Item 1. Financial Statements
Item 1. Financial Statements
QUANEX BUILDING PRODUCTS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
July 31,
2020 October 31,
2019
(In thousands, except share
amounts)
ASSETS
Current assets:
Cash and cash equivalents $ 41,073 $ 30,868
Accounts receivable, net of allowance for doubtful accounts of $ 344 and $ 393
84,479 82,946
Inventories, net 63,939 67,159
Prepaid and other current assets 7,930 9,353
Total current assets 197,421 190,326
Property, plant and equipment, net of accumulated depreciation of $ 334,664 and $ 317,568
186,830 193,600
Operating lease right-of-use assets 49,644 —
Goodwill 146,932 145,563
Intangible assets, net 96,957 107,297
Other assets 9,007 8,324
Total assets $ 686,791 $ 645,110
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 58,676 $ 63,604
Accrued liabilities 33,916 39,221
Income taxes payable 6,350 6,183
Current maturities of long-term debt 690 746
Current operating lease liabilities 7,307 —
Total current liabilities 106,939 109,754
Long-term debt 152,062 156,414
Noncurrent operating lease liabilities 42,740 —
Deferred pension and postretirement benefits 11,375 13,322
Deferred income taxes 20,507 19,363
Other liabilities 13,230 16,070
Total liabilities 346,853 314,923
Commitments and contingencies
Stockholders’ equity:
Preferred stock, no par value, shares authorized 1,000,000 ; issued and outstanding - none
— —
Common stock, $ 0.01 par value, shares authorized 125,000,000 ; issued 37,304,366 and 37,370,402 , respectively; outstanding 32,801,738 and 33,021,789 , respectively
373 374
Additional paid-in-capital 253,144 254,673
Retained earnings 193,989 185,703
Accumulated other comprehensive loss ( 28,819 ) ( 33,817 )
Less: Treasury stock at cost, 4,502,628 and 4,348,613 shares, respectively
( 78,749 ) ( 76,746 )
Total stockholders’ equity 339,938 330,187
Total liabilities and stockholders' equity $ 686,791 $ 645,110
The accompanying notes are an integral part of the financial statements.
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QUANEX BUILDING PRODUCTS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Unaudited)
Three Months Ended Nine Months Ended
July 31, July 31,
2020 2019 2020 2019
(In thousands, except per share amounts)
Net sales $ 212,096 $ 238,461 $ 596,168 $ 653,472
Cost and expenses:
Cost of sales (excluding depreciation and amortization) 162,427 181,357 469,586 511,292
Selling, general and administrative 21,973 25,718 62,818 77,466
Restructuring charges 73 94 477 281
Depreciation and amortization 11,060 12,182 35,851 37,158
Asset impairment charges — — — 29,978
Operating income (loss) 16,563 19,110 27,436 ( 2,703 )
Non-operating (expense) income:
Interest expense ( 1,165 ) ( 2,570 ) ( 4,310 ) ( 7,614 )
Other, net ( 220 ) 259 116 461
Income (loss) before income taxes 15,178 16,799 23,242 ( 9,856 )
Income tax expense ( 4,345 ) ( 4,958 ) ( 6,898 ) ( 5,926 )
Net income (loss) $ 10,833 $ 11,841 $ 16,344 $ ( 15,782 )
Basic earnings (loss) per common share $ 0.33 $ 0.36 $ 0.50 $ ( 0.48 )
Diluted earnings (loss) per common share: $ 0.33 $ 0.36 $ 0.50 $ ( 0.48 )
Weighted-average common shares outstanding:
Basic 32,610 32,899 32,716 32,984
Diluted 32,739 33,162 32,845 32,984
Cash dividends per share
$ 0.08 $ 0.08 $ 0.24 $ 0.24
The accompanying notes are an integral part of the financial statements.
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QUANEX BUILDING PRODUCTS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
Three Months Ended Nine Months Ended
July 31, July 31,
2020 2019 2020 2019
(In thousands)
Net income (loss) $ 10,833 $ 11,841 $ 16,344 $ ( 15,782 )
Other comprehensive income:
Foreign currency translation gain (loss) 7,344 ( 10,147 ) 3,088 ( 7,565 )
Change in pension from net unamortized gain (loss) adjustment (pretax) — — 2,519 ( 11 )
Change in pension from net unamortized gain (loss) adjustment tax (expense) benefit — — ( 609 ) 7
Other comprehensive income (loss) 7,344 ( 10,147 ) 4,998 ( 7,569 )
Comprehensive income (loss) $ 18,177 $ 1,694 $ 21,342 $ ( 23,351 )
The accompanying notes are an integral part of the financial statements.
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QUANEX BUILDING PRODUCTS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
July 31,
2020 2019
(In thousands)
Operating activities:
Net income (loss) $ 16,344 $ ( 15,782 )
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Depreciation and amortization 35,851 37,158
Stock-based compensation 513 1,424
Deferred income tax 438 1,930
Asset impairment charges — 29,978
Other, net 762 1,724
Changes in assets and liabilities:
(Increase) decrease in accounts receivable ( 1,852 ) 323
Decrease (increase) in inventory 3,553 ( 14,747 )
Decrease (increase) in other current assets 1,218 ( 1,022 )
(Decrease) increase in accounts payable ( 1,878 ) 1,562
Decrease in accrued liabilities ( 7,611 ) ( 15,366 )
Increase in income taxes payable 107 396
Increase in deferred pension and postretirement benefits 573 2,351
Decrease in other long-term liabilities ( 181 ) ( 143 )
Other, net ( 276 ) 250
Cash provided by operating activities 47,561 30,036
Investing activities:
Capital expenditures ( 20,673 ) ( 16,984 )
Proceeds from disposition of capital assets 131 315
Cash used for investing activities ( 20,542 ) ( 16,669 )
Financing activities:
Borrowings under credit facilities 114,500 66,500
Repayments of credit facility borrowings ( 119,000 ) ( 84,000 )
Repayments of other long-term debt ( 791 ) ( 1,102 )
Common stock dividends paid ( 7,910 ) ( 7,990 )
Issuance of common stock 2,954 2,710
Payroll tax paid to settle shares forfeited upon vesting of stock ( 454 ) ( 330 )
Purchase of treasury stock ( 6,693 ) ( 6,336 )
Cash used for financing activities ( 17,394 ) ( 30,548 )
Effect of exchange rate changes on cash and cash equivalents 580 ( 1,171 )
Increase (decrease) in cash and cash equivalents 10,205 ( 18,352 )
Cash and cash equivalents at beginning of period 30,868 29,003
Cash and cash equivalents at end of period $ 41,073 $ 10,651
The accompanying notes are an integral part of the financial statements.
