MASONITE INTERNATIONAL CORPORATION
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is based upon accounting principles generally
accepted in the United States of America and discusses the financial condition
and results of operations for Masonite International Corporation for the years
ended December 29, 2019 , and December 30, 2018 . For further discussion of our
results of operations for the years ended December 30, 2018 , and December 31,
2017 , see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for
the year ended December 30, 2018 , which was filed with the SEC on February 26,
2019 . In this MD&A, "Masonite," "we," "us," "our" and the "Company" refer to
Masonite International Corporation and its subsidiaries.
This discussion should be read in conjunction with the consolidated financial
statements and related notes included elsewhere in this Annual Report on Form
10-K. The following discussion should also be read in conjunction with the
disclosure under "Special Note Regarding Forward Looking Statements" and Part I,
Item 1A, "Risk Factors" elsewhere in this Annual Report on Form 10-K. Our actual
results could differ materially from the forward-looking statements as a result
of these risks and uncertainties.
Overview
We are a leading global designer, manufacturer and distributor of interior and
exterior doors for the new construction and repair, renovation and remodeling
sectors of the residential and non-residential building construction markets.
Since 1925, we have provided our customers with innovative products and superior
service at compelling values. In order to better serve our customers and create
sustainable competitive advantages, we focus on developing innovative products,
advanced manufacturing capabilities and technology-driven sales and service
solutions.
We market and sell our products to remodeling contractors, builders, homeowners,
retailers, dealers, lumberyards, commercial and general contractors and
architects through well-established wholesale, retail and direct distribution
channels as part of our cross-merchandising strategy. Customers are provided a
broad product offering of interior and exterior doors and entry systems at
various price points. We manufacture a broad line of interior doors, including
residential molded, flush, stile and rail, louver and specially-ordered
commercial and architectural doors; door components for internal use and sale to
other door manufacturers; and exterior residential steel, fiberglass and wood
doors and entry systems.
We operate 63 manufacturing and distribution facilities in eight countries in
North America , South America , Europe and Asia , which are strategically located
to serve our customers through multiple distribution channels. These
distribution channels include: (i) direct distribution to retail home center
customers; (ii) one-step distribution that sells directly to homebuilders and
contractors; and (iii) two-step distribution through wholesale distributors. For
retail home center customers, numerous door fabrication facilities provide
value-added fabrication and logistical services, including pre-finishing and
store delivery of pre-hung interior and exterior doors. We believe our ability
to provide: (i) a broad product range; (ii) frequent, rapid, on-time and
complete delivery; (iii) consistency in products and merchandising; (iv)
national service; and (v) special order programs enables retail customers to
increase comparable store sales and helps to differentiate us from our
competitors. We believe investments in innovative new product manufacturing and
distribution capabilities, coupled with an ongoing commitment to operational
excellence, provide a strong platform for future growth.
Our reportable segments are currently organized and managed principally by end
market: North American Residential, Europe and Architectural. In the year ended
December 29, 2019 , we generated net sales of $1,465.8 million or 67.3%, $321.6
million or 14.8% and $365.3 million or 16.8% in our North American Residential,
Europe and Architectural segments, respectively. See "Segment Information" below
for a description of our reportable segments.
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MASONITE INTERNATIONAL CORPORATION
Key Factors Affecting Our Results of Operations
Product Demand
There are numerous factors that influence overall market demand for our
products. Demand for new homes, home improvement products and other building
construction products have a direct impact on our financial condition and
results of operations. Demand for our products may be impacted by changes in
United States , Canadian, European, Asian or other global economic conditions,
including inflation, deflation, interest rates, availability of capital,
consumer spending rates, energy availability and costs, and the effects of
governmental initiatives to manage economic conditions. Additionally, trends in
residential new construction, repair, renovation and remodeling and
architectural building construction may directly impact our financial
performance. Accordingly, the following factors may have a direct impact on our
business in the countries and regions in which our products are sold:
• the strength of the economy;
• the amount and type of residential and commercial construction;
• housing sales and home values;
• the age of existing home stock, home vacancy rates and foreclosures;
• non-residential building occupancy rates;
• increases in the cost of raw materials or wages or any shortage in
supplies or labor;
• the availability and cost of credit;
• employment rates and consumer confidence; and
• demographic factors such as immigration and migration of the population
and trends in household formation.
Additionally, theUnited Kingdom's exit from theEuropean Union has created uncertainty in European demand, particularly in theUnited Kingdom , which could have a material adverse effect on the demand for our products in the foreseeable future. Product Pricing and Mix The building products industry is highly competitive and we therefore face pressure on sales prices of our products. In addition, our competitors may adopt more aggressive sales policies and devote greater resources to the development, promotion and sale of their products than we do, which could result in a loss of customers. Our business in general is subject to changing consumer and industry trends, demands and preferences. Trends within the industry change often and our failure to anticipate, identify or quickly react to changes in these trends could lead to, among other things, rejection of a new product line and reduced demand and price reductions for our products, which could materially adversely affect us. Changes in consumer preferences may also lead to increased demand for our lower margin products relative to our higher margin products, which could reduce our future profitability. In the fourth quarter of 2019, we communicated price increases that became effective onFebruary 3, 2020 , to our North American Residential customers that, for certain products, were significantly greater than our typical annual increases. We also communicated our intent to incrementally invest$100 million over the next five years in the areas of service and quality improvements, product innovation and end user marketing. While we believe that these initiatives are necessary in order to increase the profile of, and demand for, our products and that they will benefit both us and our customers, we cannot predict whether our efforts will ultimately be successful or how our customers will react to these initiatives which could have a material impact on demand and, consequently, our results of operations for future periods. Business Wins and Losses Our customers consist mainly of wholesalers and retail home centers. In fiscal year 2019, our top ten customers together accounted for approximately 43% of our net sales and our top customer, The Home Depot, Inc. accounted for approximately 17% of our net sales in fiscal year 2019. Net sales from customers that have accounted for a significant portion of our net sales in past periods, individually or as a group, may not continue in future periods, or if continued, may not reach or exceed historical levels in any period. Certain customers perform periodic product line reviews to assess their product offerings, which have, on past occasions, led to business wins and losses. In addition, as a result of competitive bidding processes, we may not be able to increase or maintain the margins at which we sell our products to our customers. 28 --------------------------------------------------------------------------------
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MASONITE INTERNATIONAL CORPORATION
Organizational Restructuring
Over the past several years, we have engaged in a series of restructuring
programs related to exiting certain geographies and non-core businesses,
consolidating certain internal support functions and engaging in other actions
designed to reduce our cost structure and improve productivity. These
initiatives primarily consist of severance actions and lease termination costs.
Management continues to evaluate our business; therefore, in future years, there
may be additional provisions for new plan initiatives, as well as changes in
previously recorded estimates, as payments are made or actions are completed.
Asset impairment charges were also incurred in connection with these
restructuring actions for those assets sold, abandoned or made obsolete as a
result of these programs.
