Quarterly Report (10-q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

o (Do not check if a smaller reporting company)

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Securities Act.

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________________________________________

FORM 10-Q

________________________________________________

(Mark One)



☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended January 31, 2020



☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 1-33913

________________________________________________

QUANEX BUILDING PRODUCTS CORPORATION

(Exact name of registrant as specified in its charter)

________________________________________________



Delaware		26-1561397
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1800 West Loop South, Suite 1500, Houston, Texas 77027

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (713) 961-4600

________________________________________________

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	NX	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x

The number of shares outstanding of the registrant's Common Stock as of March 3, 2020 was 32,947,975.

QUANEX BUILDING PRODUCTS CORPORATION

INDEX



PART I.	FINANCIAL INFORMATION	1

Item 1:	Financial Statements (Unaudited)	1

	Condensed Consolidated Balance Sheets – January 31, 2020 and October 31, 2019	1

	Condensed Consolidated Statements of Income (Loss) – Three Months Ended January 31, 2020 and 2019	2

	Condensed Consolidated Statements of Comprehensive Income (Loss) - Three Months Ended January 31, 2020 and 2019	3

	Condensed Consolidated Statements of Cash Flows – Three Months Ended January 31, 2020 and 2019	4

	Condensed Consolidated Statement of Stockholders’ Equity – Three Months Ended January 31, 2020 and 2019	5

	Notes to Unaudited Condensed Consolidated Financial Statements	6

Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25

Item 3:	Quantitative and Qualitative Disclosures About Market Risk	32

Item 4:	Controls and Procedures	33

PART II.	OTHER INFORMATION	34

Item 1A:	Risk Factors	34

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	34

Item 5:	Other Information	34

Item 6:	Exhibits	35

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

QUANEX BUILDING PRODUCTS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



	January 31, 2020			October 31, 2019
	(In thousands, except share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	23,114		$	30,868
Accounts receivable, net of allowance for doubtful accounts of $549 and $393	64,036			82,946
Inventories, net	78,117			67,159
Prepaid and other current assets	7,931			9,353
Total current assets	173,198			190,326
Property, plant and equipment, net of accumulated depreciation of $322,403 and $317,568	192,148			193,600
Operating lease right-of-use assets	41,661			—
Goodwill	146,590			145,563
Intangible assets, net	104,338			107,297
Other assets	9,265			8,324
Total assets	$	667,200		$	645,110
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	49,092		$	63,604
Accrued liabilities	28,982			39,221
Income taxes payable	5,265			6,183
Current maturities of long-term debt	707			746
Current operating lease liabilities	6,532			—
Total current liabilities	90,578			109,754
Long-term debt	166,711			156,414
Noncurrent operating lease liabilities	35,505			—
Deferred pension and postretirement benefits	11,251			13,322
Deferred income taxes	19,741			19,363
Other liabilities	13,481			16,070
Total liabilities	337,267			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 37,319,866 and 37,370,402, respectively; outstanding 32,963,475 and 33,021,789, respectively	373			374
Additional paid-in-capital	252,495			254,673
Retained earnings	182,989			185,703
Accumulated other comprehensive loss	(29,164		)	(33,817		)
Less: Treasury stock at cost, 4,356,391 and 4,348,613 shares, respectively	(76,760		)	(76,746		)
Total stockholders’ equity	329,933			330,187
Total liabilities and stockholders' equity	$	667,200		$	645,110

The accompanying notes are an integral part of the financial statements.

Table of Contents

QUANEX BUILDING PRODUCTS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(Unaudited)



	Three Months Ended
	January 31,
	2020			2019
	(In thousands, except per share amounts)
Net sales	$	196,597		$	196,808
Cost and expenses:
Cost of sales (excluding depreciation and amortization)	157,427			158,557
Selling, general and administrative	24,132			28,026
Restructuring charges	153			103
Depreciation and amortization	12,905			12,572
Operating income (loss)	1,980			(2,450		)
Non-operating (expense) income:
Interest expense	(1,582		)	(2,442		)
Other, net	36			256
Income (loss) before income taxes	434			(4,636		)
Income tax (expense) benefit	(424		)	987
Net income (loss)	$	10		$	(3,649	)

Basic earnings (loss) per common share	$	—		$	(0.11	)

Diluted earnings (loss) per common share:	$	—		$	(0.11	)

Weighted-average common shares outstanding:
Basic	32,861			33,098
Diluted	33,078			33,098

Cash dividends per share	$	0.08		$	0.08

The accompanying notes are an integral part of the financial statements.

Table of Contents

QUANEX BUILDING PRODUCTS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)



	Three Months Ended
	January 31,
	2020			2019
	(In thousands)
Net income (loss)	$	10		$	(3,649	)
Other comprehensive income:
Foreign currency translation gain	2,743			4,066
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 gain	4,653			4,062
Comprehensive income	$	4,663		$	413

The accompanying notes are an integral part of the financial statements.

