Fortune Brands Home & Security, Inc.

Good evening. My name is Rob, and I will be your conference operator today. At this time, I'd like to welcome everyone to Fortune Brands' third 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. To ask a question during the session, you will need to press star 1 in your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. Thank you. I would 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 Third 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 and our most recent Form 10-Q. The company does not undertake any obligation to update or revise any forward-looking statements which speak only to the time at which they are made. Any references to operating profit or margin, earnings per share, or cash flow on today's call will focus on our results on a before-charges-engaged 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 have allowed time to address some questions that you may have. I will now turn the call over to Nick for his remarks.

Thank you, Brian, and thanks to everyone for joining us today. We hope that you and your loved ones are all managing well and staying safe during these challenging times. In the quarter, total company sales increased 13% over the last year, and operating margin was up 90 basis points to 14.8%. This performance was the result of excellent operational execution in an accelerating market while still managing a pandemic environment and prioritizing our employees' safety. I'm extremely pleased with the strong sales and profit results that we delivered in the third quarter, which bolts upon an impressive year-to-date performance in the face of unprecedented challenges. Performance is strong across our businesses with our teams delivered and our efforts to keep our people safe. We're working hard to serve our customers' needs as the fundamentally strong housing market is accelerating further as consumers invest in the home. While we are delivering ahead of expectations this year, we're also making long-term investments in our brands, innovation, core capabilities, and supply chain capacity that will enable us to capture future opportunities and accelerate our share gains. I want to thank all of our dedicated team members who continue to work so hard to keep our people safe and our facilities operating. I am so proud of our teams who are not only caring for each other, but who are doing so while serving increasing demand for home products. In the third quarter, all of our businesses saw impressive double-digit growth, and we drove overall margin improvement for the company by leveraging efficiencies enacted since the second quarter, as well as delivering progress against our planned efficiency roadmap for the year. Our efficiency initiatives should create fuel for increased investment as we continue to improve the overall margin profile of Fortune Brains. We're ahead of our expectations on these efforts, which should accelerate share gains at higher margins over the next few years. Through our operational agility and strict focus on safety, we were able to generally serve our customers' needs, which resulted in significant share gains. In many cases, we invested heavily to keep customers supplied in this accelerating market. Our channel partners continue to coalesce around our strength, and those deepened partnerships are leading to further opportunities to grow profitably. Turning to the remainder of our remarks today, first, I will discuss what we are seeing in the home products market. I will then highlight key takeaways from our third 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. Now turning to our view on the housing market. Our U.S. home products market is underpinned by robust fundamentals, including very favorable demographics, low inventory, and attractive affordability thanks to low mortgage rates. As noted on prior calls, we saw strong demand across the board in the first quarter. This was followed by very robust activity in open channels in the second quarter. It has been encouraging to us. but as other channels opened further in the third quarter, demand for our products continued to increase. In fact, we continued to see strong retail POS even as wholesale and builder activity bounced back from the second quarter shutdowns. Key consumer trends have been expedited by the pandemic, which appears to have accelerated the movement of the key millennial generation toward household formation, suburbanization, and investment in the home. These trends, which were already in place prior to the pandemic, should drive new construction, repair, and remodel demand, especially at the entry price point part of the market where there is a short supply of available homes for purchase. The current environment has also accelerated trends for the large baby boomer generation. We have long identified that more and more seniors prefer to thrive in place in their homes. We expect that the pandemic's disproportionate impact on senior living facilities will only add to this trend. Repair and remodel activity during the quarter remained elevated, as home purchasing activity was high and consumers focused on home improvement. Additionally, as more people work from home and entertain at home, they have reconfigured and upgraded their homes to accommodate an expanded set of needs. With existing housing sales accelerating and aged housing stock and U.S. homeowners sitting on near all-time highs in home equity levels, we expect that the R&R market should continue to benefit from these underlying tailwinds. The market for single-family new construction also remains fundamentally strong as inventory is low. Our advantage to exposure to new construction provides a tailwind to our growth with strong fundamentals such as high household formation, affordability, and current supply at or near record lows. We expect this momentum to persist over the next few years. We believe our advantage mix of exposure to the stable repair and remodel market combined with the torque of a strong housing construction market gives us an unparalleled opportunity to add long-term value for our stakeholders. We've demonstrated our ability to capture the upside afforded by new construction exposure and manage the downside if or when it materializes. Given the market fundamentals of very favorable demographics, low inventory, and aged housing stock, we see a very positive multi-year tailwind powering the U.S. housing market back to consistent mid-single-digit R&R growth and high single-digit single-family new construction growth. Consistent with our long history, we intend to outperform this market and continue to gain share. Based on our view of a sustaining positive backdrop for U.S. housing, we will continue to position Fortune Brains for long-term profitable growth. The current pandemic, while unwelcome, has served as a catalyst for the consumer to focus on the critical importance of the home, which has only emphasized and unlocked this fundamental housing market strength. With that market backdrop, some thoughts on the recent quarter. As I mentioned, total company sales increased 13% over the last year, and operating margin was up 90 basis points to 14.8%. This performance was the result of excellent operational execution in an accelerating market, while our team worked tirelessly to prioritize our employees' safety and our customers' needs while still managing a pandemic environment. This operational outperformance across the company is leading to accelerated share gains as we are being rewarded with additional opportunities as consumers gravitate to trusted brands and customers coalesce around the most dependable supplier partners. We drove solid margin accretion as we saw the early benefit of our efficiency efforts. Consistent with our strategy, a portion of those efficiency gains were used to invest in key strategic growth initiatives, including the mowing brain, decking capacity, and distribution rollout, and value price category capacity. We also continued to invest in common core competencies across our businesses, including innovation, category