JELD-WEN Holding, Inc. 10-K

Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations This MD&A contains forward-looking statements that involve risks and uncertainties. Please see “Forward-Looking Statements” in Item 1- Business and Item 1A- Risk Factors in this Form 10-K for a discussion of the uncertainties, risks and assumptions associated with these statements. This discussion should be read in conjunction with our historical financial statements and related notes thereto and the other disclosures contained elsewhere in this Form 10-K. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under Item 1A- Risk Factors and included elsewhere in this Form 10-K. This MD&A is a supplement to our financial statements and notes thereto included elsewhere in this 10-K and is provided to enhance your understanding of our results of operations and financial condition. Our discussion of results of operations is presented in millions throughout the MD&A and due to rounding may not sum or calculate precisely to the totals and percentages provided in the tables. Our MD&A is organized as follows: • Overview and Background. This section provides a general description of our Company and reportable segments, business and industry trends, our key business strategies and background information on other matters discussed in this MD&A. • Consolidated Results of Operations and Operating Results by Business Segment. This section provides our analysis and outlook for the significant line items on our consolidated statements of operations, as well as other information that we deem meaningful to an understanding of our results of operations on both a consolidated basis and a business segment basis. • Liquidity and Capital Resources. This section contains an overview of our financing arrangements and provides an analysis of trends and uncertainties affecting liquidity, cash requirements for our business, and sources and uses of our cash. • Critical Accounting Policies and Estimates. This section discusses the accounting policies that we consider important to the evaluation and reporting of our financial condition and results of operations, and whose application requires significant judgments or a complex estimation process. Overview and Background We are one of the world’s largest door and window manufacturers, and we hold a leading position by net revenues in the majority of the countries and markets we serve. We design, produce, and distribute an extensive range of interior and exterior doors, wood, vinyl, and aluminum windows, and related products for use in the new construction, R&R of residential homes, and, to a lesser extent, non-residential buildings. We operate manufacturing and distribution facilities in 19 countries, located primarily in North America, Europe, and Australia. For many product lines, our manufacturing processes are vertically integrated, enhancing our range of capabilities, our ability to innovate, and our quality control as well as providing supply chain, transportation, and working capital savings. In October 2011, certain funds managed by affiliates of Onex acquired a majority of the combined voting power in the Company through the acquisition of convertible debt and convertible preferred equity. After the Onex investment, we began the transformation of our business from a family-run operation to a global organization with independent, professional management. The transformation accelerated after 2013 with the hiring of a new senior management team strategically recruited from a number of world-class industrial companies. Our current management team has extensive experience driving operational improvement, innovation, and growth, both organically and through acquisitions. As of December 31, 2020, Onex owned approximately 33% of our outstanding shares of Common Stock. In February 2017, we completed an initial public offering of our Common Stock on the New York Stock Exchange under the symbol “JELD”. Business Segments Our business is organized in geographic regions to ensure integration across operations serving common end markets and customers. We have three reportable segments: North America, Europe, and Australasia. Financial information related to our business segments can be found in Note 16 - Segment Information of our financial statements included elsewhere in this 10-K. 42 Back to top Acquisitions In March 2019, we acquired VPI Quality Windows, Inc., a leading manufacturer of vinyl windows, specializing in customized solutions for mid-rise multi-family, industrial, hospitality and commercial projects, primarily in the western U.S. VPI is located in Spokane, Washington. VPI is part of our North America segment. We paid $57.8 million in cash, net of cash acquired, for the acquisition of VPI. In April 2018, we acquired the assets of D&K, a long-standing supplier of cavity sliders to our Corinthian Doors business. D&K is part of our Australasia segment. In March 2018, we acquired the remaining issued and outstanding shares and membership interests of ABS, headquartered in Sacramento, California. ABS is a premier supplier of value-added services for the millwork industry. ABS is part of our North America segment. In February 2018, we acquired A&L, a leading Australian manufacturer of residential aluminum windows and patio doors. A&L has a network of manufacturing facilities across the eastern seaboard of Australia, which we expect will deliver synergies through operational savings from the implementation of JEM and by leveraging the benefits of our combined supply chain. A&L is part of our Australasia segment. In February 2018, we acquired Domoferm, headquartered in Gänserndorf, Austria. Domoferm is a leading European provider of steel doors, steel door frames, and fire doors for commercial and residential markets with four manufacturing sites in Austria, Germany, and the Czech Republic. Domoferm is part of our Europe segment. We paid an aggregate of approximately $229.2 million in cash, including contingent consideration, (net of cash acquired) for the 2019 and 2018 acquisitions. In addition, we assumed no debt in our 2019 acquisition and we assumed debt of approximately $70.6 million associated with our 2018 acquired companies. For additional information on our acquisition activity, see Note 2 - Acquisitions of our financial statements included elsewhere in this 10-K. Factors and Trends Affecting Our Business Components of Net Revenues The key components of our net revenues include core net revenues (which we define to include the impact of pricing and volume/mix, as discussed further under the heading, “Product Pricing and Volume/Mix” below), contribution from acquisitions made within the prior twelve months, and the impact of foreign exchange. Core net revenues reported in our financial statements are impacted by the fluctuating currency values in the geographies in which we operate, which we refer to as the impact of foreign exchange. Throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, percentage changes in pricing are based on management schedules and are not derived directly from our accounting records. Product Demand General business, financial market, and economic conditions globally and in the regions where we operate influence overall demand in our end markets and for our products. In particular, the following factors may have a direct impact on demand for our products in the countries and regions where our products are marketed and sold: • the strength of the economy; • employment rates and consumer confidence and spending rates; • the availability and cost of credit; • the amount and type of residential and non-residential construction; • housing sales and home values; • the age of existing home stock, home vacancy rates, and foreclosures; • interest rate fluctuations for our customers and consumers; • increases in the cost of raw materials or any shortage in supplies or labor; • the effects of governmental regulation and initiatives to manage economic conditions; • geographical shifts in population and other changes in demographics; and • changes in weather patterns. 43 Back to top In addition, we seek to drive demand for our products through the implementation of various strategies and initiatives. We believe we can enhance demand for our new and existing products by: • innovating and developing new products and technologies; • investing in branding and marketing strategies, including marketing campaigns in both print and social media, as well as our investments in training centers and mobile training facilities; and • implementing channel initiatives to enhance our relationships with key channel partners and customers, including the True BLU dealer management program in North America. Product Pricing and Volume/Mix The price and mix of products that we sell are important drivers of our net revenues and net income. Under the heading “Results of Operations,” references to (i) “pricing” refer to the impact of price increases or decreases, as applicable, for particular products between periods and (ii) “volume/mix” refer to the combined impact of both the number of products we sell in a particular period and the types of products sold, in each case, on net revenues. While we operate in competitive markets, pricing discipline is an important element of our strategy to achieve profitable growth through improved margins. Our strategy also includes incentivizing our channel partners to sell our higher margin products, and we believe a renewed focus on innovation and the development of new technologies will increase our sales volumes and the overall profitability of our product