Table of Contents

QUANEX BUILDING PRODUCTS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Three Months Ended
	January 31,
	2020			2019
	(In thousands)
Operating activities:
Net income (loss)	$	10		$	(3,649	)
Adjustments to reconcile net income (loss) to cash used for operating activities:
Depreciation and amortization	12,905			12,572
Stock-based compensation	(239		)	224
Deferred income tax	(413		)	(1,877		)
Other, net	1,096			785
Changes in assets and liabilities:
Decrease in accounts receivable	18,641			12,679
Increase in inventory	(10,657		)	(11,601		)
Decrease in other current assets	1,200			15
Decrease in accounts payable	(12,063		)	(11,738		)
Decrease in accrued liabilities	(12,519		)	(18,850		)
(Decrease) increase in income taxes payable	(936		)	422
Increase in deferred pension and postretirement benefits	448			684
Decrease in other long-term liabilities	(405		)	(27		)
Other, net	(725		)	118
Cash used for operating activities	(3,657		)	(20,243		)
Investing activities:
Capital expenditures	(9,312		)	(6,271		)
Proceeds from disposition of capital assets	—			74
Cash used for investing activities	(9,312		)	(6,197		)
Financing activities:
Borrowings under credit facilities	34,500			43,000
Repayments of credit facility borrowings	(24,500		)	(23,000		)
Repayments of other long-term debt	(285		)	(454		)
Common stock dividends paid	(2,659		)	(2,675		)
Issuance of common stock	3,075			27
Payroll tax paid to settle shares forfeited upon vesting of stock	(454		)	(322		)
Purchase of treasury stock	(4,639		)	(2,016		)
Cash provided by financing activities	5,038			14,560
Effect of exchange rate changes on cash and cash equivalents	177			333
Decrease in cash and cash equivalents	(7,754		)	(11,547		)
Cash and cash equivalents at beginning of period	30,868			29,003
Cash and cash equivalents at end of period	$	23,114		$	17,456

The accompanying notes are an integral part of the financial statements.

Table of Contents

QUANEX BUILDING PRODUCTS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)



Three Months Ended January 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



Three Months Ended January 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

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 13, "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 only 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.

Pricing and sales incentives

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 months ended January 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 13, “Segment Information”.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



	Three Months Ended
	January 31,
	2020			2019
	(In thousands)
North American Fenestration:
United States - fenestration	$	96,847		$	93,884
International - fenestration	6,434			8,207
United States - non-fenestration	4,563			3,505
International - non-fenestration	2,608			3,453
	$	110,452		$	109,049
European Fenestration:
International - fenestration	$	30,964		$	30,724
International - non-fenestration	5,802			4,530
	$	36,766		$	35,254
North American Cabinet Components:
United States - fenestration	$	3,147		$	3,352
United States - non-fenestration	46,450			49,962
International - non-fenestration	447			539
	$	50,044		$	53,853
Unallocated Corporate & Other
Eliminations	$	(665	)	$	(1,348	)
	$	(665	)	$	(1,348	)
Net sales	$	196,597		$	196,808

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.

We closed a kitchen and bathroom cabinet door business in Mexico in October 2016 and another plant in Lansing, Kansas in September 2017. We closed two U.S. vinyl operations plants in November 2016 and January 2017. Pursuant to these restructuring efforts, we expensed $0.1 million during the three months ended January 31, 2020 and 2019. We have not negotiated an exit from our lease obligation, which is deemed to be at fair market value, at one remaining closed plant location. We expect to continue to incur costs related to this operating lease during fiscal 2020 until we are able to sublet or otherwise exit the lease.

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 severance expense of less than $0.1 million related to this plant closure during the three months ended January 31, 2020 and we expect to incur costs related to additional restructuring activities in future periods.

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QUANEX BUILDING PRODUCTS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 CAM 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 January 31, 2020 (in thousands):



Leases	Classification	January 31, 2020
Assets
Operating lease assets	Operating lease right-of-use assets	$	41,661
Finance lease assets	Property, plant and equipment (less accumulated depreciation of $308)	16,317
Total lease assets		$	57,978

Liabilities
Current
Operating	Current operating lease liabilities	$	6,532
Finance	Current maturities of long-term debt	975
Noncurrent
Operating	Noncurrent operating lease liabilities	35,505
Finance	Long-term debt	14,921
Total lease liabilities		$	57,933

The table below presents the components of the lease costs for the three months ended January 31, 2020 (in thousands):

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



	Three months ended
	January 31, 2020
Components of lease costs
Operating lease cost	$	2,058
Finance lease cost
Amortization of leased assets	316
Interest on lease liabilities	144
Variable lease costs	125
Total lease cost	$	2,643

The table below presents supplemental cash flow information related to leases for the three months ended January 31, 2020 (in thousands):



	Three months ended
	January 31, 2020
Supplemental Cash Flow Information
Cash paid for amounts included in the measurement of lease liabilities:
Finance leases - financing cash flows	$	322
Finance leases - operating cash flows	$	144
Operating leases - operating cash flows	$	2,071

Right-of-use assets obtained in exchange for lease liabilities
Operating leases	$	3,082
Finance Leases	$	—

The table below presents the weighted average remaining lease terms and weighted average discount rates for the Company's leases as of January 31, 2020:



	January 31, 2020
Weighted average remaining lease term (in years)
Operating leases	8.2
Financing leases	16.4

Weighted average discount rate
Operating leases	4.08	%
Financing leases	3.64	%

The table below presents the maturity of the lease liabilities as of January 31, 2020 (in thousands):

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QUANEX BUILDING PRODUCTS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



	Operating Leases		Finance Leases
	(in thousands)
2020 (remaining nine months)	$	6,141	$	1,177
2021	7,195		1,425
2022	6,531		1,391
2023	6,220		1,294
2024	5,516		1,190
Thereafter	17,730		14,208
Total lease payments	49,333		20,685
Less: present value discount	7,296		4,789
Total lease liabilities	$	42,037	$	15,896

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

3. Inventories

Inventories consisted of the following at January 31, 2020 and October 31, 2019:



	January 31, 2020		October 31, 2019
	(In thousands)
Raw materials	$	40,423	$	32,818
Finished goods and work in process	39,461		35,538
Supplies and other	2,644		2,593
Total	82,528		70,949
Less: Inventory reserves	4,411		3,790
Inventories, net	$	78,117	$	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

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The change in the carrying amount of goodwill for the three months ended January 31, 2020 was as follows:



	Three Months Ended
	January 31, 2020
	(In thousands)
Beginning balance as of November 1, 2019	$	145,563
Foreign currency translation adjustment	1,027
Balance as of the end of the period	$	146,590

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. As of January 31, 2020, there were no further indicators of impairment. Should our actual results for our NA Cabinet Components operating segment be lower than expected in the future, the corresponding goodwill could become impaired and the impairment could be material. For a summary of the change in the carrying amount of goodwill by segment, see Note 13, "Segment Information."

