# Quanex Building Products CORP (NX) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Quanex Building Products CORP's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1423221/000142322121000018/nx-20211031.htm
Accession: 0001423221-21-000018
Filing date: 2021-12-17
Report date: 2021-10-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/NX/
All MD&A years: /company/NX/mda/
Next year: /company/NX/mda/fy2022/ (FY 2022)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis contains forward-looking statements based on our current assumptions, expectations, estimates and projections about our business and the homebuilding industry, and therefore, it should be read in conjunction with our consolidated financial statements and related notes thereto, as well as our “Cautionary Note Regarding Forward-Looking Statements” discussed elsewhere within this Annual Report on Form 10-K. For a listing of potential risks and uncertainties which impact our business and industry, see “Item 1A. Risk Factors.” Actual results could differ from our expectations due to several factors which include, but are not limited to: the impact of the ongoing COVID-19 pandemic, market price and demand for our products, economic and competitive conditions, capital expenditures, new technology, regulatory changes and other uncertainties. Unless otherwise required by law, we undertake no obligation to publicly update any forward-looking statements, even if new information becomes available or other events occur in the future.

Our Business

We manufacture components for original equipment manufacturers 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. In addition, we provide certain other non-fenestration components and products, which include solar panel sealants, trim moldings, vinyl decking, vinyl fencing, water retention barriers, and conservatory roof components. We use low-cost 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 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.

We continue to invest in organic growth initiatives and we intend to continue evaluating business acquisitions that allow us to expand our existing fenestration and cabinet component footprint, enhance our product offerings, provide new complementary technology, enhance our leadership position within the markets we serve, and expand into new markets or service lines. We have disposed of non-core businesses in the past, and continue to evaluate our business portfolio to ensure that we are investing in markets where we believe there is potential future growth.

We currently have three reportable business segments: (1) North American Fenestration segment (“NA Fenestration”), comprising three operating segments, manufacturing vinyl profiles, IG spacers, screens and other fenestration components; (2) European Fenestration segment (“EU Fenestration”), comprising our U.K.-based vinyl extrusion business, manufacturing vinyl profiles and conservatories, and the European insulating glass business manufacturing IG spacers; and (3) North American Cabinet Components segment (“NA Cabinet Components”), comprising our North American cabinet door and components business and two wood-manufacturing plants. We maintain a grouping called Unallocated Corporate & Other, which includes 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 and inter-segment eliminations, and executive incentive compensation and medical expense fluctuations relative to planned costs as determined during the annual planning process. Other corporate general and administrative costs have been allocated to the reportable business segments, based upon a relative measure of profitability in order to more accurately reflect each reportable business segment's administrative costs. We allocate corporate expenses to businesses acquired mid-year from the date of acquisition. The accounting policies of our operating segments are the same as those used to prepare our accompanying consolidated financial statements. Corporate general and administrative expenses allocated during the years ended October 31, 2021, 2020 and 2019 were $21.6 million, $21.7 million and $18.3 million, respectively.

Notable Items

COVID-19 Impacts

On March 11, 2020, the WHO declared the outbreak of COVID-19 to be a global pandemic and recommended containment and mitigation measures. Our first priority with regard to the COVID-19 pandemic is to do everything we can to ensure the safety, health and welfare of our employees, customers, suppliers and other partners. With the implementation of health and safety practices at our facilities, we are continuing to supply the industry during this uncertain time, recognizing the essential role the construction industry plays in providing housing and necessary infrastructure.

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As federal, state and local governments react to the public health crisis, significant uncertainties have been created in the economy. The COVID-19 pandemic and its related effects continue to have a significant adverse affect on many sectors of the economy and we may be further impacted.

As part of our response to the COVID-19 pandemic, we have taken the following measures:

•We are continuing to provide our products to support critical infrastructure needs while following national, state, and local guidelines required to continue operations during the existence of the pandemic and related local declarations of emergency. However, local or regional hotspots of the pandemic could result in other locations being temporarily idled due to the need to deep clean areas where an employee who has tested positive for COVID-19 worked or any similar impacts in our supply chain. We work with our customers to the extent idling affects fulfillment timing.

•We have taken precautionary measures intended to help minimize the risk of the virus to our employees by implementing social distancing, sanitizing the workspace, and requiring employees to report any COVID-19 symptoms to ensure safety as infection surges dictate.

•We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan.

Market Overview and Outlook

We believe the primary drivers of our operating results continue to be North American residential remodeling and replacement (R&R) and new home construction activity. We believe that housing starts and window shipments are indicators of activity levels in the homebuilding and window industries, and we use this data, as published by or derived from third-party sources, to evaluate the market. We have historically evaluated the market using data from the National Association of Homebuilders (NAHB) with regard to housing starts, and published reports by Ducker Worldwide, LLC (Ducker), a consulting and research firm, with regard to window shipments in the U.S. We obtain market data from Catalina research, a consulting and research firm, for insight into the U.S. residential wood cabinet demand.