mix. Cost Reduction Initiatives Prior to the ongoing operational transformation being executed by our senior executive team, our operations were managed in a decentralized manner with varying degrees of emphasis on cost efficiency and limited focus on continuous improvement or strategic sourcing. Our senior management team has a proven track record of implementing operational excellence programs at some of the world’s leading industrial manufacturing businesses, and we believe the same successes can be realized at JELD-WEN. Key areas of focus of our operational excellence and footprint rationalization programs include: • reducing labor, overtime, and waste costs by reducing facility count while optimizing manufacturing capacity and improving planning and manufacturing processes; • reducing or minimizing increases in material costs through strategic global sourcing and value-added re-engineering of components, in part by leveraging our significant spend and the global nature of our purchases; • reducing warranty costs by improving quality; and • a JEM-enabled facility rationalization and modernization initiative that will reduce overhead costs and complexity, while increasing our overall capacity and improving our service levels. We continue to implement our strategic initiatives under JEM to develop the culture and processes of operational excellence and continuous improvement. These cost reduction initiatives, which include plant closures and consolidations, headcount reductions, and various initiatives aimed at lowering production and overhead costs, may not produce the intended results within the intended timeframe. Raw Material Costs Commodities such as vinyl extrusions, glass, aluminum, wood, steel, plastics, fiberglass, and other composites are major components in the production of our products. Changes in the underlying prices of these commodities have a direct impact on the cost of products sold. While we attempt to pass on a substantial portion of such cost increases to our customers, we may not be successful in doing so. In addition, our results of operations for individual quarters may be negatively impacted by a delay between the time of raw material cost increases and a corresponding price increase. Conversely, our results of operations for individual quarters may be positively impacted by a delay between the time of a raw material price decrease and a corresponding competitive pricing decrease. Freight Costs We incur substantial freight costs to third party logistics providers to transport raw materials and work-in-process inventory to our manufacturing facilities and to deliver finished goods to our customers. Changes in freight rates and the availability of freight services can have a significant impact on our cost of goods sold. Freight costs have risen significantly due to a number of factors that have affected the supply and demand of trucking services, including increased regulation, such as data logging of miles, increases in general economic activity, and an aging workforce. We attempt to mitigate some of these cost increases through various internal initiatives and to pass a substantial portion of these increases to our customers; however, we may not realize the intended results within the intended timeframe. 44 Back to top Working Capital and Seasonality Working capital, which is defined as accounts receivable plus inventory less accounts payable, fluctuates throughout the year and is affected by seasonality of sales of our products and of customer payment patterns. The peak season for home construction and remodeling in our North America and Europe segments, which represent the substantial majority of our revenues, generally corresponds with the second and third calendar quarters, and therefore our sales volume is usually higher during those quarters. Typically, working capital increases at the end of the first quarter and beginning of the second quarter in conjunction with, and in preparation for, our peak season, and working capital decreases starting in the third quarter as inventory levels and accounts receivable decline. Inventories fluctuate for some raw materials with long delivery lead times, such as steel, as we work through prior shipments and take delivery of new orders. Foreign Currency Exchange Rates We report our consolidated financial results in U.S. dollars. Due to our international operations, the weakening or strengthening of foreign currencies against the U.S. dollar can affect our reported operating results and our cash flows as we translate our foreign subsidiaries’ financial statements from their reporting currencies into U.S. dollars. In the year ended December 31, 2020 compared to the year ended December 31, 2019, the depreciation or appreciation of the U.S. dollar relative to the reporting currencies of our foreign subsidiaries resulted in higher or lower reported results in such foreign reporting entities. In particular, the exchange rates used to translate our foreign subsidiaries’ financial results for the year ended December 31, 2020 compared to the year ended December 31, 2019 reflected, on average, the U.S. dollar strengthened against both the Australian dollar and Canadian dollar by 1% and weakened against the Euro by 2%. See Item 1A- Risk Factors - Risks Relating to Our Business and Industry, Item 1A- Risk Factors - Exchange rate fluctuations may impact our business, financial condition, and results of operations, and Item 7A- Quantitative and Qualitative Disclosures About Market Risk- Exchange Rate Risk. Components of our Operating Results Net Revenues Our net revenues are a function of sales volumes and selling prices, each of which is a function of product mix, and consist primarily of: • sales of a wide variety of interior and exterior doors, including patio doors, for use in residential and non-residential applications, with and without frames, to a broad group of wholesale and retail customers in all of our geographic markets; • sales of a wide variety of windows for both residential and certain non-residential uses, to a broad group of wholesale and retail customers primarily in North America, Australia, and the U.K.; and • other sales, including sales of moldings, trim board, cut-stock, glass, stairs, hardware and locks, door skins, shower enclosures, wardrobes, window screens, and miscellaneous installation and other services revenue. Net revenues do not include internal transfers of products between our component manufacturing, product manufacturing and assembly, and distribution facilities. Cost of Sales Cost of sales consists primarily of material costs, direct labor and benefit costs, including payroll taxes, repair and maintenance, depreciation, utility, rent and warranty expenses, outbound freight, insurance and benefits, supervision and tax expenses. Material Costs. The single largest component of cost of sales is material costs, which include raw materials, components, and finished goods purchased for use in manufacturing our products or for resale. Our most significant material costs include glass, wood, wood components, doors, door facings, door parts, hardware, vinyl extrusions, steel, fiberglass, packaging materials, adhesives, resins and other chemicals, core material, and aluminum extrusions. The cost of each of these items is impacted by global supply and demand trends, both within and outside our industry, as well as commodity price fluctuations, conversion costs, energy costs, and transportation costs. The imposition of new tariffs on imports, new trade restrictions, or changes in tariff rates or trade restrictions may further impact material costs. See Item 7A- Quantitative and Qualitative Disclosures About Market Risk- Raw Materials Risk. Direct Labor and Benefit Costs. Direct labor and benefit costs reflect a combination of production hours, average headcount, general wage levels, payroll taxes, and benefits provided to employees. Direct labor and benefit costs include wages, overtime, payroll taxes, and benefits paid to hourly employees at our facilities that are involved in the production and/or distribution of our products. These costs are generally managed by each facility and headcount is adjusted according to overall and seasonal production demand. We run multi-shift operations in many of our facilities to maximize return on assets and utilization. Direct labor and benefit costs fluctuate with headcount, but generally tend to increase with inflation due to increases in wages and health benefit costs. 