FORTUNE BRANDS INNOVATIONS, INC. Introduction
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is a supplement to the accompanying consolidated financial
statements 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, and a
discussion of management's general outlook regarding market demand, our
competitive position and product innovation, as well as recent developments we
believe are important to understanding our results of operations and financial
condition or in understanding anticipated future trends.
• Basis of Presentation: This section provides a discussion of the basis on
which our consolidated financial statements were prepared.
• Results of Operations: This section provides an analysis of our results of
operations for the two years ended
discussion of our 2017 results, please refer to Item 7. "Management's
Discussion and Analysis" of the Company's Annual Report on Form 10-K for the
year ended
• Liquidity and Capital Resources: This section provides a discussion of our
financial condition and an analysis of our cash flows for each of the two
years ended
discussion of our contractual obligations, other purchase commitments and
customer credit risk that existed at
discussion of our ability to fund our future commitments and ongoing operating
activities through internal and external sources of capital.
• Critical Accounting Policies and 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
The Company is a leader in home and security products focused on the design, manufacture and sale of market-leading branded products in the following categories: kitchen and bath cabinetry, plumbing and accessories, entry door systems, security products and outdoor performance materials used in decking and railing products. For the year endedDecember 31, 2019 , net sales based on country of destination were: (In millions) United States$ 4,823.9 84 % Canada 401.0 7 China 355.4 6 Other international 184.3 3 Total$ 5,764.6 100 % We believe the Company has certain competitive advantages including market-leading brands, a diversified mix of customer channels, lean and flexible supply chains, a decentralized business model and a strong capital structure, as well as a tradition of strong innovation and customer service. We are focused on outperforming our markets in growth, profitability and returns in order to drive increased shareholder value. We believe the Company's track record reflects the long-term attractiveness and potential of our categories and our leading brands. As consumer demand and the housing market continue to grow, we expect the benefits of operating leverage and strategic spending to support increased manufacturing capacity and long-term growth initiatives will help us to continue to achieve profitable organic growth. We continue to believe our most attractive opportunities are to invest in profitable organic growth initiatives, pursue accretive strategic acquisitions, non-controlling equity investments, and joint ventures, and return cash to stockholders through a combination of dividends and repurchases of shares of our common stock under our share repurchase program as explained in further detail under "Liquidity and Capital Resources" below. The U.S. market for our home products consists of spending on both new home construction and repair and remodel activities within existing homes, with the substantial majority of the markets we serve consisting of repair and remodel spending. Continued growth in the U.S. market for our home products will largely depend on consumer confidence, employment, wage growth, home prices, stable mortgage rates and credit availability. 14
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We may be impacted by fluctuations in raw materials, tariffs, transportation costs, foreign exchange rates and promotional activity among our competitors. We strive to offset the potential unfavorable impact of these items with productivity improvements and price increases. During the two years endedDecember 31, 2019 , our net sales grew at a compounded annual rate of 4.5% as we benefited from a growingU.S. home products market, acquisitions, and growth in international markets. Operating income grew at a compounded annual rate of 1.2% with consolidated operating margins between 11% and 13% from 2017 to 2019. Growth in operating income was primarily due to higher sales volume, changes to our portfolio of businesses, control over our operating expenses and the benefits of productivity programs. During 2019, theU.S. home products market grew due to increases in repair and remodel and new home construction activity. We believe spending for home repair and remodeling increased approximately 3% to 4% and new housing construction experienced approximately 2% growth in 2019 compared to 2018. In 2019, net sales grew 5.1% due to price increases to help mitigate cumulative raw material cost increases, including the impact of higher tariffs, the benefit from the 2018 Fiberon acquisition in our Doors & Security segment ($139 million ), and higher sales volume, including growth inChina . These benefits were partially offset by lower sales unit volume of make-to-order custom and semi-custom cabinetry products, unfavorable promotion and rebate costs, and unfavorable foreign exchange of$29 million . In 2019, operating income increased 17.4% over 2018 due to higher net sales, productivity improvements, and lower restructuring and asset impairment charges. These benefits were partially offset by higher commodity costs, including the impact of higher tariffs, unfavorable mix and higher employee related costs. InSeptember 2019 , we issued$700 million of unsecured senior notes ("2019 Notes") in a registered public offering. The 2019 Notes are due in 2029 with a coupon rate of 3.25%. The Company used the proceeds from the 2019 Notes offering to repay in full the Company's$350 million term loan and to pay down outstanding balances under our revolving credit facility. During the fourth quarter of 2018, our Plumbing segment entered into strategic partnerships with several companies who incorporate technology into plumbing-related products, and at the same time acquired non-controlling equity interests in two of our partners. This includes an investment inFlo Technologies, Inc. InSeptember 2018 , we issued$600 million of unsecured senior notes ("2018 Notes") in a registered public offering. The 2018 Notes are due in 2023 with a coupon rate of 4%. We used the proceeds from the 2018 Notes offering to pay down our revolving credit facility. InSeptember 2018 , we acquired 100% of the membership interests ofFiber Composites LLC ("Fiberon"), a leadingU.S. manufacturer of outdoor performance materials used in decking and railing products for a total purchase price of approximately$470.0 million , subject to certain post-closing adjustments. The acquisition of Fiberon provides category expansion and product extension opportunities into the outdoor living space for our Doors & Security segment. We financed the transaction using cash on hand and borrowings under our revolving credit and term loan facilities. Fiberon's results of operations are included in the Doors & Security segment from the date of acquisition.