In November 2021, the NAHB forecasted calendar-year housing starts (excluding manufactured units) to be 1.6 million in 2021, 2022 and 2023 calendar-years. The November 2021, Ducker forecast indicated that window shipments in the R&R market are expected to increase approximately 4.5%, 4% and 3% in the calendar-years ended 2021, 2022, 2023, respectively, and window shipments in the new construction market are expected to grow 13%, 2%, and 1% in the calendar-years ended 2021, 2022, and 2023, respectively, resulting in overall window shipment improvements of 8% in 2021, 3% in 2022, and 2% in 2023. Derived from reports published by Ducker, the overall increase in window shipments for the trailing twelve months ended September 30, 2021 was 8.9%. During this period, new construction activities increased 14.2% and R&R increased 4.7%. In November 2021, Catalina Research estimated that residential semi-custom cabinet demand in the U.S. is estimated to increase 13.4% in 2021 and 5.2% in 2022.

Our U.K. vinyl business (commonly referred to as “Liniar”) is largely focused on the sale of vinyl house systems under the trade name “Liniar” to smaller window manufacturers in the U.K. Liniar is one of the larger providers of vinyl extruded products in the U.K. in terms of volume shipped. Currently, the U.K. is experiencing a shortage in affordable housing, with rising demand due in part to a growing immigrant population. Liniar’s current primary customers are smaller window fabricators, as opposed to the larger OEMs that comprise a large portion of the North American market. These manufacturers seek the quality and technology of the specific products identified by the Liniar trade name. In addition, Liniar services non-fenestration markets including the manufacture of roofing for conservatories, vinyl decking and vinyl water retention barriers used for landscaping. We believe there are growth opportunities within these markets in the U.K. and potential synergies which may enable us to sell complementary products.

NA Cabinet Components manufactures kitchen and bathroom cabinet doors and components, amongst other products, using a variety of woods from traditional hardwoods to engineered wood products. Currently, most of the revenue in the NA Cabinet Components is earned in the U.S., so domestic housing starts and R&R activity constitute the primary drivers of this business as well. The cabinet door market is stratified as follows: stock (low-cost, low-variations), semi-custom (more customized, just-in-time manufacturing, higher price point) and custom (precise customer specifications, just-in-time manufacturing, high-end price point). NA Cabinet Component's primary market is semi-custom.

Our business is seasonal, particularly our fenestration business, as inclement weather during the winter months tends to slow down construction, particularly as related to “outside of the house” construction. To some extent, we believe our kitchen

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and bathroom cabinet door business lessens the impact of seasonality on our operating results, as the cabinet business is “inside of the house” and less susceptible to weather.

We are impacted by regulation of energy standards. Although the U.S. government has been less aggressively pursuing higher energy efficiency standards in recent years, other countries have implemented higher energy efficiency standards which should bode well for our fenestration-related business in these markets, particularly our warm-edge spacer products.

Several commodities in our business are subject to pricing fluctuations, including polyvinyl resin (PVC), titanium dioxide (TiO2), petroleum products, aluminum and wood. For the majority of our customers and critical suppliers, we have price adjusters in place which effectively share the base pass-through price changes for our primary commodities with our customers commensurate with the market at large. Our long-term exposure to these price fluctuations is somewhat mitigated due to the contractual component of the adjuster program. However, these adjusters are not in place with all customers and for all commodities, and there is a level of exposure to such volatility due to the lag associated with the timing of price updates in accordance with our customer agreements, particularly with regard to hardwoods. In addition, some of these commodities, such as silicone, are in high demand, particularly in Europe, which can affect the cost of the raw materials, a portion of which we may not be able to fully recover. We also began to experience some supply disruptions as high demand reduced availability of raw materials.

The global economy remains uncertain due to global supply chain interruptions, inflationary pressures, currency devaluations, political unrest, terror threats, global pandemics such as COVID-19, and even the political landscape in the U.S. These and other macro-economic factors have impacted the global financial markets, which may have contributed to significant changes in foreign currencies. We continue to monitor our exposure to changes in exchange rates.

Comparison of the fiscal years ended October 31, 2021 and 2020

This table sets forth our consolidated results of operations for the twelve-month periods ended October 31, 2021 and 2020.

