Fortune Brands Home & Security, Inc.

Good afternoon. My name is Donna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands third quarter 2022 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. You may press star 1 on your telephone keypad if you would like the opportunity to ask a question. If you require operator assistance during the event, please press star 0 on your telephone keypad. I will now turn the conference over to Mr. Dave Barry, Senior Vice President of Finance and Investor Relations. Thank you, sir. Please go ahead.

Good afternoon, everyone, and welcome to the Fortune Brands Home and Security Third Quarter 2022 Earnings Call and Webcast. Hopefully, everyone has had a chance to review the earnings release issued earlier. The earnings release and 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. The company does not undertake any obligation to update or revise any forward-looking statements except as required by law. Any references to operating income or margin, 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. Joining me on the call today are Nick Fink, our Chief Executive Officer, Pat Hallinan, our Chief Financial Officer, and Dave Banyard, president of our cabinet's business. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick.

Thank you, Dave, and thank you to everyone for joining us on the call today. Our teams delivered a very strong third quarter with 20% EPS growth and improved margins across all segments in a shifting demand landscape. During the quarter, we saw a softening in U.S. single-family new construction and R&R as the Federal Reserve's continued action on interest rates started to have its intended effect on housing demand. We remain strong believers in the medium to long-term market opportunity underpinned by attractive demographics and a significant shortage of U.S. housing. Our third quarter results demonstrate both the strength of our portfolio and the team's ability to deliver results regardless of the environment. Despite these increasing challenges, we once again made operating margin progress in each segment versus last year. We expect second half margin expansion versus the first half of the year, inclusive of our digital investment. Our strong performance demonstrates our ability to outgrow the market, increase margins, and make focused strategic investments in the challenging macro environment. We are expecting a soft start to 2023 and are focused on driving out performance while executing a tight set of strategic priorities. We remain strongly positioned and are well ahead of schedule in executing our plan separation into two world-class companies. Our teams are working hard towards finalizing the separation before the end of this year. I've invited Dave Banyard, who will continue to lead the cabinet's business following the separation, to join the call today. Dave will provide an update on the progress of the separation and give his perspective on his team's transformational work, as well as the exciting potential for the cabinet's business as a standalone company. Dave, thanks for joining the call today. Turning to our third quarter performance, our teams delivered impressive results in a shifting macro environment, including 20% EPS growth versus the prior year. Sales grew 3%, reflecting strong price realization offset by the continued normalization of channel inventory, coupled with comping against an exceptional third quarter of 2021. As the unprecedented supply chain and demand environment of the COVID years begins to dissipate on a training basis, our three-year organic sales and operating income CAGRs of 10% and 17%, respectively, are proof points of the sustainable, long-term value created over this period. Importantly, Our consolidated operating margin was up 150 basis points over last year, with each segment making year-over-year operating margin improvement. Price and continuous improvement outpaced inflation in the quarter, and we continue to invest in key strategic priorities, such as our digital transformation. Our digital initiatives are already yielding tangible results, including increased e-commerce sales, improved app ratings, and accelerated procurement savings. Our results are further testament to the strength of our brands, the hard work of our teams driving transformation, and the power of our Fortune Brands advantage capabilities. While our third quarter results were impressive, we are facing increasing headwinds from shifting consumer behavior in response to housing affordability and macroeconomic uncertainty. The Fed's tightening monetary policy is having the intended impact on capital goods, including housing. Rising interest rates are impacting single-family new construction permits and starts activity, and our wholesale and retail channel partners are destocking inventory as customer traffic slows and lead times normalize. The pace of impact is accelerating, and we are revising our full-year guidance to reflect the current environment. We have managed, through similar headwinds before, undertaking thoughtful yet decisive action to protect our business, while prioritizing investment in a tighter set of key strategic priorities to win for the long term. Pat will provide more detail later in the call on how we intend to manage the PML and balance sheet through the anticipated period of softness while protecting our long-term growth and market leadership positions. We constantly challenge ourselves to do better, regardless of the macro environment. We recently announced a redesign of the new Fortune Brands organization, which will better position us to realize the many opportunities to drive growth and margin progression at an accelerated pace. At the center of this exciting evolution, we are transitioning from a decentralized structure with separate businesses to a more aligned operating model that prioritizes activities that are core to brand, innovation, and channel under Sherry Pfeiffer. Additionally, we have aligned all of our global supply chain resources under Ron Wilson as our chief supply chain officer to fully leverage the scale and execution excellence of our total business. This new operational focus structure will better align the company's resources with our growth and productivity priorities following the separation. This organizational redesign increases our ability to leverage best practices across the whole organization, we will be able to further leverage the fortune brands advantage to drive increased productivity and capture additional growth at higher margins. We look forward to unveiling more of this advantage strategy at our highly anticipated Investor Day, expected