Ladies and gentlemen, thank you for standing by. And welcome to the Fourth Quarter and Full Year 2019 Quanex Building Products Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session.

[Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]I would now hand the conference over to the Chief Financial Officer and Treasurer, Mr. Scott Zuehlke..

Thanks for joining the call this morning. On the call with me today are Bill Griffiths, our Chairman, President and Chief Executive Officer; and George Wilson, our Chief Operating Officer.This conference call will contain forward-looking statements and some discussion of non-GAAP measures.

Forward-looking statements and guidance discussed on this call and in our earnings release are based on current expectations.Actual results or events may differ materially from such statements and guidance, and Quanex undertakes no obligation to update or revise any forward-looking statement to reflect new information or events.For a more detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measure to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website.I will now discuss the financial results.

Net sales decreased by 1.5% year-over-year to $240.4 million in the fourth quarter of 2019, mainly due to continued softness in our North American Cabinet Components segment.However, we generated net sales of $893.8 million for the year, which represents growth of approximately 50 basis points compared to fiscal 2018.

The increase was driven by above market growth in our North American and European Fenestration segment, which was mostly the result of price increases related to raw material inflation recovery.

Excluding foreign exchange impact, we realized revenue growth of 1.4% in fiscal 2019 compared to fiscal 2018.We reported a net loss of $30.9 million or $0.94 per diluted share for the three months ended October 31, 2019, compared to net income of $6.7 million or $0.19 per diluted share during the three months ended October 31, 2018.For fiscal 2019, we reported a net loss of $46.7 million or $1.42 per diluted share, compared to net income of $26.6 million or $0.76 per diluted share for fiscal 2018.

The reported net losses were primarily attributable to a $44.6 million non-cash goodwill impairment in the fourth quarter and a $30 million non-cash goodwill impairment in the second quarter, both in the North American Cabinet Components segment, mainly due to lower volume expectations related to the ongoing shift in the market from semi-custom to stock cabinets and customer-specific strategy changes.On an adjusted basis, net income was $14 million or $0.42 per diluted share during the fourth quarter of ‘19, compared to $7.6 million or $0.22 per diluted share during the fourth quarter of 2018.Adjusted net income was $31.4 million or $0.95 per diluted share for fiscal 2019, compared to $22.7 million or $0.65 per diluted share for fiscal 2018.

The adjustments being made to EPS are for restructuring charges, certain executive severance charges, non-cash asset impairment charges, accelerated D&A, the impact of deferred loan costs for the credit facility, foreign currency transaction impacts, transaction and advisory fees, loss on the sale of a plant and adjustments related to the Tax Cuts and Jobs Act.On an adjusted basis, EBITDA increased to $34.4 million in the fourth quarter of 2019, compared to $25 million in the fourth quarter of 2018.

For the full year 2019, adjusted EBITDA was $102.7 million, compared to $89.9 million in 2018. The increases in adjusted earnings were largely driven by lower incentive accruals, operational efficiency gains and a successful implementation of pricing initiatives in late 2018.I will now move on to cash flow and the balance sheet.

Cash provided by operating activities was $96.4 million in 2019, compared to $104.6 million in 2018.

We generated free cash flow of $71.5 million in 2019 and $78.1 million in 2018.As a result of our strong free cash flow profile consistent with our commitment to maintain a strong balance sheet while returning capital to shareholders, we repurchased approximately $9.6 million in stock and repaid $52.5 million of bank debt during fiscal 2019.

We also exited fiscal ‘19 with a leverage ratio of 1.2 times net debt to last 12 months adjusted EBITDA, which surpassed our goal.As for 2020 guidance, and as noted in the outlook section of our earnings release, based on current trends in the latest macro data, we are taking a measured approach to our 2020 revenue forecast.We expect low single-digit sales growth in our North American and European fenestration segments, offset by continued decline in revenues in our North American Cabinet Components segment.On a consolidated basis, sales are expected to be approximately $865 million to $885 million in fiscal 2020.

