The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes as of July 31, 2022, and for the three and nine months ended July 31, 2022 and 2021, 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, 2021. 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, vinyl 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 continue to invest in organic growth initiatives and we intend to continue evaluating business acquisitions that allow us to expand our existing fenestration and cabinet component footprint, enhance our product offerings, provide new complementary technology, enhance our leadership position within the markets we serve and expand into new markets or service lines. We have disposed of non-core businesses in the past, and continue to evaluate our business portfolio to ensure that we are investing in markets where we believe there is potential future growth. We currently have three reportable business segments: (1) North American Fenestration segment ("NA Fenestration"), comprising three operating segments, manufacturing vinyl profiles, IG spacers, screens and other fenestration components; (2) European Fenestration segment ("EU Fenestration"), comprising our U.K.-based vinyl extrusion business, manufacturing vinyl profiles and conservatories, and the European insulating glass business manufacturing IG spacers; and (3) North American Cabinet Components segment ("NA Cabinet Components"), comprising our North American cabinet door and components business and two wood-manufacturing plants. We maintain a grouping called Unallocated Corporate & Other, which includes transaction expenses, stock-based compensation, long-term incentive awards based on the performance of our common stock and other factors, certain severance, legal, and other costs not deemed to be allocable to all segments, depreciation of corporate assets, interest expense, other, net, income taxes and inter-segment eliminations, and executive incentive compensation and medical expense fluctuations relative to planned costs as determined during the annual planning process. Other corporate general and administrative costs have been allocated to the reportable business segments, based upon a relative measure of profitability in order to more accurately reflect each reportable business segment's administrative costs. We allocate corporate expenses to businesses acquired mid-year from the date of acquisition. The accounting policies of our operating segments are the same as those used to prepare our accompanying condensed consolidated financial statements.
U.S. and global markets are experiencing volatility and disruption following the escalation of geopolitical tensions and the start of the military conflict between Russia and Ukraine. Although the length and impact of the ongoing military conflict is highly unpredictable, the conflict in Ukraine could lead to market or operational disruptions, including significant volatility in commodity prices, credit and capital markets, as well as supply chain interruptions. Russia, Europe's largest provider of natural gas, has significantly reduced the export of natural gas compared to the same time last year resulting in the increase in natural gas prices and the potential for natural gas shortages. If this trend continues, this would not only negatively impact our European manufacturing facilities, this may also impact our customers and their demand for our products. We continue to monitor these situations and their impact on our business. On March 11, 2020, the WHO declared the outbreak of COVID-19 to be a global pandemic and recommended containment and mitigation measures. Our first priority with regard to the COVID-19 pandemic is to do everything we can to ensure the safety, health and welfare of our employees, customers, suppliers and other partners. With the implementation of health and safety practices at our facilities, we are continuing to supply the industry during this uncertain time, recognizing the essential role the construction industry plays in providing housing and necessary infrastructure. As federal, state and local governments react to the public health crisis, significant uncertainties have been created in the economy. The COVID-19 23
pandemic and its related effects continue to have a significant adverse effect on many sectors of the economy and we may be further impacted.
The war in Ukraine and the impact of COVID-19 on the global economy including inflation and the price of raw materials, supply chain disruptions, and the volatility in interest rates including home mortgage rates are unpredictable and there may be developments outside our control requiring us to adjust our operating plan.
