Fortune Brands Home & Security, Inc.

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to Fortune Brand's first quarter 2020 earnings conference call. All lines have been placed on mute, preventing background noise. After the speaker's remarks, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Thank you. I would now like to turn the call over to Mr. Brian Lance, Senior Vice President of Communications and Corporate Administration. You may begin our conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Home and Security First Quarter 2020 Investor Conference Call and Webcast. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investor section of our FBHS.com website. I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question and answer session, are based on current expectations and a market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC, such as our annual report on 10-K. The company does not undertake to update or revise any forward-looking statements, which speak only to the time at which they are made. Any references to operating profit, earnings per share, or cash flow on today's call will focus on our results on a before charges and gains basis unless otherwise specified. With me on the call today are Nick Fink, our Chief Executive Officer, and Pat Hallinan, our Chief Financial Officer. Following our prepared remarks, we've allowed some time to address questions that you may have. I will now turn the call over to Nick.

Thank you, Brian, and thanks to everyone for joining us today. We hope that you and your loved ones are all staying safe during these extraordinary times. While our teams delivered strong sales and profit growth in the first quarter that were ahead of our expectations, we also took a number of proactive steps in the quarter to begin aggressively managing cash, capital, and expenses, and to further strengthen our balance sheet as the global economy began to feel the impact of the COVID-19 pandemic. These steps will not only help us mitigate the impact of the near-term demand challenges related to the pandemic, position us to accelerate share gains and deliver more profitable growth as we emerge from this recession. The COVID-19 pandemic has brought profound change to the world and to our team, and our hearts go out to all of those who have been impacted by it. During this challenging shelter-in-place period, products in our industry have been designated as essential. As we continue to manufacture and distribute our products, we are taking great lengths beyond WHO and CDC guidelines to protect our teammates. I want to express my sincere gratitude to our Fortune Brands team all over the world who have worked so bravely and so purposefully to continue to deliver our essential home and security products to our customers and consumers. By continuing to operate through this period, we have fulfilled our critical mission as part of the essential supply chain and have also, with few exceptions, mitigated the deep disruption of full facility shutdowns and subsequent ramp-ups. It's hardwired into our DNA to thrive in the face of adversity and to use challenges to structurally reposition our business to emerge even stronger and more competitive. Our history and track record demonstrates this. We were able to emerge from the financial crisis of 2008 to 2009 much stronger, capturing share and delivering profitable growth and shareholder value. Over the last three years, we've mitigated the volatile trade and tariff climate with exceptional results. In 2018 through 2019, we successfully managed through a pause in housing demand by continuing to evolve and improve the business. We not only drove solid above market performance, but positioned ourselves to deliver outsized possible growth as demand levels accelerated. Our exceptional first quarter results demonstrate this. And our teams are not focused on navigating this current global crisis to emerge even stronger yet again. We are leveraging our most critical capabilities to ensure that we maintain our strategic advantages. We're accelerating operational transitions that were already underway. Our teams are pursuing permanent and temporary efficiency improvements to navigate virus-related demand declines and to emerge with an improved cost structure as growth returns. We're delaying capital significantly while still funding select critical initiatives to drive growth opportunities and take share. During our remarks today, First, I will briefly highlight key takeaways from our first quarter performance. Second, I will discuss how we are approaching the immediate COVID-19 environment from a demand, supply, expense, and cash perspective, as well as how we are positioning ourselves to emerge even stronger. And then past will provide color on our financial results, balance sheet strength, and liquidity, and our thoughts around financial performance in this environment. So starting with the market and key takeaways from our first quarter performance. For the first quarter, we estimate that the global market for our products grew roughly 3% to 4%, with UFB construction returning to high single-digit growth. Builder tournaments and orders were strong and we executed at a very high level as indicated by our Q1 results. Repair and remodel activity was healthy in advance of the spring season. As COVID-19 spread to North America and the majority of national and local governments executed stay-at-home orders in March, we began to see reduced activity in key indicators around home construction and building product spending. With that market backdrop, some thoughts on the recent quarter. In the quarter, total company sales increased 6% over the last year, an operating margin of up 140 basis points to 12.1%. Our successful results in the first quarter were driven by strong execution from our teams across our businesses, producing sales and margin growth in each segment, beating markets and our expectations across the board. We saw operational outperformance across the company. In the first quarter, our cabinets group demonstrated that our pivot plan is deliberate and that we are taking share at increasing margins. Sales growth versus a year ago was 8%, with operating margin improving by 120 basis points to 9%. which is exceptional performance in our seasonally lower-margin first quarter. We saw strong sales growth across channels, with high single-digit increases in dealer, builder, and within home centers. Value product lines, including our retail stock cabinetry, Aristocost within U Construction, and Mantra within our dealer network, are successfully taking share as Chinese imports exit the market, and we realize the benefits of our multi-year expansion of products and low-cost capacity in this part of the market. Turning to plumbing, during the first quarter, the Global Plumbing Group continued to outperform the global market with sales growth of 2.3% and operating margin of 22.3%. Ex-impacts for the COVID-19 pandemic and foreign exchange in the first quarter, sales have been up 9%. The majority of the impact was in our Chinese plumbing business. That business is rebounding and we continue to expect strong top-line growth this year from our business in China, driven by the continued success of our category and channel expansion. GPG executed once again at a high level, driven by above-market growth in the U.S., with particular strength in retail and e-commerce. We continue to expand our product offer with partnerships and adjacencies, which is resulting in accelerated share gains. Our re-energized known brand continued to deliver, reaching new highs on key brand metrics. Our innovation engine produced great results, including winning Best Smart Home device across all categories at the influential Kitchen and Bots show for the second year in a row. And our fuel for growth initiatives continue to drive market-leading margins and incremental cash to reinvest in our best returning projects. Turning to doors and security, sales increased 6% over this quarter last year and operating margin improved to 10.4%. Our doors business experienced double-digit growth in