Good day and thank you for standing by. Welcome to the Q3 2022 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Scott Zuehlke, Senior Vice President, 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 our financial results on a consolidated basis, followed by comments on the results for each operating segment. On a consolidated basis, we reported net sales of $324 million during the third quarter of 2022, which represents an increase of 15.8% compared to $279.9 million during the third quarter of 2021.

The increase in revenue was mostly attributable to higher prices related to the pass-through of raw material cost inflation. Net income increased by 90.4% to $25.9 million or $0.78 per diluted share during the third quarter of 2022 compared to $13.6 million or $0.41 per diluted share during the third quarter of 2021.

On an adjusted basis, EBITDA for the quarter increased by 34.3% to $44.2 million compared to $32.9 million during the same period of last year. This equates to adjusted EBITDA margin expansion of approximately 180 basis points year-over-year.

The increase in earnings for the three months ended July 31, 2022, was largely due to increased pricing and surcharges related to the pass-through of raw material cost inflation and higher volumes in the North American Fenestration segment. Now for results by operating segment.

We reported net sales of $184.7 million in our North American Fenestration segment for the third quarter of 2022, which represents growth of 25% compared to the third quarter of 2021. The increase in revenue was primarily driven by an increase in price and raw material surcharges along with increased volume.

We estimate that around half of the revenue growth in this segment was due to an increase in volume and the remainder was due to an increase in price. Adjusted EBITDA was $27.1 million in this segment or 48.7% higher than prior year.

We realized margin expansion year-over-year in this segment, and we expect that to continue through Q4 as pricing continues to catch up to inflationary pressures. We reported net sales of $72.5 million in our North American Cabinet Components segment in Q3 of 2022, which was 17% higher than prior year.

The entire increase was driven by price as volumes declined. Customers are working down their backlogs as demand softens in this segment. The increases in hardwood index pricing as well as discretionary pricing actions offset the volume decline as a result of revenue growth for the quarter.

Adjusted EBITDA was $5.6 million for the quarter, which represents an increase of 126.6% versus prior year and resulted in margin expansion of approximately 370 basis points.

Similar to 2Q, timing of price increases, better availability of green lumber, improvements in lumber yield and labor efficiency were the main drivers of the positive results in the quarter. Once again, as a reminder, we have material index pricing mechanisms in place in this segment, but they typically have a 90-day lag.

It will be a challenge to realize margin expansion year-over-year in Q4 in this segment due to the fact that we have a tough comp, but also because demand continues to soften and we expect hardwood prices to reset lower come October 1.

Our European Fenestration segment reported revenue of $67.6 million in the third quarter, which represents a decrease of 4.9% year-over-year. However, excluding foreign exchange impact, this would equate to an increase of 8.7%, all driven by increased pricing as volumes declined.

Adjusted EBITDA came in at $12.1 million for the quarter, which was 15.8% lower than prior year.

We currently expect revenue to decrease in this segment in Q4 versus the comparable quarter of 2021, due to the foreign exchange impact and the softer demand backdrop in Europe, but we anticipate that we can protect margins as price increases continue to catch up to inflationary pressures and we flex our cost structure appropriately.

Moving on to cash flow and the balance sheet. Cash provided by operating activities was $51.7 million for the third quarter of 2022 compared to $18.5 million for the third quarter of 2021.

The value of our inventory continued to increase during the quarter due to inflationary pressures, which had a negative impact on working capital, but we were still able to generate free cash flow of $46 million for the quarter, mainly due to the significant increase in net income.

We were able to repay $25 million in bank debt and repurchased $5 million of our common stock during the quarter. 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 decreased to 0.1x as of July 31, 2022.

In the near term, we will remain focused on generating cash and opportunistically repurchasing our stock. We will also maintain our focus on growing the Company through organic, inorganic and innovative growth opportunities as they arise, while continuing to preserve our healthy balance sheet.

As stated in our earnings release, we are reaffirming guidance for fiscal '22, which is based on our strong results year-to-date, coupled with ongoing conversations with our customers.

Overall, demand for our products is still relatively healthy, but in addition to the softness in Europe, we are beginning to see some signs of softness in our North American Cabinet Components business.