Basis of Presentation
The consolidated financial statements in this Annual Report on Form 10-K have been derived from the accounts of the Company and its wholly-owned subsidiaries. The Company's consolidated financial statements are based on a fiscal year endingDecember 31 . Certain of the Company's subsidiaries operate on a 52 or 53 week fiscal year ending during the month of December. InSeptember 2018 , we acquired Fiberon. The financial results of Fiberon were included in the Company's consolidated statements of income and statements of cash flow beginning inSeptember 2018 and the consolidated balance sheet as ofDecember 31, 2018 . The results of operations are included in the Doors & Security segment. Results of Operations The following discussion of both consolidated results of operations and segment results of operations refers to the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . The discussion of consolidated results of operations should be read in conjunction with the discussion of segment results of operations and our financial statements and notes thereto included in this Annual Report on Form 10-K. Unless otherwise noted, all discussion of results of operations are for continuing operations. 15
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Years Ended
(In millions) 2019 % change 2018Net Sales : Cabinets$ 2,388.5 (1.2 )%$ 2,418.6 Plumbing 2,027.2 7.6 1,883.3 Doors & Security 1,348.9 14.0 1,183.2 Total Fortune Brands$ 5,764.6 5.1 %$ 5,485.1 Operating Income: Cabinets$ 178.3 24.3 %$ 143.5 Plumbing 427.6 13.9 375.3 Doors & Security 172.3 10.7 155.6 Corporate (79.7 ) (0.6 ) (79.2 ) Total Fortune Brands$ 698.5 17.4 %$ 595.2
Certain items had a significant impact on our results in 2019 and 2018. These included the acquisition of Fiberon, restructuring and other charges, asset impairment charges and the impact of changes in foreign currency exchange rates.
In 2019, financial results included:
• asset impairment charges of
indefinite-lived tradenames within our Cabinets segment, which were primarily
the result of a continuing shift in consumer demand from custom and
semi-custom cabinetry products to value-priced cabinetry products, which led
to reductions in future growth rates related to these tradenames,
• actuarial losses within our defined benefit plans of
related to decreases in discount rates and differences between expected and
actual returns on plan assets,
• restructuring and other charges of
after tax), primarily related to severance costs within all of our segments
and costs associated with closing facilities within our Plumbing and Doors &
Security segments,
• the benefit of the Fiberon acquisition in our Doors & Security segment and
• the impact of foreign exchange primarily due to movement in the Canadian
Dollar, British Pound, Mexican Peso and Chinese Yuan, which had an unfavorable
impact compared to 2018, of approximately
approximately
net income.
In 2018, financial results included:
• the addition of the Fiberon acquisition in our Doors & Security segment,
• asset impairment charges of
indefinite-lived tradenames within our Cabinets segment, which were primarily
the result of changes in the mix of revenue across our tradenames finalized
during our annual planning process conducted during the fourth quarter, as
well as restructuring actions announced during the third quarter,
• restructuring and other charges of
after tax), primarily related to costs associated with our initiatives to
consolidate our manufacturing footprint and product lines in our Cabinets
segment and severance costs within all of our segments,
• the impact of foreign exchange primarily due to movement in the Canadian
Dollar, British Pound, Mexican Peso and Chinese Yuan, which had a favorable
impact compared to 2017, of approximately
approximately
net income,
• the favorable impact of changes from last-in, first-out ("LIFO") to first-in,
first-out ("FIFO") for product groups in which metals comprise a significant
portion of inventory cost, which resulted in income of approximately
million before tax (
• during 2018, the Company completed its
tax effects resulting from the enactment of the
2017 on
tax expense in the amount of
Total Fortune Brands Net sales Net sales increased by$279.5 million , or 5.1%, due to price increases to help mitigate cumulative raw material cost increases, including the impact of higher tariffs, the full year benefit from the 2018 Fiberon acquisition in our Doors & Security segment ($139 million ), and higher sales volume, including growth inChina . These benefits were partially offset by lower sales unit volume of make-to-order custom and semi-custom cabinetry products, unfavorable promotion and rebate costs, and unfavorable foreign exchange of$29 million . 16
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Table of Contents Cost of products sold Cost of products sold increased by$186.5 million , or 5.3%, due to the higher net sales and increased commodity costs including the impact of higher tariffs, partially offset by the benefit from productivity improvements and lower amortization of acquisition-related inventory fair value adjustments in our Plumbing and Doors & Security segments ($8.6 million ).
Selling, general and administrative expenses
Selling, general and administrative expenses increased by$14.9 million , or 1.2%, due to higher employee related costs and transportation costs, as well as the impact of expenses associated with the 2018 Fiberon acquisition in our Doors & Security segment.
Amortization of intangible assets
Amortization of intangible assets increased by
Asset impairment charges
Asset impairment charges of$41.5 million and$62.6 million in 2019 and 2018, respectively related to three indefinite-lived tradenames within our Cabinets segment. Restructuring charges Restructuring charges of$14.7 million in 2019 primarily related to severance costs and costs associated with closing facilities across all of our segments. Restructuring charges of$24.1 million in 2018 primarily related to our initiatives to consolidate and rationalize our manufacturing footprint and discontinue certain product lines in our Cabinets segment and severance costs within all our segments. Operating income Operating income increased by$103.3 million , or 17.4%, primarily due to higher net sales, productivity improvements, and lower restructuring and asset impairment charges. These benefits were partially offset by higher commodity costs, including the impact of higher tariffs, unfavorable mix and higher employee related costs.