both wholesale and retail channels with excellent operational performance. Importantly, our fiber and decking business experienced double-digit growth during the quarter ahead of our expectations as we continued to benefit from the conversion away from wood products, our distribution gains, and our continued strength in POS. Overall, while our exceptional first quarter results may not be indicative of the business climate that we are currently facing, they do demonstrate that the business has reached a new level of operational outperformance, and that discipline will serve us well in a recessionary market. And we answer this upcoming period of uncertainty from the strongest possible standpoint with all businesses on solid ground. In addition to our business being well-positioned, we also have a strong balance sheet with ample liquidity, amongst the strongest in our sector. In April, out of abundance of caution, we increased liquidity further by adding a $400 million supplemental revolving credit facility to our existing arrangements. Pat will give further details on our balance sheet and the new facility in a few minutes. Now, I would like to turn my attention to focus on how we're going to address the remainder of the year, starting with demand. Our approach to operating in times of volatility is built upon our experience as a management team and is deeply embedded in our DNA. In the current landscape, we expect to not only manage cash and expenses to lower demand levels, but also to permanently improve efficiencies across our footprint. Simultaneously, we will also seek to be flexible and nimble to capture revenue opportunities to gain share. We expect to accelerate that advantage further as the market recovers. As we look forward, we are acutely aware that demand in the U.S. for our products had started to decrease as we were ending the quarter, and we are expecting to see further demand deceleration as people stay home in the majority of states during the whole month of April, and in many cases into May. That said, April, and we worked to meet that demand while prioritizing the safety of our teammates. We expect the long period of millions of people staying home and the economic impact during the second quarter to significantly dampen demand for the quarter. As shelter-in-place orders are lifted, we expect a gradual return of demand for our products, the pace of which will be impacted by the extent and the shape of the COVID-19-related recession. We've been running numerous demand scenarios to prepare for this uncertainty and have run base case projections from mild to severe, including scenarios even worse in the global financial crisis of 2008 through 2009. Our teams have already reduced costs and cash deployment in advance of this uncertain environment, and we are building further variability into our cost structure that we can execute in ways in response to future changes in demand. We will also position our business from a cost and service perspective to capture additional growth and market share as demand begins to recover. As we manage through this new near-term reality, we will aggressively and with urgency attack our cost structure on maintaining the ability to accelerate share gains and drive profitable growth. These simultaneous top and bottom line efforts combined with a healthy fortress balance sheet should position us for long-term success. We intend to come out of this pandemic stronger than we came into it with an even higher performing business. I would also like to share some thoughts from the supply chain perspective. As I shared earlier, our teams thrive in the face of adversity. Building on our team's successes in addressing duty and tariff challenges, we've been working our global supply chains since the start of the year to mitigate the effects of COVID-19 plant closures in China. As the pandemic shifted west, focus shifted towards our North American supply chain, and we've been working to implement best-in-class solutions around keeping our people safe and our operations safely open. In the first quarter, we successfully managed through Chinese supply chain issues with modest disruption to lead times and service levels. Currently, those issues have abated as supply chains centered in China have largely recovered. As the quarter ended and we entered April, supply chain issues were shifting to North America, As our industry has been deemed essential by the federal government and the vast majority of state governments, we've been able to safely operate. Operating in these circumstances is not without its challenges, and we've learned a lot about running safe facilities in this environment. Across our supply chain networks, we've been taking steps in excess of CDC and WHO guidelines to keep our workers safe. This includes requiring that employees work at home when possible, relaxing attendance policies to provide more flexibility for our associates, establishing strict protocols for managing exposure, increased cleaning and sanitizing, including by third parties, providing cleaning products and tools for employees to use at work and home, instituting temperature and health checks, and multiple measures to increase physical distance within our facilities, such as adding extra shifts, staggering start and finish times, adjusting work stations to increase space, or adding barriers between stations. Those measures just mentioned contribute towards employee safety, but can also cause inefficiency at our locations. Other inefficiencies we have also experienced include some shifts operating below optimal variable production levels as we relaxed those attendance requirements. Fewer hours of production per day for longer shift changes. Also, we've been adding time for regular cleaning. accommodating temporary shutdowns from time to time for more extensive cleaning. And in a couple of instances, like Sioux Falls, South Dakota, and Waterloo, Iowa, where we saw community spread, we shut plants down entirely for a couple of weeks. These measures have resulted in temporary inefficiencies that will abate as these new safety measures become more routine and the shelter and home orders are lifted. At this time, the majority of our facilities remain open around the world, specifically The majority of North American, European, and Chinese locations are currently open. The only exceptions are a South African facility and a Toronto, D.C. within GPG, and a Waterloo, Iowa facility within our Cadence Group. All are expected to reopen within the next week, although we will continue to prioritize the safety of our associates, which may require temporary shutdowns from time to time. If government orders in the U.S., Canada, Mexico, China, the U.K., and Italy remain as is, we anticipate a manageable supply chain environment for the balance of the year. Facilities in Mexico have been allowed to continue to operate safely, though with some at reduced capacity. We have been commended by the local government for our safety protocols and are working with Mexican officials to expand operations as soon as safely possible to full levels. In the meantime, we're using other locations within the U.S. to offset the disruption. As mentioned, we've closed facilities for short amounts of time, ranging from a couple of days to a couple of weeks, for disinfecting and deep cleaning of facilities and some limited quarantines to keep our workers safe. It is also important to note that because we've not experienced a full production shutdown, we're not being confronted with large-scale restart challenges across our production network. While the shelter-at-home period has created temporary inefficiencies in March and into the second quarter, we expect to be through much of this period as we exit the second quarter. At the same time, as recessionary demand-driven challenges present themselves going forward, we will manage through changes in capacity and our cost structure to manage margins and flex to meet demand as needed. I will not send this all over to Pat. After Pat concludes, I'll come back to sum up my thoughts before we take questions.