to take place on December 6th at the New York Stock Exchange. We hope that you can all join us. As is well documented, there is a fundamental long-term need for housing in the U.S. as the deficit of millions of homes exists and the current age of homes today remain at or near multi-decade highs. We believe the importance of the home remains as strong as ever as consumers continue to invest in priority areas of the home, including the kitchen, bathroom, and the outdoors. Our portfolio is targeted at the heart of the market and is exceptionally well positioned to navigate the challenges ahead and capitalize on consumers' continued desire to upgrade their homes. Our brand power, innovation, and best-in-class service provides a unique value proposition that greatly resonates with the consumer and our channel partners. These attractive attributes coupled with market leadership positions and advantage channel exposure will provide stability and opportunity as we proactively manage the business through the near-term macro environment. Now, I will turn to each of our segments to provide some color on what we are seeing. Beginning with water innovations, sales were down 14% in the quarter as channel inventory reductions and a soft China market more than offset mid-single-digit POS growth in the U.S., Upgraded Moen and House of Roll showroom displays are driving double-digit POS lift, and our investments in brand and innovation continue to resonate with consumers and customers. In our core U.S. market, channel destocking accelerated ahead of our expectations during the quarter and is continuing into the fourth quarter. In addition to continued destocking at our major customers, down-channel inventory held at production plumbers, builders, and smaller wholesalers grew as lead times extended. As our service levels recovered and construction and consumer activity slowed, this additional inventory has started to work its way out of the channels at an accelerated pace. In China, economic and pandemic headwinds continue with new construction activity down almost 40% year-to-date. Our team is doing an outstanding job right-sizing our cost structure relative to the demand environment in China, and we remain positive on the opportunities for further innovation and long-term growth in this market. It is important to note that while the water innovation's top line has been impacted by inventory destocking in China over the last two quarters, U.S. POS has maintained mid-single-digit growth throughout the period. Additionally, the segment has delivered a three-year organic sales CAGR in the high single digits while expanding year-to-date operating margins by nearly 300 basis points over 2019. We expect the destocking dynamic to normalize in early 2023, and our sell-in should approximately equal our sell-out. Notwithstanding the top line challenges, our water innovations team took action in the quarter to preserve operating margin and delivered 10% incremental margins, resulting in third quarter operating margins of nearly 25%. We continue to prioritize strategic investments, including the purchase of Aqualisa and its leading smart water and valve technology. The business remains well positioned to outperform over the long term through strong brands, innovation, and industry-leading service. Turning to outdoors and security business, sales grew 6%, driven by our powerhouse ThermaTru brand, which grew at strong double digits. As one of the most recognized builder brands in housing, ThermaTru continues to convert homeowners to advanced material fiberglass door systems from traditional wood and steel alternatives. Larson sales grew mid-signal digits as we continue to capture synergies as we integrate Larson offerings with the rest of our outdoor portfolio. Security sales were down mid-single digits, driven by retail inventory reductions, partially offset by commercial sales growth. Decking sales were down low double digits as destocking continues in the wholesale channel, while retail POS remained positive during the quarter. We continue to believe the value proposition of material conversion will drive long-term secular growth in composite decking. Outdoors and security operating margin was 16.1% and improved 70 basis points sequentially and 50 basis points versus prior year as price and cost actions continued to more than offset inflation. Finally, our cabinet's business delivered another exceptional quarter with sales growth of 20% as our transformational efforts continued to deliver and pricing actions become more fully realized in the P&L. Our service levels and product offerings have enabled continued share gains across the channels. The business will continue to work down excess backlogs through the fourth quarter and expects to end the year at normal levels. cabinets operating margin was up over 400 basis points versus prior year price and cost actions more than offset inflation and our team is strategically positioning the business to enter 2023 as a standalone public company with a cost structure that reflects the macro environment. The transformational work continues as MasterBrand drives its lean culture through its operational and supply chain strategy. Cabinet's tremendous results this year are the product of several years' work to re-platform the business into a world-class performer. The transformation is remarkable, and yet we believe there are still plenty of opportunities to pursue further value creation following the separations. Our stakeholders should be excited about the increased agility resilience growth and profit potential of this market leader and its future journey ahead. summarize it's been a strong quarter and our value creation algorithm means fully intact in 2022 we expect to deliver another year of above market growth and margin progression, even in the face of multiple headwinds. We are already taking action in anticipation of softening demand and are laser focused on maintaining our margin journey and driving cash generation. We will proactively manage through the short term and are actively positioning both new fortune brands and master brand to win for the long term with above market growth and higher margins over time. We are well prepared to face any future challenges and will work to deliver on our commitments to all of our stakeholders. Before Pat addresses our quarterly financial performance and financial guidance update in greater detail, I would first like to turn it over to Dave Banyard to give his perspective on Cabinet's progress towards the separation and provide some insight into the transformational journey he has led over the past three years. Dave?