Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the call over to Mr. Scott Zuehlke, Vice President of Investor Relations and Treasurer. Sir, you may begin.

Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President and CEO; and Brent Korb, our Senior Vice President of Finance and CFO. This conference call will contain forward-looking statements and some discussion of non-GAAP measures. For a detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measures to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website. I’ll now turn the call over to Bill to say a few words about Hurricane Harvey before Brent discusses the financial results.

Thanks, Scott, and good morning, everyone. Before we get down to business, let me first provide some comments on Harvey. As you all know, much of the Texas Gulf Coast, including Houston suffered a devastating amount of rainfall and flooding during the hurricane. In fact, we had over a year’s worth of rain in four days. Fortunately, all of our employees are safe. Although, four of them, including Brent suffered flood damage to their homes, and at least, one family lost a car and the office was closed for all of last week. The encouraging news is that, rebuilding efforts are already underway, and I’m very confident that Houston will recover quickly. The question, of course, on everybody’s mind is, how will the impact of Hurricane Harvey and the Florida-bound Hurricane Irma affect business. The honest answer is, it’s really too early to tell. However, we can say that August results will see a relatively minor dip as, at least, one major customer had a plant down for all of last week. We also have a number of customers with plants that could be affected by Irma, if it goes through the center of Florida and up through South Carolina and Georgia, as currently predicted. As the rebuild efforts continue, we would speculate that it should benefit our Cabinet Components segment more so than our Window segment, and more likely in fiscal 2018 than in the fourth quarter of this year. Also, due to the disruption in the supply of chemical feedstocks, we would also speculate that some of our input costs, probably resin, will increase over the next several months. However, as a reminder, PVC resin is a pass-through cost and as such should not be an issue, if prices do, in fact, rise over time. But we also use several chemicals and compounds that are not subject to pass-throughs that could cause pricing pressure or supply constraints as we exit this year. I’ll now let Brent cover the financial results and then I’ll wrap up with additional comments afterwards.

Thank you, Bill. I’ll start with comments on our balance sheet and cash flow. Cash provided by operating activities increased to $29.6 million for the three months ended July 31, 2017, compared to $25.2 million for the same period of 2016. We generated free cash flow of $20 million during the quarter, representing an increase of approximately 20% compared to the third quarter of 2016. As a reminder, we generate most of our cash in the second-half of each year due to the seasonality of our business with Q4 historically the strongest cash generating quarter. As of July 31, 2017, our leverage ratio defined as net debt to last 112 months adjusted EBITDA was 2.5 times, which represents an improvement of 0.2 times compared to April 30, 2017. The improvement was mainly the result of the repayment of more than $22 million in debt during the third quarter. Consistent with recent comments, we remain focused on generating free cash flow to further pay down debt. Our long-term leverage ratio target is 2 to 2.5 times, and we expect to be comfortably within this range at the end of our fiscal year on October 31, 2017. Moving on to the income statement, we reported net sales of $229.4 million during the third quarter of 2017, compared to $248.1 million during the same period of last year. Similar to each quarter in the first-half of the year, the decrease was primarily attributable to our previously disclosed decision to shed less profitable business in an effort to protect margins and increase long-term returns. Net income increased to $10.2 million, or $0.29 per share for the three months ended July 31, 2017, compared to a loss of $4 million, or $0.12 per share for the three months ended July 31, 2016. On an adjusted…