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 evaluated the market using data from the National Association of Homebuilders (NAHB) with regard to housing starts, and published reports by Ducker Worldwide, LLC (Ducker), a consulting and research firm, with regard to window shipments in the U.S. We obtain market data from Catalina Research, a consulting and research firm, for insight into the U.S. residential wood cabinet demand. In August 2022, the NAHB forecasted calendar-year housing starts to be 1.5 million in both the 2022 and 2023 calendar-years and 1.6 million in 2024. In August 2022, the Ducker forecast indicated that total window shipments are expected to remain essentially flat for calendar-year 2022 and increase 1.9% in 2023. In August 2022, Catalina Research estimated that residential semi-custom cabinet sales in the U.S. is estimated to increase 8.4% in 2022 and decrease 3.8% in 2023. Several commodities in our business are subject to pricing fluctuations, including polyvinyl resin (PVC), titanium dioxide (TiO2), petroleum products, aluminum and wood. For the majority of our customers and critical suppliers, we have price adjusters in place which effectively share the base pass-through price changes for our primary commodities with our customers commensurate with the market at large. Our long-term exposure to these price fluctuations is somewhat mitigated due to the contractual component of the adjuster programs. 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 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. The global economy remains uncertain due to currency devaluations, political unrest, terror threats, global pandemics such as COVID-19, and even the political landscape in the U.S. These and other macro-economic factors have impacted the global financial markets, which may have contributed to significant changes in foreign currencies. We continue to monitor our exposure to changes in exchange rates. 24
Three Months Ended July 31, 2022 Compared to Three Months Ended July 31, 2021 Three Months Ended July 31, 2022 2021 Change $ % Variance (Dollars in millions) Net sales $ 324.1 $ 279.9 $ 44.2 16 %
Cost of sales (excluding depreciation and amortization) 251.5
219.8 31.7 (14) % Selling, general and administrative 28.8 27.8 1.0 (4) % Depreciation and amortization 9.8 10.6 (0.8) 8 % Operating income 34.0 21.7 12.3 57 % Interest expense (0.7) (0.6) (0.1) (17) % Other, net 0.4 0.1 0.3 300 % Income tax expense (7.8) (7.5) (0.3) (4) % Net income $ 25.9 $ 13.7 $ 12.2 89 %
Our period-over-period results by reportable segment follow.
Changes Related to Operating Income by Reportable Segment:
Three Months Ended July 31, 2022 2021 $ Change % Variance (Dollars in millions) Net sales $ 184.8 $ 147.7 $ 37.1 25%
Cost of sales (excluding depreciation and amortization) 143.0
116.5 26.5 (23)% Selling, general and administrative 14.6 13.3 1.3 (10)% Depreciation and amortization 4.0 4.4 (0.4) 9% Operating income $ 23.2 $ 13.5 $ 9.7 72% Operating income margin 13 % 9 % Net Sales. Net sales increased $37.1 million, or 25%, for the three months ended July 31, 2022 compared to the same period in 2021, which was primarily driven by an increase in price and raw material surcharges of $19.6 million and a $17.5 million increase in volumes. Cost of Sales. The cost of sales increased $26.5 million, or 23%, for the three months ended July 31, 2022 compared to the same period in 2021. Cost of sales, including labor, increased primarily due to higher volumes during the period as well as the inflation of raw materials.
Selling, General and Administrative. Selling, general and administrative expenses increased $1.3 million, or 10%, for the three months ended July 31, 2022 compared to the same period in 2021, primarily due an increase in compensation expense, professional fees and general expenses year-over-year.
Table of Contents EU Fenestration Three Months Ended July 31, 2022 2021 $ Change % Variance (Dollars in millions) Net sales $ 67.7 $ 71.2 $ (3.5) (5)%
Cost of sales (excluding depreciation and amortization) 47.2
49.4 (2.2) 4% Selling, general and administrative 8.3 7.6 0.7 (9)% Depreciation and amortization 2.3 2.7 (0.4) 15% Operating income $ 9.9 $ 11.5 $ (1.6) (14)% Operating income margin 15 %
Net Sales. Net sales decreased $3.5 million, or 5%, for the three months ended July 31, 2022 compared to the same period in 2021, which was primarily driven by a $7.9 million decrease in volumes and $8.9 million of foreign currency rate changes partially offset by $13.3 million of base price increases. Cost of Sales. The cost of sales decreased $2.2 million, or 4%, for the three months ended July 31, 2022 compared to the same period in 2021. Cost of sales decreased primarily due to lower volumes and foreign currency rate changes during the period partially offset by inflation of raw materials. Selling, General and Administrative. Selling, general and administrative expense increased $0.7 million, or 9%, for the three months ended July 31, 2022 compared to the same period in 2021. The increase is primarily due to higher compensation and general expenses partially offset by a decrease in professional fees and foreign currency impacts year-over-year.
