Fortune Brands Innovations, Inc. 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto, which are included in this report, as well as our audited consolidated financial statements for the year ended December 30, 2023, which are included in our Annual Report on Form 10-K for the year ended December 30, 2023. This discussion contains forward-looking statements that are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations for our business, operations, financial performance or financial condition in addition to statements regarding our general business strategies, the market potential of our brands, trends in the housing market, the potential impact of costs, including material and labor costs, the potential impact of inflation, expected capital spending, expected pension contributions, the expected impact of acquisitions, dispositions and other strategic transactions. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans,” “outlook,” “positioned” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may,” “confident,” “opportunity” and “could” are generally forward-looking in nature and not historical facts. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on current expectations, estimates, assumptions and projections of our management about our industry, business and future financial results, available at the time this report is filed with the Securities and Exchange Commission. Although we believe that these statements are based on reasonable assumptions, they are subject to numerous factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those indicated in such statements, including but not limited to: (i) our reliance on the North American and Chinese home improvement, repair and remodel and new home construction activity levels, (ii) the housing market, downward changes in the general economy, unfavorable interest rates or other business conditions, (iii) the competitive nature of consumer and trade brand businesses, (iv) our ability to execute on our strategic plans and the effectiveness of our strategies in the face of business competition, (v) our reliance on key customers and suppliers, including wholesale distributors and dealers and retailers, (vi) risks relating to rapidly evolving technological change, (vii) risks associated with our ability to improve organizational productivity and global supply chain efficiency and flexibility, (viii) risks associated with global commodity and energy availability and price volatility, as well as the possibility of sustained inflation, (ix) delays or outages in our information technology systems or computer networks, or breaches of our information technology systems or other cybersecurity incidents, (x) risks associated with doing business globally, including changes in trade-related tariffs and risks with uncertain trade environments, (xi) risks associated with the disruption of operations, (xii) our inability to obtain raw materials and finished goods in a timely and cost-effective manner, (xiii) risks associated with entering into potential strategic acquisitions and joint ventures and related integration activities, (xiv) impairments in the carrying value of goodwill or other acquired intangible assets, (xv) risks of increases in our defined benefit-related costs and funding requirements, (xvi) our ability to attract and retain qualified personnel and other labor constraints, (xvii) the effect of climate change and the impact of related changes in government regulations and consumer preferences, (xviii) risks associated with environmental, social and governance matters, (xix) potential liabilities and costs from claims and litigation, (xx) changes in government and industry regulatory standards, (xxi) future tax law changes or the interpretation of existing tax laws, (xxii) our ability to secure and protect our intellectual property rights, (xxiii) the impact of COVID-19 on the business, (xxiv) our ability to achieve the expected benefits of the separation of MasterBrand, Inc. (“MasterBrand”), the Company’s Cabinets business (the “Separation”) (xxv) the risk that we may be required to indemnify MasterBrand in connection with the Separation or that MasterBrand’s indemnities to us may not be sufficient to hold us harmless for the full amount of liabilities for which MasterBrand has been allocated responsibility and (xxvi) the potential that the Separation fails to qualify as tax-free for U.S. federal income tax purposes. These and other factors are discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 30, 2023. We undertake no obligation to, and expressly disclaim any such obligation to, update or clarify any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or changes to future results over time or otherwise, except as required by law. 19 OVERVIEW References to “Fortune Brands,” “the Company,” “we,” “our” and “us” refer to Fortune Brands Innovations, Inc. and its consolidated subsidiaries as a whole, unless the context otherwise requires. The Company is a leading innovation company focused on creating smarter, safer and more beautiful homes and improving lives that competes in attractive long-term