Thanks, Brent. During the third quarter, we transferred the operating responsibility for two wood-based accessory plants from our North American Engineered Components segment to our Cabinet Components segment. On an annualized basis, this transfers approximately $25 million in revenues and just over $3 million of EBITDA from segment to segment. Of the $25 million in revenue, approximately two-thirds is fenestration related. These moves have been contemplated since the acquisition of Woodcraft in late 2015, but were consciously postponed until the core business was more stable. While there will be some minor cost savings related to these moves in 2018, they will immediately help relieve some bottleneck capacity issues at some of the other Woodcraft plants, as we continue to relocate production to better balance capacity. In an effort to clarify the year-over-year comparisons, we have provided a segment reconciliation table in the earnings release. Operationally, we continue to make slow, but steady progress in our Cabinet Components segment, with margins improving 30 basis points during the quarter, and we continue to expect margin expansion in this segment during the fourth quarter of this year and through 2018. The underlying growth rates in this segment, excluding the business we’re exiting was 1.5% for the quarter and 5.9% year-to-date. This compares to the latest KCMA numbers for the semi-custom segment of 2.8% growth for the quarter and 3.9% growth year-to-date. In the North American Engineered Components segment, the underlying growth specific to our U.S. fenestration products business was a healthy 5.4% during the quarter and 5.0% year-to-date, which compares favorably to the latest Ducker numbers for the three months and nine months ended June 30, of 4.3% and 2.9%, respectively. Unfortunately, most of this growth has been offset by a significant decline in our non-fenestration products, driven mostly by solar edge tape…

[Operator Instructions] Thank you. And our first question comes from the line of Daniel Moore with CJS Securities. Your line is open.

Good morning, Bill. Good morning, Brent, thanks for taking the questions.

Good morning.

Good morning, Dan.

So wonder, I figured I’d start with your last few comments there, Bills, as it relates to fiscal 2018, I know it’s hard and early clearly. But you expect above market growth in fenestration. What is your outlook for fenestration? And is there any more specificity with regard to, I guess, currency adjusted your outlook for top line growth for next year? And then as a corollary, it sounds like EBITDA margins might be pressured a little early with some input costs headwinds. What type of margin expansion do you think is reasonable to expect so as we look into next year?

So as we look forward, I mean, we are clearly pleased with some of the traction we’re now getting in the fenestration markets, and clearly had a good quarter and good year-to-date numbers compared to Ducker. Ducker just reduced their full-year forecast from just under 5% to 3.8% for the full-year. I’m pretty confident, we’re going to beat that. I think at this point, we would say 4% to 5% is probably likely next year. We changed you will note the sales analysis table in the earnings release to better reflect what we call was actually going on in the business, because growth has been good in Europe. It’s been good in the fenestration business. It’s been steady despite all the customer moves in cabinets. But it’s really been disguised by the magnitude of the businesses we’re exiting, and of course, the non-fenestration business. So I think, going forward, this will better reflect the underlying growth in business. So I think, the key takeaway is, we’re almost at the end of all the noise in 2017. As I said, we don’t expect any significant shifts in any other exited products that maybe some of it trails into next year. But I’m expecting, 2018 to have a pretty clean start with mid single-digit growth rates that ought to flow right through. I think our margin expectation, the improvement overall is going to come out of Woodcraft. It was a little slower than we expected in Q3. It’s ramping up in Q4. Their August, which isn’t finalized yet, the early read is looking pretty favorable there. So I think, we’ve really turned the corner and that business will really help us out in margin expansion through 2018. And then, quite frankly, George, who will be a 100% focused on operational improvement, he will help accelerate that a little faster than I have been able to do.

Helpful. Brent, is it possible to quantify in terms of the impact in the quarter, the – both revenue and either EBIT or EBITDA, the declines in solar edge tape?

We can. But we have – we – I think that’s getting a little granular. I think it’s clear from the table at the back of the earnings release that we year-over-year we’re down some $5 million of revenue for the non-fenestration business collectively.

Okay. I can make inference there. And is this the first quarter where we’ve seen that big impact in other words do we have another few quarters to go?

It’s a bigger impact this quarter. It’s, as I said, we anticipate – this is being known, we anticipated a much slower transition. So I think, in a year-over-year comparison, you will see a very similar number in Q4 and going forward, this is a permanent change.

Got it. And lastly, I’ll jump out. You mentioned the wood flooring business, I guess, I don’t know if you want to get that granular. But what’s the overall size of that business? And you mentioned you maybe looking at that strategically and any color you would be willing to add?