Pat? Thanks, Nick. As a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing business performance. As Nick indicated, since the virus crisis began, our focus has been prioritizing the safety of our associates and managing through the crisis in a manner which makes our company stronger. During the last economic downturn, we led by taking aggressive actions to adjust the business to economic realities. We position the business to take share during and after the downturn. Our focus is the same during this period of virus-driven challenge. Among our recent priorities has been assessing liquidity and taking action to enhance decremental margins should expected sales declines materialize and persist. We entered this period from a position of business performance and balance sheet strength. I believe we have the liquidity to navigate this virus crisis and we have already taken actions to aid margin performance and cash management. I will address these topics in more detail later in my comments. First, I would like to cover our first quarter results. While we are aware we have much to navigate during the balance of this year, we believe our first quarter results prove our business's potential and that our strategies and execution are producing exceptional results. For the first quarter, Sales were $1.4 billion, up 6% from a year ago. Consolidated operating income for the quarter was $170 million, up 20% or $28 million compared to the same quarter last year. Total company operating margin was 12.1%, up 140 basis points over the same quarter last year. EPS were $0.81 for the quarter, up 29% versus the $0.63 we earned in the same quarter last year. We remain pleased by our team's continued ability to grow sales and earnings ahead of market and plan. Next, the segment results, turning to plumbing. Sales for the first quarter were $469 million, up 10 million or 2%. Absent the pandemic's effects, primarily in China where we were shut down for six weeks, as well as adjusting for foreign exchange, sales would have grown by 9%, beating market and plan. Continued strong market share momentum in the U.S. drove the quarter, with particularly strong first quarter results in retail and e-commerce. Plumbing operating income increased 15% to $104 million for the current quarter. Operating margin for the quarter was 22.3%, an excellent result driven by cost discipline and sales growth leverage. Our plumbing business was our first to experience COVID challenges in China. This operating result illustrates our commitment to margin management in a time of challenge. Turning to doors and security. Sales for the first quarter were $314 million, up $17 million, or 6%, driven by double-digit growth in doors and decking. Doors benefited from a strong new construction environment, and decking benefited from the distribution gains achieved last year. Operating income in Doors and Security was $33 million during the quarter, up 25% over the same quarter last year. Segment operating margin increased 160 basis points for the quarter over the last year to 10.4%. Now turning to cabinets. Sales for the first quarter were $620 million, showing a strong year-over-year increase of 8%. We continued to experience strong growth of value-priced products in all channels. Sales of higher-priced products were flat during the quarter. Operating income in the first quarter was $56 million, up $11 million versus the prior year. Operating margin for the quarter was 9.0%, up 120 basis points versus a respective 2019 period, which was a strong comp seasonally. Income results were driven by value price cabinet volume and the benefits of pivot strategy efficiency improvements associated with higher price and Canadian products. Turning to the balance sheet. Our balance sheet remains strong. We entered this pandemic from a position of balance sheet and business performance strength. Further, we have recently increased liquidity out of an abundance of caution and in keeping with our objective to emerge from this crisis stronger and prepared to grow. At the end of the first quarter, we had cash on the balance sheet of $360 million, net debt of $2.1 billion, and our net debt to EBITDA leverage stood at 2.2 times. We have been assessing our liquidity throughout this crisis and will continue to do so. Our liquidity testing has included scenarios even more challenging than circumstances experienced during the last downturn. Even under such circumstances, we expect to have ample liquidity to navigate this recession using our longstanding $1.25 billion revolving credit facility. In addition, given the uncertain nature and duration of this pandemic, we expanded our liquidity by adding a new additional $400 million one-year revolver. This was a proactive step taken out of an abundance of caution to provide ample liquidity to navigate this pandemic. Turning to our previous financial guidance, Demand has been volatile since late March and the demand outlook for the balance of 2020 remains significantly more uncertain than usual. Due to this demand uncertainty, it is proven for us to suspend financial guidance until the demand outlook clarifies sufficiently. In the meantime, our business teams are working tirelessly to protect the great share and margin performance of the first quarter and to proactively manage expenses and cash in a manner that optimizes margins and balance sheet strength during a period of expected demand headwinds. Our teams are focused on delivering margin performance better than that produced during our industry-leading management of the last downturn. As sales headwinds intensify, Our objective is to limit decremental margins to between 30% and 20% for the year, assuming sales headwinds are most intense during the second quarter and early third quarter and are contained to four-year sales declines of 20% or less. These metrics are not intended to be financial guidance, nor do they reflect an updated sales forecast. In fact, our present sales trends are more favorable. These financial metrics are intended only to indicate our margin objectives and business planning in an uncertain demand environment during which sales declines are expected. Within the first quarter, we initiated significant expense and cash management actions in pursuit of our margin and liquidity objectives. And we will be expanding these actions throughout the second quarter and balance of the year in anticipation of demand challenges. During the second quarter, our decremental margins are expected to deviate from our target range unfavorably as we absorb the impact of safety measures taken to aid our associates, temporary facility shutdowns, and the transition inefficiencies incurred as our facilities are rebalanced to new levels of demand. Later in the year, we expect our margin performance to be at the favorable end of the target range for better as we are through a greater portion of transition inefficiencies and are managing capacity to meet demand. We fully expect to do everything we can to preserve margin, no matter how near-term demand and supply disruptions impact our business. We are focused on continuing to prioritize the safety of our associates and on managing our margins and balance sheet through and after the crisis proactively and effectively. We are committed to coming out a stronger, leaner business on the other side of the COVID-19 pandemic, positioned to resume growth by outperforming in a manner in which we are known for. I will now pass the call back to Nick for some closing remarks. Nick? Thanks, Pat.

