Good day, and thank you for standing by. Welcome to the Q2 2023 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 turn the call over to George for his prepared remarks.

Thanks, Scott, and good morning to everyone joining the call. All things considered, and with a tough comp to Q2 of last year, we are pleased with our results for the second quarter of this year. As mentioned on our last earnings call, we believe we were starting to see a return to normal seasonality in our business during Q1 of this year and our results for the second quarter further reinforce that belief. Solid operational performance during the second quarter was somewhat masked by index-related pricing pressure and continued customer inventory rebalancing in our Fenestration segments. Although, volumes were down across all segments versus the prior year record levels, we did realize EBITDA margin expansion versus prior year on a consolidated basis. Our strong operational performance also resulted in improved free cash flow, which enabled us to repurchase $5.6 million of our common stock and repay $20 million of debt in the quarter. I will now provide some general comments on each of our reporting segments. In our North American Fenestration segment, revenues and earnings were down versus prior year due to lower volumes, driven by softer market conditions, weather-related softness in West Coast markets, customer inventory rebalancing for our spacer products and pricing pressures on lower raw material costs related to index pricing mechanisms. Operational performance remained strong in this segment and we did a good job of controlling costs despite the lower volumes. And looking at the LMI acquisition, we completed in November, I am pleased to announce that we have realized our announced synergy goal. This business continues to perform very well and we are evaluating growth opportunities. Moving on to our North American Cabinet Components segment. The decrease in revenues year-over-year was primarily a result of lower market demand and the rollback of hardwood-related index…

Thanks, George. Before I get started, I want to reiterate that we reported record results in the second quarter of last year. So we did have a tough comp. However, business did improve in the second quarter of this year versus the first quarter of this year. On a consolidated basis, we generated net sales of $273.5 million during the second quarter of 2023, which represents a decrease of 15.3% compared to $322.9 million during the second quarter of 2022. The decrease was largely due to softer demand caused in part by customer inventory rebalancing, lower pricing in North America and foreign exchange translation impact. Overall, our 2Q results further enforce our belief that we are seeing a return to normal seasonality in our business. Net income decreased to $21.5 million or $0.65 per diluted share for the three months ended April 30, 2023, compared to $26.5 million or $0.80 per diluted share for the three months ended April 30, 2022. After adjusting for one-time losses on damage to a couple of our manufacturing facilities due to inclement weather, coupled with one-time transaction and advisory fees, net income decreased to $21.7 million or $0.66 per diluted share for the quarter compared to $26.5 million or $0.80 per diluted share for the same period of last year. On an adjusted basis, EBITDA for the quarter decreased to $39.9 million compared to $45.2 million during the same period of last year. The decrease in earnings for the second quarter of 2023 was mostly attributable to lower volumes, decreased pricing, mainly due to surcharge rollbacks and raw material index pricing mechanisms in North America, foreign currency translation and higher interest expense. Now for results by operating segment. We generated net sales of $157 million in our North American Fenestration segment for the second…

Thank you. [Operator Instructions] Our first question comes from the line of Reuben Garner from The Benchmark Company, LLC.

Thanks. Good morning, everybody. Congrats on the strong quarter.

Thank you, Reuben. Thank you.

So a couple of questions about the seasonality, I guess starting with the top line. I think the low end of the range would still imply a little pickup sequentially over the next two quarters, which I think is seasonally normal. Is there any risk to that or -- I guess, what would the risks be to that? Is it further inventory reductions or just general market declines? I mean what's kind of implied in the market, I guess, to get to those levels is probably a better way to ask it?

I'll take this. I'll start here, Reuben. From a consolidated level, I would say, we're very confident in hitting that low range of the guidance. If there were concerns, it would be macro driven. I think we have some pretty good clarity now from our customer base. The order patterns and inventory levels seem to be stabilized across the supply chain and with our customers. So if there were a miss or upside either, I think it's going to be mainly driven by macro conditions.

Okay. And in that same vein on the -- it looks like you're implying that the margins are going to be sequentially lower quite a bit from where you were in Q2. And I know Q2 was pretty impressive quarter. But what would be the reason that you would see the sequential decline? I think historically, you see a bump up with the revenue in the latter half of the year.

