Quanex Building Products Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the fourth quarter and full year 2020 Quantex Building Products Corporation's earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Scott Zulke, 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. Actual results or events may differ materially from such statements and guidance. and Quantix 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 discuss the financial results. Net sales increased by 6.3 percent during the fourth quarter of 2020, mainly due to increased demand for our products across all of our operating segments. Conversely, net sales decreased to 851.6 million for the full year 2020, compared to 893.9 million in 2019. The decrease was largely due to lower volume related to the COVID-19 pandemic in 2Q and 3Q. More specifically, in addition to softer demand in North America and continental Europe during the early stages of the pandemic, Our two manufacturing facilities in the U.K. were closed in compliance with government orders in late March, and manufacturing operations at those plants did not restart until mid to late May. However, volume increased significantly in June across all product lines, and net sales in July through October exceeded prior year on a consolidated basis. We reported net income of $22.2 million, or 68 cents per diluted share, for the three months ended October 31st, 2020, compared to a net loss of $30.9 million, or $0.94 per diluted share, during the three months ended October 31st, 2019. For fiscal 2020, we reported net income of $38.5 million, or $1.17 per diluted share, compared to a net loss of $46.7 million, or $1.42 per diluted share for fiscal 2019. The reported net losses in 2019 primarily attributable to a $44.6 million non-cash goodwill impairment in the fourth quarter of last year and a $30 million non-cash goodwill impairment in the second quarter of last year, both in the North American cabinet component segment, mainly due to lower volume expectations related to the shift in the market from semi-custom to stock cabinets and customer-specific strategy changes. On an adjusted basis, Net income was $22 million or $0.67 per diluted share during the fourth quarter of 2020, compared to $14 million or $0.42 per diluted share during the fourth quarter of 2019. Adjusted net income was $40.7 million or $1.24 per diluted share for fiscal 2020, compared to $31.4 million or $0.95 per diluted share for fiscal 2019. The adjustments being made to EPS are for restructuring charges, certain executive severance charges, non-cash asset impairment charges, accelerated DNA, foreign currency and transaction impacts, and transaction and advisory fees. On an adjusted basis, EBITDA increased by 14.3 percent to 39.4 million in the fourth quarter of 2020, compared to 34.4 million in the fourth quarter of last year. For the full year 2020, adjusted EBITDA increased by almost 2 percent to 104.5 million, compared to 102.7 million in 2019. The increase in earnings for the three months ended October 31st, 2020 were mainly due to higher volumes, improved operating leverage, and lower raw material costs. The increases in earnings for the 12 months ended October 31st, 2020 were primarily driven by a decrease in SG&A expenses, mainly due to lower medical costs. I'll now move on to cash flow and the balance sheet. Cash provided by operating activities was $100.8 million for the 12 months ended October 31, 2020, which represents an increase of 4.6% when compared to $96.4 million for the 12 months ended October 31, 2019. We generated free cash flow of $75.1 million in 2020 compared to $71.5 million in 2019. As a result of our strong free cash flow profile, we repurchased $7.2 million in stock and repaid $39.5 million of bank debt during fiscal 2020, $35 million of which was repaid in the fourth quarter alone. Our balance sheet is healthy, our liquidity position is strong and getting stronger, and our leverage ratio of net debt to last 12 months adjusted EBITDA improved to 0.6 times as of October 31, 2020. which is 50 percent lower than where we exited fiscal 2019. In fact, the interest rate on our revolver will drop by another 25 basis points to the lowest tier, which is LIBOR plus 125 basis points. As for 2021 guidance, and as noted in the outlook section of our earnings release, based on conversations with our customers and the latest macro data and current trends, we expect mid to high single-digit sales growth in our North American fenestration segment, low single-digit sales growth in our North American cabinet component segment, and mid single-digit sales growth in our European fenestration segment. Overall, on a consolidated basis, this should equate to net sales of approximately 900 to 920 million, and we expect to generate between 108 and 118 million in adjusted EBITDA in fiscal 2021. This guidance assumes no adverse impact from the ongoing COVID-19 pandemic. We intend to concentrate on executing our 2021 plan with a continued focus on creating shareholder value. For modeling purposes, it's appropriate to make the following assumptions for 2021. Depreciation of approximately 33 million, amortization of approximately 14 million, SG&A of 95 to 100 million, interest expense of $3.5 to $4.5 million, and a tax rate of approximately 26%. From a CapEx standpoint, we expect to spend about $30 million in 2021. We've been very good at managing working capital and have implemented a number of successful systemic changes over the past two to three years. However, now that all of these fundamental systemic changes are in place, it will be more difficult to realize a benefit from working capital moving forward. Our goal is to generate free cash flow of approximately $60 million in fiscal 2021. I'll now turn the call over to George for his prepared remarks.