Yes, I don’t want to talk too much about that business at this time, it’s about $12 million and around 10% EBITDA margins. And that’s been – that’s not a business that that we really fully understand, or have a strong distribution network for. You may recall, this business was born out of bankruptcy, I think, six, seven years ago. We’ve significantly improved it, but are clearly reviewing how it fits, or how it does not within the rest of our portfolio.

I’ll hand it over. Thank you.

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

Hey, good morning.

Good morning.

Hey, Nick.

So kind of a technical question. Unallocated corporate and another saw pretty significant improvement in adjusted EBITDA year-over-year. I just want to make sure I understand that. Any kind of components that can impact there?

Yes. So really the unallocated portion was driven by a benefit on receiving refund from an insurance company on the – some legal disputes that we’ve had, so the insurance company reimbursed us for past expenses that we had.

Okay, all right. And then moving to North American Engineered Components, just want to maybe get any color on the margin performance there, so down about 80 basis points year-over-year, any major drivers of the margin performance?

Well, the biggest driver there is the significant loss of business in the vinyl extrusion part of it right now. I mean, we’re down $23 million in revenue, which is 10% of total revenues for the quarter, even a greater percentage of the North American fenestration. If you exclude that, the margins actually improved slightly in the legacy businesses.

So is this kind of fixed costs leverage working the other way?

Yes.

Is that the other way to think about it?

Yes, absolutely. And as I said, I mean, we successfully moved a lot of equipment and a lot of tool in. And now, we’re looking at rebalancing production in the existing three facilities, primarily the two big ones, Washington and Kentucky, to better get – to get manufacturing efficiencies. The Kent facility is relatively small and relatively cramped. And we have plenty of excess capacity now in Kentucky with some better equipment. So we’re in the process of moving – off to moving 237 tools, but we’re now going to move another 123 to better balance that. And to a certain extent, we’re doing some of that at Woodcraft as well trying to better balance our capacity across the total footprint.

Okay. And then, I guess related to that, you walked away from some business. Can you talk about your ability to go out and win new business?

Yes, obviously, we have not talked very much about that. But clearly, we’re not sitting back assuming that we’re never going to recover from this. We have a very robust pipeline for new business at this point in time. But as we’ve said before, it’s a very long sales cycle and not easy to get new business. But we have a very active pipeline that’s being in place now for, at least, six months, but I would not expect any significant announcements until early next year.

Okay, that’s a helpful color. Thanks for taking my questions.

Thank you. And our next question comes from the line of Ken Zener with KeyBanc. Your line is open.

Good morning, gentlemen.

Good morning.

Good morning, ken.

I hope, you all are doing well after Harvey down there. But we’re trying we are a lot more fortunate than many others in the city.

They’re very tragic.

Focusing on the UK within your EU Engineered, first of all, I want to say that, your disclosure is very much appreciated. And I think it helps explain the story through the numbers. I would also suggest you that, given that you gave third quarter and nine months from a modeling basis, if you guys are able in the Q to include second quarter, that would be very helpful, so we can kind of reset everything and have a true-up, that’s that’s just one comment there. But in the UK, it’s doing very well surprisingly. I mean, it was only down 1% in 3Q as I read your disclosures compared to down 6% on the first six months. Two questions there. How do you think that trend is looking in there – your fourth quarter in FY 2018? That – that’s one component. And then on the margin side, given where the currency went, I mean, how is the cost based in dollars, I assume a lot, working out versus the price you’re getting in the market?

