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 2018 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: plumbing and accessories, entry door and storm door systems, security products, outdoor performance materials used in decking and railing products, and kitchen and bath cabinetry. For the year endedDecember 31, 2020 , net sales based on country of destination were: (In millions) United States$ 5,094.3 84 % China 416.7 7 Canada 414.2 7 Other international 165.1 2 Total$ 6,090.3 100 % 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 stockholder 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. We may be impacted by fluctuations in raw materials, tariffs, transportation costs, foreign exchange rates, inflation and promotional activity among our competitors. We strive to offset the potential unfavorable impact of these items with productivity improvements and price increases. 16
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During the two years endedDecember 31, 2020 , our net sales grew at a compounded annual rate of 5.4% 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 16.0% with consolidated operating margins between 11% and 13% from 2018 to 2020. 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 the first half of 2020, in response to the COVID-19 pandemic, a number of countries andU.S. states issued orders requiring nonessential businesses to close ("closure orders") and persons who were not engaged in essential businesses to stay at home. Generally, states and jurisdictions designated our products, our retail channel partners and residential construction as essential business activities. While our financial results were negatively impacted during the second quarter of 2020 by these closure orders, sales volumes increased as these restrictions were relaxed benefiting our third and fourth quarter results. Our first priority with regard to COVID-19 continues to be to ensure the safety, health and hygiene of our employees, customers, suppliers and others with whom we partner in our business activities. Because of our comprehensive use of appropriate risk mitigation and safety practices, we have largely been able to continue our business operations in this unprecedented business environment which could differentiate us from some of our competition. We believe that the disruption caused by the pandemic created increased consumer interest in investing in their homes and accelerated trends that we were experiencing prior to the pandemic, such as the shift towards value-priced cabinetry products and a focus on outdoor living. We expect the trend toward focusing on the home to continue. We have also taken proactive steps in our manufacturing supply chain and other areas to drive efficiencies which we expect to allow us to be more competitive both during and after the pandemic. However, due to the continued inherent uncertainty surrounding COVID-19, including governmental directives, public health challenges and market reactions, our results in future periods may be negatively impacted. During 2020, 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 6% and new housing construction experienced approximately 4% growth in 2020 compared to 2019. In 2020, net sales grew 5.7% due to higher volume and price increases to help mitigate the cumulative impact from tariff related costs. These factors were partially offset by unfavorable mix, higher rebate costs and unfavorable foreign exchange of$4 million . In 2020, operating income increased 14.7% over 2019 primarily due to price increases to help mitigate the impact of higher tariffs, higher sales volume, the benefits from productivity improvements and restructuring actions and lower asset impairment charges. These factors were partially offset by the impact of unfavorable mix, higher employee related costs, higher tariffs, higher transportation costs, higher advertising and marketing costs and higher restructuring and other charges. InDecember 2020 , we acquired 100% of the outstanding equity of Larson, a leading brand of storm, screen and security doors, for a total purchase price of approximately$715.2 million , net of cash acquired and closing date working capital adjustments. The acquisition cost is further subject to the final post-closing working capital adjustment. We financed the transaction with borrowings under our existing credit facilities. This acquisition is expected to strengthen our overall product offering. Following the acquisition of Larson, our Doors & Security segment was renamed "Outdoors & Security" to better align with the segment's strategic focus on the fast-growing outdoor living space and to better represent the brands within the segment, including the newly acquired Larson. The Outdoors & Security segment name change is to the name only and had no impact on the Company's historical financial position, results of operations, cash flow or segment level results previously reported. DuringJune 2020 , we repaid all amounts outstanding on the 3.000% Senior Notes issued inJune 2015 at their maturity date using borrowings under our 2019 Revolving Credit Agreement (as defined below). InSeptember 2019 , the Company issued$700 million of 3.25% Senior Notes due 2029 ("2019 Notes") in a registered public offering. The Company used the proceeds from the 2019 Notes offering to repay in full a$350 million term loan and to pay down outstanding balances under our 2019 Revolving Credit Agreement.
In
In 2018 our Plumbing segment entered into a strategic partnership with, and acquired non-controlling equity interests in,Flo Technologies, Inc. ("Flo"), aU.S. manufacturer of comprehensive water monitoring and shut-off systems with leak detection technologies. InJanuary 2020 , we entered into an agreement to acquire 100% of the outstanding shares of Flo in a multi-phase transaction, which will be completed in 2022.
