Ladies and gentlemen, thank you for standing by. And welcome to the Second Quarter 2020 Quanex Building Products Corporation earnings conference call. At this time, all participants lines 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 maybe recorded [Operator Instructions]. I would now like to hand to conference over to today Mr. Scott Zuehlke, 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. 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 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 Web site. I'll now discuss the financial results. We generated revenue of $187.5 million during the second quarter of 2020 compared to $218.2 million during the second quarter of 2019. The decrease was primarily attributable to softer demand in April related to the COVID-19 pandemic. Volume began to decline in late March, which is also when our two manufacturing facilities in the UK were shut down completely to comply with government orders. We've reported net income of $5.5 million or $0.17 per diluted share for the three months ended April 30, 2020 compared to a net loss of $24 million or $0.73 per diluted share during the three months ended April 30, 2019. The net loss in the second quarter of 2019 was mainly due to $30 million non-cash goodwill impairment in our North American cabinet component segment. On an adjusted basis, net income was $6.4 million or $0.19 per diluted share during the second quarter of 2020 compared to $6.3 million or $0.19 per share during the second quarter of 2019. The adjustments being made to EPS are for restructuring charges, impairment charges, certain executive…

Thanks, Scott. Prior to giving my commentary on the quarter, I would like to take a moment to thank all of my Quanex teammates for their dedication and efforts during this global pandemic. As a group, they accepted the challenge of being an essential business and maintain production so that we could provide uninterrupted service and products to our customers. They did this in an environment where the rules and regulations seem to change daily. In addition, we witnessed countless examples of our employees giving their time, talents and resources to help others in their communities. I am humbled and thankful to be on the team with so many amazing people. Thank you. Similar to our first quarter, the second quarter started strong and our results were trending better than projections. However, the COVID-19 pandemic and related regulations began to impact our business toward the end of March. As such, our focus shifted to the following priorities; first, the health, safety and welfare of our employees; second, supporting our customers; and third, liquidity and cash flow management. Company wide, we have a very robust enterprise risk management process that evaluates various risk scenarios and prepares action plans to mitigate those risks. One such risk was a global pandemic and when COVID-19 hit, we were able to react quickly as we already had a plan in place. I will now discuss results from each of our operating segments. I'll start with the North American Fenestration segment. Each of our plants in this segment was deemed an essential business and operated throughout the entire quarter. Revenue declined 5.9% from prior year Q2. But we were seeing revenue growth prior to the impact from the pandemic. In fact, revenue was trending 3.1% above prior year levels for the first five months of our…

[Operator Instructions] Our first question comes from Daniel Moore with CJS Securities.

George, Scott, good morning. Thanks for taking the question. And I will say congrats on solid results given all of the challenges that you certainly faced and work through. Wanted to talk about, George, you said volumes in May kind of not as soft as anticipated. I'm assuming you're referring to little bit more to the North American operations and maybe just give a little sense of the cadence of the declines that are embedded in the Q2 guidance that you gave. How were we trending kind of early part of May and now how are we looking at kind of early part of June? Just trying to get a cadence for how each of the businesses are coming back out.

So, Dan, this is Scott. Let me start with this answer. So we referenced April volumes in George's script. So on a consolidated basis, revenues were down in April about 40% year-over-year. And if we look at May, which we're still closing the books for, but revenue looking like we trended about down 35% year-over-year. So it improved in May from April by about 5%. Some of that is the fact that Europe started back up in April, our two UK facilities started operating pretty much mid month, started to ramp up there. Looking into June, we expect further improvement. However, when we were going into May, we thought may was going to be the low water mark for the year and it ended up being from a volume standpoint better than April. So that's what gives us some confidence going forward.

I think in, this is George, in North America slightly better than we anticipated. I think, we were pleasantly surprised and really not knowing what the reaction would be in the UK and certain countries in Continental Europe when they started up and demand was better than anticipated and optimism seems strong. So, I think that was probably a larger impact on our optimism. North America was better but as we expected.

And in terms of the furloughs, maybe just kind of give us a sense for how much, what percentage or how much of those have sort of come back online? Really what I'm getting at is, what level of capacity utilization are you operating at across the three businesses today, and would you expect to be back to sort of pre-COVID levels?

So obviously, in the UK, I'll just start by saying, the UK facilities were completely shutdown. So, we're probably right now at about 30% to 40% of our capacity. The furlough situation there is different because of their government subsidy plans. In North America, at its highest we're approximately 30% of our employees being furloughed and we're now below 10% to give you a frame of reference.