From a cadence perspective, the fourth quarter of this year versus the fourth quarter of last year, we now expect about 15% revenue growth in our North American Fenestration segment and low single-digit revenue growth in our North American Cabinet Components segment.

However, due to the foreign exchange impact and the continued softness in Europe, we now expect revenue to decline by about 15% in our European Fenestration segment in the fourth quarter.

As a reminder, on a consolidated basis, we guided to net sales of $1.18 billion to $1.2 billion, which we expect will generate approximately $150 million to $155 million in adjusted EBITDA in fiscal 2022. I'll now turn the call over to George for his prepared remarks..

Thanks, Scott. I will begin my commentary by discussing the current macroeconomic environment and how we believe this will impact Quanex going forward. In North America, heightened mortgage rates increased economic uncertainty, inflation concerns and upcoming midterm elections will continue to provide headwinds to consumer confidence in the near term.

However, let's not lose sight of the fact that the U.S. housing market is significantly under built with low inventories and the demand for residential housing is still strong. We also expect the R&R market to remain healthy due to the age of existing housing and high volume of homeowner equity.

These factors will enable the building products sector to be somewhat resilient and rebound much more quickly from any downturn or recessionary environments. Another factor we believe will benefit Quanex mid- to long term will be continued changes to building codes and standards as they relate to energy performance of building envelopes.

The recently passed Inflation Reduction Act of 2022 includes provisions where households can save up to 30% with tax credits for home construction projects on windows, doors, insulation or other weatherization measures that prevent energy from escaping homes. Our current portfolio includes components used in products that accomplish those goals.

From a supply chain perspective, we have begun and expect to see continued ease and concerns over the supply of raw materials with significant downward pressure on costs. Steel, aluminum, resins and hardwoods have all begun to see decreases in input prices for the first time in over two years.

However, labor conversion and medical benefit costs will continue to see significant pressure and we will still require price pass-throughs to offset those increased costs. In the U.K.

and Europe, economic uncertainty, high levels of inflation and energy supply concerns resulting from the war in Ukraine are all negatively impacting consumer confidence and slowing residential new construction and R&R activity.

The largest concern in the region in the near term will be both the supply and cost of energy in Continental Europe, and any further erosion, which we can't predict, could change our outlook.

Even with the near-term uncertainty, the Quanex team continues to remain focused on the areas that we can control, such as service and quality to the customer, effectiveness of our pricing mechanisms, operational performance, working capital and cash management and culture development and strengthening.

Over the past few years, we've worked hard to build a foundation of people and processes that are prepared to adjust and react rapidly to changes. Our continued performance improvement through COVID and the past 1.5 years of supply chain challenges highlight this fact.

We have followed our playbook and stayed true to our mission of improving cash flow generation, return on invested capital and profitability, all while maintaining a strong balance sheet. We are ready to move Quanex into the next phase of our evolution, and it is this point that I would like to spend some time on now.

Last night, we posted an updated investor presentation to our website. You can find this document under the Investors tab of the site and in the Presentations & Events section. The presentation will give you a good overview of who we are today in terms of financial metrics, product offerings and the markets we serve.

More importantly, the updated presentation provides a deeper insight into our core competencies and lays out a road map for our growth with purpose strategy and our planned pathway to achieve $2 billion of revenue. Let me be clear, we have a very defined strategy with optionality for growth.

The goal of the strategy is profitable growth, to create further value for shareholders over time, all while maintaining a healthy balance sheet. The presentation will also serve as a checklist that we review prior to making any investment decisions, whether it'd be organic growth, inorganic growth or growth through innovation.

The most important takeaway is our view that we are not a window and door company nor are we a cabinet company. We are a manufacturing company with a broad set of core competencies. We just happen to currently serve the -- primarily the window and door and kitchen and bath cabinet markets.

While this may seem like a simple play on words, I would argue that it is a game-changing way to look at our business.

We believe that focusing on our core processes of compounded sealant mixing, extrusion, metal roll forming and mill working, rather than narrowly focusing on only opportunities in fenestration and cabinet markets, will allow us to identify additional organic and inorganic growth opportunities.

And over time, we'll improve our growth and profitability profiles versus our historical averages.

