Fortune Brands Home & Security, Inc.

Good afternoon. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brand second quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. 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 your conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Home and Security Second 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 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 and our most recent 10-Q. 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 you and your loved ones are all staying safe during these extraordinary and challenging times. I'm very pleased that we delivered strong sales and profit results through a historically turbulent quarter. Against the backdrop of a relatively resilient housing market, excellent operational execution by our teams resulted in our businesses operating at a high level of efficiency in the face of enormous headwinds. First of all, I want to thank all of our dedicated team members who worked so hard in such a challenging environment to keep our people safe and our facilities open. I'm inspired by the care our employees are showing for each other and within our operations. I'm also proud that we've been able to continue to serve our customers with essential products as families sheltered at home. As the shelter-in-place orders took hold, we saw a noticeable shift in consumer behavior towards home purchase and home improvement that I will discuss in more detail. Given varying impact of the shutdowns on our channel and supply chains, we saw strength in some parts of our product offerings ahead of expectations, while other parts performed as we had anticipated. Through our operational performance and agility, we were able to generally serve customers as needed, resulting in significant share gains for our company. Our channel partners are coalescing around us as a bedrock of strength, and those deepen partnerships by leading to further opportunities. In addition to positioning us to capture further share gains on the top line, our teams focus on driving permanent efficiencies throughout the businesses. These benefits are intended to sustain through the recession and into a recovery to free up additional dollars to drive investment as well as to improve our overall margin profile. We have made progress ahead of our expectations. Our defermental margin performance for the quarter was substantially better than what we communicated on the last earnings call. In addition, we expect the real long-term benefits will be felt as we return to growing sales with increasing investment dollars and operating leverage at higher margins. Our robust efficiency initiatives and hard work to position the businesses to outperform expectations, regardless of the environment, ensures that we can continue to win for all of our stakeholders, not only during the pandemic, but long after. Turning to the remainder of our remarks today. First, I'll speak to our company's response to COVID-19 and how our people are keeping us safe and open while we continue to outperform. Then, I will discuss what we're seeing in the home products market. I will then highlight key takeaways from our second quarter results, as well as discuss our performance acceleration initiatives and how we expect to evolve over time. And then Pat will provide highlights on our financial results, balance sheet strength and liquidity, as well as thoughts around our future financial performance in this environment. Let me start with our number one priority, safety. The second quarter environment was one of the most challenging in recent times. By making the safety of our people our number one priority and taking steps in excess of WHO and CDC guidelines, we were able to keep people safe in our facilities. I'm proud that our COVID-19 incidence rate is only about a third of the national average and materially below manufacturing benchmarks. Through a rapid response to the evolving situation, we were also able to keep facilities open through the quarter with periodic shutdowns in certain places where we saw risk of community spread. This agility has been key to both safety and to keeping our customers supplied with our essential products. we've learned a lot by continuing to remain open and operating and are continually adjusting and improving our approach to operating safely in a COVID-19 environment. While our measures have significantly contributed towards employee safety, they've also caused some inefficiencies that will resolve over time. Examples of inefficiencies experienced during the quarter include some shifts operating below optimal variable production levels as we relaxed attendance requirements. instances of fewer hours of production per day for longer shift changes and for regular deep cleaning, and accommodating temporary shutdowns from time to time for more extensive cleaning to avoid community spread and to accommodate any short-term government orders. The net result of our efforts is that we were able to keep people safe and still operate in the COVID-19 environment. We did not experience large-scale shutdowns and ramp-ups and the disruption that that would cause. Rather, we operate it, albeit somewhat inefficiently, in a continuous learning and improvement mode and feel well prepared to weather the storm should the virus resurge further. Now, turning to our market and key takeaways from our second quarter performance. Our home products market was clearly stronger than many other industries. The very nature of the pandemic and the shelter-at-home orders have led to resurgence of interest in housing. Looking recently at Google search data trends in mid-July, searches for home improvement are up 51% versus this time last year, and searches for new home sales and existing home sales are each up over 30% over this time last year. Recent purchase mortgage applications data has been up strong double digits versus this time last year as well. During the quarter, it was encouraging to us that as the economy opened back up, demand accelerated quickly. In fact, from a low of a 20% decline in sales in April, as many channels were shut down, we saw orders accelerate to being flat year-on-year in the month of June. This trend has continued into July and appears to be stronger than a catch-up from mis-shipments in April and May. New construction activity and product flows largely halted in the beginning of the quarter, but resumed in mid-May and accelerated into June and July with our builder channel expressing increasing confidence about the balance of the year. R&R activity during the quarter was largely defined by channel, with retail and e-commerce showing the most strength, driven by both the channels being open and consumers increasingly focused on home improvement. Wholesale and dealer channels were closed for the first part of the quarter and accelerated more quickly in the second half of the quarter and now into July, driven by rebounding new construction activity. Since June's quarter end and into July, R&R and new construction activity continues to improve. With that market backdrop, some thoughts on the recent quarter. In the quarter, total company sales decreased 9% over the last year, and operating margin was up 20 basis points to 14.3%. This performance was meaningfully ahead of our own expectations, a result of excellent operating execution by our teams, stronger than anticipated demand for our products, and delivery of our cost realignment initiatives ahead of schedule. Our operational outperformance across the company led to accelerated share gains, and we are being rewarded with opportunities from customers. Most importantly, as we drove our cost realignment program, we continue to invest in common core competencies across all of our operations, including strategic spending on revenue management and in