45 Back to top Repair and Maintenance, Depreciation, Utility, Rent, and Warranty Expenses. • Repairs and maintenance costs consist of equipment and facility maintenance expenses, purchases of maintenance supplies, and the labor costs involved in performing maintenance on our equipment and facilities. • Depreciation includes depreciation expense associated with our production assets and plants. • Rent is predominantly comprised of lease costs for facilities we do not own as well as vehicle fleet and equipment lease costs. Facility leases are typically multi-year and may include increases tied to certain measures of inflation. • Warranty expenses represent all costs related to servicing warranty claims and product issues and are mostly related to our window and door products sold in the U.S. and Canada. Outbound Freight. Outbound freight includes payments to third-party carriers for shipments of orders to our customers, as well as driver, vehicle, and fuel expenses when we deliver orders to customers. The majority of our products are shipped by third-party carriers. Insurance and Benefits, Supervision, and Tax Expenses. • Insurance and benefit costs are the expenses relating to our insurance programs, health benefits, retirement benefit programs (including the pension plan), and other benefits that are not included in direct labor and benefits costs. • Supervision costs are the wages and bonus expenses related to plant managers. Both insurance and benefits and supervision expenses tend to be influenced by headcount and wage levels. • Tax costs are mostly payroll taxes for employees not included in direct labor and benefit costs, and property taxes. Tax expenses are impacted by changes in tax rates, headcount and wage levels, and the number and value of properties owned. In addition, an appropriate portion of each of the insurance and benefits, supervision and tax expenses are allocated to SG&A expenses. Selling, general, and administrative expenses SG&A expenses consist primarily of research and development, sales and marketing, and general and administrative expenses. Research and Development . Research and development expenses consist primarily of personnel expenses related to research and development, consulting and contractor expenses, tooling and prototype materials, and overhead costs allocated to such expenses. Substantially all of our research and development expenses are related to developing new products and services and improving our existing products and services. To date, research and development expenses have been expensed as incurred, because the period between achieving technological feasibility and the release of products and services for sale has been short and development costs qualifying for capitalization have been insignificant. We expect our research and development expenses to increase in absolute dollars as we continue to make significant investments in developing new products and enhancing existing products. Sales and Marketing. Sales and marketing expenses consist primarily of advertising and marketing promotions of our products and services and related personnel expenses, as well as sales incentives, trade show and event costs, sponsorship costs, consulting and contractor expenses, travel, display expenses, and related amortization. Sales and marketing expenses are generally variable expenses and not fixed expenses. We expect our sales and marketing expenses to increase in absolute dollars as we continue to actively promote our products and services. General and Administrative . General and administrative expenses consist of personnel expenses for our finance, legal, human resources, and administrative personnel, as well as the costs of professional services, any allocated overhead, information technology, amortization of intangible assets acquired, and other administrative expenses. We expect our general and administrative expenses to increase in absolute dollars due to the anticipated growth of our business and related infrastructure as well as legal, accounting, insurance, investor relations, and other costs associated with being a public company. Impairment and Restructuring Costs Impairment and restructuring costs consist primarily of all salary-related severance benefits that are accrued and expensed when a restructuring plan has been put into place, the plan has received approval from the appropriate level of management and the benefit is probable and reasonably estimable. In addition to salary-related costs, we incur other restructuring costs when facilities are closed or capacity is realigned within the organization. Upon termination of an employment or commercial contract we record liabilities and expenses pursuant to the terms of the relevant agreement. For non-contractual restructuring activities, liabilities and expenses are measured and recorded at fair value in the period in which they are incurred. 46 Back to top Interest Expense, Net Interest expense, net relates primarily to interest payments on our then-outstanding credit facilities and debt securities, as well as commitment fees and amortization of any original issue discount or debt issuance costs. Debt issuance costs are included as an offset to long-term debt in the accompanying consolidated balance sheets and are amortized to interest expense over the life of the applicable facility using the effective interest method. For additional details, see Note 13 - Long-Term Debt in our financial statements for the year ended December 31, 2020 included elsewhere in this 10-K . Other Income (Expense), Net Other income (expense), net includes profit and losses related to various miscellaneous non-operating expenses primarily relating to pension benefit expenses, governmental pandemic assistance reimbursements relating to COVID-19, gain on previously held shares of an equity investment, legal settlement income, insurance reimbursements, gains and losses on sale of business units, property, and equipment, and certain foreign currency related gains and losses, including from our hedging activities used to mitigate foreign exchange impacts. Income Taxes Income taxes are recorded using the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the deferred tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities due to a change in tax rates is recognized in income in the period that includes the date of enactment. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We record interest related to unrecognized tax benefits in income tax expense. As of December 31, 2020, our U.S. federal, state, and foreign net operating loss (“NOL”) carryforwards were $1,428.9 million in the aggregate and $94.1 million of such NOL carryforwards do not expire. The Tax Act passed in December 2017 continues to have significant effects on our financial statements primarily through Treasury regulations, whether proposed or final, which continue to be issued in relation to specific provisions of the Tax Act. In accordance with Staff Accounting Bulletin #118 issued by the SEC in December 2017 immediately following the passage of the Tax Act, we made provisional estimates for certain direct and indirect effects of the Tax Act for the year ended December 31, 2017. In the fourth quarter of 2018, we completed our accounting for the enactment-date income tax effects of the Tax Act and included any adjustments as a component of income tax expense from continuing operations. The Tax Act subjects a U.S. shareholder to current tax on GILTI earned by certain foreign subsidiaries. We have elected to account for the impact of GILTI in the period in which it is incurred. For additional details, see Note 15 - Income Taxes in our financial statements for the year ended December 31, 2020 included elsewhere in this 10-K. Significant Developments In March 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. In the following weeks, global restrictions, including stay at home and similar orders, were implemented in a significant number of regions in which we operate. During the second and third quarters of 2020, we experienced intermittent closures of certain manufacturing facilities due to local and governmental mandates, with disruptions occurring primarily in April and May. Customer demand and revenue were consistent with our expectations during April and May with high-teens percentage declines from the prior year, however, they improved through the last half of the second quarter and continued to improve throughout the second half of 2020. We have modified our manufacturing facilities and procedures, based on recommended public health guidelines, to ensure the health and well-being of our employees. During 2020, we recognized approximately $7.4 million relating to governmental pandemic assistance programs, which are primarily related to reimbursements for additional costs incurred as a result of the outbreak of COVID-19. We have continued to monitor our liquidity throughout 2020 and increased liquidity compared to the prior year, primarily as a result of issuing $250.0 million of Senior Secured Notes during the second quarter, adding additional collateral to increase our borrowing base and availability under the ABL Facility, and the impact of cost savings measures. We have taken measures to reduce discretionary spending including, for example, restricted travel, implemented hiring freezes for non-essential positions, delayed merit increases, and suspended all non-critical spending, such as marketing and discretionary projects. In addition, during the second quarter, we implemented actions to reduce salary costs globally, including our executive leadership team and Board of Directors elected to reduce their second quarter compensation by 25%, and implemented short-term employee furloughs throughout our Company. During the third and fourth quarters, we reversed certain salary cost cutting initiatives to those negatively impacted. Further, to maintain sufficient levels of cash and liquidity, we are deferring tax payments where permitted through COVID-19 related government subsidy programs and are actively monitoring our accounts receivable for customers with elevated credit risk. We are monitoring the situation closely and, if necessary, will relax cost saving measures or implement additional measures as appropriate. 