quick follow up.

Thank..

It really varies down by product line.

But, in general, if I look at each of our raw material segments, the ones that continue to see the most levels inflation are primarily tied to oil or chemical-based raw materials, so resins, any other components like carbon black, some of our butyl rubbers that are very tied to oil, still see some significant inflationary pressures.

At one point, we started to see some leveling out in the metals, but those have picked up again. And same thing with wood, we started to see some leveling out of wood, but we’ve had a pretty tough winter in the Appalachian region with snow and rain that makes it really hard to forest some of those and harvest some of those lumber yards.

So those are primarily the biggest issues right now..

And when I kind of look at, let’s say, the midpoint of your guidance range, does that imply kind of pricing where we are today? Is that leave room for some additional inflation? Just how do we think about that?.

Yeah. I mean, as you can imagine, it’s very hard to forecast inflation and pricing. However, we have a pretty good handle on the pricing aspect, which some of that’s built into the model, as well as some cushion on inflation, inflationary costs going a little higher from where we are today..

Perfect. Really helpful.

The -- Scott I type as fast as I could, can you just repeat the SG&A, as well as if there’s CapEx guidance for the year?.

Sure. CapEx $30 million to $35 million..

Yeah..

SG&A $115 million to $220 million..

Perfect. And one more and I’ll jump back in queue. But, obviously, seasonally, this is a typically a little bit of use of cash, yet the balance sheet remains extremely strong. You’ll -- it implies you’ll generate $80 million plus potentially in the next three quarters.

Just talk about capital allocation with the -- when you might be willing to be a little bit more aggressive or sort of retrigger the buybacks given the authorization and what the M&A pipeline looks like, if anything? Thanks again..

So, as we look forward, and I think, your cadence on the cash flow is correct. I think we’ll stay focused on payment -- repayment of debt. We’ve made it public that, our target is to approach net debt free by the end of the year. We have some pretty large CapEx projects that, we’re going to be focused on throughout those years.

So those two will remains the priority. We will opportunistically balance our cash flow incoming and where the stock price is and we will be active. As we told you, the Board authorized the $75 million repurchase plan. So, as our projects align, we will repurchase stock.

And then, finally, the M&A pipeline, there are things that we’ll continue to look at and be interested in. And I would say that, the amount of deals crossing our debt seems to have slowed and I think that that’s been reinforced by some of the feedback that we get from the banks that the deal pipeline in general slowed down a little.

But we’re going to continue to remain diligent on our checklist of things that meet our requirements for an M&A and if something’s there, we’re in great position to capitalize on it, but at this point, nothing imminent..

All right. Very helpful. I’ll jump back in with any follow ups. Thanks..

Thank you..

Thank you. And our next question comes from line of Steven Ramsey with Thompson Research Group. Your line is open. Please go ahead..

Hi. Good morning. Maybe to start with the expectation that inflation subsides in the second half.

Is that the main reason for margin expansion at that time or what other factors help? Is that pricing flowing through better volume output? Maybe just talk to the drivers and what ranks an order of magnitude to drive that margin?.

Yeah. I think if you look back at last year’s second half, we started to see inflation really kick up in the third quarter and especially in the fourth quarter. So from a comp perspective, the comps get a little easier from margin perspective in the second half.

So what should drive that margin expansion year-over-year, obviously, volume is going to help, but I think, more so there’s going to be pricing as we enter the second half.

And like I said, there is a little bit of an assumption that inflation ticks up a little higher from where we are today, but we do expect it to subside at least we’re forecasting for that..

It’s more the rate of inflation and at some point, even if inflation continues to tick up, at least it gives us the ability to catch up. So I think that’s the major assumption we see in the second half at least at this point..

Okay. It makes sense.

And then it kind of all segments with margin expansion in the second half or do certain segments expand more and other go flattish?.

The expectation is definitely in North America for margin expansion in both of those segments. I mean, Europe, we’re hopeful that’ll happen in 3Q, but probably more likely in 4Q, I mean, margin profile in Europe continues to be strong..

Okay. Fair. And then, one more, thinking about inflation with the SG&A guidance, the low end of that SG&A range, flattish year-over-year, kind of surprised, given inflation in the U.S.

normalizing of T&E, maybe you can talk to how you’re thinking about SG&A and budgeting for that?.

I think we’ve done a good job of continuing to find ways to optimize our whole SG&A structure. So, we have internal projects, where we’ve been able to reduce SG&A in some areas.

Stock-based comp has obviously had a big benefit to that, as well as we’ve aggressively managed our medical cost and it’s, I think, performed relatively well, and although, we see inflation, it’s -- I think we’ve done better than the market in managing our medical costs.