supply chains. We were also able to invest in key strategic growth initiatives, including the low-end brand, decking capacity, and distribution rollout, and value-priced cabinetry capacity. I anticipate that if we continue to see stability in the back half of the year, we will accelerate further investments into our most critical priorities as we set ourselves up for 2021. Before I delve into each individual business, I would like to mention the Cross Fortune Brands initiatives that we are taking to create permanent efficiency in our business to free up additional funds for investment in our key priorities and to drive incremental margins. At the beginning of the year, we started a fuel for growth and margin enhancement journey predicated upon finding permanent efficiencies in the business and building core capabilities that we are leveraging across FBHS. As the COVID-19 crisis took hold, we accelerated our cost-out and cash-generating initiatives by targeting fixed costs, supply chains, and less productive SG&A. We're taking permanent cost reductions as we re-platform the company using a common set of capabilities and a unified approach to reset our base cost structure for the long term. As I mentioned, our teams have delivered ahead of schedule, and we now stand to pull our margin accretion goals forward by a year as volumes return to growth. Now, let me turn to our individual businesses and how we're positioning to be even stronger long-term, starting with plumbing. During the second quarter, our global plumbing group continued to outperform the global and U.S. markets with second-quarter sales roughly flat compared to last year and operating margins of 24.5%. Strong double-digit growth in both U.S. retail and in China drove the quarter. Our POS well exceeded our sales number as customers reduced inventory early in the quarter. Our re-energized known brand continued to record top scores in brand awareness, purchase intent, and customer loyalty. A strong margin for this quarter continued to create more fuel for growth as we continued to invest in our brands in consumer-led innovations. our ability to pursue growth in both core and new segments within the global plumbing group has never been greater. Our continued investment in new channels such as e-commerce and on-trend innovation set GPG up for long-term profitable growth. We experienced a strong return to growth in China in the second quarter, after having borne the brunt of the COVID-19 impact during the first quarter. Debt business continues to outperform its market through channel and category expansion and drives excellent leverage to the bottom line. The Chinese economy has stabilized quickly and is continuing to show strong support for housing. Turning to doors and security. Sales decreased by 9% over this quarter last year, and operating margin increased by 70 basis points to 14.4%. Importantly, our fiber on decking brand grew mid-teens in the quarter. It continues to benefit from long-term material conversion from wood to higher-performing eco-friendly recycled materials. The pandemic has accelerated consumers' focus on outdoor living, and we are seeing continued strong demand for our products. Our distribution wins and capacity expansion plans remain on track, and this is a priority for us going forward. Our doors business experienced an abrupt slowdown in the first part of the quarter as home builders stopped work and the wholesale channel destocked. Those six weeks were followed by a rapid acceleration in the second half of the quarter as the market opened back up and new construction demand significantly reaccelerated. Despite the volatility, the business operated at a high level of efficiency throughout the quarter as we delivered continuous improvement initiatives ahead of expectations. Finally, turning to cabinets. In the second quarter, our cabinets team demonstrated excellent performance as our pivot plan has reached an inflection point up to two years of aggressive repositioning, which has intensified in the last six months. The business is showing increasing resilience through the downturn and has the opportunity to accelerate as conditions improve and we continue to take share in value products. Sales versus a year ago declined 15%, with value price products declining by only 7% during the quarter. Operating margin was 8.2%, which was very respectable given the pullback in volume. Further, had we been operating in a more normal environment with standard lead times, we had orders that would have resulted in sales only being down approximately 10% overall and value product sales would have been roughly flat during the quarter. The pandemic is accelerating the mix shift to value price point products, which benefits us as market leader as we are best situated to catch this momentum given all of the positioning and supply chain work we've undertaken over the past two years as part of our pivot plan. We're gaining share from both domestic players and from the absence of Chinese players who have exited the market over the past few months or who have been replaced to a lesser extent with other importers with higher costs and longer lead times. Our work to add further value in cabinets is not over as we continue to drive this business towards our long-term goal of mid-teens margins. As the U.S. leader in cabinets, we're continuing our efficiency journey and our plan to capture more opportunity. We continue to further optimize operations and add more flexibility to prepare for additional sales upside at more accretive margins coming out of the pandemic. This includes adding capacity and flexibility to our vaunted, low-cost global supply chain as well as adding economies of scale, less variability in product configurations, and more consistent packaging solutions. We have the ability to not only grow value cabinets at above market, but expect to do so at an increasing margin profile. In summary, while the second quarter of 2020 will be noted as one of the most challenging in a generation, the U.S. home products market is emerging in relatively good shape. The nature of the pandemic has driven home improvement in the short term and is causing renewed consumer interest in household formation and renovation. Although economic outlook remains uncertain, we expect housing will continue to benefit from demographic tailwinds in the long term, altered by increased consumer interest in investing in their homes. Overall, while our strong second quarter results were executed in a very fluid business climate, They do demonstrate that our strategies remain intact and are delivered for us. Our businesses are reacting positively to the accelerated efficiency actions we are taking, and we are taking those actions very seriously with plans to do more. And as the environment turns more positive, we have the businesses positioned to grow and drive strong operating leverage. As the first half of the year has shown, we have a high-quality, diversified portfolio underpinned by common core competencies that can grow above market and take advantage of a healthy new construction backdrop to outperform in times of strength, as we did in the first quarter. That same high-quality portfolio of leading brands and advantage positioning within our channels also provides resilience in a downturn, as evidenced by our exceptional results in the second quarter. The work that we have done over the last few years to reposition the core of the portfolio to the most attractive parts of the market and to expand our channel exposure have paid off well. This strength has allowed us to focus on our key priorities of keeping people safe, serving our customers, operating with excellence, and reinvesting in our business. In addition to our businesses being well-positioned, we also have a strong balance sheet with ample liquidity.