management, and global supply chain management. We are accelerating investments in our most critical priorities as we position the business for 2021 and beyond. Last quarter, I mentioned the Cross Fortune Brands initiatives that we're taking to create permanent efficiency in our business to free up additional funds for investment in our key priorities and to drive incremental margins. As you can see from our performance, the effects of margin accretion are being felt in our 2020 results with increasing margins both quarter over quarter and year over year for the total company. we continue to take permanent cost reductions in the quarter as we re-platform the company using a common set of capabilities and a unified approach to fuel growth and reset our base cost structure for the long term. Our teams have delivered ahead of expectations, but we are not going to rest on our laurels. We will continue to position our company to generate increasing value through sustainably higher top and bottom line performance while increasing investment in core strategic initiatives. Now, Let me turn to our individual businesses and how we're positioning to be even stronger long-term. Starting with funding. During the third quarter, our global funding group continued to outperform the global and U.S. markets, with third quarter sales up 15% compared to last year and operating margins of 20.8%. Strong double-digit growth in both U.S. retail and e-commerce and in China drove the quarter. This quarter, we continued to invest heavily in our brands and consumer-led innovation, We also incurred meaningful one-time costs for items such as air freight and employee recognition to meet the increasing needs of our customers. Even with the incremental investments and costs, we are on track to deliver approximately 22% operating margin for GPG in 2020. Investments for plumbing continue to deliver results. In addition to our continued share gains as North America's number one fossil brand, Mullen continued to record market-leading scores in brand awareness, purchase intent, and customer loyalty, particularly with our key millennial consumers. A global partner group's ability to pursue growth in both core and new segments keeps opening up new opportunity sets for this business to continue to outperform the market. Our sustained investment in newer channels, such as e-commerce and in untrend innovation, sets GPG up for long-term profitable growth. We also experienced solid growth in China in the third quarter. Moen continues to outperform its market through channel and category expansion, driving 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 increased 14% over this quarter last year, and operating margin increased by 190 basis points to 16.4%. These exceptional quarterly results were defined by operational outperformance in decking indoors and the return to growth through our suite of security products after COVID impacted second quarter. Importantly, our fiber on decking brand grew by over 40% in the quarter. It continues to benefit from our distribution wins and execution as we position the brand for long-term growth in a market fueled by trends in housing, outdoor living, and 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 winds and capacity expansion plans remain on track, and we have incremental capacity coming in the fourth quarter and through 2021. Sales indoors experienced strong growth as retail remained robust, and home builders accelerated activity that began in the second half of Q2 and continued through the summer months and into the fall. Both the wholesale and retail channels recorded double-digit growth in the quarter, The synergies in scale emerging from our shared wholesale channel distribution for doors and decking has been particularly advantageous to our growth. Turning to security, sales returned to a more normal mid-single-digit growth rate for the quarter, despite an expected softer back-to-school and commercial market. We're continuing to innovate in our security product lines with touchless and connected products for residential and commercial applications. Finally, turning to cabinets. In the third quarter, our cabinet's team delivered excellent performance as they outgrew a strong market and continued to deliver on our margin initiatives. This year, the business has demonstrated how a pivot plan can produce outperformance in vastly different market environments. After more than two years of aggressive repositioning, this business is now squarely centered on the heart of the market and has proven it can be defensible when the macro dictates, but can also go above market in times of strong activity with excellent leverage. Sales versus a year ago increased 11%, with value price products continuing to drive strong growth, while we saw improving trends in our make-to-order business. Operating margin expanded to 12.2%, an increase over the last year of 200-plus basis points. Strong demand in retail big bucks and further momentum in our advantage dealer network drove the results. Make-to-order showed stabilization in the quarter. It was up in September. Our initiatives are driving scale efficiency in our made-to-order operations through a commonization of key components, which is contributing nicely to our cabinet's business performance. Our team has been aggressive in capturing operational efficiencies across the operating platforms to drive our margin improvement, and while we've made progress, we have plans to capture more opportunities in the future. With our focus on value price point cabinets, we continue to gain share from both domestic players and from the absence of Chinese suppliers who have exited the market over the past few months or have been replaced to a lesser extent with other importers with higher costs and longer lead times. While we saw imports increase from certain Southeast Asian countries, they are well below 2018 highs and, more importantly, are at a higher cost and come with longer lead times than the directly subsidized Chinese cabinetry that was in the market prior to the anti-dumping case. Our low-cost country supply chain is equipped to compete in this environment, and we are winning share on a more even playing field. We are well on our journey to drive this business towards a long-term goal of mid-teens margins. We have the ability to not only grow value cabinets at above market, but expect to do so at higher margins. Our performance initiatives across our make-to-order business are delivering and we are being rewarded with incremental business from Advantage Dealer Network. We continue to further optimize operations and add more network flexibility to prepare for additional sales upside at higher margins over the next few years. This includes adding capacity and flexibility to our advantaged low-cost global supply chain, as well as adding economies of scale, less variability in product configurations, and more consistent packaging solutions across our offerings. In summary, we continue to outperform a strong home product market driven by long-term fundamentals. The pandemic has served as a catalyst for these strong fundamentals by driving renewed consumer interest in household formation and renovation. While the immediate economic outlook remains uncertain, we expect housing will continue to benefit from demographic tailwinds in the long term, bolstered by increased consumer interest in investing in their homes. In the meantime, We will continue to operate the business with agility, managing costs in an uncertain environment, while investing in key strategic initiatives to deliver excellent long-term returns for stakeholders. Our teams yet again delivered excellent results in a challenging environment. We remain focused on keeping our people safe and serving our customers. We are investing for the long term and continue to demonstrate that this business and management team can deliver exceptional results in a variety of market environments. I could not be prouder of their performance. With that, I will turn the call over to Pat, who will speak to our financial results.

