XNYS:NX Quanex Building Products Corp Quarterly Report 10-Q Filing - 7/31/2012

Effective Date 7/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 ________________________________________________
FORM 10-Q
 ________________________________________________
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2012
OR
 
¨
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.)
1900 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
  ________________________________________________
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 and posted on its corporate Web site, if any, 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 and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
x
 
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at August 31, 2012
Common Stock, par value $0.01 per share
 
36,924,637

 




QUANEX BUILDING PRODUCTS CORPORATION
INDEX
 
PART I.
 
 
 
Item 1:
 
Consolidated Balance Sheets – July 31, 2012 and October 31, 2011
 
Consolidated Statements of Income – Three and Nine Months Ended July 31, 2012 and 2011
 
Consolidated Statements of Cash Flow – Nine Months Ended July 31, 2012 and 2011
 
Consolidated Statement of Stockholders’ Equity – Nine Months Ended July 31, 2012
 
 
 
 
Item 2:
 
 
 
Item 3:
 
 
 
Item 4:
 
 
PART II.
 
 
 
       Item 1A:
 
 
 
Item 2:
 
 
 
Item 6:



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

QUANEX BUILDING PRODUCTS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
 
July 31,
2012
 
October 31,
2011
 
(In thousands except share 
amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
62,292

 
$
89,619

Accounts receivable, net of allowance of $1,456 and $1,062
88,348

 
81,969

Inventories, net
62,944

 
55,842

Deferred income taxes
19,909

 
11,220

Prepaid and other current assets
8,443

 
6,423

Total current assets
241,936

 
245,073

Property, plant and equipment, net
165,533

 
158,209

Deferred income taxes
9,605

 
7,669

Goodwill
67,415

 
69,432

Intangible assets, net
79,792

 
87,943

Other assets
14,892

 
16,603

Total assets
$
579,173

 
$
584,929

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
75,889

 
$
66,339

Accrued liabilities
46,126

 
38,058

Current maturities of long-term debt
353

 
352

Total current liabilities
122,368

 
104,749

Long-term debt
974

 
1,314

Deferred pension and postretirement benefits
6,213

 
7,784

Liability for uncertain tax positions
6,695

 
8,412

Non-current environmental reserves
10,297

 
11,221

Other liabilities
13,888

 
14,223

Total liabilities
160,435

 
147,703

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 37,788,804 and 37,843,134, respectively
378

 
378

Additional paid-in-capital
243,930

 
241,983

Retained earnings
193,693

 
213,143

Accumulated other comprehensive income (loss)
(7,087
)
 
(3,642
)
Less treasury stock at cost, 864,167 and 1,035,288 shares, respectively
(12,176
)
 
(14,636
)
Total stockholders’ equity
418,738

 
437,226

Total liabilities and stockholders’ equity
$
579,173

 
$
584,929

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

1


QUANEX BUILDING PRODUCTS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
2012
 
2011
 
(In thousands, except per share amounts)
Net sales
$
237,905


$
252,413

 
$
593,928


$
615,333

Cost and expenses:
 
 
 
 
 
 
 
Cost of sales (exclusive of items shown separately below)
200,663


209,667

 
510,542


524,834

Selling, general and administrative
26,659


18,912

 
80,936


61,230

Depreciation and amortization
9,131


9,197

 
28,381


24,583

Operating income (loss)
1,452

 
14,637

 
(25,931
)
 
4,686

Non-operating income (expense):
 
 
 
 
 
 
 
Interest expense
(108
)

(110
)
 
(348
)
 
(341
)
Other, net
21


(311
)
 
199

 
127

Income (loss) from continuing operations before income taxes
1,365

 
14,216

 
(26,080
)
 
4,472

Income tax benefit (expense)
166


(5,200
)
 
8,578

 
(1,573
)
Income (loss) from continuing operations
1,531

 
9,016

 
(17,502
)
 
2,899

Income (loss) from discontinued operations, net of taxes

 

 

 
(12
)
Net income (loss)
$
1,531

 
$
9,016

 
$
(17,502
)
 
$
2,887

Basic earnings per common share:
 
 
 
 
 
 
 
Earnings (loss) from continuing operations
$
0.04

 
$
0.24

 
$
(0.48
)
 
$
0.08

Income (loss) from discontinued operations

 

 

 

Basic earnings (loss) per share
$
0.04

 
$
0.24

 
$
(0.48
)
 
$
0.08

Diluted earnings per common share:
 
 
 
 
 
 
 
Earnings (loss) from continuing operations
$
0.04

 
$
0.24

 
$
(0.48
)
 
$
0.08

Income (loss) from discontinued operations

 

 

 

Diluted earnings (loss) per share
$
0.04

 
$
0.24

 
$
(0.48
)
 
$
0.08

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
36,637

 
37,125

 
36,584

 
37,103

Diluted
37,163

 
37,684

 
36,584

 
37,710

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


2


QUANEX BUILDING PRODUCTS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
 
 
Nine Months Ended
 
July 31,
 
2012
 
2011
 
(In thousands)
Operating activities:
 
 
 
Net income (loss)
$
(17,502
)
 
$
2,887

Loss (income) from discontinued operations

 
12

Adjustments to reconcile net income (loss) to cash provided by operating activities from continuing operations:
 
 
 
Depreciation and amortization
28,434

 
24,635

Restructuring charges
1,206

 
1,118

Deferred income taxes
(9,437
)
 
(295
)
Stock-based compensation
3,782

 
3,599

Changes in assets and liabilities, net of effects from acquisitions and dispositions:
 
 
 
Decrease (increase) in accounts and notes receivable
(7,114
)
 
(4,991
)
Decrease (increase) in inventory
(7,515
)
 
(9,778
)
Decrease (increase) in other current assets
(757
)
 
244

Increase (decrease) in accounts payable
10,242

 
(2,801
)
Increase (decrease) in accrued liabilities
6,566

 
(6,879
)
Increase (decrease) in income taxes
(771
)
 
(1,392
)
Increase (decrease) in deferred pension and postretirement benefits
(1,572
)
 
965

Other, net
425

 
2,568

Cash provided by (used for) operating activities from continuing operations
5,987

 
9,892

Cash provided by (used for) operating activities from discontinued operations

 
(68
)
Cash provided by (used for) operating activities
5,987

 
9,824

Investing activities:
 
 
 
Acquisitions, net of cash acquired

 
(110,845
)
Capital expenditures
(31,710
)
 
(16,969
)
Proceeds from property insurance claim
479

 

Proceeds from executive life insurance

 
683

Other, net
36

 
75

Cash provided by (used for) investing activities from continuing operations
(31,195
)
 
(127,056
)
Cash provided by (used for) investing activities from discontinued operations

 

Cash provided by (used for) investing activities
(31,195
)
 
(127,056
)
Financing activities:
 
 
 
Repayments of long-term debt
(339
)
 
(333
)
Common stock dividends paid
(4,413
)
 
(4,500
)
Purchase of treasury stock
(1,284
)
 
(4,289
)
Issuance of common stock from stock option exercises, including related tax benefits
2,914

 
1,089

Other, net

 
392

Cash provided by (used for) financing activities from continuing operations
(3,122
)
 
(7,641
)
Cash provided by (used for) financing activities from discontinued operations

 
(392
)
Cash provided by (used for) financing activities
(3,122
)
 
(8,033
)
Effect of exchange rate changes on cash and equivalents
1,003

 
47

Less: (Increase) decrease in cash and equivalents from discontinued operations

 
460

Increase (decrease) in cash and equivalents from continuing operations
(27,327
)
 
(124,758
)
Cash and equivalents at beginning of period
89,619

 
187,178

Cash and equivalents at end of period
$
62,292

 
$
62,420

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

3


QUANEX BUILDING PRODUCTS CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
 
Nine Months Ended July 31, 2012
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
(In thousands, except per share amounts)
Balance at October 31, 2011
$
378

 
$
241,983

 
$
213,143

 
$
(3,642
)
 
$
(14,636
)
 
$
437,226

Net income (loss)

 

 
(17,502
)
 

 

 
(17,502
)
Foreign currency translation adjustment (net of taxes of $176)

 

 

 
(3,445
)
 

 
(3,445
)
Common dividends ($0.12 per share)

 

 
(4,413
)
 

 

 
(4,413
)
Treasury shares purchased, at cost

 

 

 

 
(1,284
)
 
(1,284
)
Stock-based compensation activity:
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation earned

 
3,180

 

 

 

 
3,180

Stock options exercised

 
16

 
(73
)
 

 
2,558

 
2,501

Restricted stock awards

 
(1,186
)
 

 

 
1,186

 

Stock-based compensation tax benefit

 
268

 

 

 

 
268

Reduction of unrecognized tax benefit liability related to Separation

 

 
2,851

 

 

 
2,851

Other

 
(331
)
 
(313
)
 

 

 
(644
)
Balance at July 31, 2012
$
378

 
$
243,930

 
$
193,693

 
$
(7,087
)
 
$
(12,176
)
 
$
418,738

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


4


QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business and Basis of Presentation
Quanex Building Products Corporation and its subsidiaries (Quanex or the Company) are managed on a decentralized basis and operate in two business segments: Engineered Products and Aluminum Sheet Products. The Engineered Products segment produces engineered systems, products and components primarily serving the window and door industry, while the Aluminum Sheet Products segment produces mill finished and coated aluminum sheet serving the broader building products markets and secondary markets such as capital goods and transportation. The primary market drivers are residential housing starts and residential remodeling expenditures. Quanex believes it is a technological leader in the production of aluminum sheet products, flexible insulating glass spacer systems, extruded vinyl profiles, thin film solar panel sealants, and precision-formed metal and wood products which primarily serve the North American building products markets. The Company uses low-cost production processes, and engineering and metallurgical expertise to provide customers with specialized products for specific applications.
On December 12, 2007, Quanex Building Products Corporation was incorporated in the state of Delaware as a subsidiary of Quanex Corporation to facilitate the separation of Quanex Corporation’s vehicular products and building products businesses. The separation occurred on April 23, 2008 through the spin-off of Quanex Corporation’s building products business to its shareholders immediately followed by the merger of Quanex Corporation (consisting principally of the vehicular products business and all non-building products related corporate accounts) with a wholly-owned subsidiary of Gerdau S.A. (Gerdau). This is hereafter referred to as the “Separation”. In 2010, management closed its start-up facility in China, and accordingly, the China assets and liabilities, results of operations and cash flows are reported as discontinued operations for all periods presented. In March 2011, the Company acquired Edgetech I.G., Inc. and its German subsidiary. Headquartered in Cambridge, Ohio, Edgetech has three manufacturing facilities (U.S., U.K. and Germany) that produce and market a full line of insulating glass (IG) spacer systems for window and door customers in North America and abroad. In November 2011, management committed to a program to consolidate its IG spacer manufacturing facility in Barbourville, Kentucky into its IG spacer manufacturing facility in Cambridge, Ohio. The facility consolidation was completed in August 2012. Unless otherwise noted, all disclosures in the notes accompanying the consolidated financial statements reflect only continuing operations.
The interim unaudited consolidated financial statements of the Company include all adjustments which, in the opinion of management, are necessary for a fair presentation of the Company’s financial position and results of operations. All such adjustments are of a normal recurring nature. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying footnotes. 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 the Company’s operating environment changes. Actual results could differ from estimates. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2011.

