MasterBrand, Inc. (MBC) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains “forward-looking statements” regarding business strategies, market potential, future financial performance, and other matters. Statements preceded by, followed by or that otherwise include the word “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans,” “may increase,” “may fluctuate,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may,” and “could,” are generally forward-looking in nature and not historical facts. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management. Although we believe that these statements are based on reasonable assumptions, they are subject to numerous factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those indicated in such statements. These factors include those listed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
The forward-looking statements included in this document are made as of the date of this Annual Report on Form 10-K and, except pursuant to any obligations to disclose material information under the federal securities laws, we undertake no obligation to update, amend or clarify any forward-looking statements to reflect events, new information or circumstances occurring after the date of this Annual Report on Form 10-K.
Some of the important factors that could cause our actual results to differ materially from those projected in any such forward-looking statements include:
◦Our ability to develop and expand our business;
◦Our anticipated financial resources and capital spending;
◦Our ability to manage costs;
◦The impact of our dependence on third parties with respect to sourcing our raw materials;
◦Our ability to accurately price our products;
◦Our anticipated future revenues and expectations of operational performance;
◦The effects of competition and consolidation of competitors in our industry;
◦Costs of complying with evolving tax and other regulatory requirements and the effect of actual or alleged violations of tax, environmental or other laws;
◦The effect of climate change and unpredictable seasonal and weather factors;
◦Failure to realize the anticipated benefits of the Separation;
◦Conditions in the housing market in the United States and Canada;
◦The expected strength of our existing customers and consumers;
◦Worldwide economic, geopolitical and business conditions and risks associated with doing business on a global basis;
◦The effects of the COVID-19 pandemic or another public health crisis or other unexpected event; and
◦Other statements contained in this Annual Report on Form 10-K regarding items that are not historical facts or that involve predictions.
Introduction
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is a supplement to the accompanying consolidated financial statements of MasterBrand and its consolidated subsidiaries and provides additional information on our business, recent developments, financial condition, liquidity and capital resources, cash flows and results of operations.
MD&A is organized as follows:
•Overview: This section provides a general description of our business, as well as recent developments we believe are important in understanding our results of operations and financial condition or in understanding anticipated future trends.
•Separation from Fortune Brands: This section provides a general discussion of our Separation from Fortune Brands.
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•Basis of Presentation: This section provides a discussion of the basis on which our consolidated financial statements were prepared, including our historical results of operations and adjustments thereto, primarily allocations of general corporate expenses from Fortune Brands.
•Results of Operations: Our consolidated financial statements are based on a 52- or 53-week fiscal year ending on the last Sunday in December in each calendar year. This section provides an analysis of our results of operations for the 53-week period that ended on December 31, 2023 as compared to the 52-week period that ended on December 25, 2022. Unless the context otherwise requires, references to years and quarters contained in this Annual Report on Form 10-K pertain to our fiscal years and fiscal quarters. Additionally, unless the context otherwise requires, references in this Annual Report on Form 10-K to: (1) “2023,” “fiscal 2023” or our “2023 fiscal year” refers to our 2023 fiscal year that is a 53-week period that ended on December 31, 2023; (2)“2022,” “fiscal 2022” or our “2022 fiscal year” refers to our 2022 fiscal year that was a 52-week period that ended on December 25, 2022; and (3) “2021,” “fiscal 2021” or our “2021 fiscal year” refers to our 2021 fiscal year that was a 52-week period that ended on December 26, 2021.
•Liquidity and Capital Resources: This section provides a discussion of our financial condition and an analysis of our cash flows for our 2023 fiscal year as compared to our 2022 fiscal year. This section also provides a discussion of our contractual obligations, other purchase commitments and customer credit risk that existed at December 31, 2023 and December 25, 2022, as well as a discussion of our ability to fund our future commitments and ongoing operating activities through internal and external sources of capital.
•Recently Issued Accounting Standards: This section identifies our adoption of recently issued accounting standards.
•Critical Accounting Estimates: This section identifies and summarizes those accounting policies that significantly impact our reported results of operations and financial condition and require significant judgment or estimates on the part of management in their application.
Overview
Founded nearly 70 years ago, we are the largest manufacturer of residential cabinets in North America based on 2022 reported net sales. Our superior product quality, innovative design and service excellence drives a compelling value proposition. We have insight into the fashion and features consumers desire, which we use to tailor our product lines across price points. Our volume leadership allows us to achieve an advantaged cost structure and service platform by standardizing product platforms and components to the greatest extent possible—resulting in an improved facility footprint and an efficient supply chain. Further, our decades of experience have informed how we use global geographies to optimize procurement and manufacturing costs. Finally, with the most extensive dealer network throughout the United States and Canada, we have an advantaged distribution model that cannot be easily replicated. We expect to further extend our competitive advantages by using technology and data to enhance the consumer’s experience from visualization to ordering to delivery and installation.
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Separation from Fortune Brands
On April 28, 2022, Fortune Brands announced that its Board of Directors approved in principle the Separation. The Cabinets segment of Fortune Brands had historically been operated by MasterBrand Cabinets, Inc. (“MBCI”). In July 2022, Fortune Brands incorporated MasterBrand, Inc. in the State of Delaware and subscribed to all of the shares of MasterBrand, Inc.’s common stock upon its incorporation. After the incorporation of MasterBrand, Inc., the following occurred: (1) Fortune Brands contributed all of the issued and outstanding shares of capital stock of MBCI to MasterBrand, Inc., resulting in MBCI becoming a wholly-owned subsidiary of MasterBrand, Inc. through a transaction between entities under common control; and (2) MBCI was converted into a Delaware limited liability company, MasterBrand Cabinets LLC (collectively, the “Reorganization”).