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 UK. 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 Quantix 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 Quantix 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 underbuilt. 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. In addition, travel restrictions and quarantine requirements have impacted discretionary spending choices and funds that historically might have been used for travel and leisure appear to now be getting diverted into the repair and remodel of existing home spaces. In the cabinet markets, we continue to see growth in total cabinet demand as well as stabilization in the shift from semi-custom to stock segments. According to KCMA data, the semi-custom cabinet market grew by 5.7% in the quarter, which compares favorably to the 5.9% growth we reported in our North American cabinet component segment. If you adjust for the customer that exited the cabinet business in late 2019, this operating segment grew by over 9% in 4Q. Year-to-date through October, the semi-custom market is down 3.9% versus the same period of 2019, primarily due to the negative demand impact the pandemic had in 2Q and 3Q. Revenue in our North American cabinet component segment decreased by 8.5% year-over-year, but if you adjust for the customer that exited the business, we were well in line with the market for the full year. Despite a recent uptick in pandemic-related restrictions, our UK and continental Europe markets remain at record levels. The repair and replacement market in Europe is being fueled by dynamics that are similar to the U.S., both in terms of being underbuilt and in terms of benefiting from ongoing travel restrictions and diversion of discretionary spending. The repair and replacement market is a clear beneficiary of these dynamics, and that is the market we primarily serve. In addition, our products fulfill the governmental energy efficiency mandates that exist in these markets, so windows and doors that are replaced, our products meet all specifications and requirements. Despite Brexit and COVID-related concerns, we still anticipate mid-single-digit growth in our European fenestration segment in 2021. I will now discuss quarterly segment results. which are highlighted by the fact that we saw margin expansion in each of our three operating segments. Our North American fenestration segment reported revenue of $142 million in Q4, which was down only slightly from prior year fourth quarter. Solid demand across all product lines was offset by the loss of one vinyl profile customer that occurred on January 1st of 2020. Absent this loss, The segment grew at 3.9 percent year-over-year in Q4, which compares favorably to industry shipments. Adjusted EBITDA of 23.8 million in this segment was 1.1 million, or 4.8 percent better than prior year fourth quarter. Volume-related impacts, favorable material costs, and lower SG&A more than offset the higher levels of overtime and startup costs associated with our new screens plant in Pennsylvania. We generated revenue of 56.8 million in our European fenestration segment in Q4, which was 13 million, or 29.6% higher than prior year, or up 36.6% after excluding the foreign exchange impact. As mentioned in our third quarter call, sales rebounded quickly in June and July after the COVID-related shutdowns expired. The uptick in volumes continued throughout Q4 and resulted in record quarterly revenue levels for the segment. Adjusted EBITDA of $13.4 million in Q4 was also a record quarter and represents margin improvement of approximately 460 basis points over prior year. This margin expansion was driven by higher volumes in the related operating leverage plus favorable material pricing. Our North American Cabinet Components segment reported net sales of $57.5 million in Q4, which was 5.9% better than prior year. Strong demand combined with opportunities created by supply chain disruptions in the cabinet component import markets continued into the quarter, and we have been successful in capitalizing on some of those opportunities. Adjusted EBITDA for the segment was $4.6 million, which represents an increase of 53.8% compared to prior year fourth quarter. Volume benefits combined with favorable raw material pricing, better wood yields, and lower than anticipated medical expenses all contributed to favorable performance during the period. Finally, unallocated corporate and SG&A costs were $2.9 million higher than prior year fourth quarter. The primary drivers of the higher expenses were higher incentive true-ups combined with the decision to make a discretionary bonus payment to all of our employees that do not participate in a formal incentive plan. As we look ahead to 2021, we remain very optimistic on our view of market dynamics and macro fundamentals. Like everyone else, we know we will need to continue navigating pandemic-related challenges in the near term, but we are encouraged by the recent vaccine news and excited to finally begin seeing some light at the end of this tunnel. As Scott stated earlier, we expect to deliver net sales of $900 to $920 million, and adjusted EBITDA of $108 to $118 million in 2021. We will continue to invest in the business while still expecting to generate approximately $60 million of free cash flow. We've worked very hard to position Quantix to succeed, and with our strong balance sheet and cash flow profile, our focus will remain on improving returns on invested capital and generating free cash flow. We will also have a renewed focus on revenue growth since we now have a more stable base and tailwinds in the markets that we serve. In summary, we have continued to execute successfully on our strategy, which has put us in a strong financial position to capitalize on potential future opportunities, even in this uncertain pandemic environment. We feel the macroeconomic indicators should provide us with tailwinds that, when combined with our expected operational execution, will make for another solid year in 2021. We look forward to another year of strong performance as we continue to focus on ways to create further shareholder value. And with that, operator, we are now ready to take some questions.