Interest expense
Interest expense increased by
Other expense (income), net
Other expense (income), net, was expense of$29.0 million in 2019, compared to income of$16.3 million in 2018. The increase of$45.3 million of expense is primarily due to higher actuarial losses within our defined benefit plans in 2019 ($30.3 million increase), the absence of the hedge gains associated with ourSeptember 2018 debt issuance and unfavorable foreign currency adjustments.
Income taxes
The effective income tax rates for 2019 and 2018 were 25.0% and 27.4%, respectively. The 2019 effective income tax rate was favorably impacted by a tax benefit related to share-based compensation ($3.7 million ), and unfavorably impacted by a valuation allowance increase ($3.4 million ), state and local taxes ($18.0 million ), unfavorable tax rates in foreign jurisdictions ($1.4 million ), and increases in uncertain tax positions ($7.5 million ). The 2018 effective income tax rate was favorably impacted by a tax benefit related to share-based compensation ($2.1 million ) and unfavorably impacted by a valuation allowance increase ($3.0 million ), an adjustment to the provisional net benefit recorded in 2017 under the Tax Act ($5.5 million ), state and local taxes ($13.7 million ), unfavorable tax rates in foreign jurisdictions ($3.5 million ), and increases in uncertain tax positions ($4.1 million ).
Net income from continuing operations
Net income from continuing operations was$431.3 million in 2019 compared to$390.0 million in 2018. The increase of$41.3 million was due to higher operating income and lower income tax expenses, partly offset by higher other expense and interest expense. 17
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Table of Contents Results By Segment Cabinets Net sales decreased by$30.1 million , or 1.2%, predominantly due to lower sales unit volume of make-to-order custom and semi-custom cabinetry products, lower sales inCanada and increased promotional costs. Foreign exchange was unfavorable by approximately$3 million . These factors were partly offset by benefits from price increases to help mitigate cumulative raw material cost increases and higher sales unit volume of stock cabinetry products. Operating income increased by$34.8 million , or 24.3%, due to price increases to help mitigate cumulative raw material cost increases, the benefit from productivity improvements, lower asset impairment charges, lower restructuring and other charges and higher sales unit volume of stock cabinetry products. These benefits were partly offset by higher employee related costs, lower sales unit volume of make-to-order custom and semi-custom cabinetry products, and commodity cost inflation.
Plumbing
Net sales increased by$143.9 million , or 7.6%, due to higher sales volume, including growth inChina , and price increases to help mitigate tariffs. These benefits were partially offset by lower sales volume inCanada ,Mexico and luxury-branded products and higher rebate costs as well as unfavorable foreign exchange of approximately$22 million . Operating income increased by$52.3 million , or 13.9%, due to higher net sales, the benefit from productivity improvements and the absence in 2019 of the amortization of the acquisition-related inventory fair value adjustment ($5.5 million of expense in 2018) related to our Victoria+Albert acquisition. These benefits were partially offset by the impact of higher tariffs, unfavorable mix and higher rebate costs. Foreign exchange was unfavorable by approximately$11 million . Doors & Security Net sales increased by$165.7 million , or 14.0%, due to the full year benefit from the 2018 Fiberon acquisition ($139 million ), price increases to help mitigate tariffs and cumulative raw material cost increases and new customers in decking products. These benefits were partially offset by lower sales unit volume of doors products due to inventory rebalancing in the retail distribution channel. Foreign exchange was unfavorable by approximately$4 million . Operating income increased by$16.7 million , or 10.7%, due to higher net sales including the full year benefit from the 2018 Fiberon acquisition and lower amortization of the acquisition-related inventory fair value adjustment related to Fiberon ($3.0 million decrease in 2019). These factors were partially offset by commodity cost inflation, an inventory valuation accounting change benefit in 2018 of$12.8 million , unfavorable product mix and an expense due to a fair value adjustment associated with an idle manufacturing facility ($1.7 million in 2019). Corporate
Corporate expenses increased by
Liquidity and Capital Resources
Our principal sources of liquidity are cash on hand, cash flows from operating
activities, cash borrowed under our credit facility and cash from debt issuances
in the capital markets. Our operating income is generated by our subsidiaries.
We believe our operating cash flows, including funds available under the credit
facility and access to capital markets, provide sufficient liquidity to support
the Company's liquidity and financing needs, which are working capital
requirements, capital expenditures and service of indebtedness, as well as to
finance acquisitions, repurchase shares of our common stock and pay dividends to
stockholders, as the Board of Directors deems appropriate.
Our cash flows from operations, borrowing availability and overall liquidity are
subject to certain risks and uncertainties, including those described in the
section entitled "Item 1A. Risk Factors." In addition, we cannot predict whether
or when we may enter into acquisitions, joint ventures or dispositions, make any
purchases of shares of our common stock under our share repurchase programs, or
pay dividends, or what impact any such transactions could have on our results of
operations, cash flows or financial condition, whether as a result of the
issuance of debt or equity securities, or otherwise.