47 Back to top The scope and nature of impacts from COVID-19, most of which are beyond our control, continue to evolve, and the outcome is uncertain. The ultimate effects of the COVID-19 pandemic on us and the end markets we service, is highly uncertain and will depend on future developments. Such effects could exist for an extended period even after the pandemic ends. Results of Operations The tables in this section summarize key components of our results of operations for the periods indicated, both in U.S. dollars and as a percentage of our net revenues. Certain percentages presented in this section have been rounded to the nearest whole number. Accordingly, totals may not equal the sum of the line items in the tables below. Comparison of the Year Ended December 31, 2020 to the Year Ended December 31, 2019 Year Ended December 31, 2020 December 31, 2019 (amounts in thousands) % of Net Revenues % of Net Revenues Net revenues $ 4,235,677 100.0 % $ 4,289,761 100.0 % Cost of sales 3,333,770 78.7 % 3,417,222 79.7 % Gross margin 901,907 21.3 % 872,539 20.3 % Selling, general and administrative 702,715 16.6 % 660,574 15.4 % Impairment and restructuring charges 10,469 0.2 % 21,551 0.5 % Operating income 188,723 4.5 % 190,414 4.4 % Interest expense, net 74,800 1.8 % 71,778 1.7 % Other income (2,752) (0.1) % (1,409) — % Income before taxes 116,675 2.8 % 120,045 2.8 % Income tax expense 25,089 0.6 % 57,074 1.3 % Net income $ 91,586 2.2 % $ 62,971 1.5 % Consolidated Results Net Revenues – Net revenues decreased $54.1 million, or 1.3%, to $4,235.7 million in the year ended December 31, 2020 from $4,289.8 million in the year ended December 31, 2019. The decrease was driven by a decline in core revenue of 2% consisting of a 5% decline in volume/mix, partially offset by a 3% pricing benefit. Gross Margin – Gross margin increased $29.4 million, or 3.4%, to $901.9 million in the year ended December 31, 2020 from $872.5 million in the year ended December 31, 2019. Gross margin as a percentage of net revenues was 21.3% in the year ended December 31, 2020 and 20.3% in the year ended December 31, 2019. Gross margins increased due to sourcing savings and improved pricing, partially offset by unfavorable volume/mix and the effect of inflation on labor compensation. SG&A Expense – SG&A expense increased $42.1 million, or 6.4%, to $702.7 million in the year ended December 31, 2020 from $660.6 million in the year ended December 31, 2019. The increase in SG&A expense was primarily due to increased legal expenses, primarily relating to litigation and environmental accruals and fees, and estimated variable compensation, partially offset by reductions in spending relating to sales, marketing and travel as a result of cost saving measures implemented in response to COVID-19, and the non-recurrence of aquisition costs recorded in 2019. Impairment and Restructuring Charges – Impairment and restructuring charges decreased $11.1 million, or 51.4%, to $10.5 million in the year ended December 31, 2020 from $21.6 million in the year ended December 31, 2019. Charges incurred in 2020 primarily related to severance charges for ongoing restructuring projects across all segments as well as impairment charges primarily related to capitalized costs of certain ERP modules due to delays in implementation and uncertainty of their future use. Charges incurred in 2019 primarily related to plant consolidations in our North America and Australasia segments resulting in impairments of ROU assets and property and equipment as well as severance costs across all segments and corporate. For more information, refer to Note 20 - Impairment and Restructuring Charges to our consolidated financial statements included in this 10-K. Interest Expense, Net – Interest expense, net, increased $3.0 million, or 4.2%, to $74.8 million in the year ended December 31, 2020 from $71.8 million in the year ended December 31, 2019. The increase was primarily due to interest on our Senior Secured Notes issued in May 2020, partially offset by reduced borrowings and interest rates under our revolving credit facilities and a lower cost of borrowing on our Term Loan Facility. 48 Back to top Other Income – Other income increased $1.3 million, or 95.3%, to $2.8 million in the year ended December 31, 2020 from $1.4 million in the year ended December 31, 2019. The other income in the year ended December 31, 2020 primarily consisted of foreign currency losses of $11.9 million and pension expense of $1.6 million, offset by $7.4 million for cash received as a result of governmental pandemic assistance reimbursements relating to COVID-19, a gain on sale of business units, property and equipment of $4.1 million, and an insurance reimbursement of $1.4 million. Other income in the year ended December 31, 2019 was primarily due to foreign currency gains of $7.4 million, a gain on the sale of business units, property and equipment of $1.5 million, and legal settlement income of $1.2 million, partially offset by pension expense of $10.7 million. Income Taxes – Income tax expense decreased $32.0 million, or 56.0%, to $25.1 million in the year ended December 31, 2020 from $57.1 million in the year ended December 31, 2019. The effective tax rate in the year ended December 31, 2020 was 21.5% compared to 47.5% in the year ended December 31, 2019. The decrease in income tax expense in 2020 was primarily due to a tax benefit recorded in 2020 as a result of the HTE election and related planning, which resulted in a decrease in the U.S. valuation allowance, partially offset by tax expense related to a reduction in U.S. foreign tax credit carryforwards and additional state tax expense related expenses. For more information, refer to Note 15 – Income Taxes to our consolidated financial statements included in this 10-K. Comparison of the Year Ended December 31, 2019 to the Year Ended December 31, 2018 December 31, 2019 December 31, 2018 (dollars in thousands) % of Net Revenues % of Net Revenues Net revenues $ 4,289,761 100.0 % $ 4,346,847 100.0 % Cost of sales 3,417,222 79.7 % 3,428,311 78.9 % Gross margin 872,539 20.3 % 918,536 21.1 % Selling, general and administrative 660,574 15.4 % 734,166 16.9 % Impairment and restructuring charges 21,551 0.5 % 17,328 0.4 % Operating income 190,414 4.4 % 167,042 3.8 % Interest expense, net 71,778 1.7 % 70,818 1.6 % Other income (1,409) — % (34,887) (0.8) % Income before taxes, equity earnings and discontinued operations 120,045 2.8 % 131,111 3.0 % Income tax expense (benefit) 57,074 1.3 % (10,058) (0.2) % Income from continuing operations, net of tax 62,971 1.5 % 141,169 3.2 % Equity earnings of non-consolidated entities — — % 738 — % Net income $ 62,971 1.5 % $ 141,907 3.3 % Consolidated Results Net Revenues – Net revenues decreased $57.1 million, or 1.3%, to $4,289.8 million in the year ended December 31, 2019 from $4,346.8 million in the year ended December 31, 2018. The decrease was due to unfavorable foreign exchange impact of 3% and a decline in core revenue of 2%, partially offset by a 4% contribution from acquisitions. Core revenue decline consisted of a 4% decrease in volume/mix, offset by a 2% increase in price. Gross Margin – Gross margin decreased $46.0 million, or 5.0%, to $872.5 million in the year ended December 31, 2019 from $918.5 million in the year ended December 31, 2018. Gross margin as a percentage of net revenues was 20.3% in the year ended December 31, 2019 and 21.1% in the year ended December 31, 2018. The decrease in gross margin percentage was due to increased costs related to manufacturing inefficiencies in North America and unfavorable volume/mix within North America and Australasia, partially offset by favorable pricing. SG&A Expense —SG&A expense decreased $73.6 million, or 10.0%, to $660.6 million in the year ended December 31, 2019 from $734.2 million in the year ended December 31, 2018. SG&A expense as a percentage of net revenues was 15.4% for the year ended December 31, 2019 and 16.9% for the year ended December 31, 2018. The decrease in SG&A expense was primarily due to a decrease of litigation contingency accruals of $76.5 million and reduction of acquisition and integration costs. Impairment and Restructuring Charges —Impairment and restructuring charges increased $4.2 million, or 24.4%, to $21.6 million in the year ended December 31, 2019 from $17.3 million in the year ended December 31, 2018. Charges incurred in 2019 primarily related to plant consolidations in our North America and Australasia segments resulting in impairments of ROU assets and 49 Back to top property and equipment as well as severance costs across all segments and corporate. The 2018 charges consisted primarily of personnel restructuring costs in our North America, Europe and Australasia segments as well as plant consolidations in our North America and Australasia segments. For more information, refer to Note 20 - Impairment and Restructuring Charges to our consolidated financial statements included in this 10-K. Interest Expense, Net —Interest expense, net, increased $1.0 million, or 1.4%, to $71.8 million in the year ended December 31, 2019 from $70.8 million in the year ended December 31, 2018. The increase was primarily due to increased borrowings during 2019. Other Income – Other income decreased $33.5 million, to income of $1.4 million in the year ended December 31, 2019 from $34.9 million in the year ended December 31, 2018. Other income in the year ended December 31, 2019 was primarily due to foreign currency gains of $7.4 million, a gain on the sale of business units, property and equipment of $1.5 million, and legal settlement income of $1.2 million, partially offset by pension expense of $10.7 million. Other income in the year ended December 31, 2018 was primarily due to a fair value adjustment of $20.8 million associated with our acquisition of the remaining shares outstanding of an equity investment, foreign currency gains of $11.3 million, and legal settlement income of $7.5 million, partially offset by pension expense of $7.0 million. Income Taxes – Income tax expense in the year ended