MasterBrand, Inc. (NYSE:MBC) Q4 2022 Earnings Call Transcript

MasterBrand, Inc. (NYSE:MBC) Q4 2022 Earnings Call Transcript March 9, 2023

Operator: Welcome to MasterBrand’s Fourth Quarter and Full Year 2022 Earnings Conference Call. Please note that this conference call is being recorded. And now I would like to turn the call over to Farand Pawlak, Vice President of Investor Relations and Corporate Communication. Thank you. You may begin.

Farand Pawlak: Thank you, and good afternoon. We appreciate you joining us for today’s call. With me on the call today are Dave Banyard, President and Chief Executive Officer; and Andi Simon, Executive Vice President and Chief Financial Officer. We issued a press release earlier this afternoon disclosing our fourth quarter and full year 2022 financial results. If you do not have this document, it is available on the Investors section of our website at masterbrand.com. I’d like to remind you that this call will include forward-looking statements either our prepared remarks or the associated question-and-answer session. Each forward-looking statement contained in this call is based on current expectations and market outlook and is subject to certain risks and uncertainties that may cause actual results to differ materially from those anticipated.

Additional information regarding these factors appears in the section entitled Forward-looking Statements in the press release we issued today. More information about risks can be found under the heading Risk Factors on our Form 10 and other filings with the SEC, which are available at sec.gov and masterbrand.com. The forward-looking statements in this call speak only as of today, and the company does not undertake any obligation to update or revise these statements, except as required by law. Today’s discussion includes certain non-GAAP financial measures. Please refer to the reconciliation tables, recurring in the press release issued earlier this afternoon and are also available at sec.gov and masterbrand.com. Our prepared remarks today will include a business update from Dave followed by a discussion of our fourth quarter and full year financial results from Andi, along with our 2023 financial outlook.

Finally, Dave will make some closing remarks before we host a question-and-answer session. And with that, let me turn the call over to Dave.

Dave Banyard: Thanks, Farand, and good afternoon, everyone. First, I’d like to thank you all for joining us here today for our first earnings conference call as a stand-alone public company. It’s been a few months since our management team and I had a chance to introduce MasterBrand at our Investor Day in New York. Since then, we’ve not only completed the successful spin-off from Fortune Brands but also continue to execute well on our near-term and long-term goals. This afternoon, I’ll be — I’ll update you on our transformation progress and provide insights on how we’re navigating the current end market conditions. But before I do so, I’ll give a brief overview of our fourth quarter and full year financial performance. Andi will provide greater details later in the call, and we’ll share our 2023 outlook.

I’m pleased with our strong finish to 2022. We delivered another quarter of solid financial and operational performance to end the year with net sales of $784.4 million, an increase of over 5% compared to the fourth quarter of 2021. This year-on-year growth was driven by the continued benefit of previously announced price increases across our business and strong performance from select brands. As an example, mantra, our affordably priced full plywood construction product grew double digits year-over-year in the fourth quarter, outpacing other parts of our business. Net sales growth was partially offset by volume declines in the broader business as higher interest rates and general economic uncertainty negatively impacted our customers. Adjusted EBITDA was $97.8 million compared to $66.7 million in the fourth quarter of 2021.

This increase is due to favorable net average selling price, or ASP, along with continuous improvement benefits which more than offset material logistics and personnel inflation. Adjusted EBITDA margin was 12.5% compared to 9% in the comparable period of the prior year, an expansion of 350 basis points. The fourth quarter performance closed out an exceptional full year. We ended 2022 with net sales of approximately $3.3 billion. This represents year-on-year growth of roughly 15%, slightly higher than our expected range of 13% to 14%. Full year 2022 adjusted EBITDA was $411.4 million, a year-on-year increase of roughly 29% compared to 2021. Adjusted EBITDA margins expanded 150 basis points year-on-year to 12.6%, in line with our expected margin performance.

We achieved our expected net sales and adjusted EBITDA margin performance despite the softening in our end markets. I’d like to take a moment and provide more color on what we’re seeing in both new construction and repair and remodel or R&R. In early December, we saw builder channel orders slow more than anticipated as we exited the year. This varies by region with new construction market in the Southeast part of the U.S. holding up better than other areas. Western states, traditionally some of the faster-growing markets are stable, but activity is slower than this time last year. Overall, for new construction, we’ve seen the market stabilize through the beginning of 2023, but we are anticipating a challenging year in this portion of our business.

R&R through both our dealer and retail channel has been consistent since the end of the third quarter, albeit at a lower level than in the prior year. While our higher-priced custom product has proven resilient, we are seeing a bigger shift to lower-priced product in general. Our breadth of offering from custom to stock cabinets allows us to shift customers between product lines. Our mantra brand, which I mentioned earlier, is a great example of a high-quality, lower-priced option we can offer to customers looking to reduce costs. As we discussed during our Investor Day presentation, our multi-brand strategy is designed to move with the market and meet consumers where they are, whether it be in style or price point. We anticipate similar market conditions to persist for much of 2023 with larger declines in new construction and more moderate declines in our dealer and retail channel servicing R&R.