So let me try the first one first. I think, quite frankly, we all continue to be somewhat surprised at the growth level in Europe. I will say just anecdotally, I was there a short while ago, I’ll be back there in a couple of weeks. Anecdotally, there are more and more discussions about things slowing down than there have been in the early part of the year. So from a growth standpoint, I would be surprised if we could continue in the high single digits on a local currency basis, I suspect that may taper off somewhat, but still with some decent numbers. On the margin side, other than, as I said, it was a pretty difficult comp because of an aberration last year. But the reality is, on a local currency basis, the third quarter margin, the run rate is consistent with the last year and about in line where we expected this year to come in. So I think normalized, we would expect margins to remain static. Having said that, already the chemical companies looking to get price increases in the UK based on a global shortage of feedstock as a result of Harvey here in Houston. So and remember, while they have pricing power in the UK, they don’t have contractual pass-throughs as we do here. We’ve already had one significant price increase this year to cover currency. So I’m concerned that as we go into 2018 continuing to pass-through some of these higher raw material costs, if in fact, they materialize could become more challenging.

Don’t you have – certainly, the extrusion side in Europe is what we’re talking about, but you opened up that commodity cost curve. Isn’t your guy, don’t you guys have contracts, I mean, that was the whole thing two years ago, where you guys, there wasn’t a pricing, fixed pricing basically, the costs went up on you. But isn’t your index tied to the CDI pipe index, I mean, is it – where is your contract tied to?

No, it is. It is to CDI, but only in North America. The European part of our business, it is not indexed.

And then the U.S., switching gears here if you don’t mind. Is it your view that much of the industry is tied to CDI price index? I mean, so how the cost that you’re seeing have contracted? I mean, is that – would you say industry standard, because I believe some participants have fixed cost pricing to their customers?

That’s true, but that’s a conscious choice, right. So almost all of the industry is tied to CDI, that’s how we buy resin, and that’s how we sell the finished product. As we stated the competitive that took our business north of the border, I think, is working on a fixed price, which could certainly impact their bottom line.

And then how, in America, when you do have these contracts, realizing they’re different for different customers. And is there are generally a lag time between the input cost you are facing and what you sell out the doors, is that kind of on a real-time? I mean, is there a month lag, or how does that work in terms of price recovery?

In some cases, they vary between 30 days and three months. So there’s a very sharp increase or decrease we can get hurt or helped, but it has to be a pretty sharp increase for that to really materialize.

Okay. And if I may, one more question. Do I? You said non-vinyl improved slightly, which obviously is going to be your warm-edge and your screens, and I suspect you’re not going to give us an EBIT margin for those businesses.

You’re correct, Ken, but it’s a nice try.

All right. But you did say interestingly, your organic vinyl, which I assume excludes the $20 million loss, is kind of doing better. Can you quantify the amount – is that $20 million loss sales? I mean, is there a way to think about that? I mean, just doing the math, you’d be up organically EBIT margin wise? I mean, can you quantify how much your EBIT drag associated with that was?

Okay. You lost me. I thought you were talking about sales growth. So I would say as a general rule that excluding our loss business, revenues in the vinyl business are growing in line with, right, with the rest of our fenestration business.

$20 million?

Yes.

Yes. But I mean, with that $20 million, did it cost you $5 million in EBIT, I guess is what I’m asking, I mean, if you lost that $20 million in sales, what’s the incrementals on that, negative incrementals?

I mean, yes, I mean, clearly, we’ve said before that the contribution margins are in the low to mid-20% range. So, you can do the math, and we’re obviously working on fixed costs in that business as well. But there’s no question year-over-year the margins in the vinyl business are down from history, because I mean, you took – with effectively on a run rate basis, we took a third of the volume out.

Yes, perfect. Thank you very much for your patience and hope everything goes well down in Houston.

Thank you.

Thank you. [Operator Instructions] And our next question comes from the line of Jay McCanless with Wedbush. Your line is open.

Good morning, everyone.

Good morning.

Jay, how are you?

Good. Thank you. And I would definitely echo Ken’s comments about Houston a very tragic situation, glad you guys seem to be fair and okay with it all. And also wanted to pick up on Ken’s question about North American costs, but maybe in a little bit different way. If I look at the distillate prices that are moving up, could you guys maybe talk about what percentage of cost of goods sold that might represent? And what type of price increases in mid single digits, high single digits? What type of price increases are you seeing on those costs that you can’t pass-through?

