MasterBrand Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 8 speakers on the call.

Operator

Welcome to the Master Brands Third Quarter 2023 Earnings Conference Call. During the company's prepared remarks, all participants will be in a listen only mode. Following management's closing remarks, callers are invited to participate in a question and answer session. Please note that this conference call is being recorded. I would now like to turn the call over to Farron Pollak, Vice President of Investor Relations and Corporate Communications.

Speaker 1

Thank you. 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 Andy Simon, Executive Vice President and Chief Financial Officer. We issued a press release earlier this afternoon disclosing our Q3 2023 financial results.

Speaker 1

If you do not have this document, it is available on the Investors section Our website at masterbrand.com. I would like to remind you that this call will include forward looking statements in 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 currently anticipated. Additional information regarding these factors appears in the section entitled Forward Looking Statements in the press release we issued today. More information about risk can be found in our filings with the Securities and Exchange Commission, including under the heading Risk Factors in our full year 2022 Form 10 ks and updated as necessary in our subsequent 2023 Form 10 Qs, which are available at sec.govand@masterbrand.com.

Speaker 1

The forward looking statements in this call speak only as of today, and the company does not undertake any obligation to update or revise any of these statements except as required by law. Today's discussion includes certain non GAAP financial measures. Please refer to the reconciliation tables, which are in the press release issued earlier this afternoon and are also available atsec.govand@masterbrand.com. Our prepared remarks today will include a business update from Dave, followed by a discussion of our Q3 2023 financial results from Andy along with our current 2023 financial outlook. Finally, Dave will make some closing remarks before we host a question and answer session.

Speaker 1

Now with that, let me turn the call over to Dave.

Speaker 2

Thanks, Farron. Good afternoon, everyone. We appreciate you joining us here today for our Q3 2023 earnings conference call. I'm pleased to report that Master Brand delivered another solid quarter of financial performance. Net sales in the Q3 were $677,000,000 a 21% decline over the same period last year.

Speaker 2

This decline was slightly greater than our expectations due to the impact of higher than anticipated trade downs. Absent the roughly 3% effect from trade downs, net sales for the Q3 were roughly in line with our previous outlook. Despite the net sales decline, adjusted EBITDA margin expanded by 150 basis points to 16.2% in the 3rd quarter. This equates to a year on year decremental margin of less than 10%, well inside our stated guidance. Our exceptional margin expansion was driven by the team's continued on Master Brands strategic initiatives, particularly around supply chain improvements and productivity savings.

Speaker 2

This performance was higher than our internal estimates as our associates continued to outperform our expectations. Our strategic initiatives drove another quarter of working capital improvements as we reduced inventory by roughly $50,000,000 sequentially from the end of the Q2 to the end of the Q3. Our supply chain efforts, which are rooted in our Align TO Grow initiative, are allowing us to reduce inventory as we continue to drive commoditization amongst our componentry, product and processes. Our rollout of RFID technology across our manufacturing network is helping improve inventory control at our facilities, while simultaneously reducing the labor costs. These inventory improvements helped us generate free cash flow of $133,000,000 in the Q3 of 2023, a threefold increase over the prior year quarter.

Speaker 2

Our year to date strong free cash flow not only demonstrates the value of our operational performance, It has also strengthened our balance sheet and provides us with great optionality in an uncertain market. Now I'll take a moment to discuss the end markets served by our customers and the trends we saw in the Q3. The single family new construction market remains the most resilient with underlying demand running flat year over year. We saw expected seasonality in this market late in Q3, which has continued into the Q4. Trends across builders vary as some are more equipped to navigate rising interest rates.

Speaker 2

Our large builder partners Continue to find ways to lower the cost of ownership for potential homebuyers. This includes buying down mortgage rates or providing other discounts. As a result, we've seen that portion of the market perform better than the overall market. As we have mentioned in the past, Builders are using product trade down to help reduce their costs and we saw this accelerate in the Q3. We expect this trend to persist through the Q4.

Speaker 2

On the whole, we continue to be encouraged by the resiliency of homebuilders despite the current interest rate environment, and we believe that the long term fundamentals for new construction are The repair and remodel market, which we serve through our dealer and retail customers, continued to be tepid in the 3rd quarter. In line with our prior commentary, this market demand is down more than our original expectations for the year as consumers are prioritizing other spending. At the beginning of the year, we expected this portion of the market to be down mid single digits. But as we finish the year, we anticipate closer to double digit Generally speaking, larger ticket R and R tends to have a greater magnitude change than the smaller project R and R. Additionally, our dealers are relaying that consumers' decision lead time has extended from a year ago, which adds some further inertia into the buying behavior.