[[GREPCENT_TABLE]]
[["","For the Years Ended October 31,"],["","2021","","2020","","2021 vs. 2020"],["","Amounts","","% of Sales","","Amounts","","% of Sales","","$ Change","","Variance %"],["","(Dollars in millions)"],["Net sales","$","1,072.1","","","100%","","$","851.6","","","100%","","$","220.5","","","26%"],["Cost of sales (excluding depreciation and amortization)","831.6","","","78%","","658.8","","","77%","","172.8","","","(26)%"],["Selling, general and administrative","116.0","","","11%","","89.7","","","11%","","26.3","","","(29)%"],["Restructuring charges","\u2014","","","\u2014%","","0.6","","","\u2014%","","(0.6)","","","100%"],["Depreciation and amortization","42.7","","","4%","","47.2","","","6%","","(4.5)","","","10%"],["Operating income","81.8","","","8%","","55.3","","","6%","","26.5","","","48%"],["Interest expense","(2.5)","","","\u2014%","","(5.2)","","","(1)%","","2.7","","","52%"],["Other, net","0.8","","","\u2014%","","0.2","","","\u2014%","","0.6","","","300%"],["Income tax expense","(23.1)","","","(2)%","","(11.8)","","","(1)%","","(11.3)","","","(96)%"],["Net income","$","57.0","","","5%","","$","38.5","","","5%","","$","18.5","","","48%"]]
[[/GREPCENT_TABLE]]

Our year-over-year results by reportable segment follow. Our comparison of the results for the fiscal years ended October 31, 2020 and 2019 by reportable segment for the prior year comparative periods can be found in the annual report on Form 10-K for the year ended October 31, 2020.

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Changes Related to Operating Income by Reportable Segment:

NA Fenestration

[[GREPCENT_TABLE]]
[["","For the Years Ended October 31,"],["","2021","","2020","","$ Change","","Variance %"],["","(Dollars in millions)"],["Net sales","$","578.3","","","$","483.4","","","$","94.9","","","20%"],["Cost of sales (excluding depreciation and amortization)","450.4","","","371.8","","","78.6","","","(21)%"],["Selling, general and administrative","53.0","","","47.8","","","5.2","","","(11)%"],["Restructuring charges","\u2014","","","0.3","","","(0.3)","","","100%"],["Depreciation and amortization","18.6","","","23.6","","","(5.0)","","","21%"],["Operating income","$","56.3","","","$","39.9","","","$","16.4","","","41%"],["Operating income margin","10","%","","8","%"]]
[[/GREPCENT_TABLE]]

Net Sales. Net sales increased $94.9 million, or 20%, for the twelve months ended October 31, 2021 compared to the same period in 2020, which was primarily driven by a $74.7 million increase in volumes, including a recovery from prior year COVID-19 impacts, and an increase in price and raw material surcharges of $20.2 million.

Cost of Sales. Cost of sales increased $78.6 million, or 21%, for the twelve months ended October 31, 2021 compared to the same period in 2020. Cost of sales, including labor, increased primarily due to higher volumes and price inflation during the period.

Selling, General and Administrative. Our selling, general and administrative expenses increased by $5.2 million, or 11%, for the twelve months ended October 31, 2021 compared to the same period in 2020. This increase was due primarily to higher compensation, including higher incentive accruals based on financial performance, and benefits year-over-year.

Restructuring Charges. Restructuring charges incurred during the twelve months ended October 31, 2020 relate to facility lease expense for a vinyl extrusion plant in the U.S. which was closed in January 2017. We exited the lease during December 2020.

Depreciation and Amortization. Depreciation and amortization expense decreased $5.0 million, or 21%, for the twelve months ended October 31, 2021 compared to the same period in 2020, reflecting the run-off of depreciation expense related to existing assets and disposals during the period.

EU Fenestration

[[GREPCENT_TABLE]]
[["","For the Years Ended October 31,"],["","2021","","2020","","$ Change","","Variance %"],["","(Dollars in millions)"],["Net sales","$","251.6","","","$","161.1","","","$","90.5","","","56%"],["Cost of sales (excluding depreciation and amortization)","172.0","","","108.8","","","63.2","","","(58)%"],["Selling, general and administrative","29.9","","","22.7","","","7.2","","","(32)%"],["Depreciation and amortization","10.4","","","9.5","","","0.9","","","(9)%"],["Operating income","$","39.3","","","$","20.1","","","$","19.2","","","96%"],["Operating income margin","16","%","","12","%"]]
[[/GREPCENT_TABLE]]

Net Sales. Net sales increased $90.5 million, or 56%, when comparing the twelve months ended October 31, 2021 compared to the same period in 2020, which was primarily driven by a $70.7 million increase in volumes, including a recovery from prior year COVID-19 impacts and the reopening of manufacturing facilities in the U.K. which were forced to close for several weeks in the second quarter of 2020, $11.8 million of foreign currency rate changes, and $8.0 million of base price increases.

Cost of Sales. The cost of sales increased $63.2 million, or 58%, for the twelve months ended October 31, 2021 compared to the same period in 2020. Cost of sales increased primarily due to higher volumes and price inflation during the period.

Selling, General and Administrative. Our selling, general and administrative expense increased $7.2 million, or 32%, for the twelve months ended October 31, 2021 compared to the same period in 2020. The increase is primarily due to higher

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compensation, including higher incentive accruals based on financial performance, general expenses and foreign currency impacts year-over-year.