On December 14, 2022, the Separation was completed via the Distribution. On December 14, 2022, the date of Separation, 128.0 million shares of MasterBrand, Inc. common stock were issued. Fortune Brands shareholders received one share of MasterBrand, Inc. common stock for each share of Fortune Brands common stock held on the record date. Following the Distribution, Fortune Brands stockholders owned 100 percent of the shares of MasterBrand, Inc. common stock, and MasterBrand, Inc. became an independent, publicly-traded company, listed under the symbol “MBC” on the New York Stock Exchange beginning December 15, 2022. All share and per share amounts for all prior periods presented in the consolidated financial statements, as discussed in further detail in Note 5, "Earnings Per Share," of our audited consolidated financial statements within this Annual Report on Form 10-K have been retroactively recast to reflect the effects of the changes in equity structure resulting from the Reorganization, Separation and Distribution. The historical activity of the Company is that of MBCI prior to the Reorganization. The Company’s equity structure prior to the Separation and Distribution included 5,000 shares of MasterBrand, Inc. common stock authorized and 100 shares issued. Prior to the incorporation of MasterBrand, Inc. in July 2022, the equity structure of MBCI included 1,000 authorized and issued shares of common stock. MasterBrand, Inc. is the registrant and the financial reporting entity following the consummation of the Separation and Distribution.
In order to govern the ongoing relationships between MasterBrand, Inc. and Fortune Brands after the Separation and to facilitate an orderly transition, the parties entered into a series of agreements including the following:
•Separation and Distribution Agreement – sets forth the principal actions to be taken in connection with the Separation, including the transfer of assets and assumption of liabilities, among others, and sets forth other agreements governing aspects of the relationship between MasterBrand and Fortune Brands.
•Transition Services Agreement – allows for Fortune Brands and MasterBrand to provide certain transition services to each other for a limited time, up to 24 months following the Separation.
•Tax Allocation Agreement – governs the respective rights, responsibilities and obligations of MasterBrand and Fortune Brands with respect to tax liabilities and benefits, tax attributes, tax contests and other matters regarding income taxes, non-income taxes and related tax returns.
•Employee Matters Agreement – addresses certain employment, compensation and benefits matters, including the allocation and treatment of certain assets and liabilities relating to MasterBrand associates.
Separating the former Cabinets segment into a standalone publicly-traded company significantly enhances the long-term growth and return prospects of our Company and offers substantially greater long-term value to stockholders, customers and associates. Moreover, separating the Cabinets segment into an independent, standalone company with publicly-traded stock provides our Company with a number of benefits, including:
•Strategic and Management Focus: The Separation enables our management team to better focus on strengthening our market-leading business and pursue targeted opportunities for long-term growth, profitability, and value creation. Like many of our competitors and peers, we believe that we will be more effective in managing our capital structure with credit tied more specifically to its industry and business performance and achieving greater margin expansion by focusing on our operational effectiveness specific to its products. A dedicated management team and board of directors streamlines operational and strategic decision-making, and ensures management incentives are optimized and aligned with our strategic priorities and financial objectives are in line with our industry.
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•Resource Allocation and Capital Deployment: The Separation provides us with an opportunity to implement a tailored capital structure that ties specifically to our industry and business that provides greater financial and operational flexibility and increased agility. We are better positioned to more effectively allocate resources to address unique operating needs relating to our manufacturing and marketing requirements within our specific markets, invest in strategic priorities that will maximize long-term potential, and manage capital return strategies. Our unique operating needs are tailored towards enhancing the standardization of our processes, including with respect to our supply chain, and the specific manufacturing needs of our products, and strengthening our lean manufacturing capabilities. The Separation provides an opportunity for us to more effectively focus on these unique operating needs and markets.
•Distinct Investment Opportunities and Investor Choice: The Separation creates a compelling investment opportunity for investors based on our unique operating model and financial profile. It also provides investors with enhanced insight into our distinct value drivers and allows for more targeted investment decisions.
Basis of Presentation
Our consolidated financial statements are based on a 52- or 53-week fiscal year ending on the last Sunday in December in each calendar year and have been principally derived from the consolidated financial statements of our Company and its consolidated subsidiaries using the historical results of operations, and historical basis of assets and liabilities. Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Our historical financial statements through the date of Separation include allocations of expenses related to certain Fortune Brands corporate functions, including information technology, finance, executive, human resources, supply chain, internal audit, governance and legal services. These expenses have been allocated based on direct usage or benefit where specifically identifiable, with the remainder allocated on a proportional cost allocation method based primarily on net sales, associate headcount or number of facilities, as applicable. Prior to the Separation, total expenses allocated for our 2022 and 2021 fiscal years were $92.5 million and $62.0 million, respectively. Of these allocations, $72.4 million and $42.3 million, respectively, were not previously allocated to us for our 2022 and 2021 fiscal years. Such amounts are primarily included within selling, general and administrative expenses in our consolidated statements of income. We consider the expense methodology and resulting allocation to be reasonable for all periods presented; however, the allocations may not be indicative of actual expenses that would have been incurred had we operated as an independent, publicly-traded company during all periods presented. Actual costs that we may have incurred had we been a standalone company during all periods presented would depend on a number of factors, including the chosen organizational structure, whether functions were outsourced or performed by our associates and strategic decisions made in areas such as manufacturing, selling and marketing, research and development, information technology and infrastructure. Accordingly, historical allocations may not be indicative of future costs we incur operating as an independent, publicly-traded company.
The income tax amounts in our consolidated financial statements have been calculated on a separate return method and presented as if our operations were separate taxpayers in the respective jurisdictions. For the period prior to the Separation in 2022, including the Separation, federal and state income tax payments and refunds were paid and received by Fortune Brands on our behalf. The net taxes paid on our behalf are payable to Fortune Brands, as provided in the indemnification provisions of the Tax Allocation Agreement. Accordingly, the net tax payable of $32.6 million to Fortune Brands as of December 25, 2022, was recorded in accounts payable on the Consolidated Balance Sheets and settled in 2023.