In February 2019 , we began implementing a plan to improve overall business
performance that includes the reorganization of our manufacturing capacity and a
reduction of our overhead and selling, general and administration workforce
across all of our reportable segments and in our head offices. The
reorganization of our manufacturing capacity involves specific plants in the
North American Residential and Architectural segments and costs associated with
the closure of these plants and related headcount reductions began taking place
in the first quarter of 2019 (collectively, the "2019 Plan"). Costs associated
with the 2019 Plan include severance, retention and closure charges and will
continue through 2020. Additionally, the plan to divest non-core assets was
determined to be a triggering event requiring a test of the carrying value of
the definite-lived assets relating to the divestitures, as further described in
Note 14. In the fourth quarter of 2019, we initiated additional restructuring
actions related to both manufacturing capacity and reduction of our overhead and
selling, general and administration workforce. Once fully implemented, the
actions taken as part of the 2019 Plan are expected to increase our annual
earnings and cash flows by approximately $17 to 21 million.
During the fourth quarter of 2018, we began implementing a plan to reorganize
and consolidate certain aspects of our United Kingdom head office function and
optimize our portfolio by divesting non-core assets to enable more effective and
consistent business processes in the Europe segment. In addition, in the North
American Residential segment we announced a new facility that will optimize and
expand capacity through increased automation, which resulted in the closure of
one existing facility and related headcount reductions beginning in the second
quarter of 2019 (collectively, the "2018 Plan"). Costs associated with the 2018
Plan included severance, retention and closure charges and continued throughout
2019. Additionally, the plan to divest non-core assets was determined to be a
triggering event requiring a test of the carrying value of the definite-lived
assets relating to the divestitures, as further described in Note 14. Once fully
implemented, the actions taken as part of the 2018 Plan are expected to increase
our annual earnings and cash flows by approximately $6 million .
Inflation
An increase in inflation could have a significant impact on the cost of our raw
material inputs. Wage inflation, increased prices for raw materials or finished
goods used in our products, tariffs and/or interruptions in deliveries of raw
materials or finished goods could adversely affect our profitability, margins
and net sales, particularly if we are not able to pass these incurred costs on
to our customers. In addition, interest rates normally increase during periods
of rising inflation. Historically, as interest rates increase, demand for new
homes and home improvement products decreases.
Seasonality
Our business is moderately seasonal and our net sales vary from quarter to
quarter based upon the timing of the building season in our markets. Severe
weather conditions in any quarter, such as unusually prolonged warm or cold
conditions, rain, blizzards or hurricanes, could accelerate, delay or halt
construction and renovation activity.
Acquisitions and Dispositions
We are pursuing a strategic initiative of optimizing our global business
portfolio. As part of this strategy, in the last several years we have pursued
strategic acquisitions targeting companies who produce components for our
existing operations, manufacture niche products and provide value-added
services. Additionally, we target companies with strong brands, complementary
technologies, attractive geographic footprints and opportunities for cost and
distribution synergies. We also continuously analyze our operations to determine
which businesses, market channels and products create the most value for our
customers and acceptable returns for our shareholders.
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Acquisitions• Top Doors: OnAugust 29, 2019 , we completed the acquisition of TOPDOORS, s.r.o. ("Top Doors") based in theCzech Republic for cash consideration of$1.8 million , net of cash acquired, following a post-closing adjustment. Top Doors is a specialist manufacturer of door frames.
• BWI: On
assets of
of
customary post-closing adjustments. BWI is headquartered in
and exterior door systems, supporting customers in the Mid-Atlantic and
interior and exterior doors, commercial doors and hardware as well as
value-added pre-finishing services.
• Graham and Maiman: On
operating assets of the wood door companies of
the brands Graham Manufacturing Corporation and
(collectively, "Graham & Maiman"). We acquired the operating assets of
Graham & Maiman for cash consideration of
Maiman are based in
& Maiman provide the non-residential construction industry with a full
range of architectural premium and custom grade flush wood doors,
architectural stile and rail wood doors, thermal-fused flush wood doors
and wood door frames.
• DW3: On
quality premium door solutions and window systems, supplying products
under brand names such as Solidor, Residor, Nicedor and Residence. We
acquired 100% of the equity interests in DW3 for consideration of $96.3
million , net of cash acquired. DW3 is based in Stoke-on-Trent and
Gloucester, England , and their products and service model are a natural
addition to our existing United Kingdom business. DW3's online quickship capabilities and product portfolio both complement and expand the
strategies we are pursuing with our business.
• A&F: On October 2, 2017 , we completed the acquisition of A&F Wood
Products, Inc. ("A&F"), through the purchase of 100% of the equity
interests in A&F and certain assets of affiliates of A&F for
consideration of $13.8 million , net of cash acquired. A&F is based inand commercial doors in the Midwest United States.
Dispositions
• Window Widgets: OnDecember 13, 2019 , we completed the sale of all of the capital stock ofWindow Widgets Limited ("WW"), a leading United
Kingdom provider of high quality window systems, for consideration of
$1.2 million , net of cash disposed. • PDS: OnMarch 21, 2019 , we completed the sale of all of the capital stock ofPerformance Doorset Solutions Limited ("PDS"), a leading supplier of custom doors and millwork in theUnited Kingdom , for nominal consideration. 30
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Results of Operations
Year Ended
(In thousands) December 29, 2019 December 30, 2018 December 31, 2017
Net sales $ 2,176,683 $ 2,170,103 $ 2,032,925
Cost of goods sold 1,699,000 1,734,797 1,625,942
Gross profit 477,683 435,306 406,983
Gross profit as a % of net sales 21.9 % 20.1 % 20.0 %
Selling, general and administration
expenses 310,567 266,193 247,917
Selling, general and administration 14.3 % 12.3 % 12.2 %
expenses as a % of net sales
Restructuring costs 9,776 1,624 850
Asset impairment 13,767 5,243 -
Loss on disposal of subsidiaries 14,260 - 212
Operating income 129,313 162,246 158,004
Interest expense, net 46,489 39,008 30,153
Loss on extinguishment of debt 14,523 5,414 -
Other expense (income), net 1,953 (2,533 ) (1,570 )
Income before income tax expense (benefit) 66,348 120,357 129,421
Income tax expense (benefit) 17,309 23,813 (27,560 )
Net income 49,039 96,544 156,981
Less: net income attributable to
non-controlling interests 4,437 3,834 5,242
Net income attributable to Masonite $ 44,602 $
92,710 $ 151,739
Year EndedDecember 29, 2019 , Compared with Year EndedDecember 30, 2018 Net Sales Net sales in the year endedDecember 29, 2019 , were$2,176.7 million , an increase of$6.6 million or 0.3% from$2,170.1 million in the year endedDecember 30, 2018 . Net sales in 2019 were negatively impacted by$22.8 million as a result of foreign exchange rate fluctuations. Excluding this exchange rate impact, net sales would have increased by$29.4 million or 1.4% due to changes in volume, average unit price and sales of components and other products. Average unit price in 2019 increased net sales by$111.5 million or 5.1% compared to 2018. Our 2018 acquisitions, net of dispositions, contributed$32.8 million or 1.5% of net sales in 2019. Lower volumes excluding the incremental impact of acquisitions ("base volume") decreased net sales by$105.8 million or 4.9% in 2019 compared to 2018. Net sales of components and other products to external customers were$9.1 million lower in 2019 compared to 2018.Net Sales and Percentage ofNet Sales by Reportable Segment Year Ended December 29, 2019 North American Corporate & (In thousands) Residential Europe Architectural Other Total Sales$ 1,469,194 $ 323,137 $ 380,300 $ 23,941 $ 2,196,572 Intersegment sales (3,386 ) (1,506 ) (14,997 ) - (19,889 ) Net sales to external customers$ 1,465,808 $ 321,631 $ 365,303 $ 23,941 $ 2,176,683 Percentage of consolidated external net sales 67.3 % 14.8 % 16.8 % 31
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Year Ended December 30, 2018
North American Corporate &
(In thousands) Residential Europe Architectural Other Total
Sales $ 1,458,957 $ 371,069 $ 340,609 $ 22,869 $ 2,193,504
Intersegment sales (4,198 ) (2,066 ) (17,137 ) - (23,401 )
Net sales to external
customers $ 1,454,759 $ 369,003 $ 323,472 $ 22,869 $ 2,170,103
Percentage of
consolidated external
net sales 67.0 % 17.0 % 14.9 %
North American Residential
Net sales to external customers from facilities in the North American
Residential segment in the year ended December 29, 2019 , were $1,465.8 million ,
an increase of $11.0 million or 0.8% from $1,454.8 million in the year ended
December 30, 2018 . Net sales in 2019 were negatively impacted by $6.6 million as
a result of foreign exchange rate fluctuations. Excluding this exchange rate
impact, net sales would have increased by $17.6 million or 1.2% due to changes
in volume, average unit price and sales of components and other products.