Speaker 2

Specific to the U. S. Retail channel, we experienced the final stages of destocking this past quarter and we now believe that we have worked through the impact of it with our retail partners and are at underlying consumer demand levels. Retail POS is following the double digit decline in this category that I mentioned earlier. In the U.

Speaker 2

S. Dealer channel, we saw similar trends overall to the retail channel. But within dealers, we continue to see better performance in the higher and lower end product categories. We expect that dynamic to continue moving forward as cash customers favor more premium products and the rest of the market targets value priced products. As we heard last quarter from our dealer network, the end consumer is getting multiple quotes before doing a remodel project and looking for trade down opportunities to achieve a desired price point.

Speaker 2

We continue to experiment with price to ensure that we are putting the right products In Canada, both new construction and repair and remodel markets remain weak, declining over 25%. While Canada represents a relatively small portion of our net sales, slightly less than 10%, Year over year declines of this magnitude are presenting a headwind to our business. As discussed in our last earnings call, we expect continued weakness in this portion of our business in the second and product trade down to continue into the Q4. Domestic new construction continues to hold up better than repair and remodel, and we expect continued weakness across both Canadian markets. Coupled with normal seasonality, we now expect the overall market to be down sequentially from the 3rd quarter, Our performance matching that trend on a daily sales cadence.

Speaker 2

Andy will provide more color on this later in the call. With this frac drop in mind, we remain encouraged by our ability to deliver incremental cost savings despite an environment with softer down volume. At the same time, we are investing in the business and positioning our company for growth. Now I'd like to talk a little more about some of the investments we are making for our strategic initiatives. On the last earnings call, I mentioned that our strong performance gave us the confidence to accelerate investment spending, particularly in our tech enabled initiative.

Speaker 2

During the Q3, we did just that, more than doubling our investment in technology sequentially. And as mentioned on our previous earnings call, We plan to increase the spending further in the Q4 of 2023. These opportunities are across the plant floor, back office and customer facing. For example, we believe our tech enabled initiative presents a meaningful opportunity in the area of quality processes. Much like supply chain efficiency, quality processes are hindered by complexity in product offering and manufacturing.

Speaker 2

With our common box initiative and more standard work across the plants, we can now improve the overall efficiency and cost of the quality processes that exist today in our manufacturing. Using technology, we'll be able to inspect product quicker and with a higher degree of accuracy. Master Brand has robust automation throughout its facilities, but we see ample opportunity to introduce newer and more advanced automation to support our quality processes. While this technology might be newer to the cabinet industry, It has been proven in a number of other industries. Accordingly, we are trialing advanced yet time tested solutions in a number of areas this year and into 2024.

Speaker 2

Beyond the plant floor, we have expedited our efforts around cloud migration. We have varied systems that organically grew and constrained our ability to optimize decisions across functions, creating reporting inefficiencies and out of support hosted applications. With our cloud migration efforts, We are standardizing our processes based on leading practices leveraging centralized master data and near real time analytics. This helps us automate processes across Master Brand and enable shared service models for functions like AP and AR. This is also helping us allocate our internal resources from manual process steps to value added activities.

Speaker 2

Finally, we continue to invest in technology to improve the overall buying experience for our customers. Our new tech platforms are designed to improve the team and in applications to bring these tools to life for our customers. Our digital and technology team is making good progress in this area and are rolling out the first of these applications this quarter. Initiatives such as these serve as a reminder that the tools of the Master Brand Way not only drive efficiency, but also target growth. I look forward to sharing more details about our progress on these efforts going forward.

Speaker 2

Now I'd like to hand the call over to Andy a more detailed discussion of our Q3 financial results and our revised 2023 outlook.

Speaker 3

Thanks, Dave, and good afternoon, everyone. It's great to be joining you here today. I'll begin with an overview of our Q3 financial results and then I'll discuss our updated 2023 outlook. 3rd quarter net sales were $677,300,000 a 21.1 percent decline compared to $858,400,000 in the same period last year. Our top line performance was primarily the result of anticipated volume declines in the market.