Following the Separation, a limited number of services that Fortune Brands provided to us, or we provided to them, prior to the Separation continue to be provided for a period of time under a Transition Services Agreement. We are now incurring certain costs as a standalone public company, including services provided by our own resources or through third-party service providers relating to corporate functions, including information technology, finance, executive, human resources, supply chain, internal audit, governance and legal services, as well as ongoing additional costs associated with operating as an independent, publicly-traded company.
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All transactions between us and Fortune Brands previously resulting in related party balances were settled in our consolidated financial statements immediately prior to the Distribution, or were settled shortly thereafter, including by making a distribution of capital by us to Fortune Brands of any remaining related party receivable owed by Fortune Brands to us. For more information regarding related party transactions with Fortune Brands, see Note 20, "Related Party Transactions," of our audited consolidated financial statements within this Annual Report on Form 10-K. Fortune Brands utilized a central approach to treasury management, and we historically participated in related cash pooling arrangements prior to the Separation. Our cash and cash equivalents on our consolidated balance sheets represent cash balances held in bank accounts owned by us and our consolidated subsidiaries. Prior to Separation, we had no third-party borrowings. All borrowings attributable to our business and due to Fortune Brands were recorded as “related party payable” in our consolidated balance sheets and classified as current or noncurrent based on loan maturity dates. Fortune Brands’ third-party debt and related interest expense have not historically been attributed to us as we were not the legal obligor of the debt, and the borrowings are not specifically identifiable to us. However, we incurred indebtedness in connection with the Separation and Distribution, which resulted in additional interest expense beginning in the fourth quarter of 2022.
Results of Operations
The following discussion includes a comparison of results of operations for the fifty-three weeks ended December 31, 2023 compared to the fifty-two weeks ended December 25, 2022. For comparisons of our 2022 fiscal year compared to our 2021 fiscal year, please refer to the heading “Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 25, 2022, as filed with the SEC.
Fiscal 2023 compared to Fiscal 2022
| (U.S. Dollars presented in millions) | December 31, 2023 | $ change | % change | December 25, 2022 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| NET SALES | $ | 2,726.2 | $ | (549.3) | (16.8 | %) | $ | 3,275.5 | |||||
| Cost of products sold | 1,824.8 | (510.2) | (21.9 | %) | 2,335.0 | ||||||||
| GROSS PROFIT | 901.4 | (39.1) | (4.2 | %) | 940.5 | ||||||||
| Selling, general and administrative expenses | 569.7 | (78.8) | (12.2 | %) | 648.5 | ||||||||
| Amortization of intangible assets | 15.3 | (1.9) | (11.0) | % | 17.2 | ||||||||
| Asset impairment charges | — | (46.4) | n/m(1) | 46.4 | |||||||||
| Restructuring charges | 10.1 | (15.0) | (59.8 | %) | 25.1 | ||||||||
| OPERATING INCOME | 306.3 | 103.0 | 50.7 | % | 203.3 | ||||||||
| Related party interest income, net | — | 12.9 | n/m(1) | (12.9) | |||||||||
| Interest expense | 65.2 | 63.0 | n/m(1) | 2.2 | |||||||||
| Other expense, net | 2.4 | 1.8 | 300.0 | % | 0.6 | ||||||||
| INCOME BEFORE TAXES | 238.7 | 25.3 | 11.9 | % | 213.4 | ||||||||
| Income tax expense | 56.7 | (1.3) | (2.2 | %) | 58.0 | ||||||||
| NET INCOME | $ | 182.0 | $ | 26.6 | 17.1 | % | $ | 155.4 |
__________
(1)Not meaningful.
Net sales
Net sales were $2,726.2 million for 2023 compared to $3,275.5 million for 2022, a decrease of $549.3 million, or 16.8 percent. The lower net sales compared to 2022 was driven mainly by a decrease in sales unit volume, partially offset by favorable price, including the carryover of price increases implemented in the second half of 2022. Foreign currency impact was unfavorable by $3.8 million during 2023 as compared to 2022.
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Cost of products sold
Cost of products sold decreased by $510.2 million, or 21.9 percent, to $1,824.8 million (66.9 percent of net sales) in 2023 as compared to $2,335.0 million (71.3 percent of net sales) in 2022. In addition to the impact of decreased sales unit volume, the lower cost of products sold as a percentage of net sales in 2023 is due to the favorable carryover of price increases implemented in the second half of 2022, as well as realized savings from various cost reduction actions taken in the fourth quarter of 2022 and throughout 2023. Fiscal 2023 was also favorably impacted by deflation in commodity costs and inbound transportation. These factors were partially offset by labor inflation. Additionally, 2023 included $9.4 million of incremental costs, less $7.4 million of insurance recoveries, related to the tornado that occurred during the first quarter at our Jackson, GA facility.
Selling, general and administrative expenses
Selling, general and administrative expenses decreased by $78.8 million, or 12.2 percent, to $569.7 million (20.9 percent of net sales) in 2023 compared to $648.5 million (19.8 percent of net sales) in the prior year. 2023 includes lower unit volume related costs, including distribution costs ($40.4 million) and commission costs ($18.1 million), offset by increased associate-related costs ($40.3 million), including salaries, incentive compensation and stock-based compensation, and professional support fees ($37.0 million). 2023 reflects associate-related and professional support fee costs for newly established MasterBrand corporate functions, as compared to 2022, which included $92.5 million of allocated costs from Fortune Brands that did not recur in 2023. In 2023, we incurred $2.4 million of additional costs directly related to the Separation from Fortune Brands, as compared to $15.4 million in 2022.