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QUANEX BUILDING PRODUCTS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
Nine Months Ended July 31, 2020 Common
Stock Additional
Paid-in
Capital Retained
Earnings Accumulated
Other
Comprehensive Loss Treasury
Stock Total
Stockholders’
Equity
(In thousands, no per share amounts shown except in verbiage)
Balance at October 31, 2019 $ 374 $ 254,673 $ 185,703 $ ( 33,817 ) $ ( 76,746 ) $ 330,187
Net income — — 10 — — 10
Foreign currency translation adjustment — — — 2,743 — 2,743
Common dividends ($0.08 per share) — — ( 2,659 ) — — ( 2,659 )
Purchase of treasury stock — — — — ( 4,639 ) ( 4,639 )
Change in pension from net unamortized gain (net of tax expense of $609) — — — 1,910 — 1,910
Stock-based compensation activity:
Stock-based compensation benefit — ( 239 ) — — — ( 239 )
Stock options exercised — 92 ( 159 ) — 3,142 3,075
Restricted stock awards granted — ( 1,082 ) 94 — 988 —
Performance share awards vested — ( 495 ) — — 495 —
Other ( 1 ) ( 454 ) — — — ( 455 )
Balance at January 31, 2020 $ 373 $ 252,495 $ 182,989 $ ( 29,164 ) $ ( 76,760 ) $ 329,933
Net income — — 5,501 — — 5,501
Foreign currency translation adjustment — — — ( 6,999 ) — ( 6,999 )
Common dividends ($0.08 per share) — — ( 2,628 ) — — ( 2,628 )
Purchase of treasury stock — — — — ( 2,054 ) ( 2,054 )
Stock-based compensation activity:
Expense related to stock-based compensation — 325 — — — 325
Stock options exercised — ( 38 ) ( 83 ) — — ( 121 )
Restricted stock awards granted — ( 65 ) — — 65 —
Balance at April 30, 2020 $ 373 $ 252,717 $ 185,779 $ ( 36,163 ) $ ( 78,749 ) $ 323,957
Net income — — 10,833 — — 10,833
Foreign currency translation adjustment — — — 7,344 — 7,344
Common dividends ($0.08 per share) — — ( 2,623 ) — — ( 2,623 )
Stock-based compensation activity:
Expense related to stock-based compensation — 427 — — — 427
Balance at July 31, 2020 $ 373 $ 253,144 $ 193,989 $ ( 28,819 ) $ ( 78,749 ) $ 339,938
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Nine Months Ended July 31, 2019 Common
Stock Additional
Paid-in
Capital Retained
Earnings Accumulated
Other
Comprehensive Loss Treasury
Stock Total
Stockholders’
Equity
(In thousands, no per share amounts shown except in verbiage)
Balance at October 31, 2018 $ 374 $ 254,678 $ 243,904 $ ( 30,705 ) $ ( 73,029 ) $ 395,222
Net loss — — ( 3,649 ) — — ( 3,649 )
Foreign currency translation adjustment — — — 4,066 — 4,066
Common dividends ($0.08 per share) — — ( 2,675 ) — — ( 2,675 )
Purchase of treasury stock — — — — ( 2,016 ) ( 2,016 )
Stock-based compensation activity:
Expense related to stock-based compensation — 224 — — — 224
Stock options exercised — — ( 35 ) — 62 27
Restricted stock awards granted — ( 1,649 ) ( 496 ) — 2,145 —
Other — ( 322 ) — ( 4 ) — ( 326 )
Balance at January 31, 2019 $ 374 $ 252,931 $ 237,049 $ ( 26,643 ) $ ( 72,838 ) $ 390,873
Net income — — ( 23,974 ) — — ( 23,974 )
Foreign currency translation adjustment — — — ( 1,484 ) — ( 1,484 )
Common dividends ($0.08 per share) — — ( 2,660 ) — — ( 2,660 )
Purchase of treasury stock — — — — ( 2,686 ) ( 2,686 )
Stock-based compensation activity:
Expense related to stock-based compensation — 819 — — — 819
Restricted stock awards granted — ( 71 ) ( 9 ) — 80 —
Balance at April 30, 2019 $ 374 $ 253,679 $ 210,406 $ ( 28,127 ) $ ( 75,444 ) $ 360,888
Net income — — 11,841 — — 11,841
Foreign currency translation adjustment — — — ( 10,147 ) — ( 10,147 )
Common dividends ($0.04 per share) — — ( 2,655 ) — — ( 2,655 )
Purchase of treasury stock — — — — ( 1,634 ) ( 1,634 )
Change in pension from net unamortized loss (net of tax expense of $7)
Stock-based compensation activity:
Expense related to stock-based compensation — 381 — — — 381
Stock options exercised 1 — ( 252 ) — 2,935 2,684
Other ( 1 ) ( 7 ) — — — ( 8 )
Balance at July 31, 2019 $ 374 $ 254,053 $ 219,340 $ ( 38,274 ) $ ( 74,143 ) $ 361,350
The accompanying notes are an integral part of the financial statements.
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Operations and Basis of Presentation
Quanex Building Products Corporation is a component supplier to original equipment manufacturers (OEMs) in the building products industry. These components can be categorized as window and door (fenestration) components and kitchen and bath cabinet components. Examples of fenestration components include: (1) energy-efficient flexible insulating glass spacers, (2) extruded vinyl profiles, (3) window and door screens, and (4) precision-formed metal and wood products. We also manufacture cabinet doors and other components for OEMs in the kitchen and bathroom cabinet industry. In addition, we provide certain other non-fenestration components and products, which include solar panel sealants, trim moldings, vinyl decking, fencing, water retention barriers, and conservatory roof components. We have organized our business into three reportable business segments. For additional discussion of our reportable business segments, see Note 12, "Segment Information." We use low-cost, short lead-time production processes and engineering expertise to provide our customers with specialized products for their specific window, door, and cabinet applications. We believe these capabilities provide us with unique competitive advantages. We serve a primary customer base in North America and the United Kingdom (U.K.), and also serve customers in international markets through our operating plants in the U.K. and Germany, as well as through sales and marketing efforts in other countries.
Unless the context indicates otherwise, references to "Quanex", the "Company", "we", "us" and "our" refer to the consolidated business operations of Quanex Building Products Corporation and its subsidiaries.
The accompanying interim condensed consolidated financial statements include the accounts of Quanex Building Products Corporation. All intercompany accounts and transactions have been eliminated in consolidation. These financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated balance sheet as of October 31, 2019 was derived from audited financial information, but does not include all disclosures required by U.S. GAAP. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2019. In our opinion, the accompanying financial statements contain all adjustments (which consist of normal recurring adjustments, except as disclosed herein) necessary to fairly present our financial position, results of operations and cash flows for the interim periods. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year or for any future periods.
In preparing financial statements, we make informed judgments and estimates that affect the reported amounts of assets and liabilities as of the date of the financial statements and affect the reported amounts of revenues and expenses during the reporting period. We review our estimates on an on-going basis, including those related to impairment of long lived assets and goodwill, contingencies and income taxes. Changes in facts and circumstances may result in revised estimates and actual results may differ from these estimates.
Revenue from Contracts with Customers
Revenue recognition
We recognize revenue that reflects the consideration we expect to receive for product sales upon transfer to customers. Revenue for product sales is recognized when control of the promised products is actually transferred to our customers, and we expect to be entitled to consideration in exchange for such transfer. We account for a contract when a customer provides us with a firm purchase order that identifies the products to be provided, the payment terms for those services, and when collectability of the consideration due is probable.
Performance obligations
A performance obligation is a promise to provide the customer with a good or service. Our performance obligations include product sales, with each product included in a customer contract being recognized as a separate performance obligation. For contracts with multiple performance obligations, the standalone selling price of each product is generally readily observable.
Revenue from product sales is recognized at a point in time when the product is transferred to the customer, in accordance with the shipping terms, which is generally upon shipment. We estimate a provision for sales returns and warranty allowances to account for product returns related to general returns and product nonconformance.
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Pricing and sales incentives
Pricing is established at or prior to the time of sale with our customers and we record sales at the agreed-upon net selling price, reflective of current and prospective discounts.
Practical expedients and exemptions
We generally expense incremental costs of obtaining a contract when incurred because the amortization period would be less than one year. Additionally, we do not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.
Shipping and handling costs
We account for shipping and handling services as fulfillment services; accordingly, freight revenue is combined with the product deliverable rather than being accounted for as a distinct performance obligation within the terms of the agreement. Shipping and handling costs incurred by us for the delivery of goods to customers are considered a cost to fulfill the contract and are included in Cost of sales in the accompanying Condensed Consolidated Statements of Income.
Contract assets and liabilities
Deferred revenue, which is not significant, is recorded when we have remaining unsatisfied performance obligations for which we have received consideration.
Disaggregation of revenue
We produce a wide variety of products that are used in the fenestration industry, including window spacer systems; extruded vinyl products; metal fabricated products; and astragals, thresholds and screens. In addition, we produce certain non-fenestration products, including kitchen and bath cabinet doors and components, flooring and trim moldings, solar edge tape, plastic decking, fencing, water retention barriers, conservatory roof components, and other products.
The following table summarizes our product sales for the three and nine months ended July 31, 2020 and 2019 into groupings by segment which we believe depicts how the nature, amount, timing and uncertainty of our revenues and cash flows are affected by economic factors. For further details regarding our results by segment, refer to Note 12, “Segment Information”.