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Table of Contents Unsecured Senior Notes AtDecember 31, 2019 , the Company had aggregate outstanding notes in the principal amount of$2.2 billion , with varying maturities (the "Notes"). The Notes are unsecured senior obligations of the Company. The following table provides a summary of the Company's outstanding Notes, including the carrying value of the Notes, net of underwriting commissions, price discounts and debt issuance costs as ofDecember 31, 2019 andDecember 31, 2018 : (in millions) Net Carrying Value Principal Issuance Date Maturity Date December 31, 2019 December 31, 2018 Coupon Rate Amount 3.000% Senior Notes$ 400.0 June 2015 June 2020 $ 399.7 $ 399.0 4.000% Senior Notes 500.0 June 2015 June 2025 495.8 495.0 4.000% Senior Notes (the "2018 Notes") 600.0 September 2018 September 2023 596.1 595.0 3.250% Senior Notes (the "2019 Notes") 700.0 September 2019 September 2029 692.7 - Total Senior Notes$ 2,200.0 $ 2,184.3 $ 1,489.0 InSeptember 2019 , we issued$700 million of unsecured senior notes ("2019 Notes") in a registered public offering. The 2019 Notes are due in 2029 with a coupon rate of 3.25%. The Company used the proceeds from the 2019 Notes offering to repay in full the Company's$350 million term loan and to pay down outstanding balances under our revolving credit facility. InSeptember 2018 , we issued$600 million of unsecured senior notes ("2018 Notes") in a registered public offering. The 2018 Notes are due in 2023 with a coupon rate of 4%. We used the proceeds from the 2018 Notes offering to pay down our revolving credit facility. As ofDecember 31, 2019 , Notes payments due during the next five years are$400 million in 2020, zero in 2021 through 2022 and$600 million in 2023 through 2024. The Company intends to repay or refinance the 3.000% Senior Notes on or before theJune 2020 maturity date.
Credit Facilities
InSeptember 2019 , the Company entered into a second amended and restated$1.25 billion revolving credit facility (the "2019 Revolving Credit Agreement"), and borrowings thereunder will be used for general corporate purposes. The terms and conditions of the 2019 Revolving Credit Agreement, including the total commitment amount, essentially remained the same as the previous revolving credit facility, except that the maturity date was extended toSeptember 2024 . Interest rates under the 2019 Revolving Credit Agreement are variable based on LIBOR at the time of the borrowing and the Company's long-term credit rating and can range from LIBOR + 0.91% to LIBOR + 1.4%. Borrowings amounting to$165.0 million were rolled over from the prior revolving credit facility into the 2019 Revolving Credit Agreement. The amendment also includes a covenant under which the Company is required to maintain a minimum ratio of consolidated EBITDA to consolidated interest expense of 3.0 to 1.0. Adjusted 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. In addition, the amendment includes a covenant under which the Company's ratio of consolidated debt minus certain cash and cash equivalents to consolidated EBITDA generally may not exceed 3.5 to 1.0. This amendment and restatement of the credit agreement was a non-cash transaction for the Company. OnDecember 31, 2019 andDecember 31, 2018 , our outstanding borrowings under this credit facility were zero and$320.0 million , respectively. As ofDecember 31, 2019 , we were in compliance with all covenants under this credit facility. InSeptember 2019 , the Company used the proceeds from the 2019 Notes to repay the full outstanding balance on the Term Loan entered into inMarch 2018 and subsequently amended inAugust 2018 andMarch 2019 (the "Term Loan"). Following theMarch 2019 amendment, the Term Loan provided for borrowings of$350 million and was scheduled to mature inMarch 2020 . AtDecember 31, 2019 andDecember 31, 2018 , amounts due under the Term Loan were zero and$525.0 million , respectively, which is included within Short-term debt in the consolidated balance sheets. We currently have uncommitted bank lines of credit inChina , which provide for unsecured borrowings for working capital of up to$17.5 million in aggregate as ofDecember 31, 2019 and$23.5 million in aggregate as ofDecember 31, 2018 , of which zero was outstanding as ofDecember 31, 2019 and 2018. The weighted-average interest rates on these borrowings were zero in 2019 and 2018. 19
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The components of external long-term debt were as follows:
(In millions) 2019 2018 Notes$ 2,184.3 $ 1,489.0 $1,250 million revolving credit agreement due September 2024 - 320.0 Term Loan (due March 2020) - 525.0 Total debt 2,184.3 2,334.0 Less: current portion 399.7 525.0 Total long-term debt$ 1,784.6 $ 1,809.0 In our debt agreements, there are normal and customary events of default which would permit the lenders to accelerate the debt if not cured within applicable grace periods, such as failure to pay principal or interest when due or a change in control of the Company. There were no events of default as ofDecember 31, 2019 . Cash and Seasonality In 2019, we invested approximately$58 million in incremental capacity to support long-term growth potential and new products. We expect capital spending in 2020 to be in the range of$160 to$175 million . OnDecember 31, 2019 , we had cash and cash equivalents of$387.9 million , of which$341.1 million was held at non-U.S. subsidiaries. We manage our global cash requirements considering (i) available funds among the subsidiaries through which we conduct business, (ii) the geographic location of our liquidity needs, and (iii) the cost to access international cash balances. The repatriation of non-U.S. cash balances from certain subsidiaries could have adverse tax consequences as we may be required to pay and record tax expense on those funds that are repatriated. Our operating cash flows are significantly impacted by the seasonality of our business. We typically generate most of our operating cash flow in the third and fourth quarters of each year. We use operating cash in the first quarter of the year. Share Repurchases In 2019, we repurchased 2.0 million shares of our outstanding common stock under the Company's share repurchase program for$100.0 million . As ofDecember 31, 2019 , the Company's total remaining share repurchase authorization under the remaining program was approximately$314 million . The share repurchase program does not obligate the Company to repurchase any specific dollar amount or number of shares and may be suspended or discontinued at any time.