However, we expect to generate between $102 million and $110 million in adjusted EBITDA at fiscal 2020, which would yield margin expansion of approximately 60 basis points to the midpoint of guidance.

We plan to stay focused on generating cash and maintaining a strong balance sheet, while also continuing to opportunistically repurchase stock.For modeling purposes, it is appropriate to make the following assumptions for 2020, depreciation of approximately $32 million, amortization of approximately $15 million, SG&A of $100 million to $105 million, interest expense of $7 million to $8 million and a tax rate of 25%.From a capital expenditure standpoint, we expect to spend approximately $35 million in 2020, which is about $10 million more than in 2019, as we intend to invest in certain specific projects in an effort to grow organically.

Our target is to generate free cash flow between $55 million and $60 million in fiscal 2020.I will now turn the call over to George for his prepared remarks..

Thanks, Scott. As I reflect on our performance in 2019, it is highlighted by free cash flow of over $70 million for the second consecutive year, allowing us to exit the year with a leverage ratio of 1.2 times, which easily surpassed our goal of 1.5 times.

We also saw very strong performance in our fenestration segments in Europe and North America.In Europe, adjusted EBITDA margins improved by approximately 340 basis points in the fourth quarter and approximately 300 basis points for the full year.

Volume growth and price increases were the drivers for the improved performance in the fourth quarter and for the full year.

Excluding foreign exchange impact, we realized above-market sales growth of 3.3% during the fourth quarter and 9.1% for the full year in this segment.In our North American Fenestration segment, adjusted EBITDA margins expanded by approximately 250 basis points in the fourth quarter and approximately 110 basis points for the full year.

Volume growth, price increases, improved operational performance and SG&A savings were all reasons for the improvements.Sales in our North American Fenestration segment grew at 6% during the fourth quarter and 3.8% for the full year, which compares favorably to Ducker’s latest window shipment estimate of negative 0.4% for the three months ended September 30, 2019, and negative 1.6% for the 12 months ended September 30, 2019.Our North American Cabinet Components segment continue to face headwinds in 2019, particularly in the semi-custom segment, with revenue shrinking by 8.1% resulting in a margin contraction of 120 basis points for the full year.

Our focus in this segment going forward will be to continue to improve operational performance, right-size our capacity footprint and optimize working capital.As we look to 2020, there is a great deal of uncertainty at the macro level. Brexit is yet to be resolved. We have an election here in the U.S.

and there is continued uncertainty with trade wars and tariffs, which mostly relates to the Cabinet industry in our case.As a result, we feel it prudent to take a conservative view on our 2020 outlook.

We believe we can continue to outperform the market in our two Fenestration segments, albeit with slightly lower overall growth expectations.Unfortunately, we believe the semi-custom segment could continue to shrink even further in 2020, resulting in our consolidated revenues being down year-over-year.

Notwithstanding that, we demonstrated in 2019 that we can execute on the things directly within our control, so we expect another year of margin expansion with adjusted EBITDA in $102 million to $110 million range.As for capital deployment in 2020, the additional $10 million in CapEx compared to 2019 is to fund growth initiatives, including a new screen facility, the upgrade of our U.S.

vinyl extrusion technology and capacity expansion in Europe.As Scott mentioned, we will continue to focus on generating cash and maintaining a strong balance sheet, while also opportunistically buying back more stock.And finally, I’d like to take a moment to thank Bill and the Board of Directors for giving me the opportunity to be the next CEO of Quanex.

I am humbled by this opportunity, yet very excited to be working with the executive team and all of the Quanex employees.We will remain focused on our internal initiatives of safety, operational excellence and cash flow generation, while continuing to explore all options to create incremental shareholder value.I will now turn the call over to Bill for his closing comments..

Thank you, George. Let me close by expressing my thanks to our Board of Directors and our employees for their unending support over the past six years.

It’s been a good ride and we have made significant progress in transforming Quanex into an industry-leading pure-play building products manufacturer.While there will be no change in strategy, it is time to hand over the reins so that George and his team can take the execution of that strategy to the next level.