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended Nine Months Ended
July 31, July 31,
2020 2019 2020 2019
(In thousands)
North American Fenestration:
United States - fenestration $ 109,455 $ 119,481 $ 302,094 $ 312,509
International - fenestration 6,696 7,172 19,284 23,474
United States - non-fenestration 4,845 3,982 13,779 12,290
International - non-fenestration 1,390 5,624 6,275 12,381
$ 122,386 $ 136,259 $ 341,432 $ 360,654
European Fenestration:
International - fenestration $ 31,904 $ 36,342 $ 87,732 $ 102,038
International - non-fenestration 6,361 7,984 16,498 19,165
$ 38,265 $ 44,326 $ 104,230 $ 121,203
North American Cabinet Components:
United States - fenestration $ 2,666 $ 3,561 $ 8,461 $ 9,909
United States - non-fenestration 48,849 54,512 142,838 163,694
International - non-fenestration 410 616 1,335 1,774
$ 51,925 $ 58,689 $ 152,634 $ 175,377
Unallocated Corporate & Other
Eliminations $ ( 480 ) $ ( 813 ) $ ( 2,128 ) $ ( 3,762 )
$ ( 480 ) $ ( 813 ) $ ( 2,128 ) $ ( 3,762 )
Net sales $ 212,096 $ 238,461 $ 596,168 $ 653,472
Restructuring
We accrue one-time severance costs pursuant to an approved plan of restructuring at the communication date, when affected employees have been notified of the potential severance and sufficient information has been provided for the employee to calculate severance benefits, in the event the employee is involuntarily terminated. In addition, we accrue costs associated with the termination of contractual commitments including operating leases at the time the lease is terminated pursuant to the lease provisions or in accordance with another agreement with the landlord. Otherwise, we continue to recognize operating lease expense through the cease-use date. After the cease-use date, we determine if our operating lease payments are at market. We assume sublet of the facility at the market rate. To the extent our lease obligations exceed the fair value rentals, we discount to arrive at the present value and record a liability. If the facility is not sublet, we expense the amount of the rental in the current period. For other costs directly related to the restructuring effort, such as equipment moving costs, we expense in the period incurred.
During the year ended October 31, 2019, our North American Cabinet Components segment experienced declines in current and forecasted demand as a result of an industry-wide shift from semi-custom cabinets to stock cabinets, and received notice about a change in strategy at one of our large customers that may result in lower sales volumes in the future. As a result, during the first quarter of fiscal 2020, we began to restructure our operations within that segment by announcing the closure of one of our plants. We incurred expenses for severance, equipment moves, and other exit activities of $ 0.3 million related to this plant closure during the nine months ended July 31, 2020 and we may incur costs related to additional restructuring activities in future periods.
COVID-19 Impact
On March 11, 2020, the World Health Organization (WHO) declared the outbreak of COVID-19 as a global pandemic and advised aggressive containment action. In response to this declaration and the rapid global spread of COVID-19, national, state, and local governments have taken extraordinary and continuously evolving measures to limit the outbreak and spread of the virus, including travel bans, quarantines, "stay-at-home" orders and similar mandates imposing varying degrees of restrictions on social and non-essential commercial activity to promote social distancing. Measures providing for business shutdowns generally exclude certain essential services commonly including critical infrastructure such as construction and the
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
businesses that support that critical infrastructure. To date, we have not experienced significant challenges or expenses implementing crisis management plans intended to meet government requirements for containment and prevention.
The COVID-19 pandemic and actions taken in response thereto are continuing to have an adverse effect on many sectors of the economy. We initially reduced operating schedules and implemented furloughs to balance production and demand, but all facilities were reopened during May 2020. However, the duration and severity of the COVID-19 pandemic, the actions to contain the pandemic and treat its impacts, and the effects on our operations are highly uncertain and cannot be predicted at this time. Therefore, while we expect some negative impacts on our business, results of operations, cash flows and financial position, the overall financial impact cannot be reasonably estimated at this time.
Additionally, in response to the current business environment as impacted by COVID-19, we are reducing capital expenditures and discretionary spending as well as closely monitoring our working capital needs.
As a result of the economic and business impact of COVID-19, we may be required to revise certain accounting estimates and judgments such as, but not limited to, those related to the valuation of goodwill, intangibles, right-of-use assets, long-lived assets, accounts receivable (including allowances for credit losses), and inventory, which could have a material adverse effect on our financial position and results of operations.
2. Leases
Effective November 1, 2019, we adopted Accounting Standards Codification Topic 842, "Leases" (ASC Topic 842), which requires leases to be recognized on the balance sheet. We recognize a right-of-use (ROU) asset and lease liability for each operating and finance lease with a contractual term greater than 12 months at the time of lease inception. We include ROU assets and lease liabilities for leases that exist within other contracts. Leases with an original term of 12 months or less are not recognized on the balance sheet, and the rent expense related to those short-term leases is recognized over the lease term. We do not account for lease and non-lease (e.g. common area maintenance) components of contracts separately for any underlying asset class.
We lease certain manufacturing plants, warehouses, office space, vehicles and equipment under finance and operating leases. Lease commencement occurs on the date we take possession or control of the property or equipment. Original terms for our real estate-related leases are generally between five and twenty years . Original terms for equipment-related leases, primarily manufacturing equipment and vehicles, are generally between one and ten years . Some of our leases also include rental escalation clauses. Renewal options are included in the determination of lease payments when management determines the options are reasonably certain of exercise, considering financial performance, strategic importance and/or invested capital.
If readily determinable, the rate implicit in the lease is used to discount lease payments to present value; however, substantially all of our leases do not provide a readily determinable implicit rate. When the implicit rate is not determinable, our estimated incremental borrowing rate is utilized, determined on a collateralized basis, to discount lease payments based on information available at lease commencement.
Total lease costs recorded include fixed operating lease costs and variable lease costs. Most of our real estate leases require we pay certain expenses, such as common area maintenance costs, of which the fixed portion is included in operating lease costs. We recognize operating lease costs on a straight-line basis over the lease term. In addition to the above costs, variable lease costs are recognized when probable and are not included in determining the present value of our lease liability.
The ROU asset is measured at the initial amount of the lease liability adjusted for lease payments made at or before the lease commencement date and initial direct costs. For operating leases, ROU assets are reduced over the lease term by the recognized straight-line lease expense less the amount of accretion of the lease liability determined using the effective interest method. For finance leases, ROU assets are amortized on a straight-line basis over the shorter of the useful life of the leased asset or the lease term. Interest expense on each finance lease liability is recognized utilizing the effective interest method. ROU assets are tested for impairment in the same manner as long-lived assets. Additionally, we monitor for events or changes in circumstances that may require a reassessment of one of our leases and determine if a remeasurement is required.