December 31, 2019 was $57.1 million, compared to a benefit of $10.1 million in the year ended December 31, 2018. The effective tax rate in the year ended December 31, 2019 was an expense of 47.5% compared to (7.7)% in the year ended December 31, 2018. The increase in income tax expense in 2019 was primarily driven by increases in valuation allowances as compared to the benefit for changes in the provisional estimates recorded under the Tax Act and our acquisition of ABS in 2018. For more information, refer to Note 15 – Income Taxes to our consolidated financial statements included in this 10-K. 50 Back to top Segment Results We report our segment information in the same way management internally organizes the business in assessing performance and making decisions regarding allocation of resources in accordance with ASC 280-10- Segment Reporting . We have determined that we have three reportable segments, organized and managed principally by geographic region. Our reportable segments are North America, Europe, and Australasia. We report all other business activities in Corporate and unallocated costs. We define Adjusted EBITDA as net income (loss), adjusted for the following items: loss from discontinued operations, net of tax; equity earnings of non-consolidated entities; income tax (benefit) expense; depreciation and amortization; interest expense, net; impairment and restructuring charges; gain on previously held shares of equity investment; (gain) loss on sale of property and equipment; share-based compensation expense; non-cash foreign exchange transaction/translation (income) loss; other non-cash items; other items; and costs related to debt restructuring and debt refinancing. For additional information on segment Adjusted EBITDA, see Note 16 - Segment Information to our consolidated financial statements included in this 10-K. Comparison of the Year Ended December 31, 2020 to the Year Ended December 31, 2019 Year Ended (amounts in thousands) December 31, 2020 December 31, 2019 Net revenues from external customers % Variance North America $ 2,528,993 $ 2,534,336 (0.2) % Europe 1,187,777 1,178,441 0.8 % Australasia 518,907 576,984 (10.1) % Total Consolidated $ 4,235,677 $ 4,289,761 (1.3) % Percentage of total consolidated net revenues North America 59.7 % 59.1 % Europe 28.0 % 27.5 % Australasia 12.3 % 13.4 % Total Consolidated 100.0 % 100.0 % Adjusted EBITDA (1) North America $ 315,952 $ 267,335 18.2 % Europe 136,363 116,193 17.4 % Australasia 62,449 74,484 (16.2) % Corporate and unallocated costs (68,350) (42,974) 59.0 % Total Consolidated $ 446,414 $ 415,038 7.6 % Adjusted EBITDA as a percentage of segment net revenues North America 12.5 % 10.5 % Europe 11.5 % 9.9 % Australasia 12.0 % 12.9 % Total Consolidated 10.5 % 9.7 % (1) Adjusted EBITDA is a financial measure that is not calculated in accordance with GAAP. For a discussion of our presentation of Adjusted EBITDA, see Note 16 - Segment Information in our consolidated financial statements. North America Net revenues in North America decreased $5.3 million, or 0.2%, to $2,529.0 million in the year ended December 31, 2020 from $2,534.3 million in the year ended December 31, 2019. The decrease was primarily due to a reduction in core revenues of 1%, consisting of a decrease in volume/mix of 6%, offset by a pricing benefit of 5%, and a 1% increase attributable to the contribution from the acquisition of VPI. Adjusted EBITDA in North America increased $48.6 million, or 18.2%, to $316.0 million in the year ended December 31, 2020 from $267.3 million in the year ended December 31, 2019. The increase was due to favorable pricing, lower material costs, reduced marketing and travel expenses, and contributions from our VPI acquisition, partially offset by unfavorable revenue mix and the effect of inflation on labor compensation. 51 Back to top Europe Net revenues in Europe increased $9.3 million, or 0.8%, to $1,187.8 million in the year ended December 31, 2020 from $1,178.4 million in the year ended December 31, 2019. The increase was primarily due to a favorable foreign exchange impacts of 2%, partially offset by a decrease in core revenue of 1%, consisting of a decrease in volume/mix of 2%, offset by a pricing benefit of 1%. Adjusted EBITDA in Europe increased $20.2 million, or 17.4%, to $136.4 million in the year ended December 31, 2020 from $116.2 million in the year ended December 31, 2019. The increase was primarily due to labor and material cost savings and favorable pricing, partially offset by unfavorable revenue mix and the effect of inflation on labor compensation. Australasia Net revenues in Australasia decreased $58.1 million, or 10.1%, to $518.9 million in the year ended December 31, 2020 from $577.0 million in the year ended December 31, 2019. The decrease was primarily due to a reduction in core revenues of 9%, consisting of a decrease in volume/mix of 8% and reduced pricing of 1%, as well as adverse foreign exchange impacts of 1%. Adjusted EBITDA in Australasia decreased $12.0 million, or 16.2%, to $62.4 million in the year ended December 31, 2020 from $74.5 million in the year ended December 31, 2019. The decrease was primarily due to lower volumes from market headwinds and adverse pricing, partially offset by labor cost savings and reductions in spending relating to sales, marketing, travel, and salaries as a result of cost saving measures implemented in response to COVID-19. Corporate and unallocated costs Corporate and unallocated costs increased in the year ended December 31, 2020 compared to the year ended December 31, 2019 primarily due to increased variable compensation and the impact of foreign exchange hedges, resulting in a decrease to Adjusted EBITDA of $25.4 million, or 59.0%. 52 Back to top Comparison of the Year Ended December 31, 2019 to the Year Ended December 31, 2018 Year Ended (dollars in thousands) December 31, 2019 December 31, 2018 Net revenues from external customers % Variance North America $ 2,534,336 $ 2,461,633 3.0 % Europe 1,178,441 1,215,299 (3.0) % Australasia 576,984 669,915 (13.9) % Total Consolidated $ 4,289,761 $ 4,346,847 (1.3) % Percentage of total consolidated net revenues North America 59.1 % 56.6 % Europe 27.5 % 28.0 % Australasia 13.4 % 15.4 % Total Consolidated 100.0 % 100.0 % Adjusted EBITDA (1) North America $ 267,335 $ 279,526 (4.4) % Europe 116,193 122,810 (5.4) % Australasia 74,484 90,885 (18.0) % Corporate and Unallocated costs (42,974) (34,003) 26.4 % Total Consolidated $ 415,038 $ 459,218 (9.6) % Adjusted EBITDA as a percentage of segment net revenues North America 10.5 % 11.4 % Europe 9.9 % 10.1 % Australasia 12.9 % 13.6 % Total Consolidated 9.7 % 10.6 % (1) Adjusted EBITDA is a financial measure that is not calculated in accordance with GAAP. For a discussion of our presentation of Adjusted EBITDA, see Note 16 - Segment Information in our consolidated financial statements. North America Net revenues in North America increased $72.7 million, or 3.0%, to $2,534.3 million in the year ended December 31, 2019 from $2,461.6 million in the year ended December 31, 2018. The increase was primarily due to a 5% increase attributable to the acquisitions of ABS and VPI, partially offset by a 2% decrease in core revenues. Core revenue decline included a 5% decrease in volume/mix, offset by a 3% increase in price. Adjusted EBITDA in North America decreased $12.2 million, or 4.4%, to $267.3 million in the year ended December 31, 2019 from $279.5 million in the year ended December 31, 2018. The decrease was primarily due to lower core volumes, the non-recurrence of proceeds of a 2018 legal settlement of $7.5 million, and increased costs related to operating inefficiencies, partially offset by favorable pricing and the contributions from our ABS and VPI acquisitions. Europe Net revenues in Europe decreased $36.9 million, or 3.0%, to $1,178.4 million in the year ended December 31, 2019 from $1,215.3 million in the year ended December 31, 2018. The decrease was primarily due to an unfavorable foreign exchange impact of 6%, partially offset by a 2% increase attributable to the acquisition of Domoferm and core revenue growth of 1%, which included a 2% increase in price offset by a decrease in volume/mix. Adjusted EBITDA in Europe decreased $6.6 million, or 5.4%, to $116.2 million in the year ended December 31, 2019 from $122.8 million in the year ended December 31, 2018. The decrease was primarily due to the impact of unfavorable foreign exchange, unfavorable revenue mix, and higher SG&A costs, partially offset by improved productivity and favorable pricing. 