Andi will provide more detail on our outlook later in the call. While 2023 looks to be a softer environment. We believe, and I think there’s good data to support this view that the longer term trends are very favorable for the housing market and the building products company is servicing it. We look at the significant aging of the housing stock with the median age of the house now at 39 years and the U.S. market being roughly underbuilt by 3 million homes is a positive long-term backdrop for us. And if you look at our performance over the last several years, we’ve built a track record of continuous improvement. Since we started our transformation in 2019, we’ve grown net sales by almost $1 billion with a compounded annual growth rate of 11%.

Likewise, we’ve grown adjusted EBITDA during the same 3-year period by over $150 million for a compound annual growth rate of roughly 17%. The exceptional results we delivered over the last few years is due to consistent execution. Having a clear strategy is important, but it needs to yield results, and that’s why execution is a key to success. Unique culture we have at MasterBrand is focused on utilizing the established tools of the MasterBrand Way, our business system, which is allowing us to achieve our strategic goals. At our Investor Day, we discussed why MasterBrand is the number one North American residential cabinet business. It’s our industry-leading dealer network, our unmatched product and brand portfolio and our operational excellence at scale.

The continuing transformation of the company is how we win going forward, and it’s what makes me so excited about our future growth potential. We’ve made meaningful progress in the fourth quarter on the 3 key initiatives driving this future growth, aligned to grow, lead through lean and tech-enabled. Aligned to grow based on the tools of 80/20 helps us identify great customers, determine what they want and then deliver exactly the way they want it in the most efficient way. That’s how we get value from align to grow. I spoke about some meaningful align to grow successes at our Investor Day, specifically around our common box initiative, and I’m pleased to say that we continue to make progress in this area. During the fourth quarter, we moved 2 more facilities to one of our 4 common construction platforms.

With our Winnipeg, Manitoba operations now converted, roughly 75% of our facilities are utilizing common construction. The common box has greatly reduced the number of component SKUs within our operations and eliminated unnecessary complexity. The important point to remember is this is complexity our customers and any consumers did not notice or value. Therefore, complexity we were not being rewarded for. Common box also allows us to shift volume across our platform, which has proven extremely advantageous as we look to manage capacity in a softer environment. Since we’ve now transformed the business to allow us to ship volume across our manufacturing network, we’ve been able to take 3 facilities offline in 2022 with no impact to customer service and delivery.

We know our business can be cyclical. So our strategic transformation aims to create a company that can flex production up and down depending on the market conditions. This is one reason why we believe we can deliver superior margin performance in any market. Lead through Lean is the next set of tools we’re using to drive future growth for the organization. Many of you might be familiar with the tools by now. And candidly, they’re not the differentiator. The tools are foundational, it’s the disciplined deployment of them and our culture that sets us apart. We look at lead through Lean as the ultimate engagement tool. We host a plethora of events every week empowering associates with the tools and resources they need to solve problems and drive efficiency.

During the fourth quarter alone, the organization held 59 Kaizen events. And for the full year, we hosted over 350 events, identifying roughly $80 million in addressable waste. Equipped with this information, we will prioritize these ways for future cost savings initiatives. In 2022, our prior initiatives yielded over $40 million in accumulated cost savings. When we get employees closer to the problem with tools and training they need to address it, we see them step forward and fix the issue. This not only engages them with their work, but it also helps us see leadership in action and allows us to promote from . Given the continued labor constraints, our ability to develop talent is great for retention. That’s why we say trust the tools, empower the team and move forward.

Our last tool and one with a lot of runway left is tech-enabled. We are focused on simplifying and modernizing our technology foundation to drive better insights and outcomes for the business. We plan to further leverage data and analytics in the back office, on the plant floor and with our customers to create value. During the fourth quarter, we continued to make progress in this area. In the back office, we made great strides on data consistency. We expanded our data lake footprint and usage of recently created digital dashboards, which have standardized multiple key metrics across the business. These focus on sales, orders, receivables, purchases, operations and incentives providing our team the near real-time information they need to make decisions.

On the plant floor, we’re making similar progress. We outlined additional automation solutions in the fourth quarter, such as further RFID usage and a pallet serialization implementation. These initiatives will both improve inventory accuracy and provide better visibility to material movement on the plant floor. We believe these actions can have a cost savings as early as the first half of 2023. On the customer-facing front, we successfully piloted a third-party delivery management software solution. This software enhances the customer experience for home delivery with improved order information, answering the common questions, where is my order? As you can see, a lot of great operational improvements by the team since we last spoke publicly in December.

Now let me hand it over to Andi for a deeper review of our financial performance. Andi?

Andi Simon: Thanks, Dave, and good afternoon, everyone. Like Dave said, it’s great to be joining you all here today on our first earnings call. I’ll begin with an overview of our fourth quarter and full year financial results, and then I’ll discuss our 2023 outlook. Fourth quarter net sales were $784.4 million, an increase of 5.3% over the same period last year. This growth was primarily driven by previously implemented price, partially offset by volume declines in certain areas of our business as higher interest rates and general economic uncertainty negatively impacted the end consumer. Gross profit was $215 million in the quarter, up over 14.4% compared to $187.9 million in the fourth quarter of last year. Gross profit margin expanded 220 basis points year-over-year from 25.2% to 27.4%.