From an M&A perspective, our priorities will focus on identifying margin-accretive businesses that either, one, expand our portfolio in current markets and reinforce our sector leadership, or two, are synergistic with our manufacturing capabilities and provide entry points into new growth-oriented markets.

From an innovation perspective, our investments will be driven from our desire to build on our manufacturing core competencies and materials expertise. We will identify and develop new products and markets, while using current strengths and capitalizing on synergies.

We have effectively followed our road map over the past two years to improve operational and financial performance. And now we will work to execute our new revised strategy to achieve above-market growth, continued margin expansion and most importantly, increased shareholder value. And with that, operator, we are now ready to take questions..

[Operator Instructions] And our first question will come from Daniel Moore of CJS Securities. Daniel, your line is open..

Start a little bit backward-looking before we get into some of the changes, but double-digit volume growth in North America Fenestration pretty impressive.

Can you kind of break that down by product and end market, vinyl, screens, et cetera? And how much of it reflects end market growth versus maybe some share gain?.

So, I would tell you that out of the products that make up that segment, screens and spacer drove that growth, probably more screens than spacer.

Vinyl profile -- window vinyl profiles did not help, but I will say that we've been talking for a while now about vinyl fencing and we started manufacturing and producing volume there that contributed and will probably contribute more as we go forward to the vinyl extrusion piece..

Got it. Very helpful. And then maybe just talk about your -- shifting gears a little bit to Europe. The cadence of demand over the past several months has been kind of slowing month-over-month.

And how much of the guide for fiscal Q4 is FX-driven versus kind of volume decline expectations?.

So most of the softness or even the FX, obviously, is in our European Fenestration segment. And if you look, there's a sales chart on the very last page of the earnings release.

And if you look at the footnote, we had about a $9 million negative impact just due to FX in the quarter, and that's meaningful because you take what looks like a decrease in revenue on the top line from the income statements, and it's actually an increase in revenue if you adjust for FX. So, it's had a meaningful effect.

It will continue to have a meaningful effect year-over-year in 4Q. Who knows what FX rates are going to do through next year, but it has definitely had a very significant impact on top line..

Yes. I would -- to add to Scott's comments. I would say the market itself has remained surprisingly strong, considering everything else that's going out there when you neutralize the FX piece of it.

So, the one thing that we continue to adjust for and you see really in all the segments as the supply chain is also eased up, we've peeled back and reduced our lead times to customers. So, we're trying to net out the volume impact as well as people readjusting with lead times and their ability to not carry as much inventory.

So, we've seen some of our customers do a little stocking, but the European market has shown some surprising resiliency considering everything that's going on there..

Got it. And then maybe just shifting back to North America.

Do you have an updated kind of overall window shipment projection for calendar '22, with Ducker is, obviously, but your thoughts there? And what does your crystal ball tell you at this stage for '23?.

Yes. Crystal ball is pretty cloudy. For Ducker, their late assessment for '22 over '21 for window shipments is barely above flat, so 0.2% growth this year versus last year. And then like I said, I mean, we're actually going through our budgeting process right as we speak.

So, we're not -- we don't have a firm view on volume for next year across product lines, but I can tell you that from a revenue standpoint, just based on what we're seeing in the raw materials markets and costs coming down, if you think about -- we've talked in the past about adding surcharges in specific situations.

Those -- we will start to peel back surcharges. So, revenue could very well be down next year versus this year. However, we are comfortable and confident that we can continue to expand margin..

Kind of, as we stated at the beginning of the macroeconomic section, we hope to be able to give you better clarity on what we see in '23 in our December meeting with midterm elections and some of the energy concerns that are still shaking out.

Our hope is by that point in time, we'll have a little better a clear indication of what we're seeing for that point..

All right. Last for me, I'll jump out. But it's really helpful, the new slide deck, as it kind of pass-through it last night.

The -- on the M&A front, can you maybe talk a little bit about what sort of adjacencies that would be complementary to your manufacturing capabilities? You've talked about fencing obviously, multiple times in the past, but any others that you may have your eye on now would be helpful..

So, as we look at our manufacturing processes and really, as we said, we're approaching M&A in two very distinct paths. One, we'll look to fill out any holes in our current portfolio and the sectors that we serve today.