Three Months Ended July 31, 2022 2021 $ Change Variance % (Dollars in millions) Net sales $ 72.4 $ 61.9 $ 10.5 17%
Cost of sales (excluding depreciation and amortization) 61.6
54.4 7.2 (13)% Selling, general and administrative 5.3 5.2 0.1 (2)% Depreciation and amortization 3.4 3.4 - -% Operating income (loss) $ 2.1 $ (1.1) $ 3.2 291% Operating income (loss) margin 3 %
Net Sales. Net sales increased $10.5 million, or 17%, for the three months ended July 31, 2022 compared to the same period in 2021, which was driven by an increase in price and raw material indexes of $15.0 million partially offset by a $4.5 million decrease in volumes due to labor and material shortages throughout the supply chain. Cost of Sales. Cost of sales increased $7.2 million, or 13%, for the three months ended July 31, 2022 compared to the same period in 2021. Cost of sales increased primarily due to rising lumber prices, which are recovered on a lag, partially offset by lower volumes during the period. Selling, General and Administrative. Selling, general and administrative expense was similar to the three months ended July 31, 2022 compared to the same period in 2021. 26
Table of Contents Unallocated Corporate & Other Three Months Ended July 31, 2022 2021 $ Change Variance % (Dollars in millions) Net sales $ (0.8) $ (0.9) $ 0.1 11%
Cost of sales (excluding depreciation and amortization) (0.3)
(0.5) 0.2 (40)% Selling, general and administrative 0.6 1.7 (1.1) 65% Depreciation and amortization 0.1 0.1 - -% Operating loss $ (1.2) $ (2.2) $ 1.0 45%
Net Sales. Net sales for Unallocated Corporate & Other represents the elimination of inter-segment sales for the three months ended July 31, 2022 and 2021.
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 $1.1 million, or 65%, for the three months ended July 31, 2022 compared to the same period in 2021. This decrease is primarily attributable to a decrease of $2.6 million related to medical expense claims partially offset by $1.0 million of higher compensation expense including the valuations of our stock based compensation awards and a $0.5 million increase in professional fees during the three months ended July 31, 2022 as compared to the prior year period.
Changes related to Non-Operating Items:
Income Taxes. We recorded income tax expense of $7.8 million on pre-tax income of $33.7 million for the three months ended July 31, 2022, an effective rate of 23.1%, and income tax expense of $7.5 million on pre-tax income of $21.2 million for the three months ended July 31, 2021, an effective rate of 35.3%. The increase in income tax expense year-over-year was primarily driven by the increase in pre-tax book income during the three months ended July 31, 2022, relative to the three months ended July 31, 2021. The decrease in the effective tax rate for the three months ended July 31, 2022, was primarily driven by a non-recurring tax detriment that occurred during the three months ended July 31, 2021, associated with the remeasurement of U.K. deferred taxes from a 19% to 25% tax rate as a result of an enacted tax law change during the period.
Nine Months Ended July 31, 2022 Compared to Nine Months Ended July 31, 2021
Nine Months Ended July 31, 2022 2021 Change $ % Variance (Dollars in millions) Net sales $ 914.0 $ 780.4 $ 133.6 17 %
Cost of sales (excluding depreciation and amortization) 712.9
604.7 108.2 (18) % Selling, general and administrative 87.8 88.3 (0.5) 1 % Depreciation and amortization 30.6 32.5 (1.9) 6 % Operating income 82.7 54.9 27.8 51 % Interest expense (1.8) (2.0) 0.2 10 % Other, net 0.9 0.6 0.3 (50) % Income tax expense (18.1) (17.4) (0.7) (4) % Net income $ 63.7 $ 36.1 $ 27.6 76 %
Our period-over-period results by reportable segment follow.
Changes Related to Operating Income by Reportable Segment:
Nine Months Ended July 31, 2022 2021 $ Change % Variance (Dollars in millions) Net sales $ 509.3 $ 422.0 $ 87.3 21%
Cost of sales (excluding depreciation and amortization) 396.5
328.3 68.2 (21)% Selling, general and administrative 43.1 38.9 4.2 (11)% Depreciation and amortization 12.2 14.4 (2.2) 15% Operating income $ 57.5 $ 40.4 $ 17.1 42% Operating income margin 11 % 10 % Net Sales. Net sales increased $87.3 million, or 21%, for the nine months ended July 31, 2022 compared to the same period in 2021, which was primarily driven by an increase in price and raw material surcharges of $52.6 million and a $34.7 million increase in volumes. Cost of Sales. The cost of sales increased $68.2 million, or 21%, for the nine months ended July 31, 2022 as compared to the same period in 2021. Cost of sales, including labor, increased primarily due to higher volumes during the period as well as the inflation of raw materials.