Identifiable Intangible Assets

Amortizable intangible assets consisted of the following as of January 31, 2020 and October 31, 2019:



	January 31, 2020				October 31, 2019
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
	(In thousands)
Customer relationships	$	154,727	$	73,029	$	153,950	$	70,103
Trademarks and trade names	55,988		35,811		55,745		35,210
Patents and other technology	22,397		19,934		22,386		19,471
Total	$	233,112	$	128,774	$	232,081	$	124,784

We had aggregate amortization expense related to intangible assets for the three months ended January 31, 2020 of $3.7 million and $4.0 million for the comparable prior year period.

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 nine months)	$	10,594
2021	12,619
2022	11,998
2023	11,251
2024	10,520
Thereafter	47,356
Total	$	104,338

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QUANEX BUILDING PRODUCTS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

5. Debt and Capital Lease Obligations

Debt consisted of the following at January 31, 2020 and October 31, 2019:



	January 31, 2020			October 31, 2019
	(In thousands)
Revolving Credit Facility	$	152,500		$	142,500
Finance lease obligations and other	16,047			15,865
Unamortized deferred financing fees	(1,129		)	(1,205		)
Total debt	$	167,418		$	157,160
Less: Current maturities of long-term debt	707			746
Long-term debt	$	166,711		$	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 if necessary. 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.

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 January 31, 2020, we had $152.5 million of borrowings outstanding under the Credit Agreement (reduced by unamortized debt issuance costs of $1.1 million), $4.8 million of outstanding letters of credit and $16.0 million outstanding primarily under finance leases and other debt. We had $167.7 million available for use under the Credit Agreement at January 31, 2020. Outstanding borrowings under the Credit Agreement accrue interest at 3.15% per annum. Our weighted average borrowing rate for borrowings outstanding during the three months ended January 31, 2020 and 2019 was 3.27% and 4.03%, respectively. We were in compliance with our debt covenants as of January 31, 2020.

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.

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QUANEX BUILDING PRODUCTS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 months ended January 31, 2020 and 2019 was as follows:



	Three Months Ended
	January 31,
	2020			2019
	(In thousands)
Service cost	$	538		$	977
Interest cost	293			283
Expected return on plan assets	(491		)	(543		)
Amortization of net loss	108			16
Net periodic pension cost	$	448		$	733

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 different 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

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 January 31, 2020 and October 31, 2019, our liability under the supplemental benefit plan was approximately $4.3 million and $4.2 million, respectively. As of January 31, 2020 and October 31, 2019, the liability associated with the deferred compensation plan was approximately $3.7 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. Warranty Obligations

We accrue warranty obligations as we recognize revenue associated with certain products. We make provisions for our warranty obligations based upon historical experience of costs incurred for such obligations adjusted, as necessary, for current conditions and factors. There are significant uncertainties and judgments involved in estimating our warranty obligations, including changing product designs, differences in customer installation processes and future claims experience which may vary from historical claims experience. Therefore, the ultimate amount we incur as warranty costs in the near and long-term may not be consistent with our current estimate.

A reconciliation of the activity related to our accrued warranty, including both the current and long-term portions (reported in accrued liabilities and other liabilities, respectively, on the accompanying condensed consolidated balance sheets) follows:

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



	Three Months Ended
	January 31, 2020
	(In thousands)
Beginning balance as of November 1, 2019	$	260
Warranty costs paid	(20		)
Total accrued warranty as of January 31, 2020	$	240
Less: Current portion of accrued warranty	136
Long-term portion of accrued warranty	$	104

8. 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 three months ended January 31, 2020 and 2019 was 20.5% and 24.0%, respectively, excluding discrete items. The 2020 effective rate was impacted by an additional discrete charge of $0.4 million related to the vesting or exercise of equity-based compensation awards.

The 2019 effective rate was primarily impacted by a net charge of $1.4 million related to global intangible low-taxed income and foreign-derived intangible income, as well as discrete charges of $0.6 million for the adjustment of the one-time mandatory transition tax on deemed repatriation of previously tax-deferred and unremitted foreign earnings and $0.3 million related to the vesting or exercise of equity-based compensation awards.

As of January 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 January 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 January 31, 2020 and October 31, 2019.

Final regulations were published by the Internal Revenue Service and U.S. Department of the Treasury regarding Uniform Capitalization (UNICAP) that became effective during fiscal 2020. We are evaluating the regulations but do not believe there will be a material impact on our consolidated financial statements.

10. 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

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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 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.

10. 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 January 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 January 31, 2020 and October 31, 2019. 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 January 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 11, "Stock-Based Compensation -Performance Share Awards."

11. Stock-Based Compensation

We have established and maintain an Omnibus Incentive Plan (2008 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 2008 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 2008 Plan is 7,650,000 as approved by

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shareholders. In February 2020, shareholders authorized an increase of 1,300,000 shares for grant under a new 2020 plan, which became effective at that time. Any officer, key employee and/or non-employee director is eligible for awards under the 2008 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.

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 three months ended January 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	56,000		$	19.40
Forfeited	(27,300	)	$	17.31
Vested	(55,000	)	$	19.45
Non-vested at January 31, 2020	203,800		$	16.98

The total weighted average grant-date fair value of restricted stock awards that vested during each of the three month periods ended January 31, 2020 and 2019 was $1.1 million and $1.3 million, respectively. As of January 31, 2020, total unrecognized compensation cost related to unamortized restricted stock awards was $2.2 million. We expect to recognize this expense over the remaining weighted average vesting period of 2.2 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, 2019 or during the three months ended January 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.