2. New Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update No. 2011-04 (ASU 2011-04), Fair Value Measurement (ASC Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amended guidance changes the wording used to describe many requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Additionally, the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements. The guidance provided in ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 (February 1, 2012 for the Company) and is applied prospectively. The adoption of ASU 2011-04 did not have a material impact on the Company's consolidated financial statements.
In June 2011, the FASB issued Accounting Standards Update No. 2011-05 (ASU 2011-05), Presentation of Comprehensive Income. This amendment will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amended guidance, which must be applied retroactively, is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 (November 1, 2012 for the Company), with earlier adoption permitted. ASU 2011-05 impacts presentation only and will have no effect on the Company’s financial condition, results of operations or cash flows. In December 2011, the FASB issued Accounting Standards Update No. 2011-12 (ASU 2011-12), “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 deferred the effective date of ASU 2011-05 related to the presentation of reclassifications of items out of accumulated other comprehensive

5

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


income. All other requirements of ASU 2011-05 were not affected by ASU 2011-12.
In September 2011, the FASB issued Accounting Standards Update No. 2011-08 (ASU 2011-08), Testing Goodwill for Impairment which amends the guidance in ASC 350-20. The amendments in ASU 2011-08 provide entities with the option of performing a qualitative assessment before performing the first step of the two-step impairment test. If entities determine, on the basis of qualitative factors, it is not more likely than not that the fair value of the reporting unit is less than the carrying amount, then performing the two-step impairment test would be unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any. ASU 2011-08 also provides entities with the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to the first step of the two-step impairment test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 (November 1, 2012 for the Company), although early adoption is permitted. The provisions of ASU 2011-08 will not have a material effect on the Company's consolidated financial statements.
In December 2011, the FASB issued Accounting Standards Update No. 2011-11 (ASU 2011-11), Disclosures about Offsetting Assets and Liabilities, where entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements, and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. These disclosures assist users of financial statements in evaluating the effect or potential effect of netting arrangements on a company’s financial position. The Company is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013 (November 1, 2013 for the Company). Retrospective disclosure is required for all comparative periods presented. The Company does not expect the provisions of ASU 2011-11 to have a material impact on its consolidated financial statements.

3. Acquisitions
On March 31, 2011, Quanex completed its acquisition of Edgetech I.G., Inc., an Ohio corporation (“Edgetech I.G.”), the United Kingdom division of Edgetech (“Edgetech UK”), and Edgetech Europe GmbH, a German company (“Edgetech Germany” and together with Edgetech I.G. and Edgetech UK, “Edgetech”). Headquartered in Cambridge, Ohio, Edgetech has three manufacturing facilities located in the United States, the United Kingdom and Germany that produce a full line of warm-edge, dual seal insulating glass spacer systems for window and door customers in North America and abroad. Edgetech’s products separate and seal double and triple glass within a window and act as a thermal barrier that enhances the window’s energy efficiency. Edgetech has been integrated into the Engineered Products segment.
 
As consideration for the acquisition, Quanex paid $104.4 million in cash, net of $0.8 million of cash acquired. Of the cash paid, $7.0 million was placed into an escrow fund to satisfy certain indemnity obligations under the merger agreement. Additionally, Quanex is responsible for and has paid the tax liability resulting from the pre-closing reorganization of Lauren and its subsidiaries limited to $3.5 million. The Edgetech acquisition was accounted for as a business combination using the acquisition method of accounting under which the total purchase price consideration is allocated to assets and liabilities assumed based upon their fair values. The purchase price allocation resulted in goodwill of $44.6 million, which is not deductible for income tax purposes. Any transaction-related costs in connection with the Edgetech acquisition were expensed as incurred within Selling, general and administrative expense in its Consolidated Statement of Income.
The following table provides consolidated results of operations for the three and nine months ended July 31, 2012 compared to unaudited pro forma consolidated results of operations for the combined entity for the three and nine months ended July 31, 2011 as if Edgetech had been acquired as of November 1, 2009.
 

6

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
Actual
 
Pro forma
 
Actual
 
Pro forma
 
2012
 
2011
 
2012
 
2011
 
(In thousands, except per share amounts)
Net sales
$
237,905

 
$
252,413

 
$
593,928

 
$
645,330

Operating income (loss)
1,452

 
15,670

 
(25,931
)
 
8,470

Income (loss) from continuing operations
$
1,531

 
$
9,836

 
$
(17,502
)
 
$
5,385

Diluted earnings (loss) per common share from continuing operations
$
0.04

 
$
0.26

 
$
(0.48
)
 
$
0.14


The unaudited pro forma consolidated results of operations were prepared using the acquisition method of accounting and are based on the historical financial information of the Company and Edgetech. The unaudited pro forma financial information does not purport to reflect the results the combined company may achieve in future periods or the results that would have been obtained had Quanex acquired Edgetech on the first day of its fiscal 2010 period. The unaudited pro forma financial information does not include any operating efficiencies or cost savings that may be achieved or any integration expenses. Additionally, the historical Edgetech financial information has not been adjusted to remove expenses that have ceased under Quanex’s ownership, such as the prior parent company allocation, or to add incremental anticipated stand-alone expenses going forward. Generally, the pro forma financial information reflects the allocation of the purchase price to the appropriate assets and liabilities based upon their fair values, and related changes in depreciation and amortization expense. Accordingly, such amounts are not necessarily indicative of the results that would have occurred if the acquisition had occurred on the dates indicated or that may result in the future. The unaudited pro forma information reflects primarily the following unaudited pro forma adjustments for the three and nine months ended July 31, 2011:
 
Historical pre-acquisition results of operations for Edgetech for the three and nine months ended July 31, 2011;
Amortization expense related to the fair value of identifiable intangible assets acquired;
Additional depreciation expense related to the fair value adjustment to property, plant and equipment acquired;
Additional facility rental expense;
Benefit in cost of goods sold of $0.7 million and $1.6 million in the three and nine months ended July 31, 2011 as a result of applying purchasing accounting;
Reduction of expense of $0.3 million and $2.5 million in the three and nine months ended July 31, 2011 to remove the transaction-related costs incurred;
The Edgetech historical results and all of the above adjustments were adjusted for the applicable tax impact.
 
4. Goodwill and Acquired Intangible Assets
Goodwill
All of the Company’s goodwill is recorded on the Engineered Products segment. The change in the carrying amount of goodwill for the period ended July 31, 2012 is as follows (in thousands):
 
 
Engineered
Products Goodwill
Balance at October 31, 2011
$
69,432

Foreign currency translation adjustment
(2,017
)
Balance at July 31, 2012
$
67,415

Acquired Intangible Assets
Intangible assets consist of the following (in thousands):
 

7

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


 
As of July 31, 2012
 
As of October 31, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Amortized intangible assets:
 
 
 
 
 
 
 
Customer relationships
$
43,296

 
$
(10,830
)
 
$
44,260

 
$
(8,588
)
Trademarks and trade names
44,281

 
(13,720
)
 
44,857

 
(11,540
)
Patents and other technology
24,642

 
(8,875
)
 
25,300

 
(7,552
)
Other
1,392

 
(394
)
 
1,392

 
(186
)
Total
$
113,611

 
$
(33,819
)
 
$
115,809

 
$
(27,866
)

 
The aggregate amortization expense for the three and nine months ended July 31, 2012 was $2.0 million and $6.2 million, respectively. The aggregate amortization expense for the three and nine months ended July 31, 2011 was $2.1 million and $4.2 million, respectively. The increased amortization expense relates to the intangibles acquired in the March 2011 Edgetech acquisition. Estimated amortization expense for the next five years for existing intangibles follows (in thousands):
 
Fiscal Years Ending
October 31,
Estimated
Amortization
 
(In thousands)
2012 (remaining three months)
$
2,041

2013
$
8,088

2014
$
7,964

2015
$
7,825

2016
$
7,584


5. Inventories
Inventories consist of the following:
 
 
July 31,
2012
 
October 31,
2011
 
(In thousands)
Raw materials
$
31,172

 
$
27,862

Finished goods and work in process
28,752

 
24,988

Supplies and other
3,020

 
2,992

Total
$
62,944

 
$
55,842

Fixed costs related to excess manufacturing capacity, if any, have been expensed in the period, and therefore, are not capitalized into inventory. The values of inventories are based on the following accounting methods:
 
 
July 31,
2012
 
October 31,
2011
 
(In thousands)
LIFO
$
22,554

 
$
18,782

FIFO
40,390

 
37,060

Total
$
62,944

 
$
55,842


An actual valuation of inventory under the last in, first out (LIFO) method can be made only at the end of each year based on the inventory costs and levels at that time. Accordingly, interim LIFO calculations must be based on management’s estimates of expected year-end inventory costs and levels. Because these are subject to many factors beyond management’s control, interim

8

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


results are subject to the final year-end LIFO inventory valuation which could significantly differ from interim estimates. To estimate the effect of LIFO on interim periods, the Company performs a projection of the year-end LIFO reserve and considers expected year-end inventory pricing and expected inventory levels. Depending on this projection, the Company may record an interim allocation of the projected year-end LIFO calculation. This projection resulted in zero interim LIFO allocation (reported in Cost of sales) for the nine months ended July 31, 2012. With respect to inventories valued using the LIFO method, replacement cost exceeded the LIFO value by approximately $12.3 million as of July 31, 2012 and October 31, 2011.
 