Speaker 3

As Dave mentioned, we also experienced some softening in our net ASP due primarily to more pronounced trade down activity. As mentioned in previous calls, we were the leader in price enactment in 2022, but the benefit of price to the top line was limited by trade downs in the Q3. Gross profit was $237,500,000 in the 3rd quarter, down 10.3% compared to $264,900,000 in the same period last year. Gross profit margin expanded 421 basis points year over year from 30.9 percent to 35.1 percent. The margin expansion was driven by Continued execution on Master Brand strategic initiatives, particularly around supply chain improvements and productivity savings, which mitigated the impacts of reduced volume, trade downs and personnel inflation year over year.

Speaker 3

Also, I want to highlight that this year's 3rd quarter gross profit includes 2 discrete items. We received insurance proceeds of $2,000,000 related to the tornado damage Sustained at our Jackson, Georgia facility earlier in the year as well as $3,000,000 in accumulated medical rebates related to the favorable renegotiation of our health insurance program. Excluding these two discrete items, we still delivered strong gross margin expansion. Selling, general and administrative expenses were $140,300,000 20.3 percent lower compared to the same period last year. Outbound freight savings as well as an additional $700,000 in medical rebates discussed earlier Lowered our SG and A spend even as we invested more quarter over quarter in our strategic initiatives, particularly tech enabled.

Speaker 3

As I've previously discussed, we were allocated a portion of Fortune Brands home and security costs in 2022, but that allocation is now gone. Instead, we have stand alone costs. But if you compare the impact of the 2, it remains a net savings year over year in 2023 as anticipated. You should expect a sequential increase in SG and A spend in the Q4 as we continue to ramp up the pace of investment in our strategic initiatives. I'll provide more color on this when I discuss outlook shortly.

Speaker 3

We delivered net income of $59,700,000 in the 3rd quarter compared to $52,200,000 in the same period last year. The 14.4% year over year increase was driven by higher operating income and lower income tax expense, partially offset by higher interest expense. Income tax was $18,200,000 or a 23.4 percent effective tax rate in the quarter, compared to 26 while our Q3 2022 effective tax rate was unfavorably impacted by adjustments made by Fortune Brands following an IRS audit settlement. In the Q3 of 2023, interest expense of $15,300,000 was related to debt necessary to fund The dividend of Fortune Brands at the time of the spin. As a reminder, in 2022, we did not have any external debt assigned to our balance sheet, and therefore, there was no external interest expense in our earnings during the prior year.

Speaker 3

Further, we recognized related party interest income of $4,300,000 from loan agreements with Fortune Brands in the Q3 of 2022. Diluted earnings per share were $0.46 in the 3rd quarter, an increase from a pro form a diluted earnings per share of $0.41 in the Q3 last year. Please note that prior year pro form a diluted earnings per share is calculated using 128,000,000 shares outstanding As under U. S. GAAP, it is assumed that there were no dilutive equity instruments prior to the separation as there were no equity awards of MVC outstanding.

Speaker 3

Adjusted EBITDA was $109,800,000 compared to $126,000,000 in the same period last year. Adjusted EBITDA margin expanded 153 basis points to 16.2% compared to 14.7% in the comparable period of the prior year despite lower sales. Our strong margin performance was driven by continued execution on Master Brands strategic initiatives, particularly around supply chain improvements, productivity savings and the discrete items I mentioned earlier. These more than offset year over year volume declines, the impact of trade downs and personnel inflation. Finally, as I mentioned earlier, We recognize 2 discrete items in the quarter that were not factored into our previous outlook.

Speaker 3

To quickly recap, We received $2,000,000 in insurance proceeds related to the tornado damage sustained at our Jackson, Georgia facility earlier in the year. 2nd, we received $3,700,000 in accumulated rebates related to the favorable renegotiation of our health insurance program. Excluding these two discrete line items, we still expanded our adjusted EBITDA margin, and I'm pleased with the operational excellence our associates delivered in the quarter. Turning to the balance sheet. We ended the Q3 with $122,500,000 of cash on hand and $480,200,000 of liquidity available on our revolver.