Well, so first of all, let me be clear. This is still speculation, right. As of today, we have not received notification, at least, to my knowledge of any price increases at this point. But clearly, I’m not concerned about resin or and based on history, the resin producers will take any excuse whether legitimate or not to try and push through a price increase. I’m not concerned about that, because it’s going to affect everybody the same way. It’s going to be highly publicized and we have contractual pass-throughs. So that’s really not going to impact us at all. What we typically don’t talk about though is, for example, you will have seen on the news, the chemical plant in Crosby, Texas where they’ve been burning off silos of peroxide-based chemicals. We actually use some of that product in our warm-edge spacer. TIO2 is an ingredient in the PVC windows, which we use a relatively small amount, it’s already seen a significant price increase through this year. It would speculate and that will also increase. Now to the extent we can, we will factor those into pass-throughs wherever it’s possible. But it’s just an early warning that there could be some inflationary pressure here if we can’t pass on some of those ingredients.

Yes, and if I can maybe add just a little bit of color. If you think about it in North America across all of the businesses, our primary chemicals that we have protection in place is about an 80-20 split. So the parts that we’re talking about is the 20% where there is not maybe a contractual pass-through or some mechanism.

Okay. I’m sorry, 80% of that you do have protection on, is it correct?

Correct.

Okay. All right. Good. That’s, yes, that’s very helpful. Thank you. And then the next question I had, the SG&A leverage this quarter was much better than we had anticipated. Do you guys see that continuing in the fourth quarter? And then any color or outlook you want to give for 2018 if that can continue?

No, it’s not going to continue. That that was driven primarily by the insurance refund. So I mean, think of it perhaps this way, if you take the year-to-date number right that that refund sort of gets normalized, and that run rate will continue through Q4 and into next year.

Okay. So what should we think about as a normal SG&A level in dollar terms for you guys going forward on a quarterly basis?

We’ll get back to you, because I don’t want to give out a number off the top of my head and then find it’s not right. Let us do the work and we’ll – Scott will give you guidance on what that is.

Okay, got it. And then just wanted to – the other question I had is, Bill, you talked about how you’re probably going to see from a flood recovery efforts probably more benefit in cabinets than in windows. Is that just a function of rising flood levels taking out cabinets and people not doing as much window replacement and just a little more light on that one?

Yes. So I think, it’s fair to say as far as Harvey is concerned and Harvey only, most of the damage to property was a result of flooding. And if you just look at what’s on the Internet and what you see on TV, there are a lot of kitchen cabinets piled up in people’s front yards right now that are going to have to be replaced. In fact, Brent, he is smiling, because he is in exactly that position right now. When it comes to, if you move down towards Corpus Christi, where the hurricane actually hit, there was a lot of property down there that was either completely destroyed or certainly windows blown out. But I think that’s relatively small in terms of numbers compared to the number of homes that were damaged by flooding here in Houston. The early read on Irma is, I mean, that’s obviously a very, very powerful hurricane much more so than Harvey. So, if, in fact, that continues its track through Southern Florida, I would expect there that they could be an awful lot more wind damage and maybe windows will be a bigger beneficiary, if, in fact, that storm continues on its current trajectory.

Understood. All right. Thank you guys for taking the questions.

Thank you. And our next question comes from the line of Julio Romero with Sidoti. Your line is open.

Hey, good morning.

Good morning, Julio.

So just on the gross margins, I know you mentioned there was a difficult year-over-year comp on the consolidated business. But were there any unusual items impacting this particular quarter?

