Ladies and gentlemen, thank you for standing by, and welcome to the Fourth Quarter and Full Year 2020 Quanex Building Products Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. 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, CFO 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 extremely pleased with our fourth quarter and full year 2020 results, especially considering the uncertainty that has existed since the beginning of the pandemic. The full year 2020 results were like a roller coaster ride. The year started very strong before COVID began to impact operations during our second quarter. The pandemic caused uncertainty at all levels of our business, slowdowns across all of our product lines, and temporary plant closures in the U.K. Then, volumes rebounded swiftly midway through the third quarter, which has continued through year end. We ended 2020 with record order and sales levels in October. As Scott mentioned, we generated net sales of $851.6 million in 2020, which was 4.7% lower than 2019. However, even with the lower volume in sales in 2020, we were able to increase adjusted EBITDA on a consolidated basis. The increase was driven by our continued focus on operational improvements, along with SG&A reductions. Also, in a renewed effort to improve our return on invested capital metric over time, we have implemented various processes designed to improve capital efficiency, reduce costs, and really scrub the expected returns on our capital projects. In fact, over the course of the last three years, we have significantly improved ROIC, and we plan to stay the course and expect further improvement in this metric in the coming years. Before I move on to discuss market and segment performance, I really would like to take a moment to thank the entire Quanex team for their continued commitment and dedication to keeping each other safe, maintaining a high level of supply and quality performance for our customers, and for giving their time and resources to help the communities in which they live. It has been a challenging year for everybody and I am very proud of what the Quanex team has accomplished. From a macro perspective, the markets we operate in are all showing robust activity, despite the ongoing challenges presented by COVID. Pre-pandemic, we strongly believe that the U.S. housing market was under-built. Fast forward to today, and you can see a growing migration from urban to suburban living, low existing housing inventory, low mortgage rates, and what appears to be a pickup in millennial household purchases. Given all these factors, we believe the stage is set for what should translate into continued high demand for building products for the foreseeable future.

Certainly. Our first question comes from the line of Daniel Moore from CJS Securities. Your question please.

George and Scott, good morning. Thanks for taking the question.

Hey, good morning.

Starting with Europe, exceptional strength, obviously in Q4 and carrying forward, how much of that in Q4 would you attribute to kind of catch-up for manufacturing shutdowns earlier in the year and are we now through that process? In other words, going forward, is it more sort of a one-to-one end market demand versus your production?

Dan, this is George. So, to answer your question, we feel like that it isn't a catch-up that the demand is actually there. And the reason why we take that position is really the nature of product, especially on the vinyl profile. The size of the product and the bulkiness of it doesn't really allow for building of inventory. So, it is a one-for-one shipment to the job site, and we do not see any slowdowns in the near-term, and we expect that this will continue throughout 2021.

Helpful. And you gave estimates of growth for each of the segments in fiscal 2021. You're experiencing relatively similar growth in fiscal Q1? Are you doing a little bit better perhaps to start the year in Europe? And maybe just a little bit of cadence around that guide would be really helpful.

Hey, Dan, this is Scott. I can handle that one. So far, this first quarter is unlike any other in recent history where it's much stronger already. And I think from a cadence standpoint, on the revenue side of things, I would be modeling around 20%, maybe a little more than that for the – as a percentage of full year revenue in the first quarter. Typically, I think that's been closer to 15% prior year.

Overall, correct? Not just Europe?

Correct. That's overall, so --

Got it.

Yes.

Understood. Okay. Really helpful. And then, the guide for the full year implies a range admittedly, but relatively flat EBITDA margins despite pretty significant growth. So, is it may be tougher comps with raw materials, higher SG&A, conservatism, combination of all three?

I would say, it's a combination of all three, but really the thing that we've hedged a little bit on the margins is that we are seeing some pressures for the first time on some raw material inflation, as well as we're still dealing with labor-related COVID impacts. So, over time it tends to be a little higher in certain spots as people are still quarantining and testing positive. And so, until we get the vaccine and that shows some effectiveness, we anticipate that labor will continue to be tight for not only us, but our suppliers and our customers.

Yes. And then, the way that we forecast for medical expenses is, we're expecting somewhat of a reversion to what had been normalized prior to 2020. Medical costs in 2020 were much lower than expected.

Got it, okay. And then capital allocation, obviously, balance sheet is in the best shape, it's been in quite some time generating plenty of cash. You bought back a little bit more stock. Maybe just update us on your priorities and willingness to be a little bit more aggressive from here?