But from an adjacency perspective, looking at things like our mixing capabilities and there's different seals and gaskets that go into numerous applications in other markets, not only in building products, but across many different markets. So, the fencing will continue to look at different types of -- PVC types of extrusion opportunities.

The whole intent is really looking at that complete core competency of manufacturing processes and then going into different markets based on that.

So opportunities where we can vertically integrate and then identify new markets, yes, I think that's something we'll continue to look at in building off of mixing, extrusion, metal forming, roll forming and millwork. Those will be the key..

And our next question will come from Steven Ramsey of the Thompson Research Group. Steven, your line is open..

Excellent. Maybe to start with on the pressure of North America cabinetry volume coming down, maybe some of this seems to be in conflict with some of the recent KCMA data and large producers recent results and outlook.

Maybe kind of talk to just any more details on the cabinetry volume outlook over the next two to three quarters?.

So, first thing to note is for the KCMA data, be cognizant of those are cabinet sales. So, it doesn't really break out volume versus price. And obviously, price is driving any of those sales growth numbers, same with our results, even though volume is down..

Yes. And in terms of complete volume, I think you're seeing a couple of things, and there's -- some of our customers who have recently announced earnings, highlighted the same thing. I mean as they continue to reduce their backlogs because of the availability of lumber becoming more abundant price starting to drop. Lead times are going back.

So we're really trying to identify is it truly a drop in revenue or in units produced? Or is it really customers adjusting with the lead times and carrying less inventory? We know backlogs for our customers are starting to drop, which would indicate that there is some softness in opening orders, but it also could indicate that I don't need to place orders eight months in advance now, too.

So, there's still a lot of noise in the system. We anticipate some continued softness in volume as well as pressure, as Scott said, on the index pricing, but still a lot of noise to be able to determine exactly what sort of trends exist..

Okay. Helpful. And then to make sure I understand on the fencing opportunity, maybe you can kind of talk to how that is scaling up in the past couple of quarters just for some context.

And then going forward in fencing, do you need to acquire or invest to scale that up? Or are you in a position to serve that market effectively with what you have as you increase your internal production?.

So as we look at the fencing market, we were evaluating it very heavy to begin with and where we felt like we added the most value. I think right now it is a very segmented market that driven regionally by designs channels to market.

But when all is said and done, the components that are manufactured and shipped to the installers and the wholesalers and the distributors are very common. So I think what we see is we're settling very nice in the OE model again.

I don't think at this point in time, you would ever see us getting into some high level of distribution, but from a manufacturing and an OE perspective to continue to serve all of those regions, I think we're very well scaled up. I don't think it would need significant investment.

And really, at this point, it's just getting our components out to all the distributors in all the different regions and showing our capabilities is a very good OE supplier of PVC components. We've acquired a couple of new customers and that continues to scale up. So, I think we're well along the path.

And hopefully, within the next year, we'll be able to start giving some references of size of that market for us. We're not ready to break that out at this point, but soon..

Okay. Helpful. And then last question for me.

This shift in M&A and this execution plan, maybe the first, how soon do you see this playing out, especially in the context of changing outlook for housing in general? And then this idea of taking your current capabilities and expanding them to different product sets, I guess, why is now the time for this?.

So first, to answer your question, on the timing of it, there's really no specific timing.

What we've done is we've built a business and we focus on our playbook, as I mentioned, to get the balance sheet and the fundamental processes in people and processes in place within the organization so that when we were ready to make this next step we could execute. And that's where we're at today.

So as we look forward, there's no specific time line. We're going to look at opportunities by expanding our view outside of the fenestration in the cabinet market. So what I will tell you is we're seeing more opportunities of things that are adjacent and fit our core competencies.

So I think we're getting better looks, but we have no specific target on a time line to make anything happen. We're going to continue to be diligent and making sure that whatever we do fits within our somewhat conservative operational view of leverage. And if it fits, we put ourselves in that position.

We are pretty happy with the fact that by taking a more broader look and trying to build off of our core competencies. We are seeing more opportunities in different looks at businesses that we really like..

And our next question will come from Julio Romero of Sidoti. Julio, your line is open..