To sum it up, we do not think the challenge has lied ahead of us lightly. It is an unprecedented event in modern times with more unknowns than known. What we do know is that we are well equipped to manage what unfolds in our markets and our business. As an industry, we started from a solid foundation. Our sector is far healthier than it was at this juncture of the global financial crisis. Housing in the U.S. is significantly underbuilt versus household formations, unlike the overbuilding leading up to 2007 and 2008. Home equity levels almost 50% higher than they were then, and months of inventory levels of 40% lower. Our key customers, builders, retailers, and wholesalers are in good financial shape. Our millennial consumers are just coming into their key buying years, and we believe that the pandemic will further drive household formation and R&R activity, similar to the impact of 9-11 on our sector. And while our industry has good, real momentum coming into this period, we were still just trying to catch up with the need for housing in the United States. There's no doubt that a recession and a blow to consumer confidence and financial uncertainty will have an impact on our industry. But as the economy recovers, with low interest rates, low inventory, good home equity, and high household formation, housing is in a great place to help lead a U.S. economic recovery. And if our industry is well positioned, then our company is even more so. We enter this time not with hubris, but with the confidence of a business that is demonstrating performance at its highest level. Our cabinet pivot plan, known brand reinvention, fiber on integration and distribution gains, indoors and security performance are all delivering for us in a way that will help us execute aggressively in the downturn. Our years of tackling tariffs and trade, rapidly changing consumer preferences, and market slowdown and reacceleration have built a deep management DNA of facing info change and using it to make the business stronger. And that is exactly what we intend to do. We've built a fortress around an already strong balance sheet. We've taken swift action to reduce expenses and capital and generate cash. And we've built successive ways with performance improvement initiatives that are intended to minimize detrimental margins while making our business even more competitive in recovery. We will preserve and grow our position as market leaders in our product categories. We are working with seriousness and urgency and we will manage the downturn and may capture outsized market share at leading margins as the economy recovers. Our experience and track record will be reflected in our results. Importantly, we will continue to do everything we can to protect our team as we manage through the COVID-19 pandemic, going beyond CDC and WHO guidelines to provide safe working environments for our associates. I could not be prouder as we worked tirelessly to do our part as a provider of essential products. I will now pass the call back to Brian.

Brian? That concludes our prepared remarks on the first quarter. We will now begin taking a limited number of questions. Since there may be a number of you who would like to ask a question, I'll ask that you limit your initial questions to two and then re-enter the queue to ask additional questions. I will now turn the call back over to the operator to begin the question and answer session. Operator?

Thank you. At this time, I would like to remind everyone that in order to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. Your first question comes from Phil Ng from Jefferies.

Hey, good morning, everyone. Good afternoon, everyone. Thanks for all the great color. Can you give us a little more color on how to think about April sales trends? And based on some of the color on the shape of the year, it sounds like, you know, the trough 2Q, 3Q sales could potentially be down 30% to 40%. So I just want to get a little perspective if we're thinking about that correctly and how some of the different businesses may perform in this environment.

Hey, Paul. This is Nick. Hope you are doing well. Why don't I start and then I'll pass to Pat. You can talk about what you thought about some of the trends. I would say, you know, into April, It's been fairly choppy. There have been parts of the market that are down, as you would expect, and then other parts that are showing more resilience than we would have expected. And so our approach is really to be very flexible and nimble, both as we look at cost reduction capacity so that we can capture the parts of the market that are working for us. You know, we're seeing particular strength around the value offerings that we have in cabinets, you know, mowing, decking, and doors from a price point perspective. And then I'd say from a channel perspective, really in retail and e-commerce. And so if you think about the portfolio, just, you know, as a reminder, you know, 24% of the business is USDA construction. We would expect, and we are seeing more resilience in R&R, you know, China and our security business. And then I think the fact that we've also bolstered the portfolio around that value sweet spot is why we're continuing to see that resilience there. And so, you know, it's tough reading to April. I think particularly given the stay-at-home orders, you're seeing weeks that are very strong and then weeks where it falls off and then weeks where it's strong again. And I think that's just as people kind of move in and out of, of retail or home improvement projects. So it's pretty early to get a read through. But as we look at it, you know, we continue our commitment to beat the market and that's where we think we are. So I think it's a path to talk a little bit about your question around forecast.