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The following table summarizes our stock option activity for the three months ended January 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	(58,734	)	$	20.61
Outstanding at January 31, 2020	1,179,419		$	18.89	4.2	$	395
Vested or expected to vest at January 31, 2020	1,179,419		$	18.89	4.2	$	395
Exercisable at January 31, 2020	1,179,419		$	18.89	4.2	$	395

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 three months ended January 31, 2020 and 2019 was $0.5 million and less than $0.1 million, respectively. The weighted-average grant date fair value of stock options that vested during the three months ended January 31, 2020 and 2019 was $0.4 million and $1.1 million, respectively. As of January 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 three months ended January 31, 2020 and 2019, non-employee directors received 25,326 and 25,920 restricted stock units, respectively, at a grant date fair value of $19.02 per share and $15.31 per share, respectively, which vested immediately. As of January 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 three months ended January 31, 2019, we paid approximately $0.1 million to settle previously vested restricted stock units; there were no corresponding payments to settle vested restricted stock units during the three months ended January 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

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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	$	—	46,608
December 5, 2018	131,500	$	—	$	—	$	13.63	33,500
December 5, 2019	55,900	$	—	$	—	$	19.40	—

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 a decrease in compensation expense of $0.5 million for the three months ended January 31, 2020 related to the expected payout of our performance share awards that are outstanding as of January 31, 2020. During the three months ended January 31, 2019, we recorded a decrease in compensation expense of $0.3 million related to the expected payouts of performance share awards that were outstanding as of January 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 January 31, 2020, we have deemed 18,730 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	24,854
December 5, 2018	89,200	$	13.63	25,500
December 5, 2019	35,000	$	19.40	—

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

During the three months ended January 31, 2020, we recorded compensation expense of approximately $0.1 million and $0.2 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 January 31, 2020, we have deemed 28,449 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, with the remainder recorded as a charge to retained earnings. We recorded a charge to retained earnings of $0.1 million during the three months ended January 31, 2020.

The following table summarizes the treasury stock activity during the three months ended January 31, 2020:



	Three Months Ended
	January 31, 2020
Beginning balance as of November 1, 2019	4,348,613
Restricted stock awards granted	(56,000	)
Performance share awards vested	(28,051	)
Stock options exercised	(178,033	)
Treasury stock repurchases	269,862
Balance at January 31, 2020	4,356,391

12. Other Income

Other income, included under the caption "Other, net" on the accompanying condensed consolidated statements of income (loss), consisted of the following for the three months ended January 31, 2020 and 2019:



	Three Months Ended
	January 31,
	2020			2019
	(In thousands)
Foreign currency transaction losses	$	(49	)	$	(32	)
Foreign currency derivative (losses) gains	(11		)	11
Pension service benefit	90			244
Interest income	5			30
Other	1			3
Other, net	$	36		$	256

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

13. 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 month period ended January 31, 2020 was $5.5 million and $4.8 million for the prior year comparable period.

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 distributors will vary amongst the businesses; (5) similar regulatory environment; and (6) converging long-term economic similarities.

Segment information for the three months ended January 31, 2020 and 2019, and total assets as of January 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 January 31, 2020
Net sales	$	110,452	$	36,766	$	50,044		$	(665	)	$	196,597
Depreciation and amortization	6,979		2,408		3,402			116			12,905
Operating income (loss)	1,631		3,164		(2,115		)	(700		)	1,980
Capital expenditures	6,928		1,219		1,075			90			9,312
Three Months Ended January 31, 2019
Net sales	$	109,049	$	35,254	$	53,853		$	(1,348	)	$	196,808
Depreciation and amortization	6,873		2,236		3,339			124			12,572
Operating income (loss)	1,843		2,781		(2,267		)	(4,807		)	(2,450		)
Capital expenditures	3,436		1,708		1,127			—			6,271
As of January 31, 2020
Total assets	$	247,396	$	219,133	$	181,746		$	18,925		$	667,200
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 three months ended January 31, 2020 (in thousands):

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



	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	—		1,027		—		—		1,027
Balance as of January 31, 2020	$	38,712	$	68,731	$	39,147	$	—	$	146,590

For further details of Goodwill, see Note 4, "Goodwill & Intangible Assets", located herewith.

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 months ended January 31, 2020 and 2019:



	Three Months Ended
	January 31,
	2020			2019
	(In thousands)
Operating income (loss)	$	1,980		$	(2,450	)
Interest expense	(1,582		)	(2,442		)
Other, net	36			256
Income tax (expense) benefit	(424		)	987
Net income (loss)	$	10		$	(3,649	)

14. 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 months ended January 31, 2020 and 2019 were calculated as follows (in thousands, except per share data):



	Net Income (Loss)			Weighted Average Shares	Per Share

Three Months Ended January 31, 2020
Basic earnings per common share	$	10		32,861	$	—
Effect of dilutive securities:
Stock options				77
Restricted stock awards				93
Performance shares				28
Performance restricted stock units				19
Diluted earnings per common share	$	10		33,078	$	—

Three Months Ended January 31, 2019
Basic loss per common share	$	(3,649	)	33,098	$	(0.11	)
Diluted loss per common share⁽¹⁾	$	(3,649	)	33,098	$	(0.11	)

⁽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. During the three months ended January 31, 2019, 6,775 shares of common stock equivalent and 96,507 shares of restricted stock were excluded from the

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computation of diluted earnings per share. In addition 15,735 potentially dilutive contingent shares related to performance share awards for the three months ended 2019 were excluded.

We had common stock equivalents that were potentially dilutive in future earnings per share calculations of 772,756 for the three months ended January 31, 2020 and 1,694,464 for the comparable prior year period. We also had 56,000 restricted stock award equivalents that were potentially dilutive in future earnings per calculations for the three months ended January 31, 2020 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.

15. 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 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 flow. See Note 2, "Leases" for further discussion.