Maybe -- I think you misheard me. So what we're saying is 3Q margins should be flat to up 25 basis points quarter-over-quarter.

So then would that not -- wouldn't that imply a big reduction in the fourth quarter to get to the full year guidance? [Multiple Speakers]

No, if we're guiding to the lower end of revenue but the upper end of EBITDA, that's actually better profitability.

Okay. I will work that and give it you offline on that one. The -- so then maybe last one for me. I'm going sneak one in that will be exactly my best question, okay. If you -- the gross margin performance in the second quarter in both Europe and cabinet was quite strong, was there anything kind of one-time there? Is this just finally getting completely past the price/cost issues that you've had or any color on those two segments in particular would be great.

Yeah. I'll give you some color, and we'll break it down between the two. In terms of the cabinet performance, it was really as expected, very much index driven. Last year, as we talked about almost every quarter, we were chasing the profitability because of the 90 day lag. And as pricing was going up, we're kind of -- we're paying faster than we're able to pass it along. Well, it's -- the complete inverse happens as it's going down. So it's exactly what we anticipated as the hardwood pricing are coming down. We're able to buy hardwood at lower prices faster than the index triggers. So we should be harvesting margins on the way down, and we've kind of alluded to that in past calls. So that's really what's driving that. I mean, the market itself is very defined in terms of pricing. So it's index related. In Europe, it's a combination. Operational performance has been very, very strong, and we're doing some good things from both the sourcing team and the operational teams and then the other piece of it is some carryover pricing that we're starting to realize as the inflation levels in certain areas have kind of panned out. There are still pressures in Europe as it relates to inflation. So there's going to be some continued conversations with our customers because the European inflation levels at least at this point because of energy cost and some of the higher levels of freight and logistics costs are just ahead of what we're seeing in North America. So we think price will still be an important factor over in Europe, and we'll see what happens there.

Okay. Great. Thanks, congrats and good luck going forward.

Yeah.

Thank you. One moment for our next question. Our next question comes from the line of Steven Ramsey from the Thompson Research Group.

Hey. Good morning. This is actually Brian Biros on for Steven. Thank you for taking my question. To start, I guess, on pricing, can you maybe -- you mentioned some givebacks largely attributable to the indexing. Any specific materials there to call out and the magnitude of the declines and maybe if there's any increases to call out as well? And just kind of what you're looking for the rest of the year kind of pricing embedded in the guidance from here?

So -- as a reminder, the indexes are primarily in North America. So we'll start with our -- in North American Fenestration, the main commodities that are typically on index or vinyl PVC resins, aluminum and steel in our screen products, and then an oil-based index for our butyl based spacers. So those have obviously had downward pressures across the board. Now as we progress through the year, I think we're starting to see that the pricing on a lot of those commodities are starting to stabilize and flatten out, in a couple of cases maybe even showing some signs of ticking back up. But they're pretty volatile, as you know. So we believe that the indexes are such that it will protect our margins and it's fair to both us and our customers. In the Quanex custom cabinet components group, it's very much hardwoods, soft maple, hard maple, Cherry, Red Oak, and a couple of other minor species, but those are the big ones. And -- what we're seeing is the same thing there is that those hardwood species have dropped in price pretty significantly over the prior year, but we're now starting to see that the rate of decreases is flattening and then at a couple of the species as well starting to level up to even maybe bumping up a little bit. So we think the rate of price givebacks as it relates to index will start to slow down. In Europe, it is all negotiated price. And it's very much based on the commodities, and we continue to have discussions with our customers as to when do we give back price as well as -- there's still a lot of inflationary pressures, as I just mentioned to Reuben in other areas. So Europe tends to be a little more complicated and a little more specific negotiations with the customers.

Okay, helpful. Thank you. And the second follow-up is, can you expand on what you guys are hearing from end markets and customers? I know you mentioned demand is improving sequentially, orders back to normal seasonality. We've been hearing sentiment today is better than expected -- better than was expected at the beginning of the year. So I just kind of parse out are things getting better just because of this seasonality and inventory rebalancing is over or are things actually getting better on the ground from the final customer perspective? Thank you.