NA Cabinet Components

[[GREPCENT_TABLE]]
[["","For the Years Ended October 31,"],["","2021","","2020","","$ Change","","Variance %"],["","(Dollars in millions)"],["Net sales","$","246.1","","","$","210.1","","","$","36.0","","","17%"],["Cost of sales (excluding depreciation and amortization)","211.1","","","179.8","","","31.3","","","(17)%"],["Selling, general and administrative","20.8","","","18.7","","","2.1","","","(11)%"],["Restructuring charges","\u2014","","","0.3","","","(0.3)","","","100%"],["Depreciation and amortization","13.3","","","13.7","","","(0.4)","","","3%"],["Operating income (loss)","$","0.9","","","$","(2.4)","","","$","3.3","","","138%"],["Operating income (loss) margin","\u2014","%","","(1)","%"]]
[[/GREPCENT_TABLE]]

Net Sales. Net sales increased $36.0 million, or 17%, for the twelve months ended October 31, 2021 compared to the same period in 2020, which was primarily driven by a $19.8 million increase in price and raw material indexes and a $16.2 million increase in volumes.

Cost of Sales. The cost of sales increased $31.3 million, or 17%, for the twelve months ended October 31, 2021 compared to the same period in 2020 as a primarily as a result of higher volumes and rising lumber prices, which are recovered on a lag.

Selling, General and Administrative. Our selling, general and administrative expense increased $2.1 million, or 11%, for the twelve months ended October 31, 2021 compared to the same period in 2020. The increase is primarily due to higher compensation, including higher incentive accruals based on financial performance, and general expenses year-over-year.

Restructuring Charges. Restructuring charges of $0.3 million in the twelve months ended October 31, 2020 related to severance, equipment moving and other charges incurred for a plant closure.

Unallocated Corporate & Other

[[GREPCENT_TABLE]]
[["","For the Years Ended October 31,"],["","2021","","2020","","$ Change","","Variance %"],["","(Dollars in millions)"],["Net sales","$","(3.9)","","","$","(3.0)","","","$","(0.9)","","","(30)%"],["Cost of sales (excluding depreciation and amortization)","(1.9)","","","(1.6)","","","(0.3)","","","19%"],["Selling, general and administrative","12.3","","","0.5","","","11.8","","","(2,360)%"],["Depreciation and amortization","0.4","","","0.4","","","\u2014","","","\u2014%"],["Operating loss","$","(14.7)","","","$","(2.3)","","","$","(12.4)","","","(539)%"]]
[[/GREPCENT_TABLE]]

Net Sales. Net sales for Unallocated Corporate & Other represents the elimination of inter-segment sales for the twelve months ended October 31, 2021 and 2020.

Cost of Sales. Cost of sales for Corporate & Other consists of the elimination of inter-segment sales, profit in inventory, and other costs.

Selling, General and Administrative. Our selling, general and administrative expenses increased $11.8 million, or 2,360%, for the twelve months ended October 31, 2021 compared to the same period in 2020. This increase is attributable to $7.3 million of higher compensation expense related to the valuations of our stock based compensation awards and executive bonuses due to financial performance, $4.8 million of medical expenses due to a higher claims experience during the twelve months ended October 31, 2021 compared to the same period in 2020, and $1.4 million of loss on the sale of a plant. These increases were partially offset by a reduction in executive severance and legal charges.

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Changes Related to Non-Operating Items:

Interest Expense. Interest expense decreased $2.7 million for the twelve months ended October 31, 2021 compared to the same period in 2020 primarily due to lower interest rates and lower overall debt outstanding. The weighted average interest rate for borrowings outstanding for the twelve months ended October 31, 2021 was 1.42% compared with 2.45% for the twelve months ended October 31, 2020.

Other, net. Other, net increased $0.6 million for the twelve months ended October 31, 2021 compared to the same period in 2020. The increase is primarily due to an increase in pension benefits year-over-year.

Income Taxes. We recorded income tax expense of $23.1 million on pre-tax income of $80.1 million for the twelve months ended October 31, 2021, an effective rate of 28.9%, and income tax expense of $11.8 million on pre-tax income of $50.3 million for the twelve months ended October 31, 2020, an effective rate of 23.5%. The effective rate for the twelve months ended October 31, 2021 was primarily impacted by state income taxes, global intangible low-taxed income, and changes in uncertain tax positions, partially offset by U.S. foreign tax credits. The effective rate for the twelve months ended October 31, 2020 was impacted by the true-up of our accruals and related deferred taxes from prior year filings and settled audits.