I will remain active in assisting George and his team as we continue down the path of operational excellence to further enhance profitability and cash flow, and to ultimately increase value for our shareholders.Thank you. Operator, we will now take questions..

Thank you. [Operator Instructions] And our first question comes from Daniel Moore with CJS Securities. Please go ahead..

Good morning..

Good morning..

Good morning..

I will just start quickly just not take a lot of time, but, Bill, congrats on the transition and leaving Quanex in great shape from not only competitive, but certainly a financial stability and liquidity perspective, and George, congrats on the promotion.

Topline guide for 2020, if doing the simple math, but implies double-digit declines in North American Cabinet, is kind of an extension of what we have seen in the last quarter or two.

Are there lines in that that you plan to exit or there larger customers that are -- you mentioned some strategy shifts among customers? Any more detail with regard to just the overall acceleration away from stock to semi-custom, is that accelerating, any more detail there, color there would be very helpful? Thank you..

In terms of the cabinet sales, in addition to the continued shift from a semi-custom to stock, which we have noted, the major change has been with one customer, who we have been working with in terms of strategic projects for a long period of time that changed their strategic direction during the year and is deciding to exit one of their product lines and so that is the big change year-over-year and what we are seeing and why it’s expedited from that -- from what we had given guidance for in the past..

Helpful.

And from a cadence perspective, I would presume that larger declines in the first half of the year versus the second given that decisions made within the last several months?.

I think it will be even is what we are seeing..

Okay..

To be clear, Dan, we are expecting those decline on a quarterly basis going forward..

Okay. I can dig in a little further after. On the margin side, looking for 60 basis points of improvement at the midpoint, maybe can you just provide a little bit more detail around the between the segments, what your expectations look like and the drivers of that improvement? Thanks..

Sure. I can add a little detail and color there. So in the North American Fenestration segment, you should expect, we said low single-digit, so 2% to 3% growth there. We continue to gain share in the Screens business.

We also gained some share back in the vinyl profile business and in the Spacer business we expect some growth there as well.In Europe, we expect again low single-digit growth, I’d say, 1% to 2% range. Hopefully, that’s a conservative number. But a lot’s going on in Europe as you know. We are adding a line in Germany to our spacer facility there.

We are also continuing to gain a little share in our vinyl profile business in the U.K. as really specifically one competitor continues to lose share and we are picking that business up for the most part. And then in cabinets we just explained, it’s really the shift -- mid double-digit shift down the shift from the semi-custom to stock..

Yeah. That’s great color on the topline. I will ask one more or just kind of review, kind of looking for a little bit more detail with -- as it relates to the margin expansion, the 60 bps of margin expansion, maybe it goes hand in hand with that topline that you described.

But if you could sort of rank order where you see the greatest opportunity for margin expansion among the segments and what the drivers would be and I will jump back to queue? Thanks..

Sure. On the margin expansion side, it does kind of go along the same lines of revenue. We expect the most margin expansion in North American Fenestration. In Europe, there is opportunity for better margin expansion. The margins in that segment are already very healthy. So maintaining or improving those is the plan.

And then in cabinet, even with the lower revenue, there is some opportunity to expand margin slightly..

We are still seeing the results of the operational excellence programs that we have been putting in across the board. So as we have said in past calls, there would be continued margin improvement in all segments of the business based on those activities albeit at a slower rate and we are seeing some of that now..

Very good. Understood. I will jump back in queue with any follow-ups. Thanks..

Thank you..

Thank you. Our next question comes from Steven Ramsey with Thompson Research. Please go ahead..

Hey. Good morning. This is actually Brian Biros on for Steven. Thank you taking my questions. I wanted to start with the guidance for the Fenestration segments, low single-digit growth you guys mentioned.

Can you provide some color on how much of that is strictly price versus any other growth drivers and then maybe the cadence from quarter-to-quarter versus just the full year?.

I mean, without going into too much detail, I think, we can comfortably say, that price will be less of a driver in 2020 than it was in 2019, and the volume growth will drive revenue higher in 2020, and that’s across the board except for cabinet..

Got it.