What I would echo in Nick's statement, I would say across product lines and across channels, we've at least seen I'd call it a measure of stability. By that I mean it seems like across the board, irrespective of product line and channel, we're no longer trying to find kind of new lows that are either flattening out or recovering. And as Nick said, I'd say in particular showing some strength in retail and e-commerce, I think what's going on in trade-centric channels is less of a problem and more of just You know, there's fewer outlets that are open in that arena. And also, you know, those are a lot of privately held companies that have to manage their balance sheets. They manage their inventory pretty tightly. In terms of, you know, looking at the quarter, obviously we're not giving strong form guidance. But, you know, I would say a range enterprise-wide for the quarter of down, 10% to 20% seems like the plausible range at this moment in time with what we're seeing in terms of POF, inbound orders, and shipments. I see more like mid-teens to low-teens seems like the more plausible realm of that spectrum. Obviously, things change every day in this world, but that seems to be where we are, and we're not seeing anywhere near that 30 or 40 that you referenced in your question across the portfolios.

Great. I mean, that's a really helpful color. That's far better than I think many people were fearing, especially on the cabinet side of things. And then, Pat, one more question. On the decrementals, that 20% to 30% for the full year, that's quite impressive. Any color on how to think about, you know, the impact you're going to see in 2Q and 3Q, appreciating there's probably more cost associated as you kind of manage through some of the supply disruptions? And does this factor in any lower input costs as well? Thanks a lot.

Yeah, I'd say on the full year, 30% to 20%, yeah, that's quite, you know, a great achievement that we are targeting to deliver, and we're confident that we're tracking in that direction. You know, realize our gross profit margin is 36% roughly enterprise-wide, so that means we're beating our gross profit margin. It does include, to your question, some assumption of some favorable commodities that will start hitting our P&L in the first quarter and fourth quarter as they come off our balance sheet. In terms of the second quarter, you're right. Given the safety measures and capacity rebalancing we're going through and some temporary shutdowns, be they by government order or on our own safety decisions, We're going through a bit more inefficiencies. I'd say decrementals in the second quarter are probably 40% plus or minus five percentage points in either direction, depending on how volumes and how choppy the quarter is. But we would expect the back half of the year to be trailing at the more favorable end of our range.

Got it. Thanks a lot.

I was just adding on your cabinet's reference. Recall that 50% of the cabinet's business is now at that value plus point. I mean, that's really been the execution of the pivot plan. And so that's where we're seeing it deliver. And then as you think about, particularly about I'd say the end of Q1 and into Q2, and the journey we're on from a decremental margin perspective, you could almost clear it into two parts, right? There's the part one, which is keeping people safe. We've been learning that journey. It's not an efficient journey. We think we've been doing it very well. As we eventually move beyond the health-related part of what will be a COVID-19 recession, you know, you then deal with stranded costs and capacity. And that's something we know how to do. And we've done it before, and, you know, we'll do it again. And so, you know, it's really – it gets blended together in a margin, but it's really two parts to the journey. And we're seeing ourselves kind of emerge from that first part now. And I think even if there's a second wave down the road, at that point we will have put in, you know, all the safety procedures we would have learned, you know, how this works, and, you know, we'll be in a better place to operate through that health-related portion of it.

Got it. Thanks a lot, Nick and Pat. Appreciate the call.

Your next question comes from Justin Spear from Zellman & Associates.

Hi. Good afternoon, guys. Thank you. Just a couple questions. I don't know if you have any sense that you can give us or provide us with the percentage of your customer base currently temporarily shut down or disrupted across each of your businesses due to the social distancing measures and stay-at-home orders.

Jeff, I don't know that he could nail a percentage. I mean, I think it would be kind of in the pockets where you might expect, as Pat would reference. I mean, you certainly are aware that the large retailers and e-commerce portions continue to function and have been pretty resilient. When you look at some of the trade-related and wholesale channel in cabinets and dealers, you've seen a number of small dealers shut down for the period. And in plumbing wholesale, what we've seen is a lot of counters remain open, but showrooms are closed. On the door side, you know, in the two-step distribution world, you know, a lot of our big distributors have remained open, down tier from them. Some of their smaller distributors have been closed. So, you know, I think that's how I encourage you to think about it. I don't know if it's a percentage, but it's kind of the trade-related channels, particularly where you have, you know, smaller points of distribution is where you might see And, you know, I think, you know, that's where you're seeing some of the larger demand hits and probably some of the offset then coming into retail and e-commerce.

All right. Thank you. And then another question for me is the inventories in the channel, particularly retail, does it agree you have any visibility there? I'd love to get some sense across your business how those are faring and how you expect that will shape this quarter, next couple quarters.