Speaker 3

Net debt at the quarter end was $585,000,000 resulting in a net debt to adjusted EBITDA leverage ratio of 1.5 times, down from 2 times and 1.7 times at the end of the first and second quarters of 2023, respectively, our 3rd successive quarterly reduction. Our balance sheet remains strong with the financial flexibility to invest in the business for growth. Operating cash flow was $336,500,000 for the 9 months ended September 24, 2023, compared to $117,900,000 in the comparable period last year. Our working capital improvement plans as well as strong operational performance, specifically around inventory management and collections drove this tremendous year on year improvement. We expect our working capital to be flat in the 4th quarter as our pace of improvement slows and as we plan for normal seasonal activities.

Speaker 3

Capital expenditures for the 9 months ended September 24, 2023 were $21,400,000 We anticipate significant payments in the 4th Order as invoices come due and now expect to spend $50,000,000 in capital expenditures in 2023. Free cash flow was $315,100,000 for the 9 months ended September 24, 2023, compared to 85 $700,000 in the comparable period last year. This is a $229,400,000 improvement year over year. As we have discussed previously, cash outflows are expected to increase in the Q4 due to our last significant related payment to Fortune Brands of roughly $30,000,000 increased capital expenditures and the slowing of improvement on our working capital. Because of these items, we now expect 4th quarter free cash flow to be slightly positive.

Speaker 3

Finally, during the quarter, we repurchased Approximately $11,500,000 of our common stock under our existing stock repurchase program. Turning to our outlook. We remain optimistic about the steady demand we've seen with our customers servicing the new construction market and expect this trend to continue through the balance of the year. For those customers servicing the repair and remodel market, we anticipate a current pace of weaker year over year conditions will persist throughout the Q4. Additionally, we believe the entirety of the Canadian market will remain weak into the 4th quarter.

Speaker 3

In total, we expect next sales in the Q4 to be down mid teens year over year. Given this market backdrop and the typical Q4 seasonality, We are currently planning for a 2 week holiday shutdown in December. Included in this 2 week shutdown is our 53rd week, so we will see no benefit from that in our 4th quarter top line performance. As a reminder, this extra week is the result of our normal 4.45 fiscal calendar. From an adjusted EBITDA standpoint, our operational momentum is expected to continue through the 4th quarter.

Speaker 3

As discussed on the last earnings call, we plan for accelerated investment spending in the second half of twenty twenty three, particularly in our tech enabled initiatives to position the company for future growth. Based on our strong operational performance again in the Q3, We are raising our adjusted EBITDA outlook range to $370,000,000 to $380,000,000 a $20,000,000 increase at the midpoint compared to our prior outlook. On this updated range, we now expect adjusted EBITDA margins of roughly 13.5% to 14% for 2023. This revised 2023 outlook shows our confidence in our ability to expand adjusted EBITDA margins year over year even in a softer environment. Because we have already collected a final payment of $3,200,000 in the 4th quarter, this full year outlook includes these final insurance proceeds related to the tornado damage sustained at our Jackson, Georgia facility earlier in the year.

Speaker 3

We expect the benefit of this payment to be nearly Our expected 2023 interest expense of $65,000,000 to $70,000,000 remains unchanged and our 2023 year to date effective tax rate of 25.4 percent is the approximate tax rate for the year. The established tools and principles of the Master Brand Way have helped the team deliver strong results in the 1st 9 months of 2023. We believe that continued execution on our strategic initiatives and further investments in the business will yield incremental savings in future years, positioning us for net sales growth and market outperformance. With that, I would like to turn the call back to Dave.

Speaker 2

Thanks, Andy. As you can see, there's a lot of great work taking place across the organization. Our associates are executing at a very high level and their progress on our strategic initiatives continues to drive results. The ability to deliver strong EBITDA dollars on declining sales and expanded adjusted EBITDA margins is a result of their disciplined use of the tools of the Beyond our financial and operational results, I'm extremely pleased with our ESG efforts and the impact we are having on our broader stakeholders. During the Q3, we participated in Habitat for Humanity's 2023 Jimmy and Rosalynn Carter work project as the exclusive cabinet provider.

Speaker 2

Our associates have supported Habitat events from coast to coast for over 2 decades, and now we're excited to support the organization in a more focused way. As a Platinum level partner, we were pleased to provide design, material and labor to help build a 27 home community in Charlotte, North Carolina. This was a great event and a meaningful way to support local families in the Charlotte area. Since this is our last earnings call before our 1 year anniversary as a standalone public I'd like to take a moment to thank our more than 13,000 associates for their hard work and dedication this year. We exceeded our initial expectations for what we would accomplish this year and I look forward to what 2024 will bring us.