Asset impairment charges
During 2022, we incurred $46.4 million of asset impairment charges related to indefinite-lived tradenames. During the second quarter of 2022, we incurred an asset impairment charge of $26.0 million related to an indefinite-lived tradename, as production was shifted within our manufacturing footprint to enable what we expect to be a higher value purpose and growth opportunity, which led to downward revisions to forecasted revenue growth rates associated with the tradename and the recognition of the corresponding asset impairment charge. In the fourth quarter of 2022, we incurred an additional asset impairment charge of $12.8 million related to the same indefinite-lived tradename as a result of further shifts within our product portfolio to better align with forecasted future customer demand as a result of a significant decrease in sales during the fourth quarter of 2022, driven by continued and persistent inflation, as well as elevated interest rates and economic uncertainty. These downward revisions to forecasted revenue growth were not known when recording the impairment charge during the second quarter of 2022. In the fourth quarter of 2022, we also incurred an impairment charge of $7.6 million related to another indefinite-lived tradename, due to a shift in customer demand in the fourth quarter from this tradename to a lower price point product, as a result of continued and persistent inflation, as well as elevated interest rates and economic uncertainty. We did not incur any asset impairment charges in 2023.
Restructuring charges
Restructuring charges were $10.1 million in 2023 as compared to $25.1 million in 2022. Restructuring charges for all periods presented are largely related to severance costs and other associate-related costs in order to better align our workforce with our forecasted demand within our manufacturing footprint. In the fourth quarter of 2023, we also recorded an asset impairment charge associated with a decision to permanently close our Newton, Kansas manufacturing facility, which had previously been idled.
Operating income
We recorded operating income of $306.3 million for 2023, compared to operating income of $203.3 million for 2022. The $103.0 million, or 50.7 percent, increase in operating income was driven by the favorable carryover of price increases implemented in 2022, realized savings from various cost reduction actions taken in the fourth quarter of 2022 and fiscal 2023, and lower commodity costs and inbound transportation. Additionally, 2023 included lower selling, general and administrative expenses, decreased restructuring charges and the non-recurrence of the impairment of indefinite-lived tradenames of $46.4 million occurring in fiscal 2022.
Related party interest income, net
Related party interest income, net, was $12.9 million in 2022 based upon the related party loan receivable from Fortune Brands. Prior to the Separation, excess cash generated by our operations was remitted to Fortune Brands on a regular basis through the cash pooling arrangements. At the date of the Separation, such arrangements ceased.
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Interest expense
We incurred indebtedness in connection with the Separation and Distribution, which resulted in $65.2 million of interest expense in fiscal 2023, as compared to $2.2 million in fiscal 2022. Prior to the Separation, we had no third-party borrowings in 2022.
Other expense, net
Other expense, net of $2.4 million in 2023 was comparable to other expense, net of $0.6 million in 2022.
Income taxes
Our consolidated income tax expense, income before taxes, and effective tax rate for the fiscal years ended December 31, 2023 and December 25, 2022 were as follows:
| (U.S. Dollars presented in millions) | December 31, 2023 | December 25, 2022 | |||||
|---|---|---|---|---|---|---|---|
| Income before taxes | $ | 238.7 | $ | 213.4 | |||
| Income tax expense | 56.7 | 58.0 | |||||
| Effective tax rate | 23.8 | % | 27.2 | % |
For 2023, the Company’s effective tax rate was 23.8 percent, compared to an effective tax rate of 27.2 percent for 2022. The decrease in effective tax rate in 2023 was primarily the result of changes in state and local income taxes and the nonrecurrence of IRS audit adjustments in 2022, including recognition of a deferred tax liability for earnings of various foreign entities, partially offset by benefits for the release of uncertain tax positions in 2022 and foreign income taxed at higher rates.
The 2023 effective income tax rate of 23.8 percent was unfavorably impacted by net changes in state and local income taxes, and foreign income taxed at higher rates. The 27.2 percent effective income tax rate for 2022 was unfavorably impacted by IRS audit adjustments, including recognition of a deferred tax liability for earnings of various foreign entities, and state and local income taxes, partially offset by favorable benefits for the release of uncertain tax positions and foreign income taxed at lower rates.
Net income
Net income was $182.0 million for 2023 compared to $155.4 million for 2022. The $26.6 million, or 17.1 percent, increase in net income was primarily due to the increase in operating income partially offset by the $65.2 million of interest expense in 2023 resulting from the indebtedness we incurred upon Separation from Fortune Brands.
Liquidity and Capital Resources
Our primary liquidity needs have historically been to support working capital requirements and fund capital expenditures. Subsequent to the Separation, we may have liquidity needs to finance acquisitions and return cash to stockholders, if and when appropriate. Historically, prior to Separation, our principal sources of liquidity were cash on hand, cash flows from operating activities and financial support from Fortune Brands via participation in Fortune Brands’ centralized approach to treasury management, including financing and cash management activities. Subsequent to the Separation, we implemented our own centralized approach to treasury, including cash management performed through cash pooling arrangements. Certain of our entities have standalone cash accounts that are not included in the centralized cash pooling arrangements. All cash balances specifically identifiable to us are included in our consolidated balance sheets and statement of cash flows. The cash flows presented in our consolidated statement of cash flows may not be indicative of the cash flows we would have recognized had we operated as a standalone publicly-traded company for the periods presented prior to the Separation.
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After the Separation, we no longer have financial support from Fortune Brands. Our operating income is generated by our subsidiaries. There are no restrictions on the ability of our subsidiaries to pay dividends or make other distributions to MasterBrand. We periodically review our portfolio of brands, manufacturing and supply chain footprint, and evaluate potential strategic transactions to increase stockholder value. However, we cannot predict whether or when we may enter into acquisitions, joint ventures or dispositions, or what impact any such transactions could have on our results of operations. Our cash flows from operations, borrowing availability and overall liquidity are subject to certain risks and uncertainties, including those described in the section entitled “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
On November 18, 2022, we entered into a 5-year, $1.25 billion credit agreement, consisting of a $750.0 million term loan and a $500.0 million revolving credit facility (the “2022 Credit Agreement”). Initial proceeds of $955.0 million from the credit agreement were received at the time of Separation from Fortune Brands. The proceeds were primarily used to make a cash dividend payment of $940.0 million to Fortune Brands and to pay related fees and expenses at the Separation. The 2022 Credit Agreement is secured by certain assets as well as the guarantee of certain of our subsidiaries.
