Ladies and gentlemen, thank you for standing by. And welcome to the Quanex Building Products Corporation Second Quarter 2021 Earnings Conference Call. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Scott Zuehlke, Senior Vice President, Chief Financial Officer and Treasurer. Please go ahead, sir.

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

Thanks Scott. We are pleased to report another quarter of solid results as demand for all our products remained strong and exceeded our expectations. Operational performance was excellent across all segments, and I'd like to take a moment to thank the entire Quanex team for their continued efforts and dedication to our customers and shareholders. Similar to most others in the building product space, we are facing inflationary pressures and labor shortages. However, we continue to stay focused on operational excellence projects and other initiatives that improve our return on invested capital and our ability to generate cash flow. We have had success in these areas and believe this focus will continue to generate value for our shareholders. Prior to discussing the detail by segment, I'm going to provide some color on the ever changing macroeconomic conditions of the markets in which we serve. In the North American residential housing market, both new construction and repair and remodel remained strong. Demand for windows and doors remain solid and according to many of our OEM customers lead times to their consumers are being extended while backlogs continue to increase. Specific to cabinet components, we believe that the semi-custom segment, which is the main segment we serve, again outperformed the stock segment. As we mentioned in our last call, there was a significant shift in market share away from the semi- custom segment to the stock segment over the previous few years. So the recent KCMA data is encouraging and that it shows the semi-custom segment continuing to outpace the stock segment. Demand for the products we manufacture in the UK and Germany also remains strong. Although markets are slowly beginning to reopen in the UK and Europe, continued travel restrictions coupled with an under built housing market bodes well for demand…

Our first question comes from the line of Daniel Moore from CJS Securities, Inc.

Good morning, George. Good morning, Scott. Thanks for taking the questions. Hoping you can break down or at least directionally give a little bit more detail in terms of price versus quantity, as far as the growth is concerned for each of the three segments.

Yes, that's a tough one to answer. I don't have the data right here in front of me. Volumes, definitely the main driver, pricing in North America is really pushed through via contractual pass throughs for major raw materials, as you know. And then in Europe, it's the opposite. We don't have contractual pass throughs there. So it's all prices that we've pushed through to customers. Give me a little time to gather more detail, we can talk offline.

Fair enough. Obviously, Europe remains exceptionally strong. Is it the lack of new -- of housing stock that's sort of causing boom in R&R? And qualitatively any commentary and how would you describe your visibility beyond sort of the next two quarters?

I would say, right now the under build housing market is the main driver, you couple that with still some restrictions on travel and the increase in discretionary spending income that people have, that is continued to bode well, and I don't think that that's going to subside in the short term. So those two factors are the main driver. And in terms of visibility outside of the first two quarters or the next two quarters, it is limited, but I would say, depending on raw material availability, and supply issues, the next two quarters looked extremely strong, and we're very confident in what we see over the next two quarters.

Got it. And similarly in North America, backlogs for new homes are rising till all time highs, you benefiting from people choosing to refurbish instead of purchasing a new home to the extent that you have Intel there.

I think what we're seeing is exactly that, the availability of new housing starts I mean, there's just no builders, or lack of builders and the existing home inventory is in at an all time low, homes are turning over extremely quick. So there's no inventory. So people that want to do something are being forced into the R&R market. And we absolutely see that and our customers are seeing it as well.

And I think just to clarify I think you meant challenge getting labor.

Oh, in terms of the labor. It's a challenge across the board for every industry, and that's not letting up, I mean in every aspect of our supply chain is having a hard time getting labor; our customers are having a hard time getting laborers. As it's a challenge for us as well. Now, I will tell you that we are cautiously optimistic that, as I mentioned, some of the changes in some of the state unemployment funding levels appear to be repealing. And in certain areas, we're starting to see some signs of maybe some relief, but still too early to tell them.

Yes, you actually answered my next one as well. So I got two birds with one stone. Lastly, maybe just talk about the, you added glass to the list, growing list for everybody of supply chain challenges, any incremental color there? And sort of I assume that that's baked into, other challenges baked into the guidance, are you just sort of seeing incremental pressures build in? Any detail, any color would help?