Yeah, I'd say on kind of the wholesale side, as Pat referenced, we did see destocking. Now, inventories weren't inflated coming into this. I mean, they've been managing them fairly lean. And so we've seen some advanced destocking, you know, ahead of what people anticipate is going to come at us in Q2 and I think the early part of Q3. That seems to have leveled out now. We're standing in April. This is a very volatile situation. We'll see what happens in May. But as we look at that today, we kind of saw it in the early part of the month, and then it started to level out. On the retail side of the business, I think inventory kind of sits at a fair spot depending on the category. But, again, because those channels have been pretty resilient, I think there's probably room to actually build some inventory over time. But, you know, we'll see how consumers continue to act and pros continue to act as they come in and out of those channels.

I guess the last question for me is on that DIY versus pro side of the ledger, do you guys have any insights into the behavior, particularly for some of those product categories that require getting into the home? Are you noticing any distinction in behavior and demand trends that you can point out?

You know, I've read a lot of conjecture about it, and I think the conjecture is probably fairly accurate, where you assume that people can do something on their own. They might have been getting off to those projects, and they're aware they might have to bring somebody into the house. Perhaps it's been slower, but that's not the lead-through that we're getting when I look at the product portfolio. I mean, particularly, you know, Cabot's not particularly – DIY, necessarily DIY-friendly products, but we're seeing a lot of strength there. Now, you know, that might be coupled by the fact that we've also seen a lot of reduction in subsidized Chinese cabinetry coming out of the market. We've got products sitting right at the sweet spot, and so where there is a need, where people need to complete a project, they're getting it done. So while I've read a lot about what you're referring to, and, you know, it does make sense, I wouldn't say that we're necessarily seeing that distinction in our portfolio.

Thank you, guys.

Your next question comes from John Lovallo from Bank of America.

Hey, guys. Thank you for taking my call as well, and I hope everyone is healthy and safe. First question is the 10% to 20% sales decline that you're thinking about for the second quarter, that would seem to be pretty solidly above market. I mean, am I thinking about that correctly? Are you guys expecting some fallout? some pretty significant outperformance? And if so, you know, are there certain segments that would kind of lead the charge there?

I'm actually good, and then I'll pass to Pat, John. You know, I think it again goes to the fact that we're seeing strength around, you know, relative to the market around the value offering that we have. And, you know, it's not something – That just happened. I mean, this is a part of the portfolio. We've really been working hard for the last few years to bolster our position in value cabinetry, you know, to bolster the power of the Moen brand. You know, fiber on indexing, you know, really plays, you know, powerfully at that entry level. And, you know, and also we bolstered the offering in doors. And so, you know, we're seeing those hold, you know, fairly well, and I think that's why, you know, that 10 to 20, which for us is really a bottoms-up forecast, is where we see it. And I think it's pretty tough to get a read on the market. You know, as I said, it's up and then down, you know, week to week as people move in and out of channels. And so, you know, it's going to take a little while, I think, before you can clearly say whether, you know, it's a beat or not. But I will tell you, we came into this If you look at Q1, you know, we're not going to rest on our laurels about Q1 markets, but we feel very confident that the outperformance of the business, both on the top and bottom line, carries through, right? I mean, we were winning and beating the market. We were doing it for reasons because the products were resonating with consumers and the value that we're providing at the price point was resonating with consumers. You know, that will continue. We'll continue to beat the market, whatever the market is. And then, you know, the operational excellence that we saw in the leverage through, you know, we're going to express that through the decremental margin, you know, as much as we did through the incremental margin and the leverage.

Yes. John, what I'd add to that is, you know, we're seeing all of our businesses perform within that range. It's no one business salvaging another. They're all kind of in that range. And, you know, there's sources of strength. in all the businesses, including some of the ones like Georgia Cabinetry that you might not intuitively expect given what happened during the last downturn. In Cabinetry, we set out the year for a plan that basically there was some skepticism when we set out the year around could we achieve the plan targeted growth rates, but it was predicated on high single, low double-digit growth of value price point cabinetry and the rest of the portfolio being flat. Now, obviously, we're not in the planned environment, but we're still seeing strength in entry price point cabinetry. As Nick said, I'm sure in part helped by the absence of subsidized Chinese imports. You know, in plumbing, you know, the POS, both globally and in the U.S. in the quarter was really strong. It was like roughly mid-single digits globally and high single or double digits in the first quarter, and that TOS continues to be strong. And plumbing in China, which was a little bit slow in its initial comeback stages, has really, you know, accelerated its comeback. And then, you know, the distribution gains in decking, but, you know, I'd say the strength in DOORS would lead us to believe that, you know, builders, because that's largely a new construction product, probably where the most new construction exposure we have from what we're sending, is they must be stretching out the orders they have from the fourth quarter and the first quarter because, you know, we still see stable and respectable demand indoors.

That's helpful. And then, you know, maybe just on the decking side quickly, you know, realizing that there was the distribution gain there, but Are you guys getting the sensors too early that, you know, folks after being stuck at home, you know, for five, six weeks here are looking to make their living spaces, you know, even their outdoor living spaces more livable? And do you think that that's an opportunity perhaps, you know, longer term for composite decking?