Average unit price increased net sales in 2019 by $78.5 million or 5.4% compared
to 2018. Our 2018 acquisition of BWI contributed $38.9 million or 2.7% of net
sales in 2019. Lower base volume decreased net sales by $93.2 million or 6.4% in
2019 compared to 2018. Net sales of components and other products to external
customers were $6.6 million lower in 2019 compared to 2018.
Europe
Net sales to external customers from facilities in the Europe segment in the
year ended December 29, 2019 , were $321.6 million , a decrease of $47.4 million
or 12.8% from $369.0 million in the year ended December 30, 2018 . Net sales in
2019 were negatively impacted by $15.2 million as a result of foreign exchange
fluctuations. Excluding this exchange rate impact, net sales would have
decreased by $32.2 million or 8.7% due to changes in volume, average unit price
and sales of components and other products. Net sales in 2019 were reduced by
$30.3 million or 8.2% due to the net impact of acquisitions and dispositions,
including lost sales due to the dispositions of three non-core businesses,
partially offset by one month of incremental sales from the DW3 acquisition.
Lower base volume in 2019 decreased net sales by $13.6 million or 3.7% compared
to 2018. Average unit price increased net sales in 2019 by $13.2 million or 3.6%
compared to 2018. Net sales of components and other products to external
customers were $1.5 million lower in 2019 compared to 2018.
Architectural
Net sales to external customers from facilities in the Architectural segment in
the year ended December 29, 2019 , were $365.3 million , an increase of $41.8
million or 12.9% from $323.5 million in the year ended December 30, 2018 . Net
sales in 2019 were negatively impacted by $0.9 million as a result of foreign
exchange fluctuations. Excluding this exchange rate impact, net sales would have
increased by $42.7 million or 13.2% due to changes in volume, average unit price
and sales of components and other products. Our 2018 acquisition of Graham &
Maiman contributed $24.2 million or 7.5% of net sales in 2019. Average unit
price increased net sales in 2019 by $19.7 million or 6.1% compared to 2018.
Higher base volume increased net sales in 2019 by $0.4 million or 0.1% compared
to 2018. Net sales of components and other products to external customers were
$1.6 million lower in 2019 compared to 2018.
Cost of Goods Sold
Our cost of goods sold is comprised of the cost to manufacture products for our
customers and includes the cost of materials, direct labor, overhead,
distribution and depreciation associated with assets used to manufacture
products. Research and development costs are primarily included within cost of
goods sold. We incur significant fixed and variable overhead at our global
component locations that manufacture interior molded door facings. Our overall
average production capacity utilization at these locations was approximately 73%
for the year ended December 29, 2019 , and 77% for each of the years ended
December 30, 2018 , and December 31, 2017 .
Cost of goods sold as a percentage of net sales was 78.1% and 79.9% for the
years ended December 29, 2019 , and December 30, 2018 , respectively. Material
cost of sales, direct labor costs and distribution costs as a percentage of net
sales decreased by 2.2%, 0.4% and 0.1%, respectively, in 2019 compared to 2018.
Partially offsetting these
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decreases, overhead and depreciation as a percentage of sales increased by 0.6%
and 0.3% over the 2018 period. The decrease in material cost of sales as a
percentage of net sales was driven by higher average unit prices, partially
offset by increases due to inflation, including tariffs. Conversely, overhead as
a percentage of net sales was negatively impacted by charges related to plant
damages and factory start-up costs and lower volumes in 2019 compared to 2018.
Selling, General and Administration Expenses
Selling, general and administration ("SG&A") expenses primarily include the
costs for our sales organization and support staff at various plants and
corporate offices. These costs include personnel costs for payroll, related
benefits and stock based compensation expense; professional fees; depreciation
and amortization of our non-manufacturing equipment and assets; environmental,
health and safety costs; advertising expenses and rent and utilities related to
administrative office facilities. In the year ended December 29, 2019 , selling,
general and administration expenses, as a percentage of net sales, were 14.3%
compared to 12.3% in the year ended December 30, 2018 , an increase of 200 basis
points.
Selling, general and administration expenses in the year ended December 29,
2019 , were $310.6 million , an increase of $44.4 million from $266.2 million in
the year ended December 30, 2018 . SG&A expenses were positively impacted by
favorable foreign exchange impacts of $2.8 million . Non-cash items drove an
increase of $11.0 million , including share based compensation, depreciation and
amortization, deferred compensation and loss on disposal of property, plant and
equipment including a $2.5 million charge related to the divestiture of a
non-core business in the Europe segment. Excluding these impacts, SG&A expenses
would have increased by $36.2 million . The remaining increase was driven by
personnel cost increases of $22.6 million , primarily due to incentive
compensation and resource investments in our Architectural segment to facilitate
acquisition integration and support growth, incremental SG&A expenses from our
2018 acquisitions of $7.6 million (net of dispositions), professional and other
corporate costs of $3.3 million , advertising costs of $1.5 million and other
increases of $1.2 million .
Restructuring Costs
Restructuring costs in the year ended December 29, 2019 , were $9.8 million ,
compared to $1.6 million in the year ended December 30, 2018 . Restructuring
costs in 2019 related to severance, retention and closure charges associated
with the 2019 and 2018 Plans. Restructuring costs in 2018 related to severance,
retention and closure charges associated with the 2018 Plan.
Asset Impairment
Asset impairment charges in the year ended December 29, 2019 , were $13.8 million
compared to $5.2 million in the year ended December 30, 2018 . Asset impairment
charges in 2019 resulted from actions associated with the 2019 Plan. Asset
impairment charges in 2018 resulted from actions associated with the 2018 Plan.
Loss on Disposal of Subsidiaries
Loss on disposal of subsidiaries represents the difference between proceeds
received upon disposition and the book value of a subsidiary which has been
divested and was excluded from treatment as a discontinued operation. Also
included in loss on disposal of subsidiaries is recognition of the cumulative
translation adjustment out of accumulated other comprehensive loss. Loss on
disposal of subsidiaries was $14.3 million in the year ended December 29, 2019 .
There were no charges associated with the disposal of subsidiaries in the year
ended December 30, 2018 . The loss in the current year was related to the sale of
WW and PDS. WW was sold for consideration of $2.2 million , net of cash disposed.