Dividends
In 2019, we paid dividends in the amount of$123.0 million to the Company's shareholders. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and if future dividends will be paid, and at what level, because the payment of dividends is dependent on our financial condition, results of operations, cash flows, capital requirements and other factors deemed relevant by our Board of Directors. There are no restrictions on the ability of our subsidiaries to pay dividends or make other distributions to Fortune Brands.
Acquisitions
We periodically review our portfolio of brands and evaluate potential strategic transactions and other capital initiatives to increase shareholder value. InSeptember 2018 , we acquired 100% of the membership interests of Fiberon, a leadingU.S. manufacturer of outdoor performance materials used in decking and railing products, for a total purchase price of approximately$470 million , subject to certain post-closing adjustments. The acquisition of Fiberon provided category expansion and product extension opportunities into the outdoor living space for our Doors & Security segment. We financed the transaction using cash on hand and borrowings under our revolving credit and term loan facilities. The results of operations are included in the Doors & Security segment from the date of acquisition. Cash Flows Below is a summary of cash flows for the years endedDecember 31, 2019 and 2018. (In millions) 2019 2018 Net cash provided by operating activities$ 637.2 $ 604.0 Net cash used in investing activities (127.6 ) (634.3 ) Net cash used in financing activities (389.7 ) (6.8 ) Effect of foreign exchange rate changes on cash 4.3 (15.2 ) Net (decrease) increase in cash, cash equivalents and restricted cash$ 124.2 $ (52.3 ) 20
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Net cash provided by operating activities was$637.2 million in 2019 compared to$604.0 million in 2018. The$33.2 million increase in cash provided from 2018 to 2019 was primarily due to increases in net income and lower increases in inventories, partially offset by increases in accounts receivable balances and decreases in accrued taxes. Net cash used in investing activities was$127.6 million in 2019 compared to$634.3 million in 2018. The decrease in cash used of$506.7 million from 2018 to 2019 was primarily due to a$465.6 million decrease in cost of acquisitions. Net cash used by financing activities was$389.7 million in 2019 compared to$6.8 million in 2018. The increase in net cash used of$382.9 million from 2018 to 2019 was primarily due to net repayments of debt in 2019 compared to net borrowings in 2018 ($976.9 million increase), partly offset by lower share repurchases in 2019 compared to 2018 ($594.6 million decrease).
Pension Plans
Subsidiaries of Fortune Brands sponsor their respective defined benefit pension plans that are funded by a portfolio of investments maintained within our benefit plan trust. In 2019 and 2018, we contributed$10.0 million and$10.0 million , respectively, to our qualified pension plans. In 2020, we expect to make pension contributions of approximately$23.0 million . As ofDecember 31, 2019 , the fair value of our total pension plan assets was$677.2 million , representing funding of 77% of the accumulated benefit obligation liability. 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.
Foreign Exchange
We have operations in various foreign countries, principally
Contractual Obligations and Other Commercial Commitments
The following table describes other obligations and commitments to make future
payments under contracts, such as debt and lease agreements, and under
contingent commitments, such as debt guarantees, as of
(In millions) Payments Due by
Period as of
Less than After
Contractual Obligations Total 1 year 1-3 years 4-5 years 5 years
Short-term and long-term debt $ 2,200.0 $ 400.0 $ - $ 600.0 $ 1,200.0
Interest payments on long-term debt(a) 439.5 72.8 133.5 109.5 123.7
Operating leases 202.2 39.1 60.2 41.5 61.4
Purchase obligations(b) 408.5 373.9 24.5 10.0 0.1
Defined benefit plan contributions(c) 23.0 23.0 - - -
Total $ 3,273.2 $ 908.8 $ 218.2 $ 761.0 $ 1,385.2 (a) Interest payments on long-term debt were calculated using the borrowing rate
in effect on
(b) Purchase obligations include contracts for raw material and finished goods
purchases; selling and administrative services; and capital expenditures.
(c) Pension and postretirement contributions cannot be determined beyond 2020.
Due to the uncertainty of the timing of settlement with taxing authorities, we are unable to make reasonably reliable estimates of the period of cash settlement of unrecognized tax benefits. Therefore,$88.0 million of unrecognized tax benefits as ofDecember 31, 2019 have been excluded from the Contractual Obligations table above. In addition to the contractual obligations and commitments listed and described above, we also had other commercial commitments for which we are contingently liable as ofDecember 31, 2019 . Other corporate commercial commitments include standby letters of credit of$38.7 million , in the aggregate, all of which expire in less than one year, and surety bonds of$10.7 million , of which$10.6 million matures in less than one year and$0.1 million matures in 1-3 years. These contingent commitments are not expected to have a significant impact on our liquidity.
Off-Balance Sheet Arrangements
As ofDecember 31, 2019 , we did not have any off-balance sheet arrangements that are material or reasonably likely to be material to our financial condition or results of operations. 21
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Table of Contents Foreign Currency Risk Certain anticipated transactions, assets and liabilities are exposed to foreign currency risk. Principal currencies hedged include the Canadian dollar, British pound, the Mexican peso and the Chinese yuan. We regularly monitor our foreign currency exposures in order to maximize the overall effectiveness of our foreign currency hedge positions. For additional information on this risk, see Item 7A. "Quantitative and Qualitative Disclosures about Market Risk" in this Annual Report on Form 10-K.