Look, that's the feedback we're getting anecdotally through the channel. I think it would be early for us to tell you we've seen it in numbers, although what we are seeing is a lot of confidence around. But what we are hearing through the channel is that there's a lot of excitement that even as shelter-at-home orders are relaxed, people are going to be more likely to entertain at home and use their outdoor spaces than they are to go out to restaurants or entertainment venues. And the channel itself is feeling pretty confident that outdoor living and decking will have some tailwind.

Thanks, guys. Your next question comes from Mike Wood from Nomura Internet.

Hi, good afternoon. First question, wondering if you could give us some information on whether the glut of Chinese cabinet inventory had cleared before COVID-19 hit and what that current situation looks like.

Sure, I'll kick it off. You know, we... It's very hard to read. We know there was a big build of Chinese inventory during the course of last year. Our estimate, and it fairly consists on this, is that we would see that come out sometime in Q1. Our sense is that's probably happened. I mean, it's hard to nail down exactly, but we think it's largely come out, and we're probably not seeing the benefit of that. You know, if you look at the import data, you are seeing an increase in some Southeast Asian imports. You know, we look at that very, very closely. We know where the capacity is. We use a chunk of that capacity. There is not a ton of it. In fact, you know, some of the countries on the import data likely don't have much cabinet capacity at all. And so as we look at that, you know, we're – Leveraging that where it benefits us, but we're also monitoring it very closely and working with customs who are, you know, proving to be very cooperative around looking at anybody who's not necessarily adhering. So, you know, short answer is we think it's come off, and, you know, we haven't seen it come back and swamp, and if anything, there's been a big pull on the product that we've positioned at that part of the market.

And what are you hearing from dealers in terms of, whether they're still able to meet with customers for, you know, kitchen design or is it being done virtually? Will there be any extension in lead times as a result?

You know, there's, There has been some extension in lead time, and that's been stated. I think that us and others have put safety provisions around. You know, we've been able to continue to operate pretty much everywhere, although, you know, I don't think that's always been the case. And so, you know, I think some others have had to also extend lead times with respect to that. You know, and I do think some of the dealers, particularly some of the independent ones, are, you know, are closed. And so... You know, I think it is more challenging, and I don't know how that design process is advancing. I suspect that, you know, we are going to see a period here in Q2 where there is a lull in the custom side of the business as people, you know, were unable or unwilling to go and, you know, sit in a store and get a design done. Some of that's moved online, but I think, you know, a large chunk of it will just be delayed.

Thank you.

Your next question comes from Mike Dahl from RBC Capital Markets.

Hi, thanks for taking my questions. Just a follow-up on cabinets and also some of your earlier commentary about kind of channel partner health. On the dealer side in particular, are you seeing anything in terms of either receivables or bad debt? Anything from a from a customer standpoint with some of your channel partners that have actually gotten shut down, or what are your expectations with respect to that?

It's something we're monitoring closely across all of our businesses. You know, many of us were around in the last downturn, so, you know, as soon as this, virus spread west, that was among our initial considerations. Right now, we're not seeing things that leave us feeling like we have any kind of big or material exposures, but it's something we are tracking and managing very proactively. We don't anticipate something right now that is material or significant just because we got on it early.

And as a quick follow-up, are you doing anything specific to partner with people to either extend credit or terms proactively?

We're not in the business of being the bank to the channel, not because we're unfriendly. We just, you know, we have pre-existing relationships, and we're kind of sticking to those pre-existing relationships, and we'll just – work with channel partners respectively to make them as successful as they can be, but we're not going to be, you know, expanding our risk profile in that regard.

Okay, thanks. My second question, just with respect to China Plumbing, can you give us a little more granularity, help us maybe quantify what the what the magnitude of declines were as you go kind of month by month through China, and then what the – and I think you said it was a little slow to start to recover, but now has. Just give us kind of an update on where you're at maybe on a year-on-year basis at this point.

Yeah, well, now I'll give you some color, and Pat can provide some additional granularity. You know, the starting point is we shut down for six weeks. I mean, you know, and the nature of their shutdown was more severe in that, you know, that was reflected in the Q1 number for plumbing. As that started to come back, what we initially saw was strength in e-commerce and strength in developers as they got back onto job sites and started to get back to work. You know, a few weeks once the economy started to reopen, it was probably tracking at the 70th percentile versus, you know, what we would have anticipated after COVID. Over the last couple weeks, though, it really has started to ramp. You've seen traffic back in the big building products malls. You're starting to see traffic in showrooms, which is positive. And then our developer partners are kind of closer to 90%, 95% of what we would have expected from a construction standpoint.

Yeah. That's great. It was a seven-point hit in plumbing in the quarter for COVID and FX, about $4 million was FX, and the balance was COVID-related. And that was really our facility in China that ships product to customers was shut for And when things started opening back up in China, which was late March for them, just as it was hitting up here, some of the really big developers were kind of early back to action. And retail was pretty quiet to start. But now, as Nick was saying, retail is starting to come back. And developers are kind of in the 90% to 95%. projects back up and running. So, you know, that market is coming back to life nicely. We do expect them to perform well in the second quarter.

Okay. Thanks, Matt. Thanks, Nick. Your next question comes from Selden Clark from Deutsche Bank.

Hey, guys. Good afternoon. Can you just talk about the range on the decremental margin framework that you provided for and kind of just give us a sense of what might cause you to be on the, you know, lower or higher end of that range and whether this includes any, you know, cost savings in terms of corporate expenses or, you know, production rationalization or anything along those lines.