PDS was sold for nominal consideration. Charges related to the disposition of WW
and PDS consist of $8.3 million and $3.6 million , respectively, relating to the
write-off of the net assets sold and other professional fees as well as $1.4
million and $1.0 million , respectively, relating to the recognition of the
cumulative translation adjustment out of accumulated other comprehensive loss.
Interest Expense, Net
Interest expense, net, in the year ended December 29, 2019 , was $46.5 million ,
compared to $39.0 million in the year ended December 30, 2018 . This increase
primarily relates to the issuance of $500.0 million aggregate principal amount
of 2028 Senior Notes on July 25, 2019 and $300.0 million aggregate principal
amount of 2026 Senior Notes on September 27, 2018 .
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Loss on Extinguishment of Debt
Loss on extinguishment of debt represents the difference between the
reacquisition price of debt and the net carrying amount of the extinguished
debt. The net carrying amount includes the principal, unamortized premium and
unamortized debt issuance costs. Loss on extinguishment of debt was $14.5
million in the year ended December 29, 2019 , compared to $5.4 million in the
year ended December 30, 2018 . Loss on extinguishment of debt in the current year
related to the redemption of our senior unsecured notes due 2023. This charge
represents the difference between the redemption price of our senior unsecured
notes due 2023 of $514.1 million and the net carrying amount of such notes of
$499.6 million . In addition to the $500.0 million of principal, the redemption
price included a make-whole premium of $14.1 million and the net carrying amount
included unamortized debt issuance costs of $3.5 million , partially offset by
unamortized premiums of $3.1 million . Loss on extinguishment of debt in the
prior year related to the partial redemption of our senior unsecured notes due
2023.
Other Expense (Income), Net
Other expense (income), net includes profits and losses related to our
non-majority owned unconsolidated subsidiaries that we recognize under the
equity method of accounting, unrealized gains and losses on foreign currency
remeasurements, pension settlement charges and other miscellaneous non-operating
expenses. Other expense (income), net, in the year ended December 29, 2019 , was
$2.0 million of expense, compared to $2.5 million of income in the year ended
December 30, 2018 . The change in other expense (income), net, is primarily due
to a pre-tax pension settlement charge of $5.7 million recognized in the fourth
quarter, unrealized gains and losses on foreign currency remeasurements and
other miscellaneous non-operating expenses.
Income Tax Expense (Benefit)
Our income tax expense in the year ended December 29, 2019 , was $17.3 million , a
change of $6.5 million from $23.8 million of income tax expense in the year
ended December 30, 2018 . The decrease in income tax expense is primarily
attributable to (i) the mix of income or losses within the tax jurisdictions
with various tax rates in which we operate offset by (ii) the increase in income
tax expense in the United Kingdom due to nondeductible loss on disposal of
subsidiaries.
Segment Information
Our reportable segments are organized and managed principally by end market:
North American Residential, Europe and Architectural. The North American
Residential reportable segment is the aggregation of the Wholesale and Retail
operating segments. The Europe reportable segment is the aggregation of the
United Kingdom and the Central Eastern Europe operating segments. The
Architectural reportable segment consists solely of the Architectural operating
segment. The Corporate & Other category includes unallocated corporate costs and
the results of immaterial operating segments which were not aggregated into any
reportable segment. Operating segments are aggregated into reportable segments
only if they exhibit similar economic characteristics. In addition to similar
economic characteristics we also consider the following factors in determining
the reportable segments: the nature of business activities, the management
structure directly accountable to our chief operating decision maker for
operating and administrative activities, availability of discrete financial
information and information presented to the Board of Directors and investors.
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Our management reviews net sales and Adjusted EBITDA (as defined below) to
evaluate segment performance and allocate resources. Net assets are not
allocated to the reportable segments. Adjusted EBITDA is a non-GAAP financial
measure which does not have a standardized meaning under GAAP and is unlikely to
be comparable to similar measures used by other companies. Adjusted EBITDA
should not be considered as an alternative to either net income or operating
cash flows determined in accordance with GAAP. Adjusted EBITDA is defined as net
income (loss) attributable to Masonite adjusted to exclude the following items:
• depreciation;
• amortization;
• share based compensation expense;
• loss (gain) on disposal of property, plant and equipment;
• registration and listing fees;
• restructuring costs; • asset impairment;
• loss (gain) on disposal of subsidiaries;
• interest expense (income), net;
• loss on extinguishment of debt;
• other expense (income), net;
• income tax expense (benefit);
• loss (income) from discontinued operations, net of tax; and
• net income (loss) attributable to non-controlling interest.
This definition of Adjusted EBITDA differs from the definitions of EBITDA
contained in the indenture governing the 2028 and 2026 Notes and the credit
agreement governing the ABL Facility. Adjusted EBITDA is used to evaluate and
compare the performance of the segments and it is one of the primary measures
used to determine employee incentive compensation. Intersegment sales are
recorded using market prices.
We believe that Adjusted EBITDA, from an operations standpoint, provides an
appropriate way to measure and assess segment performance. Our management team
has established the practice of reviewing the performance of each segment based
on the measures of net sales and Adjusted EBITDA. We believe that Adjusted
EBITDA is useful to users of the consolidated financial statements because it
provides the same information that we use internally to evaluate and compare the
performance of the segments and it is one of the primary measures used to
determine employee incentive compensation.
Year Ended December 29, 2019
North American Corporate &
(In thousands) Residential Europe Architectural Other Total
Adjusted EBITDA $ 232,512 $ 46,219 $ 40,470 $ (35,817 ) $ 283,384
Adjusted EBITDA as a
percentage of segment net
sales 15.9 % 14.4 % 11.1 % 13.0 %
Year Ended December 30, 2018
North American Corporate &
(In thousands) Residential Europe Architectural Other Total
Adjusted EBITDA $ 202,465 $ 44,985 $ 37,742 $ (17,256 ) $ 267,936
Adjusted EBITDA as a
percentage of segment net
sales 13.9 % 12.2 % 11.7 % 12.3 %
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The following reconciles Adjusted EBITDA to net income (loss) attributable to
Masonite:
Year Ended December 29, 2019
North American Corporate &
(In thousands) Residential Europe Architectural Other Total
Net income (loss)
attributable to Masonite $ 167,097 $ 2,664 $ 19,928 $ (145,087 ) $ 44,602
Plus:
Depreciation 35,992 11,604 11,343 11,797 70,736
Amortization 1,697 14,653 8,362 4,401 29,113
Share based compensation
expense - - - 10,023 10,023
Loss on disposal of
property, plant and
equipment 3,934 2,109 331 22 6,396
Restructuring costs 6,929 1,322 506 1,019 9,776
Asset impairment 13,767 - - - 13,767
Loss on disposal of
subsidiaries - 14,260 - - 14,260
Interest expense, net - - - 46,489 46,489
Loss on extinguishment of
debt - - - 14,523 14,523
Other expense (income), net - (393 ) - 2,346 1,953
Income tax expense - - - 17,309 17,309
Net income attributable to
non-controlling interest 3,096 - - 1,341 4,437
Adjusted EBITDA $ 232,512 $ 46,219 $ 40,470 $ (35,817 ) $ 283,384
Year Ended December 30, 2018
North American Corporate &
(In thousands) Residential Europe Architectural Other Total
Net income (loss)
attributable to Masonite $ 165,981 $ 13,602 $ 17,895 $ (104,768 ) $ 92,710
Plus:
Depreciation 29,959 9,922 10,431 8,777 59,089
Amortization 1,466 14,716 9,236 3,165 28,583
Share based compensation
expense - - - 7,681 7,681
Loss on disposal of
property, plant and
equipment 1,799 92 180 1,399 3,470
Restructuring costs 275 1,349 - - 1,624
Asset impairment - 5,243 - - 5,243
Interest expense, net - - - 39,008 39,008
Loss on extinguishment of
debt - - - 5,414 5,414
Other expense (income), net (57 ) 61 - (2,537 ) (2,533 )
Income tax expense - - - 23,813 23,813
Net income attributable to
non-controlling interest 3,042 - - 792 3,834
Adjusted EBITDA $ 202,465 $ 44,985 $ 37,742 $ (17,256 ) $ 267,936
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Adjusted EBITDA in our North American Residential segment increased $30.0
million , or 14.8%, to $232.5 million in the year ended December 29, 2019 , from
$202.5 million in the year ended December 30, 2018 . Adjusted EBITDA in the North
American Residential segment included corporate allocations of shared costs of
$55.9 million and $54.7 million in 2019 and 2018, respectively. The allocations
generally consist of certain costs of human resources, legal, finance,
information technology, research and development and share based compensation.