The table below presents the lease-related assets and liabilities recorded on the balance sheet at July 31, 2020 (in thousands):
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Leases Classification July 31, 2020
Assets
Operating lease assets Operating lease right-of-use assets $ 49,644
Finance lease assets Property, plant and equipment (less accumulated depreciation of $821) 14,960
Total lease assets $ 64,604
Liabilities
Current
Operating Current operating lease liabilities $ 7,307
Finance Current maturities of long-term debt 961
Noncurrent
Operating Noncurrent operating lease liabilities 42,740
Finance Long-term debt 14,637
Total lease liabilities $ 65,645
The table below presents the components of the lease costs for the three and nine months ended July 31, 2020 (in thousands):
Three Months Ended Nine Months Ended
July 31, 2020 July 31, 2020
Components of lease costs
Operating lease cost $ 2,243 $ 6,464
Finance lease cost
Amortization of leased assets 285 899
Interest on lease liabilities 136 418
Variable lease costs 207 535
Total lease cost $ 2,871 $ 8,316
The table below presents supplemental cash flow information related to leases for the six months ended July 31, 2020 (in thousands):
Nine Months Ended
July 31, 2020
Supplemental Cash Flow Information
Cash paid for amounts included in the measurement of lease liabilities:
Finance leases - financing cash flows $ 857
Finance leases - operating cash flows $ 418
Operating leases - operating cash flows $ 6,400
Right-of-use assets obtained in exchange for lease liabilities
Operating leases $ 15,331
Finance Leases $ 398
The table below presents the weighted average remaining lease terms and weighted average discount rates for the Company's leases as of July 31, 2020:
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
July 31, 2020
Weighted average remaining lease term (in years)
Operating leases 8.2
Financing leases 15.5
Weighted average discount rate
Operating leases 3.62 %
Financing leases 3.62 %
The table below presents the maturity of the lease liabilities as of July 31, 2020 (in thousands):
Operating Leases Finance Leases
(in thousands)
2020 (remaining three months) $ 2,271 $ 378
2021 8,762 1,510
2022 8,028 1,463
2023 7,592 1,364
2024 6,816 1,260
Thereafter 24,292 14,114
Total lease payments 57,761 20,089
Less: present value discount 7,714 4,491
Total lease liabilities $ 50,047 $ 15,598
As a result of the adoption of ASC Topic 842, we are required to present future minimum lease payments for operating and financing obligations having initial or remaining non-cancelable lease terms in excess of one year. These future minimum lease payments were previously disclosed in our 2019 Annual Report on Form 10-K and accounted for under previous lease guidance. Commitments as of October 31, 2019 were as follows:
Operating Leases Capital Leases
(in thousands)
2020 $ 9,121 $ 1,020
2021 6,981 810
2022 6,012 815
2023 5,506 973
2024 4,699 713
Thereafter 15,220 11,392
Total 47,539 15,723
Less: amount representing interest 5,064
Present value of minimum lease payments 10,659
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Inventories
Inventories consisted of the following at July 31, 2020 and October 31, 2019:
July 31,
2020 October 31,
2019
(In thousands)
Raw materials $ 35,205 $ 32,818
Finished goods and work in process 33,418 35,538
Supplies and other 2,470 2,593
Total 71,093 70,949
Less: Inventory reserves 7,154 3,790
Inventories, net $ 63,939 $ 67,159
Fixed costs related to excess manufacturing capacity, if any, have been expensed in the period they were incurred and, therefore, are not capitalized into inventory.
4. Goodwill and Intangible Assets
Goodwill
The change in the carrying amount of goodwill for the nine months ended July 31, 2020 was as follows:
Nine Months Ended
July 31, 2020
(In thousands)
Beginning balance as of November 1, 2019 $ 145,563
Foreign currency translation adjustment 1,369
Balance as of the end of the period $ 146,932
During the year ended October 31, 2019, we recorded impairment charges of $ 74.6 million associated with our NA Cabinet Components segment, which reduced the goodwill balance applicable to this reporting unit from $ 113.7 million to $ 39.1 million. Our other reporting units were not deemed to be impaired at our annual goodwill impairment testing date, August 31, 2019. During the three months ended April 30, 2020, we determined the WHO's characterization of the outbreak of COVID-19 as a global pandemic was a triggering event which could indicate that the carrying value of our goodwill was no longer greater than the fair value. As a result of this determination, we performed a qualitative assessment for each of the five goodwill reportable units. As a result of this analysis, we determined that our goodwill was not more likely than not impaired and no quantitative assessment was necessary. During the three months ended July 31, 2020, we determined that there were no further triggering events related to the impacts of COVID-19 or any other areas of our operations. However, the long term effects of the COVID-19 pandemic on the demand and pricing of our products may result in future impairment charges. For a summary of the change in the carrying amount of goodwill by segment, see Note 12, "Segment Information."
Identifiable Intangible Assets
Amortizable intangible assets consisted of the following as of July 31, 2020 and October 31, 2019:
July 31, 2020 October 31, 2019
Gross Carrying
Amount Accumulated
Amortization Gross Carrying
Amount Accumulated
Amortization
(In thousands)
Customer relationships $ 144,418 $ 68,137 $ 153,950 $ 70,103
Trademarks and trade names 55,876 36,833 55,745 35,210
Patents and other technology 22,502 20,869 22,386 19,471
Total $ 222,796 $ 125,839 $ 232,081 $ 124,784
During the three months ended July 31, 2020, we retired identifiable intangibles of $ 9.9 million related to fully amortized customer relationships.
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We had aggregate amortization expense related to intangible assets for the three and nine months ended July 31, 2020 of $ 3.4 million and $ 10.8 million, respectively, and $ 3.7 million and $ 11.6 million, respectively, for the comparable prior year periods.
Estimated remaining amortization expense, based on current intangible balances, for each of the fiscal years ending October 31, is as follows (in thousands):
Estimated
Amortization Expense
2020 (remaining three months) $ 3,474
2021 12,628
2022 12,004
2023 11,246
2024 10,497
Thereafter 47,108
Total $ 96,957
5. Debt and Finance Lease Obligations
Debt consisted of the following at July 31, 2020 and October 31, 2019:
July 31,
2020 October 31,
2019
(In thousands)
Revolving Credit Facility $ 138,000 $ 142,500
Finance lease obligations and other 15,729 15,865
Unamortized deferred financing fees ( 977 ) ( 1,205 )
Total debt $ 152,752 $ 157,160
Less: Current maturities of long-term debt 690 746
Long-term debt $ 152,062 $ 156,414
As more fully described in our Annual Report on Form 10-K for the year ended October 31, 2019, on October 18, 2018, we amended and extended our prior credit facility by entering into a $ 325.0 million revolving credit facility (the “Credit Facility”), with Wells Fargo Bank, National Association, as Agent, Swingline Lender and Issuing Lender, and Bank of America, N.A. serving as Syndication Agent. The Credit Facility has a five-year term, maturing on October 18, 2023, and requires interest payments calculated, at our election and depending upon our Consolidated Leverage Ratio, at either a Base Rate plus an applicable margin or the LIBOR Rate plus an applicable margin. The Credit Facility contains appropriate provisions to substitute LIBOR with a replacement rate upon transition away from LIBOR. These provisions include a temporary conversion of applicable interest for all borrowings outstanding to be calculated as base rate loans until such time that the replacement rate is agreed upon. In addition, we are subject to commitment fees for the unused portion of the Credit Facility.
The applicable margin and commitment fees are outlined in the following table:
Pricing Level Consolidated Leverage Ratio Commitment Fee LIBOR Rate Loans Base Rate Loans
I Less than or equal to 1.50 to 1.00 0.200 % 1.25 % 0.25 %
II Greater than 1.50 to 1.00, but less than or equal to 2.25 to 1.00 0.225 % 1.50 % 0.50 %
III Greater than 2.25 to 1.00, but less than or equal to 3.00 to 1.00 0.250 % 1.75 % 0.75 %
IV Greater than 3.00 to 1.00 0.300 % 2.00 % 1.00 %
In the event of default, outstanding borrowings would accrue interest at the Default Rate, as defined, whereby the obligations will bear interest at a per annum rate equal to 2 % above the total per annum rate otherwise applicable.
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The Credit Facility contains a: (1) Consolidated Interest Coverage Ratio requirement whereby we must not permit the Consolidated Interest Coverage Ratio, as defined, to be less than 2.25 to 1.00, and (2) Consolidated Leverage Ratio requirement, whereby we must not permit the Consolidated Leverage Ratio, as defined, to be greater than 3.25 to 1.00.
In addition to maintaining these financial covenants, the Credit Facility also limits our ability to enter into certain business transactions, such as to incur indebtedness or liens, to acquire businesses or dispose of material assets, make restricted payments, pay dividends (limited to $ 20.0 million per year) and other transactions as further defined in the Credit Facility. Substantially all of our domestic assets, with the exception of real property, are utilized as collateral for the Credit Facility.
As of July 31, 2020, we had $ 138.0 million of borrowings outstanding under the Credit Agreement (reduced by unamortized debt issuance costs of $ 1.0 million), $ 4.8 million of outstanding letters of credit and $ 15.7 million outstanding primarily under finance leases and other debt. We had $ 182.2 million available for use under the Credit Agreement at July 31, 2020. Outstanding borrowings under the Credit Agreement accrue interest at 1.91 % per annum. Our weighted average borrowing rate for borrowings outstanding during the nine months ended July 31, 2020 and 2019 was 2.62 % and 4.16 %, respectively. We were in compliance with our debt covenants as of July 31, 2020.
During the three months ended July 31, 2020, we repaid $78.0 million of borrowings outstanding on the Credit Facility, including $50.0 million of precautionary borrowings in March 2020 as a result of COVID-19. In the future, we may be required to borrow additional funds in order to be prepared for any unforeseen impacts of the COVID-19 pandemic.