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 mentioned, we are very pleased with our team's performance. They prioritized safe operations, addressed accelerated demand, and delivered exceptional results. Last quarter, I mentioned our priorities to build an even stronger company remain, including protecting the health and safety of our teammates, servicing our customers, and positioning our business for share gains, delivering strong margin performance this year, and accelerating progress on our profit objectives while investing to sustain competitive advantages and maintaining a strong balance sheet. Our teams executed against these priorities across the board in the third quarter, which led to exceptional sales and margin performance. This high level of execution positions us to continue capturing share and increasing margins for the balance of 2020 and beyond. Now I will cover the specifics of our third quarter results. For the quarter, sales were $1.65 billion, up 13% from a year ago. We experienced double-digit sales growth in every business segment, a sign of the widespread consumer interest in R&R and new construction. Consolidated operating income for the quarter was $244 million, up 20% or $41 million compared to the same quarter last year. Operational excellence and volume leverage drove this strong income growth. Total company operating margin was 14.8%, up 90 basis points over the same quarter last year. Building on the efficiency gains initiated earlier in the year, we continue to accelerate our margin improvements and are on track to exceed our original margin plan for 2020. We expect to deliver full-year operating margin of approximately 14%. EPS were $1.19 for the quarter, up 25% versus the 95 cents in the same quarter last year. Now on to segment results. Plumbing sales for the third quarter were $591 million, up 15% versus the same quarter last year. Strong U.S. retail and e-commerce sales, as well as continued growth in China, drove the quarter. Plumbing operating income increased 10% to $123 million for the current quarter. Operating margin for the quarter was 20.8%, reflective of investments in brand, innovation, and customer service to enable continued market-beating growth. Four-year margins for plumbing continued to track to approximately 22%. Turning to doors and security. Sales for the third quarter were $407 million, up 51 million, or 14%. Importantly, decking sales grew over 40% during the quarter. We continue to sell every board we can produce with additional capacity coming online during this fourth quarter. Sales and doors grew mid-teens as trade channels and new construction activity reaccelerated during the quarter. Sales and security grew mid-single digits. despite headwinds caused by this year's COVID challenge back-to-school season and continued softness in commercial markets. Doors and security operating income was $67 million during the quarter, up 29% over the same quarter last year. Segment operating margin for the quarter increased 190 basis points over last year to 16.4%. Our doors and decking operations ran with exceptional efficiency during the quarter, and our security operations moved beyond the most challenging COVID inefficiencies. Now, turning to cabinets. Sales for the third quarter were $655 million, showing a year-over-year increase of 11%. We continue to experience strong interest in value price products in all channels and are seizing share gain opportunities. Make-to-order sales for the quarter were almost flat and have started the fourth quarter with sales up low single digits. Operating income in the third quarter was $80 million, up $21 million versus the prior year. Operating margin for the quarter was 12.2%, up 220 basis points. Our cabinet's team continues to elevate its strong execution. The team delivered continued cost structure improvement and leveraged volume effectively. More opportunities lie ahead, and we look forward to continued competitive sales performance and margin improvement. Our cabinet's business is deploying a winning value proposition with a business model and cost structure designed to capture share in the marketplace and deliver attractive margins. Our supply chain is positioned advantageously to compete with domestic and non-subsidized importers, and we are delivering. Turning to the balance sheet. Third quarter results have enhanced our already strong balance sheet. At the end of the third quarter, we had cash on the balance sheet of $465 million, net debt of $1.6 billion, and our net debt to EBITDA leverage stood at 1.7 times. We now have $1.35 billion of total liquidity available between our $1.25 billion revolver and supplemental $400 million one-year revolver. We have the ability to make investments and deploy capital to accelerate growth and stakeholder value creation and are assessing opportunities to do so. Consistent with prior practices, we will remain opportunistic as opposed to programmatic and will be mindful of pandemic uncertainties. Turning to the topic of financial guidance. While COVID and macroeconomic uncertainties remain, we are reinitiating 2020 full-year financial guidance. We expect full-year net sales growth between 4% and 5%, and earnings per share of $4.03 to $4.11, with a full-year operating margin of approximately 14%. We expect full-year free cash flow of $590 million to $620 million, reflecting a cash conversion of approximately 105% to 110%. This EPS outlook includes the following assumptions. Interest expense of $82 million to $86 million, a tax rate between 24% and 25%, average fully diluted shares of approximately 140 million to 140.5 million. We expect the new phase of demographic-driven housing growth to result in prolonged market strength, with market growth averaging 5 plus percent per year over the next few years, assuming the current level of unemployment continues to stabilize, then improves. We expect our sales to continue outperforming the market and our margin progression to remain accelerated, averaging annual improvement above 50 basis points in 2020 and each of the next few years. While COVID uncertainties remain, we will continue to prioritize associate safety and manage expenses thoughtfully. Our balance sheet strength supports capital deployment, and we will continue to assess opportunities to deploy capital. We see promising value potential ahead. I will now pass the call back to Brian to open the call for questions. Brian?