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
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ending
InDecember 2020 , the Company acquired 100% of the outstanding equity of Larson for a total purchase price of approximately$715.2 million , net of cash acquired and closing date working capital adjustments. The acquisition cost is further subject to the final post-closing working capital adjustment. We financed the transaction with borrowings under our existing credit facilities. The financial results of Larson were included in the Company's consolidated balance sheet as ofDecember 31, 2020 . Larson's net sales, operating income and cash flows from the date of acquisition toDecember 31, 2020 were not material to the Company. The results of operations are included in the Outdoors & Security segment.
Results of Operations
The following discussion of both consolidated results of operations and segment results of operations refers to the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . The discussion of consolidated results of operations should be read in conjunction with the discussion of segment results of operations and our financial statements and notes thereto included in this Annual Report on Form 10-K. Unless otherwise noted, all discussion of results of operations are for continuing operations.
Years Ended
(In millions) 2020 % change 2019Net Sales : Plumbing$ 2,202.1 8.6 %$ 2,027.2 Outdoors & Security 1,419.2 5.2 1,348.9 Cabinets 2,469.0 3.4 2,388.5 Total Fortune Brands$ 6,090.3 5.7 %$ 5,764.6 Operating Income: Plumbing$ 467.9 9.4 %$ 427.6 Outdoors & Security 201.3 16.8 172.3 Cabinets 235.7 32.2 178.3 Corporate (103.5 ) (29.9 ) (79.7 ) Total Fortune Brands$ 801.4 14.7 %$ 698.5
Certain items had a significant impact on our results in 2020 and 2019. These included restructuring and other charges, asset impairment charges and the impact of changes in foreign currency exchange rates.
In 2020, financial results included:
• restructuring and other charges of
after tax), largely related to headcount actions associated with COVID-19
across all segments and costs associated with changes in our manufacturing
processes within our Plumbing segment,
• asset impairment charges of
indefinite-lived tradenames within our Plumbing and Cabinets segments, which
were primarily the result of forecasted sales declines resulting from the
COVID-19 pandemic,
• actuarial losses within our defined benefit plans of
related to decreases in discount rates and differences between expected and
actual returns on plan assets 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 2019, of approximately$4 million on net sales and a favorable impact compared to 2019, of approximately$1 million both on operating income and net income.
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 Outdoors
& Security segments 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.
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Table of Contents Total Fortune Brands Net sales
Net sales increased by
Cost of products sold
Cost of products sold increased by$213.7 million , or 5.8%, due to higher net sales, unfavorable mix and the impact of higher tariffs, partially offset by the benefit from productivity improvements.
Selling, general and administrative expenses
Selling, general and administrative expenses increased by$26.3 million , or 2.1%, due to higher employee related costs, higher advertising and marketing cost and higher transportation costs. These increases were partially offset by the benefits from organizational restructuring initiatives.
Amortization of intangible assets
Amortization of intangible assets are consistent with the prior year.
Asset impairment charges
Asset impairment charges of$22.5 million in 2020 related to indefinite-lived tradenames within our Plumbing and Cabinets segments. Asset impairment charges of$41.5 million in 2019 related to two indefinite-lived tradenames within our Cabinets segment. Restructuring charges Restructuring charges of$15.9 million in 2020 largely related to headcount actions associated with COVID-19 across all segments and costs associated with changes in our manufacturing processes within our Plumbing segment. Restructuring charges of$14.7 million in 2019 primarily related to severance costs within our Plumbing and Cabinets segments and costs associated with closing facilities within our Plumbing and Outdoors & Security segments.
Operating income
Operating income increased by$102.9 million , or 14.7%, primarily due to price increases to help mitigate the impact of higher tariffs, higher sales volume, the benefits from productivity improvements and restructuring actions and lower asset impairment charges. These factors were partially offset by unfavorable mix, higher employee related costs, higher tariffs, higher transportation costs, higher advertising and marketing costs and higher restructuring and other charges.