The situation is obviously fluid and as opportunities present themselves, we'll continue to look at everything. How I would answer that is, we have a very aggressive but achievable five-year strategy plan that we use as our roadmap. That strategy plan, in our mind, creates significant value for our shareholders, so that gives us a good baseline on where we're going to fund our growth. As opportunities arise, if they exceed that threshold, we'll obviously take a look at them or if they present maybe a different growth profile, we're not going to not look at it, but we have a defined plan. We will continue to pay down debt and that will be our priority, and we'll often opportunistically buy stock when we can. But, we're very comfortable with our strategic plan, and it provides growth and value to our shareholders. And the good thing about this is, our balance sheet is in a position that when opportunities do arise, we're in a position to be able to jump on them very fast. And so, that's why I answered the fact that it's a pretty fluid situation, but we're in a very good spot.

Indeed. Lastly for me, Scott, my pencil wasn't fast enough. Can you run through, I heard depreciation, $33 million, just the other pieces of the guide for fiscal 2021?

Yes. Let me find it here.

Sorry, about that.

Depreciation, $33 million; amortization, $14 million; SG&A, $95 million to $100 million; interest expense, $3.5 million to $4.5 million; and then tax rate of about 26%.

Perfect. And the CapEx guide embedded in that $60 million-ish rough free cash flow?

Roughly $30 million.

Perfect. Thank you. I’ll jump back with any follow-ups.

Sure.

Thanks, Dan.

Thank you. Your next question comes from the line of Julio Romero from Sidoti & Company. Your question, please.

Hey, good morning, George and Scott.

Good morning.

Good morning.

Hey. I wanted to ask about pricing across the three segments. Really appreciate you giving by segment, your outlook for revenue there. But can you just talk about – is there any kind of any pricing gains embedded in any of the three?

We're looking at pricing opportunities where they exist. As you know, in North America, most of our products are on index for raw material pass-throughs. So, the opportunities will be obviously evaluated on a case-by-case basis for non-material related increases. We're seeing inflationary pressures. So, we'll obviously try to pass along those where we can or parlay those into growth opportunities to pair back. In Europe, because things are not on an index, yes, we'll be a little more aggressive with price, and that will be dictated by the market.

Got it. So, I guess right now, the top line guidance, no real price embedded in it at the moment?

I would say limited price other than what we expect for index.

And more rifle shot approach.

Got it. And I guess on the CapEx, could you just talk about $30 million you're deploying in 2021? And is there a -- given where your balance sheet is and the cash flow you're expecting, is there any opportunity to maybe deploy above $30 million internal initiatives this year?

Well, I know my business leaders would love to have more than $30 million. The problem is it becomes -- you only have so many engineers in the group, too. So there's only so many projects in bandwidth that an organization can handle. So we're going to be smart about launching and implementing CapEx. And our focus on the return generation, make sure and puts an emphasis on completing projects and completing them to expectations. So not just spending money for the sake. So we're very methodical in our approach. So if we're able to integrate the projects at a fast enough rate, there may be an opportunity to invest more than $30 million, especially for projects that add margin or benefit the company's profile and exceed the working cost of capital. So but really, we're being very diligent in our drive to get the expected results out of the projects that we do do.

Got it. And then I guess just lead into my last one, you reiterated your first priority for cash is to pay down debt, followed by opportunistic share repurchases, I guess. So given the free cash flow guidance, I guess you'll get to net -- to net cash position pretty soon?

Should be in -- by 2023.

Excellent. Thanks for taking the questions.

Sure. Thank you, Julio.

Thank you. Our next question comes from the line of Reuben Garner from Benchmark Company. Your question, please.

Thank you. Good morning, guys, and congrats on the quarter.

Thanks.

Thanks, Reuben.

I guess to start, the fenestration -- North American fenestration growth versus the cabinets growth here in the near-term, it was nice to cabinet's growth has returned. Have you -- has the kind of boost in new housing from the summer not started to flow through yet, at least for the full quarter? And is that maybe, Scott, you mentioned how strong your Q1 is looking? Is that where you're starting to kind of see the benefits in North American fenestration kick in?

Yes and no. I mean, I think, we're seeing strength across all product lines, cabinets included right now. What we're still challenged within the cabinet business is just this shift from semi-custom to stock. And we've been pretty successful in navigating that shift over the past probably six to nine months, and we expect to continue to be successful there. But we're still battling that and we expect to continue battling that for the foreseeable future, at least this year. However, what I can say on that front is, if you follow KCMA data, that shift has slowed significantly, which will benefit us and has benefited us moving forward. But a lot of the growth, as indicated in the release will be coming from the North American Fenestration segment. Screens is still doing really well.