Year-over-year growth and margin expansion were driven by higher net ASP and continuous improvement initiatives, which more than offset inbound logistics, material and labor inflation in our factories. Selling, general and administrative expenses were $161.3 million, up 18% compared to the same period last year, primarily due to separation costs, personnel-related inflation, outbound logistics costs and investments in our strategic initiatives, primarily in our tech-enabled efforts. This was partially offset by savings from our continuous improvement initiatives. SG&A as a percentage of net sales was 20.6%, an increase of 220 basis points compared to the same period last year. As a reminder, we classify outbound freight in SG&A, so any inflation in that area increases our SG&A spend.

We delivered net income of $15.4 million in the fourth quarter compared to $35.2 million in the comparable period last year, primarily due to the combined impact of intangible asset impairment, restructuring charges and restructuring-related items as well as additional Fortune Brands Home & Security allocations and onetime separation costs in the fourth quarter of 2022. These intangible asset impairments, restructuring charges and restructuring-related items were largely due to our continued strategic transformation resulting in a leaner, more agile manufacturing footprint. Excluding the impact of these charges, along with net cost savings as a stand-alone company, separation costs and defined benefit actuarial gains and losses, adjusted net income increased 66.6% year-over-year to $67.5 million.

Diluted earnings per share were $0.12 in the fourth quarter, down from a pro forma diluted earnings per share of $0.27 in the fourth quarter last year. It is important to note that prior year pro forma diluted earnings per share is calculated using 128 million shares outstanding. As under U.S. GAAP, it is assumed that there were no dilutive equity instruments prior to separation, as there were no equity awards of MBC outstanding. Adjusted diluted earnings per share were $0.52 in the fourth quarter. This is a 62.5% year-over-year increase compared to a pro forma adjusted diluted earnings per share of $0.32 in the fourth quarter of 2021. Adjusted EBITDA was $97.8 million in the fourth quarter, an increase of 46.6% compared to $66.7 million in the same period last year.

Our definition of adjusted EBITDA includes estimated net cost savings as a stand-alone company and excludes separation costs, restructuring charges and restructuring-related items, asset impairment charges and defined benefit actuarial gains and losses. Adjusted EBITDA margin expanded 350 basis points to 12.5% compared to 9% in the comparable period of the prior year. Moving on to our full year results. We delivered net sales of $3.3 billion in 2022, an increase of approximately 14.7% over the prior year. As Dave mentioned, this was slightly higher than the expectation laid out at our Investor Day. The year-over-year growth was driven by favorable net ASP, partially offset by a small volume decline. Gross profit was $940.5 million, up 20% compared to $783.9 million last year.

Gross profit margin expanded 120 basis points year-over-year from 27.5% to 28.7%. Like the fourth quarter, full year margin expansion was driven by higher net ASP and continuous improvement initiatives, which more than offset material logistics and personnel inflation in our factories. Selling, general and administrative expenses were $648.5 million, up 22.9% compared to the same period last year, primarily due to higher pre-spend corporate allocations from FBHS and the inflationary impact on outbound logistics and labor costs, partially offset by our continuous improvement efforts that allow for better utilization of fixed costs and personnel. These results include $5 million of strategic investments in the business. SG&A as a percentage of net sales was 19.8%, an increase of 130 basis points compared to last year due to the reasons previously explained.

I would like to note that we’ll not be discussing operating income as a financial metric going forward. Operating income was used by FBHS to speak about the various operating segment’s performance. As a stand-alone company, we believe our net income, EPS and adjusted EBITDA are more meaningful measures to discuss going forward. However, given we did provide near-term guidance for adjusted operating income at our Investor Day, I’m going to briefly touch on how we perform for 2022. Operating income for the full year was $203.3 million, down 13.2% from $234.3 million in 2021. This is primarily due to higher pre-spend corporate allocations from FBHS and the full year impact of intangible asset impairments and restructuring charges and restructuring-related items.

Excluding restructuring charges and restructuring-related items, asset impairments, separation costs, defined benefit actuarial gains and losses and parent company allocations, adjusted operating income was $375.3 million. Adjusted operating income margin for 2022 using historical FBHS reporting methodology, was 11.5%, consistent with our guidance at our Investor Day. Net income was $155.4 million compared to $182.6 million in the prior year, primarily due to higher pre-spend corporate allocations from FBHS, separation costs and the full year impact of asset impairments and restructuring charges and restructuring-related items, partially offset by the benefit of higher gross profit, including net cost savings as a stand-alone company and excluding separation costs, restructuring charges and restructuring-related items, asset impairments and defined benefit actuarial gains and losses, adjusted net income increased 30.5% year-over-year to $260.4 million.

Diluted earnings per share were $1.20 in 2022, down from a pro forma diluted earnings per share of $1.43. Again, the prior year pro forma diluted earnings per share is calculated assuming that there were no dilutive equity instruments prior to separation as there were no equity awards of MBC outstanding. Adjusted diluted earnings per share were $2.02 in 2022. This is a 29.5% year-over-year increase compared to a pro forma adjusted diluted earnings per share of $1.56 in 2021. Adjusted EBITDA was $411.4 million in 2022, an increase of 29.3% compared to $318.1 million last year. Adjusted EBITDA margin expanded 150 basis points to 12.6% for the full year compared to 11.1% in the prior year. We are extremely pleased with our ability to deliver strong full year margin expansion.