Speaker 2

Now with that, I will open up the call to Q and A.

Operator

Thank you. We will now be conducting a question and answer session.

Speaker 3

A

Operator

confirmation Our first question comes from the line of Adam Baumgarten with Zelman. Please proceed with your question.

Speaker 4

Hey, good evening, guys, this quarter. I guess maybe to start just if you could give us a rough sense of the tailwind that you got from Material and freight costs in that quarter, just because it seems like they are pretty meaningful.

Speaker 2

Yes. I think it's I'd say The combination of tailwinds from continued price excuse me, continued cost reductions Sequentially as well as the continuous improvement efforts that we've put into the business, Adam, is what's driving the results that you're seeing in Q3. Andy, did you want to add anything? You want to talk a little bit more detail about any of the particular elements?

Speaker 3

Yes, sure. So really that Q3 was a great quarter and Especially with those decrementals full of 10%. But our continued progress really on continuous improvement in those supply chain initiatives Very significantly offset the headwinds we had, whether it was market related volumes, the trade downs, which Dave mentioned in the prepared remarks at about 3%, the increased spend in our tech initiatives and personnel costs. So we did that price discipline and continued initiatives in supply chain and cost improvement really helped us out. And then of course, we have those discrete in the Q3 as well of $5,700,000 that was in our prepared remarks, which also helped the quarter.

Speaker 2

And Adam, I'll add one other thing in terms of the pace of change in the market. Labor is still a headwind and We have various layers of that throughout the year. The other aspect is freight, I'd say, has stabilized now. And so that as we look forward, those benefits are probably behind us. Materials is still not what I'd say below COVID levels.

Speaker 2

There's still been inflation that stacked up over the year. It's sequentially come down. But again, I'd say that that part of the market and all those things have Stabilized moving forward here.

Speaker 4

Okay, got it. And then just on pricing generally, are you seeing any pickup in pricing pressure, whether it's promotions or Outside of mix, obviously, pricing promotions or outright price cuts, specifically in the R and R market. And If so, or maybe you can talk about dealer versus retail?

Speaker 2

Yes. I think the pricing environment is Similar to what I said last quarter, which is normal and cabinets do have a normal tempo of promotional activity And we're seeing some of that, but I think it's not outsized in terms of what we would normally see. So there's Obviously, there's situations where somebody is anxious to get a particularly maybe a large deal done and there's some promotion that goes along with that. There are certain seasonal promotions that you certainly see in retailers that's normal course. And so We built that into our plan and the guidance that we've given, but I wouldn't say anything's outsized in terms of change of price.

Speaker 4

Got it. And just lastly for me, how much of your revenue is from the multifamily channel? And I guess what trends are you seeing there?

Speaker 2

Yes. I mean, we follow the multi family activity because it gets released around the same time as single family, De minimis for us. We've intentionally not focused on that portion of the market.

Speaker 4

Okay, got it. Thanks. Best of luck.

Operator

Thank you. Our next question comes from the line of Garik Shmois with Loop Capital Markets. Please proceed with your question.

Speaker 5

Hi, thanks. Thanks for taking my question. Just first off, for the Q4, how much of the anticipated sales decline Do you anticipate being impacted by the trade downs? Is it a similar rate as what we saw in Q3? Or is there any change in that anticipation?

Speaker 2

Yes, Garik, we actually expect it to be greater than the Q3 impact, so I'd say More mid single digit. We had 3% impact to the top line in Q3 and it will be more in Q4 as That has taken hold more. And so obviously we look at that and we've said before that we're comfortable with mix change within our Portfolio in terms of the margin that that drives, but we're cognizant of the fact that there are fewer dollars coming in when you have a trade down And so we have to look at that. And as we look ahead, that's part of our planning process is to be prepared for that. And That requires at certain points, you have to look at your fixed costs.

Speaker 2

So we're doing that and we're reacting to that, but that is a trend that we think is continuing.

Speaker 5

Great. Just given the, I guess, relative performance in new construction versus The remodel market, is there anything that you're able to do or contemplating doing as you look out to 2024, Maybe strengthening your position even more in new residential or any way to target the market That's outperforming for the next indefinite period of time.