Liquidity and Capital Resources

Overview

Historically, our principal sources of funds have been cash on hand, cash flow from operations, and borrowings under our credit facilities. As of October 31, 2021, we had $40.1 million of cash and cash equivalents, $38.0 million outstanding under our credit facilities, $4.5 million of outstanding letters of credit and $15.5 million outstanding under finance leases. We had $282.5 million available for use under a revolving credit facility at October 31, 2021.

On October 18, 2018, we entered into a $325.0 million revolving credit facility (the “Credit Facility”), under which we borrowed $205.0 million. The proceeds from the Credit Facility, along with additional funding of $10.0 million of cash on hand, were used to repay outstanding borrowings under a previous credit agreement of $213.5 million, to settle outstanding interest accrued under the prior facility, and to pay loan fees which totaled $1.0 million. In addition, we expensed $1.1 million to write-off unamortized deferred financing fees associated with the previous credit agreement. The Credit Facility matures in 2023 (5-year term) and requires interest payments calculated, at our election and depending upon our Consolidated Leverage Ratio, at either a Base Rate plus an applicable margin (0.25% to 1.00%) or the LIBOR Rate plus an applicable margin (1.25% to 2.00%). We included deferred financing fees of $1.5 million as a contra-liability account, and are amortizing this balance straight-line over the term of the facility.

The weighted average interest rate of borrowings outstanding for the twelve-month periods ended October 31, 2021 and 2020 was 1.42% and 2.45%, respectively. We were in compliance with our debt covenants as of October 31, 2021. For additional details of the Credit Agreement, see “Item 1A. Risk Factors,” included elsewhere within this Annual Report on Form 10-K.

We expect to repatriate excess cash moving forward and use the funds to retire debt or meet current working capital needs. We believe our business model, our current cash reserves and the recent steps we have taken to strengthen our balance sheet leave us well-positioned to manage our business and remain in compliance with our debt covenants through the COVID-19 crisis as it continues to unfold.

Analysis of Cash Flow

The following table summarizes our cash flow results for the years ended October 31, 2021, 2020, and 2019:

[[GREPCENT_TABLE]]
[["","Year Ended October 31,"],["","2021","","2020","","2019"],["","(In millions)"],["Cash flows provided by operating activities","$","78.6","","","$","100.8","","","$","96.4"],["Cash flows used for investing activities","$","(18.7)","","","$","(25.2)","","","$","(23.6)"],["Cash flows used for financing activities","$","(71.9)","","","$","(55.1)","","","$","(71.3)"]]
[[/GREPCENT_TABLE]]

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Our year-over-year cash flow analysis follows. Our cash flow analysis for the fiscal years ended October 31, 2020 and 2019 for the prior year comparative periods can be found in the annual report on Form 10-K for the year ended October 31, 2020.

Operating Activities

Operating cash flow for the year ended October 31, 2021 decreased $22.2 million while cash flow for the year ended October 31, 2020 increased by $4.4 million. The decrease in cash provided by operating activities is primarily due to an increase in working capital partially offset by higher net income year-over-year due to increased demand. The increase in working capital was largely driven by an inventory build and raw material price inflation and an increase in accounts receivable.

Investing Activities

Cash used for investing activities for the year ended October 31, 2021 decreased $6.5 million compared to the year ended October 31, 2020 due to an increase of $4.8 million in proceeds from the disposition of capital assets and a $1.7 million decrease in capital expenditures.

At October 31, 2021, we had firm purchase commitments of approximately $5.2 million for the purchase or construction of capital assets. We plan to fund these capital expenditures through cash from operations or borrowings under our revolving credit facility.

Financing Activities

In the year ended October 31, 2021, cash used for financing activities was $71.9 million and related primarily to net debt repayments of $65.7 million, share repurchases of $11.2 million and payment of dividends of $10.8 million, partially offset by $16.3 million of proceeds from the exercise of stock options. In the year ended October 31, 2020, cash used for financing activities was $55.1 million and related primarily to net debt repayments of $40.5 million, payment of dividends of $10.5 million, and share repurchases of $7.2 million.

Liquidity Requirements

Our strategy for deploying cash is to invest in organic growth opportunities, develop our infrastructure, and explore strategic acquisitions. Other uses of cash include paying cash dividends to our shareholders and repurchasing our own stock. We maintain cash balances in foreign countries which totaled $10.6 million and $16.8 million as of October 31, 2021 and 2020. During the years ended October 31, 2021 and 2020, we repatriated $28.4 million and $31.9 million, respectively, of foreign earnings from our international divisions.

We believe that we have sufficient funds and adequate financial resources available to meet our anticipated liquidity needs. We expect to use our cash flow from operations to fund operations for the next twelve months and the foreseeable future. We believe these funds should be adequate to provide for our working capital requirements, capital expenditures, and dividends, while continuing to meet our debt service requirements.