So those are the three big areas that I think that has allowed us to remain flat in SG&A even with the inflationary pressures that we see..

Great. And then last quick one for me, if I think about the high end of the guidance range on sales and EBITDA, it implies lower incremental margin on the high side of both numbers than it does on the low end.

I am curious if there are certain drivers to drive that result or if it’s just a math problem?.

Yeah. I wouldn’t -- there’s nothing really to point to explain either one. I think it’s more the math and ranges there. I will say that, sitting here today, probably, more comfortable with the higher end of the revenue guidance range than we are on the EBITDA range just because of the inflationary environment where in..

Makes sense. Thank you..

Thank you..

Thank you. And our next question comes from the line of Julio Romero with Sidoti & Company. Your line is open. Please go ahead..

Hey. Good morning, George and Scott..

Good morning..

Good morning..

Hey. So really appreciate you guys providing guidance. You listed a couple of contributing factors that decision, the improvements in labor performance, continued pricing and speaking to customers, et cetera.

Is it fair to say the biggest kind of swing factor is labor improvement? I know you were having some issues last quarter in terms of short-term delivery schedules and truckers kind of showing off for the day? Are you seeing better visibility on that, and if so, could you expand on that?.

I think the improvement in labor comes from a couple areas. One is the supply chain started to stabilize. That obviously helps the scheduling of our plants and the ability to schedule production in the most efficient manner. So that had a big impact.

I think our human resource teams across the company have done a very good job of filling in and filling the open positions across all the plants.

We made some labor adjustments in terms of our wage rates throughout last year and so as you bring new people on and get them acclimated to our processes, the learning curve around that has improved versus prior year and that’s been a big deal. And then just finding continued different ways to operate in this environment. We’re getting better at it.

And in our North American Cabinet Components segment where we talked about -- our customers reducing labor hours that, that’s mainly attributable to them losing labor. So, the reduction of overtime and scaling back to a five-day or a 40 hour, 48 Hour work week has been a big help in that area as well, especially for that segment..

Got it. So labor improvement sounds a little more broad based than just kind of drive it -- drivers..

Yes..

Are you seeing better retention rates?.

I would say, in general, yes. I mean, it’s -- that tends to be more plant specific. But I think as we try to do different things internally, we have some very active retention projects in place across the company. It has begun to improve. So we’re pretty happy with the internal actions that we have going on right now.

Focusing on training and those types of projects on a go-forward basis will continue to help as we look ahead..

Okay. Understood. And then just last one for me and I appreciate the commentary on Russia, Ukraine, and very early to kind of understand all the impacts there. But if I could try to zero in on just any aluminum impacts, since that kind of just sticks out to me as a potential impact from my seat.

How are you thinking about any potential availability constraints or in terms of aluminum in Europe?.

Yeah. So, I think, as I look at it as it relates to Quanex. The main areas that I’m going to be focused on as it relates our impact, first and foremost, will be the European economy. What will do to the window in demand? What will do demand to demand in general? And what will it do to some of the components that go into a window, for example, glass.

To make glass it takes a lot of energy, a lot of that energy in Europe is provided by Russia, as we know. So a rapid inflation of heating and energy costs will drive -- could drive the cost of glass and the components up to pretty significant levels. That may impact, obviously, the price of a window and negatively impact demand.

So keep -- I keep an eye on that. In terms of our components, aluminum pricing, which we’re already starting to see on the rise and I’m not as worried about supply, but people are trying to capitalize on this to drive price up. We’ll obviously be able to recover it, but then it goes into the time lags.

And then the other areas tend to be things like carbon black and butyl rubbers, which do have a lot of components that have micro ingredients that come from Russia. So those are the areas that I’m going to stay focused on as it relates to Quanex..

Really helpful. Definitely appreciate the detail you provided there. Thanks very much..

Thanks..

Thanks..

Thank you. And our next question comes from a line of Ken Zener with KeyBanc. Your line is open. Please go ahead..

Good morning, gentlemen..

Good morning..

Good morning, Ken..

So, I wonder if you can comment on not just your, right, supply cost challenges, but also as a supplier. In the window business, you kind of are, right, Northern Europe window spacers, U.K. actual the windows versus the U.S. Can you just talk about how demand trends might be a little different in COVID using the U.K. and the U.S.

is counterpoints just, not even extended answer, but just how different those markets have been in terms of demand?.