Okay. Yeah, sure. Why don't I start out and then I'll pass it to Pat. You know, I'll start with the kind of production standpoint. I think, you know, this is an important point, I think, particularly as you... You look across a variety of different companies and industries. You know, one of the reasons we're setting the target where we've set the target is for this first thing I talked about, there's kind of two hubs. You have the hub where you're, you know, it's really about preserving safety and health, and then you've got the demand-driven recessionary side, and you've got a size to capacity. You know, for the first part, I think a very important point is, From the start, the industry was deemed essential by the federal government, and then we've been working at the local level every single day to keep our facilities open and keep our people safe. We've worked with local health experts, officials, with our plant leadership, and really been problem solving at the local level. It's really rapid issue resolution. learned a lot. We're going to keep adapting. But that, you know, that has been a key driver versus having to have a total shutdown and then a complete ramp-up as you're managing through this. And so, you know, that has been really critical. It's been nowhere near the efficiency levels we like. You know, there have been some facilities where, you know, we're maybe operating at 60% or 50%, but it's a lot better than a zero. And so that's That's really allowed us to pursue, you know, top priority of keeping people safe, you know, but without, you know, the giant expense of a shutdown and then a ramp up. And so that's for the first part. You then sort of move – as we move out beyond that or we get into a groove of operating that way, you know, to, you know, what will be, you know, handling reduced demand in a recessionary environment. And that, you know, is a set of cost actions that are both – The easy things I think you'd expect to be able to go after first, and we attacked a lot of that stuff towards the end of Q1. But then really we're looking at it as a set of actions that we have prepared and are preparing to respond to tier changes in demand as we see them. But all of the actions are designed to make us a stronger company going through this. and a stronger company coming out of it. And so, you know, we really want to target best-in-class deferral mental margins as we move through. We want to target best-in-class leverage as we come out. And so, you know, we're going to look at, you know, not just temporary, but also, you know, permanent changes to the cost structure as we move through this. And, you know, we expect to act with a lot of urgency around that.

Yeah. You know, just to kind of put the numeric stuff around it – During the last economic downturn, over the three years from 2006 to 2009, which was kind of our sales peak to sales trough, our decrementals over that three-year period, cumulatively, were about 35%. So, you know, our objective is to beat that and beat that handily. It is a challenge, but we're committed to addressing it, right? If we did nothing to address... Bonnie, all our decrementals could easily be 50-plus percent. You know, if you just leave stranded costs in production and distribution facilities and don't do anything to your corporate costs, it could easily be 50-plus percent. And then your question for kind of what puts you at the more favorable end of that 30% to 20% range, it depends on how early the demand headwinds come and stabilize. So the earlier they come and stabilize, the sooner we can adjust capacity both in production and distribution facilities and the sooner we know the magnitude of action in corporate expense and can get that into our run rate. The later in the year those happen or the more choppy they are, the more difficult the equation becomes. And so a lot of it has to do with what's the order of magnitude of demand headwinds, how choppy is it to get to that, new normal and when in the year it happens. And then I say, you know, there's also, yes, you're kind of asking, this is not just a production facility, distribution facility, cost optimization as we go through this in a, you know, incident that is, you know, this order of magnitude, everything is on the table. And, you know, there will be SG&A reduction that is already underway. and we'll continue to move with demand reality in order to get us to a decremental margin that is below our gross profit margin.

And so a lot of this is permanent in nature. I mean, there are the variable costs that you size, but there are permanent changes that will make us stronger, leaner, and better, both going through and again as we emerge. And that is something that we take very seriously. At the same time, we will very strategically make sure that we have the capacity to continue our hot-size share gains, which we think will actually accelerate through an event like this. And so, you know, that capacity will be there and we will be able to flex it to take advantage of opportunities that come our way. And we are seeing, you know, our biggest customers coalesce around the strongest suppliers. And so, you know, we will look to make changes that really improve us from an efficiency perspective. That's how I think about it.

Okay, that's really helpful. And then just as my follow-up to that question, given everything you're looking at and doing on the cost side, you know, as we think about, you know, things normalizing in the 2021, realize this is, you know, a little bit far away and somewhat of an unprecedented situation, but just given everything you're doing on the cost side, is 20 to 30 percent incrementals you know as we get into a more normalized tier and modest mid-single-duty revenue growth something along those lines is that the right way to think about it or given all these cost actions you're taking to see something closer to that 30 percent into your range well i would say you know part of the way we're gonna work on delivering this year is where

we can cut back on investment expense without harming our ability to compete for share. I think as we get out of this, you'd probably more expect the incremental margins coming out of this to be in the 20% to 25% range, which were consistent with our strat plan was around 25%. You know, there might be a little catch-up in 21 because you've kind of set on your wallet in some respects, but our longer-term trajectory on incremental margins in a growth mode is about 25%, and I'd say we'd be working to get back to there pretty quickly. I mean, there are periods where we get up around 30%, but that tends to be where we're leveraging latent capacity more than anything. Where we're investing in innovation and brands, we tend to be tracking more closely to that 25%.

I do think if you look at our performance in this quarter now, Q1, it does demonstrate what the business does when volume comes its way, our way when we're executing well everywhere and driving share gains, and you're seeing leverage well north of 30.

I appreciate the time. Thanks, Chris.

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