Selling, General and Administrative. Selling, general and administrative expenses increased $4.2 million, or 11%, for the nine months ended July 31, 2022 as compared to the same period in 2021. This increase was primarily due to higher compensation expense, professional fees and general expenses year-over-year.
Depreciation and Amortization. Depreciation and amortization expense decreased $2.2 million, or 15%, for the nine months ended July 31, 2022 as compared to the same period in 2021, reflecting the run-off of depreciation expense related to existing assets and disposals during the period.
Nine Months Ended July 31, 2022 2021 $ Change Variance % (Dollars in millions) Net sales $ 200.0 $ 181.9 $ 18.1 10%
Cost of sales (excluding depreciation and amortization) 138.1
122.6 15.5 (13)% Selling, general and administrative 24.2 21.6 2.6 (12)% Depreciation and amortization 7.4 7.8 (0.4) 5% Operating income $ 30.3 $ 29.9 $ 0.4 1% Operating income margin 15 % 16 % Net Sales. Net sales increased $18.1 million, or 10%, comparing the nine months ended July 31, 2022 to the same period in 2021, which was primarily driven by $35.8 million of base price increases partially offset by $11.7 million of foreign currency rate changes and $6.0 million decrease in volumes. Cost of Sales. The cost of sales increased $15.5 million, or 13%, for the nine months ended July 31, 2022 compared to the same period in 2021. Cost of sales increased primarily due to inflation of raw materials partially offset by a decrease in volumes and foreign currency impacts. Selling, General and Administrative. Selling, general and administrative expense increased $2.6 million, or 12%, for the nine months ended July 31, 2022 compared to the same period in 2021. The increase is primarily due to higher compensation and general expenses partially offset by foreign currency impacts year-over-year. 28
Table of Contents NA Cabinet Components Nine Months Ended July 31, 2022 2021 $ Change Variance % (Dollars in millions) Net sales $ 207.7 $ 179.5 $ 28.2 16%
Cost of sales (excluding depreciation and amortization) 179.8
155.4 24.4 (16)% Selling, general and administrative 15.8 15.4 0.4 (3)% Depreciation and amortization 10.7 10.0 0.7 (7)% Operating income (loss) $ 1.4 $ (1.3) $ 2.7 208% Operating income (loss) margin 1 %
Net Sales. Net sales increased $28.2 million, or 16%, for the nine months ended July 31, 2022 compared to the same period in 2021, which was driven by a $47.7 million increase in price and raw material indexes partially offset by $19.5 million decrease in volumes due to labor and material shortages throughout the supply chain. Cost of Sales. Cost of sales increased $24.4 million, or 16%, for the nine months ended July 31, 2022 compared with the same period in 2021, primarily as a result of lumber price inflation, which is recovered on a lag, partially offset by lower volumes during the period. Selling, General and Administrative. Selling, general and administrative expense increased $0.4 million, or 3%, for the nine months ended July 31, 2022 compared to the same period in 2021 due to an increase in general expenses year-over-year.
Nine Months Ended July 31, 2022 2021 $ Change Variance % (Dollars in millions) Net sales $ (3.0) $ (3.0) $ - -%
Cost of sales (excluding depreciation and amortization) (1.5)
(1.6) 0.1 (6)% Selling, general and administrative 4.7 12.4 (7.7) 62% Depreciation and amortization 0.3 0.3 - -% Operating loss $ (6.5) $ (14.1) $ 7.6 54%
Net Sales. Net sales for Unallocated Corporate & Other represents the elimination of inter-segment sales for the nine months ended July 31, 2022 and 2021.