6. Earnings and Dividends Per Share
Earnings Per Share
The computational components of basic and diluted earnings per share from continuing operations for the three and nine months ended July 31, 2012 and 2011 are as follows (shares and dollars in thousands except per share amounts):
 
For the Three Months Ended
July 31, 2012
For the Three Months Ended
July 31, 2011
 
 
 
 
Per
 
 
 
Per
 
Income
 
Shares
Share
Income
 
Shares
Share
 
(Numerator)
 
(Denominator)
Amount
(Numerator)
 
(Denominator)
Amount
Basic earnings and earnings per share
$
1,531

 
36,637

$
0.04

$
9,016

 
37,125

$
0.24

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Common stock equivalents arising
 
 
 
 
 
 
 
 
from stock options

 
416

 

 
366

 
Restricted stock

 
110

 

 
193

 
Diluted earnings and earnings per share
$
1,531

 
37,163

$
0.04

$
9,016

 
37,684

$
0.24

 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended
July 31, 2012
For the Nine Months Ended
July 31, 2011
 
 
 
 
Per
 
 
 
Per
 
Income
 
Shares
Share
Income
 
Shares
Share
 
(Numerator)
 
(Denominator)
Amount
(Numerator)
 
(Denominator)
Amount
Basic earnings and earnings per share
$
(17,502
)
 
36,584

$
(0.48
)
$
2,899

 
37,103

$
0.08

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Common stock equivalents arising
 
 
 
 
 
 
 
 
from stock options

 

 

 
380

 
Restricted stock

 

 

 
227

 
Diluted earnings and earnings per share
$
(17,502
)
 
36,584

$
(0.48
)
$
2,899

 
37,710

$
0.08


Fiscal 2012 basic and diluted earnings per share from continuing operations are identical for the nine months ended July 31, 2012 as the Company reported a loss from continuing operations. The computation of diluted earnings per share excludes outstanding options and other common stock equivalents in periods where inclusion of such potential common stock instruments would be anti-dilutive in the periods presented.
When income from continuing operations is a loss, all potential dilutive instruments are excluded from the computation of diluted earnings per share as they would be anti-dilutive. Accordingly, for the nine months ended July 31, 2012, 0.1 million of restricted stock and 0.4 million of common stock equivalents were excluded from the computation of diluted earnings per share as the Company had a loss from continuing operations.
For the nine months ended July 31, 2012 and 2011, the Company had 0.8 million and 0.3 million, respectively, of securities that are potentially dilutive in future earnings per share calculations. Such dilution will be dependent on the excess of the market price of the Company’s stock over the exercise price and other components of the treasury stock method.
Dividends Per Share
During the three and nine months ended July 31, 2012, the Company paid $0.04 and $0.12, respectively, cash dividend per common share. During the three and nine months ended July 31, 2011, the Company paid $0.04 and $0.12, respectively, cash dividend per common share.

9

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 



7. Comprehensive Income
Comprehensive income comprises net income and all other non-owner changes in equity, including foreign currency translation, pension related adjustments and realized and unrealized gains and losses on derivatives, if any. Comprehensive income (loss) for the three and nine months ended July 31, 2012 and 2011 was as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Comprehensive income (loss):
 
 
 
 
 
 
 
Net income (loss)
$
1,531

 
$
9,016

 
$
(17,502
)
 
$
2,887

Foreign currency translation adjustment, net of taxes
(2,284
)
 
(1,026
)
 
(3,445
)
 
951

Total comprehensive income (loss), net of taxes
$
(753
)
 
$
7,990

 
$
(20,947
)
 
$
3,838


Foreign currency translation activity is primarily associated with Edgetech, acquired by the Company on March 31, 2011. As a result of this acquisition, Quanex has operations in Germany and the United Kingdom whose functional currencies are the Euro and the British Pound Sterling, respectively.

8. Long-Term Debt and Capital Lease Obligations
Long-term debt consists of the following:
 
 
July 31,
2012
 
October 31,
2011
 
(In thousands)
Revolving Credit Facility
$

 
$

City of Richmond, Kentucky Industrial Building Revenue Bonds
800

 
900

Scott County, Iowa Industrial Waste Recycling Revenue Bonds
400

 
600

Capital lease obligations and other
127

 
166

Total debt
$
1,327

 
$
1,666

Less maturities due within one year included in current liabilities
353

 
352

Long-term debt
$
974

 
$
1,314


The Company’s $270.0 million Senior Unsecured Revolving Credit Facility (the Credit Facility) was executed on April 23, 2008. The Credit Facility has a five-year term and is unsecured. The Credit Facility expires April 23, 2013 and provides for up to $50.0 million for standby letters of credit, limited to the undrawn amount available under the Credit Facility. Borrowings under the Credit Facility bear interest at a spread above LIBOR based on a combined leverage and ratings grid. Proceeds from the Credit Facility may be used to provide availability for acquisitions, working capital, capital expenditures and general corporate purposes.
Under the Credit Facility, the Company is obligated to comply with certain financial covenants requiring the Company to maintain a Consolidated Leverage Ratio of no more than 3.25 to 1 and a Consolidated Interest Coverage Ratio of no less than 3.00 to 1. As defined by the Credit Facility’s indenture, the Consolidated Leverage Ratio is the ratio of consolidated indebtedness as of such date to consolidated EBITDA for the previous four fiscal quarters; and the Consolidated Interest Coverage Ratio is the ratio of consolidated EBITDA to consolidated interest expense for the previous four consecutive fiscal quarters. EBITDA is defined by the indenture to include proforma EBITDA of acquisitions and to exclude certain items like non-cash charges. Additionally, the Credit Facility contains certain limitations on additional indebtedness, asset or equity sales, and acquisitions. Dividends and other distributions are permitted so long as after giving effect to such dividend or stock repurchase, there is no event of default.
As of July 31, 2012, the Company had no borrowings under the Credit Facility, and the Company was in compliance with all Credit Facility financial covenants. The availability under the Credit Facility is a function of both the facility amount utilized and meeting covenant requirements. Although there were no borrowings on the Credit Facility and only $5.6 million of outstanding letters of credit under the Credit Facility, the aggregate availability under the Credit Facility was limited by the Consolidated

10

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


Leverage Ratio resulting in an availability of $141.0 million at July 31, 2012.

9. Retirement Plans
The Company has a number of retirement plans covering substantially all employees. The Company provides both defined benefit and defined contribution plans. In general, the plant or location of employment determines an employee’s coverage for retirement benefits. Effective with the respective acquisition dates in the second fiscal quarter of 2011, the Edgetech employees were eligible to participate in the Company’s retirement plans.
Pension Plan
The Company has a non-contributory, single employer defined benefit pension plan that covers substantially all non-union employees. Effective January 1, 2007, the Company amended this defined benefit pension plan to include a new cash balance formula for all new salaried employees hired on or after January 1, 2007 and for any non-union employees who were not participating in a defined benefit plan prior to January 1, 2007. All new salaried employees are eligible to receive credits equivalent to 4% of their annual eligible wages, while some of the employees at the time of the plan amendment were “grandfathered” and are eligible to receive credits ranging up to 6.5% based upon a percentage they received in the defined contribution plan prior to the amendment of the pension plan. Additionally, every year the participants will receive an interest related credit on their respective balance equivalent to the prevailing 30-year Treasury rate. Benefits for participants in this plan prior to January 1, 2007 continue to be based on a more traditional formula for retirement benefits, where the plan pays benefits to employees upon retirement using a formula based upon years of service and pensionable compensation prior to retirement. Of the Company’s participants, 99% are under the cash balance formula.
The components of net periodic pension cost are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Net periodic benefit cost:
 
 
 
 
 
 
 
Service cost
$
884

 
$
1,002

 
$
2,710

 
$
2,884

Interest cost
184

 
213

 
592

 
614

Expected return on plan assets
(250
)
 
(276
)
 
(831
)
 
(795
)
Amortization of net loss
45

 
24

 
118

 
69

Net periodic benefit cost
$
863

 
$
963

 
$
2,589

 
$
2,772


The decrease in net periodic benefit cost from 2011 to 2012 is primarily attributable to decreases in the liabilities and normal costs used to calculate the net periodic benefit cost primarily attributable to demographic data changes. The Company’s pension funding policy generally has been to make the minimum annual contributions required by applicable regulations while considering targeted funded percentages. In fiscal 2010, the Company decided to modify its funding strategy and accelerate contributions to target a 100% funding threshold. Additionally, the Company will consider funding fiscal year requirements early in the fiscal year to potentially maximize returns on assets. The Company made no contributions during the three months ended July 31, 2012 to its defined benefits plan. During the nine months ended July 31, 2012, the Company contributed $4.2 million to the plan. The Company does not expect to make any additional contributions for the balance of fiscal 2012. Future contributions are dependent on many variables, including the variability of the market value of the assets as compared to the obligation and other market or regulatory conditions. In addition, the Company takes into consideration its business investment opportunities and resulting cash requirements. Accordingly, actual funding may differ greatly from current estimates.