Thanks, Pat. That concludes our prepared remarks on the third 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 reenter 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? Operator?

Thank you. At this time, I'd like to remind everyone, in order to ask a question, you will need to press star 1 in your telephone. If you need to withdraw your question, press the pound key. And your first question comes from the line of Michael Reholt from J.P. Morgan. Your line is open.

Thanks. Good afternoon, everyone, and congrats on the results, and hope everyone's safe and healthy. First question I had was on the cabinet division. It obviously continued great progress there, solid progress. And, you know, your comments around gaining share from both domestic and international competitors I think is pretty important. Obviously, you know, still concern or questions that we receive a lot around import competition. I was hoping if you could delve a little bit deeper into where you feel you're gaining share from domestic competitors and which channels and perhaps new products, as well as what you're seeing on the import market since the Chinese imports have diminished. Where does that stand right now in terms of a percent of the market, and you're saying that you're much more competitive with the remaining set of importers, as you talked about, non-subsidized with higher cost structures?

Sure. I'd be happy to talk about that. So at a high level, to answer your first question, I mean, the share gains really are across the board. You'll see that come through with 11% sales in the quarter and still building backlog in certain elements of the portfolio. You look on the one side at value cabinetry that performed really well across all channels and continued the double digit growth rate that we've seen for a while. As we said in the prepared remarks, make to order, we really saw a recovery in the quarter And then actually return to growth, and I'll tell you it's coming into the fourth quarter with some backlog built there as well, and is performing, that part of the business is performing very, very well from a margin perspective with excellent capacity utilization. So, you know, we look at that and go, well, you know, pretty confident that the share gain is across. Now, you know, why? Well, you go back, I mean, we've talked a long time about The pivot plan is reaching its inflection point. I mean, it is now delivering for us. And part of the pivot plan was not just a rebalancing of capacity. It really was to launch a suite of products at the heart of the market, right? And so while the anti-dumping case was ongoing, we were sort of sitting on the wall going, well, if this happens, volume will flow back to us. We were really launching products at that sweet spot in the marketplace, right? where we had to win whether that case was successful or not. And as we've done that, we've really found that a lot of volumes flowed back to us and that whether it be in big box retail or through our 4,500 dealer network, they really are kind of looking to us for price, quality, value and service, right? And it's all of those things. And as we've progressed here through the year, we have seen increased imports from places like Vietnam and Malaysia. Those levels are still materially below where they were in 2018. So more important than that, those products are coming in at higher price points with longer lead times and without a full assortment. So it's a different competitive picture. And whether that's because they're actually produced in those countries or whether they're because people are cheating and shipping stuff around and cross-stocking it, it's adding enough cost and complexity to that market to put us in a much, much better position. And as we've always said, you know, our... supply chain, which, you know, has a low-cost country kind of componentry supply plus our own manufacturing. It comes together in the U.S. and then is, you know, networked through our distributed assembly. You know, we always thought that that was a very competitive footprint that would be successful against, you know, any kind of low-cost country setup. And we're seeing that come through. And, you know, even as those imports have increased, I think they've been high-priced enough, but long enough lead times and spotting enough that we continue to see share gains, whether that's, you know, coming through big bucks or in our dealer network. And, you know, you asked about new products. I mean, you know, you've heard us talk about Mantra. You know, we launched that last year in the northeast, you know, really to get this part of the market hugely successful, now rolling out into other parts of the country. Our dealers are asking for it. But beyond that, there's an entire suite of products that whether it's through our AOK brand, whether it's through the Homecrest brand, that are really geared at this part of the market where we're getting a lot of reception, as well as innovation that we're driving into our retail partners that is really on the market. So it's an entire portfolio approach. You know, it's backed by, I think, a much more efficient network within the cabinet's business. It's also giving us a lot more network flexibility to move things around. And I just say, overall, we're really, really happy with the performance both on the top line and, you know, particularly with that margin accretion coming through, notwithstanding the fact that there still were inefficiencies in Q3 that, you know, we think we're going to get beyond as we move into Q4 into 2021.