Turning to the balance sheet. Our balance sheet remains strong with cash on hand of $101.1 million and $265 million of liquidity available on our revolver. Net debt at the year-end was $877.9 million resulting in a net debt to adjusted EBITDA leverage ratio of 2.1x. This net debt to adjusted EBITDA ratio is based on the adjusted EBITDA provided in our earnings release, which varies slightly from the adjusted EBITDA under our credit agreement. The credit agreement definition also excludes the management equity compensation. We’ve chosen to lead this item in our definition of adjusted EBITDA because it is indicative of ongoing operations. Full year operating cash flow was $235.6 million compared to $148.2 million last year. This year-on-year improvement in operating cash flow is inclusive of elevated working capital due to continued inflation, inventory builds, designed to mitigate supply chain disruptions and restructuring related cash outflow and separation costs.

Our teams have already taken steps to bring our working capital in line with our 2023 outlook, which I will discuss shortly. Capital expenditures in 2022 were $55.9 million, and free cash flow was $179.7 million compared to $96.6 million last year. Overall, the team delivered strong 2022 results in the face of numerous challenges. We’ve achieved year-over-year double-digit net sales growth and adjusted EBITDA margin expansion of 150 basis points. At the same time, we continue to invest in our business to drive our strategy and deliver the growth and margin expansion outlined in our long-term financial targets. Before turning to the financial details of our outlook, let me build on Dave’s earlier market comments and the operating environment we anticipate in 2023.

Since our Investor Day, we have seen market conditions further soften. At that time, we anticipated the market to be down high single digits in 2023. We now expect our end markets to be down low double digits. This market outlook reflects larger declines in single-family new construction and more moderate declines in R&R, as Dave mentioned. We believe we will continue to outperform the market, so we will expect our performance to be slightly better from an order intake perspective. Our net sales will be further impacted by 2 additional factors. First, we will continue to benefit from the positive impact of price annualization in 2023 due to our previously announced pricing actions in 2022. This benefit will be partially offset by the shift we are seeing to lower-priced products in general, which will reduce overall ASP.

Adjusted EBITDA margins are relatively immune from shifts in product categories, but net sales and adjusted EBITDA dollars will be negatively impacted. Second, as mentioned at our Investor Day, our backlog has returned to a more normalized level due to our strong operational performance. This will present a headwind of nearly $200 million in 2023 or roughly a mid-single-digit impact to net sales year-over-year. Taking these factors into account, we now expect our 2023 net sales to be down mid-teens year-over-year. In anticipation of this environment, we have already taken action and continue to take actions to preserve margin performance. We are proactively executing our pricing strategies, supply chain improvements, cost controls and continuous improvement initiatives in order to maintain margins.

Coupled with our relatively higher variable cost structure and our flexible manufacturing network, we believe we will have best-in-class decremental margin performance in 2023. Our management team and organization have been through these market cycles before, and we know how to navigate them and deliver results. Similarly, we also know that now is not the time to stop investing for future growth. We will continue to invest further in our strategic initiatives especially in high-return areas such as our tech-enabled initiatives. We expect additional corporate expense of about $5 million to $10 million in 2023 for investments in these areas. We believe we can balance near-term margin performance with long-term value creation for all our stakeholders.

Given our net sales expectations, our ability to manage costs and our continued strategic investments, we expect adjusted EBITDA in the range of $305 million to $335 million with related adjusted EBITDA margins roughly 11% to 12% for 2023. In terms of quarter-by-quarter cadence through this year, while we won’t be providing quarter-by-quarter guidance, I will highlight that we expect to return to a normal seasonal pattern in 2023. In a typical year, first quarter and fourth quarter are lower margin periods with the spring and summer seasons driving higher sales and subsequent margins. First quarter 2023 margins will be further impacted by the flushing out of higher-priced inventory. MasterBrand has delivered best-in-class margin improvements over the last 3 years, and we are on track to continue this performance utilizing the prudent tools of the MasterBrand Way in 2023.

I recognize you are looking at us as a stand-alone company and creating your models for the first time. With that in mind, I will take this opportunity to provide some brief color on some other areas. Interest expense is expected to be approximately $70 million to $75 million primarily related to our $979 million of debt. We anticipate a tax rate between 25% to 26%. We are planning 2023 capital expenditures to be in the range of $50 million to $60 million as we pace our investments to align with anticipated future demand. Given the steps we have already taken to reduce working capital and these other factors, we expect free cash flow in excess of net income for 2023. Lastly, we expect no meaningful change in 2023 to our shares outstanding of approximately 128 million shares.

In closing, Master Brand has a history of delivering financial and operational excellence. While the market backdrop currently presents a more challenging environment for 2023, we believe our outlook reflects the continued strong performance you should expect from us through the cycle. With that said, I would like to turn the call back to Dave.