This is [Stefan] on for Julio Romero. I have a question. Basically, there is a lot of concern on the macro level with energy prices in Europe.

So basically, I just wondered like how they like affecting operations in Europe?.

Great question. So at this point, we have not been impacted on supply, and we've had a fixed contract in place that has protected us from the cost side up until this point. That will expire in the near future.

We anticipate the impact to be what I would call significant, but one that we fully anticipate to pass-forward and through to our customers as everyone else in that region will. So, it will impact our operating performance. It is a significant level and -- but we expect it to be margin neutral because we anticipate passing those prices through.

Again, at this point, there in our manufacturing facility, remind everyone is in Germany. So, we continue to watch the situation. They have not gone to full rationing of any sort of natural gas at this point where we're located, but we'll continue to look at it. But our intent is to pass along price as it is incurred..

My next question is basically, how should we think about inventory levels, like maybe stay at the same level as now or maybe come down as supply chain challenges ease up?.

It's different by segment. I think value-wise, I would anticipate just as our inventory ramped up because of valuation of raw materials and input costs that you'll see the same sort of downward pressure.

So, I don't see significant changes in terms of the volume of inventory we carry, but I think you'll see some easing of the valuation of that inventory on a go-forward basis. We're fairly just in time. So as long as there's availability of raw materials, we don't typically have a need to stock or over abundantly hold any certain specific inventory.

So, we monitor and measure our days of inventory very, very closely. And I don't expect a significant adjustment from days, but value of inventory should come down..

And our next question will come from Kenneth Zener of KeyBanc Capital Markets. Kenneth, Your line is open..

This is actually Christian Zyla on for Ken Zener. First question I have is just in regards to the European Fenestration. I guess two-part question. Just in regards to what happened in the quarter.

Did you see that demand kind of slow as the months went by? Or did that kind of -- com kind of more abrupt halt? And then is that a function of maybe customers getting priced out with all the price increases? Or does that tie into some of the commentary you guys had on the pull-forward last quarter?.

So in terms of the timing, I think what we've seen is a very slow not even really that noticeable. As Scott mentioned, I mean, when you neutralize for the exchange rate, revenue was actually up, although volumes have come down slightly.

As I said, we've been very surprised at the resiliency of those markets not dropping faster than maybe we would have anticipated. So, I think it's been very general to this point..

I think a lot of it has to do with just discretionary income and the uncertainty over in Europe, mainly sending around energy costs going higher and just taking a safer approach from a consumer standpoint..

As we've talked about in the past, the one thing that we noticed is energy costs do get more expensive globally. That tends to be, to some extent, a little bit of a positive for us because the products that we serve tend to be significantly more energy efficient than some of our competition or basic programs.

So when people are replacing things, the energy payback to go to systems that use our components now are affordable. So, it's not all gloom and doom as it relates to that. It actually lends itself to our products very nicely..

Great. That was actually my follow-up question. And then in regards to capital allocation, I know last quarter, you talked about the compelling view of the share buybacks and you follow up that commentary with about $5 million in share buybacks.

It sounds like with the slide I can start in the commentary from today that M&A maybe is kind of creeping up in that priority list.

Can you just talk about, is buybacks still number one and kind of the ranking of that order?.

I think, at this point, we're not really prioritizing any. We're looking at each opportunities exist when we are in open periods. And we're very restricted because we don't have a 10b program. So we do buy stock were opportunistically in the market. And as you know, there's limits on how many shares we can buy per day.

And with the low float, it's a pretty low number. So, the impact that we can have on share buyback can be relatively minimal because we're not able to buy large amounts. I would tell you, I think we are looking at M&A a little differently now. But again, everything is project or day specific.

So, I think we holistically look at our capital allocation strategy on a daily and weekly basis and determine what we want to do on a go-forward basis. We put ourselves in a very good position to be able to utilize any of the tools that are available to us and capitalize on opportunities. We feel like we're in a very good spot right now..

I would now like to turn the conference back to George Wilson..

I'd like to thank everyone for joining us today, and we look forward to providing you an update on our full year results in our next earnings call in December. Thank you..

This concludes today's conference call. Thank you for participating. You may now disconnect..