Speaker 2

Yes, absolutely. I think the No. Probably the biggest thing that I mean, there are a lot of factors that matter into how you win business in any given market, but I think an overarching part of Winning in new construction is the service level that you provide. I think we are world class at that and we have a great team that's focused on that and that's A lot of what we sell and I think also builders are appreciating our ability to adjust product mix with them And get them to a lower cost point and not take away anything from what they're delivering to their customers. And You saw that all through COVID when it was a very difficult time for all the builders, both with labor, material, you name it.

Speaker 2

We were very reliable with them in many ways and I think that's carried through this year and that's what we lead with. We have a great product, don't get me wrong, But I think that our ability to really deliver the service level that they need to be successful because we're one piece of a very large project and they That project out over and over again. So if you can frankly, it's the tools that we use internally that we bring to them when it comes The things like lead through lean, we bring that kind of approach to our customers because we know that helps them.

Speaker 5

Understood. Last question is just on the incremental or decremental margins Moving forward, you've done a fantastic job this year, but it seems like The top line is still going to be a bit choppy given the trends that you discussed. It seems like you're lapping some of the Material and transportation cost benefits, but you are contemplating taking fixed costs out of the system. So just Kind of curious how to think about the incremental margin line moving forward. Any additional All color that you can provide would be great.

Speaker 2

Sure. I think that maybe Andy can speak a little bit about Q4 As you do the math on that, but I think that's we want to outperform, but we're also cognizant, particularly with what we've been able to accomplish in the Second half of this year, we're cognizant of our desire to keep investing in the business because the investments we're making right now are Focused on growth in the future. Some of them take more time to come to fruition and we'll talk more specifically about those as they develop. But I think that that's the balance. And so our team I think is institutionalized as part of our culture, Continuous improvement mindset and so that's just part of how we do things.

Speaker 2

And so they take that money and we can either make it higher return for shareholders And or it's usually an and, take some of that money and invest it. And that's going to really dictate moving forward How we have decremental margins. Our goals are always to be world class and to be better than contribution margin. And we look at The fixed cost base that we have, we're always looking to make sure we're optimizing that along with the continuous improvement in the variable side to build The headroom, if you will, for us to make decisions about investments. And obviously, as you go into a market like this year, even We were unsure and so we wanted to hold off and wait until we saw how things progress before we dove into investments and we'll treat it Same way any given year.

Speaker 2

As things go better, we'll invest more and as things if things don't go well, we'll trim back.

Speaker 3

Yes, I think I can add a little color for the Q4, if it's helpful. Generally for this year, we do still plan to Stay within our stated guidance, so decremental is no more than 20%. So we continue that trend. And really, we'll see the Q4 From a what's impacting the quarter perspective to be very similar to Q3. And again, it will be that continuous improvement Supply chain initiatives on top of deflation, that we expect again heavily to offset that volume decline, trade downs, the Strategic initiatives spend, which we are going to continue for growth purposes, and those personnel costs.

Speaker 3

And just a slight clarification just To make sure we understand on the discrete, of course, the Q3 discrete will not repeat in the Q4. But as we mentioned in our prepared remarks, We do have that last insurance payment coming through from the tornado we experienced earlier in the year, a 3,200,000 That is in the outlook. However, just to be clear, we do anticipate that to be offset by some FX headwinds and also some just normal

Speaker 2

And to put a finer point on what Andy said, Similar, but we will be investing more in Q4 and we do have the inefficiency, which we're going to We've already seen far enough ahead to say we're going to take a couple of weeks shutdown for maintenance in our plants and that Fixed costs therefore just comes and hits the bottom line. So it's I think if you do the math on the numbers, It's not quite as good a performance as Q3, but that's for a number of reasons that we are looking at controlling and deciding to do.

Speaker 5

Understood. Thanks for all that and I'll pass it on.

Operator

Thank you. Our next question comes from the line of Tom Mahoney with Cleveland Research. Please proceed with your question.

Speaker 6

Hello, good afternoon. I wanted to ask about the working capital comment in the 4th quarter where Neutral and you mentioned normal seasonal activity. Is there some restart of Production that's associated with that, just trying to get a sense for how you think about Building it into the end of this year and looking forward into 2024 from a working capital perspective.