Interest expense
Interest expense decreased
Other (income) expense, net
Other (income) expense, net, was income of$13.3 million in 2020, compared to expense of$29.0 million in 2019. The increase of$42.3 million of income is primarily due to higher defined benefit income in 2020 ($33.2 million increase) and gains of$11.0 million related to our investment in Flo, partially offset by unfavorable foreign currency losses.
Income taxes
The effective income tax rates for 2020 and 2019 were 23.1% and 25.0%, respectively. The 2020 effective income tax rate was unfavorably impacted by state and local taxes ($22.3 million ) and foreign taxes ($6.2 million ), and was favorably impacted by a benefit related to share-based compensation ($11.5 million ). The 2019 effective income tax rate was unfavorably impacted by state and local taxes ($18.0 million ), foreign taxes ($1.8 million ), a valuation allowance increase ($3.4 million ), and increases in uncertain tax positions (7.5 million). The 2019 effective income tax rate was favorably impacted by a tax benefit related to share-based compensation ($3.7 million ). 19
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Net income from continuing operations
Net income from continuing operations was$554.4 million in 2020 compared to$431.3 million in 2019. The increase of$123.1 million was due to higher operating income, higher other (income) expense, net and lower interest expense, partly offset by higher income taxes and equity in losses of affiliate.
Results By Segment
Plumbing
Net sales increased by$174.9 million , or 8.6%, due to higher sales volume from retail and e-commerce customers in theU.S. who benefited from strong consumer demand from higher home investments, higher sales volume inChina despite temporary closures for COVID-19 and price increases to help mitigate the cumulative impact of tariffs. These factors were partly offset by higher rebate costs and lower sales from showroom customers whose locations closed or operated at limited capacity as a result of the COVID-19 pandemic as well as unfavorable foreign exchange of approximately$1 million . Operating income increased by$40.3 million , or 9.4%, due to higher sales volume and the benefit from productivity improvements. These benefits were partly offset by unfavorable channel mix, higher advertising and marketing costs, asset impairment charges ($13.0 million in 2020), higher employee related costs and the impact of higher tariffs as well as unfavorable foreign exchange of approximately$2 million .
Outdoors & Security
Net sales increased by$70.3 million , or 5.2%, due to higher volume for decking and doors products due to strong consumer demand benefiting from higher home investments, price increases to help mitigate tariffs and the benefit from new customers in decking products. These factors were partially offset by lower volume primarily due to COVID-19 related weakness in the commercial and international security markets, the discontinuance of a doors product line, higher rebate costs and unfavorable mix. Foreign exchange was unfavorable by approximately$2 million . Operating income increased by$29.0 million , or 16.8%, due to higher sales volume, the benefit from productivity improvements, the absence in 2020 of expenses related to Fiberon's inventory fair value adjustment ($1.8 million in 2019) and a fair value adjustment associated with an idle manufacturing facility ($1.7 million in 2019). Foreign exchange was favorable by approximately$3 million . These factors were partially offset by unfavorable mix, higher employee related costs, the impact of higher tariffs and higher restructuring costs.
Cabinets
Net sales increased by$80.5 million , or 3.4%, due to higher volume and price increases to help mitigate the cumulative impact of tariffs. These factors were partly offset by a continued shift to value-priced products from make-to-order products and higher transportation costs, as well as unfavorable foreign exchange of approximately$1 million . Operating income increased by$57.4 million , or 32.2%, due to higher net sales, lower asset impairment charges ($32.0 million decrease) and the benefit from productivity improvements. These factors were partly offset by a continued shift to value-priced products from make-to-order products and higher transportation costs. 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 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, 2020 , the Company had aggregate outstanding notes in the principal amount of$1.8 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, 2020 andDecember 31, 2019 : (in millions) Net Carrying Value Coupon Rate Principal Issuance Date Maturity
Date
Amount
3.000% Senior Notes $ 400.0 June 2015 June 2020 $ - $ 399.7
4.000% Senior Notes 500.0 June 2015 June 2025 496.6 495.8
4.000% Senior Notes (the
"2018 Notes") 600.0 September 2018 September 2023 597.1 596.1
3.250% Senior Notes (the
"2019 Notes") 700.0 September 2019 September 2029 693.5 692.7
Total Senior Notes $ 1,787.2 $ 2,184.3
During June 2020 , we repaid all outstanding 3.000% Senior Notes issued in June
2015 at their maturity date using borrowings under our 2019 Revolving Credit
Agreement (as defined below). In September 2019 , we issued $700 million of the
3.25% Senior Notes due 2029 in a registered public offering. 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.
