Quanex Building Products Corporation (NYSE:NX) Q4 2022 Earnings Call Transcript

Quanex Building Products Corporation (NYSE:NX) Q4 2022 Earnings Call Transcript December 16, 2022

Operator: Good day and thank you for standing by. Welcome to the Quanex Building Products Q4 and Fiscal Year 2022 Earnings 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 hand the conference over to your speaker today, Scott Zuehlke, SVP, CFO, and Treasurer. Please go ahead.

Scott Zuehlke: 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 statements 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.

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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 $307.5 million during the fourth quarter of 2022, which represents growth of 5.4% compared to $298.1 million for the same period of 2021. We reported net sales of $1.22 billion for the full-year, which represents growth of 13.9% compared to $1.07 billion for 2021. The increases were primarily attributable to higher prices related to the pass through of raw material cost inflation. Net income increased by 18% to $24.7 million or $0.75 per diluted share during the three months ended October 31 2022 compared to $20.9 million or $0.62 per diluted share during the three months ended October 31 2021.

For the full-year 2022, net income increased by 55% to $88.3 million or $2.66 per diluted share, compared to $57 million or $1.70 per diluted share for full-year 2021. On an adjusted basis, EBITDA for the quarter increased by 3.8% to $38.7 million compared to $37.3 million during the same period of last year. For the full-year 2022, adjusted EBITDA increased by 20.3% to $152.5 million compared to $126.8 million in 2021. This equates to adjusted EBITDA, margin expansion of approximately 70 basis points year-over-year. The increase in earnings for the three months and 12 months ended October 31 2022 was mostly 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.

In addition, we had a return to provision tax benefit of approximately $6 million in fiscal ’22 related to updates to taxable differences, or non-cash compensation, bonus depreciation and GILTI which is Global Intangible Low Tax Income. Looking ahead, we expect our effective tax rate to return to a more normalized level of approximately 25%. Now for results by operating segment, we reported net sales of $178.2 million in our North American Fenestration segment for the fourth quarter of 2022, which represents growth of 14% compared to the fourth quarter of 2021. For the full-year, we reported net sales in this segment of $687.5 million or 18.9% growth compared to last year. The increase in revenue for both periods was primarily driven by an increase in price and raw material surcharges along with increased volume throughout the year.

We estimate that around 30% of the Q4 revenue growth in this segment was due to an increase in volume and the remainder was due to an increase in price. For the full-year, we estimate that around 40% 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 of $21.1 million in this segment for the fourth quarter, which was 4.9% higher than prior-year. Adjusted EBITDA was $90.8 million in this segment for the full-year or 20.5% higher than 2021, which equates to margin expansion of approximately 20 basis points year-over-year. We reported net sales of $68 million in our North American Cabinet Components segment in Q4 of 2022, which was 2.1% higher than prior-year.

For the full-year, we reported net sales of $275.7 million in this segment, which represents an increase of 12% year-over-year. The increases were driven solely by price as volumes declined throughout the year. Customers continued to work down their backlogs as demand softened. The increases in hardwood index pricing as well as discretionary pricing actions offset the volume decline that resulted in revenue growth for both periods. Adjusted EBITDA was $5 million for the quarter, which represents a decline of 8% versus prior-year. Adjusted EBITDA for the year was $17.1 million or 20.6% higher than 2021 and represented margin expansion of 40 basis points year-over-year. Price increases, better availability of green lumber, improvements in lumber yield and labor efficiency are the main drivers of the positive results for the year.

We reported revenue of $62.1 million in our European Fenestration segment in the fourth quarter, which represents a decrease of 10.9% year-over-year. After adjusting for FX, revenue actually grew by 5.2% during the fourth quarter. For the full-year, we reported revenue of $262.1 million, which represents an increase of 4.2% compared to 2021. However, excluding foreign exchange impact, this would equate to an increase of 14.2%. Revenue increases for both periods were driven by increased pricing as volumes declined. Adjusted EBITDA came in at $12.3 million for the quarter, which was 2.5% higher than the fourth quarter of 2021. For the full-year, adjusted EBITDA was essentially flat at $50 million compared to 2021 in this segment. Moving on to cash flow in the balance sheet, cash provided by operating activities was $48.1 million for the fourth quarter of 2022 and $98 million for the full-year 2022, which represents increases of 54.4% and 24.7% respectively compared to the same periods of 2021.