Sure. So for the glass, it's a relatively new issue. And it's primarily in UK and continental Europe. So the glass suppliers there's two suppliers that have float lines that manufacture the glass that have gone down and their own force majeure with customers on allocation. Now, obviously, we don't buy that. But any of our window indoor customers that use glasses will impact their ability to manufacture. So there's restricted capacity in both UK and Europe for glasses. It's mainly European issue. As it was being relatively new, there's very little of that impact baked into our guidance. What's baked into our guidance is what we're being told now. So the only comment being is if that situation worsens, and something else was to happen unexpectedly, that could have an impact. And that is not baked into our guidance.

Our next question comes from the line of Steven Ramsey from Thompson Research.

Hey, good morning. Maybe can you talk to share gain or share shift in any of your segments if it was a contributor to Q2 results or in the guidance?

So as we see and I won't give you specific numbers; I will give you anecdotally what we see is happening and what has been our selling point in terms of what we bring to the table as labor continues to be a challenge. In many of our product lines, we have external customers but some of our customers also have, are vertically integrated and have the ability to manufacture the same product. And they are looking to find ways to better increase their output. They're looking at potentially outsourcing non critical components. And so when we say share gain in many cases, it is customers deciding to outsource some product. And that's primarily in screens and cabinets, is where we'll see the biggest impact of those types of share gains. You can also see that in vine, although that's a little more complicated.

Are you still there, Steven? Sounds like we may have lost Steven.

Hey, guys. Okay, sorry. Quick question two, if under a scenario of a multi year strength in the housing market, do you foresee a stronger shift, kind of beyond the current supply chain challenges to outsourcing that would drive results in a pretty strong way over the next two to three years?

I think what we would see, and we've stated all along that we seen that trend even before COVID, as people look to optimize their output, minimize capacity expansion in terms of their footprint, and then also the labor that trend will continue to challenge. We think it is a big upside. Yes.

Our next question comes in line of Reuben Garner from Benchmark.

Thank you. Good morning, everybody. And congrats on the quarter guys. Maybe just to start on the North American Fenestration strength that you saw, you mentioned the darker numbers. And obviously, you guys have the screens business to I think help you grow above and beyond the market. Is it -- how do we think about your customers building inventory? Is that happening at all? In other words, if they haven't been able to keep up with demand, is there any risk that they've built inventory of your products to be ready for what they expect to see over the next six months or so? Or does it not work like that with most of your products?

I think what we're seeing right now, there's really no ability for anyone to build inventory Reuben right now, because of supply chain pressures, even if you wanted to build some excess inventory and finished goods or anything, there's just not enough supply, or labor to be able to do that. So I'm really doubtful that there's anyone being able to build up significant levels of inventory.

Okay and then it sort of in a related vein, if there's been a lot of talk about, maybe that this level of housing starts one five to one, six, or even one seven is sort of the best the market can do in terms of materials and labor in an environment where, the start level is kind of flattish in 2022, or even in your fiscal '22. Do you guys think because of your exposure to R&R because windows in particular has been such a tight product category, that you'd still be able to grow in that kind of setup, because you're still, all the backlogs that you've talked about and other initiatives that you have and maybe just touch on initiatives you have to grow above and beyond the market? Maybe if there's anything else other than screens that you could elaborate on?

Sure. To answer that I will answer it in two segments, in terms of our growth expectations on a go forward basis. And we will obviously try to give further guidance in future meetings on that. We are very confident in the macroeconomic data points that we see that this cycle does have an extended length of time. And even if the new construction side of it were to drop, again, the same fundamentals in R&R that you just mentioned. So we're pretty confident in the outlook in the near to mid term. And through our strategic planning period. The other things that we're doing in terms of initiatives, we've been so focused and we talked about it on return on invested capital is also finding ways to optimize existing assets that we have, and we're pursuing other markets with some adjacency products. For example, if you were to look at either rubber extrusion, in our space or business where we're pursuing other markets for extrusions, as well as vinyl extrusion, where the need for capacity and other people that extrude vinyl is very much out there. So we're becoming a supplier to OEMs in different markets. We're just planting those seeds. So the impacts of that on today's numbers are not meaningful, but we believe that there's opportunity to grow potentially different markets organically, and we're working very hard on that.