Dave Banyard: Thanks, Andi. Before we move to Q&A, I also want to take a moment to thank our more than 13,000 associates. Without them, we wouldn’t have achieved year-on-year double-digit growth in both net sales and adjusted EBITDA for 2022. Our first priority is always their safety, and we’re maniacal about it. I’m proud to say that in 2022, we achieved an OSHA recordable rate of 1.04, a year-on-year improvement of 5% from 2021. Over 69% better than the industry average, our goal is zero, keeping our teams safe is core to our culture. More so than ever, the concept of safety extends beyond physical. We’re a leader in our industry and that leadership extends to being a good steward of resources. Accordingly, we’re working to build an inclusive environment where employees feel safe coming to work and bringing their authentic selves.

Tomorrow, we will recognize International Women’s Day as a company. In advance of that, I would just like to thank all the women of MasterBrand for their contributions to our success. We’ve worked hard to bring many of the employee resource groups over during the spin from Fortune Brands. Our female-focused ERG included SAGE or support, advocate, grow and empower is for all women and their allies. Its purpose is to empower and raise the visibility of women through networking, professional development, engagement and business opportunities. I know the group has some great events planned for tomorrow, and I look forward to them. Now with that, I will open up the call to Q&A. Operator?

Q&A Session

Operator: And our first question comes from the line of Adam Baumgarten with Zelman.

Adam Baumgarten: Maybe just to start, Dave, if you could give an update on how the company’s strategy is progressing year-to-date and you gave some really good color at the Investor Day on some of the evolution you guys have driven in the business. But maybe sort of since the Investor Day, any kind of updates would be super helpful?

Dave Banyard: Yes, sure. Thanks, Adam. We’ve got a lot of — continue to make a lot of great progress on our strategy since the Investor Day. I’ll tick off a couple of examples on each of the sections, starting with a align to grow. There’s really 2 key components to align to grow. The align part, which is we’ve talked a lot about. It’s how we build a product set and a set of factories that have common characteristics to them that allow us to move production as necessary to meet the market. And a great example of that, it’s an unfortunate situation, but it’s an example where this really helped us I don’t know if you remember back in January, there was a lot of severe weather in the Southeast. It made national news with tornadoes in Southern Alabama, where we were impacted by that as well.

We have a plant in Southeastern Georgia. And the building, we share the building with another tenant, the building was damaged with the tornado during that time. And — the best news of it all, of course, is that our team acted promptly and well and everybody was in the storm shelter when the tornado hit. But we sustained some damage to our building. And so that plant has been closed since then. We anticipate at this point that the plant will be back up and running by the end of March. But this applies to align to grow because we were able to effectively move that production and none of this impacted any of our customers. And so that just shows the flexibility that we have within our network. It also shows, I think, that all of our associates are really keyed into safety and can act quickly.

But I think within align to grow, it’s a great example of how we’re able to move quickly when things change. And this is one that we hope obviously doesn’t happen regularly. The second part of align to grow is growth. And align to grow really focuses the organization on where the pockets of growth are whether that be in a particular channel, with a particular customer or with a particular product set — we launched a new product in early January, let’s say, RTA product that’s ready-to-assemble cabinet product based on the mantra platform. We’ve started putting that product out in select markets through here in the first quarter, and it’s doing quite well so far. So this initiative really helps us align the organization from the consumer all the way back through our supply chain, and we continue to drive forward with that.

I’ll talk briefly about the other 2 lead through lean and tech-enabled in a lot of ways go hand-in-hand, lead through lean is all about tackling the toughest problems that we have in the organization and empowering all of our associates to tackle those problems with the right tools. And the nice part about tech — a lot of the work we’re doing in tech-enabled is they’re facilitating a lot of that work as well. And I’ll give you a quick example of something that we’ve done over the last couple of months. We do these lean events, not just in the factory floor, which is a traditional place for these events. We do them in the back office as well, and our back office teams have reduced traction over the last couple of months by 60%, and they partner with the tech-enabled initiatives and that team to — when you find the waste and start eliminating and the tech-enabled team can come in and really accelerate the elimination of that waste by permanently eliminating it with automation or other tech tools that we have.

So those teams working hand-in-hand really drive results across every part of the business, which has been great.

Adam Baumgarten: Great. That’s super helpful. Just on the 2023 revenue guidance, I think you mentioned at one point outperforming the market, but it seems like that’s maybe not necessarily the case given the mid-teens revenue decline versus the market down low double digits. Can you maybe walk through in more detail kind of what’s driving that? And if you expect that to reverse at some point or even go the other way?

Dave Banyard: Yes, sure. I think the one way — the one word I would use to characterize the market at the moment is dynamic. And what I’ve learned and what we’ve learned over the past couple of months is the underlying demand is there. And we saw that early in the year when interest rates kind of stabilized in the later part of 2022 into early ’23, people jumped right back into the market. So I think it’s the challenge we’re facing is that there’s that dynamic movement of interest rates. And this market is — the consumer is much more interest rate sensitive than I think they’ve certainly been in the last few years and that they’ve been in a long time. And so the way we look at the market, we’re not going to try to react to these near-term swings because it’s not a good way to run your business.