That's great. Thank you, Nick, for that rundown. It's very helpful. I guess secondly, just to switch to plumbing, obviously another very strong top-line result. The margins continue to be plus 20, but a little bit down sequentially. Still kind of on track, as you alluded to, around the 22% full-year margin goal. But you talked about a little bit about some one-time costs impacting the third quarter. You know, I was hoping maybe you could give a little bit more kind of, you know, numbers around that, what was the rough impact and, you know, but also bigger picture, you know, should we expect this, you know, 22% to persist and you just have this continued strong reinvestment into growth?

Sure. Why don't I kick it off? I'll give you some perspectives and then I'm going to hand it to Pat and he can give you some more particulars around the numbers. But I would start, you know, obviously really pleased with the top line, continued top line performance. And, you know, not just the book, but, I mean, this business is now into its fourth year of, you know, this kind of market-beating performance. And we saw it, you know, continue to gain share in And, you know, a credit to Sherry Pfeiffer and her team. I mean, working so hard to satisfy our customers and to meet the demand. And, you know, it will be a while. before we've kind of fully, you know, rebuilt customer inventories. And so, you know, a lot of that in the backdrop. Now, you know, notwithstanding that, when, you know, we have a business that can perform at this kind of level as consistently as it has, and we have seen the strength come through really even in, you know, the latter part of Q2 into Q3, and what we see ahead of us, you know, we're going to take the opportunity to invest and drive the business. And so that, you know, is – Now, there are also some inefficiencies we can touch on, in fact, give you a bit more color on, but, you know, we saw an opportunity to accelerate investment in this business because we want to continue to drive that top line growth, and we did. Material increases investment in sales and marketing. investments in capabilities, particularly around e-commerce, some supply chain capabilities, some things that, you know, you're going to see us do around innovation. And we expect those to deliver. And to be able to make, you know, the step-up in investment that we did and still deliver a 22% margin for the year, is something we're really pleased with. And so that's what I really focus is kind of the landing points of the year and the direction that the business is pointing going forward while we're really investing heavily to continue to drive that top line. And, you know, just before I end that, you know, I'll say we're also seeing, you know, pretty big returns on those investments. I mean, you know, Moen, you know, for a long time has been, the number one brand in the market in terms of awareness, purchase intent, loyalty. We've even now seen a step change higher in our data on the brand's performance, particularly as we drove the refresh to really focus it on the key millennial consumer. And so we're really pleased with those investments, and it gives us confidence to lean in further. Pat? Yes.

And Mike, I think to speak a little bit to the numbers, but I'll come back to the key point is, you know, we feel confident we're positioned to deliver 22% this year, and that's after delivering 21.5% last year. And we do think the business is positioned to drive above that 21% we've been talking about for a while. So I think you should expect that the margin in this business remains strong, healthy, and consistent. You know, the The variance to 22% in the quarter was roughly $7 million. That's the delta between 22 and 20.8. If you look at one-time items, things like air freight that we're absorbing to support our channel partners or things we're doing to recognize our associates during this COVID period, that alone there was more than the $7 million. And then if you add incremental increase in brand investment during the quarter, you're more than 2x that $7 million. So the cost structure very much intact and absorbing some one-time items in this quarter and some increased brand investments, but very much positioned to deliver 22% to have that kind of cost structure in place or a profit structure in place going forward. I think the other thing I'd say is if you pan out a bit and you look at quarterly performance, from the beginning of 2018 all the way through the third quarter of this year, 11 quarters in a row, when you look at that performance, we've basically been performing every single quarter between 20% and 25% operating margin in every single quarter for those 11 quarters. So when you look at the consistency of the performance of this business, it's absolutely breathtaking because over that 11 quarters, we've had multiple tariff waves, we've had border shutdowns between the U.S. and Canada and Mexico, and we've had a global pandemic. So I think this team has done just an exceptional job of not just driving industry-leading margins but delivering it with unbelievable consistency in the face of really, really astounding macroeconomic challenges over the last, you know, almost three, four years.

Great. Thanks so much. Good luck for the rest of the year.

Your next question comes from a line of filming from Jeffrey's. Your line is open.