Speaker 2

Yes, Tom, I'll add a few things and then Andy may want to add some further detail. But generally speaking, in a normal year, We tend to have a slight build in inventory at the tail end of Q4 and into Q1 and a lot of that is driven by Lunar New Year in Asia. You have to get material on the water sooner to bolster through a couple of weeks of shutdown in that region. So that's a normal course. I will say It's really hard to look through our financials for last year because that wasn't the case last year.

Speaker 2

We actually extended the Lunar New Year Shut down with our suppliers longer to kind of help reduce some of the choppiness that we had And we had plenty of inventory obviously. So it's really hard in this particular 1 year period to look at a year over year is what's a normal Q4 into Q1. So I would say the normal pace for our working capital is we have to build some inventory for Lunar New Year. And then on top of that, if you think about the New construction market, it does have some seasonality to it because of the weather in the north. And so we tend to have Higher activity coming out of Q1 and so you start building some inventory ahead of that as well.

Speaker 2

So those two dynamics are back in play this year. Again, we still think we have improvements to make to inventory. So it's kind of balances each other out, maybe not Perfectly, but somewhere in the middle to balance each other out. So we're going to continue to work on improving inventory with the supply chain initiatives that we have, But there is a dynamic of needing to order more materials starting sooner rather than later here in the Q4. Andy, is there anything Yes.

Speaker 3

Maybe just kind of add, we talked a bit about our tech enabled initiatives and want to talk about how that's really helping us Working capital, it's not just about volume coming down and adjusting inventory. We're fundamentally reducing our need And just a couple of examples, using the Master Brand Way, we've developed a pretty robust S and program and that's really been a key driver in the year to date reduction of inventory of $100,000,000 and then secondly, we have really embraced our tech enabled to improve the data availability of our customers and customer receivables, and it's allowed us to collect faster and more completely. So those types of trends despite the cyclicality, those types of improvements will continue. And probably this is a Good time to mention, just a reminder on the Q4 on cash flow. Again, we expect real we expect great operational performance and cash flow generated from that.

Speaker 3

However, as we stated in the last quarter, the Q4 has some unique cash outflows, that will offset that Cash flow generation, we've done year to date, and again, it's related to the final fortune related spin payment of about $30,000,000 We have remaining CapEx to go out the door of about $30,000,000 and most of that's related to the timing of the invoices and when they're due and paid. We are increasing that SD investment and we'll have even though working capital again keeps improving, that slowing pace of improvement will occur in So just a reminder of that, and that's why we stated in our comments, we expect that free cash flow to be positive, but not at the level we've seen year to date.

Speaker 6

Got it. I appreciate that color on the cadence. And then, As you look out into 2024 and think about the market environment, Yes. I realize that it's early, but are there any way you could characterize how you're thinking about 2024 from a demand perspective, Primarily on the repair, remodel side is my question, but curious what thoughts you have there.

Speaker 2

Yes, Tom, we're not going to give an outlook today. We will in our normal course as part of our guidance in the Q4 earnings Next year, I think what I will say is the market is hard to gauge right now. And so Well, the way we're approaching that is we do scenario planning. And I think that what our strategy is designed to do is to give us The flexibility to be nimble in any environment that we enter into. And I think you saw a lot of the elements of that this year.

Speaker 2

We planned ahead for this year. We saw what was coming. We took the appropriate action from a fixed standpoint and then really went To work hard on continuous improvement. And that's as I said, that's our methodology. We look at what we think might happen.

Speaker 2

In this case, I would say we have multiple several scenarios that we think might happen and that applies this year obviously it was in a focusing on a down environment. We don't know. There could be a wide variety of outcomes next year. We want that flexibility and that nimble behavior to apply both up or down That we can react both with from an overall picture of our capacity, but beyond that just how we can drive continuous improvement To be able to deliver on whichever direction the market goes. So that's how we think about planning.

Speaker 2

We've done that planning so far with our budget, But not ready yet to really tell you what we think about the market because frankly it changes quite a bit Week to week here right now. So we're letting that settle out a little bit before we really tell you which scenario we think is most likely.

Speaker 6

Understood. That's helpful.

Operator

Thank you. Our next question comes from the line of Julio Romero with Sidoti. Please proceed with your question.

Speaker 7

Yes. Hi. Thank you. This is Alex Hanman on for Julio. Could we talk a little bit about the impact of higher interest rates?

Speaker 7

Curious how you guys think about this directly and indirectly across the value chain?