So we’re looking through that and picking an end point, and we’ve built our operational footprint, our capacity, our supply chains around that. And so that’s what you’re seeing from us is picking that end point out to the future where we think the market is going. And so we think it’s going to be steady in that direction. Obviously, we’ll have the seasonality of the spring and summer that we normally see. And we’re seeing — we think that’s — we’re fairly back to that seasonality. And I think it’s fair to say we’ve changed our view slightly from what we talked about at the Investor Day where we said that we were going to — we expected the market to be down high single digits. We’re now saying down low teens. The big change there is in the builder side, the single-family new construction.

And what we’re seeing there, the change that we saw coming through 2022 and into the early part of this year is that the builder backlogs have started to come down. They’ve completed houses. And then obviously, at some point, you catch up to the starts level. And our initial thoughts on when that was going to occur have come in a little bit. So that’s what’s driving that move from high single digits to low teens. So that’s the market that we’re looking at. I think there’s a couple of additional factors that Andi highlighted, and these are things that are what they are. First and foremost is our backlog is very different at the beginning of this year. I’d actually say our backlog is normal now, which we had inflated backlogs for 2021 and 2022 and which is not an operating environment that we’re used to or that we like.

It extends lead times, it can be difficult to operate through. And that backlog is not present anymore. So I wouldn’t characterize our backlog as down. It’s certainly down compared to the beginning of 2022 by that roughly $200 million and that’s revenue that’s just not going to be there in this year. So that takes a big chunk out right there. But I think our backlog is normal now, and we like that. We have good visibility into what customers are looking for and can move quickly on that. So you combine those 2 and you’ve got a downdraft. On the flip side, we see ourselves gaining share this year. We commit to gaining 100 basis points of share every year, and we are annualizing the price increases. Our price increases didn’t occur all on January 1, 2022.

So there’s price annualization that occurs throughout the year as we go. And when you basically take all those things together, you end up at mid-teens down. So we still think — we still think we have opportunities to do better. Maybe there’s a difference there in backlog position. We got out of our backlog, I think, quicker than most. We were operating without a backlog towards the middle part or early part of Q4 because of our operational performance. And what that’s helped us do is see the path forward. So we’ve been able to adjust our fixed cost to be prepared for the current market environment.

Adam Baumgarten: Okay. And then just lastly, a couple for me. On just the kind of the biggest drivers behind the better than previously expected decremental margin guidance? And then just to clarify on the mix piece, I know the trade down is affecting ASP, but just to confirm, that’s not an EBITDA margin impact, if anything, could it be actually accretive to margins with the ?

Dave Banyard: Yes, let’s take the pieces that you’ve asked. You talked about the decrementals. And we feel that our decrementals are now 20% or better. A couple of things on that. One is we’ve gotten after the fixed cost side of things ahead of this. So we come into the year feeling that we’ve done the fixed cost actions that we needed to, to get there. And then on top of that, our funnel I think Andi highlighted some numbers around that, that our funnel of continuous improvement has really filled in nicely, and we know we have a team that can execute on that. So we’re confident in that. Your second question remind me again, sorry.

Adam Baumgarten: Just on the trade-down impact, is that — I know it hurts ASP, but does it — it seems like it doesn’t have a negative impact on the percentage margin, at least on EBITDA margin. Just maybe some clarity around that.

Dave Banyard: Yes. I mean, part of the efforts of the last few years has to — has been to really get all of our product categories into a profitability range that we’re happy with. And so — and it has a lot of strategic implications. We want to be able to bring the right product that the consumer wants at the right cost to that consumer. And so — and this is the kind of market where people are thinking about certain trade downs, and we see that. And we’ve spent a lot of time over the last 3 years building that engine that can make products in any price point that we’re happy with.

Operator: And the next question comes from the line of Garik Shmois with Loop Capital Markets.

Garik Shmois: Thanks for the color today. First question is just on the end markets, particularly on the R&R side of the equation, you highlighted that you’ve seen a weaker outlook on the new residential piece. But just curious, over the last several months since Investor Day, is your outlook on the R&R side changed at all?

Andi Simon: No. I think R&R has been very steady, even going back into the third quarter of last year. So I think we have good visibility of the pace of that market. There’s going to be some ups and downs that associated with interest rates because some people do borrow against their home to do those projects. So you see a little bit more activity when there’s — interest rates are down. But I think generally speaking, the pace has been very steady from last year third quarter into today.

Garik Shmois: Got it. Wanted to follow up on the price/mix comment. Just wanted to be clear here that the negative mix would more than offset the pricing carryover, I just wanted to make sure I heard that. But also just wanted to get your thoughts on pricing in maybe a little bit of a softer market, if you’re seeing any degradation in the — in your bidding activity?

Dave Banyard: Yes. So maybe it’s — maybe it was unclear. I think the — we are indifferent from a margin standpoint on the products we sell, for the most part, within our range. So I wouldn’t say that there’s a degradation of margin from a shift to lower price on products. And I also wouldn’t say that it’s trumping what I’ll say, the price annualization that we’ll see in the first part of this year. So sorry if I mischaracterized that, but that we will — price will help continue that into 2023. To your other question around price, again, for us, it comes back to the starting point is we want to move our customers into the price point that they’re comfortable with, so that they have the cost position that they’re comfortable with.