Hey, good afternoon, everyone. Congrats on a very strong quarter. Top line was really, really robust. So my question is, just from a capacity standpoint, as well as inventory, if we see continued momentum and essentially a spike in 2021, how are you guys set up from a capacity standpoint? I think one of the areas that I'm a little more concerned about would be decking and maybe even cabinets, but any color there would be helpful.

For your asking specifically, you said spikes are, you know, continued COVID spikes or just capacity generally?

Spike and demand. If we see really strong continued momentum and demand, do you have enough capacity to kind of meet that? And from an inventory standpoint, are you well set up? Because if I heard you correctly, 40% growth in decking sounds significant. pretty impressive, and obviously you've done some restructuring on the cabinet side. So I just want to make sure you guys have enough supply to kind of meet that demand if that continues.

Yeah, you know, it depends particularly where you look. I mean, as Pat said in his remarks, I mean, decking capacity really stretched in the third quarter, but, you know, more capacity coming online here in the fourth quarter. And so, you know, what I tell you is we certainly have the capacity to hit the guidance that we just gave. And, you know, we're working very hard to add capacity and supply chain flexibility, right? It doesn't just have to be sort of big cap X investments. It's a lot of supply chain flexibility and making our network more agile as we go through here into 2021. And I think that with the work that our team has been doing, and I'll tell you, our supply chain team has been nothing short of heroic this year in both managing COVID, keeping people safe, and building in capacity. You know, I'm pretty confident that we will have the capacity to manage, you know, what comes at us in 2021.

Okay, great. And then plumbing, really strong growth. You called out, you know, the retail channel, China, and I think e-com in particular. Are you starting to see momentum rebuild in the trade channel as well as the builder side of things? And have you seen any restocking as of 3Q and maybe potentially in the fourth quarter as well?

Thanks a lot. So obviously, as I mentioned, there's very strong growth in those three areas, U.S. retail, e-commerce, and China. The wholesale channel and a lot of our builder business goes through all of that builder business goes through the wholesale channel, really did start to pick up. And so we saw it come back and then accelerate as we went into the quarter, not quite at the pace of retail or e-commerce. But what was really encouraging was as wholesale opened up and as builders really sort of got to work, we didn't see much let up in the retail channel at all or in e-commerce. One of the questions we is as channels reopened up, you're just going to see a lot of channel shift back and forth, and now we saw a really sustained amount of performance in retail, which was really encouraging. As the wholesale and trade channels opened back up, you know, we were able to meet demand, and I, you know, probably saw a little bit of the inventory that had been created, but I think by no means was there a big inventory build in the quarter. You know, to be honest, you know, just from a customer service perspective, we'd like to be able to help our customers go back, but I think, you know, as I said on the last call, it's probably going to be a few quarters, and, you know, I think... you know, all the way through Q1, if not into Q2 of next year, to really build back inventories that were pretty severely depleted. And I think it's going to happen at a pretty steady pace versus a spike. And so, you know, we work hard to really track the point-of-sale growth, and we've been satisfied with our ability to do that and keep people tracking to their point-of-sale, and then rebuild that inventory slowly over time as our supply chain permits.

Okay, thanks.

Yes, wholesale was probably mid-single-digit POS to give you kind of a feel for kind of where they were running from POS. And all North America shipments, like all brands, all channels, were, you know, approaching the team. So the health was across the business, just being led by retail in China.

Okay. Yeah, that's really encouraging. You still have that opportunity on the retail and the builder side coming back and some restocking optionality down the road. Thanks a lot.

That's much more confident that you really are seeing a very strong wave of both home building and renovation because, I mean, you've seen the stuff from the home builders, and you're going to see that pull through the wholesale channel. But you're still seeing consumers and products come into both the wholesale channel and other channels, and they're doing projects at a level we haven't seen in a long time.

Here our next question comes from a line of Ken Zinner from KeyBank. Your line is open.

Afternoon, gentlemen. Hello. How are you? Good. I would like you to perhaps, because you have obviously DIY product, let's say plumbing at Home Depot, but you also have the higher ticket project costs that require labor and comfort with COVID to have things installed like cabinets. Can you talk about, you know, the nation started shutting down in March. It's now October. We have seven months. Can you talk to your experience here about how that cabinet demand and the dealers being open is reflecting customers' and contractors' ability to actually, you know, deliver the product into the customer's house? Because it seems like there's a large tail when building up not only on the inventory that you talked about in plumbing, but really just about these deferred projects. And cabinets is, you know, there's not a better category to assess that. So can you talk to the comfort of customers as opposed to the macro trends that drive demand like home appreciation?