10. Industry Segment Information
Quanex has two reportable segments: Engineered Products and Aluminum Sheet Products. The Engineered Products segment produces systems, finished products and components serving the OEM residential window and door industry, while the Aluminum Sheet Products segment produces mill finished and coated aluminum sheet serving the broader building and construction markets. The primary market drivers of both segments are residential repair and remodel activity (R&R) and new home construction.
The Company measures its inventory at the segment level on a FIFO or weighted-average basis; however, at the consolidated Company level, approximately one third of the inventory is measured on a LIFO basis. The LIFO reserve is computed on a

11

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


consolidated basis as a single pool and is thus treated as a corporate expense. See Note 5 to the financial statements for more information. LIFO inventory adjustments along with corporate office charges and intersegment eliminations are reported as Corporate, Intersegment Eliminations or Other. The Company accounts for intersegment sales and transfers as though the sales or transfers were to third parties, that is, at current market prices. Intersegment sales, related cost of sales, and intercompany profit are eliminated in consolidation at Corporate. Corporate assets primarily include cash and equivalents partially offset by the Company’s consolidated LIFO inventory reserve.
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Net Sales:
 
 
 
 
 
 
 
Engineered Products
$
134,060

 
$
124,119

 
$
342,223

 
$
290,623

Aluminum Sheet Products
107,024

 
132,130

 
261,017

 
334,328

Intersegment Eliminations
(3,179
)
 
(3,836
)
 
(9,312
)
 
(9,618
)
Consolidated
$
237,905

 
$
252,413

 
$
593,928

 
$
615,333

Operating Income (Loss):
 
 
 
 
 
 
 
Engineered Products
$
13,063

 
$
14,146

 
$
14,949

 
$
15,411

Aluminum Sheet Products
(3,162
)
 
7,417

 
(16,213
)
 
14,027

Corporate & Other
(8,449
)
 
(6,926
)
 
(24,667
)
 
(24,752
)
Consolidated
$
1,452

 
$
14,637

 
$
(25,931
)
 
$
4,686

 
 
July 31,
2012
 
October 31,
2011
 
(In thousands)
Identifiable Assets:
 
 
 
Engineered Products
$
387,041

 
$
389,889

Aluminum Sheet Products
135,504

 
132,161

Corporate, Intersegment Eliminations & Other
56,628

 
62,879

Consolidated
$
579,173

 
$
584,929

Goodwill:
 
 
 
Engineered Products
$
67,415

 
$
69,432

Consolidated
$
67,415

 
$
69,432


11. Stock-Based Compensation
Effective on April 23, 2008, the Company established the Quanex Building Products Corporation 2008 Omnibus Incentive Plan (the 2008 Plan). The 2008 Plan provides for the granting of stock options, stock appreciation rights, restricted stock awards, restricted stock units (RSUs), performance stock awards, performance unit awards, annual incentive awards, other stock-based awards and cash-based awards. The 2008 Plan is administered by the Compensation and Management Development Committee of the Board of Directors and allows for immediate, graded or cliff vesting options, but options must be exercised no later than ten years from the date of grant. The aggregate number of shares of common stock originally authorized for grant under the 2008 Plan was 2,900,000. At the Company’s annual shareholder meeting in February 2011, the shareholders approved an amendment which increased the aggregate number of shares available for grant under the 2008 Plan by an additional 2,400,000 shares. Any officer, key employee and/or non-employee director of the Company or any of its affiliates is eligible for awards under the 2008 Plan. The initial awards granted under the 2008 Plan were on April 23, 2008; service is the vesting condition.
 
The Company’s practice is to grant options and restricted stock or RSUs to non-employee directors on the last business day of each fiscal year, with an additional grant of options to each director on the date of his or her first anniversary of service. Additionally, the Company’s practice is to grant options, restricted stock and RSUs to employees at the Company’s December board meeting and occasionally to key employees as deemed appropriate at other times during the year. The exercise price of the

12

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


option awards is equal to the closing market price on the date granted. The Company generally issues shares from treasury stock, if available, to satisfy stock option exercises and grants of restricted stock. If there are no shares in treasury stock, the Company issues additional shares of common stock. The Company has not capitalized any stock-based compensation cost as part of inventory or fixed assets during the nine months ended July 31, 2012 and 2011.
Restricted Stock Awards
Under the 2008 Plan, common stock may be awarded to key employees, officers and non-employee directors. The recipient is entitled to all of the rights of a shareholder, except that during the forfeiture period the shares are nontransferable. The awards vest over a specified time period, but typically either immediately vest or cliff vest over a three-year period with service as the vesting condition. Upon issuance of stock under the plan, fair value is measured by the grant-date price of the Company’s shares. This fair value is then expensed over the restricted period with a corresponding increase to additional paid-in-capital. A summary of non-vested restricted stock award changes during the nine months ended July 31, 2012 follows:
 
 
Shares
 
Weighted - Average
Grant-Date Fair
Value Per Share
Non-vested at October 31, 2011
256,390

 
$
12.67

Granted
83,900

 
15.08

Cancelled
(11,800
)
 
16.07

Vested
(115,790
)
 
7.82

Non-vested at July 31, 2012
212,700

 
$
16.08


The weighted-average grant-date fair value of restricted stock granted during the nine months ended July 31, 2012 and 2011 was $15.08 and $17.14 per share, respectively. The total fair value of restricted stock vested during the nine months ended July 31, 2012 was $0.9 million. Total unrecognized compensation cost related to unamortized restricted stock awards was $1.5 million as of July 31, 2012. This cost is expected to be recognized over a weighted-average period of 1.9 years.
Stock Options
As described in the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2011, the Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of its stock options. The fair value of each option was estimated on the date of grant. The following is a summary of valuation assumptions and resulting grant-date fair values for grants during the following periods:
 
 
Nine Months Ended
  
July 31,
 
2012
 
2011
Weighted-average expected volatility
54.0
%
 
53.0
%
Expected term (in years)
4.9-5.1

 
4.9-5.1

Risk-free interest rate
0.9
%
 
1.7
%
Expected dividend yield over expected term
1.0
%
 
1.0
%
Weighted-average grant-date fair value per share
$
6.70

 
$
7.59



Below is a table summarizing the stock option shares activity for the 2008 Plan since October 31, 2011:
 

13

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


 
Shares
 
Weighted-
Average
Exercise
Price Per
Share
 
Weighted-
Average
Remaining
Contractual
Term (in years)
 
Aggregate
Intrinsic
Value (000s)
Outstanding at October 31, 2011
2,137,436

 
$
14.08

 
 
 
 
Granted
572,050

 
15.57

 
 
 
 
Exercised
(181,558
)
 
13.78

 
 
 
 
Cancelled/Expired
(42,735
)
 
15.71

 
 
 
 
Outstanding at July 31, 2012
2,485,193

 
14.42

 
7.4

 
$
6,524

Vested or expected to vest at July 31, 2012
2,410,118

 
14.34

 
7.4

 
$
6,480

Exercisable at July 31, 2012
1,569,836

 
$
13.38

 
6.5

 
$
5,665


The total intrinsic value of options (the amount by which the market price of the stock on the date of exercise exceeded the exercise price of the option) exercised during the nine months ended July 31, 2012 and 2011 was $0.8 million and $0.3 million, respectively. The total fair value of shares vested during the nine months ended July 31, 2012 and 2011 was $2.3 million and $2.4 million, respectively. Total unrecognized compensation cost related to stock options granted under the 2008 Plan was $3.8 million as of July 31, 2012. This cost is expected to be recognized over a weighted-average period of 1.7 years.
Restricted Stock Units
RSUs vest over a specified time period, but typically either immediately vest or cliff vest over a three-year period with service as the vesting condition. RSUs are not considered to be outstanding shares of common stock and do not have voting rights. Holders of RSUs receive cash for an equivalent amount of cash dividends paid on the underlying common stock. Upon the earlier of the date the director ceases to be a board member or a change of control or upon vesting for the employee grants, each RSU is payable in cash in an amount equal to the market value of one share of the Company’s common stock. Accordingly, the RSU liability will be adjusted to fair market value at each reporting date. A summary of non-vested restricted stock unit changes during the nine months ended July 31, 2012 follows:
 
Shares
 
Weighted - Average
Grant-Date Fair
Value Per Share
Non-vested at October 31, 2011
21,000

 
$
18.35

Granted
155,000

 
15.33

Cancelled
(15,000
)
 
18.35

Non-vested at July 31, 2012
161,000

 
$
15.47

The weighted-average grant-date fair value of restricted stock units granted during the nine months ended July 31, 2012 was $15.33 per share. No restricted stock units were granted during the nine months ended July 31, 2011. No restricted stock units vested during the nine months ended July 31, 2012 and 2011. Total unrecognized compensation cost based on service related to unamortized restricted stock units was $1.9 million as of July 31, 2012. This cost does not include market fluctuations and is expected to be recognized over a weighted-average period of 2.4 years. Cash used to settle restricted stock units during the nine months ended July 31, 2012 was $0.2 million. The number of RSU awards outstanding as of July 31, 2012 and October 31, 2011 was 186,726 and 56,410, respectively.

12. Income Taxes
The provision for income taxes is determined by applying an estimated annual effective income tax rate to income from continuing operations before income taxes. The rate is based on the most recent annualized forecast of pretax income, permanent book versus tax differences and tax credits. The Company’s estimated annual effective tax rate for the nine months ended July 31, 2012 is 32.9% compared to the estimated annual effective tax rate of 35.2% for the nine months ended July 31, 2011. The decrease in the current year effective tax rate benefit is primarily attributable to nondeductible employee related items in the current year.
The Company recorded a state Net Operating Loss (NOL) valuation allowance, net of federal taxes, of $1.0 million in the third quarter of 2012. In assessing the need for a valuation allowance, the Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The charge to income tax expense for the valuation allowance

14

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


was largely offset in the quarter by adjustments from the true up of the prior year's tax provision and from the liability for uncertain tax positions due to a lapse in the statute of limitations.
Prepaid and other current assets on the Consolidated Balance Sheets include an income tax receivable of $1.5 million and $0.2 million as of July 31, 2012 and October 31, 2011, respectively.
The Company’s unrecognized tax benefit (UTB) is related to the Separation and state tax items regarding the interpretations of tax laws and regulations. The total UTB as of July 31, 2012 is $15.7 million. Of this, $6.7 million is recorded in Liability for uncertain tax positions and $9.0 million is recorded in Deferred income taxes (non-current assets) on the Consolidated Balance Sheets. The UTB includes $14.6 million for which the disallowance of such items would not affect the annual effective tax rate. During the three months ended July 31, 2012, the Company reduced the liability for uncertain tax positions related to the Separation by $3.6 million as a result of the lapse in the statute of limitations. This resulted in a non-cash increase to retained earnings in stockholders’ equity of $2.9 million and a decrease in income tax expense of $0.7 million.
 
Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s financial statements or income 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 the Company’s financial statements. The Company is subject to the effects of these matters occurring in various jurisdictions. The Company believes that it is reasonably possible that a decrease of approximately $2.7 million in the UTB may be recognized within the next twelve months as a result of a lapse in the statute of limitations.

13. Contingencies
Environmental
Quanex is subject to extensive laws and regulations concerning the discharge of materials into the environment and the remediation of chemical contamination. To satisfy such requirements, Quanex must make capital and other expenditures on an ongoing basis. The Company accrues its best estimates of its remediation obligations and adjusts such accruals as further information and circumstances develop. Those estimates may change substantially depending on information about the nature and extent of contamination, appropriate remediation technologies, and regulatory approvals. In accruing for environmental remediation liabilities, costs of future expenditures are not discounted to their present value, unless the amount and timing of the expenditures are fixed or reliably determinable. When environmental laws might be deemed to impose joint and several liability for the costs of responding to contamination, the Company accrues its allocable share of liability taking into account the number of parties participating, their ability to pay their shares, the volumes and nature of the wastes involved, the nature of anticipated response actions, and the nature of the Company’s alleged connections. The cost of environmental matters has not had a material adverse effect on Quanex’s operations or financial condition in the past, and management is not currently aware of any conditions that it believes are likely to have a material adverse effect on Quanex’s operations, financial condition or cash flows.
Total environmental reserves and corresponding recovery for the Company as of July 31, 2012 and October 31, 2011 were as follows:
 
 
July 31,
2012
 
October 31,
2011
 
(In thousands)
Current1
$
1,700

 
$
1,965

Non-current
10,297

 
11,221

Total environmental reserves
$
11,997

 
$
13,186

Receivable for recovery of remediation costs2
$
11,690

 
$
12,304

 ________________________
1 
Reported in Accrued liabilities on the Consolidated Balance Sheets.
2 
Reported in Accounts receivable and Other assets on the Consolidated Balance Sheets.
Currently, the Company’s ongoing remediation activities are at one of its subsidiaries, Nichols Aluminum-Alabama, LLC (NAA). NAA operates a plant in Decatur, Alabama that is subject to an Alabama Hazardous Wastes Management and Minimization Act Post-Closure Permit. Among other things, the permit requires NAA to remediate, as directed by the state, historical environmental releases of wastes and waste constituents. Consistent with the permit, NAA has undertaken various studies of site conditions and, during the first quarter of 2006, started a phased program to treat in-place free product petroleum that had been

15

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


released underneath the plant. During the second quarter 2010, NAA submitted to the state the first component of its proposed workplan for implementing a site-wide remedy. The full workplan was submitted to the state during the third quarter 2010, revised during the second quarter 2011 to reflect both additional sampling data and responses to state comments, and revised again in the fourth quarter 2011 in response to another round of state comments. Based on those plans, which remain subject to further comment, revision, and state approval, the Company’s remediation reserve at NAA’s Decatur plant is $12.0 million as of July 31, 2012. Approximately $1.2 million of the July 31, 2012 reserve represents administrative costs; the balance of $10.8 million represents estimated costs for investigation, studies, cleanup, and treatment. The reserve has not been discounted. NAA was acquired through a stock purchase in which the sellers agreed to indemnify Quanex and NAA for identified environmental matters related to the business and based on conditions initially created or events initially occurring prior to the acquisition. Environmental conditions are presumed to relate to the period prior to the acquisition unless proved to relate to releases occurring entirely after closing. The limit on indemnification is $21.5 million excluding legal fees. While the Company’s current estimates indicate it will not reach this limit, changing circumstances could result in additional costs or expense that are not foreseen at this time. In accordance with the indemnification, the indemnitors paid the first $1.5 million of response costs and have been paying 90% of ongoing costs. Based on its experience to date, its estimated cleanup costs going forward, and costs incurred to date as of July 31, 2012, the Company expects to recover from the sellers’ shareholders an additional $11.7 million which has not been discounted. Of that, $10.8 million is recorded in Other assets on the Consolidated Balance Sheets, and the balance is reflected in Accounts receivable on the Consolidated Balance Sheets. The undiscounted recovery from indemnitors as of October 31, 2011was $12.3 million.
The Company’s final remediation costs and the timing of those expenditures will depend upon such factors as the nature and extent of contamination, the cleanup technologies employed, the effectiveness of the cleanup measures that are employed, and regulatory concurrences. While actual remediation costs, therefore, may be more or less than amounts accrued, the Company believes it has established adequate reserves for all probable and reasonably estimable remediation liabilities. It is not possible at this point to reasonably estimate the amount of any obligation for remediation in excess of current accruals because of uncertainties as to the extent of environmental impact, cleanup technologies, and concurrence of governmental authorities. The Company currently expects to pay the accrued remediation reserve through at least fiscal 2034, although some of the same factors discussed earlier could accelerate or extend the timing.
Other
From time to time, the Company and its subsidiaries are involved in various litigation matters arising in the ordinary course of their business. Although the ultimate resolution and impact of such litigation on the Company is not presently determinable, the Company’s management believes that the eventual outcome of such litigation will not have a material adverse effect on the overall financial condition, results of operations or cash flows of the Company.

14. Warranty Obligations
The Company’s estimated obligations for warranty are accrued concurrently with the revenue recognized. The Company makes provisions for its warranty obligations based upon historical experience incurred for such obligations adjusted, as necessary, for current conditions and factors. Due to the significant uncertainties and judgments involved in estimating the Company’s warranty obligations, including changing product designs, variance in customer installation process and future claims experience varying from historical claims experience, the ultimate amount incurred for warranty costs could change in the near and long-term from the current estimate.
 
The following table provides a reconciliation of the activity related to the Company’s accrued warranty, including both the current (reported in Accrued liabilities on the Consolidated Balance Sheets) and long-term portions (reported in Other liabilities on the Consolidated Balance Sheets), for the nine months ended July 31, 2012 (in thousands):
 
 
July 31,
2012
Balance at October 31, 2011
$
5,262

Provision for warranty expense
546

Change in accrual for preexisting warranties
(838
)
Warranty costs paid
(209
)
Total accrued warranty
$
4,761

Less long-term portion
2,892

Current accrued warranty
$
1,869



16

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


For the nine months ended July 31, 2012, the Company changed its estimate for preexisting warranties due to a decline in claims experience.

15. Derivative Instruments and Fair Value Measurement of Assets and Liabilities
Fair Value Measurement

The Company holds Money Market Fund investments that are classified as cash equivalents and pension plan assets measured at fair value based on active market quotations. The Company also utilizes financial derivative contracts to manage exposures to fluctuations in foreign currency exchange rates stemming from its international operations. Derivative instruments, which include forward exchange and options contracts, are recorded as either an asset or a liability measured at fair value based on quoted prices from brokers.
The Company’s investments and financial derivative contracts that are measured at fair value on a recurring basis are categorized below using the fair value hierarchy. The fair value hierarchy has three levels based on reliability of inputs used to determine fair value. Level 1 refers to fair values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values obtained from readily available pricing sources for comparable instruments. Level 3 includes fair values requiring measurement without observable market values that would require a high level of judgment to determine fair value. The following table summarizes assets measured on a recurring basis based on the fair value hierarchy:
 
 
July 31, 2012
 
October 31, 2011
 
Level 1
Level 2
Level 3
Total
 
Level 1
Level 2
Level 3
Total
Assets
(In thousands)
Money Market Fund investments
$
54,443

$

$

$
54,443

 
$
80,688

$

$

$
80,688

Pension plan assets
18,218



18,218

 
14,004



14,004

Total assets
$
72,661

$

$

$
72,661

 
$
94,692

$

$

$
94,692

 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
Foreign currency exchange derivatives
$

$
(21
)
$

$
(21
)
 
$

$
134

$

$
134

Total liabilities
$

$
(21
)
$

$
(21
)
 
$

$
134

$

$
134

 
 
 
 
 
 
 
 
 
 
Net assets (liabilities)
$
72,661

$
(21
)
$

$
72,640

 
$
94,692

$
134

$

$
94,826


As of July 31, 2012 and October 31, 2011, the Company did not have any assets or liabilities measured at fair value on a recurring basis in Level 3.
Derivative Instruments

The Company utilizes financial derivative contracts to manage exposures to fluctuations in foreign currency rates stemming from its international operations. Since the derivatives are not designated as hedges, all gains and losses, realized or unrealized, from these foreign currency derivative contracts are recognized in the consolidated income statement. The gains and losses from foreign currency derivatives and the line item where they appear on the Consolidated Statements of Income is:
 
Three months ended
 
Nine months ended
 
July 31,
 
July 31,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Other, net
$
700

 
$
(7
)
 
$
1,326

 
$
(17
)

The foreign currency transaction gains and losses are also recorded in Other, net. See Note 17 for further information.