Derivative Financial Instruments
In accordance with 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. If the derivative is
designated as a fair value hedge and is effective, the changes in the fair value
of the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings in the same period. If the derivative is designated as a
cash flow hedge, the changes in the fair value of the derivative are recorded in
other comprehensive income ("OCI") and are recognized in the consolidated
statement of income when the hedged item affects earnings. If the derivative is
designated as an effective economic hedge of the net investment in a foreign
operation, the changes in the fair value of the derivative is reported in the
cumulative translation adjustment section of OCI. Similar to foreign currency
translation adjustments, these changes in fair value are recognized in earnings
only when realized upon sale or upon complete or substantially complete
liquidation of the investment in the foreign entity.
Deferred currency gains of $4.1 million and $2.2 million (before tax impact)
were reclassified into earnings for the year ended December 31, 2019 and 2018,
respectively. Based on foreign exchange rates as of December 31, 2019 , we
estimate that $2.3 million of net derivative gain included in AOCI as of
December 31, 2019 will be reclassified to earnings within the next twelve
months.
Recently Issued Accounting Standards
The adoption of recent accounting standards, as discussed in Note 2, "Significant Accounting Policies," to our Consolidated Financial Statements, has not had and is not expected to have a significant impact on our revenue, earnings or liquidity.
Critical Accounting Policies and Estimates
Our significant accounting policies are described in Note 2, "Significant Accounting Policies," of the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K. The Consolidated Financial Statements are prepared in conformity with GAAP. Preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the amounts of assets and liabilities reflected in the financial statements and revenues and expenses reported for the relevant reporting periods. We believe the policies discussed below are the Company's critical accounting policies as they include the more significant, subjective and complex judgments and estimates made when preparing our consolidated financial statements.
Allowances for Doubtful Accounts
Trade receivables are recorded at the stated amount, less allowances for discounts and doubtful accounts. The allowances for doubtful accounts represent estimated uncollectible receivables associated with potential customer defaults on contractual obligations (usually due to customers' potential insolvency) or discounts related to early payment of accounts receivables by our customers. The allowances include provisions for certain customers where a risk of default has been specifically identified. In addition, the allowances include a provision for customer defaults 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 various factors, including the length of time the receivables are past due, historical collection experience and existing economic conditions. In accordance with this policy, our allowance for doubtful accounts was$3.0 million and$3.7 million as ofDecember 31, 2019 and 2018, respectively.
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$46.1 million and$45.3 million as ofDecember 31, 2019 and 2018, respectively. 22
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Table of Contents Long-lived Assets In accordance with ASC requirements for Property, Plant and Equipment, a long-lived asset (including amortizable identifiable intangible assets) or asset group held for use is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. When such events occur, we compare the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group to the carrying amount of a long-lived asset or asset group. The cash flows are based on our best estimate of future cash flows derived from the most recent business projections. If this comparison indicates that there is an impairment, the amount of the impairment is calculated based on fair value. Fair value is estimated primarily using discounted expected future cash flows on a market-participant basis.
In accordance with ASC requirements for 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. 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. Furthermore, our cash flow projections used to assess impairment of our goodwill and other intangible assets are significantly influenced by our projection for theU.S. home products market, our annual operating plans finalized in the fourth quarter of each year, and our ability to execute on various planned cost reduction initiatives supporting operating income improvements. Our projection for theU.S. home products market is inherently uncertain and is subject to a number of factors, such as employment, home prices, credit availability, new home starts and the rate of home foreclosures. For the market approach, we apply market multiples for peer groups to the current operating results of the reporting units to determine each reporting unit's fair value. The Company's reporting units are operating segments, or one level below operating segments when appropriate. When the estimated fair value of a 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 ofU.S. new home starts and home repair and remodel spending; management's sales, operating income and cash flow forecasts; peer company EBITDA earnings 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 repair and remodel segments of theU.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. Purchased intangible assets other than goodwill are amortized over their useful lives unless those lives are determined to be indefinite. The determination of the useful life of an intangible asset other than goodwill is based on factors including historical tradename performance with respect to consumer name recognition, geographic market presence, market share, plans for ongoing tradename support and promotion, customer attrition rates, and other relevant factors. Certain of our tradenames have been assigned an indefinite life as we currently anticipate that these tradenames will contribute cash flows to the Company 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 rate; and the market-participant discount rate. We measure fair value of our indefinite-lived tradenames using the standard 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 rate and the market-participant discount rate. 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. 23