Great, that's very helpful. And last one for me is I, this will probably be a question for Scott, you mentioned some, whether it's price cost or difficult comps, or what have you reasons why margin expansion might be tough in the back half as we move out into the next year. I know it's a little bit early, but just for modeling purposes, do you think that we kind of get past those pressures based on what we know today, and you can get back into expanding margins as you grow the business?

Yes, I think there's some confidence that we'll be able to do that specifically in the North American cabinet components segment where we've been chasing hardwood costs higher, and at some point as those stabilizer perhaps come down, we should benefit from a margin perspective. So I think you're right, we should expect that.

Our next question comes from the line of Julio Romero from Sidoti & Company.

Hey, good morning, George. Good morning, Scott. So wanted to start on the European segment, you saw very strong sales growth in Europe. I know you had the shutdowns in the second quarter of last year. What kind of exit sales growth rate did Europe do in April?

Year-over-year. I mean we're stronger than the, above the average of the quarter, we're still doing very well in Europe. If you think about it, April and May of last year, we were shut down some in Europe. So the year-over-year call is right.

That's right. Yes. Okay. Makes sense. Okay. And maybe, can you speak to pricing in Europe? I know you don't have contractual pass through there. But what's your confidence level there that you can continue to kind of pass through any price in Europe?

The market is so different. And I think the understanding of the OEMs, about the cost structure of the products has made it, pricing is never an easy discussion. But when you go with data and transparent and your raw material costs; it's a much more rational type of discussion with a customer. So I think we're very confident in our ability to continue to get price when needed. And with the understanding that when price comes back, we also share at that point, too. So I think we're confident and being able to keep up with inflation. And as long as you show it's not necessarily a margin.

Yes. Maybe switching over to the cabinet segment. Can you maybe remind us what the lag is, with price increases, contractually effective? And when you see that price, is it for hardwood? Is it closer to 30 days or 90 days, for hardwood --?

The pricing index, the way it works for cabinets is typically a 90 day lag before it triggers and there's a certain percentage, so the price has to go up a certain percentage, and then it triggers and that's usually on a 90 day lag, the part that gets to be an issue is because we're buying from the mills, which tend to have a very short time period for us. And everyone else that buys lumber is you're typically paying in five to 10 days. So a net 80 day gap between when you're paying the new price, and when you're getting to pass it along to the customer, and then you take into account further escalation of price during that timeframe. We're chasing it right now. At some point when that flattens and goes back down, there'll be a benefit to us with the same time periods, but until that happens, we're chasing and it's pretty significant with the rate of inflation that we see today.

That makes sense, but since they're contractual, I mean, they're automatically triggered; it's just a matter of the time lag at the moment, the 90 day time lag before they catch up.

That is correct.

Is that there, okay, and I guess maybe just my last one here, just sticking with cabinets is obviously demand is strong. Is there any strategic kind of initiative or components of taking orders even with maybe the overtime you might have to pay out to the incremental there? You saw these quarters aren't great right. So I don't know if there's any things strategic to you maybe taking orders at those incremental margins or is it just pricing catching up? Or is it ramping up labor and banking on lower overtime costs, once you secure that labor?

I think right now for us to minimize some of the over time and that's the big is challenged from a margin perspective that's non index related. We are evaluating capacity expansion and have the potential to add some different capacity in a different region that not only will grow our revenue, but also take pressure off of freight, interplant freight cost as well as the amount of labor time utilized. And we're working very hard at this point to assess our options on that. But I would think that that's an opportunity in the very near future for us to announce something there.

Our next question comes from the line of Ken Zener from KeyBanc.