growth markets in our product categories. We believe that the Company has certain competitive advantages including market-leading brands, a diversified mix of channels, lean and flexible supply chains, 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 the categories we serve and our leading brands. The long-term outlook for our products remain favorable, and our strategic advantages, including the set of capabilities we refer to as the Fortune Brands Advantage, helps 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 products primarily consists of spending on both new home construction and repair and remodel activities within existing homes, with a 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. Increases in inflation and mortgage rates during the preceding years have slowed the pace of single-family and existing home sales activity and new home construction and repair and remodel activities. However, we believe we are well positioned to manage what we expect to be a short-term slow-down in the housing market as we believe the fundamental drivers of the housing market remain intact. We have been and may continue to be impacted by near-term supply, labor and freight constraints, a volatile global supply chain environment, as well as sustained increased rates of inflation, increased interest rates, unfavorable fluctuations in foreign exchange rates and the ongoing costs of tariffs. We continue to manage these challenges and are diligently working to offset potential unfavorable impacts of these items through continuous productivity improvement initiatives and price increases. On February 29, 2024, we acquired 100% of the outstanding equity of Wise Water Solutions LLC, doing business as SpringWell Water Filtration Systems ("SpringWell"), for a purchase price of $105.2 million, subject to post-closing adjustments, net of cash acquired of $1.4 million. We financed the transaction using cash on hand and borrowings under our existing credit facility. The results of SpringWell are reported as part of the Water Innovations ("Water") segment. We have not included pro forma financial information as the transaction is immaterial to our condensed consolidated statements of comprehensive income. The fair value allocated to assets acquired and liabilities assumed as of February 29, 2024, was $105.2 million, which includes $84.0 million of goodwill. Goodwill includes expected sales and cost synergies and is expected to be deductible for income tax purposes. In June 2023, we acquired the Emtek and Schaub premium and luxury door and cabinet hardware business (the "Emtek and Schaub Business") and the U.S. and Canadian Yale and August residential smart locks business (the "Yale and August Business", and, collectively with the Emtek and Schaub Business, the "Acquired Businesses") from ASSA ABLOY, Inc. and its affiliates ("ASSA"). The Company completed the acquisition for a total purchase price of approximately $809.3 million, subject to post-closing adjustments, net of cash acquired of $16.3 million. As of the date of this filing, legal title to international operations in Vietnam has not yet transferred, but we expect a deferred closing, which will include a payment of approximately $23.5 million (which amount is already included in the overall purchase price but for which the cash payment has not yet been made) shortly following receipt of local regulatory approval. In preparation for the deferred closing, $23.5 million is classified as restricted cash within Other current assets and the corresponding payable is included within Other current liabilities. We financed the transaction with cash on hand. The results of the Emtek and Schaub Business are reported as part of the Water segment, and the results of the Yale and August Business are reported as part of the Security segment. 20 RESULTS OF OPERATIONS Thirteen Weeks Ended March 30, 2024 Compared to Thirteen Weeks Ended April 1, 2023 Net Sales (In millions) 2024 2023 % Change vs. Prior Year Water $ 625.3 $ 594.2 5.2 % Outdoors 315.0 289.9 8.7 Security 169.3 155.9 8.6 Net sales $ 1,109.6 $ 1,040.0 6.7 % Operating Income (Loss) 2024 2023 % Change vs. Prior Year Water $ 141.3 $ 128.4 10.0 % Outdoors 34.3 13.0 163.8 Security 19.1 21.1 (9.5 ) Less: Corporate expenses (39.3 ) (30.7 ) (28.0 ) Operating income $ 155.4 $ 131.8 17.9 % The following discussion of consolidated results of operations and segment results refers to the thirteen weeks ended March 30, 2024 compared to the thirteen weeks ended April 1, 2023. Consolidated results of operations should be read in conjunction with segment results of operations. Net sales Net sales increased by $69.6 million, or 6.7%, due to the benefit from the acquisition of the Acquired Businesses ($93.7 million) and higher sales in our international markets ($14.9 million), partially offset by higher customer sales incentives, lower sales unit volume in the U.S. and unfavorable foreign exchange ($1.0 million). Cost of products sold Cost of products sold decreased by $9.7 million, or 1.5%, due to raw material cost deflation, lower transportation costs and productivity improvements in all of