Got it. Okay. And then you discussed kind of the guidance for the margins, the puts and takes this coming year. What about -- if we continue to see this kind of growth for the next few years, which I think is not an unreasonable expectation at this point. What kind of margin bogeys for either consolidated or by segment? Are you guys thinking are reasonable three years from now?

Yes, that's a little tougher of a question. I think from a consolidated standpoint, let's just take it segment-by-segment just to give our bogey the opportunity there. So, top of the list there would be our cabinet business or the North American Cabinet Components segment. We still think that the margin expansion opportunity is real, and could exceed probably a couple of hundred basis points over the next two to three years. There's still some left in the North American Fenestration segment. So, you should expect some margin expansion there, albeit smaller than cabinets. And in Europe, quite frankly, the margins are so good there and so healthy that we're just trying to protect and maintain margins there.

And I think we've been -- I think as you heard in the flavor of the transcript in our talk, we are so focused right now on return on invested capital and looking at past projects. I think that focus -- I think we've proved that we -- our operational execution has been pretty diligent and exceeded expectations over the course of the last few years. There is plenty of projects on the plate on a, what I would say, short to mid-term go forward. And we're pretty excited about the opportunities that we have on some margin expansion across others, again, just being diligent on that metric.

Okay. And then as far as new administration goes, risks and opportunities, are there any risks associated with the maybe tariffs getting eliminated or opportunities in terms of maybe code changes that here in the U.S. for more energy efficiency in the home, does that -- if that were to happen, do you guys have an advantage over your peers there or would that just kind of lift all boats?

Yes, I'll run with that one. I think, we have identified both risks and opportunities associated with the new administration, and we've talked about that for a period of time. On the risk side, we have benefited by some of the tariffs on the cabinet side as well as our customers. I'm not sure that those will be repealed to a level where it's just completely open. And I think there's been enough changes in the supply base that it's not a catastrophic risk, but it's a risk nonetheless that could put pressure on margins down the road. But we feel pretty good about our plans to weather that risk. It is an opportunity in terms of energy efficiency codes. As you can see in Europe, where those codes and standards are very much in place, they're probably 10 years ahead of the U.S. in terms of their requirements for passive house and electrical usage. And you're right; our product lines absolutely meet those standards and add to better performing products in the fenestration industry. So that would be an opportunity for us. Energy Star was there at one point. And that's why we saw some of the drive in some of our products, something like that reinstituted. We believe, would have a benefit for us.

Great. Congrats again on the quarter. And you guys have a Merry Christmas and a Happy New Year.

You too.

Thanks.

Reuben, thank you.

Thank you. Our next question comes from the line of Steven Ramsey from Thompson Research. Your question please.

Hey, good morning guys.

Morning.

Good morning.

I want to start on, little more on CapEx outlook, stepping up from the $25 million spent in the past two years. What is -- what, kind of, projects are driving that increase, maybe how much of it is -- of the CapEx this year is growth oriented versus margin enhancing? And if you're able to share any flavor by segment?

Sure. And I will give you a general overview. We would have probably -- if we could have spent more in 2020, we would have, some of our projects that we had in the hopper were actually restricted, because of some of the equipment that we're trying to implement comes from overseas or across country borders. So we could not get people to install because of the travel and quarantine restrictions. So really, that was the limitation on 2020. It wasn't, as though we were trying to limit projects or reduce cash flow. It was really just the logistics and the ability to get the equipment into the pipeline. In terms of how it's going to be deployed on a go-forward basis, so I think you're going to see a majority of it start going towards growth and capacity expansion in certain areas, obviously, fueling the growth in Europe, as we continue to take share. So you'll see some investments in our mixing capabilities. Some of our spacer capacity and things there will get a heavy waiting. In terms of North America, I think you'll see some continued investment on technology improvements and the cabinets as we continue to do some different things on how we process wood that is margin improvement and that's why Scott mentioned, that there's a larger runway for margin improvement in the Cabinet segment, because there are some things that we can do technology-wise. And then, in North American fenestration, I think you'll see it more growth oriented. We made a fairly large investment in the vinyl profile, upgrading technology. It's been short-term, very successful. And we're starting to see some nice results, sooner than anticipated. If that pans out, we may go to step two on that. And in terms of -- we continue to grow our screen business. And we'll look at adding capacity, where volume and sales opportunities dictate. So I think that's the way we'll see flavor, in terms of how we spend our CapEx over the next one to three years.