Notes payments due during the next five years as of December 31, 2020 are zero
in 2021 through 2022, $600 million in 2023, zero in 2024 and $500 million in
2025.
Credit Facilities
In
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, 2020 andDecember 31, 2019 , our outstanding borrowings under this credit facility were$785.0 million and zero, respectively. As ofDecember 31, 2020 , we were in compliance with all covenants under this credit facility. We currently have uncommitted bank lines of credit inChina , which provide for unsecured borrowings for working capital of up to$17.5 million in aggregate as ofDecember 31, 2020 andDecember 31, 2019 , of which there were no outstanding balances as ofDecember 31, 2020 and 2019. The weighted-average interest rates on these borrowings were zero in 2020 and 2019.
The components of external long-term debt were as follows:
(In millions) 2020
2019
Notes$ 1,787.2 $
2,184.3
$1,250 million revolving credit agreement due September 2024 785.0 - Total debt 2,572.2 2,184.3 Less: current portion - 399.7 Total long-term debt$ 2,572.2 $ 1,784.6 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, 2020 . 21
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Table of Contents Cash and Seasonality In 2020, we invested approximately$97.8 million in incremental capacity to support long-term growth potential and new products inclusive of cost reduction and productivity initiatives. We expect capital spending in 2021 to be in the range of$210 to$250 million . OnDecember 31, 2020 , we had cash and cash equivalents of$419.1 million , of which$342.9 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 2020, we repurchased 2.9 million shares of our outstanding common stock under the Company's share repurchase program for$187.6 million . As ofDecember 31, 2020 , the Company's total remaining share repurchase authorization under the remaining program was approximately$462.4 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 2020, we paid dividends in the amount of$133.3 million to the Company's stockholders. 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 stockholder value. InDecember 2020 , we acquired 100% of the outstanding equity of Larson, the North American market leading brand of storm, screen and security doors, for a total purchase price of approximately$715.2 million , net of cash acquired and closing date working capital adjustments. The acquisition cost is further subject to the final post-closing working capital adjustment. Larson also sells related outdoor living products including retractable screens and porch windows. 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$470 million , subject to certain post-closing adjustments. The acquisition of Fiberon provided category expansion and product extension opportunities into the outdoor living space for our Outdoors & Security segment. We financed the transactions using cash on hand and borrowings under our revolving credit and term loan facilities. The results of both acquisitions are included in the Outdoors & Security segment from the date of acquisition. Cash Flows Below is a summary of cash flows for the years endedDecember 31, 2020 and 2019. (In millions) 2020 2019 Net cash provided by operating activities$ 825.7 $ 637.2 Net cash used in investing activities (923.5 ) (127.6 ) Net cash provided by (used in) financing activities 111.6 (389.7 ) Effect of foreign exchange rate changes on cash 16.3
4.3
Net increase in cash, cash equivalents and restricted cash
Net cash provided by operating activities was$825.7 million in 2020 compared to$637.2 million in 2019. The$188.5 million increase in cash provided from 2019 to 2020 was primarily due to higher net income, lower increases in working capital and increases in accrued taxes. Net cash used in investing activities was$923.5 million in 2020 compared to$127.6 million in 2019. The increase in cash used of$795.9 million from 2019 to 2020 was primarily due to the acquisition of Larson and additional shares of Flo Technologies during 2020 and increased capital expenditures. Net cash provided by financing activities was$111.6 million in 2020 compared to cash used in financing activities of$389.7 million in 2019. The increase in net cash provided of$501.3 million from 2019 to 2020 was primarily due to lower net borrowings in 2020 compared to 2019 ($535.7 million ), higher proceeds from the exercise of stock options and the absence of deferred 22
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acquisition payments made during 2019 (
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 2020 and 2019, we contributed$47.7 million and$10.0 million , respectively, to our qualified pension plans. In 2021, we expect to make pension contributions of approximately$10.0 million . As ofDecember 31, 2020 , the fair value of our total pension plan assets was$784.9 million , representing funding of 84% 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
Long-term debt $ 2,585.0 $ - $ 600.0 $ 1,285.0 $ 700.0
Interest payments on long-term debt(a) 408.0 77.8 163.7 75.5 91.0
Operating leases 203.5 42.8 67.5 40.5 52.7
Purchase obligations(b) 731.7 689.0 32.6 10.1 -
Defined benefit plan contributions(c) 10.0 10.0 - - -
Total $ 3,938.2 $ 819.6 $ 863.8 $ 1,411.1 $ 843.7 (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 2021.