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 $7.7 million, or 62%, for the nine months ended July 31, 2022 compared to the same period in 2021. This decrease is primarily attributable to $3.7 million of decreased compensation expense including the valuations of our stock based compensation awards, a decrease of $2.9 million related to medical expense claims and a decrease of $0.5 million related to workers' compensation claims partially offset by an increase of $0.8 million professional fees during the nine months ended July 31, 2022 as compared to the prior year period. Additionally, we recorded a $1.4 million loss on the sale of a plant during the nine months ended July 31, 2021, for which we did not have a comparable expense in the corresponding nine months ended July 31, 2022. Changes related to Non-Operating Items: Income Taxes. We recorded income tax expense of $18.1 million on pre-tax income of $81.8 million for the nine months ended July 31, 2022, an effective rate of 22.2%, and income tax expense of $17.4 million on a pre-tax income of $53.4 million for the nine months ended July 31, 2021, an effective rate of 32.5%. The increase in income tax expense year-over-year was primarily driven by the increase in pre-tax book income during the nine months ended July 31, 2022, relative to the nine months ended July 31, 2021. The decrease in the effective tax rate for the nine months ended July 31, 2022, was primarily driven by a non-recurring tax detriment that occurred during the nine months ended July 31, 2021, associated with the remeasurement of U.K. deferred taxes from a 19% to 25% tax rate as a result of an enacted tax law change during the period as well as a charge related to the vesting or exercise of equity-based compensation awards. 29
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) that matures in 2027 (5-year term) and requires interest payments calculated at a variable market rate depending upon our Consolidated Net Leverage Ratio. The applicable rate during the nine months ended July 31, 2022 was RFR Rate + 1.25%. Our cost of capital could increase depending upon the Consolidated Net Leverage Ratio at the end of any given quarter. In addition to the Consolidated Net 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 $25.0 million per year). We are amortizing deferred financing fees of $1.6 million straight-line over the remaining term of the facility. For further details of the Credit Facility, refer to Note 4, "Debt and Finance Lease Obligations" to the accompanying unaudited condensed consolidated financial statements contained elsewhere herein. As of July 31, 2022, we had $50.0 million of cash and equivalents, $38.0 million outstanding under the Credit Facility, $5.1 million of outstanding letters of credit and $20.1 million outstanding under finance leases and other debt. We had $281.9 million available for use under the Credit Facility at July 31, 2022. We repatriated $18.2 million and $17.7 million of foreign cash during the nine months ended July 31, 2022 and 2021, respectively. We expect to repatriate excess cash moving forward and use the funds to retire debt or meet current working capital needs. In the U.K., we insure against a portion of our credit losses. We believe our business model, our current cash reserves and the recent steps we have taken to strengthen our balance sheet leave us well-positioned to manage our business and remain in compliance with our debt covenants.
The following table summarizes our cash flow results for the nine months ended July 31, 2022 and 2021: Nine Months Ended July 31, 2022 2021 (In millions) Cash provided by operating activities $ 49.9 $ 47.4 Cash used for investing activities $ (19.4) $ (12.9) Cash used for financing activities $ (17.9) $ (43.5) Operating Activities. Cash provided by operating activities increased $2.5 million for the nine months ended July 31, 2022 compared to the nine months ended July 31, 2021. The increase in operating cash flows is primarily due to higher net income year-over-year due to increased demand partially offset by unfavorable changes in working capital. The unfavorable changes in working capital were largely driven by an increase in inventory value due to raw material price inflation and a higher payout of accrued incentives. Investing Activities. Cash used for investing activities increased $6.5 million for the nine months ended July 31, 2022 compared to the same period in 2021, primarily as a result of an increase in capital expenditures and a decrease in proceeds from dispositions. Financing Activities. Cash provided by financing activities was $17.9 million for the nine months ended July 31, 2022, which included $7.9 million of dividends paid to our shareholders, $6.6 million purchase of treasury stock, $1.4 million of payroll tax paid to settle shares forfeited upon vesting of stock, $1.3 million of net repayment of long-term debt and $1.2 million of debt issuance costs. Liquidity Requirements Historically, our strategy for deploying cash has been to invest in organic growth opportunities, develop our infrastructure, and explore strategic acquisitions. Other uses of cash include paying cash dividends to our shareholders and repurchasing our common stock. During the nine months ended July 31, 2022 and 2021, we repatriated $18.2 million and $17.7 million, respectively, of foreign earnings from our foreign locations. We maintain cash balances in foreign countries which total $14.9 million as of July 31, 2022. 30
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, 2021. Our critical accounting policies and estimates have not changed materially during the nine months ended July 31, 2022. While there have been no changes in the application of principles, methods, and assumptions used to determine our significant estimates, we may be required to revise certain accounting estimates and judgments related to the economic and business impact of the COVID-19 pandemic, such as, but not limited to, those related to the valuation of goodwill, intangibles, long-lived assets, accounts receivable, and inventory, which could have a material adverse effect on our financial position and results of operations.
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. We did not adopt any new accounting pronouncements during the three and nine months ended July 31, 2022. As of July 31, 2022, 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 condensed consolidated financial statements upon adoption. 31
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