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We generated free cash flow of $34.5 million during the fourth quarter 2022 and $64.8 million for the full-year in 2022, increases of 48.9% and 18.8% respectively. We were able to repay $25 million in bank debt during the fourth quarter and we did not repurchase any common stock during the quarter since we were restricted due to the LMI acquisition that we closed on November 1. 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 negative 0.2 times as of October 31 2022. Pro Forma for the $92 million that we borrowed to fund the LMI acquisition, our net leverage ratio was 0.5 times. Going forward, we will 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 on earnings release, our long-term view continues to be optimistic as the underlying fundamentals for the residential housing market remain positive. However, like last year based on current macro indicators and recent conversations with our customers, we are taking a measured approach to 2023 guidance. As such, we believe it would be premature to give official guidance at this time. We intend to revisit the guidance when we report earnings for the first quarter. Nevertheless to help for modeling purposes, you can use the following assumptions for now, which reflect our current view and may change by the time we give official guidance. Revenue and adjusted EBITDA may end up relatively flat in 2023 versus 2022. This accounts for the contribution from the LMI acquisition but also includes the negative impact from FX in Europe and assume softer demand or reduced pricing in our divisions, mainly due to rolling back surcharges as raw material costs subside.

From a cadence perspective for Q1 of 2023, net sales should be up approximately 2% to 3% year-over-year on a consolidated basis. Net sales in our North American Fenestration segments should be up approximately 11% to 12% in Q1, driven by the contribution from the LMI acquisition. Net sales are expected to decline by approximately 12% to 13% in our North American Cabinet Components segment, due to softening demand and lower index pricing for hardwoods. In Europe, net sales may be down by approximately 9% to 10% in Q1 due to softer demand combined with negative foreign exchange translation impact. From an EBITDA margin perspective, on a consolidated basis, we think there is opportunity for slight margin expansion in Q1 of 2023 compared to Q1 of 2022.

I’ll now turn the call over to George for his prepared remarks.

George Wilson: Thanks, Scott and good morning, everyone. Before I provide my prepared remarks on the operating environment, I would like to take a moment to comment on our interesting and challenging fiscal 2022. The year began with fears of new COVID variants, and that was followed by continued high demand, labor shortages and material supply challenges. As if those items weren’t challenging enough, the idea of a Russia-Ukraine war became a stark reality. The resulting fears of a global energy crisis translated directly into inflationary pressure from virtually every aspect of a business. While foreign exchange translation impacted our international business units. In our fourth quarter, rising mortgage rates continued to impact demand and commodity raw material costs began to decrease rapidly, which put pressure on index pricing for the first time in over three years.

Despite all these challenges, we were able to report another year of record revenue in earnings in yet another difficult year. In the face of these abnormal challenges, what has become normal is how the Quanex team continues to perform well. I’m extremely proud of the results we posted. And we’d like to highlight a few of these points. First and foremost, the Quanex team had a record year in 2022 for safety performance, despite high levels of overtime and scheduling challenges caused by material shortages throughout the first half, the team remained focused on protecting every person who entered our facilities, and we continue to systematically improve our safety performance. Above all else, this is what makes me the proudest. In addition, our focused efforts on improving return on investment capital continues to pay dividends and translate into improved performance, cash flow generation and a solid balance sheet.

In conjunction with third quarter results, we introduced a refreshed look of our go forward growth strategy. We call it the road to $2 billion in revenue. The refreshed strategy includes a renewed focus on both organic and inorganic growth that will revolve around our core process competencies and material science. Whether we’re building out our current markets or expanding into different adjacent markets, we will use the same diligence that we have demonstrated with our operational performance, and we expect the same positive results for our shareholders. The first move in executing on this refresh strategy was the acquisition of LMI Custom Mixing, which we closed and announced on November 1. LMI, which will now be referred to as Quanex Custom Mixing is a state-of-the-art custom polymer mixer that produces high quality customized rubber compounds used in a variety of applications in complementary and attractive diversified industrial end markets.

As our executive team evaluated this acquisition opportunity, it became clear that this was a business we wanted, that we wanted to own and grow for the following reasons. It fits squarely within Quanex’s material science and process engineering expertise, it expands our product portfolio into a new attractive category with significant growth opportunities. It allows us to vertically integrate and realize cost savings through the supply of compounds to our existing IG spacer business in North America, which is located on the same site as LMI’s Cambridge, Ohio plant. It is a familiar complementary operation that represents low execution and integration risks. The acquisition is immediately accretive to adjusted EPS, and adding this business improves our consolidated margin profile.