Senior Credit Facility

We maintain our $325.0 million Credit Facility, which contains a revolving 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. At the time of the initial borrowing, the applicable rate was LIBOR + 1.50%. In addition, we are subject to commitment fees for the unused portion of the Credit Facility. The applicable margin and commitment fees range from 0.45% to 2.30%, depending upon the type of loan and consolidated leverage ratio. 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.

The Credit Facility provides for revolving credit commitments for a minimum principal amount of $10.0 million, up to an aggregate amount of $150.0 million, subject to the lender's discretion to elect or decline the incremental increase. We can also borrow up to the lesser of $15.0 million or the revolving credit commitment, as defined, under a Swingline feature of the Credit Facility.

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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 to conduct other transactions as further defined in the Credit Facility. Some of these limitations, however, do not take effect so long as total leverage is less than or equal to 2.75 to 1.00 and available liquidity exceeds $25.0 million. Substantially all of our domestic assets, with the exception of real property, are pledged as collateral for the Credit Facility.

Issuer Purchases of Equity Securities

On August 30, 2018, our Board of Directors approved a stock repurchase program that authorized the repurchase of up to $60.0 million worth of shares of our common stock. Repurchases under the program were made in open market transactions or privately negotiated transactions, subject to market conditions, applicable legal requirements and other relevant factors. During the years ended October 31, 2021, 2020 and 2019, we purchased 478,311, 450,000 and 583,398 shares, respectively, at a cost of $11.2 million, $7.2 million and $9.6 million, respectively, under this program. As of October 31, 2021, this share repurchase authorization was exhausted and the program is now complete.

Critical Accounting Policies and Estimates

The preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires us to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. Estimates and assumptions about future events and their effects cannot be perceived with certainty. Estimates may change as new events occur, as more experience is acquired, as additional information becomes available and as our operating environment changes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, and that we believe provide a basis for making judgments about the carrying value of assets and liabilities that are not readily available through open market quotes. We must use our judgment with regard to uncertainties in order to make these estimates. Actual results could differ from these estimates.

We believe the following are the most critical accounting policies used in the preparation of our consolidated financial statements as well as the significant judgments and uncertainties affecting the application of these policies. We consider an estimate to be critical if it is subjective and if changes in the estimate using different assumptions would result in a material impact to our financial position or results of operations.

While there have been no changes in the application of principles, methods, and assumptions used to determine our significant estimates, we may be required to revise certain accounting estimates and judgments related to the economic and business impact of the COVID-19 pandemic, such as, but not limited to, those related to the valuation of goodwill, intangibles, long-lived assets, accounts receivable, and inventory, which could have a material adverse effect on our financial position and results of operations.

Impairment or Disposal of Long-Lived Assets

Property, Plant and Equipment and Intangible Assets with Defined Lives

We make judgments and estimates in conjunction with the carrying value of our long-term assets, including property, plant and equipment, and identifiable intangibles. These judgments may include the basis for capitalization, depreciation and amortization methods and the useful lives of the underlying assets. In accordance with U.S. GAAP, we review the carrying values of these assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We determine that the carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying value exceeds the sum of the undiscounted cash flows and after considering alternate uses for the asset, an impairment charge would be recorded in the period in which such review is performed. We measure the impairment loss as the amount by which the carrying amount of the long-lived asset exceeds its fair value. Fair value is determined by reference to quoted market prices in active markets, if available, or by calculating the discounted cash flows associated with the use and eventual disposition of the asset. Therefore, if there are indicators of impairment, we are required to make long-term forecasts of our future revenues and costs related to the assets subject to review. Forecasts require assumptions about demand for our products and future market conditions. Although there may be no indicators of impairment in the current period, unanticipated changes to assumptions or circumstances in future

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periods could result in an impairment charge in the period of the change. No impairment charges were incurred with regard to our property, plant and equipment for the years ended October 31, 2021, 2020 and 2019.

We monitor relevant circumstances, including industry trends, general economic conditions, and the potential impact that such circumstances might have on the valuation of our identifiable intangibles. Events and changes in circumstances that may cause a triggering event and necessitate such a review include, but are not limited to: a decrease in sales for certain customers, improvements or changes in technology, and/or a decision to phase-out a trademark or trade name. Such events could negatively impact the carrying value of our identifiable intangibles. It is possible that changes in such circumstances or in the numerous variables associated with the judgments, assumptions, and estimates made by us in assessing the appropriate valuation of our identifiable intangibles could require us to further write down a portion of our identifiable intangibles and record related non-cash impairment charges in the future. We apply a variety of techniques to establish the carrying value of our intangible assets, including the relief from royalty and excess current year earnings methods.