Interest rates under these facilities are variable based on the Secured Overnight Financing Rate (“SOFR”) at the time of the borrowing, and our net leverage ratio as measured by our Net Leverage to our consolidated earnings before interest, taxes, depreciation and amortization (“Consolidated EBITDA”). Net Leverage is defined as consolidated total indebtedness minus certain cash and cash equivalents. Consolidated EBITDA is defined as consolidated net income before interest expense, income taxes, depreciation, amortization of intangible assets, losses from asset impairments, and certain other one-time adjustments. The Net Leverage Ratio could not exceed 3.875 to 1.0 at the initial borrowing through the second fiscal quarter of 2023, adjusting downward in various future quarters before settling at 3.25 to 1.0 in January 2025. As of December 31, 2023, the net leverage ratio could not exceed 3.75 to 1.0. Interest rates can range from SOFR plus 1.85 percent to SOFR plus 2.60 percent. We also are required to maintain a minimum Interest Coverage Ratio of 3.0 to 1.0. The Interest Coverage Ratio is defined as Consolidated EBITDA to consolidated interest expense.
Our 2022 Credit Agreement contains additional covenants which limit or preclude certain corporate actions based upon the measurement of certain financial covenant metrics. The $750.0 million Term Loan has quarterly required amortization payments, which began in March 2023. During the third quarter of fiscal 2023, the Company made total payments of $28.1 million on the term loan, consisting of a $4.7 million required payment due September 2023, and $23.4 million of required amortization payments due during each of the next three quarters. We did not make any additional term loan payments during the fourth quarter of fiscal 2023, and, as of December 31, 2023, we were paid in advance for our next two scheduled quarterly payments due during the first and second quarters of 2024. Additionally, the revolving credit facility was paid in full during the third quarter of 2023. These additional amortization payments, made possible due to the generation of strong operating cash flow, were made to reduce future interest expense and provide financial flexibility.
As of December 31, 2023, the Company was in compliance with all financial covenants set forth in the 2022 Credit Agreement, and expects to remain in compliance for the foreseeable future.
As of December 31, 2023, we had $707.8 million outstanding in third-party borrowings, net of deferred financing fees. We may also incur additional indebtedness in the future.
Cash Flows
Below is a summary of cash flows for the fiscal years ended December 31, 2023 and December 25, 2022.
| For years ended | ||||||
|---|---|---|---|---|---|---|
| (U.S. Dollars presented in millions) | 2023 | 2022 | ||||
| Net cash provided by operating activities | $ | 405.6 | $ | 235.6 | ||
| Net cash used in investing activities | (56.9) | (55.9) | ||||
| Net cash used in financing activities | (299.9) | (215.3) | ||||
| Effect of foreign exchange rate changes on cash | (1.2) | (4.7) | ||||
| Net increase (decrease) in cash and cash equivalents | $ | 47.6 | $ | (40.3) |
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Fiscal 2023 as compared to Fiscal 2022
Net cash provided by operating activities increased to $405.6 million in 2023 as compared to $235.6 million in 2022. Net cash provided by operating activities included net income of $182.0 million in 2023, as compared to net income of $155.4 million in 2022. Net income in 2023 included interest expense of $65.2 million on external debt that was entered into at the Separation, which resulted in cash outflows of $64.0 million for interest in the period. In 2023, accounts receivable generated $88.1 million of cash, as a result of improvements in our collection processes and decreased sales. In 2022, our accounts receivable generated $13.5 million. In 2023, the movement in inventory was $123.6 million favorable, as compared to 2022, which had an unfavorable movement in inventory of $70.1 million. In 2022, we executed an intentional build in inventory in the first three quarters of the year in order to mitigate the impact of an uncertain and volatile global supply chain environment. The favorable inventory movement in 2023 reflects our efforts to more efficiently manage our inventory levels in the current supply chain environment and in alignment with sales volume. Accounts payable was $69.4 million unfavorable in 2023 as a result of decreased purchasing levels aligned with our lower inventory levels, as well as a reduction in the payable to Fortune Brands of $42.4 million, primarily related to income tax related payments. This compares to the favorable accounts payable movement of $18.3 million in 2022 in conjunction with our increasing inventory levels. Fiscal 2023 was also unfavorably impacted by $9.4 million of restructuring charges net of cash payments, primarily for reserves established in fiscal 2022, as compared to favorable restructuring charges net of cash payments of $13.0 million in fiscal 2022.
Net cash used in investing activities of $56.9 million in 2023 was comparable to net cash used in investing activities of $55.9 million in 2022.
Net cash used in financing activities was $299.9 million in 2023 as compared to $215.3 million in 2022. Fiscal 2023 included net payments on external debt of $272.5 million, as we used cash generated from operations to pay off our revolving credit facility and make advanced payments on our term loan. Fiscal 2023 also includes $22.0 million of stock repurchases made under the $50.0 million stock repurchase program authorized in the second quarter of 2023. Financing activities in 2022 reflect the payment of a dividend of $940.0 million to Fortune Brands in conjunction with the Separation. This dividend was funded by the borrowing of $985.0 million of external debt at, and subsequent to, the Separation date. The remaining activity in 2022 primarily reflects our cash remittances to Fortune Brands, net of cash lending from Fortune Brands, to finance our operations prior to the Separation. The financing relationship with Fortune Brands ceased as of the date of Separation.
We believe that our cash and cash equivalent balances, along with available cash from operating cash flows and credit facilities, will be adequate to fund our typical needs, including working capital requirements and projected capital expenditures. We also believe we have access to additional funds from capital markets to fund strategic initiatives.