Adjusted EBITDA in our Europe segment increased $1.2 million , or 2.7%, to $46.2
million in the year ended December 29, 2019 , from $45.0 million in the year
ended December 30, 2018 . Adjusted EBITDA in the Europe segment included
corporate allocations of shared costs of $1.0 million in the year ended
December 29, 2019 . There were no such allocations in the year ended December 30,
2018 . The allocations generally consist of certain costs of human resources,
legal, finance and information technology.
Adjusted EBITDA in our Architectural segment increased $2.8 million or 7.4% to
$40.5 million in the year ended December 29, 2019 , from $37.7 million in the
year ended December 30, 2018 . Adjusted EBITDA in the Architectural segment also
included corporate allocations of shared costs of $10.6 million and $8.9 million
in 2019 and 2018, respectively. The allocations generally consist of certain
costs of human resources, legal, finance, information technology and research
and development.
Liquidity and Capital Resources
Our liquidity needs for operations vary throughout the year. Our principal
sources of liquidity are cash flows from operating activities, the borrowings
under our ABL Facility and an accounts receivable sales program with a third
party ("AR Sales Program") and our existing cash balance. Our anticipated uses
of cash in the near term include working capital needs, capital expenditures and
share repurchases. As of December 29, 2019 , we do not have any material
commitments for capital expenditures. We anticipate capital expenditures in
fiscal year 2020 to be approximately $70 million to $75 million . On a continual
basis, we evaluate and consider strategic acquisitions, divestitures and joint
ventures to create shareholder value and enhance financial performance.
We believe that our cash balance on hand, future cash generated from operations,
the use of our AR Sales Program, our ABL Facility, and ability to access the
capital markets will provide adequate liquidity for the foreseeable future. As
of December 29, 2019 , we had $167.0 million of cash and cash equivalents,
availability under our ABL Facility of $198.0 million and availability under our
AR Sales Program of $12.4 million .
Cash Flows
Year Ended December 29, 2019 , Compared with Year Ended December 30, 2018
Cash provided by operating activities was $221.7 million during the year ended
December 29, 2019 , compared to $203.2 million during the year ended December 30,
2018 . This $18.5 million increase in cash provided by operating activities is
primarily due to $16.0 million of net working capital improvements in 2019
compared to 2018.
Cash used in investing activities was $82.1 million during the year ended
December 29, 2019 , compared to $254.5 million cash used during the year ended
December 30, 2018 . This $172.4 million decrease in cash used in investing
activities was primarily driven by a decrease in cash paid for acquisitions of
$155.4 million and a $12.0 million decrease in cash paid in the issuance of a
note receivable in 2019 compared to 2018. The remaining $5.0 million decrease is
a result of a $2.2 million increase in cash proceeds for the sale of property
plant and equipment, decreases in other investing outflows of $2.1 million , and
a $1.0 million increase in cash obtained from the sale of subsidiaries in 2019
compared to 2018, partially offset by a $0.3 million increase in capital
expenditures.
Cash used in financing activities was $89.4 million during the year ended
December 29, 2019 , compared to $10.0 million of cash used during the year ended
December 30, 2018 . This $79.4 million increase in cash used in financing
activities was primarily driven by a $186.0 million net increase in cash used in
debt-related transactions, partially offset by a $107.0 million decrease in cash
used for repurchases of common shares in 2019 compared to 2018.
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Share Repurchases
We currently have in place a $600.0 million share repurchase authorization,
stemming from three separate authorizations by our Board of Directors. On
February 23, 2016 , our Board of Directors authorized a share repurchase program
whereby we may repurchase up to $150.0 million worth of our outstanding common
shares and on February 22, 2017 , and May 10, 2018 , our Board of Directors
authorized an additional $200.0 million and $250.0 million , respectively
(collectively, the "share repurchase programs"). The share repurchase programs
have no specified end date and the timing and amount of any share repurchases
will be determined by management based on our evaluation of market conditions
and other factors. Any repurchases under the share repurchase programs may be
made in the open market, in privately negotiated transactions or otherwise,
subject to market conditions, applicable legal requirements and other relevant
factors. The share repurchase programs do not obligate us to acquire any
particular amount of common shares, and they may be suspended or terminated at
any time at our discretion. Repurchases under the share repurchase programs are
permitted to be made under one or more Rule 10b5-1 plans, which would permit
shares to be repurchased when we might otherwise be precluded from doing so
under applicable insider trading laws. During the year ended December 29, 2019 ,
we repurchased and retired 1,170,925 of our common shares in the open market at
an aggregate cost of $59.9 million as part of the share repurchase programs.
During the year ended December 30, 2018 , we repurchased 2,771,684 of our common
shares in the open market at an aggregate cost of $166.9 million . As
of December 29, 2019 , $144.0 million was available for repurchase in accordance
with the share repurchase programs.
Other Liquidity Matters
Our cash and cash equivalents balance includes cash held in foreign countries in
which we operate. Cash held outside Canada , in which we are incorporated, is
free from significant restrictions that would prevent the cash from being
accessed to meet our liquidity needs including, if necessary, to fund operations
and service debt obligations in Canada . However, earnings from certain
jurisdictions are indefinitely reinvested in those jurisdictions. Upon the
repatriation of any earnings to Canada , in the form of dividends or otherwise,
we may be subject to Canadian income taxes and withholding taxes payable to the
various foreign countries. As of December 29, 2019 , we do not believe adverse
tax consequences exist that restrict our use of cash or cash equivalents in a
material manner.
We also routinely monitor the changes in the financial condition of our
customers and the potential impact on our results of operations. There has not
been a change in the financial condition of a customer that has had a material
adverse effect on our results of operations. However, if economic conditions
were to deteriorate, it is possible that there could be an impact on our results
of operations in a future period and this impact could be material.
Accounts Receivable Sales Program
Under the AR Sales Program, we can transfer ownership of eligible trade accounts
receivable of certain customers. Receivables are sold outright to a third party
who assumes the full risk of collection, without recourse to us in the event of
a loss. Transfers of receivables under this program are accounted for as sales.