Other Debt Instruments
We maintain certain finance lease obligations related to equipment purchases, vehicles, and warehouse space. Refer to Note 2, "Leases" for further information regarding our finance leases.
6. Retirement Plans
Pension Plan
Our non-contributory, single employer defined benefit pension plan covers a majority of our employees in the U.S. The net periodic pension cost for this plan for the three and nine months ended July 31, 2020 and 2019 was as follows:
Three Months Ended Nine Months Ended
July 31, July 31,
2020 2019 2020 2019
(In thousands)
Service cost $ 242 $ 907 $ 1,022 $ 2,722
Interest cost 280 364 853 1,092
Expected return on plan assets ( 509 ) ( 494 ) ( 1,503 ) ( 1,483 )
Amortization of net loss ( 4 ) 31 200 94
Net periodic pension cost $ 9 $ 808 $ 572 $ 2,425
On January 1, 2020, we enacted changes to our pension plan whereby the benefits for all participants were frozen and thereafter those participants will receive increased benefits in the company sponsored defined contribution plan in lieu of participation in a defined benefit plan. As a result of this action, we have remeasured the pension assets and obligations for the pension plan as of December 31, 2019. This resulted in a decrease in our projected benefit obligation and recognition of a net actuarial gain of approximately $ 2.5 million that was recorded in accumulated other comprehensive income. The decrease in the projected benefit obligation was impacted by our asset performance through December 31, 2019, the impact of the pension plan freeze and an increase in the discount rate since October 31, 2019.
The remeasurement described above is in addition to our annual year-end measurement of the funded status of our benefit plans that we will record as of October 31, 2020. As a result, the change in our pension benefit obligation and net actuarial loss will differ from the $2.5 million discussed above primarily as a result of any changes in interest rates and actual asset performance differs from our expected return on assets during the year.
During September 2019, we contributed $ 0.7 million to fund our plan, and we expect to make a contribution to our plan in September 2020 of approximately $ 3.7 million.
Other Plans
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We also have a supplemental benefit plan covering certain executive officers and key employees and a non-qualified deferred compensation plan covering members of the Board of Directors and certain key employees. As of July 31, 2020 and October 31, 2019, our liability under the supplemental benefit plan was approximately $ 2.4 million and $ 4.2 million, respectively. As of July 31, 2020 and October 31, 2019, the liability associated with the deferred compensation plan was approximately $ 3.4 million and $ 3.8 million, respectively. We record the current portion of liabilities associated with these plans under the caption "Accrued Liabilities," and the long-term portion under the caption "Other Liabilities" in the accompanying condensed consolidated balance sheets.
7. Income Taxes
To determine our income tax expense or benefit for interim periods, consistent with accounting standards, we apply the estimated annual effective income tax rate to year-to-date results. Our estimated annual effective tax rates for the nine months ended July 31, 2020 and 2019 was 27.4 % and 24.8 %, respectively, excluding discrete items. The 2020 effective rate was primarily impacted by a discrete charge of $0.5 million related to the vesting or exercise of equity-based compensation awards. The 2019 effective rate was primarily impacted by the goodwill impairment charge recorded during the nine months ended July 31, 2019, which did not generate a significant tax benefit.
As of July 31, 2020, our liability for uncertain tax positions (UTP) of $ 0.6 million relates to certain state tax items regarding the interpretation of tax laws and regulations. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. The final outcome of the future tax consequences of legal proceedings, if any, as well as the outcome of competent authority proceedings, changes in regulatory tax laws, or interpretation of those tax laws could impact our financial statements. We are subject to the effect of these matters occurring in various jurisdictions. The disallowance of the UTP would not materially affect the annual effective tax rate. We do not believe any of the UTP at July 31, 2020 will be recognized within the next twelve months.
We evaluate the likelihood of realization of our deferred tax assets by considering both positive and negative evidence. We maintain a valuation allowance for certain state net operating losses which totaled $ 1.6 million at July 31, 2020 and October 31, 2019.
Final regulations were published by the Internal Revenue Service regarding Uniform Capitalization (UNICAP) that became effective during fiscal 2020. Also, on March 27, 2020, The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. We are evaluating these regulations but do not believe they will result in a material impact on our consolidated financial statements.
8. Contingencies
Remediation and Environmental Compliance Costs
Under applicable state and federal laws, we may be responsible for, among other things, all or part of the costs required to remove or remediate wastes or hazardous substances at locations we, or our predecessors, have owned or operated. From time to time, we also have been alleged to be liable for all or part of the costs incurred to clean up third-party sites where there might have been an alleged improper disposal of hazardous substances. At present, we are not involved in any such matters.
From time to time, we incur routine expenses and capital expenditures associated with compliance with existing environmental regulations, including control of air emissions and water discharges, and plant decommissioning costs. We have not incurred any material expenses or capital expenditures related to environmental matters during the past three fiscal years, and do not expect to incur a material amount of such costs in fiscal 2020. While we will continue to have future expenditures related to environmental matters, any such amounts are impossible to reasonably estimate at this time. Based upon our experience to date, we do not believe that our compliance with environmental requirements will have a material adverse effect on our operations, financial condition or cash flows.
Litigation
From time to time, we, along with our subsidiaries, are involved in various litigation matters arising in the ordinary course of our business, including those arising from or related to contractual matters, commercial disputes, intellectual property, personal injury, environmental matters, product performance or warranties, product liability, insurance coverage and personnel and employment disputes.
We regularly review with legal counsel the status of all ongoing proceedings, and we maintain insurance against these risks to the extent deemed prudent by our management and to the extent such insurance is available. However, there is no
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assurance that we will prevail in these matters or that our insurers will accept full coverage of these matters, and we could, in the future, incur judgments, enter into settlements of claims, or revise our expectations regarding the outcome or insurability of matters we face, which could materially impact our results of operations.
We have been and are currently party to multiple claims, some of which are in litigation, relating to alleged defects in a commercial sealant product that was manufactured and sold during the 2000's. While we believe that our product was not defective and that we would prevail in these commercial sealant product claims if taken to trial, the timing, ultimate resolution and potential impact of these claims is not currently determinable. Nevertheless, after taking into account all currently available information, including our defenses, the advice of our counsel, and the extent and currently-expected availability of our existing insurance coverage, we believe that the eventual outcome of these commercial sealant claims will not have a material adverse effect on our overall financial condition, results of operations or cash flows, and we have not recorded any accrual with regard to these claims.
9. Fair Value Measurement of Assets and Liabilities
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market data developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to Level 1 and the lowest priority to Level 3. The three levels of the fair value hierarchy are described below:
• Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
• Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability either directly or indirectly including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates) and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
• Level 3 - Inputs that are both significant to the fair value measurement and unobservable.
As of July 31, 2020 and October 31, 2019, foreign currency derivatives were being measured on a recurring basis. Less than $ 0.1 million of foreign currency derivatives were included in total assets as of October 31, 2019. There were no outstanding foreign currency derivatives as of July 31, 2020. All of our derivative contracts are valued using quoted market prices from brokers or exchanges and are classified within Level 2 of the fair value hierarchy.
Carrying amounts reported on the balance sheet for cash, cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term maturity of these instruments. Our outstanding debt is variable rate debt that re-prices frequently, thereby limiting our exposure to significant change in interest rate risk. As a result, the fair value of our debt instrument approximates carrying value at July 31, 2020, and October 31, 2019 (Level 2 measurement).
The liability portion of our performance share awards are marked-to-market on a quarterly basis during a three-year vesting period based on market data (Level 2 measurement). For further information, refer to Note 10, "Stock-Based Compensation -Performance Share Awards."
10. Stock-Based Compensation
We have established and maintain an Omnibus Incentive Plan (2020 Plan) that provides for the granting of restricted stock awards, stock options, restricted stock units, performance share awards, performance restricted stock units, and other stock-based and cash-based awards. The 2020 Plan replaced a prior plan (formerly the 2008 Plan) in February 2020. The 2020 Plan is administered by the Compensation and Management Development Committee of the Board of Directors.