53 Back to top Australasia Net revenues in Australasia decreased $92.9 million, or 13.9%, to $577.0 million in the year ended December 31, 2019 from $669.9 million in the year ended December 31, 2018. The decrease was due primarily to a decrease in core revenues of 10% and unfavorable foreign exchange rates of 6%, partially offset by a 2% increase attributable to the acquisition of A&L. Adjusted EBITDA in Australasia decreased $16.4 million, or 18.0%, to $74.5 million in the year ended December 31, 2019 from $90.9 million in the year ended December 31, 2018. The decrease was primarily due to lower volumes from market headwinds and unfavorable mix, partially offset by improved productivity and reduced SG&A. Liquidity and Capital Resources Overview We have historically funded our operations through a combination of cash from operations, draws on our revolving credit facilities, factoring agreements, and the issuance of non-revolving debt such as our Term Loan Facility, Senior Notes, and Senior Secured Notes. Working capital, which we define as accounts receivable plus inventory less accounts payable, fluctuates throughout the year and is affected by the seasonality of sales of our products, customer payment patterns, and the translation of the balance sheets of our foreign operations into the U.S. dollar. Typically, working capital increases at the end of the first quarter and beginning of the second quarter in conjunction with, and in preparation for, the peak season for home construction and remodeling in our North America and Europe segments, which represent the substantial majority of our revenues, and decreases starting in the fourth quarter as inventory levels and accounts receivable decline. Inventories fluctuate for raw materials with long delivery lead times, such as steel, as we work through prior shipments and take delivery of new orders. As of December 31, 2020, our cash balances, including $0.8 million of restricted cash, consisted of $383.0 million in the U.S. and $353.6 million in non-U.S. subsidiaries. In May 2020, we issued $250.0 million in Senior Secured Notes, the proceeds of which were used to repay the outstanding balance under our ABL Facility with the remainder to be used for general corporate purposes. In addition, we increased the borrowing base and availability under our ABL Facility by $40.1 million with the accounts receivable and inventory of certain recently acquired U.S. businesses and amended our Australia Senior Credit Facility to add AUD 30.0 million of additional revolving loan capacity. Although there is uncertainty surrounding the anticipated impact of the COVID-19 pandemic on our operating results and liquidity, based on our current level of operations, the seasonality of our business and anticipated growth, we believe that cash provided by operations and other sources of liquidity, including cash, cash equivalents and borrowings under our revolving credit facilities, will provide adequate liquidity for ongoing operations, planned capital expenditures and other investments, and debt service requirements for at least the next twelve months. As of December 31, 2020, we had total liquidity (a non-GAAP measure) of $1,121.5 million, consisting of $735.8 million in unrestricted cash, $346.0 million available for borrowing under the ABL Facility, and AUD 51.6 million ($39.7 million) available for borrowing under the Australia Senior Secured Credit Facility, compared to total liquidity of $554.5 million as of December 31, 2019. The increase in total liquidity was primarily due to the May 2020 Senior Secured Notes issuance, increasing the borrowing base and availability under our ABL Facility, additional capacity under our Australia Senior Credit Facility, and cash provided by operations. We may, from time to time, refinance, reprice, extend, retire or otherwise modify our outstanding debt to lower our interest payments, reduce our debt or otherwise improve our financial position. These actions may include repricing amendments, extensions, and/or opportunistic refinancing of debt. The amount of debt that may be refinanced, repriced, extended, retired or otherwise modified, if any, will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants and other considerations. Our affiliates may also purchase our debt from time to time, through open market purchases or other transactions. In such cases, our debt may not be retired, in which case we would continue to pay interest in accordance with the terms of the debt, and we would continue to reflect the debt as outstanding in our consolidated balance sheets. Based on hypothetical variable rate debt that would have resulted from drawing each revolving credit facility up to the full commitment amount, a 1.0% decrease in interest rates would have reduced our interest expense by $2.4 million for the year ended December 31, 2020. A 1.0% increase in interest rates would have increased our interest expense by $7.4 million for the same period. The impact of these hypothetical changes would have been partially mitigated by interest rate caps and the floors that apply to certain of our debt agreements. Borrowings and Refinancings In the fourth quarter of 2020, we began to include the accounts receivable and inventory balances of certain recently acquired U.S. businesses in determining our availability, which expanded our borrowing base on our U.S. ABL Facility. In May 2020, we issued $250.0 million of Senior Secured Notes, the proceeds of which were used to repay the outstanding balance under our ABL Facility with the remainder to be used for general corporate purposes. In addition, we amended our Australia Senior Credit Facility to add AUD 30.0 million of additional revolving loan capacity. 54 Back to top In December 2019, we amended our ABL facility to reflect current banking regulatory requirements, which did not have a financial impact. In September 2019, we amended the Term Loan Facility to provide for an incremental aggregate principal amount of $125.0 million and used the proceeds to repay $115.0 million of outstanding borrowings under the ABL Facility. In June 2019, we reallocated AUD 5.0 million from the term loan commitment to the interchangeable commitment of the Australia Senior Secured Credit Facility. In December 2018, we amended the ABL Facility, providing for a $100.0 million increase in the U.S. revolving credit commitments. In February 2018, we amended the Australia Senior Secured Credit Facility to include an additional AUD 55.0 million floating rate term loan facility. As of December 31, 2020, we were in compliance with the terms of all of our Credit Facilities and the indentures governing the Senior Notes and Senior Secured Notes. Our results have been and will continue to be impacted by substantial changes in our net interest expense throughout the periods presented and into the future. See Note 13 - Long-Term Debt in our consolidated financial statements for additional details. Cash Flows The following table summarizes the changes to our cash flows for the periods presented: Year Ended (amounts in thousands) December 31, 2020 December 31, 2019 December 31, 2018 Cash provided by (used in): Operating activities $ 355,655 $ 302,709 $ 219,653 Investing activities (82,003) (184,948) (284,141) Financing activities 207,909 (6,411) (67,475) Effect of changes in exchange rates on cash and cash equivalents 25,157 903 (6,648) Net change in cash and cash equivalents $ 506,718 $ 112,253 $ (138,611) Cash Flow from Operations Net cash provided by operating activities increased $52.9 million to $355.7 million in the year ended December 31, 2020 from $302.7 million in the year ended December 31, 2019. The increase in cash provided by operating activities was due primarily to increases in accruals for the deferral of payroll taxes, including $20.9 million as a result of the CARES Act, which will be paid equally over the subsequent two years, legal and environmental matters, and estimated variable compensation. Net cash provided by operating activities increased $83.1 million to $302.7 million in the year ended December 31, 2019 from $219.7 million in the year ended December 31, 2018. The increase in cash provided by operating activities was due primarily to improvement in working capital as a result of optimization of vendor payment terms, lower inventory balances due to reduced core revenue volumes, and reduced cash taxes. Cash Flow from Investing Activities Net cash used in investing activities decreased $102.9 million to $82.0 million in the year ended December 31, 2020 from $184.9 million in the year ended December 31, 2019 primarily due to a decrease in the cash used for acquisitions and a reduction in capital expenditures. Net cash used in investing activities decreased $99.2 million to $184.9 million in the year ended December 31, 2019 from $284.1 million in the year ended December 31, 2018. The decrease was primarily due to a decrease in cash used for acquisitions. Cash Flow from Financing Activities Net cash provided by financing activities was $207.9 million in the year ended December 31, 2020 and consisted primarily of increased borrowings of $210.9 million, partially offset by repurchases of our Common Stock of $5.0 million. Net cash used in financing activities was $6.4 million in the year ended December 31, 2019 and consisted primarily of repurchases of our Common Stock of $20.0 million, partially offset by increased borrowings of $13.1 million. 55 Back to top Net cash used in financing activities in the year ended December 31, 2018 was $67.5 million and was comprised primarily of repurchases of our Common Stock of $125.0 million and payments to tax authorities of $9.5 million, partially offset by increased borrowings of $70.5 million. Holding Company Status We are a holding company that conducts all of our operations through subsidiaries. The majority of our operating income is derived from JWI, our main operating subsidiary. Consequently, we rely on dividends or advances from our subsidiaries. The ability of our subsidiaries to pay dividends to us is subject to applicable local law and may be limited due to the terms of other contractual arrangements, including our Credit Facilities, Senior Notes, and Senior Secured Notes. The Australia Senior Secured Credit Facility also contains restrictions on dividends that limit the amount of cash that the obligors under these facilities can distribute to JWI. Obligors under the Australia Senior Secured Credit Facility may pay dividends only to the extent they do not exceed 80% of after tax net profits (with a one-year carryforward of unused amounts) and only while no default is continuing under such agreement. For further information regarding the Australia Senior Secured Credit Facility, see Note 13 - Long-Term Debt in our consolidated financial statements. The amount of our consolidated net assets that were available to be distributed under our credit facilities as of December 31, 2020 was $674.1 million. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. Contractual Obligations The following table summarizes our significant contractual obligations at December 31, 2020: Payments Due By Period Total Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years (dollars in thousands) Contractual Obligations (1) Long-term debt obligations $ 1,775,525 $ 64,961 $ 77,460 $ 1,204,669 $ 428,435 Finance lease obligations 6,236 1,950 2,945 1,274 67 Operating lease obligations 258,419 53,958 86,532 55,073 62,856 Purchase obligations (2) 31,538 9,885 20,291 1,362 — Interest on long-term debt obligations (3) 359,479 69,401 136,405 112,421 41,252 Totals: $ 2,431,197 $ 200,155 $ 323,633 $ 1,374,799 $ 532,610 ____________________________ (1) Not included in the table above are our unfunded pension liabilities totaling $121.3 million and uncertain tax position liabilities of $21.8 million as of December 31, 2020, for which the timing of payment is unknown. (2) Purchase obligations are defined as purchase agreements that are enforceable and legally binding and that specify all significant terms, including quantity, price, and the approximate timing of the transaction. The obligations reflected in the table primarily relate to raw materials purchase agreements, costs associated with enterprise solutions implementations, sales and marketing, and software hosting services. (3) Interest on long-term debt obligations is calculated based on debt outstanding and interest rates in effect on December 31, 2020, taking into account scheduled maturities and amortization payments. 56 Back to top Critical Accounting Policies and Estimates Our MD&A is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which may differ from these estimates. Our significant accounting policies are fully disclosed in our annual consolidated financial statements included elsewhere in this Form 10-K. The following discussion highlights the estimates we believe are critical and should be read in conjunction with the consolidated financial statements included in Part II, Item 8 of this Form 10-K. Revenue Recognition Revenue is recognized when obligations under the terms of a contract with our customer are satisfied. Generally, this occurs with the transfer of control of our products or services. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. The taxes we collect concurrent with revenue-producing activities (e.g., sales tax, value added tax, and other taxes) are excluded from revenue. Incentive payments to customers that directly relate to future business are recorded as a reduction of net revenues over the periods benefited. Shipping and handling costs are treated as fulfillment costs and are not considered a separate performance obligation. Shipping and handling costs charged to customers and the related expenses are reported in revenues and cost of sales for all customers. The expected costs associated with our base warranties and field service actions continue to be recognized as expense when the products are sold (see Note 12 - Warranty Liability ). Since payment is due at or shortly after the point of sale, the contract asset is classified as a receivable. We do not adjust the promised amount of consideration for the effects of a significant financing component when we expect, at contract inception, that the period between our transfer of a promised product or service to a customer and when the customer pays for that product or service will be one year or less. We do not typically include extended payment terms in our contracts with customers. Incidental items that are immaterial in the context of the contract are recognized as expense. Acquisitions We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. If the fair value of the acquired assets exceeds the purchase price the difference is recorded as a bargain purchase in other income (expense). Such valuations require us to make significant estimates and assumptions, especially with respect to intangible assets. As a result, during the measurement period, which may be up to one year from the acquisition date, material adjustments must be reflected in the comparative consolidated financial statements in the period in which the adjustment amount will be determined. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations. Newly acquired entities are included in our results from the date of their respective acquisitions. Intangible Assets Definite lived intangible assets are amortized on a straight-line basis over their estimated useful lives that typically range from 3 to 40 years. The lives of definite lived intangible assets are reviewed and reduced if necessary, whenever changes in their planned use occur. Legal and registration costs related to internally developed patents and trademarks are capitalized and amortized over the lesser of their expected useful life or the legal patent life. We review the carrying value of intangible assets to assess their recoverability when facts and circumstances indicate that the carrying value may not be recoverable. Long-Lived Assets Long-lived assets, other than goodwill, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business or a change in utilization of property and equipment. We group assets to test for impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the assets. 57 Back to top When evaluating long-lived assets and definite lived intangible assets for potential impairment, the first step to review for impairment is to forecast the expected undiscounted cash flows generated from the anticipated use and eventual disposition of the asset. If the expected undiscounted cash flows are less than the carrying value of the asset, then an impairment charge is required to reduce the carrying value of the asset to fair value. If we recognize an impairment loss, the carrying amount of the asset is adjusted to fair value based on the discounted estimated future net cash flows. For a depreciable long-lived asset, the new cost basis will be depreciated over the remaining useful life of that asset. For an amortizable intangible asset, the new cost basis will be amortized over the remaining useful life of the asset. Our impairment loss calculations require management to apply judgments in estimating future cash flows to determine asset fair values, including forecasting useful lives of the assets and selecting the discount rate that represents the risk inherent in future cash flows. Goodwill Goodwill is tested for impairment on an annual basis during the fourth quarter and between annual tests if indicators of potential impairment exist, using a fair-value-based approach. Current accounting guidance provides an entity the option to perform a qualitative assessment to determine whether it is more-likely-than-not that the fair value of a reporting unit is impaired. If we do not perform a qualitative assessment, or if we determine that it is more likely than not that the fair value of the reporting unit exceeds its carrying amount, we calculate the estimated fair value of the reporting unit. We estimated the fair value of our reporting units using a discounted cash flow model (implied fair value measured on a non-recurring basis using level 3 inputs). Inherent in the development of the discounted cash flow projections are assumptions and estimates derived from a review of our expected revenue and terminal growth rates, profit margins, and cost of capital. Changes in assumptions or estimates used in our goodwill impairment testing could materially affect the determination of the fair value of a reporting unit, and therefore, could eliminate the excess of fair value over carrying value of a reporting unit and, in some cases, could result in impairment. Such changes in assumptions could be caused by items such as a loss of one or more significant customers, decline in the demand for our products due to changing economic conditions, or failure to control cost increases above what can be recouped in sale price increases. These types of changes would negatively affect our profits, revenues, and growth over the long term and such a decline could significantly affect the fair value assessment of our reporting units and cause our goodwill to become impaired. As of December 31, 2020, the fair value of our North America, Europe, and Australasia reporting units would have to decline by approximately 52%, 37%, and 20%, respectively, to be considered for potential impairment. As the carrying value and fair value of the Australasia reporting unit are closely aligned, a material change in the fair value or carrying value would put the reporting unit at risk of goodwill impairment. For example, our ability to realize synergies, revenue growth, and increased margins are key assumptions in our projections of revenue, earnings and cash flows. If our actual experience in future years falls significantly below our current projections, the fair value of the reporting unit could be negatively impacted. Similarly, an increase in interest rates would lower our discounted cash flows and negatively impact the fair value of the reporting unit. We believe our projections and assumptions are reasonable, but it is possible they could change, impacting our fair value estimate, or the carrying value could change. Warranty Accrual Warranty terms range primarily from one year to lifetime on certain window and door components. Warranties are normally limited to replacement or service of defective components for the original customer. Some warranties are transferable to subsequent owners and are generally limited to ten years from the date of manufacture or require pro-rata payments from the customer. A provision for estimated warranty costs is recorded at the time of sale based on historical experience and we periodically adjust these provisions to reflect actual experience. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We evaluate both the positive and negative evidence that is relevant in assessing whether we will realize the deferred tax assets. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. This projected realization is directly related to our future projections of the performance of our business and 58 Back to top management’s planning initiatives at any point in time. As a result, valuation allowances are subject to change as proven business trends and planning initiatives develop. The Tax Act passed in December 2017 continues to have significant effects on our financial statements primarily through Treasury regulations, whether proposed or final, which continue to be issued in relation to specific provisions of the Tax Act. In accordance with Staff Accounting Bulletin No.118 issued by the SEC in December 2017 immediately following the passage of the Tax Act, we made provisional estimates for certain direct and indirect effects of the Tax Act based on information available to us for the year ended December 31, 2017. In the fourth quarter of 2018, we completed our accounting for the enactment-date income tax effects of the Tax Act and recorded any adjustments as a component of income tax expense from continuing operations. The Tax Act subjects a U.S. shareholder to current tax on GILTI earned by certain foreign subsidiaries. We have elected to account for the impact of GILTI in the period in which it is incurred. The tax effects from an uncertain tax position can be recognized in the consolidated financial statements only if the position is more likely than not to be sustained, based on the technical merits of the position and the jurisdiction. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit and the tax related to the position would be due to the entity and not the owners. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized, upon ultimate settlement with the relevant tax authority. We apply this accounting standard to all tax positions for which the statute of limitations remains open. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We file a consolidated federal income tax return in the U.S. and various states. For financial statement purposes, we calculate the provision for federal income taxes using the separate return method. Certain subsidiaries file separate tax returns in certain countries and states. Any U.S. federal, state and foreign income taxes refundable and payable are reported in other current assets and other current liabilities in the consolidated balance sheets as of December 31, 2020 and December 31, 2019. We record interest and penalties on amounts due to tax authorities as a component of income tax expense in the consolidated statements of operations. Contingent Liabilities Contingent liabilities require significant judgment in estimating potential losses for legal claims. Each quarter, we review significant new claims and litigation for the probability of an adverse outcome. Estimates are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will materially exceed the recorded provision. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analysis of multiple forecasts that often depend on judgments about potential actions by third parties such as regulators, and the estimated loss can change materially as individual claims develop. Share-based Compensation Plan We have share-based compensation plans that provide for compensation to employees through various grants of share-based instruments. We apply the fair value method of accounting using the Black-Scholes option pricing model to determine the compensation expense for stock appreciation rights. The compensation expense for RSU awarded is based on the fair value of the RSU at the date of grant. Compensation expense is recorded in the consolidated statements of operations and is recognized over the requisite service period. The determination of obligations and compensation expense requires the use of several mathematical and judgmental factors, including stock price, expected volatility, the anticipated life of the option, estimated risk-free rate, and the number of shares or share options expected to vest. Any difference in the number of shares or share options that actually vest can affect future compensation expense. Other assumptions are not revised after the original estimate. For stock options granted, we prepare the valuations with the assistance of a third-party valuation firm, utilizing approaches and methodologies consistent with the AICPA Practice Aid. The Black-Scholes option-pricing model requires the use of weighted average assumptions for estimated expected volatility, estimated expected term of stock options, risk-free rate, estimated expected dividend yield, and the fair value of the underlying common stock at the date of grant. We estimate the expected term of all stock options based on previous history of exercises. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the stock option. The expected dividend yield rate is 0% which is consistent with the expected dividends to be paid on common stock. The number of PSUs that vest is determined by a payout factor consisting of equally weighted performance measures of Adjusted EBITDA and free cash flow, each as reported over the applicable three year performance period and is adjusted based upon a market condition measured by our relative total shareholder return (“TSR”) over the applicable three year performance period as compared to the TSR of the Russell 3000 index. The fair value of the award is estimated using a Monte Carlo simulation approach in a risk-neutral framework to model future stock price movements based on historical volatility, risk free rates of return, and correlation matrix. 59 Back to top We estimate forfeitures based on our historical analysis of actual stock option forfeitures. Actual forfeitures are recorded when incurred and estimated forfeitures are reviewed and adjusted at least annually. Employee Retirement and Pension Benefits The obligations under our defined benefit pension plans are calculated using actuarial models and methods. The most critical assumption and estimate used in the actuarial calculations is the discount rate for determining the current value of benefit obligations. Other assumptions and estimates used in determining benefit obligations and plan expenses include expected return on plan assets, inflation rates, and demographic factors such as retirement age, mortality, and turnover. These assumptions and estimates are evaluated periodically and are updated accordingly to reflect our actual experience and expectations. The discount rate used to determine the benefit obligations was computed through a projected benefit cash flow model. This approach determines the discount rate as the rate that equates the present value of the cash flows (determined using that single rate) to the present value of the cash flows where each cash flows' present value is determined using the spot rates from the Willis Towers Watson RATE: Link 10:90 Yield Curve. The discount rate utilized to calculate the projected benefit obligation at the measurement date for our U.S. pension plan decreased to 2.55% at December 31, 2020 from 3.31% at December 31, 2019. As the discount rate is reduced or increased, the pension and post retirement obligation would increase or decrease, respectively, and future pension and post-retirement expense would increase or decrease, respectively. Lowering the discount rate by 0.25% would increase the U.S. pension and post-retirement obligation at December 31, 2020 by approximately $16.4 million and would increase estimated fiscal year 2021 expense by approximately $1.7 million. Increasing the discount rate by 0.25% would decrease the U.S. pension and post-retirement obligation at December 31, 2020 by approximately $15.6 million and would decrease estimated fiscal year 2021 expense by approximately $1.7 million. We determine the expected long-term rate of return on plan assets based on the plan assets’ historical long-term investment performance, current asset allocation, and estimates of future long-term returns by asset class. Holding all other assumptions constant, a 1% increase or decrease in the assumed rate of return on plan assets would have decreased or increased, respectively, 2020 net periodic pension expense by approximately $3.9 million. The actuarial assumptions we use in determining our pension benefits may differ materially from actual results because of changing market and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience or changes in assumptions might materially affect our financial position or results of operations. Capital Expenditures We expect that the majority of our capital expenditures will be focused on supporting our cost reduction and efficiency improvement projects, certain growth initiatives, and to a lesser extent, on sustaining our current manufacturing operations. We are subject to health, safety, and environmental regulations that may require us to make capital expenditures to ensure our facilities are compliant with those various regulations .