Scott, how much -- it is really impressive to see the free cash flow target staying as strong as it is. How much working capital benefit is in terms of range is implied in that guidance of $30 million to $35 million for the full year?

Yes, that's tough to answer. But what I can say is compared to where we ended Q2, we absolutely expect some benefit from working inventories down. And then as you may imagine, the AR and AP side of the business in Q2 suffered a bit because of COVID. We extended some terms on a temporary basis and we expect for those terms to revert back to the original terms here within the quarter. So, we expect working capital to be a benefit in the second half.

One more for me, I'll jump out. I'm just trying to get a sense for corporate, the SG&A control was up, was obviously very strong. Corporate was actually a benefit, so trying of about $2.5 million in the quarter. So was that mostly reversing comp accruals, healthcare related, trying to get a sense for what drove the change in SG&A on the corporate side and what a good run-rate might be going forward? Thanks.

So, you're right. What drove the benefit was largely driven by comp accrual reversals obviously, because of the impact from COVID. Medical was lower than we anticipated. And then stock-based comp was obviously lower, because our stock price took a hit rebounding nicely today, which is good to see. Going forward. I think $2.5 million a quarter I think is what we would expect going forward and that would be an expense not a benefit.

On the corporate, that portion of SG&A?

Correct.

Our next question comes from Julio Romero with Sidoti. Your line is open.

I wanted to start on North American fenestration, saw margins rise nicely even with the sales decline. Could you maybe break that out for us from maybe there's structural cost reductions versus more shorter term expense management?

As we look at that, Julio, I mean the majority of what we saw is structural you know the short time, and we will have to get back to you on details with the breakout. Obviously, as volume dropped we managed some of the discretionary spending just as you would expect. And it's really hard to determine exactly those pieces when you bridge it out. But I would tell you and I think you've seen this in prior quarters under Bill's guidance and what we were doing. The majority of the things that we've done operationally in cabinets, as well as NAF are structural in nature and we expected these types of improvements.

I was totally surprised by the margin improvement there. And I know last quarter you guys called out some labor inefficiency in that segment and be related to a specific project. But it sounds like maybe those inefficiencies are under at this point?

In that specific one that we talked about, we believe that we have that headed in the right direction. Not completely fixed but we saw significant improvement. So yes.

Now, Julio, to be fair, what you're seeing in year-over-year improvement for North America Fenestration and EBITDA margin that does include some incentive accrual reversals as well that did help.

And I guess, as we begin to see kind of the market stabilizing. How are you thinking maybe long return on capital allocation? I know you're focused on debt reduction. But do you maybe have any update on some of the internal projects you're considering, especially considering the cash flow that you expect in the back half of the year?

So we talked about the debt reduction, the dividend policy will stay as is. But in terms of our CapEx, we're going to continue to prioritize it based on safety projects. And then there is three or four strategic projects that will continue on. The Extranet vinyl extrusion project, which I mentioned in my script, as well as we'll continue to spend money on screen expansion in the regions where we're underserved right now. So anything related to strategic growth projects we will continue to spend money on.

And just to add to that, Julio with the screens business, we are moving forward, opening a new screens plant here in August-September timeframe.

Our next question comes from Steven Ramsey with Thompson Research Group.

I guess on the UK plants being shutdown now operating again. How much backlog was less sitting and how much of that has been cancelled, or do customers still desire that product? And is there a time lag for those orders to be fulfilled?

We think that the initial demand that we're seeing is backlog related. But the good news that we have in the UK is that their order and opening up did not prohibit people, installers and salespeople from going into the homes and that continues to be remained unknown. What's the consumer sentence confidence and allowing others into their house. But what I would say is short term feedback is that that remains pretty strong and people are investing in projects in their own homes.

And then on cabinet business, I know a mix of the decline with the customer exiting the business, and then you talked about in the last quarterly calls in the custom stabilizing. I guess is there any way to get a feel for some of custom, how it trends from here, will it kind of remain in a stabilized state or could this accelerate decline in the coming quarters?

So we're trying to digest the new KCMA numbers. There was such a rapid change across a lot of the segments. It's really hard to determine what was causing any sort of drop. And so I think that for us to be able to determine the shifts between stock and semi custom and getting balanced, we're going to need another quarter of look to be able to determine what is that true impact. We anticipate that the conditions are such that people will start looking at the R&R projects and we're seeing signs of that. And we think with wood pricing starting to stabilize that the semi custom market that we participate in will be a good place to be.

And then lastly for me, I guess to circle back to the inventory question. You talked about in the last quarterly call, how you had built up inventory ahead of large capital investments in North America Fenestration. I guess, how does that play out as the quarter moved along? Is that kind of that factor passed this, or is that part of the inventory work down that you're in the process of?