Accounting Standards Recently 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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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:


•	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;


•	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 information is reliable, we cannot guarantee the accuracy or completeness of the information and have not independently verified it.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes as of January 31, 2020, and for the three months ended January 31, 2020 and 2019, included elsewhere herein. For additional information pertaining to our business, including risk factors which should be considered before investing in our common stock, refer to our Annual Report on Form 10-K for the fiscal year ended October 31, 2019.

Our Business

We manufacture components for 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 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 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 currently have three reportable business segments: (1) North American Fenestration segment (NA Fenestration), comprising three operating segments primarily focused on the fenestration market in North America manufacturing 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 and 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 a grouping called Unallocated Corporate & Other, which includes transaction expenses, stock-based compensation, long-term incentive awards based on performance of our common stock and other factors, certain severance and legal costs not allocable to our operating 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. 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. The accounting policies of our operating segments are the same as those used to prepare our accompanying condensed consolidated financial statements.

We continue to invest in organic growth initiatives, enhance our product offerings, provide new complementary technology, enhance our leadership position within the markets we serve, expand into new markets or service lines, and explore strategic acquisitions. 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.

Recent Transactions and Events

Market Overview and Outlook

We believe the primary drivers of our operating results continue to be North American new home construction and residential remodeling and replacement (R&R) 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.

The NAHB has forecasted calendar-year housing starts (excluding manufactured units) to increase slightly through calendar year 2021. Ducker indicated that window shipments in the R&R market are expected to increase 1% during the calendar year ended 2020 and increase 1.5% in 2021. Derived from reports published by Ducker, the overall decline in window shipments for

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the trailing twelve months ended December 31, 2019 was 1.0%. During this period, R&R and new construction activities decreased 1.1% and 0.9%, respectively. Catalina Research estimates that residential semi-custom cabinet demand in the U.S. will decline slightly through 2020.

We utilize several commodities in our business for which pricing can fluctuate, 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.

On June 23, 2016, voters in the U.K. voted for the U.K. to exit the European Union (E.U.) (referred to as Brexit). In October 2019, the U.K. and E.U. ratified a withdrawal agreement, and subsequently the U.K. left the E.U. on January 31, 2020. A transition period is in place until December 31, 2020 while the U.K. and E.U. negotiate additional arrangements. The current rules for trade, travel, and business for the U.K. and E.U. will continue to apply during the transition period and any new rules will take effect January 1, 2021. Since the 2016 vote, the primary impact on Quanex’s financial performance has been related to foreign currency fluctuations of the British Pound Sterling. This fluctuation has driven foreign currency translation impacts, as well as raw material cost increases from upstream suppliers located outside of the U.K.

Given the lack of comparable precedent, it is difficult for us to predict the future impacts on our U.K. based operations, which accounted for approximately 15% of our total sales for the year ended October 31, 2019. Due to the fact that we manufacture and sell a majority of our U.K. products within the U.K., there is minimal risk to our ability to physically deliver goods and complete sales. As such, we believe we are well positioned within the U.K. to respond to potential changes to underlying demand as a result of the final Brexit outcome. The primary focus for our U.K. operations centers on the availability and pricing of raw materials. While we source the majority of our raw materials from within the U.K., many of the primary upstream raw materials our vendors utilize are being sourced from outside of the U.K., which could expose us to cross-border issues and raw material price impacts due to foreign currency volatility. In February 2020, the U.K. announced its intention to introduce border controls and our U.K. businesses have positioned themselves well to cope with additional demands that this will bring in order to comply and facilitate the flow of goods in and out of the U.K.

Results of Operations

Three Months Ended January 31, 2020 Compared to Three Months Ended January 31, 2019



	Three Months Ended January 31,
	2020			2019			Change $			% Variance
	(Dollars in millions)
Net sales	$	196.6		$	196.8		$	(0.2	)	—	%
Cost of sales (excluding depreciation and amortization)	157.4			158.6			(1.2		)	1	%
Selling, general and administrative	24.1			28.0			(3.9		)	14	%
Restructuring charges	0.2			0.1			0.1			(100	)%
Depreciation and amortization	12.9			12.6			0.3			(2	)%
Operating income	$	2.0		$	(2.5	)	$	4.5		180	%
Interest expense	(1.6		)	(2.4		)	0.8			33	%
Other, net	—			0.3			(0.3		)	(100	)%
Income tax expense	(0.4		)	1.0			(1.4		)	(140	)%
Net income	$	—		$	(3.6	)	$	3.6		100	%

Our period-over-period results by reportable segment follow.

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Changes Related to Operating Income by Reportable Segment:

NA Fenestration



	Three Months Ended January 31,
	2020			2019			$ Change			% Variance
	(Dollars in millions)
Net sales	$	110.5		$	109.0		$	1.5		1%
Cost of sales (excluding depreciation and amortization)	88.7			87.1			1.6			(2)%
Selling, general and administrative	13.1			13.1			—			—%
Restructuring charges	0.1			0.1			—			—%
Depreciation and amortization	7.0			6.9			0.1			(1)%
Operating income	$	1.6		$	1.8		$	(0.2	)	(11)%
Operating income margin	1		%	2		%

Net Sales. Net sales increased $1.5 million, or 1%, for the three months ended January 31, 2020 compared to the same period in 2019, which was primarily driven by price increases.

Cost of Sales. The cost of sales increased $1.6 million when comparing the three months ended January 31, 2020 to the same period in 2019. Cost of sales increased primarily due to inflationary cost increases for raw materials.

Selling, General and Administrative. Selling, general and administrative expenses remained flat when comparing the three months ended January 31, 2020 to the same period in 2019.

Restructuring Charges. Restructuring charges for each of the three month periods ended January 31, 2020 and 2019 of $0.1 million relate to facility lease expense for a vinyl extrusion plant which was closed in January 2017 in the U.S. that has not been sublet or otherwise exited as of January 31, 2020.