Yeah, sure. I'll give you a couple perspectives on that. It's actually a fascinating question as you peel the data apart. You know, I'll tell you, perhaps, you know, a kind of maybe, except for maybe a week or two in March, and I'm not even sure it was that much, we really didn't see cabinet sales let up in open channels. And so if you go back to kind of, you know, March April and the first wave and what happened, you know, we had dealer channel shutdown. We had a lot of designers shut down, even within retail. And so you weren't getting orders through kind of make the order part of the business. And as you suggest, you're probably building quite a bit of backlog. But we were seeing our in-stock cabinetry really fly off the shelves. And so, you know, that told us that notwithstanding, you know, shutdowns in shelves at home, you know, there are either some very advanced DIYers out there or a lot of consumers that were figuring out how to get contractors into their homes safely. And what we heard back through the channel was, is that they were figuring it out. Okay, you go work over there. And by the way, the trades have to be comfortable too. And the trades are saying, look, I'm gonna be in the kitchen for the next seven hours. Don't come in here. This kind of part of your house is now off limits while I work. And so we really saw some continued strength which suggests to us that people were comfortable with pros, and I think way more comfortable than a lot of people may have expected fairly early on, and they figured out how to make it work. That, however, did not change the fact that a lot of designers were shut down and a lot of dealers were shut down. And as those started to open up, we saw that business kind of flow back into dealers, and we saw it flow back into the retailers in their make-to-order desks as they brought their designers back. And, you know, I would agree with your sentiment there that, you know, a lot of those projects that require designers, you know, probably had an air pocket in Q2 where they just didn't get done and are probably backlogged as people now have to sort of not just, you know, come in and get the design work done, get them manufactured and through the whole supply chain but then actually have to get people to be able to come in and install them. Other perspectives on that?

No, I would say, I mean, I'd say in the case of cabinets that you picked up, it was... a two-fold complexity because you have to sit down with a designer that's almost in closer proximity than a contractor. The cabinet's business had to work through both of that, but we could really see the acceleration now in the interest of make-to-order, especially as you've seen two months of really, really strong existing home data, existing home sales data. To your point, You know, if that existing home-based sales data stays strong and persists, that's a great tailwind for the cabinet business.

Great. And just the next question for Fibron, given you're basically selling out, obviously a lot of the larger competitors are adding capacity. How are you balancing this, you know, secular growth with execution risk? Thank you.

Yeah, I mean, and we've been saying, you know, for the last couple years as we were and still are looking to get that business to $300 million by 2022 or sooner, which has been the game plan we've been talking to for, you know, the better part of the last two or so years since we acquired Fiberon. We already had... a CapEx plan in place that was pretty significant. We've talked about $35 to $45 million a year of CapEx as early as 18 plus months ago. We're probably accelerating that considerably being at the $50 million plus a year. it's marginal acceleration from an aggressive plan we already had to support the business's growth. But you're seeing this year the business outperform its annual plan and do so in the face of a pandemic that was quite disruptive to absenteeism in plants and so forth. So it's always non-trivial to grow a business at that pace, especially when you have to layer in the CapEx to do so. But I think this year demonstrates the team's ability to do so and do so facing quite a jolt from a pandemic.

Can I just add that, you know, we talked a lot about the synergies that we've unlocked from the shared route to market between doors and decking and the power of putting those two things together. And we talked less about the synergies that we've unlocked by putting that operations team together. And, you know, the doors team absolutely best in class with the decking team. It's phenomenal. and what they're doing. I think that's proven out in the marketplace. By bringing those two teams together and having them work together, we've been able to unlock additional capacity out of what we had in addition to the capital that we're putting in to add more extrusion capacity to the business. It's operating at an even more efficient level while we add more to it. We're feeling pretty good about our ability to execute and the the kind of the sweet spot of the market in which this business was built, you know, which is that sort of entry-level composite deck board, is what Fiverr has really been built on. And so it's something that we do very, very well and we've done for a long time. And, you know, we've been able to continue to supply the market with what I'd say are industry-leading lead times even throughout this pretty disruptive few months.

Thank you.

Your next question comes from the line of Stephen King from Evancor ISI. Your line is open.

Yeah, thanks very much, guys. Appreciate it. Just one quick question here on the commodities. I think last quarter you suggested the commodity head might be in the neighborhood of $25 to $30 million. I was curious if you could give us an update on that. And then in answer to, I think, Mike, question about investment. I thought I heard you mention air freight and employee recognition. I think you threw out $7 million and $15 million. Together, that would be about 370 basis points in the margin. So I was just wondering if you could just clarify that. I thought maybe I took it out of context or something.

Steven, for inflation in total, We're still consistent. Our four-year outlook is still consistent with where we were for the last call, which is we have about one percentage point of four-year inflation, which is still in that zip code of $30-ish million that you referenced. I'd say this year it's turning out to be predominantly driven by tariffs, annualizing, and logistics costs. I'd say there's select puts and takes inside of commodities separate from tariffs. that are relatively neutral. Obviously, anybody watching copper and zinc of late will see it's up about 10, 11% over prior year at this time. But that cost will reattach more next year than in the present income statement. But we'll be able to handle that with a combination of cost and price actions like we always do. So I would say this year, we're managing that level of inflation including some of the recent logistics inflation very handily with a mix of supply chain and pricing actions as we typically do. In terms of cabinet margins or plumbing margins, as you were referring, we always know whenever we're one millimeter below 21%, there's lots of interrogation on the plumbing margin. What I was trying to do was simply say if you do the simple math on a $590-ish million sales quarter. The variance to 22% was about $7 million of expense. And we had more than $7 million of expense for things like air freight and things we're doing to keep our employees safe and recognized. And then, you know, we did have, as we will for the year, have investment, increase in brand investment. He put those two things together. It's over $14 million. So, yeah, I mean, you're talking over 200 basis points. I don't know that I'd get quite to 300 basis points, but it's been that.