We’re about a month and a half into integrating this business and we are confident in our ability to realize the expected synergies and to grow this business. With all that said, I would like to thank all of my Quanex teammates for their dedication and efforts during fiscal 2022 and then for delivering spectacular results in a very challenging environment. Looking ahead into 2023, we do anticipate that softer volumes, along with index and surcharge rollbacks will pressure revenue across our legacy divisions. However, we do believe that the underlying fundamentals will favor housing recovery sooner than later as the demand for housing remains high, with inventory levels still low. Affordability will be the key and as material cost pressures subside, demand could be spurred again.

It is also worth noting that despite pressure on the residential new construction market in 2023, we derive approximately 70% of our revenue from the repair and remodel market, which should fare better than new construction in the near-term. From a profitability point of view, even though pricing for commodity raw materials is trending lower, inflationary pressures remain significant in areas such as labor, medical benefits, packaging and freight and chemical feedstocks. As such, it will be necessary for companies to continue to fight for price in these areas, and Quanex will be no different in that regard. Current levels of inflation are simply too high to be offset completely through productivity gains. In addition, as commodity prices drop and index pricing rollbacks occur, we couldn’t be in a position to benefit from a margin standpoint due to timing lag.

In summary, we expect 2023 to be a year in which revenues will be challenged, but the opportunities to hold or slightly improved margin percentage is real. We plan to stay focused on safety, operational excellence, optimizing ROIC and integrating and growing Quanex Custom Mixing. We will continue to invest in new product and process development. And we will also work to identify inorganic opportunities that align with our road to $2 billion strategy, all while making sure our balance sheet remains healthy. Despite the challenges we expect in 2023, Quanex is well positioned to continue creating shareholder value. And with that operator, we’re now ready to take questions.

Q&A Session

Operator: First question will come from line of Daniel Moore from CJS Securities, your line is open.

Daniel Moore: Thank you. Good morning, George and Scott, thanks for color and taking questions.

George Wilson: Dan, good morning.

Daniel Moore: To start with just piggybacking off your comments, George on LMI. Maybe dig into that a little bit more, they’re co-located with their process at all around that acquisition. And you talked about many of the things that they bring to the table, is mixing compounding an area that you would like to grow and scale? Or is this more of a sort of a one-off opportunistic. And a quick follow-up there.

George Wilson: Yes, no it absolutely is a process and area that we expect to grow. Currently, they supply EPDM and a few other materials. And then we think by combining the two companies, not only can we invest and grow in their current product portfolio, but we’ll give them now the opportunity to add our silicone and our butyl capabilities that we had within Quanex already. And a lot of that Custom Mixing, excuse me, that Custom Mixing to be able to offer multiple solutions to customers through many different channels so that we think that there’s a great opportunity to continue to expand that business.

Scott Zuehlke: And to answer your first question Dan, there was not a process run. This is a business that we were familiar with and have been for a long time. In fact, the parent company of this LMI business was a company that we acquired Edgetech, which is our IG spacer business from way back in 2011. That’s actually how George came to the company.

Daniel Moore: Indeed, absolutely. That’s helpful. So, longer term, what kind of sort of growth margin profile are we looking at for LMI. And near-term, you mentioned accretive, I know you’re not giving guidance, any range around kind of what EPS accretion could look like in the near-term?

Scott Zuehlke: From a growth standpoint, we think this business can grow at a rate that’s above our legacy, our core business. So if historically, that was in the low to mid-single-digit range for our legacy business prior to COVID, we think this business can do better than that. From an EPS accretion standpoint, yes, that’s just — that’s information we haven’t disclosed publicly.

Daniel Moore: Got it. And maybe just one more, and I’ll jump back. But the free cash flow has been and conversion has been improving. Do you see that trend continuing, you see the working capital likely be a benefit in fiscal ’23 or more neutral and any expectations for CapEx?

Scott Zuehlke: Yes, good question. Obviously, working capital has definitely been a hit to free cash flow in 2022, I think to the tune of close to $30 million. A lot of that had to do with the value of our inventory going higher because of inflation. Looking ahead into fiscal 2023, we’re hopeful that working capital won’t be a negative. But I’m not sure, it’ll be a positive. So I think keeping it somewhat flat when you model is probably the prudent choice at this point.

Daniel Moore: And any view, thoughts on CapEx?

Scott Zuehlke: Yes, I would say around the same level as last year, maybe a little higher. So call it $35 million. Maybe a little more, we’ll come out with more firm guidance, hopefully in the next quarter.

Daniel Moore: All right, I’ll jump back in queue if any follow-up. Thank you.

George Wilson: Thank you.

Operator: One moment for our next question. Our next question comes from the line of Reuben Garner from The Benchmark Company. Your line is open.

Reuben Garner: Thanks, good morning, guys. And congrats on the strong close to the year.

George Wilson: Thanks very much, Reuben.