our segments as a result of strategic sourcing initiatives and manufacturing efficiencies. These factors were partially offset by the impact of the acquisition of the Acquired Businesses. Selling, general and administrative expenses Selling, general and administrative expenses increased by $50.8 million, or 19.5%, due to higher headcount related costs and higher advertising and marketing costs mainly as a result of the acquisition of the Acquired Businesses in addition to higher corporate expenses. Restructuring charges Restructuring charges of $2.8 million in the thirteen weeks ended March 30, 2024 are largely related to costs associated with the previously announced planned closure of a manufacturing facility within our Security segment, a product line rationalization within our Outdoors segment and headcount actions across all segments. Restructuring charges for the thirteen weeks ended April 1, 2023 were $3.1 million. Operating income Operating income increased by $23.6 million, or 17.9%, primarily due to raw material cost deflation, lower transportation costs and productivity improvements in all of our segments as a result of strategic sourcing initiatives and manufacturing efficiencies, and the impacts of the acquisition of the Acquired Businesses. These factors were partially offset by increased intangible amortization expense as a result of the acquisition of the Acquired Businesses ($5.2 million), higher customer sales incentives, higher headcount related costs, and unfavorable foreign exchange of approximately $1 million. 21 RESULTS OF OPERATIONS (Continued) Interest expense Interest expense increased by $3.3 million to $30.1 million due to higher floating rate debt balances ($373.7 million outstanding as of March 30, 2024) and higher fixed rate debt interest rates with the issuance of the $600 million outstanding principal amount of 5.875% Senior Notes due in June 2033 relative to the maturity and settlement of the $600 million outstanding principal amount of 4.000% Senior Notes due in September 2023. Other (income) expense, net Other expense, net, was $0.1 million in the thirteen weeks ended March 30, 2024, compared to other income, net of $6.3 million in the thirteen weeks ended April 1, 2023. The decrease in other income, net is primarily due to a decrease in foreign currency transaction income and interest income. Income taxes The effective income tax rates for the thirteen weeks ended March 30, 2024 and thirteen weeks ended April 1, 2023 were 23.0% and 23.1%, respectively. The difference between the Company’s effective income tax rate for the thirteen weeks ended March 30, 2024, and the U.S. statutory rate of 21% primarily relates to state income taxes and foreign income taxed at higher rates, partially offset by a valuation allowance release and tax credits. The difference between the Company’s effective income tax rate for the thirteen weeks ended April 1, 2023, and the U.S. statutory rate of 21% primarily relates to state income taxes, foreign income taxed at higher rates, partially offset by a favorable benefit related to decreases in uncertain tax positions and a valuation allowance release. Income from Continuing Operations, net of tax Income from continuing operations, net of tax, was $96.4 million in the thirteen weeks ended March 30, 2024, compared to $85.6 million in the thirteen weeks ended April 1, 2023. The increase was due to higher operating income, partly offset by higher interest expense, higher income tax expense and lower other income. Results By Segment Water Net sales increased by $31.1 million, or 5.2%, due to the benefit from the acquisition of the Acquired Businesses ($67.6 million) partially offset by higher customer sales incentives, lower sales unit volume in the U.S. and unfavorable foreign exchange ($1.2 million). Operating income increased by $12.9 million, or 10.0%, primarily due to the benefit from the acquisition of the Acquired Businesses, productivity improvements as a result of strategic sourcing initiatives and manufacturing efficiencies, lower transportation costs and raw material cost deflation. These factors were partially offset by increased intangible amortization expense due to the impact of the acquisition of the Acquired Businesses ($4.8 million) and higher headcount related costs. Outdoors Net sales increased by $25.1 million, or 8.7%, due to higher sales unit volume for our exterior doors products, partially offset by higher customer sales incentives and unfavorable channel mix. Operating income increased by $21.3 million, or 163.8%, due to the higher sales unit volume and productivity improvements as a result of strategic sourcing initiatives and manufacturing efficiencies. Security Net sales increased by $13.4 million, or 8.6%, due to the benefit from the acquisition of the Acquired Businesses ($26.1 million) partially offset by lower sales unit volume. Operating income decreased by $2.0 million, or 9.5%, due to lower sales unit volume and higher restructuring and other charges associated with the planned closure of a manufacturing facility, partially offset by productivity improvements as a result of strategic sourcing initiatives and manufacturing efficiencies, lower transportation costs and raw material cost deflation. 