Customer Credit Risk
We routinely grant unsecured credit to customers in the normal course of business. Accounts receivable, net, were $203.0 million and $289.6 million as of December 31, 2023 and December 25, 2022, respectively, and are recorded at their stated amount less allowances for discounts and credit losses. Allowances for credit losses include provisions for certain customers where a risk of default has been specifically identified, as well as provisions determined on a general formula basis when it is determined that the risk of some default is probable and estimable but cannot yet be associated with specific customers. The assessment of the likelihood of customer defaults is based on a variety of factors, including the length of time the receivables are past due, the historical collection experience, existing economic conditions and estimated future collection expectations. In accordance with our policy, our allowance for credit losses was $4.6 million and $11.6 million as of December 31, 2023 and December 25, 2022, respectively. The conditions in the global economy and ongoing market volatility may reduce our customers’ ability to access sufficient liquidity and capital to fund their operations and make our estimation of customer defaults inherently uncertain. While we believe current allowances for credit losses are adequate, it is possible that continued weak economic conditions may cause significantly higher levels of customer defaults and bad debt expense in future periods.
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Pension Plan
We sponsor a defined benefit pension plan. However, the plan has been frozen to new participants and benefit accruals were frozen for active participants on or prior to December 31, 2016. The defined benefit pension plan is funded with a portfolio of investments maintained within our benefit plan trust. As of December 31, 2023, the aggregate fair value of our pension plan assets was $131.1 million, representing 96.7 percent of the accumulated benefit obligation liability. During fiscal 2023, we made pension contributions of $8.1 million. For the foreseeable future, we believe that we have sufficient liquidity to meet the minimum funding that may be required by the Pension Protection Act of 2006.
During 2023, the Board of Directors of MasterBrand, Inc. approved a plan to terminate the defined benefit pension plan. The termination and settlement process, which preserves retirement benefits due to participants but changes the ultimate payor of such benefits, is expected to take up to 24 months to complete, subject to receipt of customary regulatory approvals. During 2024, the Company expects to offer a lump-sum benefit payout option to certain plan participants. During 2025, we expect to complete the purchase of group annuity contracts that will transfer any remaining pension benefit obligation to an insurance company.
Contractual Obligations and Other Commercial Commitments
The following table summarizes our contractual obligations and commitments as of December 31, 2023:
| (U.S. Dollars presented in millions) | Payment Due by Period | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | 2024 | 2025 | 2026 | 2027 | 2028 | Thereafter | |||||||||||||||||||||
| Contractual Obligations | |||||||||||||||||||||||||||
| Purchase obligations (a) | $ | 38.3 | $ | 25.6 | $ | 7.3 | $ | 2.7 | $ | 2.7 | $ | — | $ | — | |||||||||||||
| Non-cancellable operating leases | 71.1 | 18.1 | 13.5 | 10.5 | 8.7 | 7.0 | 13.3 | ||||||||||||||||||||
| Non-cancellable financing leases | 4.2 | 1.9 | 1.4 | 0.8 | 0.1 | — | — | ||||||||||||||||||||
| Other Corporate Commercial Commitments | |||||||||||||||||||||||||||
| Debt payments (b) | 712.5 | 18.8 | 37.5 | 37.5 | 618.7 | — | — | ||||||||||||||||||||
| Interest payments | 192.7 | 53.5 | 51.1 | 48.3 | 39.8 | — | — | ||||||||||||||||||||
| Total contractual cash obligations | $ | 1,018.8 | $ | 117.9 | $ | 110.8 | $ | 99.8 | $ | 670.0 | $ | 7.0 | $ | 13.3 |
(a) Purchase obligations related to operating activities include agreements and contracts that give the supplier recourse to us for cancellation or nonperformance under the contract or contain terms that would subject us to liquidated damages. The purchase obligations in the table above include contracts for raw materials and finished goods purchases, selling and administrative services and capital expenditures.
(b) Debt payments include our $750.0 million term loan and $500.0 revolving credit facility under the 2022 Credit Agreement.
In addition to the contractual obligations and commitments described above, we also had other corporate commercial commitments for which we are contingently liable as of December 31, 2023. Other corporate commercial commitments as of December 31, 2023 include standby letters of credit of $19.8 million and surety bonds outstanding of $3.6 million, of which $3.4 million are due in the next 12 months.
We do not currently have any off-balance sheet arrangements that are material or reasonably likely to be material to our financial condition or results of operations.
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Derivative Financial Instruments
In accordance with Accounting Standards Codification (“ASC”) requirements for derivatives and hedging, we recognize all derivative contracts as either assets or liabilities on the balance sheet, and the measurement of those instruments is at fair value.
We account for derivative instruments as follows:
•Derivative instruments that are designated as cash flow hedges - The changes in the fair value of the derivative instrument are reported in other comprehensive income and are recognized in the consolidated statements of income when the hedged item affects earnings. In all periods presented, the recognized gain or loss on the derivative instrument, as well as the offsetting loss or gain on the hedged item, are recognized in cost of products sold on the consolidated statements of income.
•Derivative instruments that are designated as fair value hedges - The gain or loss on the derivative instrument, as well as the offsetting loss or gain on the hedged item, are recognized in other expense, net on the consolidated statements of income.
•Derivative instruments that are designated as net investment hedges - The changes in fair value of the derivative instrument are recognized in the consolidated statements of income when realized upon sale or upon complete or substantially complete liquidation of the investment in the foreign entity.
Deferred currency gains of $10.2 million, $4.5 million, and $2.9 million (before tax impact) were reclassified into earnings for the 2023, 2022, and 2021 fiscal years, respectively. Based on foreign exchange rates as of December 31, 2023, we estimate that $2.2 million of net derivative gain included in other comprehensive income (“AOCI”) as of December 31, 2023, will be reclassified to earnings within the next twelve months.