17

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


The fair value of foreign currency exchange derivatives and the line items where they appear on the Consolidated Balance Sheet is:
 
July 31, 2012
 
October 31, 2011
 
(In thousands)
Liabilities
 
 
 
Accrued liabilities
$
21

 
$
(134
)
Hedge accounting has not been used for the foreign currency derivatives. The Company has not entered into a master netting arrangement, nor a collateral security arrangement.
The Company had the following notional position of outstanding foreign currency exchange derivatives:

 
 
July 31, 2012
 
October 31, 2011
Foreign currency exchange derivatives:
 
(In thousands)
Sell EUR, buy GBP
EUR
2,400

 

Sell EUR, buy US dollar
EUR
6,100

 
8,500

Buy GBP, sell US dollar
GBP
610

 
600

Buy US dollar, sell CAD
CAD
1,002

 
894


16. Stock Repurchase Program and Treasury Stock
On May 27, 2010, the Board of Directors approved a stock repurchase program of 1.0 million shares, and on August 25, 2011, the Board of Directors authorized an additional 1.0 million shares to this program. The objectives of this program are to manage the dilution created by shares issued under stock-based compensation plans and to repurchase shares opportunistically. The Company records treasury stock purchases under the cost method whereby the entire cost of the acquired stock is recorded as treasury stock. The Company uses a moving-average method on the subsequent reissuance of shares, and any resulting proceeds in excess of cost are credited to additional paid in capital while any deficiency is charged to retained earnings.
As of October 31, 2011, the number of shares in treasury stock was 1,035,288. During the nine months ended July 31, 2012, the Company purchased 94,337 shares at a cost of $1.3 million partially offset by shares issued for stock option exercises and restricted stock grants for a net decrease to the number of shares in treasury stock to 864,167 as of July 31, 2012. Since inception of the program, Quanex has purchased 1,094,337 shares through July 31, 2012. The remaining shares authorized for repurchase in the program was 905,663 as of July 31, 2012.

17. Other Income (Expense)
The Company's non-operating income (expense), ("Other,net") includes the impact of Edgetech's foreign currency denominated exposure and transactions as well as the offsetting foreign currency derivatives used to hedge that exposure. See Note 15 for further explanation.
During the three and nine months ended July 31, 2012, the netted impact of both types of transactions was a loss of $12 thousand and $3 thousand, respectively. During the three and nine months ended July 31, 2012, the net loss consisted of $0.7 million and $1.3 million, respectively, of transaction losses related to foreign currency denominated exposures offset by gains of $0.7 million and $1.3 million related to gains on foreign currency derivatives.
During the three and nine months ended July 31, 2011, the netted impact of foreign currency transactions and foreign currency derivatives was a loss of $0.4 million and $0.2 million, respectively. During the three and nine months ended July 31, 2011, the net loss consisted of $0.4 million and $0.2 million, respectively, of transaction losses related to foreign currency denominated exposures and $7 thousand and $17 thousand of losses related to foreign currency derivatives.


18. Restructuring and Related Activities
In November 2011, management committed to a plan to close its Barbourville, Kentucky facility (Barbourville) which is

18

QUANEX BUILDING PRODUCTS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
 


included in the Engineered Products segment. The consolidation plan, in part, called for the permanent closing of Barbourville, with the equipment used to manufacture the single seal spacer system being relocated to the Company’s Cambridge, Ohio facility. The Company believes this consolidation will allow it to better serve customers through streamlined operations. The consolidation of operations and the subsequent closure of the Barbourville facility was completed in August 2012 with residual cash payments and minor program costs expected to continue into fiscal 2013. All equipment to be retained has been relocated with the main outstanding activities only related to selling remaining equipment and the facility itself.
Under ASC Topic 712, “Compensation — Nonretirement Postemployment Benefits”, the Company is required to record charges for contractual termination benefits and other ongoing benefit arrangements when it is probable that employees will be entitled to benefits under the contract’s terms and the amount can be reasonably estimated. The Company determined that certain severance pay qualifies as either a contractual termination benefit or an ongoing benefit arrangement, and accordingly recognized$1.6 million in severance during the nine months ended July 31, 2012. Severance is being paid out during 2012 as employees exit. Under ASC Topic 420, “Exit or Disposal Cost Obligations,” the Company is required to record charges for one-time employee termination benefits, contract termination costs, and other associated costs as incurred. In February 2012, the Company and the union reached an agreement to pay a one-time incentive bonus to employees upon their planned exit date termination, providing certain performance criteria are met. The salaried employees were offered the same one-time incentive bonus under the same terms as the union employees. For the three and nine months ended July 31, 2012, the Company expensed total employee-related termination costs of $0.3 million and $3.3 million, respectively, and facility consolidation costs of $2.0 million and $4.7 million, respectively. All other costs related to the closure and relocation activities are being recorded as incurred, when they meet the definition of a liability, and they are included in the statements of income as selling, general, and administrative expenses, in accordance with the applicable accounting guidance. Cumulative costs incurred as of July 31, 2012 total $8.0 million. Total expected costs of $9 million for the project are comprised of approximately $4 million for employee-related costs and $5 million for plant closure, equipment moving and set up costs, substantially all of which will be charged to selling, general and administrative expense.

During November 2010, the Company committed to a plan to shut down its plant in The Dalles (included in the Engineered Products segment) and service its clients out of other locations. The Dalles shut down was completed in January 2011. The Company accrued a net lease liability for the difference between remaining lease rental payments offset by sublease income, since management subleased the facility in November 2011. The Company does not expect to have any additional charges for contract termination and other exit costs related to The Dalles.

A reconciliation of the beginning and ending liability balances showing charges to expense, cash payments and other adjustments for the nine months ended July 31, 2012 is as follows (in thousands):
 
 
Employee
termination
costs
 
Facility
consolidation
costs
 
Contract
termination and
other exit costs
 
Total
Reconciliation of the liability in the balance sheet
 
 
 
 
 
 
 
Beginning balance, October 31, 2011
$

 
$

 
$
722

 
$
722

Charges to expense, continuing operations
3,336

 
4,683

 
12

 
8,031

Cash payments
(2,270
)
 
(4,204
)
 
(290
)
 
(6,764
)
Other adjustments

 

 
(61
)
 
(61
)
Ending balance, July 31, 2012
$
1,066

 
$
479

 
$
383

 
$
1,928


The employee termination and facility consolidation activity above related to the IG spacer consolidation program while the contract termination and other exit costs relate to The Dalles shut down.

19


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The discussion and analysis of Quanex Building Products Corporation and its subsidiaries’ financial condition and results of operations should be read in conjunction with the July 31, 2012 Consolidated Financial Statements of the Company and the accompanying notes and in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2011. References made to the “Company” or “Quanex” include Quanex Building Products Corporation and its subsidiaries and Quanex Corporation (accounting predecessor to Quanex Building Products Corporation) unless the context indicates otherwise.
Private Securities Litigation Reform Act
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. All statements which address future operating performance, events or developments that the Company expects or anticipates will occur in the future, including statements relating to volume, sales, operating income and earnings per share, and statements expressing general outlook about future operating results, are forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the Company’s historical experience and the present projections or expectations. As and when made, management believes 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. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Factors exist that could cause the Company’s actual results to differ materially from the expected results described in or underlying the Company’s forward-looking statements. Such factors include domestic and international economic activity, prevailing prices of aluminum scrap and other raw material costs, the rate of change in prices for aluminum scrap, fluctuations in foreign currency exchange rates, energy costs, interest rates, construction delays, market conditions, particularly in the home building and remodeling markets, any material changes in purchases by the Company’s principal customers, labor supply and relations, environmental regulations, changes in estimates of costs for known environmental remediation projects and situations, world-wide political stability and economic growth, warranty obligations, the Company’s successful implementation of its internal operating plans, acquisition strategies and integration, performance issues with key customers, suppliers and subcontractors, and regulatory changes and legal proceedings. Accordingly, there can be no assurance that the forward-looking statements contained herein will occur or that objectives will be achieved. All written and verbal forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by such factors. For more information, see Part I, Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K, for the year ended October 31, 2011.
About Third-Party Information
In this report, the Company relies on and refers to information regarding industry data obtained from market research, publicly available information, industry publications, U.S. government sources and other third parties. Although the Company believes the information is reliable, it cannot guarantee the accuracy or completeness of the information and has not independently verified it.

Description of Business
On December 12, 2007, Quanex Building Products Corporation was incorporated in the state of Delaware as a subsidiary of Quanex Corporation to facilitate the separation of Quanex Corporation’s vehicular products and building products businesses. The separation occurred on April 23, 2008 through the spin-off of Quanex Corporation’s building products business to its shareholders immediately followed by the merger of Quanex Corporation (consisting principally of the vehicular products business and all non-building products related corporate accounts) with a wholly-owned subsidiary of Gerdau S.A. (Gerdau).
The spin-off and subsequent merger is hereafter referred to as the “Separation”. For purposes of describing the events related to the Separation, as well as other events, transactions and financial results of Quanex Corporation and its subsidiaries related to periods prior to April 23, 2008, the term “the Company” refers to Quanex Building Products Corporation’s accounting predecessor, Quanex Corporation. In March 2011, the Company acquired Edgetech I.G., Inc. and its German subsidiary. Headquartered in Cambridge, Ohio, Edgetech has three manufacturing facilities (U.S., U.K., and Germany) that produce and market a full line of insulating glass spacer systems for window and door customers in North America and abroad.

20


In November 2011, management committed to a program to consolidate its Insulating Glass (IG) spacer manufacturing facility in Barbourville, Kentucky into its IG spacer manufacturing facility in Cambridge, Ohio. The facility consolidation was completed in August 2012. In 2010, management closed its start-up facility in China due to the contraction of demand and the Company’s ability to serve the overseas thin film solar panel market from its North American operations. Accordingly, the China assets and liabilities, results of operations and cash flows are reported as discontinued operations for all periods presented. Unless otherwise noted, all discussions reflect only continuing operations.