Proceeds from the transfers reflect the face value of the accounts receivable
less a discount. Receivables sold under the AR Sales Program are excluded from
trade accounts receivable in the consolidated balance sheets and are included in
cash flows from operating activities in the consolidated statements of cash
flows. The discounts on the sales of trade accounts receivable sold under the AR
Sales Program were not material for any of the periods presented and were
recorded in selling, general and administration expense within the consolidated
statements of comprehensive income.
Senior Notes
On July 25, 2019 , we issued $500.0 million aggregate principal senior unsecured
notes (the "2028 Notes"). The 2028 Notes were issued in a private placement for
resale to qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933, as amended (the "Securities Act"), and to buyers outside
of the United States pursuant to Regulation S under the Securities Act. The 2028
Notes were issued without registration rights and are not listed on any
securities exchange. The 2028 Notes bear interest at 5.375% per annum, payable
in cash semiannually in arrears on February 1 and August 1 of each year and are
due February 1, 2028 . The 2028 notes were issued at par. We received net
proceeds of $493.3 million after deducting $6.7 million of debt issuance costs.
The debt issuance costs were capitalized as a reduction to the carrying value of
debt and are being accreted to interest expense over the term of the 2028 Notes
using the effective interest method. The net proceeds from issuance of the 2028
Notes, together with available cash balances, were used to redeem the remaining
$500.0 million aggregate principal amount of the 2023 Notes (as described
below), including the payment of related premiums, fees and expenses.
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MASONITE INTERNATIONAL CORPORATION
Obligations under the 2028 Notes are fully and unconditionally guaranteed,
jointly and severally, on a senior unsecured basis, by certain of our directly
or indirectly wholly-owned subsidiaries. We may redeem the 2028 Notes under
certain circumstances specified therein. The indenture governing the 2028 Notes
contains restrictive covenants that, among other things, limit our ability and
the ability of our subsidiaries to: (i) incur additional debt and issue
disqualified or preferred stock, (ii) make restricted payments, (iii) sell
assets, (iv) create or permit restrictions on the ability of our restricted
subsidiaries to pay dividends or make other distributions to the parent company,
(v) create or incur certain liens, (vi) enter into sale and leaseback
transactions, (vii) merge or consolidate with other entities and (viii) enter
into transactions with affiliates. The foregoing limitations are subject to
exceptions as set forth in the indenture governing the 2028 Notes. In addition,
if in the future the 2028 Notes have an investment grade rating from at least
two nationally recognized statistical rating organizations, certain of these
covenants will be terminated. The indenture governing the 2028 Notes contains
customary events of default (subject in certain cases to customary grace and
cure periods). As of December 29, 2019 , we were in compliance with all covenants
under the indenture governing the 2028 Notes.
On August 27, 2018 , we issued $300.0 million aggregate principal senior
unsecured notes (the "2026 Notes"). The 2026 Notes were issued in a private
placement for resale to qualified institutional buyers pursuant to Rule 144A
under the Securities Act, and to buyers outside of the United States pursuant to
Regulation S under the Securities Act. The 2026 Notes were issued without
registration rights and are not listed on any securities exchange. The 2026
Notes bear interest at 5.75% per annum, payable in cash semiannually in arrears
on March 15 and September 15 of each year and are due September 15, 2026 . The
2026 Notes were issued at par. We received net proceeds of $295.7 million after
deducting $4.3 million of debt issuance costs. The debt issuance costs were
capitalized as a reduction to the carrying value of debt and are being accreted
to interest expense over the term of the 2026 Notes using the effective interest
method. The net proceeds from issuance of the 2026 Notes were used to redeem
$125.0 million aggregate principal amount of the 2023 Notes (as described in the
footnotes to the consolidated financial statements), including the payment of
related premiums, fees and expenses, with the balance of the proceeds available
for general corporate purposes.
Obligations under the 2026 Notes are fully and unconditionally guaranteed,
jointly and severally, on a senior unsecured basis, by certain of our directly
or indirectly wholly-owned subsidiaries. We may redeem the 2026 Notes under
certain circumstances specified therein. The indenture governing the 2026 Notes
contains restrictive covenants that, among other things, limit our ability and
the ability of our subsidiaries to: (i) incur additional debt and issue
disqualified or preferred stock, (ii) make restricted payments, (iii) sell
assets, (iv) create or permit restrictions on the ability of our restricted
subsidiaries to pay dividends or make other distributions to the parent company,
(v) create or incur certain liens, (vi) enter into sale and leaseback
transactions, (vii) merge or consolidate with other entities and (viii) enter
into transactions with affiliates. The foregoing limitations are subject to
exceptions as set forth in the indenture governing the 2026 Notes. In addition,
if in the future the 2026 Notes have an investment grade rating from at least
two nationally recognized statistical rating organizations, certain of these
covenants will be terminated. The indenture governing the 2026 Notes contains
customary events of default (subject in certain cases to customary grace and
cure periods). As of December 29, 2019 , we were in compliance with all covenants
under the indenture governing the 2026 Notes.
On September 27, 2017 , and March 23, 2015 , we issued $150.0 million and $475.0
million aggregate principal senior unsecured notes, respectively (the "2023
Notes"). The 2023 Notes were issued in two private placements for resale to
qualified institutional buyers pursuant to Rule 144A under the Securities Act,
and to buyers outside the United States pursuant to Regulation S under the
Securities Act. The 2023 Notes were issued without registration rights and are
not listed on any securities exchange. The 2023 Notes bear interest at 5.625%
per annum, payable in cash semiannually in arrears on March 15 and September 15
of each year and are due March 15, 2023 . The 2023 Notes were issued at 104.0%
and par in 2017 and 2015, respectively, and the resulting premium of $6.0
million is being amortized to interest expense over the term of the 2023 Notes
using the effective interest method. We received net proceeds of $153.9
million and $467.9 million , respectively, after deducting $2.1 million and $7.1
million of debt issuance costs in 2017 and 2015, respectively. The debt issuance
costs were capitalized as a reduction to the carrying value of debt and are
being accreted to interest expense over the term of the 2023 Notes using the
effective interest method. The net proceeds from the 2017 issuance of the 2023
Notes were for general corporate purposes. The net proceeds from the 2015
issuance of the 2023 Notes, together with available cash balances, were used to
redeem $500.0 million aggregate principal of prior 8.25% senior unsecured notes
due 2021 and to pay related premiums, fees and expenses. As of August 10, 2019 ,
the 2023 Notes were fully redeemed, as described above.
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ABL Facility
On January 31, 2019 , we and certain of our subsidiaries entered into a $250.0
million asset-based revolving credit facility (the "ABL Facility") maturing on
January 31, 2024 . The borrowing base is calculated based on a percentage of the
value of selected United States , Canadian and United Kingdom accounts receivable
and inventory, less certain ineligible amounts. Obligations under the ABL
Facility are secured by a first priority security interest in such accounts
receivable, inventory and other related assets of Masonite and our subsidiaries.