Foreign Currency Risk
We have operations in various foreign countries, principally Canada and Mexico. Therefore, changes in the value of the related currencies affect our financial statements when translated into U.S. dollars. Certain anticipated transactions, assets and liabilities are exposed to foreign currency risk. Principal currencies hedged include the Canadian dollar and the Mexican peso. We regularly monitor our foreign currency exposures in order to maximize the overall effectiveness of our foreign currency hedge positions.
Recently Issued Accounting Standards
The adoption of recent accounting standards, as discussed in Note 2, "Significant Accounting Policies," of our audited consolidated financial statements within this Annual Report on Form 10-K, has not had and is not expected to have a significant impact on our revenue, earnings or liquidity.
Critical Accounting Estimates
The consolidated financial statements are prepared in accordance with GAAP, which require us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses for the reporting period. Management has established detailed policies and control procedures intended to ensure the appropriateness of such estimates and assumptions and their consistent application from period to period. For a description of our significant accounting policies, see Note 2, "Significant Accounting Policies," of our audited consolidated financial statements within this Annual Report on Form 10-K.
Due to their nature, estimates involve judgment based upon available information. Actual results or amounts could differ from estimates and the difference could have a material impact on the consolidated financial statements. Therefore, understanding these critical accounting estimates is important in understanding our reported results of operations and financial position. We believe that of our accounting estimates and assumptions, those described in the following sections involve a high degree of judgment and complexity.
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Inventories
Inventory provisions are recorded to reduce inventory to the net realizable dollar value for obsolete or slow moving inventory based on assumptions about future demand and marketability of products, the impact of new product introductions, inventory levels and turns, product spoilage and specific identification of items, such as product discontinuance, engineering/material changes, or regulatory-related changes. In accordance with this policy, our inventory provision was $15.9 million and $19.6 million as of December 31, 2023 and December 25, 2022, respectively.
Goodwill and Indefinite-lived Intangible Assets
Goodwill
In accordance with ASC Topic 350, Intangibles—Goodwill and Other, goodwill is tested for impairment at least annually in the fourth quarter and written down when impaired. An interim impairment test is performed if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below the carrying value.
To evaluate the recoverability of goodwill, we first assess qualitative factors to determine whether it is more likely than not that goodwill is impaired. Qualitative factors include changes in volume, margin, customers and the industry. If it is deemed more likely than not that goodwill for a reporting unit is impaired, we will perform a quantitative impairment test using a weighting of the income and market approaches. We may also elect to bypass the qualitative testing and proceed directly to the quantitative testing. For the income approach, we use a discounted cash flow model, estimating the future cash flows of the reporting units to which the goodwill relates and then discounting the future cash flows at a market-participant-derived discount rate. In determining the estimated future cash flows, we consider current and projected future levels of income based on management’s plans for that business; business trends, prospects and market and economic conditions; and market-participant considerations. For the market approach, we apply market multiples for peer groups to the current operating results of the reporting unit to determine the reporting unit’s fair value. Our reporting unit is our operating segment. When the estimated fair value of the reporting unit is less than its carrying value, we measure and recognize the amount of the goodwill impairment loss based on that difference.
The significant assumptions that are used to determine the estimated fair value for goodwill impairment testing include the following: third-party market forecasts of U.S. new home starts and home R&R spending; management’s sales, operating income and cash flow forecasts; peer company earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples; the market-participant-based discount rate; and the perpetuity growth rate. Our estimates of reporting unit fair values are based on certain assumptions that may differ from our historical and future actual operating performance. Specifically, assumptions related to growth in the new construction and R&R market of the U.S. home products markets drive our forecasted sales growth. The market forecasts are developed using independent third-party forecasts from multiple sources. In addition, estimated future operating income and cash flow consider our historical performance at similar levels of sales volume and management’s future operating plans as reflected in annual and long-term plans that are reviewed and approved by management.
Indefinite-Lived Intangible Assets
Certain of our tradenames have been assigned an indefinite life as we currently anticipate that these tradenames will contribute cash flows to us indefinitely. Indefinite-lived intangible assets are not amortized, but are evaluated at least annually to determine whether the indefinite useful life is appropriate. We measure the fair value of identifiable intangible assets upon acquisition and we review for impairment annually in the fourth quarter and whenever market or business events indicate there may be a potential impairment of that intangible. Impairment losses are recorded to the extent that the carrying value of the indefinite-lived intangible asset exceeds its fair value. The significant assumptions that are used to determine the estimated fair value for indefinite-lived intangible assets upon acquisition and subsequent impairment testing are: forecasted revenue growth rates; the assumed royalty rates; and the market-participant discount rates.
Our cash flow projections used to assess impairment of our goodwill and other intangible assets are significantly influenced by our projection for the U.S. home products market, our annual operating plans finalized in the fourth quarter of each fiscal year and our ability to execute on various planned cost reduction initiatives supporting operating income improvements. Our projection for the U.S. home products market is inherently uncertain and is subject to a number of factors, such as employment rates, home prices, interest rates, credit availability, new home starts and the rate of home foreclosures.
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We first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. Qualitative factors include changes in volume, customers and the industry. If it is deemed more likely than not that an intangible asset is impaired, we will perform a quantitative impairment test. We may also elect to bypass the qualitative testing and proceed directly to the quantitative testing. We measure fair value of our indefinite-lived tradenames using the relief-from-royalty approach which estimates the present value of royalty income that could be hypothetically earned by licensing the brand name to a third party over the remaining useful life. The determination of fair value using this technique requires the use of estimates and assumptions related to forecasted revenue growth rates, the assumed royalty rates and the market-participant discount rates.