22 Corporate Corporate expenses increased by $8.6 million, or 28.0%, due to headcount related costs and costs related to our digital transformation efforts. 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 of our Annual Report on Form 10-K for the year ended December 30, 2023 entitled “Item 1A. Risk Factors”. In addition, we cannot predict whether or when we may enter into acquisitions, joint ventures or dispositions, repurchase shares of our common stock under our share repurchase program 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. Long-Term Debt At March 30, 2024, the Company had aggregate outstanding notes in the principal amount of $2.7 billion, with varying maturities (the “Notes”). The Notes are unsecured senior obligations of the Company. In addition, we believe that we have the ability to obtain alternative sources of financing if required. The following table provides a summary of the Company’s outstanding Notes, including the net carrying value of the Notes, net of underwriting commissions, price discounts and debt issuance costs as of March 30, 2024 and December 30, 2023: Net Carrying Value (in millions) Principal Amount Issuance Date Maturity Date March 30, 2024 December 30, 2023 4.000% Senior Notes $ 500.0 June 2015 June 2025 $ 499.1 $ 498.9 3.250% Senior Notes $ 700.0 September 2019 September 2029 695.9 695.7 4.000% Senior Notes $ 450.0 March 2022 March 2032 446.4 446.2 4.500% Senior Notes $ 450.0 March 2022 March 2052 436.0 435.9 5.875% Senior Notes $ 600.0 June 2023 June 2033 593.6 593.4 Total Senior Notes $ 2,671.0 $ 2,670.1 Credit Facilities In August 2022, the Company entered into a third amended and restated $1.25 billion revolving credit facility (the “Revolving Credit Agreement”), and borrowings thereunder will be used for general corporate purposes. The maturity date of the facility is August 2027. Interest rates under the Revolving Credit Agreement are variable based on SOFR at the time of the borrowing and the Company’s long-term credit rating and can range from SOFR + 1.02% to SOFR + 1.525%. Under the Revolving Credit Agreement, the Company is required to maintain a minimum ratio of consolidated EBITDA to consolidated interest expense of 3.0 to 1.0. Consolidated EBITDA is defined as consolidated net income before interest expense, income taxes, depreciation, amortization of intangible assets, losses from asset impairments, and certain other one-time adjustments. In addition, 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. On March 30, 2024 and December 30, 2023, there were no outstanding borrowings under this facility. As of March 30, 2024, we were in compliance with all covenants under this facility. We currently have uncommitted bank lines of credit in China, which provide for unsecured borrowings for working capital of up to $30.5 million in aggregate as of March 30, 2024 and December 30, 2023, respectively. There were no outstanding balances as of March 30, 2024 and December 30, 2023. 23 Commercial Paper The Company operates a commercial paper program (the “Commercial Paper Program”) pursuant to which the Company may issue unsecured commercial paper notes. The Company's Revolving Credit Agreement is the liquidity backstop for the repayment of any notes issued under the Commercial Paper Program, and as such borrowings under the Commercial Paper Program are included in Long-term debt in the condensed consolidated balance sheets. Amounts available under the Commercial Paper Program may be borrowed, repaid and re-borrowed, with the aggregate principal amount outstanding at any time, including borrowings under the Revolving Credit Agreement, not to exceed $1.25 billion. The Company will use any issuances under the Commercial Paper Program for general corporate purposes. Outstanding borrowings under the Commercial Paper Program as of March 30, 2024 and December 30, 2023 were $373.7 million and zero, respectively. Cash and Seasonality On March 30, 2024, we had cash and cash equivalents of $359.7 million, of which $274.2 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 fiscal quarters of each year. We believe that our current cash position, cash flow generated from operations, and amounts available under our revolving credit facility should be sufficient for our operating requirements and enable us to fund our capital expenditures, share repurchases, dividend payments, and any required long-term debt payments. Share Repurchases and Dividends On January 29, 2024, the Company's Board of Directors authorized the repurchase of up to $650 million of shares of the Company’s outstanding common stock over the next two years on the open market or in privately negotiated transactions or otherwise (including pursuant to a Rule 10b5-1 trading plan, block trades and accelerated share repurchase transactions), in accordance with applicable securities laws. In the thirteen weeks ended March 30, 2024, we repurchased 1.3 million shares of our outstanding common stock under the Company’s share repurchase program for $100.0 million. As of March 30, 2024, the Company’s total remaining share repurchase authorization under its share repurchase program was approximately $624.8 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. In the thirteen weeks ended March 30, 2024, we paid dividends in the amount of $30.1 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 On February 29, 2024, we acquired 100% of the outstanding equity of SpringWell for a purchase price of $105.2 million, subject to post-closing adjustments, net of cash acquired of $1.4 million. We financed the transaction using cash on hand and borrowings under our existing credit facility. The results of SpringWell are reported as part of the Water segment. We have not included pro forma financial information as the transaction is immaterial to our condensed consolidated statements of comprehensive income. The fair value allocated to assets acquired and liabilities assumed as of February 29, 2024, was $105.2 million, which includes $84.0 million of goodwill. Goodwill includes expected sales and cost synergies and is expected to be deductible for income tax purposes. In June 2023, we acquired the Acquired Businesses from ASSA. The Company completed the acquisition for a total purchase price of approximately $809.3 million, subject to post-closing adjustments, net of cash acquired of $16.3 million. We financed the transaction with cash on hand. As of the date of this filing, legal title to international operations in Vietnam has not yet transferred, but we expect a deferred closing, which will include a payment of approximately $23.5 million (which amount is already included in the overall purchase price but for which the cash payment has not yet been made), shortly following receipt of local regulatory approval. In preparation for the deferred closing, $23.5 million is classified as restricted cash within Other current assets and the corresponding payable is included within Other current liabilities. The results of the Emtek and Schaub Business are reported as part of the Water segment and the results of the Yale and August Business are reported as part of the Security segment. 24 We periodically review our portfolio of brands and evaluate potential strategic transactions and other capital initiatives to increase stockholder value. Cash Flows Below is a summary of cash flows for the thirteen weeks ended March 30, 2024 and the thirteen weeks ended April 1, 2023. (In millions) March 30, 2024 April 1, 2023 Net cash (used in) provided by operating activities $ (71.3 ) $ 76.1 Net cash used in investing activities (169.8 ) (42.6 ) Net cash provided by (used in) financing activities 238.7 (139.3 ) Effect of foreign exchange rate changes on cash (5.0 ) 2.2 Net decrease in cash and cash equivalents $ (7.4 ) $ (103.6 ) Net cash used in operating activities was $71.3 million in the thirteen weeks ended March 30, 2024, compared to net cash provided by operating activities of $76.1 million in the thirteen weeks ended April 1, 2023. The increase in cash used of $147.4 million was primarily due to an increase in inventory balances compared to the prior period as a result of our 2023 initiative to decrease inventory balances to align with the U.S. home product market activity and increases in accounts receivables resulting from higher net sales, partially offset by increases in accounts payable. Net cash used in investing activities was $169.8 million in the thirteen weeks ended March 30, 2024, compared to net cash used in investing activities of $42.6 million in the thirteen weeks ended April 1, 2023. The increase in cash used of $127.2 million reflects the cash used in the SpringWell acquisition in February 2024 ($105.2 million) and an increase in capital expenditures. Net cash provided by financing activities was $238.7 million in the thirteen weeks ended March 30, 2024, compared to cash used in financing activities of $139.3 million in the thirteen weeks ended April 1, 2023. The increase in cash provided of $378 million was primarily due to net issuances under our commercial paper program ($375.0 million) and an increase in proceeds from the exercise of stock options. 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. As of December 30, 2023, the fair value of our total pension plan assets was $468.0 million, representing funding of about 96% of the accumulated benefit obligation liability. During the thirteen weeks ended March 30, 2024, we made no pension contributions. 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 Canada, Mexico, the United Kingdom, China, South Africa, Vietnam and France. Therefore, changes in the value of the related currencies affect our financial statements when translated into U.S. dollars. RECENTLY ISSUED ACCOUNTING STANDARDS Refer to Note 2, "Recently Issued Accounting Standards," in Item 1 for discussion of recently issued accounting standards. 25 Item 3. QUANTITATIVE AND QUALITATI VE DISCLOSURES ABOUT MARKET RISK. There have been no material changes in the information provided in the section entitled “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K for the year ended December 30, 2023.