EU Fenestration



	Three Months Ended January 31,
	2020			2019			$ Change		Variance %
	(Dollars in millions)
Net sales	$	36.7		$	35.3		$	1.4	4%
Cost of sales (excluding depreciation and amortization)	25.2			24.5			0.7		(3)%
Selling, general and administrative	5.9			5.7			0.2		(4)%
Depreciation and amortization	2.4			2.2			0.2		(9)%
Operating income	$	3.2		$	2.9		$	0.3	10%
Operating income margin	9		%	8		%

Net Sales. Net sales increased $1.4 million, or 4%, when comparing the three months ended January 31, 2020 to the same period in 2018. This increase reflects $1.0 million of volume increases, $0.2 million of base price increases, and $0.2 million of foreign currency exchange rate changes.

Cost of Sales. The cost of sales increased $0.7 million for the three months ended January 31, 2020 compared to the same period in 2019. Higher volumes and unfavorable foreign currency exchange rate changes were partially offset by lower material costs incurred during the period.

Selling, General and Administrative. Selling, general and administrative expense increased $0.2 million, or 4%, for the three months ended January 31, 2020 compared to the same period in 2019. The increase was attributable to selling costs at our U.K. vinyl business and unfavorable foreign currency exchange rate changes.

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NA Cabinet Components



	Three Months Ended January 31,
	2020			2019			$ Change			Variance %
	(Dollars in millions)
Net sales	$	50.0		$	53.8		$	(3.8	)	(7)%
Cost of sales (excluding depreciation and amortization)	43.8			47.9			(4.1		)	9%
Selling, general and administrative	4.8			4.9			(0.1		)	2%
Restructuring charges	0.1			—			0.1			(1)%
Depreciation and amortization	3.4			3.3			0.1			(3)%
Operating income	$	(2.1	)	$	(2.3	)	$	0.2		9%
Operating income margin	(4		)%	(4		)%

Net Sales. Net sales decreased $3.8 million for the three months ended January 31, 2020 compared to the same period in 2019. The decrease in sales was driven by $2.7 million of lower volume, primarily related to a strategy change specific to one customer, as well as a $1.1 million decline in raw materials surcharges and price.

Cost of Sales. Cost of sales decreased $4.1 million, or 9%, for the three months ended January 31, 2020 compared with the same period in 2019 as a result of lower volume and decreases in costs for raw materials.

Selling, General and Administrative. Selling, general and administrative expense remained relatively flat for the three months ended January 31, 2020 compared to the same period in 2019.

Restructuring Charges. Restructuring charges incurred during the three months ended January 31, 2020 related to severance charges incurred for a plant closure as further described in Note 1, "Nature of Operations and Basis of Presentation - Restructuring" to the accompanying unaudited condensed consolidated financial statements contained elsewhere herein.

Unallocated Corporate & Other



	Three Months Ended January 31,
	2020			2019			$ Change			Variance %
	(Dollars in millions)
Net sales	$	(0.6	)	$	(1.3	)	$	0.7		54%
Cost of sales (excluding depreciation and amortization)	(0.3		)	(0.9		)	0.6			(67)%
Selling, general and administrative	0.3			4.3			(4.0		)	93%
Depreciation and amortization	0.1			0.2			(0.1		)	50%
Operating loss	$	(0.7	)	$	(4.9	)	$	4.2		86%

Net Sales. Net sales for Unallocated Corporate & Other represents the elimination of inter-segment sales for the three months ended January 31, 2020 and 2019.

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

Selling, General and Administrative. Selling, general and administrative expenses decreased $4.0 million for the three months ended January 31, 2020 compared to the same period in 2019 primarily due to lower medical expenses due to a decline in medical claims experience compared to the prior year period, as well as lower severance expense during 2020.

Changes related to Non-Operating Items:

Interest Expense. Interest expense decreased $0.8 million for the three months ended January 31, 2020 compared to the same period in 2019 as a result of a lower average outstanding debt balance and lower interest rates during the period.

Other, net. The decrease in other, net of $0.3 million at January 31, 2020 compared to the same period in 2019 relates primarily to a reduction in the pension service benefit.

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Income Taxes. We recorded income tax expense of $0.4 million on pre-tax income of $0.4 million for the three months ended January 31, 2020, an effective rate of 97.7% and income tax benefit of $1.0 million on pre-tax loss of $4.6 million for the three months ended January 31, 2019, an effective rate of 21.3%. The difference in the effective rate between these periods reflects an increased charge from the vesting or exercise of equity-based compensation awards.

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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.

We maintain a $325.0 million revolving credit facility (the Credit Facility). 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%). The applicable rate during the three months ended January 31, 2020 was LIBOR + 1.50%. In addition to the Consolidated Leverage Ratio covenant, we are required to meet a Consolidated Interest Coverage Ratio covenant, and there are limitations on certain transactions including our ability to incur indebtedness, incur liens, dispose of material assets, acquire businesses, make restricted payments and pay dividends (limited to $20.0 million per year). We are amortizing deferred financing fees of $1.1 million straight-line over the remaining term of the facility.

As of January 31, 2020, we had $23.1 million of cash and equivalents, $152.5 million outstanding under the Credit Facility, $4.8 million of outstanding letters of credit and $16.0 million outstanding under finance leases and other debt. We had $167.7 million available for use under the Credit Facility at January 31, 2020.

We repatriated $3.1 million and $2.3 million of foreign cash during the three months ended January 31, 2020 and 2019, respectively. We expect to repatriate excess cash moving forward and utilize the funds to retire debt or meet current working capital needs.

Analysis of Cash Flow

The following table summarizes our cash flow results for the three months ended January 31, 2020 and 2019:



	Three Months Ended
	January 31,
	2020			2019
	(In millions)
Cash used for operating activities	$	(3.7	)	$	(20.2	)
Cash used for investing activities	$	(9.3	)	$	(6.2	)
Cash provided by financing activities	$	5.0		$	14.6

Operating Activities. Cash used for operating activities for the three months ended January 31, 2020 declined approximately $16.5 million compared to the three months ended January 31, 2019. Cash receipts were favorably impacted by an increase in net income as well as favorable working capital changes, including a lower payout of accrued incentives and improved accounts receivable collections compared to the same period in 2019.