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Goodwill

We use the acquisition method to account for business combinations and, to the extent that the purchase price exceeds the fair value of the net assets acquired, we record goodwill. In accordance with U.S. GAAP, we are required to evaluate our goodwill at least annually. We perform our annual goodwill assessment as of August 31, or more frequently if indicators of impairment exist. Qualitative factors that indicate impairment could include, but are not limited to, (i) macroeconomic conditions, (ii) industry and market considerations, (iii) cost factors, (iv) overall financial performance of the reporting unit, and (v) other relevant entity-specific events. The first step in our annual goodwill assessment is to perform the optional qualitative assessment allowed by ASC Topic 350 “Intangibles - Goodwill and Other” (ASC 350). In our qualitative assessment, we evaluate relevant events or circumstances to determine whether it is more likely than not (i.e., greater than 50%) that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, ASC 350 requires us to compare the fair value of such reporting unit to its carrying value including goodwill. To determine the fair value of our reporting units, we use multiple valuation techniques including a discounted cash flow analysis, using the applicable weighted average cost of capital, in combination with a market approach that uses market multiples and a selection of guideline public companies. This test requires us to make assumptions about the future growth of our business and the market in general, as well as other variables such as the level of investment in capital expenditure, growth in working capital requirements and the terminal or residual value of our reporting units beyond the periods of estimated annual cash flows. We use a third-party valuation firm to assist us with this analysis. If the fair value of each reporting unit exceeds its carrying value, no action is required. Otherwise, an impairment loss is recorded to the extent that the carrying amount of the reporting unit including goodwill exceeds the fair value of that reporting unit. We believe the estimates and assumptions used in our impairment assessment are reasonable based on available market information, but variations in any of the assumptions could result in materially different calculations of fair value and determinations of whether or not an impairment is indicated during current or future periods.

As a result of quantitative assessments performed during the year ended October 31, 2019, we recorded impairment charges totaling $74.6 million during the year ended October 31, 2019, reducing the goodwill balance applicable to the reporting unit included in our NA Cabinet Components operating segment from $113.7 million to $39.1 million.

For the year ended October 31, 2020, the World Health Organization's declaration of COVID-19 as a global pandemic also created significant changes in market conditions that were indicators of triggering events which necessitated an evaluation of certain long-term assets, including goodwill, for potential impairment. We performed quantitative assessments based upon undiscounted cash flows we expected to realize associated with these assets over the remaining useful lives of the primary operating assets to the net book value of the long-term assets, including goodwill, and determined that these assets, including goodwill, were not impaired.

At our annual testing date, August 31, 2021, we had five reporting units with goodwill balances: two reporting units included in our NA Fenestration operating segment, two reporting units included in our EU Fenestration operating segment, and one reporting unit included in our NA Cabinet Components operating segment. We performed a qualitative assessment of the two reporting units in the NA Fenestration segment and one of the two reporting units in the EU Fenestration segment. This review included an analysis of historical goodwill test results, operating results relative to forecast, projected results over the next five years, and other measures and concluded that there were no indicators of potential impairment associated with these reporting units. Therefore, no additional testing was deemed necessary for the reporting units in the NA Fenestration segment and the EU Fenestration segment that were assessed qualitatively. We also updated the quantitative assessments for the reportable unit in the NA Cabinet Components segment and the second reportable unit in the EU Fenestration segment. We determined the fair value of these reportable units exceeded the carrying value by 17.6% and 113.6%, respectively, and concluded that no impairment was necessary.

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Income Taxes

We operate in various jurisdictions and therefore our income tax expense relates to income taxes in the U.S., U.K., Canada, and Germany, as well as local and state income taxes. We recognize the effect of a change in tax rates in the period of the change. We record the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and the amounts reported in our consolidated balance sheets, as well as net operating losses and tax credit carry forward. We evaluate the carrying value of our net deferred tax assets and determine if our business will generate sufficient future taxable income to realize the net deferred tax assets. We perform this review for recoverability on a jurisdictional basis, whereby we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence can be objectively verified. We evaluate recoverability based on an estimate of future taxable income using the long-term forecasts we use to evaluate long-lived assets, goodwill and intangible assets for impairment, taking into consideration the future reversal of existing taxable temporary differences and reviewing our current financial operations. In the event that our estimates and assumptions indicate we will not generate sufficient future taxable income to realize our deferred tax assets, we will record a valuation allowance, to the extent indicated, to reduce our deferred tax assets to their realizable value.

Annually, we evaluate our tax positions to determine if there have been any changes in uncertain tax positions or if there has been a lapse in the statute of limitations with regard to such positions. Our liability for uncertain tax positions at October 31, 2021 and 2020 totaled $1.4 million and $0.5 million, respectively, and related to certain federal and state tax items regarding the interpretation of tax laws and regulations.

We believe we will have sufficient taxable income in the future to fully utilize our deferred tax assets recorded as of October 31, 2021, net of our valuation allowance. There is a risk that our estimates related to the future use of loss carry forwards and our ability to realize our deferred tax assets may not come to fruition, and that the results could materially impact our financial position and results of operations. Our total gross deferred tax assets at October 31, 2021 and 2020 totaled $13.8 million and $14.3 million, respectively, against which we had recorded a valuation allowance of $1.2 million and $1.5 million, respectively.