Okay, got it. Yeah, I just wanted to clarify that. I appreciate it. And then you mentioned in Doors and Security, the security segment had a back-to-school effect, which obviously makes sense. I was curious if you could quantify that in any way in terms of the sales impact and or the profitability impact.

There's many moving parts. What I would say, because if we start breaking stuff like that up, we end up having to do it in perpetuity, is that's a business we would expect that business to grow mid-single digits on a full year basis and in most quarters. It grew in that mid single digit range in the quarter. That was with back to school being less than half of its normal self and the commercial business which is safety and security inside of mostly factories being negative. So the rest of that came from retail growth that was not back-to-school growth.

Got it. Okay, well, that's impressive. Thanks a lot, guys. Appreciate it. Thanks.

Our next question comes from a line of Adam Bobgarten from Credit Suisse. Your line is open.

Hey, guys. Thanks for taking my questions. I'm just curious if lower promotional activity played a role in the margin performance in cabinets this quarter?

You know, I don't – you know, there was – I don't think it was an overly, you know, promoted quarter, particularly given, A, you know, safety concerns of not driving a gazillion people into stores, and then, B – The fact that the top line has been so strong, I think, you know, the channel probably feels less need to promote. But that, no, that, you know, the driver has really been all the work that we've put into the pivot plan around getting, you know, the portfolio centered at the right point of the market, you know, getting our benefit of scale across the entire portfolio, commonization of the chassis of and the ability to then kind of shift volumes around. And so, you know, we saw a lot of that come through, which we're really excited by. It's by no means done. There's a lot of opportunity ahead of us. And Dave Manning and his team have, you know, gotten at it, I'd say, at an accelerated pace. But what we're really feeling is the benefit of all that work over the last couple years really starting to deliver and bear fruit now, but identifying more yet to go. And, you know, it's not, you know, inconsistent with some of the work that we're doing across the entire portfolio now. If you look at how we've taken an approach on, I'd say, a leaner and more choiceful operating model at the core, and then rolling out some core capabilities across the entire portfolio to drive things like global supply chain management, category management, business simplification. Those are being applied to cabinets, but they're actually being applied across the entire portfolio. And as we do that, we'll continue to free up incremental margin, some of which will be reinvested to take share and drive top line consistent with our strategy, and some of which will be delivered to the bottom line. But it's a It's really paying dividends at cabinets, but it's a consistent approach across the entire portfolio.

Got it. That's helpful. And then just on the acquisition pipeline, maybe what that looks like, your appetite to do deals going forward, if you're focused in any specific part of the portfolio, that'd be helpful.

Sure. Sure. Well, as Pat mentioned, the signed cash flow and the health of the balance sheet, for one, put us in a position to really manage the business prudently and weather the storm as we've gone through it. But the cash generation and free cash flow also does create the opportunity to accelerate shareholder value. priorities have not shifted, you know, and we'll continue to focus on CapEx and investment, you know, within our own business. Those tend to drive the highest returns. And next, we'll look at accretive M&A. And, you know, third, we will return cash to shareholders. You know, what I will tell you is, you know, never kind of predict on a single thing, but, you know, we do look at the pipeline and sort of judge the activity. And, you know, it was dead before. in Q2 we have seen the pipeline heat up quite a bit as we come towards the end of the year here. And what's interesting about it is it really does give you some insight into how businesses perform in a variety of circumstances. We kind of hold it against our own portfolio. I mean, our portfolio has performed well. I think we're demonstrating that now, that the portfolio and this management team can deliver in markets where a lot of volume is coming at us and we can deliver in markets that are more anemic. And as we look at the M&A pipeline, you know, we're now able to see how companies have performed through some pretty challenging quarters. So it is heating up. You know, I want to predict Whether we get something or not, we will be disciplined about it and we have to do it on the right terms as to whether there's a particular area. We will look across the portfolio and in addition to having to get a business at fair value, the other standard we hold ourselves to is we have to be able to create value with it. It's not enough just to get it. And so, you know, we look across the portfolio and say, you know, where do we think we can leverage either our brands, our routes to market, or these common core capabilities to drive value? And, you know, I think the most recent one is Fiberon, and that's a great example of, you know, having taken something that was actually somewhat adjacent to what we were doing, but in a shared route to market, and by bringing it in, sharing that route to market, sharing some ops capability and other core capabilities, we've been able to create a lot of value for shareholders, and we'll continue to look for other opportunities like that.

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