Investing Activities. Cash used for investing activities increased $3.1 million when comparing the three months ended January 31, 2020 to the same period in 2019 as a result of higher capital expenditures.

Financing Activities. Cash provided by financing activities was $5.0 million for the three months ended January 31, 2020, primarily attributable to $9.7 million of net debt borrowings and $3.1 million of proceeds received from stock option exercises, partially offset by $4.6 million related to the purchase of treasury stock and $2.7 million of dividends paid to our shareholders. For the three months ended January 31, 2019, cash provided by financing activities was $14.6 million primarily attributable to $19.5 million of net borrowings of debt, partially offset by dividends paid to our shareholders of $2.7 million and $2.0 million related to the purchase of treasury stock.

Liquidity Requirements

Our strategy for deploying cash is to invest in organic growth opportunities, develop our infrastructure, and exploring strategic acquisitions. Other uses of cash include paying cash dividends to our shareholders and repurchasing our common stock. We have historically invested cash and cash equivalents in commercial paper with terms of three months or less. We did not have any investments during the three months ended January 31, 2020 and 2019. We maintain cash balances in foreign countries which total $9.5 million as of January 31, 2020. During the three months ended January 31, 2020 and 2019, we repatriated $3.1 million and $2.3 million, respectively, of foreign earnings from our foreign locations.

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Critical Accounting Policies and Estimates

The preparation of our financial statements in accordance with accounting principles generally accepted in the U.S. (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.

For a description of our critical accounting policies and estimates, see our Annual Report on Form 10-K for the fiscal year ended October 31, 2019. During the three months ended January 31, 2020, we adopted new lease accounting guidance. For further details of this change, refer to "Part I, Financial Information" of this Quarterly Report on Form 10-Q.

New Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (FASB) or other standards setting bodies that we adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of any recently issued standards that are not yet effective are either not applicable to us at this time or will not have a material impact on our consolidated financial statements upon adoption.

In June 2016, the FASB issued Accounting Standards Update 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.

Refer to our Annual Report on Form 10-K for the year ended October 31, 2019 for additional standards we are currently evaluating.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discussion of our exposure to various market risks contains “forward looking statements” regarding our estimates, assumptions and beliefs concerning our exposure. Although we believe these estimates and assumptions are reasonable in light of information currently available to us, we cannot provide assurance that these estimates will not materially differ from actual results due to the inherent unpredictability of interest rates, foreign currency rates and commodity prices as well as other factors. We do not use derivative financial instruments for speculative or trading purposes.

Interest Rate Risk

Our outstanding debt bears interest at variable rates and accordingly is sensitive to changes in interest rates. Based upon the balances of the variable rate debt at January 31, 2020, a hypothetical 1.0% increase or decrease in interest rates could result in approximately $1.5 million of additional pretax charges or credit to our operating results per year. This sensitivity is impacted by the amount of borrowings under our credit facilities, and amounts outstanding under finance leases.

Foreign Currency Rate Risk

Our international operations have exposure to foreign currency rate risks, primarily due to fluctuations in the Euro, the British Pound Sterling and the Canadian Dollar. From time to time, we enter into foreign exchange contracts associated with our operations to manage a portion of the foreign currency rate risk. Less than $0.1 million of foreign currency derivatives were included in total assets as of January 31, 2020 and October 31, 2019. These foreign currency derivative contracts hedge cross-border intercompany and commercial activity for our insulating glass spacer business. Although these derivatives hedge our exposure to fluctuations in foreign currency rates, we do not apply hedge accounting and therefore, the change in the fair value of these foreign currency derivatives is recorded directly to other income and expense in the accompanying condensed consolidated statements of income (loss). To the extent the gain or loss on the derivative instrument offsets the gain or loss from the re-measurement of the underlying foreign currency balance, changes in exchange rates should have no effect.

Commodity Price Risk

We purchase PVC as the significant raw material consumed in the manufacture of vinyl extrusions. We have a monthly resin adjuster in place with a majority of our customers and our resin supplier that is adjusted based upon published industry indices for resin prices for the prior month. This adjuster effectively shares the base pass-through price changes of PVC with our customers commensurate with the market at large. Our long-term exposure to changes in PVC prices is somewhat mitigated due to the contractual component of the resin adjuster program. In addition, there is a level of exposure to short-term volatility due to the one month lag.

We also charge certain customers a surcharge related to petroleum-based raw materials. The surcharge is intended to offset the rising cost of products which are highly correlated to the price of oil including butyl and other oil-based raw materials. The surcharge is in place with the majority of our customers who purchase these products and is adjusted monthly based upon the 90-day average published price for Brent crude. The oil-based raw materials that we purchase are subject to similar pricing schemes. As such, our long-term exposure to changes in oil-based raw material prices is significantly reduced under this surcharge program.

Similarly, our NA Cabinet Components business includes a surcharge provision in the majority of its customer arrangements to insulate against significant fluctuations in the price for various hardwood products used as the primary raw material for kitchen and bathroom cabinet doors. We are exposed to short-term volatility in wood prices due to a lag in the timing of price updates which generally could extend for up to three months.

While we maintain surcharges and other adjusters to manage our exposure to changes in the prices of our critical raw materials, we utilize several commodities in our business that are not covered by contractual surcharges or adjusters for which pricing can fluctuate, including titanium dioxide (TiO2), aluminum, silicone and other inputs. Further discussion of our industry risks is included within our Annual Report on Form 10-K for the year ended October 31, 2019.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and Interim Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (1934 Act) as of January 31, 2020. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of January 31, 2020, the disclosure controls and procedures are effective.