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,$96.1 million of unrecognized tax benefits as ofDecember 31, 2020 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, 2020 . Other corporate commercial commitments include standby letters of credit of$34.6 million , in the aggregate, all of which expire in less than one year, and surety bonds of$15.1 million , of which$15.0 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, 2020 , 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. Foreign Currency Risk Certain anticipated transactions, assets and liabilities are exposed to foreign currency risk. Principal currencies hedged include the Canadian dollar, the 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 Accounting Standards Codification ("ASC") requirements for
Derivatives and Hedging, we recognize all derivative contracts as either assets
or liabilities on the balance sheet, and the measurement of those instruments is
at fair value. 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
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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 (loss) gains of$(3.0) million and$4.1 million (before tax impact) were reclassified into earnings for the years endedDecember 31, 2020 and 2019, respectively. Based on foreign exchange rates as ofDecember 31, 2020 , we estimate that$2.0 million of net derivative gain included in accumulated other comprehensive income ("AOCI") as ofDecember 31, 2020 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 withU.S. generally accepted accounting principles ("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 Credit Losses
Trade receivables are recorded at the stated amount, less allowances for discounts and credit losses. The allowances 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 for credit losses include provisions for certain customers where a risk of default has been specifically identified. In addition, the allowances include a provision for expected customer defaults on a general formula basis when it cannot yet be associated with specific customers. Expected credit losses are estimated using 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 credit losses was$6.7 million and$3.0 million as ofDecember 31, 2020 and 2019, 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$51.2 million and$46.1 million as ofDecember 31, 2020 and 2019, respectively. 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. During 2020, we recorded an impairment of$3.6 million related to a long-lived asset to be disposed of in selling, general and administrative expenses. During 2019, we recorded an impairment of$1.7 million related to a long-lived asset to be disposed of in cost of products sold. No impairments of long-lived assets were recorded during 2018. 24
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Table of Contents Business Combinations We account for business combinations under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations, which requires an allocation of the consideration we paid to the identifiable assets, intangible assets and liabilities based on the estimated fair values as of the closing date of the acquisition. The excess of the fair value of the purchase price over the fair values of these identifiable assets, intangible assets and liabilities is recorded as goodwill. Purchased intangibles other than goodwill are initially recognized at fair value and amortized over their useful lives unless those lives are determined to be indefinite. The valuation of acquired assets will impact future operating results. The fair value of identifiable intangible assets is determined using an income approach on an individual asset basis. Specifically, we use the multi-period excess earnings method to determine the fair value of customer relationships and the relief-from-royalty approach to determine the fair value of the tradename and proprietary technology. Determining the fair value of acquired intangibles involves significant estimates and assumptions, including forecasted revenue growth rates, EBITDA margins, percentage of revenue attributable to the tradename, contributory asset charges, customer attrition rate, market-participant discount rates and the assumed royalty rates. 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 rate, and other relevant factors.