The aggregate number of shares of common stock authorized for grant under the 2020 Plan is 3,094,587 as approved by shareholders. Any officer, key employee and/or non-employee director is eligible for awards under the 2020 Plan. We grant restricted stock units to non-employee directors on the first business day of each fiscal year. As approved by the Compensation & Management Development Committee of our Board of Directors annually, we grant a mix of restricted stock awards, restricted stock units, performance shares and/or performance restricted stock units to officers, management and key employees. We also historically granted stock options to certain officers, directors and key employees. Occasionally, we may make additional grants to key employees at other times during the year.
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Restricted Stock Awards
Restricted stock awards are granted to key employees and officers annually, and typically cliff vest over a three year period with service and continued employment as the only vesting criteria. The recipient of the restricted stock award is entitled to all of the rights of a shareholder, except that the award is nontransferable during the vesting period. The fair value of the restricted stock award is established on the grant date and then expensed over the vesting period resulting in an increase in additional paid-in-capital. Shares are generally issued from treasury stock at the time of grant.
A summary of non-vested restricted stock awards activity during the nine months ended July 31, 2020 is presented below:
Restricted Stock Awards Weighted Average
Grant Date Fair Value per Share
Non-vested at October 31, 2019 230,100 $ 17.02
Granted 59,700 $ 18.82
Forfeited ( 42,800 ) $ 17.30
Vested ( 55,000 ) $ 19.45
Non-vested at July 31, 2020 192,000 $ 16.82
The total weighted average grant-date fair value of restricted stock awards that vested during each of the nine month periods ended July 31, 2020 and 2019 was $ 1.1 million and $ 1.3 million, respectively. As of July 31, 2020, total unrecognized compensation cost related to unamortized restricted stock awards was $ 1.4 million. We expect to recognize this expense over the remaining weighted average vesting period of 1.9 years.
Stock Options
Historically, stock options have been awarded to key employees, officers and non-employee directors. Effective May 2015, the director compensation structure was revised to eliminate the annual grant of stock options to non-employee directors. During December 2017, the Compensation & Management Development Committee of the Board of Directors approved a change to the long-term incentive award program eliminating the grant of stock options and replacing this award with a grant of performance restricted stock units as further described below. As a result, stock options were not granted during the years ended October 31, 2018, October 31, 2019, or during the nine months ended July 31, 2020. Employee stock options typically vest ratably over a three-year period with service and continued employment as the vesting conditions. Our stock options may be exercised up to a maximum of ten years from the date of grant. The fair value of the stock options is determined on the grant date and expensed over the vesting period resulting in an increase in additional paid-in-capital. For employees who are nearing retirement-eligibility, we recognize stock option expense ratably over the shorter of the vesting period or the period from the grant-date to the retirement-eligibility date.
We use a Black-Scholes pricing model to estimate the fair value of stock options. A description of the methodology for the valuation assumptions was disclosed in our Annual Report on Form 10-K for the fiscal year ended October 31, 2019.
The following table summarizes our stock option activity for the nine months ended July 31, 2020:
Stock Options Weighted Average
Exercise Price Weighted Average
Remaining Contractual
Term (in years) Aggregate
Intrinsic
Value (000s)
Outstanding at October 31, 2019 1,416,186 $ 18.71
Granted — $ —
Exercised ( 178,033 ) $ 16.93
Forfeited/Expired ( 93,734 ) $ 20.40
Outstanding at July 31, 2020 1,144,419 $ 18.85 3.7 $ 16
Vested or expected to vest at July 31, 2020 1,144,419 $ 18.85 3.7 $ 16
Exercisable at July 31, 2020 1,144,419 $ 18.85 3.7 $ 16
Intrinsic value is the amount by which the market price of the common stock on the date of exercise exceeds the exercise price of the stock option. The total intrinsic value of stock options exercised during the nine months ended July 31, 2020 and 2019 was $ 0.5 million and $ 0.3 million, respectively. The weighted-average grant date fair value of stock options that vested
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during the nine months ended July 31, 2020 and 2019 was $ 0.4 million and $ 1.1 million, respectively. As of July 31, 2020, all compensation cost related to stock options has been recognized.
Restricted Stock Units
Restricted stock units may be awarded to key employees and officers from time to time, and annually to non-employee directors. The non-employee director restricted stock units vest immediately but are payable only upon the director's cessation of service unless an election is made by the non-employee director to settle and pay the award on an earlier specified date. Restricted stock units awarded to employees and officers typically cliff vest after a three-year period with service and continued employment as the vesting conditions. Restricted stock units are not considered outstanding shares and do not have voting rights, although the holder does receive a cash payment equivalent to the dividend paid, on a one-for-one basis, on our outstanding common shares. Once the criteria is met, each restricted stock unit is payable to the holder in cash based on the market value of one share of our common stock. Accordingly, we record a liability for the restricted stock units on our balance sheet and recognize any changes in the market value during each reporting period as compensation expense.
During the nine months ended July 31, 2020 and 2019, non-employee directors received 25,326 and 29,065 restricted stock units, respectively, at a grant date fair value of $ 19.02 per share and $ 15.29 per share, respectively, which vested immediately. As of July 31, 2020, there were 26,390 non-vested restricted stock units, which were awarded in June 2019 and January 2020 to key employees at a weighted average grant date fair value of $ 17.01 . During the nine months ended July 31, 2019, we paid approximately $ 0.4 million to settle previously vested restricted stock units; there were no corresponding payments to settle vested restricted stock units during the nine months ended July 31, 2020.
Performance Share Awards
We have awarded annual grants of performance shares to key employees and officers. These awards cliff vest after a three-year period. Performance share awards issued prior to fiscal 2019 vest with service and performance measures (relative total shareholder return (R-TSR) and earnings per share (EPS) growth), as vesting conditions. The number of shares earned is variable depending on the metrics achieved, and the settlement method is 50 % in cash and 50 % in our common stock. Performance share awards issued during fiscal 2019 and 2020 vest with return on net assets (RONA) as the vesting condition and pay out 100% in cash.
To account for these awards, we have bifurcated the portion subject to a market condition (R-TSR) and the portion subject to an internal performance measure (EPS or RONA). We have further bifurcated these awards based on the settlement method, as the portion expected to settle in stock (equity component) and the portion expected to settle in cash (liability component).
To value the shares subject to the market condition, we utilized a Monte Carlo simulation model to arrive at a grant-date fair value. This amount will be expensed over the three-year term of the award with a credit to additional paid-in-capital. To value the shares subject to the EPS and RONA performance measures, we used the value of our common stock on the date of grant as the grant-date fair value per share. This amount is being expensed over the three-year term of the award, with a credit to additional paid-in-capital, and could fluctuate depending on the number of shares ultimately expected to vest based on our assessment of the probability that the performance conditions will be achieved. The portion of the awards expected to settle in cash is recorded as a liability and is being marked to market over the three-year term of the award, and can fluctuate depending on the number of shares ultimately expected to vest. Depending on the achievement of the performance conditions, 0 % to 200 % of the awarded performance shares may ultimately vest.
The following table summarizes our performance share grants and the grant date fair value for the EPS, R-TSR and RONA performance metrics:
Grant Date Fair Value
Grant Date Shares Awarded EPS R-TSR RONA Shares Forfeited
December 7, 2017 146,500 $ 20.70 $ 21.81 $ — 54,008
December 5, 2018 131,500 $ — $ — $ 13.63 40,900
December 5, 2019 55,900 $ — $ — $ 19.40 5,300
On November 30, 2019, a total of 56,103 shares vested pursuant to the November 2016 grant, which were settled with 28,051 shares of common stock and a cash payment of $ 0.6 million. We recorded compensation expense of $0.1 million for the three months ended July 31, 2020 and a decrease in compensation expense of $ 0.3 million for the nine months ended July 31,
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2020 related to the expected payout of our performance share awards that are outstanding as of July 31, 2020. For each of the three and nine months ended July 31, 2019, we recorded compensation expense of $ 0.5 million related to the expected payouts of performance share awards that were outstanding as of July 31, 2019.
Performance share awards are not considered outstanding shares and do not have voting rights, although dividends are accrued over the performance period and will be payable in cash based upon the number of performance shares ultimately earned.