Changes in Internal Control over Financial Reporting

Effective November 1, 2019, we adopted new lease accounting guidance. For further details of this change, refer to "Part I, Financial Information" of this Quarterly Report on Form 10-Q. As a result, we implemented a new accounting system and modified existing reporting systems, processes and internal controls over leases to assist us in the application of the new accounting guidance. There have been no other changes in internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the 1934 Act) during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1A. Risk Factors

Company Risks

Epidemics, pandemics or other disease outbreaks could significantly disrupt our operations or those of our customers or suppliers.

If the COVID-19 coronavirus spreads worldwide, or if similar widespread disease outbreaks occur in the future, our business, financial condition and results of operations could be negatively affected to the extent such event harms the worldwide economy. If we or any of our customers or suppliers are forced to temporarily cease manufacturing operations as a part of any voluntary or mandatory effort to prevent or contain an outbreak, then we may be unable to supply our customers in a timely manner and our business, cash flow, and results of operations may suffer as a result.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

During the three months ended January 31, 2020, we repurchased common stock as follows:



Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs ⁽¹⁾	(d) Maximum US Dollars Remaining that May Yet Be Used to Purchase Shares Under the Plans or Programs ⁽¹⁾
November 2019	13,626	$	19.45	—	$	18,415,158
December 2019	99,609	17.73		89,999	16,836,834
January 2020	179,863	17.02		179,863	13,776,306
Total	293,098	$	17.37	269,862

⁽¹⁾ 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 new program will be made in open market transactions or privately negotiated transactions, subject to market conditions, applicable legal requirements and other relevant factors. The program does not have an expiration date or a limit on the number of shares that may be repurchased.

⁽²⁾ November 2019 includes 13,626 shares cancelled in connection with tax withholding related to the vesting of restricted share awards. December 2019 includes 9,610 shares cancelled in connection with tax withholding related to the vesting of performance share awards. Shares so cancelled pursuant to the terms of our 2008 Omnibus Incentive Plan, as amended, are not part of any publicly announced share repurchase authorizations.

Item 5. Other Information

In February 2020, the stockholders of Quanex Building Products Corporation (the “Company”) approved the adoption of the Quanex Building Products Corporation 2020 Omnibus Incentive Plan (as approved, the “2020 Plan”). The 2020 Plan provides for the granting of various equity awards, including restricted stock, stock options, stock appreciation rights, restricted stock units, performance shares, performance units, annual incentive awards, other stock-based awards and cash-based awards.

For more information related to the contents of the 2020 Plan and the changes approved as part of the 2020 Plan, please see the description of the 2020 Plan under Proposal No. 2 included in the Company’s Definitive Proxy Statement relating to its 2020 Annual Meeting of Stockholders, as filed with the Securities and Exchange Commission on January 29, 2020, which description of the 2020 Plan is incorporated herein by reference. For the full text of the 2020 Plan, please see Exhibit 10.2 of the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on March 2, 2020.

The Company’s Compensation and Management Development Committee (the “Committee”) has also adopted a new form of award agreement to be used in connection with future grants of restricted stock awards under the 2020 Plan (the “RSA Form”). From time to time in the future, and pursuant to the terms and conditions of the RSA Form and the 2020 Plan, the Committee may grant restricted stock to employees of the Company as permitted by the 2020 Plan.

The RSA Form as approved by the Committee is attached to this Quarterly Report on Form 10-Q as Exhibit 10.1, and is incorporated by reference herein.

Item 6. Exhibits

The exhibits required to be furnished pursuant to Item 6 are listed in the Exhibit Index filed herewith, which Exhibit Index is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		QUANEX BUILDING PRODUCTS CORPORATION

Date:	March 6, 2020	/s/ Scott M. Zuehlke
		Scott M. Zuehlke
		Senior Vice President - Chief Financial Officer & Treasurer (Principal Financial Officer)

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EXHIBIT INDEX

Exhibit Number Description of Exhibits



3.1		Restated Certificate of Incorporation of the Registrant dated as of March 4, 2016, filed as Exhibit 3.1 of the Registrant’s Current Report on Form 8-K (Reg. No. 001-33913) as filed with the Securities and Exchange Commission on March 7, 2016, and incorporated herein by reference.

*3.2		Fourth Amended and Restated Bylaws of the Registrant dated as of February 27, 2020.

4.1		Form of Registrant’s Common Stock certificate, filed as Exhibit 4.1 of Amendment No. 1 to the Registrant’s Registration Statement on Form 10 (Reg. No. 001-33913) as filed with the Securities and Exchange Commission on February 14, 2008, and incorporated herein by reference.

4.2		Credit Agreement dated as of October 18, 2018, by and among the Company; the lenders party thereto; and Wells Fargo Bank, National Association, as Agent; filed as Exhibit 10.1 of the Registrant's Current Report on Form 8-K (Reg. No. 001-33913) as filed with the Securities and Exchange Commission on October 18, 2018, and incorporated herein by reference.

*†10.1		Form of Restricted Stock Award Agreement for Employees under the Quanex Building Products Corporation 2020 Omnibus Incentive Plan.

*31.1		Certification by chief executive officer pursuant to Rule 13a-14(a)/15d-14(a).

*31.2		Certification by chief financial officer pursuant to Rule 13a-14(a)/15d-14(a).

*32.1		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*101.INS		XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

*101.SCH		XBRL Taxonomy Extension Schema Document

*101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

*101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

*101.LAB		XBRL Taxonomy Extension Label Linkbase Document

*101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

* Filed herewith

† Management Compensation or Incentive Plan

As permitted by Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant has not filed with this Quarterly Report on Form 10-Q certain instruments defining the rights of holders of long-term debt of the Registrant and its subsidiaries because the total amount of securities authorized under any of such instruments does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of any such agreements to the Securities and Exchange Commission upon request.

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