Excellent. And thinking about the guidance for North America Fenestration mid-single to high single-digit, can you talk about some of the factors there that might swing you to the low-end or the high-end? And how much of this is impacted by longer lead times, maybe in certain end markets, maybe driving strength early in calendar 2021 or mid-calendar 2021? Any factors on the North American Fenestration sales range?

The factors that may weigh it towards the low end of the range would really be market dynamics. And if our customers cannot get labor to install windows and that limitation stifles demand and not just for Quanex, but for everyone, that would probably push us down to the lower end of the range. On the upside piece of that is -- and it may also be, if they can divert their labor to installing windows or doors and then they continue to choose to outsource some of the components that gives us some opportunity to capitalize on that. So a company that may be making their on-screens internally decides to outsource to a supplier to better utilize their labor. If that kind of dynamic continues to play out then – we may see growth rates a little higher on the higher-end of that range.

Got you. And then last quick one for me. Maybe thinking for Q4 results and then what's embedded in the outlook for expenses, how much have expenses that were pulled back tightly as COVID hit in the spring? How much of those have come back to-date? How much of those are coming back in 2021; T&E being one of those items, but whatever other cost items are coming back or staying reduced?

Well, the T&E piece is really the one item that I would say is still being held back really just based on travel restrictions and quarantines and the uptick in cases here recently. But we suspect that as the year progresses in 2021 that we'll get back to a more normalized T&E level, probably not back to where we were in 2019, but slowly progressing for so the spend for that item will go up over time.

I think the one item -- there are a couple of areas. When you look at SG&A, for example, that we're going to evaluate what have we learned during this virtual timeframe, things such as trade shows, that can add up to an enormous amount of money. Is there a different way to do it? And do we get the value? So I suspect that there will be accrete back to some level of normalcy. But I think that we've learned and we've evolved and some things may be different. So I'm not necessarily convinced that it will go back to the way it was pre-pandemic regardless.

Great. Thanks for the color.

Sure.

Thank you. Our next question comes from the line of Ken Zener from KeyBanc. Your question please.

Good morning, everybody.

Good morning.

Hi, Ken.

Impressive quarter. A lot of details. I wonder because I just looked at the press release, George, this is about a year for you being CEO, correct?

That is correct. We're a year in January 1.

Good. It's been a long year, so I had to double check that. This year, given your success, and I do have individual questions, but I wonder if you could just give us a little perspective here, because Bill’s faced a lot of headwinds, and I know you were in the spacers business and came to operations. But despite good efforts, there were a lot of industry curve balls that you guys got. Ironically, you got arguably one of the biggest curveballs, COVID, yet you've delivered very solid results. So, I guess, my first question is, if we could just take a step back, what is different about the company that -- now, it's basically following a year of you being the CEO, realizing COVID happened. What's kind of changed about your view of the company versus a year ago? An opportunity, you've always been involved. But I just wanted to understand, because this has been a very strong quarter. And I just wonder if it's actually indicative of much better things to come.

Well, that's a good question, because I do -- when you do get a breath, it is a good opportunity to take a step back to reflect than I have. I think, I would love to sit here and say that, the results were the result of me being CEO, but that would be a complete lie in that respect. Ken what I would say is, the fact that I was the internal successor made the transition easier, because prior to me taking this role, I was very involved with strategy, and we really haven't changed the strategy focus over this time. Under Bill's guidance, we've really built a solid operational footprint on what we wanted to do and how we wanted to accomplish, and we haven't diverted from that at all. I think, in terms of -- I think, we've got a new team across the board, and me being new to this, I think it's allowed us to work together in different ways and COVID has forced us to look at things in different ways, which is always good. So what I've learned about this company over time is that our five-year strategic plan is extremely solid. And now, the focus on operational excellence that has been there has put us in a great position. And so, I probably have learned about the opportunities more than anything during this course of the year. I know that's a pretty generic answer. I thought COVID would completely change everything, but it really hasn't. And I think that's testament to what we have in place right now. We have a plan. We followed the plan. We have a very solid risk management process. So it's not like, oh, my god, what are we going to do? It's like, okay, here's the plan, you execute it and let's go. And it's really been that simple. So I'm taking -- I guess, I'm diverting a little bit of a credit away from me, but that's the truth.