In the second quarter ended June 26, 2022, we recognized an impairment charge of $26.0 million related to an indefinite-lived tradename. During the second quarter ended June 26, 2022, production was shifted within our manufacturing footprint to enable what we expect to be a higher value purpose and growth opportunity, which led to downward revisions to forecasted revenue growth rates associated with the tradename. In the fourth quarter ended December 25, 2022, we incurred an additional asset impairment charge of $12.8 million related to the same indefinite-lived tradename as a result of further shifts within our product portfolio to better align with forecasted future customer demand as a result of a significant decrease in sales during the fourth quarter of 2022, driven by continued and persistent inflation, as well as elevated interest rates and economic uncertainty. These downward revisions to forecasted revenue growth were not known when recording the impairment charge during the second quarter of 2022. In 2023, we did not recognize any impairment charges related to this indefinite-lived tradename. As of both December 31, 2023 and December 25, 2022, the carrying value of this tradename was $46.2 million.
In the fourth quarter ended December 25, 2022, we incurred an impairment charge of $7.6 million to another indefinite-lived tradename. This was primarily due to a shift in customer demand from this tradename to a lower price point product, as a result of continued and persistent inflation as well as elevated interest rates and economic uncertainty. In 2023, we did not recognize any impairment charges related to this indefinite-lived tradename. As of both December 31, 2023 and December 25, 2022, the carrying value of this tradename was $19.1 million.
The fair values of the impaired tradenames were measured using the relief-from-royalty approach. Some of the more significant assumptions inherent in estimating the fair values include forecasted revenue growth rates, assumed royalty rates, and market-participant discount rates that reflect the level of risk associated with the tradenames’ future revenues and profitability. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management plans. These assumptions represent Level 3 inputs of the fair value hierarchy. See Note 8, "Goodwill and Identifiable Intangible Assets," and Note 10, "Fair Value Measurements," of our audited consolidated financial statements within this Annual Report on Form 10-K, for additional information.
During our 2023 impairment test, we elected to bypass the qualitative test and tested all of our indefinite lived tradenames quantitatively. The significant assumptions used to estimate the fair values of the tradenames tested quantitatively during the fiscal years ended December 31, 2023, December 25, 2022 and December 26, 2021 were as follows:
| 2023 | 2022 | 2021 | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Unobservable Input | Min | Max | WtdAvg(a) | Min | Max | WtdAvg(a) | Min | Max | WtdAvg(a) | |||||||||||||||||
| Discount rate | 10.5 | % | 11.0 | % | 10.8 | % | 11.9 | % | 12.6 | % | 12.2 | % | 10.9 | % | 11.5 | % | 11.2 | % | ||||||||
| Royalty rate(b) | 3.0 | % | 4.0 | % | 3.6 | % | 2.5 | % | 4.0 | % | 3.5 | % | 2.4 | % | 4.0 | % | 3.4 | % | ||||||||
| Long-term revenue growth rate(c) | 2.0 | % | 2.5 | % | 2.3 | % | 1.0 | % | 3.0 | % | 2.0 | % | 1.0 | % | 3.0 | % | 2.6 | % |
(a)Weighted by the relative fair value of the tradenames that were tested quantitatively.
(b)Represents estimated percentage of sales a market-participant would pay to license the tradenames that were tested quantitatively.
(c)Selected long-term revenue growth rate within 10-year projection period of the tradenames that were tested quantitatively.
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A 50 basis point change in any of the significant assumptions used during the fiscal year ended December 31, 2023 would not have resulted in an impairment being recognized when estimating the fair value of our indefinite-lived tradenames. A 50 basis point change in any of the significant assumptions used during the fiscal year ended December 25, 2022 would not have resulted in an impairment being recognized when estimating the fair value of our indefinite-lived tradenames, with the exception of the fourth quarter indefinite-lived tradename impairments noted above, which were subject to partial impairments of $20.4 million. Relating to the impaired indefinite-lived tradenames in the fourth quarter of 2022, a 50 basis point change in the discount rate, royalty rate or long-term revenue growth rate at December 25, 2022 would have resulted in an incremental impairment of $2.8 million, $12.2 million and $1.5 million, respectively.
Income Taxes
For taxable periods prior to and including the Separation, our operations were included in the consolidated U.S. federal and certain state and local income tax returns of Fortune Brands, as applicable. We filed separate foreign income tax returns. The income tax expense in our Consolidated Financial Statements has been determined on a stand-alone return basis in accordance with ASC Topic 740, Income Taxes, which requires the recognition of income taxes using the liability method. The tax provision and current and deferred tax balances have been prepared on a separate-return basis as if we were a separate filer.
Post-Separation, our income tax provisions are calculated based on our operating footprint, as well as our tax return elections and assertions. For taxable periods ended after the Separation, we file a consolidated U.S. federal income tax return and various state and local income tax returns. Our foreign income tax returns will continue to be filed on a full-year basis.
Deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The recognition and measurement of deferred tax asset and liability balances, and the corresponding deferred tax expense or benefit, are determined for each tax-paying component in each relevant jurisdiction. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period the new tax rate is enacted.
We reduce our deferred tax assets by a valuation allowance if it is more likely than not that we will not realize some portion or all of the deferred tax assets. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance in the period in which such changes occur, which would reduce the provision for income taxes.
Customer Program Costs
Customer programs and incentives are a common practice in our business. Our business incurs customer program costs to obtain favorable product placement, to promote sales of products and to maintain competitive pricing. We record estimates to reduce revenue for customer programs and incentives, which are considered variable consideration, and include price discounts, volume-based incentives, promotions and cooperative advertising when revenue is recognized in order to determine the amount of consideration we will ultimately be entitled to receive. These estimates are based on historical and projected experience for each type of customer. In addition, for certain customer program incentives, we receive an identifiable benefit in exchange for the consideration given and record the associated expenditure in selling, general and administrative expenses. Volume allowances are accrued based on management’s estimates of customer volume achievement and other factors incorporated into customer agreements, such as new products, store sell-through, merchandising support, levels of returns and customer training. Management periodically reviews accruals for these rebates and allowances, and adjusts accruals when circumstances indicate, typically as a result of a change in volume expectations.