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. 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 comparison, 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 the 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 underbuilt 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 the 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 roadmap 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 they 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 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 millwork, 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 expand our portfolio in current markets and reinforce our sector leadership, or 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 roadmap 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.

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 is 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?

I would say that within that segment, screens and spacers were the main contributors to growth, likely more from screens than spacers. Vinyl window profiles did not contribute positively, but we've been discussing vinyl fencing for some time now, and we've begun manufacturing and producing volume in that area, which has contributed and is expected to contribute more to the vinyl extrusion segment as we move forward.

Got it. Very helpful. Could you discuss the situation in Europe? The demand has been slowing month-over-month over the past several months. How much of the guidance for fiscal Q4 is influenced by foreign exchange compared to expectations of volume decline?

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 Q4. Who knows what FX rates are going to do through next year, but it has definitely had a very significant impact on top line.

I would like to add to Scott's comments. The market has remained surprisingly strong, especially when excluding the effects of foreign exchange. We continue to adapt to the conditions, and as the supply chain has improved, we have reduced our lead times for customers. We are assessing both the volume impact and how customers are adjusting their inventory levels. Some customers have engaged in a bit of stocking, but the European market has displayed unexpected resilience in light of the current situation.

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, obviously, but your thoughts there? And what does your crystal ball tell you at this stage for '23?

Yes, the outlook is uncertain. For Ducker, their recent evaluation for 2022 compared to 2021 indicates that window shipments are only slightly above flat, showing a growth of 0.2% this year compared to last year. Currently, we are going through our budgeting process, so we don't have a definitive view on volume for next year across product lines. However, based on the trends we see in raw materials markets and decreasing costs, we anticipate that in specific situations where we have discussed surcharges previously, we will begin to reduce those. This could potentially lead to a decrease in revenue next year compared to this year. Nevertheless, we remain confident that we can continue to improve our margins.

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 clear indication of what we're seeing for that point.

All right, I'll jump in. The new slide deck is really helpful. Regarding M&A, can you discuss what types of adjacencies might complement your manufacturing capabilities? You've mentioned fencing several times before, but are there any other areas you are currently interested in?

As we evaluate our manufacturing processes, we are approaching opportunities for mergers and acquisitions in two distinct ways. First, we aim to address any gaps in our existing portfolio within the sectors we currently serve. Additionally, we are exploring adjacent opportunities, such as enhancing our mixing capabilities and considering various seals and gaskets that are applicable in multiple markets beyond just building products. We will continue to examine diverse PVC extrusion opportunities within fencing. Our goal is to leverage our core manufacturing competencies and expand into new markets. We are particularly focused on opportunities for vertical integration and identifying new markets, which will help us build on our strengths in mixing, extrusion, metal forming, roll forming, and millwork. These areas will be essential for our growth.

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 that 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. Regarding the complete volume, you're noticing a few things that some of our customers have mentioned in their recent earnings announcements. As they continue to reduce their backlogs due to increased availability of lumber and declining prices, lead times are returning to normal. We are trying to determine whether the changes indicate a genuine drop in revenue or units produced, or if customers are simply adjusting to the shorter lead times and holding less inventory. We recognize that our customers' backlogs are decreasing, suggesting softness in new orders, but it might also mean that customers no longer need to place orders eight months in advance. There is still considerable uncertainty in the system. We expect to see ongoing softness in volume and pressure on index pricing, but it's difficult to draw clear conclusions about the underlying trends.

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 heavily to begin with and where we felt like we added the most value. I think right now it is a very segmented market that is 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 nicely 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 as 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 the 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 and 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 timeline. We're going to look at opportunities by expanding our view outside of the fenestration and 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 timeline to make anything happen. We're going to continue to be diligent and make 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 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 how they are affecting operations in Europe?

Great question. At this time, our supply chain has not faced any disruptions, and we have a fixed contract that has shielded us from cost increases so far. However, that contract will expire soon. We expect a significant impact, but we plan to pass these costs onto our customers, similar to others in the region. This will affect our operating performance, and while it is a considerable change, we believe it will be margin neutral since we intend to transfer these price increases. Currently, our manufacturing facility is in Germany, and we are closely monitoring the situation. There has been no full rationing of natural gas in our area as of now, but we will keep an eye on developments. Our aim is to pass on any incurred price increases.

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 the 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 it's a 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 come to a 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 centering 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 that 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 followed 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 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.