Right. No, I think that's understood. Well, I appreciate that. Look, I do have some questions. I do think you guys should think about hosting at the Analyst Day as well, just to reacquaint, it's been a while since you guys have done that. That's something I would suggest, just to add more to your plate. All right. Some specific questions. Your margin improvement was pronounced, it was greatest in Europe Fenestration from a margin and EBIT contribution perspective. And your gross margins went up substantially. Is that really the gross margin lift and the EBIT expansion we saw in European Fenestration? Isn't that the same thing that high growth drove a lot of that margin, or is there something else like, lower input costs that we should be aware of?

For last year, I mean, it's a combination of those. The majority of it was volume-driven. And because they're extrusion operations, when you can lever up and effectively run efficient at high full capacity. You should see margin expansion. So, there was no surprise there. When you're at full volume, we're going to do very, very well. And that was the case in both spaces and the vinyl extrusion. We did see a period of time early in the quarter where we had some lower-than-anticipated raw material costs, which has since started to creep back. And as you know, the European products are not on index. So, when the raw material inputs are a little bit lower, we're going to see higher gross margins. And that's exactly what we saw.

Now switching to U.S. windows, which is a category, new construction, R&R, that's actually been called out by many industry participants as having bottlenecks. Could you from your perspective as a supplier for both the extrusion, the edge spacers, and screens. Can you talk to, what is different based upon what you're seeing right now as opposed to history? Is it the fact that, crews can't be so close together? Is it that they can't scale up? Why is that industry on such a bottleneck right now given your perspective?

I think it's truly labor. And it's really hard to get your head around because you hear 10%, 12% and higher unemployment levels across the country, but we cannot get people to work in the plants. And we know from talking with our customers that install our labor. I mean, if you were to go out and try to build a new house right now or do any sort of project, you're looking two months out for lead times, and that's standard. In my mind, it's -- and what I'm hearing, it's purely a labor bottleneck.

Could you describe -- and you're saying both in factories as well as in the field, correct, George?

Yes.

Now as that relates to your Warm Edge Spacer, which the last time I think publicly, you guys talked about it a lot at your Analyst Day. Warm Edge Spacer’s, reflect lower volume customers historically, because they have to do it manually. However, there are some new machines that some of the larger window manufacturers, the higher volume machines get close to 1,500 units to ship, that actually use less labor. Can you talk to how market share has gone for you in that category related to customers buying those $1.5 million machines to cut their production, their labor intensity down by half?

Yes. No, it continues to progress at a slow, steady pace. And the only reason that is slow is really the limited number of equipment manufacturers that exist across the globe. There's four or five suppliers of that equipment. If you think in the U.S., for example, there's really only one or two that manufacturer here in the U.S. So during a COVID year, when you really can't get anyone on two of the major suppliers are in Europe and they can't send people over to install equipment. That delayed some of the implementations last year. But that demand to reduce labor through automation absolutely exists, and it will -- there's a strong pipeline of equipment orders that will continue to benefit us. So, the equipment guys are sold out for probably the next two years. So, the bottleneck is getting the equipment into the field.

Right. And can you just publicly state that equipment, I mean, it reduces people per line shift in production from what to what? My recollection is seven or eight people for about 1,500 units in the shift down to two or three. Is that--?

It's 400. Eight or nine people down to three people.

Right. That's eight or nine on a manual. Yeah. Okay.

Yes.

A manual line. Last question, cabinets, it's improving. The market is doing better, you have a tailwind. Could you quantify, first, you did in fourth quarter, the lost customer exposure for fiscal 2020 in total? And then second, while things are getting better, it's not exactly stellar margin, right? EBITDA, it's obviously better. But can you talk to -- you talked about a couple of hundred basis points, Scott, in terms of potential margin. I mean, when you guys acquired the business, it was certainly about 200 or 300 basis points on an EBIT level. Is that really -- I guess, that's what I heard you say. I'm just -- I'm kind of surprised by that's the target, a couple of hundred basis points out of zero EBIT. Is that accurate or could you clarify that?

A couple of hundred basis points on EBITDA margin expansion over the next two to three years, yes, what I said. On the customer that exited the cabinet business, that on an annualized basis, that was roughly $11 million to $12 million.

Thank you very much, gentlemen.

Thanks Ken.

All right. Thanks.

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

Yes, I'd like to thank you all for joining and we look forward to providing you all an update on our next earnings call. I'd like to take this opportunity to wish you all a very happy holiday. Be safe. 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.