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.