And we do a lot of work to help them using our various product categories to do that. So if they need a lower price product or a lower cost basket to build a kitchen, which obviously is a big part of what builders are asking for right now. We help them move into a different product category that can help them do that in many ways, more meaningful way than just a price reduction. So that’s our first approach to this. I will say there’s — we have retail partners that we do have some of the price indexed around the commodities that go into the product, and that’s going to ebb and flow. The nice part about that is it typically results in material costs out as well. They usually are fairly closely matched. And so we follow along and those retail customers are able to take advantage of that.

So that’s been our approach so far. I will say it’s — we’re not out of the inflation world yet, and we’re going to find out more information soon here on where that pace is going, but we’re still seeing inflation in certain parts. And so I think it would be — while demand has slowed compared to a year ago, I think you have to be careful about assuming that we’re seeing any deflation because that’s not the case.

Garik Shmois: Okay. That’s helpful. This is my last question, just on the decremental margins coming in better than what you had initially indicated. Just wondering if you could speak to the — just the sustainability of the permanence of some of these initiatives to drive better decrementals, whether it’s — if we’re going to be in a longer downturn, how sustainable is this with the new near 20% decremental level? And then conversely, if the market does improve to the degree you can drive better than normal incremental margins?

Dave Banyard: I mean what you’ve just stated is kind of the goal of the strategic initiatives that we’ve built, starting with align to grow is designed to identify where in your portfolio you have gaps in terms of profitability and where you’re not servicing the customer well enough, you’re providing something that you’re not getting paid for, all these kinds of things. And so it starts there. And then it moves on to our lean efforts, which really goes after every bit of waste that we have in the organization. And for good or bad, we have a lot more to do there. There’s a lot of waste still in our organization. We know that. So that, in my view, just this opportunity. And then to me, the tech-enabled part of it, as I highlighted in my example earlier, really accelerates stickiness of change because when you automate something, you almost make it permanent.

And so yes, it’s aggressive. That’s the kind of company we want to be. And we’re going to continue to go after the waste that we have in our organization. And at the same time, use these tools to help really show our customers that we’re the right partner to grow with. And we think both of those have a good effect on the P&L at the end of the day.

Operator: And the next question comes from the line of Tom Mahoney with Cleveland Research.

Tom Mahoney: I wanted to ask about the components of inventory growth year-over-year at the end of the year, and you spoke to efforts to move through working capital and move it lower I guess, early in the year, in particular, but through the year, can you size those efforts or speak to what you’re doing on those fronts?

Dave Banyard: Yes. Let me just start, and I’ll turn it over to Andi to be more specific. But the our — the majority of our inventory, Tom, is in raw material. We’re not a big finished goods holder. We don’t have space for it, frankly, and we tend to — most of our make-to-order product ships as soon as it’s manufactured. So we don’t carry a lot of finished goods in general. And I think we’re — we have direct control over that. So that’s one that I think we’re in a good place on. WIP very similarly, you end up with a steady state of WIP, and I think we’re in a good place there. So the majority of the inventory increases that we saw last year were around raw material. And we actually started investing in that in late 2021, seeing that the supply chain wasn’t getting any better and that we needed to make sure we could still deliver at a high service level to our customers.

And we did that through, I’d say, the first quarter of 2022 and then started seeing that perhaps we need to change that. And as volumes start coming down at the same time you’re trying to reduce inventory, it takes a little longer, but I still — I’m really proud of the team’s effort. We had — I think we increased inventory by about $70 million last year, but yet still delivered, I think, really good cash flow for the year. And so I think we’ve got more to go. But — and so I think we’re going to have another great cash flow year this year in 2023 as we do that. But it was a conscious effort on our part to build inventory, and we just have to get it back down to the main product. Andi, do you want to add anything on that…

Andi Simon: Yes, just I think a couple, if you remember from Investor Day, we mentioned that inventory was up year-on-year about $100 million. And in reality, you’ll see in the cash flow, it was up 70%, and that’s because we started those initiatives early in October. So we were able to reduce inventory pretty significantly in November and December. And so far, year-to-date, we are continuing on our trend to reduce that inventory down to more normal levels, relieving that excess safety stock from the supply chain disruption.

Tom Mahoney: Got it. That’s helpful. And then in terms of facilities, you talked about 3 facilities off-line in 2022. Are those able to come back as demand returns? Are there any further facility closures or plans contemplated in the outlook and the better decrementals that you’re guiding to today? Can you talk through that?

Dave Banyard: Sure. First and foremost, we — one of the first things I addressed when I joined the company 3 years ago was capacity, and we’ve been consistently investing in the right capacity since then, since early 2020. And so — and the facilities we took offline this year are — they are coming in several different flavors. So bear with me. One of them was a facility that we don’t need anymore. That one’s offline, and we’ll be selling that building at some point. The — one of them is a situation where our efficiency, and this is in Winnipeg, Manitoba, in Canada. We’ve gotten the efficiency down in that portion of the business that we didn’t need to buildings. So we’re holding on the other one. We have some growth ideas that we might use it, but it’s — we were able to drive efficiency in that business enough to consolidate into 1 building.