When I look at them, demand has been extremely strong in both of the markets, because a lot of the fundamental economic indicators are the same. I mean, both companies have tight labor -- tight housing markets. Their discretionary spending has been high in both markets. So, we’ve seen strong demand in both areas.

I think, where I contrast on a go-forward basis, in the U.K. and Europe, I think, discretionary impact will be impacted more by increases in energy costs, even more so than what we complain about here in the U.S. about fuel and heating fuel and energy costs going up. It’s significantly higher in Europe.

So I think it’ll have an ability -- the potential to impact the U.K. and Europe much faster than we’ll see here in the U.S..

And then, George or Scott, I’m not sure which one of you made the comment or which region? But I believe you said something about customers or somebody’s not doing overtime as much. Could you talk about that and in the U.S.

what that means in terms of the backlogs that you are seeing in terms of backlogs going down? I know there’s been some public companies that have talked about four months backlogs falling down to half that or more, can you just talk about your customers the ability to handle or work through backlog?.

Yeah. So I made that comment as it related to the Cabinet Components segment. In those markets, the labor piece of it, especially in 2021, when it was so difficult, you have wages going up and so many job openings across the entire country.

People -- when you have companies that are working 50 hours to 60 hours and sometimes more than an hours a week, you have significant loss of employees, you cannot continue to work at that level, someone will go across the street, make the same amount of money.

And so they realized, in that segment, our customers there that, that they’re working too many hours, so they physically made the decision, we’re going to back off and let the backlogs grow and that’s what we saw during the course of last year and it’s remained.

Now they’ve also, as they start to retain their employees, because of the reduction in working hours, we’re seeing better performance, because they’re able to retain their labor. So, I don’t think we’ll see the continued growth in that backlog, but that’s what happened..

And then in windows, since you call that Cabinet, could you talk to the cadence, perhaps, of your customers their and the glass? I mean, you talked to one of the things people focus on is, does do when this price increases create demand destruction, which you mentioned, and I don’t know if you just were being very holistic in your comments.

But if you….

Yeah..

Are we seeing that labor issue in the window category at all and then, since you brought up pricing, just some comments there. Thank you very much..

Yeah. So the two pieces, I’ll start with your second question first. I was being a little holistic in terms of my discussion on the impact of the impact that additional costs will have on demand. We have not seen that yet. Could it be a possibility? Sure.

But we are -- we haven’t seen it at this point and that was more related to Europe than it is to U.S. Now in terms of backlogs with my window customers, they seem to be handling that more. I don’t think the backlogs have been growing and we anticipate that their continued improvement and operations will continue to drive that down.

Not to the level where it will disappear home. So that’s what gives us so much confidence, as we look at our demand going forward, because of such high backlogs. They’ve done a very good job of being able to control their labor and fulfill the man as much as possible, so..

Thank you. Appreciate it..

Thank you. And our next question is a follow up question from the line of Daniel Moore with CJS. Your line is open. Please go ahead..

Oh! Sorry, just kind of get off mute. Thank you again. This has been an, obviously, multiple years of an unprecedented operating environment with everything that’s gone on.

If we ever get back to normalization, one thing we haven’t talked about as much in recent calls is, what kind of opportunity is left to drive margins higher longer term and I realize Europe is that had pretty significant margins right now, but specifically in North America Fenestration and/or the Cabinets, be it with automation or other internal initiatives? Thanks..

So we’ve touched on this in the past and I don’t think it’s changed much. I think going forward in more normalized environment and it’s anybody’s guess what normal means going forward. But I think you’re right in Europe the margin profile is strong and it’s really more about protecting margins there than growing margins there. We’ve done a lot of work.

In North America, I still think and we still think that the biggest opportunity for margin expansion is in the Cabinet Components business.

We’ve gone through quite a long period here of chasing price and the 90-day lag hurting us and it’s really masked all the things we’ve done on the shop floor to improve efficiencies and things of that nature and I think once pricing does stabilize and come down on the wood side, you’re going to see that margin expansion at some point.

Just don’t know when that’s going to be. And then in the North America fenestration segments, we still think there’s some meat left on that bone too and it’s probably more related to our screens business and the vinyl business, and not so much the vinyl windows business.

As you know, we’ve been ramping up production and manufacturing of the vinyl fencing business. And I think going forward, that should start to move the needle at some point..

Very helpful. Thank you again..

All right..

Thank you. And I’m showing no further questions at this time and I would like to hand the conference back over to George Wilson for any further remarks..

We appreciate everyone’s time today. Thanks for joining and we look forward to providing an update on our next earnings call in June..

This does conclude today’s conference call. Thank you for participating. Everyone have a great day..