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. 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 25
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rates; the assumed royalty rates; and the market-participant discount rates. We measure fair value of our indefinite-lived tradenames using the relief-from-royalty approach which estimates the present value of royalty income that could be hypothetically earned by licensing the brand name to a third party over the remaining useful life. The determination of fair value using this technique requires the use of estimates and assumptions related to forecasted revenue growth rates, the assumed royalty rates and the market-participant discount rates. 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. See Note 5, "Goodwill and Identifiable Intangible Assets," for additional information. During the second quarter of 2020, extended closures of luxury plumbing showrooms associated with COVID-19 led to lower than expected sales related to an indefinite-lived tradename within the Plumbing segment, which combined with the updated financial outlook compared to previous forecasts and the continued uncertainty of the pandemic on the sales and profitability related to the tradename led us to conclude that it was more likely than not that the indefinite-lived tradename was impaired. Therefore, we performed an interim impairment test as ofJune 30, 2020 , and as a result we recognized a pre-tax impairment charge of$13.0 million related to this tradename. We also performed an evaluation of the useful life of this tradename and determined it was no longer indefinite-lived due to changes in long-term management expectations and future operating plans. As a result, the remaining carrying value of this tradename is being amortized over its estimated useful life of 30 years. In the first quarter of 2020, we recognized an impairment charge of$9.5 million related to an indefinite-lived tradename in our Cabinets segment. This charge was primarily the result of lower expected sales of custom cabinetry products related to the impact of COVID-19. In the fourth quarter of 2019, we recognized an impairment charge of$12.0 million related to the same indefinite-lived tradename, which 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, 2020 , the carrying value of this tradename was$29.1 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, 2020 , the carrying value of this tradename was$85.0 million . 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, 2020 , the carrying value of this tradename was$39.8 million . 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, assumed royalty rates, and market-participant discount rates that reflect the level of risk associated with the tradenames' future revenues and profitability. We selected the assumptions used in the financial forecasts using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management plans. These assumptions represent level 3 inputs of the fair value hierarchy (refer to Note 9). As ofDecember 31, 2020 , the fair value of four Cabinets' tradenames exceeded their carrying values of$180.6 million by less than 30%. A reduction in the estimated fair value of the tradenames in our Cabinets segment 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, more severe impacts of the COVID-19 pandemic than currently expected, 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. 26
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Table of Contents Defined Benefit Plans We have a number of pension plans inthe United States , covering many of the Company's employees. In addition, the Company provides postretirement health care and life insurance benefits to certain retirees. Service cost for 2020 relates to benefit accruals for an hourly Union group within the defined benefit plan for our Outdoors & Security segment. All other benefit accruals under our defined benefit pension plans were frozen as of, or prior to,December 31, 2016 . 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 losses was$2.8 million and$34.7 million in 2020 and 2019, respectively. The total net actuarial losses in accumulated other comprehensive income for all defined benefit plans were$87.1 million as ofDecember 31, 2020 , compared to$87.4 million as ofDecember 31, 2019 . We record amounts relating to these defined benefit plans based on various actuarial assumptions, including discount rates, assumed rates of return, compensation increases, 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 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 rate of 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, 2020 and 2019 was 4.5% and 4.9%, 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, 2020 and 2019 was 2.6% and 3.3%, 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, 2020 , for postretirement medical and prescription drugs in the next year, our assumption was an assumed rate of increase of 6.4% for pre-65 retirees and 7.4% for post-65 retirees, declining until reaching an ultimate assumed rate of increase of 4.5% per year in 2027. 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.
Below is a table showing pre-tax pension and postretirement expenses, including the impact of actuarial gains and losses:
(In millions) 2020
2019
Total pension (income) expense$ (0.8 ) $ 32.3 Actuarial loss component of expense above 2.7
34.1
Total postretirement expense 0.7
1.1
Actuarial loss component of expense above 0.1
0.6
Amortization of prior service credit component of expense above -
0.2
The actuarial losses in 2020 were principally due to changes in discount rates
offset by positive asset returns. The actuarial losses in 2019 were principally
due to changes in discount rates. Discount rates in 2020 used to determine
benefit obligations decreased by an average of 70 basis points for pension
benefits. Discount rates for 2020 postretirement benefits decreased an average
of 50 basis points. 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. Our
actual return on plan assets in 2020 was 16.5% compared to an actuarial
assumption of an average 4.5% expected return. Our actual return on plan assets
in 2019 was 19.7% compared to an actuarial assumption of an average 4.9%
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
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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 basis 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, 2020 , we had liabilities for unrecognized tax benefits pertaining to uncertain tax positions totaling$96.1 million . It is reasonably possible that the unrecognized tax benefits may decrease in the range of$4.0 million to$48.1 million in the next 12 months primarily as a result of the conclusion ofU.S. federal, state and foreign income tax proceedings.
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).
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, 2020 , ten
such instances have not been dismissed, settled or otherwise resolved. In 2020,
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
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