Certainly. Ladies and gentlemen, once again, if you have a question at this time, please press star then 1 on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. 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 questions. Starting with Europe's exceptional strength, obviously, in Q4 and carrying forward, how much of that in Q4 would you attribute to kind of catch up from 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 the 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 21. Are you experiencing relatively similar growth in fiscal Q1? Are you doing a little bit better perhaps to start the year in Europe? 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 as a percentage of full-year revenue in the first quarter. Typically, I think that's been closer to 15% prior years.

Overall, correct, not just Europe?

Correct. That's overall. Got it. Yeah.

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

Good. 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 overtime 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.

Yeah, 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 brought back a little bit more stock. Maybe just update us on your priorities and willingness to be a little bit more aggressive from here.

You know, the situation is obviously fluid, and as opportunities present themselves, we'll continue to look at everything. You know, 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 a priority. And we'll often opportunistically buy stock when we can. But we're very comfortable. with our strategic plan in that 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 answer 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 21?

Yeah, let me find it here. Sorry about that. Depreciation $33, amortization $14, SG&A $95 to $100, interest expense $3.5 to $4.5, and then tax rate of about 26%.

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

Roughly 30.

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

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

Hey, good morning, George and Scott. 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?

You know, 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. You know, we're seeing inflationary pressures, so we'll obviously try to pass along those where we can or parlay those into growth opportunities to pare back. In Europe, because things are not on an index, yeah, 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 is No real price embedded in it at the moment.

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

Yeah, more rifle shot approach.

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

I know my business leaders would love to have more than 30 million. The problem becomes, you know, you only have so many engineers in the group, too. So there's only so many projects and bandwidth that an organization can handle. So we're going to be smart about, you know, launching and implementing CapEx. And our focus on the return generation makes 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. 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. So then I guess I'll 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 a net cash position probably Pretty soon.

Should be by 2023.

Excellent. Thanks for taking the questions.

Sure. Thank you. We will.

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

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

Thanks. Thanks, Ruben.

I guess to start... The fenestration, North American fenestration growth versus the cabinets growth here in the near term, it was nice to see cabinets growth return. Has the kind of boost in new housing from this 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 with in 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 America fenestration segment. Screens is still doing really well.

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

Yeah, 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 of the North American Cabinet Component segment. We still think that the margin expansion opportunity is real and could exceed probably a couple 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, Ruben, you know, 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. You know, I think that focus, you know, I think we've proved that 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 midterm 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 maybe tariffs getting eliminated or opportunities in terms of maybe code changes here in the U.S. for more energy efficiency in the home? If that were to happen, do you guys have an advantage over your peers there, or would that just kind of lift all boats?

Yeah, I'll run with that one. I think we have identified both risks and opportunities associated with a new administration, and we've talked about that for a period of time. On the risks 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, you know, 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 US 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.

You as well, Ruben. Thank you.