And then the last one is more of a situation where we have the capacity. We don’t need it right now. So I’d call it more of an idling of that facility. Obviously, that one will take a little time to get back online, but because we’ll have to bring people in and train them, but we have that available to us should the market turn. But I’d also say with the existing capacity we have today, we have upside ability should that market turn differently than how we’re forecasting the market today. So we’re prepared for that as well as, frankly, a further downturn. We’ll go after further action. We always want to get the fixed cost under control is the first move you have to do. And that’s what we did for most of the second half of last year.

Operator: And the next question comes from the line of Tim Wojs with Baird.

Tim Wojs: Maybe just a bigger picture question, Dave. When you think about just the goal to kind of gain share every year for the organization, I mean, are there 2 or 3 specific buckets that you’re kind of targeting for those share gains? Or is it just a little bit of share in a lot of different spots?

Dave Banyard: Thanks, Tim. Great question. I think it’s — align to grow really divides up your thought process in the smaller, what I’ll call, digestible chunks. So it may come across in some ways as smaller in a discrete fashion. But I’d say in general, you think about we have the best dealer network in the industry. And we — but we know we don’t have 100% of the wallet of that in every case. So first move is to gain share of wallet in your existing channels. And so that’s always your first move, and you do that with either different service offerings or new products like this RTA product that I highlighted earlier. So we’ve done a lot of that with the mantra product. That’s what’s allowed us to accelerate the growth of that product — product line.

And then obviously, your next move is to go find those channels that you want, but you don’t have. And it’s a more competitive dynamic, obviously, in that, and there is some stickiness to particularly in the dealer channel to do that. But we think that align to grow really allows us to see the opportunities with the right service offering. And then as we further develop our tech-enabled initiative, I think there’s going to — we’re going to bring forward some things that really make that a compelling story. So that’s generally the approach you can bucket in those 2 large buckets, if you like. But I think each one is going to be on the street level smaller within the realm of responsibility that we give to people.

Tim Wojs: Okay. Okay. No, that’s helpful. And then just from an input cost perspective, I mean, — are you seeing kind of, I guess, a leveling out of input costs at this point? I mean, are you still seeing kind of pockets of inflation or any sort of kind of the outright deflation at this point?

Dave Banyard: Yes. So I think there’s a couple of things to add to that, and I’ll let Andi kind of give you guys a breakdown of our COGS here that might be helpful. But I think first and foremost, most like price, we’re sort of still annualizing the inflation we saw last year. So that’s going to take some time through the year. Plus our inventory was purchased last year. So it’s — some of that has higher costs. I will say vast majority, if not all, of our domestically sourced material is now into what I’d call a normal lead time in a normal safety stock. So that’s turning a lot quicker. — we’re pretty comfortable with the inventory position we have from a domestic supply chain, which is things like hardwood. The overseas material that it just has a longer lead time and you’ve got to work and we want to be good partners for our suppliers and work with them to manage that inventory level down.

So that’s — those 2 dynamics do affect and roll through the P&L here, particularly earlier in the year. However, we are seeing things — if you follow some of the indexes, obviously, there’s been some decline or flattening of prices in certain areas. And then in others, there hasn’t been as much. The key things — obviously, we buy a lot of wood, particleboard, plywood — we do buy resin and that’s also oil products are part of our finished products that we buy, and then we buy hardware that’s steel, and those are the general inputs. Andi, do you want to talk a little bit about the breakdown of our COGS, so…

Andi Simon: Yes. So when you look at our cost of the goods sold about 50% of it is material, and that includes freight . So just like resin, obviously impacted by fuel oil costs as well. And then our majority buys by far are wood and wood products. And then the remaining cost of sales is about 30% labor and then 20% overhead, and that overhead is variable and fixed. A little bit about 50-50 between fixed and variable on that overhead. And I think what’s important to mention is our distribution costs, which includes spread out. We have it in SG&A. I believe others have it up in cost of goods sold. So we have that down in SG&A, and it’s about — it is usually around mid-single digits of net sales, and that’s obviously impacted by fuel and oil and freight constraints.

Tim Wojs: Okay. Okay. Good. And then just, I guess, last one, just how do you think about normalized free cash flow for the organization? And I guess, for ’23, how would ’23 kind of perform relative to what a normalized cash flow number should be?

Andi Simon: So we do anticipate — in like 2022, our free cash flow was 115% of net income. And we, again, in 2023, plan to deliver free cash flow in excess of net income. A couple of dynamics going on. Obviously, performance, EBIT performance is we’re going to maintain margins and deliver there. We’re well on our way to working capital improvements that we talked about already on inventory, and we will be controlled in our CapEx spend. We’re going to focus our CapEx spend on particularly efficiency-related items, tech-enabled items, and we’ll keep that highly controlled. So again, we expect a strong free cash flow again in excess of net income in 2023.

Dave Banyard: And Tim, I’ll put a point on it. You know this about me, but I think cash is a great measure of performance, and it’s top of mind for us. So we’ll continue to drive that as we go forward.

Operator: At this time, there are no further questions. And now I’d like to turn the floor back over to Farand Pawlak for any closing comments.

Farand Pawlak: Thank you, operator, and thanks, everyone, for joining us. We appreciate your interest and support for the company, and we look forward to speaking on future calls. This concludes our call.

Operator: Thank you, everyone. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.