Is that kind of even across quarters or are you seeing maybe one quarter would jump out and be more substantial versus others?.

I think that’s consistent across all quarters, I -- the ability at this time to get additional price. I think we are priced very competitively in the market and what -- we will see no major movements across any of the quarters..

Got it. Helpful. And then last one from me, I guess, is on the cabinet side, the guidance previously mentioned probably down double digits for the year.

Is there anything throughout the year that would have to change significantly or I guess what would have to change significantly to surprise on the upside and kind of do better than the guidance?.

I think the thing that we would look at is if there was any significant change in tariffs that would drive the pricing of something higher that would force them to look back.

In addition to that, if we start seeing a consumer trend shift back to semi-custom from the stock as people start to remodel and focus on that, and upgrading their kitchens, we may see a shift back to higher end cabinets, which would lend to the upside on our business..

Understood. Thank you..

Thank you. Our next question comes from Ken Zener with KeyBanc. Please go ahead..

Good morning, gentlemen..

Good morning..

Good morning..

Hello..

Yeah.

Can you hear us?.

I can hear….

We can hear you, ken..

Okay. I apologize about that. Well, big quarter for everybody, Bill, congratulations. George, since we met, yeah, obviously, it’s a nice [indiscernible] as well as for you, Scott. So I just want to take, I think, I understand how you are outlining 2020.

I just want to go over some basics, because you are doing so well in two of your three segments and North America margins are up nicely, basically back to where they were in ‘16. Europe wouldn’t have thought in the middle of all this chaos, you would be delivering the margins that you did there.

So you are obviously executing well in those core businesses. And George, as it relates to what is sustained cabinet headwind obviously, you have been involved with Bill, and Bill, you deployed capital in cabinets, you did some of the European stuff. But what is, George, your view, cabinets, it’s unclear what’s going to happen with the tariffs.

But is there a possibility that you will have a simpler business in time within categories that are more secular in nature in terms of growth. I know who knew cabinets was going to break away and could make a case for knowing that ahead of time.

But your margins are so strong in other businesses and cabinets, does an OEM cabinets really make sense to you and how are you going to go about determining that with the Board?.

So to answer your question, I think, the first part of that would be, I think, it’s really too early to make a wholesale strategic change in that business. As you know the shift from semi-custom down the stock happen so rapidly and wasn’t predicted by anyone.

So I think that we are evaluating it, we are obviously, our eyes on it, but it’s too early to change strategic direction.However, I do think operationally, we still have a lot of runway and we are making significant improvements on a continuous basis. And so, I think, we are going to let both sides play out.

We are going to continue to focus on what we do well in the plants and making that even better, and then, we will keep our eye on the rapidly changing market and work with the Board for strategic direction..

Okay. And I do empathize with the challenges you face there, in terms of the fenestration extrusion, it really seems like the last, I don’t know if its two quarters or last two quarters to six quarters, you have been gaining share.

Can you talk to some of the dynamics in that category please? Because I know you guys had shutdown a lot of the Kentucky lines and it seems like you are actually gaining share from the point that you shutdown lines. Is it -- what -- can you go into a little bit of the dynamic that is affording that opportunity? Thank you..

Sure. What we focused on in the Vinyl space in North America specifically over the last few years is really controlling and improving what we do.

So focusing on our cost structure, our ability to deliver on time and servicing customers.And as some of our customers have left us for price and price -- things where we have walked away, we have continue to focus on and doing the things that we do well, the quality, the delivery, and as we have seen, as those customers figure out that their total cost is much more inclusive than just the purchase price per pound that we are starting to see some ability of us coming back and we are trying to capitalize on that.So we will continue to stay focused on working on operations, delivering the customer service that we feel like we are very good at and we will improve on.

And we will continue to go after share in that way..

Very nice to hear that. Related to window M&A, so large window company has recently been sold, I believe that company was a big proponent of the warm edge spacers that you guys produce, as well as some of the -- they had invested in some of the machinery to enable that possibility.

Can you talk about growth rates that we are seeing in that warm edge spacer, are you still getting share gains or -- and/or how does the CapEx side look on the window side to enable greater market share gains in that category?.