It is definitely part of our inventory work down. Obviously, you try to build and level load those plants to be able to manage the peaks in the busy time. Right now as our forecasts we're trying to evaluate what that peak will now be, we are bleeding down inventory. So that is part of this process.

Our next question comes from Reuben Garner with Benchmark Company.

So, maybe on the margin front. So is there anything structurally different maybe from a fixed variable standpoint between the North American Fenestration segment and the Cabinet's business? Or was the margin kind of, I guess performed -- relative margin performance in the quarter solely tied to those issues going on with some of your customers on the cabinet side, not being able to be open in the quarter? In other words, you were able to expand margins year-over-year in windows despite everything going on, but you had some pressure on Cabinet side?

Without the write-off of the accrual for the customer that left, the inventory accrual, we would have had margin expansion in cabinets as well in the quarter. However, the difference between the two that we called out is truly managing that fixed cost piece when we have certain customers that did shutdown for cabinets, and we didn't see that in North American Fenestration. So that's really the difference. Our customer base on the NAF side, almost every customer was deemed essential and in the cabinet side, we did have some. So you had to continue running the plants and the cabinet side at less than ideal run rates and levels to support the ones that are still running. So that's the biggest difference, Reuben.

And then maybe on the, let's see, on the guidance for Q3. So I think if I'm reading it correctly, it's implying somewhere the quarter being down in 25% to 30% range. So, a little bit better than the trend you're seeing in May. I'm a little surprised that you're still seeing that or expecting that type, or those types of declines. Do you have any way of breaking down what your new business looks like relative to your R&R? I know that might be difficult. But the reason I'm asking is a lot of the builders seem to be pretty optimistic and I think in fact even already started to bounce back in May. Is it the new construction site is going to fare a lot better and the R&R side might not, because people are hesitant to have contractors come in their home to do things like replace kitchen cabinets. Can you just talk to us about maybe what you're hearing and seeing there?

I think we are seeing, or we are hearing optimism from our customers as well. So I think what we're dealing with right now is where we're at in the supply chain. You have our customers also trying to work through inventory levels and adjust. So where we're at in the supply chain, it's just delayed. So we won't see the impact of some of is for a little longer than those builders and some of the OEMs. But we're definitely hearing optimism, Reuben. And we think as people reduce their travel and some of the larger expenses on that type of thing, they're going to invest and we're seeing more of that type invest in their homes and living spaces and we see more of that optimism. There's a lot of comments that housing will lead to recovery and we are hearing that.

And then last one from me, I mean obviously, some of the states that were shut down, you're going to see it. But any notable regional disparity in your markets that’s worth calling out other than New York? Anything that you've noticed trend-wise that certain markets are bouncing back stronger or faster than others?

I think, you know for us and it goes consistent with what we were seeing in quarters before. For us, the Southwest, South Central, and Southeast continue to remain strong or stronger. From the cabinet side, the shutdowns were primarily Northwest. Washington did not deem their cabinet customers as essential and neither did Pennsylvania. So, that was where we saw some short-term hits in those regions for the cabinet side.

We have follow up question from Daniel Moore from CJS Securities. Your line is open.

Just on capital allocation, I guess number one, any thoughts, like M&A has sort of been on the back burner for quite a while. Any thoughts that the disruptions might shake loose a few tuck-ins and opportunities, or was it just too sort of short-lived, number one. And number two, obviously you took very prudent action of focusing on cash preservation as this was going on. What would you need to see to be more comfortable, more confident in maybe allocating capital or returning cash to shareholders more aggressively once again? Thanks.

In terms of the M&A, my comment is, listen, we'll listen and we'll continue to look at opportunities as they come to us. We think there will will be a pause for, in that area as everyone's going to be trying to understand what true valuations are all about and where that should be. So, I think both the selling and the buying are going to be very cautious and as will we. So not that we wouldn't look anything, we just think that there will be a natural pause. And we're going to put ourselves in the position by the tactics that we're doing now and building and protecting our balance sheet to be ready when that does break. In terms of providing cash back to the shareholders, I think we're really going to need to see, at least another quarter. I mean, it's constantly talked at the Board level and they're very cognizant of doing things to provide value to our shareholders. But we want at least another quarter to see what we, and some look into 2021, I think, before we really make that decision permanently.

That concludes today's question-and-answer session. I'd like to turn the call back to George Wilson for closing remarks.

Thank you all for joining. And we look forward to providing an update on our next earning call in September. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.