Consolidated Results of Operations
Summary Information
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
Change
 
%
 
2012
 
2011
 
Change
 
%
 
(Dollars in millions)
Net sales
$
237.9

 
$
252.4

 
$
(14.5
)
 
(5.7
)
 
$
593.9

 
$
615.3

 
$
(21.4
)
 
(3.5
)
Cost of sales 1
200.7

 
209.7

 
(9.0
)
 
(4.3
)
 
510.5

 
524.8

 
(14.3
)
 
(2.7
)
Selling, general and administrative
26.6

 
18.9

 
7.7

 
40.7

 
80.9

 
61.2

 
19.7

 
32.2

Depreciation and amortization
9.1

 
9.2

 
(0.1
)
 
(1.1
)
 
28.4

 
24.6

 
3.8

 
15.4

Operating income (loss)
1.5

 
14.6

 
(13.1
)
 
(89.7
)
 
(25.9
)
 
4.7

 
(30.6
)
 
(651.1
)
Interest expense
(0.1
)
 
(0.1
)
 

 

 
(0.4
)
 
(0.3
)
 
(0.1
)
 
33.3

Other, net

 
(0.3
)
 
0.3

 
(100.0
)
 
0.2

 
0.1

 
0.1

 
100.0

Income tax (expense) benefit
0.1

 
(5.2
)
 
5.3

 
(101.9
)
 
8.6

 
(1.6
)
 
10.2

 
(637.5
)
Income (loss) from continuing operations
$
1.5

 
$
9.0

 
$
(7.5
)
 
(83.3
)
 
$
(17.5
)
 
$
2.9

 
$
(20.4
)
 
(703.4
)
_______________________________
1 
Exclusive of items shown separately below.
Overview
The first nine months of fiscal year 2012 saw some positive signs for the housing market, including rising home starts and falling new home inventory levels.  While the housing market is showing some positive signs, Quanex sees a negative trend in the residential building products market this year. While new home starts are projected to be up about 25% over a year ago, residential repair and remodel (R&R) activity is relatively flat. Quanex believes the best indicator of the strength of its end markets is U.S. window shipments as reported by Ducker Worldwide, a market intelligence firm. For calendar year 2012, Ducker is forecasting total window shipments to be up about 5% year over year; however, the outlook for replacement windows is projected to be down slightly. This is a concern as Quanex estimates that about two-thirds of its Engineered Products segment sales are related to the U.S. residential R&R window market. Also, discussions concerning replacement window demand with some of the Company's larger customers have not been encouraging. While it is difficult to identify the exact causes for this weakness, Quanex believes that ongoing tight credit conditions, flat existing home prices, and lagging consumer confidence continue to discourage homeowners from making significant improvements to their homes.
The decline in Quanex Net sales through July 2012 compared to the year ago period was driven by reduced aluminum shipments and lower aluminum prices within the Aluminum Sheet Products segment whose Net sales declined by $73.3 million during the nine months ended July 31, 2012 compared to the same 2011 period. The segment experienced a strike at two of Nichols' Davenport, Iowa facilities (see further discussion in Aluminum Sheet Products) which had a significant negative impact on shipments. Ducker reported that total U.S. window shipments for the twelve months ended June 30, 2012 were down 2% and replacement window shipments were down 8% compared to the year ago period while the Company's Engineered Products segment experienced a 6% increase in same store sales predominately related to higher vinyl extrusion sales. Same store sales reflect the Net sales of Edgetech, acquired on March 31, 2011, for only comparable months of the last twelve month periods. Operating income declined for the three and nine months ended July 31, 2012 by $13.1 million and $30.6 million, respectively, compared to the year ago periods, most of which is tied to lower aluminum shipments and lower aluminum prices experienced in the aluminum segment. Additionally, the Engineered Products segment incurred an increase in facility related consolidation expenses of $2.3 million and $4.9 million during the three and nine months ended July 31, 2012, respectively, compared to the same 2011 periods.

21


Quanex historically experiences its lowest sales during the first half of its fiscal year as winter weather typically reduces homebuilding and home improvement activity. Sales are generally seasonally stronger in the second half of the fiscal year with the weather sensitive building season underway. Profits tend to be lower in quarters with lower sales because a high percentage of manufacturing overhead and operating expense is due to labor and other costs that are generally semi-variable through the year. Macro-economic factors like weak residential construction and high unemployment will continue to create difficult end market conditions for Quanex. The Company currently expects calendar year 2012 U.S. window shipments to be about 39 million units, essentially in line with Ducker's 2012 forecasted shipments of 39.6 million. However, the Company remains positive on the long term prospects of its residential and commercial end markets and will continue to invest in its future.
The Company believes that consumer demand for more energy efficient products and its ability to provide innovative window and door systems in addition to stand-alone components will fuel long-term organic growth incremental to the housing market recovery. The integration of Edgetech into the Engineered Products sales and marketing organization was completed in September 2011 and it is clear that Quanex is already a stronger, more customer-focused organization as a result. The Company remains bullish long-term as demographics for long-term housing demand in the U.S. remain favorable when factoring the projected population increase and continuing immigration. The Company believes taking a disciplined approach to the way it seeks new business opportunities will make it a more successful company and a stronger competitor by offering a broader range of customers a more robust slate of systems, products, services and solutions, while intensely focusing on continuously improving customer service. Additionally, the Company is elevating its programs to develop more energy efficient products. These programs and initiatives, coupled with an eventual return to a more normal new home construction market and R&R market, will benefit Quanex over the long term.

Business Segments
Quanex has two reportable segments: Engineered Products and Aluminum Sheet Products. The Engineered Products segment produces systems, finished products, and components serving the OEM residential window and door industry, while the Aluminum Sheet Products segment produces mill finished and coated aluminum sheet serving the broader residential building products markets.  The primary market drivers of both segments are residential repair and remodel activity and new home construction.
For financial reporting purposes, three of the Company’s four operating segments, Homeshield, Insulating Glass (IG) and Mikron, have been aggregated into the Engineered Products reportable segment. The remaining operating segment, Aluminum Sheet Products (Nichols Aluminum), is reported as a separate reportable segment. Corporate & Other is comprised of corporate office expenses, Company-wide program costs and certain inter-division eliminations. The sale of products between segments is recognized at market prices. The financial performance of the operations is based upon operating income. The segments follow the accounting principles described in Item 1, Note 1 to the consolidated financial statements of the Company’s 2011 Form 10-K. The two reportable segments value inventory on a FIFO or weighted-average basis while the LIFO reserve relating to those operations accounted for under the LIFO method of inventory valuation is computed on a consolidated basis in a single pool and treated as a corporate item.
Three and Nine Months Ended July 31, 2012 Compared to Three and Nine Months Ended July 31, 2011

Engineered Products
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
Change
 
%
 
2012
 
2011
 
Change
 
%
 
(Dollars in millions)
Net sales
$
134.1

 
$
124.1

 
$
10.0

 
8.1

 
$
342.2

 
$
290.6

 
$
51.6

 
17.8

Cost of sales 1
98.0

 
90.5

 
7.5

 
8.3

 
256.4

 
222.1

 
34.3

 
15.4

Selling, general and administrative
16.1

 
12.4

 
3.7

 
29.8

 
49.9

 
35.0

 
14.9

 
42.6

Depreciation and amortization
6.9

 
7.1

 
(0.2
)
 
(2.8
)
 
21.0

 
18.1

 
2.9

 
16.0

Operating income (loss)
$
13.1

 
$
14.1

 
$
(1.0
)
 
(7.1
)
 
$
14.9

 
$
15.4

 
$
(0.5
)
 
(3.2
)
_______________________________
1 
Exclusive of items shown separately below.
 
Engineered Products is focused on providing window and door OEM customers with fenestration components, products

22


and systems. Key end markets are residential remodel and repair and new home construction. Engineered Products finished the period with sales up $10.0 million or 8% for the quarter and up $51.6 million or 18% for the nine months ended July 31, 2012 compared to the same 2011 periods. The improvement in Net sales was predominantly related to higher vinyl fenestration extrusion sales. Additionally, year-to-date results include nine months of Edgetech sales in 2012 compared to four months in 2011 as Edgetech was acquired on March 31, 2011. Considering Edgetech's partial year contribution, comparable Net sales for the nine months ended July 31, 2012 were 7% higher than the same 2011 period even though the beginning of 2011 benefited from a pull-forward of demand as a result of a $1,500 energy efficient window tax credit program that expired on December 31, 2010. There were no similar tax credits in fiscal 2012.  For the twelve months ended July 31, 2012, Engineered Products’ Net sales before contributions from acquisitions were up 6% compared to the previous twelve months, versus U.S. window shipments that were down approximately 2%. The 2012 gain was primarily from higher vinyl fenestration extrusion sales where the business executed exceptionally well and saw demand rise.  JELD-WEN, a major Quanex customer that produces mid to high-end wood and vinyl windows, has gained significant market share this year at the big box stores. They displaced a competitor that did not buy Quanex extrusions, benefiting Quanex sales in 2012. Although there were favorable signs in housing in the first nine months of fiscal 2012 time will tell as to how much can be attributed to a sustainable housing recovery. U.S. residential replacement window shipments, which drive an estimated two-thirds of its Engineered Products' sales, are down in 2012 and any long-term recovery is likely to take better hold once changes in housing prices, credit availability and consumer confidence turn to the positive.