Speaker 2

Sure. I mean, I think higher interest rates in general put a damper on housing activity, in particular Higher ticket housing activity. So that's going to be, A, the home purchase. Obviously, it's a direct input to the cost of the home, because most people borrow Or to certain projects that people might do if they're planning on borrowing against their home equity. So Generally speaking, high interest rates is not a good thing for the housing market.

Speaker 2

What I would say is the way the market behaves and it's been an interesting year in that And that plays in when the consumer has money to spend, when the home when the consumer feels that the home is worth What the price tag says or what they've paid for it gives them that wealth effect. And so with interest rates Stabilize in a particular zone, they feel more comfortable taking the action. And I think you're seeing that with new construction this year. A, I think it's a proof point that there's demand, there's underlying demand for housing in the world because as interest rates have Significantly increased this year. New construction continues to plug along very nicely.

Speaker 2

So I look for, A, there's an absolute Interest rate to look at, but I also look at the rate of change and consumers generally just don't like rates of change when things cost things. It's sort of similar to inflation. So, I look for stability in rates. We saw that coming out of 2020 2 into 2023 and I think that sparked some demand in the new construction and that rates although higher Stabilized for a while. So people can you can just plan better when you can see something that's stable.

Speaker 2

I mean, we all kind of think that way. So that's what I'm looking for. I mean, It's a very volatile situation right now. I spend more time paying attention to the 10 year than what the Fed says because that 10 year is really what drives mortgage. 10 years skyrocketed a month ago and then last week it came down significantly in a week.

Speaker 2

And so That's a lot of volatility and probably similar to stock market. It's just people tend to stop doing stuff when it's like that. I don't think that's a normal World that we'll live in for a long period of time, but it is the world we're in this week.

Speaker 7

Yes, super helpful. Appreciate the color there. And you're talking about a number of strategic initiatives today, Plant Forward, Cloud Migration, Supply Chain and Tech Platforms. Just curious, as you look across the strategic initiative portfolio, is there something you think will be most impactful to the 2024 P and L?

Speaker 2

Yes. I think the most impactful thing that we do day in and day out, which is, I'd say now embedded in our culture, but It spreads itself out into these initiatives is that lean culture and the continuous improvement culture that we've driven over the last 4 years.

Speaker 7

This is an

Speaker 2

organization that's great at problem solving and every issue with even day to day issues, but strategic Issues always have problems to solve and the team has done a wonderful job of learning how to do that in a very crisp and fact based way. And that helps drive these projects forward, because when you run into a roadblock, which you invariably do and anything you're That's complicated. Problem solving really helps you get to the core of why you're at that roadblock and it helps you come up with solutions to get around that roadblock. So I think that underlies everything we do. It's the culture that we have as an organization.

Speaker 2

And I think that's going to not only does it help drive tangible dollar savings, but it also helps move things forward at pace. And That's always key to do that so that you can get out in front of whatever issue you're facing. But I really am excited about the tech initiatives That we're working on, I think they're all focused on how do we grow this business beyond the market growth rate. Some of them take a little longer to germinate when you plant them, but some of them are direct impact. And I think we described those things today in our

Speaker 7

Appreciate the context there. And last one from me. Should we be expecting somewhat similar pacing with respect to buybacks over the next couple of quarters?

Speaker 2

Yes. I think the we're still kind of working through our forward look on capital I think as I look at our capital deployment priorities, 1st and foremost, it's invest in the business. We think we have some great investments with great return. Secondly, is to continue to focus on our debt position, which for us, I think we're in a really good spot right now. I think we have a great balance sheet.

Speaker 2

But I think that's always prudent in a market that's uncertain. It's a great way to bolster yourself In the face of what we don't know is going to happen in front of us. So those are the top two priorities in terms of returning cash to shareholders. I think The way we look at the market is we're going to if we think we're a cheap stock, we're going to keep buying it. We think it's a good investment.

Speaker 3

And just for a point of reference, so it'll save you some time, we have about $35,000,000 left on the currently approved program as of the end of the Q3.

Speaker 7

Thank you. Very helpful. That's all for me.

Operator

Thank you. There are no further questions at this time. And I would like to turn the floor back over to Farron Pawlik for closing comments.

Speaker 1

Thank you, operator. Thank you everyone for joining us. We appreciate your interest and support and look forward to speaking with you in the future. This concludes our call.

Operator

Thank you. You may now disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
MasterBrand Q3 2023
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