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Table of Contents In the fourth quarter of 2019, we recognized an impairment charge of$12.0 million related to an indefinite-lived tradename in our Cabinets segment. This charge was the result of a strategic shift associated with new segment leadership and acceleration of our capacity rebalancing initiatives from custom cabinetry products to value-based cabinetry products as a result of lower than expected sales of custom cabinetry products compared to prior forecasts. As ofDecember 31, 2019 , the estimated fair value of this tradename equaled its carrying value of$38.6 million . In the third quarter of 2019, we recognized an impairment charge of$29.5 million related to a second indefinite-lived tradename in our Cabinets segment, which was primarily the result of a continuing shift in consumer demand from semi-custom cabinetry products to value-priced cabinetry products, which led to consecutive downward adjustments of internal sales forecasts and future growth rates associated with the tradename. In the fourth quarter of 2018, we recorded an impairment charge of$35.5 million related to the same indefinite-lived tradename, which was primarily the result of lower than forecasted sales during the fourth quarter of 2018 as well as projected changes in the mix of revenue across our tradenames in future periods, including the impact of more moderate industry growth expectations, which were finalized during our annual planning process conducted during the fourth quarter of 2018. As ofDecember 31, 2019 , the estimated fair value of this tradename exceeded its carrying value of$85.0 million by less than 10%. During the third quarter of 2018, we recorded a pre-tax impairment charge of$27.1 million related to a third indefinite-lived tradename within the Cabinets segment. This charge was primarily the result of reduced revenue growth expectations associated with Cabinets operations inCanada , including the announced closure of Company-owned retail locations. As ofDecember 31, 2019 , the estimated fair value of this tradename exceeded its carrying value of$39.1 million by less than 10%. The fair values of the impaired tradenames were measured using the relief-from-royalty approach, which estimates the present value of royalty income that could be hypothetically earned by licensing the tradename to a third party over its remaining useful life. Some of the more significant assumptions inherent in estimating the fair values include forecasted revenue growth rates for the tradename, assumed royalty rate, and a market-participant discount rate that reflects 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 (refer to Note 11). A reduction in the estimated fair value of these three tradenames could trigger additional impairment charges in future periods. Events or circumstances that could have a potential negative effect on the estimated fair value of our reporting units and indefinite-lived tradenames include: lower than forecasted revenues, actual new construction and repair and remodel growth rates that fall below our assumptions, actions of key customers, increases in discount rates, continued economic uncertainty, higher levels of unemployment, weak consumer confidence, lower levels of discretionary consumer spending, a decrease in royalty rates and a decline in the trading price of our common stock. We cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of goodwill and indefinite-lived assets. Defined Benefit Plans We have a number of pension plans inthe United States , covering many of the Company's employees; however, the majority of these plans have been frozen to new participants and benefit accruals were frozen for active participants onDecember 31, 2016 . In addition, the Company provides postretirement healthcare and life insurance benefits to certain retirees. Service cost for 2019 relates to benefit accruals in an hourly Union defined benefit plan in our Doors & Security segment, which is the only remaining plan where benefit accruals have not been frozen. We recognize changes in the fair value of pension plan assets and net actuarial gains or losses in excess of 10 percent of the greater of the fair value of pension plan assets or each plan's projected benefit obligation (the "corridor") in earnings immediately upon remeasurement, which is at least annually in the fourth quarter of each year. Net actuarial gains and losses occur when actual experience differs from any of the assumptions used to value defined benefit plans or when assumptions change as they may each year. The primary factors contributing to actuarial gains and losses are changes in the discount rate used to value obligations as of the measurement date and the differences between expected and actual returns on pension plan assets. This accounting method results in the potential for volatile and difficult to forecast gains and losses. The pre-tax recognition of actuarial (gains) losses was$34.7 million and$3.8 million in 2019 and 2018, respectively. The total net actuarial losses in accumulated other comprehensive income for all defined benefit plans were$87.4 million as ofDecember 31, 2019 , compared to$71.5 million as ofDecember 31, 2018 . We record amounts relating to these defined benefit plans based on various actuarial assumptions, including discount rates, assumed rates of return, turnover rates and health care cost trend rates. We review our actuarial assumptions on an annual basis and make modifications to the assumptions based on current economic conditions and trends. We believe that the assumptions utilized in recording our obligations under our plans are reasonable based on our experience and on advice from 24
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our independent actuaries; however, differences in actual experience or changes in the assumptions may materially affect our financial condition or results of operations. The expected return on plan assets is determined based on the nature of the plans' investments, our current asset allocation and our expectations for long-term rates of return. The weighted-average long-term expected rate of return on pension plan assets for the years endedDecember 31, 2019 and 2018 was 4.9% and 6.0%, respectively. Compensation increases reflect expected future compensation trends. The discount rate used to measure obligations is based on a spot-rate yield curve on a plan-by-plan basis that matches projected future benefit payments with the appropriate interest rate applicable to the timing of the projected future benefit payments. The bond portfolio used for the selection of the discount rate is from the top quartile of bonds rated by nationally recognized statistical rating organizations, and includes only non-callable bonds and those that are deemed to be sufficiently marketable with a Moody's credit rating of Aa or higher. The weighted-average discount rate for defined benefit liabilities as ofDecember 31, 2019 and 2018 was 3.3% and 4.4%, respectively. For postretirement benefits, our health care trend rate assumption is based on historical cost increases and expectations for long-term increases. As ofDecember 31, 2019 , for postretirement medical and prescription drugs in the next year, our assumption was an assumed rate of increase of 6.7% for pre-65 retirees and 7.8% for post-65 retirees, declining until reaching an ultimate assumed rate of increase of 4.5% per year in 2027. As ofDecember 31, 2018 , for postretirement medical and prescription drugs in the next year, our assumption was an assumed rate of increase of 6.9% for pre-65 retirees and 8.0% for post-65 retirees, declining until reaching an ultimate assumed rate of increase of 4.5% per year in 2027.