In addition, obligations under the ABL Facility are fully and unconditionally
guaranteed, jointly and severally, on a senior secured basis, by certain of our
directly or indirectly wholly-owned subsidiaries. Borrowings under the ABL
Facility bear interest at a rate equal to, at our option, (i) the United States ,
Canadian and United Kingdom Base Rate (each as defined in the credit agreement
relating to the ABL Facility, the "Amended and Restated Credit Agreement") plus
a margin ranging from 0.25% to 0.50% per annum, or (ii) the Adjusted LIBO Rate
or BA Rate (each as defined in the Amended and Restated Credit Agreement), plus
a margin ranging from 1.25% to 1.50% per annum. In addition to paying interest
on any outstanding principal under the ABL Facility, a commitment fee is payable
on the undrawn portion of the ABL Facility in an amount equal to 0.25% per annum
of the average daily balance of unused commitments during each calendar quarter.
The ABL Facility contains various customary representations, warranties and
covenants by us that, among other things, and subject to certain exceptions,
restricts our ability and the ability of our subsidiaries to: (i) pay dividends
on our common shares and make other restricted payments, (ii) make investments
and acquisitions, (iii) engage in transactions with our affiliates, (iv) sell
assets, (v) merge and (vi) create liens. The Amended and Restated Credit
Agreement amended the ABL Facility to, among other things, (i) permit us to
incur unlimited unsecured debt as long as such debt does not contain covenants
or default provisions that are more restrictive than those contained in the ABL
Facility, (ii) permit us to incur debt as long as the pro forma secured leverage
ratio is less than 4.5 to 1.0, and (iii) add certain additional exceptions and
exemptions under the restricted payment, investment and indebtedness covenants
(including increasing the amount of certain debt permitted to be incurred under
existing exceptions). As of December 29, 2019 , we were in compliance with all
covenants under the credit agreement governing the ABL Facility and there were
no amounts outstanding under the ABL Facility.
Supplemental Guarantor Financial Information
Our obligations under the 2028 Notes and 2026 Notes and the ABL Facility are
fully and unconditionally guaranteed, jointly and severally, by certain of our
directly or indirectly wholly-owned subsidiaries. The following unaudited
supplemental financial information for our non-guarantor subsidiaries is
presented:
Our non-guarantor subsidiaries generated external net sales of $1.9 billion ,
$1.9 billion and $1.8 billion in the years ended December 29, 2019 , December 30,
2018 and December 31, 2017 , respectively. Our non-guarantor subsidiaries
generated Adjusted EBITDA of $241.6 million , $224.1 million and $209.2 million
for the years ended December 29, 2019 , December 30, 2018 , and December 31, 2017 ,
respectively. Our non-guarantor subsidiaries had total assets of $2.0 billion
and $1.8 billion as of December 29, 2019 , and December 30, 2018 ; and total
liabilities of $834.5 million and $711.8 million as of December 29, 2019 , and
December 30, 2018 , respectively.
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MASONITE INTERNATIONAL CORPORATION Contractual Obligations
The following table presents our contractual obligations over the periods
indicated as of
Fiscal Year Ended
(In thousands) 2020 2021 2022 2023 2024 Thereafter Total
Long-term debt
maturities $ - $ - $ - $ - $ - $ 800,000 $ 800,000
Scheduled interest
payments 44,125 44,125 44,125 44,125 44,125 128,563 349,188
Operating leases 27,197 20,058 17,276 14,212 13,515 87,088 179,346
Finance leases 1,393 1,326 1,365 1,287 1,445 52,981 59,797
Pension
contributions (1) 785 1,086 1,141 1,197 1,258 3,794 9,261
Total (2) $ 73,500 $ 66,595 $ 63,907 $ 60,821 $ 60,343 $ 1,072,426 $ 1,397,592 ____________
(1) Pension contributions relate to ourUnited Kingdom pension plan. (2) As ofDecember 29, 2019 , we have$5.8 million recorded as a long-term liability for uncertain tax positions. We are not able to reasonably estimate the timing of payments, or the amount by which our liability for these uncertain tax positions will increase or decrease over time, and accordingly, this liability has been excluded from the above table. Off-Balance Sheet Arrangements We do not have any material off-balance sheet arrangements. Critical Accounting Policies and Estimates Our significant accounting policies are fully disclosed in our annual consolidated financial statements included elsewhere in this Annual Report. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements. Business Acquisition Accounting We use the acquisition method of accounting for all business acquisitions. We allocate the purchase price of our business acquisitions based on the fair value of identifiable tangible and intangible assets. The difference between the total cost of the acquisitions and the sum of the fair values of the acquired tangible and intangible assets less liabilities is recorded as goodwill.Goodwill We evaluate all business combinations for intangible assets that should be recognized and reported apart from goodwill.Goodwill is not amortized but instead is tested annually for impairment on the last day of fiscal November, or more frequently if events or changes in circumstances indicate the carrying amount may not be recoverable. The test for impairment is performed at the reporting unit level by comparing the reporting unit's carrying amount to its fair value. Possible impairment in goodwill is first analyzed using qualitative factors such as macroeconomic and market conditions, changing costs and actual and projected performance, amongst others, to determine whether it is more likely than not that the book value of the reporting unit exceeds its fair value. If it is determined more likely than not that the book value exceeds fair value, a quantitative analysis is performed to test for impairment. When quantitative steps are determined necessary, the fair values of the reporting units are estimated through the use of discounted cash flow analyses and market multiples. If the carrying amount exceeds fair value, then goodwill is impaired. Any impairment in goodwill is measured as the excess of the carrying value of goodwill over the fair value. The inputs utilized to derive projected cash flows are subject to significant judgments and uncertainties. As such, the realized cash flows could differ significantly from those estimated. We performed a quantitative impairment test during the fourth quarter of 2019 and determined that goodwill was not impaired. The resulting fair values of each reporting unit tested based upon such inputs exceeded their respective carrying values by greater than 10%. Further, had the discount rate of each of our reporting units been hypothetically increased by 100 basis points, the fair values of each reporting unit would still have exceeded their respective carrying values. To the extent that future operating results of the reporting units do not meet the 41 --------------------------------------------------------------------------------
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MASONITE INTERNATIONAL CORPORATION
forecasted cash flow projections, we can provide no assurance that a future
goodwill impairment charge would not be incurred.
Intangible Assets
Intangible assets with definite lives include customer relationships,
non-compete agreements, patents, supply agreements, certain acquired trademarks
and system software development. Definite-lived intangible assets are amortized
on a straight-line basis over their estimated useful lives. Amortizable
intangible assets are tested for impairment whenever events or changes in
circumstances indicate that the carrying value may be greater than the fair
value. An impairment loss is recognized when the estimate of undiscounted future
cash flows generated by such assets is less than the carrying amount.
Measurement of the impairment loss is based on the fair value of the asset,
determined using discounted cash flows when quoted market prices are not readily
available. Indefinite-lived intangible assets are tested for impairment annually
on the last day of fiscal November, or more frequently if events or
circumstances indicated that the carrying value may exceed the fair value. We
performed a qualitative impairment test during the fourth quarter of 2019 and
determined that indefinite-lived intangible assets were not impaired.
Long-lived Assets
Long-lived assets other than goodwill and indefinite-lived intangible assets,
which are separately tested for impairment, are evaluated for impairment
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. When evaluating long-lived assets for potential impairment,
we first compare the carrying value of the asset to the estimates of asset's
useful lives and undiscounted future cash flows based on market participant
assumptions. If the undiscounted expected future cash flows are less than the
carrying amount of the asset and the carrying amount of the asset exceeds its
fair value, an impairment loss is recognized.