Net sales less Cost of sales (Contribution margin) at Engineered Products for the three and nine months ended July 31, 2012 compared to the same period of last year improved by $2.4 million and $17.3 million, respectively. The increase in contribution margin for the third quarter 2012 over the third quarter 2011 is predominately due to the higher vinyl extrusion sales in 2012. Approximately one-third of the improvement in contribution margin for the nine months ended July 31, 2012 compared to the same 2011 period is from the rise in vinyl extrusion sales while approximately half of the increase is related to a full nine months of Edgetech sales in 2012 compared to four months of Edgetech business during the same 2011 period. Net sales less Cost of sales as a percent of Net sales for the nine months ended July 31, 2012 is higher than the same 2011 period even with the weak market and pressure on volume. Increased revenues, combined with pricing initiatives, cost controls, productivity improvements, warranty benefits and 2011 purchase accounting costs strengthened margins. One such pricing initiative was the oil-based raw material surcharge initiated May 1, 2011 at Truseal, one of the Company’s insulating glass spacer operations. The surcharge helped Truseal offset the higher cost of butyl, a key raw material of the business that is highly correlated to the price of oil. In 2011, Quanex consolidated facilities in Kent, Washington and closed a facility in The Dalles, Oregon. Of the $3.1 million in 2011 plant consolidation costs, $1.3 million is recognized in Cost of sales benefiting the nine month margin comparison. The three and nine months ended July 31, 2012 include a warranty benefit of $0.8 million from a change in warranty estimate for pre-existing warranties due to a decline in claims experience. The nine months ended July 31, 2011 reflects a $2.1 million charge to increase the warranty reserve estimate associated with a legacy product that Quanex discontinued some years ago, which also contributed to the year over year improvement in margins. Because the establishment of the warranty reserve is an inherently uncertain process involving estimates of the number of future claims and the cost to settle claims, the Company's ultimate losses may differ from the warranty reserve and future adjustments to the reserve may be necessary. Finally, 2011 results were negatively impacted by $0.7 million and $1.6 million of additional non-cash Cost of goods sold during the three and nine months ended July 31, 2011, respectively, due to the increased value of inventory sold from applying purchase accounting to the Edgetech inventory acquired.
On November 7, 2011, the Company announced a consolidation program for its IG spacer manufacturing facility in Barbourville, Kentucky into its IG spacer manufacturing facility in Cambridge, Ohio. The facility consolidation was completed ahead of schedule in August 2012, and the Barbourville facility is permanently closed. Total cash spending associated with the consolidation plan is estimated at about $16.0 million (excludes a pre-tax, non-cash impairment charge of $1.6 million taken in the fourth quarter 2011). Of the $16.0 million of cash, total expenses (to be recognized in Selling, general and administrative costs) are expected to be about $9.0 million for the project, comprised of approximately $4.0 million for employee-related costs and $5.0 million for plant closure, equipment moving and set up costs, substantially all of which will be charged to Selling, general and administrative expense. While Quanex expects a modest benefit in the fourth quarter from the project completion, the Company expects the estimated annual pre-tax cash savings of $9.0 million to begin in fiscal 2013. Selling, general and administrative costs increased by $3.7 million and $14.9 million for the three and nine months ended July 31, 2012 compared to the same 2011 periods, respectively, primarily due to more plant consolidation expenses in 2012 compared to 2011. The three and nine months ended July 31, 2012 Selling, general and administrative costs included expenses of $2.3 million and $8.0 million, respectively, associated with the Company’s IG spacer consolidation program compared to $1.4 million (included in the total $3.1 million discussed above) in first quarter 2011 related to plant consolidations. The Company does expect the residual cash payments and minor IG consolidation program costs to continue into fiscal 2013. Also the nine months ended July 31, 2012 Selling, general and administrative costs are higher than the same 2011 period from the acquisition of Edgetech in 2011, which contributed $6.3 million of the higher expenses, In March 2012, a portion of the roof collapsed at the Barbourville, Kentucky facility due to extreme weather. While $0.7 million of clean-up and related costs were incurred during the nine months ended July 31, 2012, customers had minimal service interruption as the clean-up activities were well executed and equipment moves to Cambridge were expedited. The Company did experience inefficiencies from the accelerated move and did incur additional costs, some of which are expected

23


to be recovered as the insurance claim is processed and settled. Insurance recoveries are recognized when realized, and may occur in periods subsequent to costs being incurred. Selling, general and administrative costs for the full fiscal year of 2012 are expected to be higher over fiscal 2011 as a full twelve months of expense associated with Edgetech is realized and due to the IG spacer consolidation project.
Depreciation and amortization has increased for the nine months ended July 31, 2012 compared to 2011 primarily due to the addition of Edgetech, which contributed $3.4 million higher depreciation and amortization. Partially offsetting this increase for the nine months ended July 31, 2012 compared to the same 2011 period was $0.3 million (included in the $3.1 million discussed above) of accelerated depreciation related to the plant consolidations recognized in the first quarter of 2011. Depreciation and amortization for the full fiscal year of 2012 is expected to be higher over fiscal 2011 as a full twelve months of expense associated with the recognition of Edgetech intangible assets and the step-up in Edgetech’s tangible assets is realized going forward.
Engineered Products’ operating income for the three and nine months ended July 31, 2012 declined compared to the same 2011 periods by $1.0 million and $0.5 million, respectively. While the 2012 results benefited from the increase in vinyl extrusion sales and favorable changes in warranty estimates, the 2012 reported results and margins were negatively impacted by the aforementioned IG spacer consolidation program and roof collapse related expenses as well as the Company's start up spacer facility in Germany and reduced higher margin non-fenestration IG sales. The three and nine months ended July 31, 2012 saw $2.5 million and $8.7 million, respectively, of the combined IG consolidation and roof related expense compared to $3.1 million of combined facility consolidation in the nine months ended July 31, 2011. The Company continues to believe that investments in growth opportunities like its Germany facility and plant consolidations like the IG consolidation program will have long-term benefits that will outweigh these current period costs and lead to revenue growth and margin improvements in future years.
Even in the face of weaker window demand, 2012 comparable Net sales increased 8.1% and 6.9%, during the three and nine months ended July 31, 2012, respectively, compared to the same 2011 periods from the strong performance of vinyl fenestration extrusions. Engineered Products’ long-term organic growth programs are focused on driving profitable growth through a single sales and marketing team that is intensely focused on driving continuous improvement of customer satisfaction. The Company believes this will drive profitable growth at Engineered Products by furthering the goal of becoming the leading energy efficiency expert in the market by offering customers state-of-the-art engineering, design and marketing support. While the Company believes that it is competively strong in its energy efficient product offerings, the higher price points often associated with these higher-end products may limit sales volumes in these times of tight credit conditions and low consumer confidence. Engineered Products is in the early stages of its long-term organic growth initiatives but believes they will have a meaningful impact on its long-term growth and profitability. The Company will continue to incur expenses and to invest in additional resources at Engineered Products to support this organic growth effort.

Aluminum Sheet Products
 
 
Three Months Ended
 
Nine Months Ended
 
July 31,
 
July 31,
 
2012
 
2011
 
Change
 
%
 
2012
 
2011
 
Change
 
%
 
(Dollars in millions)
Net sales
$
107.0

 
$
132.1

 
$
(25.1
)
 
(19.0
)
 
$
261.0

 
$
334.3

 
$
(73.3
)
 
(21.9
)
Cost of sales 1
105.9

 
120.8

 
(14.9
)
 
(12.3
)
 
263.4

 
307.9

 
(44.5
)
 
(14.5
)
Selling, general and administrative
2.6

 
1.8

 
0.8

 
44.4

 
7.7

 
5.9

 
1.8

 
30.5

Depreciation and amortization
1.7

 
2.1

 
(0.4
)
 
(19.0
)
 
6.2

 
6.4

 
(0.2
)
 
(3.1
)
Operating income (loss)
$
(3.2
)
 
$
7.4

 
$
(10.6
)
 
(143.2
)
 
$
(16.3
)
 
$
14.1

 
$
(30.4
)
 
(215.6
)
Shipped pounds
74.7

 
79.9

 
(5.2
)
 
(6.5
)
 
180.0

 
211.8

 
(31.8
)
 
(15.0
)
_______________________________
1 
Exclusive of items shown separately below.
The primary market drivers for the Aluminum Sheet Products segment are residential repair and remodel activity and new home construction (together approximately 70% of the segment’s sales) and transportation (approximately 20% of the segment’s sales) markets.

On January 20, 2012, Nichols Aluminum experienced a strike by about 240 bargaining unit employees at its two facilities located in Davenport, Iowa. During the second quarter, Nichols offered permanent positions to the approximately 100 temporary employees it hired since the strike began. The majority of those employees accepted a full time position. Shortly after that action,

24


the union ended its strike. At this time, Nichols does not have a formal agreement with the union, but is operating with the necessary crew levels to meet demand.
The decrease in net sales at the Aluminum Sheet Products segment for the three and nine months ended July 31, 2012 was the result of a 6.5% and 15.0%, respectively, decrease in shipments and a 13% and 8%, respectively, decrease in average selling price compared to the same period of 2011. Shipments were down 5.2 million pounds in the third quarter 2012 from the year ago quarter due primarily to an equipment outage at the Company's casting facility. Shipments for the nine months ended July 31, 2012 were down due to reduced production related to the second quarter strike, reliability issues and weaker end demand experienced early in the fiscal year from the absence of the window tax credit program compared to the available program in 2011. The Company estimates that approximately one third of the nine months' volume decline is attributable to the strike. The Aluminum Association, which tracks aluminum industry shipments of sheet products, reported non-can sheet aluminum shipments during the nine months ended July 31, 2012 were up 8% from a year ago, while Aluminum Sheet Products’ shipments were down. Nichols underperformance is primarily attributed to the impact of the strike as well as facility performance issues and relatively weaker residential demand, where it has a large presence, compared to relatively stronger distribution and transportation demand, where it has a smaller presence. Average selling price decreased primarily due to lower London Metal Exchange (LME) aluminum prices in the comparative periods. LME aluminum prices are the most commonly used index for correlating aluminum sheet prices and have been around 90 cents per pound compared to about $1.20 per pound a year ago.
Selling, general and administrative costs increased by $0.8 million and $1.8 million, respectively, for the three and nine months ended July 31, 2012 compared to the same 2011 periods primarily due to $0.3 million and $1.0 million of strike expenses as well as employee related expenses incurred during the third quarter 2012. The strike costs are directly associated with the negotiating activities themselves and include such items as legal fees and security. Quanex does not expect any significant strike related costs in future periods.
Depreciation and amortization has declined for the three and nine months ended July 31, 2012 compared to the same 2011 periods primarily due to equipment reaching the end of its depreciable life.and accelerated depreciation during the first quarter of fiscal 2011