Below is a table showing pre-tax pension and postretirement expenses, including the impact of actuarial gains and losses:
(In millions) 2019
2018
Total pension expense (income)$ 32.3 $ (5.9 ) Actuarial loss component of expense above 34.1
3.9
Total postretirement expense (income) 1.1 (0.1 ) Actuarial loss (gain) component of expense above 0.6 (0.1 ) Amortization of prior service credit component of expense above 0.2 - The actuarial losses in 2019 were principally due to changes in discount rates. The actuarial losses in 2018 were principally due to lower asset returns. Discount rates in 2019 used to determine benefit obligations decreased by an average of 110 basis points for pension benefits. Discount rates for 2019 postretirement benefits increased an average of 220 basis points. Discount rates in 2018 used to determine benefit obligations increased by an average of 60 basis points for pension benefits. Discount rates for 2018 postretirement benefits increased an average of 80 basis points. Our actual return on plan assets in 2019 was 19.7% compared to an actuarial assumption of an average 4.9% expected return. Our actual return on plan assets in 2018 was (3.5)% compared to an actuarial assumption of an average 6.0% expected return. Significant actuarial losses in future periods would be expected if discount rates decline, actual returns on plan assets are lower than our expected return, or a combination of both occurs. A 25 basis point change in our discount rate assumption would lead to an increase or decrease in our pension and postretirement liability of approximately$28 million . A 25 basis point change in the long-term rate of return on plan assets used in accounting for our pension plans would have a$1.6 million impact on pension expense. In addition, if required, actuarial gains and losses will be recorded in accordance with our defined benefit plan accounting method as previously described. It is not possible to forecast or predict whether there will be actuarial gains and losses in future periods, and if required, the magnitude of any such adjustment. These gains and losses are driven by differences in actual experience or changes in the assumptions that are beyond our control, such as changes in interest rates and the actual return on pension plan assets. Income Taxes In accordance with ASC requirements for Income Taxes, we establish deferred tax liabilities or assets for temporary differences between financial and tax reporting bases and subsequently adjust them to reflect changes in tax rates expected to be in effect when the temporary differences reverse. We record a valuation allowance reducing deferred tax assets when it is more likely than not that such assets will not be realized. We record liabilities for uncertain income tax positions based on a two-step process. The first step is recognition, where we evaluate whether an individual tax position has a likelihood of greater than 50% of being sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation processes. For tax positions that are currently estimated to have a less than 50% likelihood of being sustained, no tax benefit is recorded. For tax positions that have met the recognition threshold in the first step, we perform the second step of measuring the benefit to be recorded. The actual benefits ultimately realized may differ from our estimates. In future periods, changes in facts, circumstances, and new information may require us to change the recognition and measurement estimates with regard to individual tax positions. Changes in recognition and measurement estimates are recorded in the consolidated statement of income and consolidated balance sheet in the period in which such changes occur. As ofDecember 31, 2019 , we had liabilities for unrecognized tax benefits pertaining to uncertain tax positions totaling$88.0 million . It is reasonably possible that the unrecognized tax benefits 25
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may decrease in the range of
The Tax Act, enacted onDecember 22, 2017 , made significant changes to theU.S. Internal Revenue Code including a reduction in the corporate tax rate from 35% to 21% for tax years beginning afterDecember 31, 2017 , an exemption from federal income tax for dividends received from foreign subsidiaries, and an imposition of a one-time transition tax on the deemed repatriation of cumulative foreign earnings and profits as ofDecember 31, 2017 .
Customer Program Costs
Customer programs and incentives are a common practice in our businesses. Our businesses incur 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 the Company 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 (goods or services) 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). The costs typically recognized in "selling, general and administrative expenses" include product displays, point of sale materials and media production costs. Litigation Contingencies Our businesses are subject to risks related to threatened or pending litigation and are routinely defendants in lawsuits associated with the normal conduct of business. Liabilities and costs associated with litigation-related loss contingencies require estimates and judgments based on our knowledge of the facts and circumstances surrounding each matter and the advice of our legal counsel. We record liabilities for litigation-related losses when a loss is probable and we can reasonably estimate the amount of the loss in accordance with ASC requirements for Contingencies. We evaluate the measurement of recorded liabilities each reporting period based on the then-current facts and circumstances specific to each matter. The ultimate losses incurred upon final resolution of litigation-related loss contingencies may differ materially from the estimated liability recorded at any particular balance sheet date. Changes in estimates are recorded in earnings in the period in which such changes occur.
Environmental Matters
We are involved in remediation activities to clean up hazardous wastes as
required by federal and state laws. Liabilities for remediation costs of each
site are based on our best estimate of undiscounted future costs, excluding
possible insurance recoveries or recoveries from other third parties.
Uncertainties about the status of laws, regulations, technology and information
related to individual sites make it difficult to develop estimates of future
environmental remediation exposures. Some of the potential liabilities relate to
sites we own, and some relate to sites we no longer own or never owned. Several
of our subsidiaries have been designated as potentially responsible parties
("PRP") under "Superfund" or similar state laws. As of December 31, 2019 , ten
such instances have not been dismissed, settled or otherwise resolved. In 2019,
none of our subsidiaries were identified as a PRP in a new instance and no
instances were settled, dismissed or otherwise resolved. In most instances where
our subsidiaries are named as a PRP, we enter into cost-sharing arrangements
with other PRPs. We give notice to insurance carriers of potential PRP
liability, but very rarely, if ever, receive reimbursement from insurance for
PRP costs. We believe that the cost of complying with the present environmental
protection laws, before considering estimated recoveries either from other PRPs
or insurance, will not have a material adverse effect on our results of
operations, cash flows or financial condition. At December 31, 2019 and 2018, we
had accruals of $0.2 and $0.6 million , respectively, relating to environmental
compliance and cleanup including, but not limited to, the above mentioned
Superfund sites.
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