No, that comp is specific to Europe, where there was an aberration last year. There were no unusual items in this quarter. We did continue to struggle with over time in a number of our facilities. We elected, because volumes were soft. We elected to close our vinyl extrusion facilities for an extended period over the 4th of July weekend. And the nature of that process is, it can sometimes be difficult to restart smoothly. And unfortunately, we were actually inundated with a bunch of project orders as we restarted. So we ended up working in an ordinate amount of over time in that business. It got better at Woodcraft in terms of over time through the quarter. It got progressively better each month. And I think the worst is behind us there. But I would say, there are no unusual items in the gross margin level that would affect modeling going forward.

Understood. Just switching gears here, so yesterday we saw an unrelated company lower their guidance and cite higher anticipated resin prices due to the weather situation, Texas and Louisiana. So I know, you mentioned they’re strictly pass-through, and in the past, you’ve proven that you’ve not chased business where you wouldn’t be able to pass along resin increases. But just any color you can provide on how a temporary spike would affect, if not your ability to pass-through prices ability for the industry overall?

Yes, I’m not concerned about the margin impact, because we are able to pass it through, and this is a very highly publicized event. So I think, already there’s expectations throughout the channel. And so, I would not expect difficulty in getting any pass-throughs there. I’d be surprised, if there was a large enough increase that the inflection point would harm us right now. So I’m not concerned about it from that standpoint. One concern would be a disruption in supply. And there was, at least, I think, one resin plant down here on the Gulf Coast, not one that we actually buy from that was severely damaged, I think, they’re still assessing whether they can bring that up and win. But I’d be more concerned about a complete disruption in supply than anything else. But again, it’s still early days. One of the observations we have been right here in Houston is that, the resilience in the community is astounding. And quite frankly, the speed at which infrastructure is being put back together and the rebuild is starting to take place, is actually positively shocking. So I have a high degree of confidence that this part of the country is going to recover very quickly.

Couldn’t agree more on that front. And then just lastly, I know some other callers have touched on it. Just on – because the Cabinets business is relatively new to Quanex, maybe you could give some color on what the – what Woodcraft have seen in the past after some severe weather? And what the timeline typically looks like for incremental demand to pull through? I know it’s kind of more anecdotal than scientific, but any color you could give, would help?

Yes, certainly, there’s going to be a time lag. I mean, if you think about it, by the time insurance adjusters and/or people decide how they’re going to finance their own reconstruction here. You can see the first 30 days just getting organized then orders being placed on cabinet companies, and could easily be 9 days from then before we see any components business, which is why I don’t think we will see any positive impact of this in our current fiscal year. But I would expect in our first quarter to see an uplift in our Cabinet Components business.

Got it. That’s very helpful. Thank you.

Thank you. And we have a follow-up question from Daniel Moore with CJS Securities. Your line is open.

Thank you, and thank you for the color, again. Just very simple math and sorry to be so simplistic. But just to clarify the comments we’ve had so far, so revised guidance, about $870 million for the full-year. And Bill, low kind of low 11s in terms of adjusted EBIT margin, that’s for the full-year, not the fourth quarter, correct?

That’s correct.

So that would put us in the sort of $95 million to $100 million range in terms of revised full-year EBITDA guidance?

Yes.

And then next year, you gave a lot of color and commentary, so maybe we’ll leave it at that. But do we think we can get back to the 12% that we did in 2016, or is there potentially upside to that, given some of the initiatives?

Dan, I’ve – not to try and avoid the question, I really prefer to wait until we get closer to the end of our fourth quarter. We’re actually in the middle of our planning process now for 2018. I haven’t seen a first pass of the numbers. I have definitely a high personal expectation. But I’d like to go through our normal process before I start talking publicly about expectations for next year.

Understood. Appreciate it and good luck to everybody with the rebuild down there. Thank you.

Thank you.

Thank you. And I’m showing no further questions at this time. I would now like to turn the call back over to Bill Griffiths for closing remarks.

Thanks, everyone, for joining us, again, and we look forward to talking to you in early December when we close our year. Thank you, and goodbye.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may all disconnect. Everyone have a great day.