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

Hey, good morning, guys. Morning. Good. I wanted to start a little more on CapEx Outlook stepping up from the $25 million spent the past two years. 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. You know, 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 some of the equipment that we're trying to implement comes from overseas or cross-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 equipment into the pipeline. In terms of how it's going to be deployed on a go-forward basis, 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 weighting. In terms of North America, I think you'll see some continued investment on technology improvements in the cabinets as we continue to do some different things on how we process wood that is margin improvement. And that's why, you know, 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. In terms of, you know, we continue to grow our screen business in the 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, administration, 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 21 or mid-calendar 21, any factors on the North American administration sales range?

The factors that may weight 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 Quantix but for everyone, that would probably push us down to the lower end of the range. On the upside piece of that, 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 an opportunity to capitalize on that. So a company that may be making their own 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.

Gotcha. 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 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 21 that we'll get back to a more normalized T&E level, probably not back to where we were in 2019, but slowly progressing so the spin for that item will go up over time.

You know, I think the one item, there are a couple areas when you look at SG&A, for example, that, you know, we're going to evaluate what did we learn 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? Do we get the value? So I suspect that there will be, you know, a creep 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 it'll go back to the way it was pre-pandemic regardless.

Great. Thanks for the colors.

Sure. Thank you. Our next question comes in the line of Ken Simon from KeyBank. Your question, please.

Good morning, everybody. 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 approaching a year in January 1.

Good. It's been a long year, so I had to double check that. this year, given your success, you know, and I do have individual questions, but I wonder if you could just give us a little perspective here, because Bill 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 curveballs 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, you know, now it's basically following a year of you being, uh, the CEO, uh, realizing COVID happened. What, what's kind of changed about your view of the company versus a year ago? Um, an opportunity. You've always been involved, but I just want 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.

That's a good question, because when you do get a breath, it is a good opportunity to take a step back to reflect, and I have. I would love to sit here and say that the results were the result of me being CEO, but that would be a complete in that respect. You know, 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. You know, under Bill's guidance, we 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, you know, 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. What I've learned about this company over time is that our five-year strategic plan is extremely solid. Now, the focus on operational excellence that has been there has put us in a great position. 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 you know, completely changed everything, but it really hasn't. And I think that's a 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 the 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 an 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 your 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 know, 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 spacers and the vinyl extrusion operations. 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, you know, 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%. you know, 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 installer 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, 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, you know, the last time I think publicly, you guys talked about it a lot. That's your analyst day. Uh, warm edge spacers, um, reflect lower volume customers historically because they have to do it manually. However, uh, there are some new machines that some of the larger, window manufacturers, you know, the higher volume machines gets closer to, you know, 1500 units a shift, you know, that actually use less labor. Can you talk to how market share has gone for you in that category related to customers buying those, you know, million and a half dollar machines to cut their production, their labor intensity down by half?

Yeah, no, it continues to progress. Uh, 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 US, for example, there's really only one or two that manufacture here in the US. So during a COVID year when you really can't get anyone, you know, when 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. That demand to reduce labor through automation absolutely exists, and there's a strong pipeline of equipment orders that will continue to benefit us. The equipment guys are sold out for probably the next two years. So the bottleneck is getting equipment into the field.

Right. And can you just publicly state that 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 a shift down to two or three. Is that or 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's doing better. You have a tailwind. Could you quantify first You did in fourth quarter the lost customer exposure for fiscal 20 in total. And then second, while things are getting better, it's not exactly a stellar margin, right? EBITDA is obviously better. But can you talk to – you talked about a couple hundred basis points, Scott, in terms of potential margin. I mean, you know, when you guys acquired the business, it was certainly above 200 or 300 basis points on an EBIT level. Is that really – I guess that's what I heard you say. I'm kind of surprised by that. That's the target, a couple hundred basis points off of zero EBIT. Is that accurate, or could you clarify that?

A couple hundred basis points on EBITDA margin expansion over the next two to three years. Yes, that's what I said. On the customer that exited the cabinet business on an annualized basis, that was roughly $11 to $12 million. Thank you very much, gentlemen. Thanks, Ken.

All right.

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.