Good morning, gentlemen. So things are coming back, lots of demand in fenestration is you're actually, all these price index I was trying to look back to see what year you guys didn't have those locked in. And it wasn't good. But obviously spacers and the screens, I think, are doing quite well. I just want to touch on, as we think about next year, which is getting closer and closer, there's an earlier question about, can you have margin expansion? Scott, I think you said, probably, cabinets are where you are going to do that. And you guys can't have the 2% margin EBIT target, I think, if my recollection for that industry, so that's going to be helpful. As I look at next year, the corporate expense, you're calling out the stock comp and stuff. Can you give us what you think, it's kind of a normalized corporate expense rate for the company and at either annually, or how should we think about that, realizing '20 was low, 21 is higher because the stock comp like what's in your normalized rate, as we think about the kind of, next year.

Are you talking about SG&A on a consolidated base?

Yes.

Well, for SG&A, just on the income statement, we guided about $115 million this year, our guidance was, I think, $100 million to $105 million. The main driver of the increase now is, when we gave the prior guidance, our stock was trading at not even $22. And now we're up closer to $27, $28. So that was a big Delta there, along with the more normalized medical expenses that we're seeing now. Also, incentives are also combined in there. So we're obviously having a good year. So the incentive accruals are higher. So on a more normalized basis going forward at target, I mean, I would assume, somewhere between $90 million and $100 million on an annual basis for SG&A.

Okay, appreciate that. And then because you just called out cabinets or responded, I guess, when the question was about margin expansion. Obviously, are there issues or ceilings that you're seeing? And the fenestration business, Europe, North America. Next year, obviously, you talked about glass in Europe and understand that, but is there something in screens, US spacers, extrusion that we should be aware of? That's kind of a ceiling? I mean, you obviously just had really good margin expansion this year? Well, it's not over, but it's implied, I guess. Is there something that would keep this year's margin from not going higher in North America fenestrations, structurally, that you would want to call out or, talk about these different businesses? Because it seems like if demand is there, you should still be getting favorable incrementals as well.

Yes, I mean, that's definitely a possibility. The transparency in this business as you know is pretty limited. We're in an inflationary environment right now. If and when that subsides or trends the other way, I mean, we should benefit from a margin perspective, as long as volumes stay up, because our operating leverage, as we've demonstrated, is pretty good. And we expect that to continue.

And we think the opportunities for continued volume with the product lines that we have, when you Ken, as you know with our spacer business very high efficient, as we continue to identify ways to improve energy efficiency throughout our whole nation, US tends to be significantly behind Europe. Yes, that we think that there's also growth opportunities just on the product line itself, because of where we think that the US market will ultimately go in terms of pushing energy efficient products.

Right, understood and I guess, pricing is kind of funny, right? You got the indexes running through the extrusion stuff and the other businesses cabinets, you're on this hardwood. So given those lags, I guess it is reasonable to assume your business in total can grow 20% organic incrementals except for the fact that when you get price, right, if it covers costs, it's actually right margin dilutive. Which, but is there anything besides that component? Because it seems like your prices, your cost inflation is covered on, let's say, a two quarter forward basis, right. Your guidance is what it is. But that means we're entering FY22, with your prices covered and volume set to go up for that to cover your price at the middle margin headwind. Is that really the only thing that causes you guys' issues when you think about where next year could go? Because your leverage is low, you're obviously expanding your business, which is great to have capital deployment opportunities. Just seems like it's a pretty constructive base that you're exiting the year and if you've covered your cost.

I think we've been and by design, we've been very methodical in terms of staying on our roadmap, for the last two to three years, and we put into place the operational improvements. We've focused on trying to add technology and capacity in certain areas. And we'll continue to do that. I think right now, inflation is the biggest issue, that we're -- the headwind that we're fighting. And it's the one thing that's the challenge without that piece, I think, although we still have opportunities, and there's a lot of projects that we're doing, we feel we're positioned fairly well. And we've done a good job of preparing our balance sheet for that point and capitalizing on any opportunity that does come all right. So, the inflation is has been a, it's tough for us and everyone else to deal with, because it consumes so much energy. But I think, what we've done over the course of the last couple years, I think has positioned us extremely well. And we're very excited about the opportunities that lie ahead of us.

Thank you. This does include the question-and-answer session of today's program. I'd like to hand the program back to George Wilson, CEO for any further remarks.

We'd like to thank everyone for taking time out and joining us today and we look forward to providing you all with an update on our next earnings call in early September. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.