The performance shares are excluded from the diluted weighted-average shares used to calculate earnings per share until the performance criteria is probable to result in the issuance of contingent shares. As of July 31, 2020, we have deemed 17,342 shares related to the December 2017 grants of performance shares as probable to vest.
Performance Restricted Stock Units
We awarded performance restricted stock units to key employees and officers beginning in December 2017. These awards cliff vest upon a three-year service period with the absolute total shareholder return of our common stock over this three-year term as the vesting criteria. The number of shares earned is variable depending on the metric achieved, and the settlement method is 100% in our common stock, with accrued dividends paid in cash at the time of vesting, assuming the shares had been outstanding throughout the performance period.
To value the performance restricted stock units, we utilized a Monte Carlo simulation model to arrive at a grant-date fair value. This amount will be adjusted for forfeitures and expensed over the three-year term of the award with a credit to additional paid-in-capital. Depending on the achievement of the performance conditions, a minimum of 0 % and a maximum of 150 % of the awarded performance restricted stock units may vest. Specifically, the awards vest on a continuum with the following Absolute Total Shareholder Return (A-TSR) milestones:
Vesting Level Vesting Criteria Percentage of Award Vested
Level 1 A-TSR greater than or equal to 50% 150 %
Level 2 A-TSR less than 50% and greater than or equal to 20% 100 %
Level 3 A-TSR less than 20% and greater than or equal to -20% 50 %
Level 4 A-TSR less than -20% — %
The following table summarizes our performance restricted stock unit grants and the grant date fair value for the A-TSR performance metric:
Grant Date Shares Awarded Grand Date Fair Value Shares Forfeited
December 7, 2017 78,200 $ 17.76 28,854
December 5, 2018 89,200 $ 13.63 25,500
December 5, 2019 35,000 $ 19.40 —
During the three and nine months ended July 31, 2020, we recorded compensation expense of approximately $ 0.1 million and $ 0.4 million, respectively, and $ 0.2 million and $ 0.6 million, respectively, for the comparable prior year period related to our performance share restricted units.
Similar to performance shares, the performance restricted stock units are not considered outstanding shares, do not have voting rights, and are excluded from diluted weighted-average shares used to calculate earnings per share until the performance criteria is probable to result in the issuance of contingent shares. As of July 31, 2020, we have deemed 24,673 shares related to the December 2017 grants of performance restricted stock units as probable to vest.
Treasury Shares
We record treasury stock purchases under the cost method whereby the entire cost of the acquired stock is recorded as treasury stock. Shares are generally issued from treasury stock at the time of grant of restricted stock awards, upon the exercise of stock options, and upon the vesting of performance shares and performance restricted stock units. On the subsequent issuance of treasury shares, we record proceeds in excess of cost as an increase in additional paid in capital. A deficiency of such proceeds relative to costs would be applied to reduce paid-in-capital associated with prior issuances to the extent available,
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with the remainder recorded as a charge to retained earnings. We recorded a charge to retained earnings of $ 0.1 million during the nine months ended July 31, 2020.
The following table summarizes the treasury stock activity during the nine months ended July 31, 2020:
Nine Months Ended
July 31, 2020
Beginning balance as of November 1, 2019 4,348,613
Restricted stock awards granted ( 59,700 )
Performance share awards vested ( 28,051 )
Stock options exercised ( 178,033 )
Treasury stock repurchases 419,799
Balance at April 30, 2020 4,502,628
11. Other Income
Other (loss) income, included under the caption "Other, net" on the accompanying condensed consolidated statements of income (loss), consisted of the following for the three and nine months ended July 31, 2020 and 2019:
Three Months Ended Nine Months Ended
July 31, July 31,
2020 2019 2020 2019
(In thousands)
Foreign currency transaction (losses) gains $ ( 458 ) $ 101 $ ( 375 ) $ 75
Foreign currency derivative gains (losses) — 11 ( 15 ) ( 8 )
Pension service benefit 232 130 449 328
Interest income 5 15 24 59
Other 1 2 33 7
Other, net $ ( 220 ) $ 259 $ 116 $ 461
12. Segment Information
We present three reportable business segments in accordance with ASC Topic 280-10-50, "Segment Reporting" (ASC 280): (1) North American Fenestration segment (NA Fenestration), comprising three operating segments primarily focused on the fenestration market in North America including vinyl profiles, insulating glass spacers, screens & other fenestration components; (2) European Fenestration segment (EU Fenestration), comprising our U.K.-based vinyl extrusion business, manufacturing vinyl profiles & conservatories, and the European insulating glass business manufacturing insulating glass spacers; and (3) North American Cabinet Components segment (NA Cabinet Components), comprising our cabinet door and components operations. We maintain an Unallocated Corporate & Other grouping which includes corporate office charges, and inter-segment eliminations, less an allocation of a portion of the general and administrative costs associated with the corporate office which have been allocated to the reportable business segments, based upon relative share of revenue, in order to more accurately reflect each reportable business segment's administrative cost. Certain costs are not allocated to the reportable operating segments, but remain in Unallocated Corporate & Other, including transaction expenses, stock-based compensation, long-term incentive awards based on the performance of our common stock and other factors, certain severance and legal costs not deemed to be allocable to all segments, depreciation of corporate assets, interest expense, other, net, income taxes, inter-segment eliminations, and executive incentive compensation and medical expense fluctuations relative to planned costs as determined during the annual planning process. The accounting policies of our operating segments are the same as those used to prepare the accompanying condensed consolidated financial statements. Corporate general and administrative expense allocated during the three and nine month period ended July 31, 2020 was $ 5.2 million and $ 15.4 million, respectively, and $ 4.8 million and $ 14.6 million for the comparable prior year periods.
ASC 280 permits aggregation of operating segments based on factors including, but not limited to: (1) similar nature of products serving the building products industry, primarily the fenestration business; (2) similar production processes, although there are some differences in the amount of automation amongst operating plants; (3) similar types or classes of customers, namely the primary OEMs; (4) similar distribution methods for product delivery, although the extent of the use of third-party
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distributors will vary amongst the businesses; (5) similar regulatory environment; and (6) converging long-term economic similarities.
Segment information for the three and nine months ended July 31, 2020 and 2019, and total assets as of July 31, 2020 and October 31, 2019 are summarized in the following table (in thousands):
NA Fenestration EU Fenestration NA Cabinet Comp. Unallocated Corp. & Other Total
Three Months Ended July 31, 2020
Net sales $ 122,386 $ 38,265 $ 51,925 $ ( 480 ) $ 212,096
Depreciation and amortization 5,371 2,307 3,264 118 11,060
Operating income (loss) 12,383 5,365 ( 193 ) ( 992 ) 16,563
Capital expenditures 1,963 1,787 602 8 4,360
Three Months Ended July 31, 2019
Net sales $ 136,259 $ 44,326 $ 58,689 $ ( 813 ) $ 238,461
Depreciation and amortization 6,578 2,213 3,258 133 12,182
Operating income (loss) 15,944 5,367 1,558 ( 3,759 ) 19,110
Capital expenditures 2,299 485 942 236 3,962
Nine Months Ended July 31, 2020
Net sales $ 341,432 $ 104,230 $ 152,634 $ ( 2,128 ) $ 596,168
Depreciation and amortization 18,311 7,045 10,139 356 35,851
Operating income (loss) 21,442 9,140 ( 3,481 ) 335 27,436
Capital expenditures 13,199 3,413 3,946 115 20,673
Nine Months Ended July 31, 2019
Net sales $ 360,654 $ 121,203 $ 175,377 $ ( 3,762 ) $ 653,472
Depreciation and amortization 20,208 6,669 9,902 379 37,158
Operating income (loss) 24,048 12,951 ( 29,361 ) ( 10,341 ) ( 2,703 )
Capital expenditures 8,672 4,825 3,251 236 16,984
As of July 31, 2020
Total assets $ 257,606 $ 220,460 $ 173,797 $ 34,928 $ 686,791
As of October 31, 2019
Total assets $ 226,243 $ 212,239 $ 181,416 $ 25,212 $ 645,110
The following table summarizes the change in the carrying amount of goodwill by reportable business segment for the nine months ended July 31, 2020 (in thousands):
NA Fenestration EU Fenestration NA Cabinet Comp. Unallocated Corp. & Other Total
Balance as of October 31, 2019 $ 38,712 $ 67,704 $ 39,147 $ — $ 145,563
Foreign currency translation adjustment — 1,369 — — 1,369
Balance as of July 31, 2020 $ 38,712 $ 69,073 $ 39,147 $ — $ 146,932
For further details of Goodwill, see Note 4, "Goodwill & Intangible Assets", located herewith.