Inventory

We record inventory at the lower of cost or net realizable value. Inventories are valued using the first-in first-out (FIFO) method. Fixed costs related to excess manufacturing capacity have been expensed in the period, and therefore, are not capitalized into inventory. Inventory quantities are regularly reviewed and provisions for excess or obsolete inventory are recorded primarily based on our forecast of future demand and market conditions. Significant unanticipated changes to our forecasts or changes in the net realizable value of our inventory would require a change in the provision for excess or obsolete inventory. For the years ended October 31, 2021, 2020 and 2019, our inventory reserves are approximately 3%, 10%, and 5% of gross inventory, respectively.

Retirement Plans

We sponsor a defined benefit pension plan and an unfunded postretirement plan that provides health care and life insurance benefits for a limited pool of eligible retirees and dependents. 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. The measurement of liabilities related to these plans is based on our assumptions related to future events, including expected return on plan assets and healthcare cost trend rates. The discount rate reflects the rate at which benefits could be effectively settled on the measurement date. We determine our discount rate using a RATE: Link Model whereby target yields are developed from bonds across a range of maturity points, and a curve is fitted to those targets. Spot rates (zero coupon bond yields) are developed from the curve and used to discount benefit payments associated with each future year. This model assumes spot rates will remain level beyond the 30-year point. We determine the present value of plan benefits by applying the discount rates to projected benefit cash flows. Actual pension plan asset investment performance, as well as other economic experience such as discount rate and demographic experience, will either reduce or increase unamortized pension losses at the end of any fiscal year, which ultimately affects future pension costs.

As of October 31, 2021, our projected benefit obligation (PBO) and accumulated benefit obligation (ABO) each exceeded the fair value of the plan assets by $4.7 million. As a comparison, our PBO and ABO exceeded the fair value of plan assets by $10.7 million as of October 31, 2020. During fiscal 2021, we contributed $0.5 million to the pension plan to meet minimum contribution requirements. Expected contributions are dependent on many variables, including the variability of the market value of the assets as compared to the obligation and other market or regulatory conditions. In addition, we take into

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consideration our business investment opportunities and our cash requirements. Accordingly, actual funding may differ greatly from current estimates.

Under U.S. GAAP, we are not required to immediately recognize the effects of a deviation between actual and assumed experience under our pension plan, or to revise our estimate as a result. This approach allows the favorable and unfavorable effects that fall within an acceptable range to be netted and disclosed as an unrecognized gain or loss. As of October 31, 2021 and 2020, a net actuarial loss of $4.5 million and $9.9 million, respectively, was included in our accumulated other comprehensive (loss) income. There were no net prior service costs or transition obligations for the years ended October 31, 2021 and 2020. The effect on fiscal years after 2021 will depend on the actual experience of the plans.

Mortality assumptions used to determine the obligations for our pension plans are based on the Pri-2012 base mortality table with MP-2020 mortality improvement scale.

Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments include unconditional purchase obligations which consist of commitments to buy miscellaneous parts, inventory, and expenditures related to capital projects in progress. In addition, during fiscal 2022, we do not expect to need to contribute to our pension plan to meet our minimum contribution requirements. Pension contributions beyond 2022 cannot be determined since the amount of any contribution is heavily dependent on the future economic environment and investment returns on pension plan assets. Obligations are based on current and projected obligations of the plans, performance of the plan assets, if applicable, and the timing and amount of funding contributions. At October 31, 2021, we have recorded a long-term liability for deferred pension benefits totaling $4.7 million. We believe the effect of the plans on liquidity is not significant to our overall financial condition.

Our supplemental benefit plan and deferred compensation plan liabilities fluctuate based on changes in the market value of certain equity securities, including our common stock. As of October 31, 2021, our liability under the supplemental benefit plan and the deferred compensation plan was approximately $2.9 million and $3.4 million, respectively.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, as such term is defined in the rules promulgated by the SEC, that we believe would be material to investors and for which it is reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

Effects of Inflation

We have experienced the impact of inflation on our cost of raw materials, labor, freight and overhead, particularly during the year ended October 31, 2021.  Although we use contractual price indexing along with periodic base price increases to minimize the effect of inflation on our results, we have not been able to fully recover all of the inflationary cost increases.  We cannot provide assurance, however, that our results of operations and financial position will not be materially impacted by inflation in the future.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326). This ASU sets forth a “current expected credit loss” model, which requires the measurement of all expected credit losses for financial instruments or other assets (e.g., trade receivables), held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. We adopted this amendment on November 1, 2020, with no material impact on our condensed consolidated financial statements as pre-existing processes for estimating credit losses for trade receivables aligned with the expected credit loss model.

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