Sure. So in regards to the Spacer business, we are still gaining share.

We have been very open in past calls that the rate of that growth is being really dictated by the ability of machine and equipment makers to get that those high-speed lines out to the customer base and there is very few globally that provide that equipment, so lead times on new equipment are six months to a year.So our -- the speed of growth is really dictated by the ability to get new equipment into the market.

The demand for automated equipment is still there. Customers are looking for ways to automate and outsource, and eliminate their labor, because the availability of labor across the country is still limited. So I think we are just -- we still see growth rates, it’s dictated by the equipment makers right now..

Excellent. And Bill, if I could try my perennial question for you, realizing George is now in the seat.

Would you like to give a margin dispersion for the Fenestration business in North America?.

Ken, you never disappoint, I shall miss talking to you..

Is that non-answer though?.

My new role is Chairman, that’s all I am allowed to give at this point..

Excellent. George, would you like expand upon the Chairman’s reticence in terms of the….

I think, Bill, have taught me well and that’s a level of detail that we are not prepared to disclose at this point..

Congratulations, gentlemen, on all your new opportunities. Thank you..

Thank you..

Thanks, Ken..

Thank you. And our next question is from Julio Romero with Sidoti. Please go ahead..

Hey. Good morning, everyone..

Good morning..

Good morning..

Hey.

First off, Bill, congratulations on your success, transforming Quanex over the last few years, certainly, a large scale transformation and congrats to George as well in a new role?.

Thank you..

Thanks..

So, George, I know you have had success at operational improvement.

Can you just talk about how your background and experience at Quanex maybe shapes your vision and strategy over the next three or so years or so?.

Sure. I think, for me, we are a manufacturing company that focuses on quality product, quality service, delivering energy efficient products to all of the fenestration and cabinet markets. And we will continue to stay focused on that.

And that starts with an operational background and an operational level.So, whatever businesses we are in are always going to be put in that regards. So my background in terms of operations, I think, lends itself very well, because our strategy has always been an operational excellence and letting that drive our performance..

Got it. And on that point, you mentioned, operationally, you do have a lot of runway left in cabinets.

But how about runway for the two Fenestration segments, obviously, the margins they are already very strong, but how much headroom do you see in the Fenestration segments to improve margins over two-year to three-year timeframe?.

I think, we -- as we have said in previous calls, we still believe that there is some runway left, not near the rate that we have captured in previous years, but in every facility in all of our product lines. We have projects and goals, and objectives set that have a path to completion and we believe that they will all contribute to margin expansion.

I mean, that’s what we are focused on. So there will be some but just not at the rate that you have seen in the past in those segments..

Understood. Thanks for taking the questions and best of luck in 2020..

Thank you so much..

Thank you. And our next question is from Daniel Moore with CJS Securities. Please go ahead..

Thank you again.

In the past, you have gone as far as to quantify the -- in rough terms, the dollars lost when you had a customer perhaps shift in other segments to another supplier, is there sort of rough terms a dollar amounts that we should be thinking about in annualized terms from the customer that you called out in the cabinets business and one last follow-up..

Sure. Based on the run rates where we are at today, we are expecting that would be between $10 million to $15 million range..

Got it. Very helpful. And Bill, alluded to the answer being no, but I will ask it anyway.

In terms of just capital allocation towards any tweaks or subtle shifts in emphasis or focus you may have as you take over the reins in 2020 and beyond?.

No. As we said in our commentary, our normal capital expense is very consistent and we will focus on operational improvements and then the additional $10 million this year is really identifying three major areas in terms of the new screen facility, vinyl, some new assets in our North American vinyl platform and then a capacity expansion.

And then outside of that, we will opportunistically buy stock as the cash flow dictates it and we will continue to stay on that path..

Very good. Appreciate the color. Thanks again..

Thank you..

Thank you. And this concludes our Q&A session. I would like to turn the call back to George Wilson for his final remarks..

I’d like to thank you all for joining and we look forward to providing you an update on our next earnings call in March. Thank you..

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