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
We did not allocate non-operating loss or income tax benefit to the reportable segments. The following table reconciles operating income (loss) as reported above to net income (loss) for the three and nine months ended July 31, 2020 and 2019:
Three Months Ended Nine Months Ended
July 31, July 31,
2020 2019 2020 2019
(In thousands)
Operating income (loss) $ 16,563 $ 19,110 $ 27,436 $ ( 2,703 )
Interest expense ( 1,165 ) ( 2,570 ) ( 4,310 ) ( 7,614 )
Other, net ( 220 ) 259 116 461
Income tax expense ( 4,345 ) ( 4,958 ) ( 6,898 ) ( 5,926 )
Net income (loss) $ 10,833 $ 11,841 $ 16,344 $ ( 15,782 )
13. Earnings Per Share
We compute basic earnings (loss) per share by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings per common and potential common shares include the weighted average of additional shares associated with the incremental effect of dilutive employee stock options, non-vested restricted stock as determined using the treasury stock method prescribed by U.S. GAAP and contingent shares associated with performance share awards, if dilutive.
Basic and diluted earnings (loss) per share for the three and nine months ended July 31, 2020 and 2019 were calculated as follows (in thousands, except per share data):
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Net Income (Loss) Weighted Average Shares Per Share
Three Months Ended July 31, 2020
Basic earnings per common share $ 10,833 32,610 $ 0.33
Effect of dilutive securities:
Stock options 1
Restricted stock awards 86
Performance shares 17
Performance restricted stock units 25
Diluted earnings per common share $ 10,833 32,739 $ 0.33
Three Months Ended July 31, 2019
Basic loss per common share $ 11,841 32,899 $ 0.36
Effect of dilutive securities:
Stock options 77
Restricted stock awards 118
Performance shares 68
Diluted loss per common share $ 11,841 33,162 $ 0.36
Nine Months Ended July 31, 2020
Basic earnings per common share $ 16,344 32,716 $ 0.50
Effect of dilutive securities:
Stock options 5
Restricted stock awards 82
Performance shares 17
Performance restricted stock units 25
Diluted earnings per common share $ 16,344 32,845 $ 0.50
Nine Months Ended July 31, 2019
Basic loss per common share $ ( 15,782 ) 32,984 $ ( 0.48 )
Diluted loss per common share $ ( 15,782 ) 32,984 $ ( 0.48 )
Excluded effect of dilutive securities (1) :
Stock options 31
Restricted stock awards 121
Performance shares 68
(1) The computation of diluted earnings per share excludes outstanding stock options and other common stock equivalents when their inclusion would be anti-dilutive. This is always the case when an entity incurs a net loss.
We had common stock equivalents that were potentially dilutive in future earnings per share calculations of 1,139,419 and 1,106,891 for the three and nine months ended July 31, 2020, respectively, and 1,155,941 and 1,419,408 , respectively, for the comparable prior year periods. We also had 50,700 restricted stock award equivalents that were potentially dilutive in future earnings per calculations for the three and nine months ended July 31, 2020, respectively, and no corresponding equivalents for the corresponding prior year. Such dilution will be dependent on the excess of the market price of our stock over the exercise price and other components of the treasury stock method.
14. New Accounting Guidance
Accounting Standards Recently Adopted
Effective November 1, 2019, we adopted Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), using the modified retrospective approach and did not have a cumulative-effect adjustment in retained earnings as a result of the
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QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
adoption. Topic 842 significantly changes accounting for leases by requiring that lessees recognize a liability representing the obligation to make lease payments and a related right-of-use (ROU) asset for virtually all lease transactions. Upon adoption, we implemented policy elections and practical expedients which include the following:
• package of practical expedients which allows us to avoid reassessing contracts that commenced prior to adoption that were properly evaluated under legacy lease accounting guidance;
• excluding ROU assets and lease liabilities for leases with terms that are less than one year;
• combining lease and non-lease components and accounting for them as a single lease (elected by asset class);
• excluding land easements that existed or expired prior to adoption; and
• policy election that eliminates the need for adjusting prior period comparable financial statements prepared under legacy (Accounting Standards Codification Topic 840) lease accounting guidance.
As a result of adopting Topic 842, we recorded additional lease liabilities of approximately $ 39.3 million and ROU assets of approximately $ 38.9 million on our consolidated balance sheet. The difference between the lease liabilities and ROU assets is due to rent holiday and lease build-out incentives that were recorded as deferred lease liabilities under legacy accounting guidance. The adoption of Topic 842 did not materially change our consolidated statements of income or consolidated statements of cash flows. See Note 2, "Leases" for further discussion.
Accounting Standards Not Yet Adopted
In June 2016, the Financial Accounting Standards Board issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326). This amendment replaces the incurred loss impairment methodology in current U.S. GAAP and requires that financial assets be measured on an amortized cost basis and presented at the net amount expected to be collected. This new methodology reflects expected credit losses (rather than probable credit losses) and requires consideration of a broader range of supportable information when determining these estimated credit losses, including relevant experience, current conditions and supportable forecasts to determine collectability. In addition, the amendment provides guidance with regard to the use of an allowance for credit losses for purchased financial assets and available-for-sale debt securities. This amendment becomes effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. We expect to adopt this amendment during fiscal 2021, with no material impact on our consolidated financial statements.
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Unless the context indicates otherwise, references to "Quanex", the "Company", "we", "us" and "our" refer to the consolidated business operations of Quanex Building Products Corporation and its subsidiaries.
Cautionary Note Regarding Forward-Looking Statements
Certain of the statements contained in this document and in documents incorporated by reference herein, including those made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are “forward-looking” statements as defined under the Private Securities Litigation Reform Act of 1995. Generally, the words “expect,” “believe,” “intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature. Forward looking statements are (1) all statements which address future operating performance, (2) events or developments that we expect or anticipate will occur in the future, including statements relating to volume, sales, operating income and earnings per share, and (3) statements expressing general outlook about future operating results. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our current projections or expectations. As and when made, we believe that these forward-looking statements are reasonable. However, caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date when made and there can be no assurance that such forward-looking statements will occur. We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include, but are not limited to the following:
• impacts from public health issues (including pandemics, such as the recent COVID-19 pandemic and quarantines) on the economy, demand for our products or our operations, including the responses of governmental authorities to contain such public health issues;
• changes in market conditions, particularly in the new home construction, and residential remodeling and replacement (R&R) activity markets in the U.S., U.K. and Germany;
• changes in non-pass-through raw material costs;
• changes in domestic and international economic conditions, including impacts from public health issues, including the COVID-19 pandemic;
• changes in purchases by our principal customers;
• fluctuations in foreign currency exchange rates;
• our ability to maintain an effective system of internal controls;
• our ability to successfully implement our internal operating plans and acquisition strategies;
• our ability to successfully implement our plans with respect to information technology (IT) systems and processes;
• our ability to control costs and increase profitability;
• changes in environmental laws and regulations;
• changes in warranty obligations;
• changes in energy costs;
• changes in tax laws, and interpretations thereof;
• changes in interest rates;
• our ability to service our debt facilities and remain in good standing with our lenders;
• changes in the availability or applicability of our insurance coverage;
• our ability to maintain a good relationship with our suppliers, subcontractors, and key customers; and
• the resolution of litigation and other legal proceedings.
For information on additional factors that could cause actual results to differ materially, please refer to the section entitled “Item 1A. Risk Factors ” in our Annual Report on Form 10-K for the fiscal year ended October 31, 2019.
About Third-Party Information
In this report, we rely on and refer to information regarding industry data obtained from market research, publicly available information, industry publications, U.S. government sources and other third parties. Although we believe this
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information is reliable, we cannot guarantee the accuracy or completeness of the information and have not independently verified it.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.