Income Taxes
As a multinational corporation, we are subject to taxation in many jurisdictions
and the calculation of our tax liabilities involves dealing with inherent
uncertainties in the application of complex tax laws and regulations in various
taxing jurisdictions. We assess the income tax positions and record tax
liabilities for all years subject to examination based upon our evaluation of
the facts, circumstances and information available as of the reporting date.
We account for income taxes using the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences of temporary differences between the carrying amounts and the tax
basis of assets and liabilities at enacted rates. We base our estimate of
deferred tax assets and liabilities on current tax laws and rates and, in
certain cases, business plans and other expectations about future outcomes. We
record a valuation allowance to reduce our deferred tax assets to the amount
that is more likely than not to be realized. While we have considered future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance, in the event that we were to
determine that we would be able to realize our deferred tax assets in the future
in excess of our net recorded amount, an adjustment to the deferred tax assets
would be a credit to income in the period such determination was made. The
consolidated financial statements include changes to the valuation allowances as
a result of uncertainty regarding our ability to realize certain deferred tax
assets in the future.
Our accounting for deferred tax consequences represents our best estimate of
future events that can be appropriately reflected in the accounting estimates.
Changes in existing tax laws, regulations, rates and future operating results
may affect the amount of deferred tax liabilities or the valuation of deferred
tax assets over time. The application of tax laws and regulations is subject to
legal and factual interpretation, judgment and uncertainty. Tax laws and
regulations themselves are also subject to change as a result in changes in
fiscal policy, changes in legislation, the evolution of regulations and court
rulings.
Although we believe the measurement of liabilities for uncertain tax positions
is reasonable, no assurance can be given that the final outcomes of these
matters will not be different than what is reflected in the historical income
tax provisions and accruals. If we ultimately determine that the payment of
these liabilities will be unnecessary, the liability is reversed and a tax
benefit is recognized in the period in which such determination is made.
Conversely, additional tax charges are recorded in a period in which it is
determined that a recorded tax liability is less than the ultimate assessment is
expected to be. If additional taxes are assessed as a result of an audit or
litigation, there could be a material effect on our income tax provision and net
income in the period or periods for which that determination is made.
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Inventory
We value inventories at the lower of cost or replacement cost for raw materials,
and the lower of cost or net realizable value for finished goods, with expense
estimates made for obsolescence or unsaleable inventory. In determining net
realizable value, we consider such factors as yield, turnover and aging,
expected future demand and market conditions, as well as past experience. A
change in the underlying assumptions related to these factors could affect the
valuation of inventory and have a corresponding effect on cost of goods sold.
Historically, actual results have not significantly deviated from those
determined using these estimates.
Share Based Compensation Plan
We have a share based compensation plan, which governs the issuance of common
shares to employees as compensation through various grants of share instruments.
We apply the fair value method of accounting using the Black-Scholes-Merton
option pricing model to determine the compensation expense for stock
appreciation rights. The compensation expense for the restricted stock units
awarded is based on the fair value of the restricted stock units at the date of
grant. Additionally, the compensation expense for certain performance based
awards was determined using the Monte Carlo simulation method. There were no
awards outstanding as of December 29, 2019 , valued using this method.
Compensation expense is recorded in the consolidated statements of comprehensive
income and is recognized over the requisite service period. The determination of
obligations and compensation expense requires the use of several mathematical
and judgmental factors, including stock price, expected volatility, the
anticipated life of the award, estimated risk free rate and the number of shares
or share options expected to vest. Any difference in the number of shares or
share options that actually vest can affect future compensation expense. Other
assumptions are not revised after the original estimate.
Changes in Accounting Standards and Policies
Changes in accounting standards and policies are discussed in Note 1. Business
Overview and Significant Accounting Policies in the Notes to the Consolidated
Financial Statements in this Annual Report.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk from changes in foreign currency exchange rates,
interest rates and commodity prices, which can affect our operating results and
overall financial condition. We manage exposure to these risks through our
operating and financing activities and, when deemed appropriate, through the use
of derivative financial instruments. Derivative financial instruments are viewed
as risk management tools and are not used for speculation or for trading
purposes. Derivative financial instruments are generally contracted with a
diversified group of investment grade counterparties to reduce exposure to
nonperformance on such instruments.
We have in place an enterprise risk management process that involves systematic
risk identification and mitigation covering the categories of enterprise,
strategic, financial, operation and compliance and reporting risk. The
enterprise risk management process receives Board of Directors and Management
oversight, drives risk mitigation decision-making and is fully integrated into
our internal audit planning and execution cycle.
Foreign Exchange Rate Risk
We have foreign currency exposures related to buying, selling, and financing in
currencies other than the local currencies in which we operate. In the years
ended December 29, 2019 , December 30, 2018 , and December 31, 2017 , approximately
32%, 36% and 34% of our net sales were generated outside of the United States ,
respectively. In addition, a significant percentage of our costs during the same
period were not denominated in U.S. dollars. For example, for most of our
manufacturing and distribution facilities, the prices for a significant portion
of our raw materials are quoted in the domestic currency of the country where
the facility is located or other currencies that are not U.S. dollars. We also
have substantial assets outside the United States . As a result, the volatility
in the price of the U.S. dollar has exposed, and in the future may continue to
expose, us to currency exchange risks. Also, since our financial statements are
denominated in U.S. dollars, changes in currency exchange rates between the U.S.
dollar and other currencies have had, and will continue to have, an impact on
many aspects of our financial results. Changes in currency exchange rates for
any country in which we operate may require us to raise the prices of our
products in that country or allow our competitors to sell their products at
lower prices in that country. Unrealized exchange gains and losses arising from
the translation of the financial statements of our non-U.S. functional currency
operations are accumulated in the
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cumulative translation adjustments account in accumulated other comprehensive loss. Net gains from currency translation adjustments as a result of translating our foreign assets and liabilities intoU.S. dollars during the year endedDecember 29, 2019 , were$16.9 million , which were primarily driven by the weakening of theU.S. dollar against the other major currencies in which we transact. When deemed appropriate, we enter into various derivative financial instruments to preserve the carrying amount of foreign currency-denominated assets, liabilities, commitments and certain anticipated foreign currency transactions. We held no derivative financial instruments as ofDecember 29, 2019 , orDecember 30, 2018 . If not mitigated by derivative financial instruments, price increases or other methods, a hypothetical 10% strengthening of theU.S. Dollar against all foreign currencies in the jurisdictions in which we operate would result in an approximate$65 million translational decrease in our net sales and an approximate$1 million translational decrease in our net income. Interest Rate Risk We are subject to market risk from exposure to changes in interest rates with respect to borrowings under our ABL Facility to the extent it is drawn on and due to our other financing, investing and cash management activities. As ofDecember 29, 2019 , andDecember 30, 2018 , there were no outstanding borrowings under our ABL Facility. Impact of Inflation, Deflation and Changing Prices We have experienced inflation and deflation related to our purchase of certain commodity products. We believe that volatile prices for commodities have impacted our net sales and results of operations. We maintain strategies to mitigate the impact of higher raw material, energy and commodity costs, which include cost reduction, sourcing and other actions, which typically offset only a portion of the adverse impact. Inflation and deflation related to our purchases of certain commodity products could have an adverse impact on our operating results in the future. A hypothetical 10% inflationary increase in our material cost of goods sold would result in approximately$90 million of increased consolidated cost of goods sold. 44 --------------------------------------------------------------------------------
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