I think what we're seeing and what we've been impacted by is definitely more of a macro environment. The affordability of housing becomes an issue. So if you can imagine in our fenestration businesses, as we're looking at new starts, that's an important metric. But also, the size of homes, the affordability piece comes into play. Then people are either building or buying smaller homes, which has smaller openings and less windows. I think those have been more of an impact over purely customer demand. So the affordability piece in the market becomes an issue. And then for cabinets and then what we're seeing in Europe, it's really the discretionary income piece. So I mean, those tend to be a little more discretionary whether you redo your kitchen or your bathroom cabinets versus replacing a window and door. So I think that's why we're seeing volume hit a little more. In terms of overall expectations, I think the market is exactly where we anticipated it would be, and we've talked about that for the last couple of quarters. And I think we'll see some normal seasonality. Again, it will be dependent upon macro conditions, what the Fed does and different things of that nature will have more impact, but -- for us, we've been pretty pleased that the year is panning out exactly the way we forecasted and saw it to come out, at least at this point.

Got it. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Julio Romero from Sidoti & Company, LLC.

Thanks. Hey. Good morning, George and Scott.

Good morning.

Hey. Good morning. Maybe to continue on price for a little bit, can you talk about price aside from anything on an index or anything surcharge related? Maybe speak to the efforts to maintain price across the three segments, and has that gotten any more or less challenging than maybe three months ago?

Yeah. I think we work very hard to be a fair supplier to all of our customers. And so we're open and transparent and continue to have those discussions with the customers. I think in areas that are non-indexed, the biggest impacts, in most cases tend to be freight and then packaging supplies, things of that nature. And we continue to go after price where we can, cognizant of the fact that we're also trying to support our customers in the market. So I think, in North America, there's been -- I'd step back. Globally, there's much more pressure right now on either repealing price or at least holding prices flat. I think we're seeing the customers in the market begin to really start pushing back on further price increases. So to answer your question, it's absolutely much more of a challenge today than it was six months ago. There's no doubt. But I think our efforts to continue to be transparent and work with our customers to make us all successful has worked for both sides.

Got it. That's helpful. And then maybe just turning to the cost side. You guys obviously did a good job controlling costs in the quarter. And you talked about some of the things that helped you were some favorable purchases while the index figures hadn't happened yet. Were there other levers you were able to pull on the cost side within the quarter? And would those levers on the cost side be able to benefit you in the back half of the year?

Yeah, absolutely. Great question. And the answer to that is, yes, there are other triggers that we pulled. And I think it highlights what we've said all along that our cost structure is built in such a way that when we do go up or down, we have the ability to be ahead of the game, probably more than most. And I think so for example, in cabinets, I would tell you, they're not easy discussions. But when volume starts dropping, the team was ahead of it and controlled our labor cost, controlled our supply cost and really focus on managing their inventory levels. And we have those kind of things in place in all the divisions. So we have triggers that we pull. We test our different models, if volume were to do this, here's what you do. And they were prepared and all the groups reacted very well. So it's really cost structure across the board that we're managing.

Got it. And then maybe turning to the LMI integration. It sounds like that's going well. Maybe just talk about that, if you could and would there be a potential of maybe additional synergies beyond the target?

Yeah. No, we've been extremely happy with the acquisition of that business. One, from a culture perspective, it fit in very, very well. The teams are working well together. It's opened us up to new and additional markets. So we're servicing not only the fenestration markets, it's through vertical integration supplying us, but we're now supplying a little bit into the automotive business, wire cable. We actually -- they supply materials into like dog toys and things of that nature. So it's allowed us to get a view into a lot of different things. And we've been very, very thrilled with their performance and continue to be. In terms of growth in more synergies, I think the answer is yes. I think that there's an opportunity to use other materials that we currently make. For example, in our spacer business, maybe expanding their sales team and giving them offerings in silicone and butyl types of rubbers and allowing them to be a full service compound provider of not only EPDM, which is currently what they do. So I do believe there's both cost synergies as well as potentially new sales opportunities, which will help us improve the utilization of current assets. We'll be able to do some of that without investing in any more CapEx. So we're pretty excited about the opportunities that lie within this business.

Got it. Well, thanks very much for taking the questions and good luck on the back half of the year.

Thanks, Julio

Thank you. I would now like to turn the conference back over to George Wilson for closing remarks.

We'd like to thank you all for joining and we look forward to providing you an update on our next earnings call in September. Have a great day.

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