Fortune Brands Home & Security, Inc.

Greetings. My name is Kevin, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Fortune Brands fourth quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. I'd now like to turn the conference over to Lee Afsek, Vice President, Investor Relations and Corporate Affairs. You may begin our conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Innovations fourth quarter and full year 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 website, fbin.com. 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 and are various filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, except as may be required by law. Any references to operating income, margin, EBITDA, earnings per share, or cash flow on today's call will focus on our results on a non-GAAP before charges and gains basis, unless otherwise specified. Please visit our website for a full reconciliation. Joining me on the call today are Nick Fink, our Chief Executive Officer, Pat Hallinan, our Chief Financial Officer, and Dave Barry, who, as we recently announced, We'll be succeeding Pat as our next Chief Financial Officer in early March. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick.

Thank you, Leigh, and thank you to everyone for joining us today for our first earnings call as Fortune Brands Innovations. As we detailed during our recent Investor Day, Fortune Brands Innovations is a growth company powered by Secular Tailwinds underpinned by leading brands, innovation, and channel management, and supported by our Fortune Brands Advantage. Before we begin, I want to thank the thousands of Fortune Brands Innovations team members across the globe for your continued dedication and commitment to excellence. Our people are the foundation upon which our business is built, and you are the drivers of our next phase of growth. I would like to recognize the Monster Brand Associates who contributed so much to Fortune Brains. We wish you well on your exciting journey ahead. I also want to take a moment to congratulate Dave on becoming our next Chief Financial Officer. As part of our well-established succession planning process, Dave has gained finance leadership experiences throughout the company and has distinguished himself as a true partner to me and our teams. I'm excited for us to be working closely together. Finally, I want to sincerely thank Pat for his leadership and friendship over the last six years as CFO. Pat, while you will be missed, I know that we are in great hands with Dave. Our teams delivered an impressive year in the face of a challenging environment while also executing several key initiatives. The actions we took, including the separation of our cabinets business and our reorganization into a highly aligned operating model, will enable Fortune Brands innovations continued long-term growth and sustained value creation. Let me speak for a moment about the 2022 results of Fortune Brands Home and Security, inclusive of Cabinet's results through the full fiscal year. Our teams delivered net sales of approximately $8 billion, a 4% increase over 2021, as well as 20 basis points of margin improvement amid a softening demand environment and channel inventory reductions. Full-year EPS were $6.32, an increase of 10% versus 2021. As we previously said, following Labor Day, there was a significant slowdown in U.S. single-family new construction and R&R demand as higher interest rates and inflation impacted affordability and typical seasonality returned to the businesses. In response to the slowdown, our teams took decisive actions to reduce our fixed-cost base and to preserve our margins. However, we also maintained investments in our key strategic initiatives, including our digital transformation, brand building, and incremental capacity, critical to our long-term growth. While our full-year margin expansion was not at the levels we initially targeted at the start of 2022, our margin results are impressive in light of the abrupt shift in the marketplace dynamics as a result of the Fed's rate actions. Focusing now on the 2022 performance of Fortune Brands Innovations' continuing businesses the company generated sales of $4.7 billion for the full year, down 2% from 2021. Importantly, the company's performance over the last three years demonstrates our team's commitment and ability to create long-term value during both growth periods as well as through near-term disruptions. Since 2019, Fortune Brains Innovations has grown net sales at a three-year CAGR of 11.8%. Our organic sales CAGR during this time was 8%, against an estimated market CAGR of 6%. Notably, we also expanded our operating margin 130 basis points to 17.1%. Even as we face an expected down market in 2023, our guidance reflects our commitment to continued outperformance and long-term growth. I'm confident in our ability to drive value for our shareholders regardless of the external environment, and I am excited for the future. Going into 2023, we are fully aware of the challenges we face ahead, particularly in the first half of the year. We will remain proactive in our response to any short-term headwinds while continuing to focus on outgrowing the market, preserving margins, generating cash, and prioritizing strategic investments. We remain excited in the medium to long-term potential of the housing market and are confident in our ability to deliver outsized results as we focus on the supercharged growth opportunities within our categories. Our Fortune brand's advantage capabilities will continue to advance our growth and margin journey by reducing cost, informing our strategic and pricing strategies, and enabling our higher growth focus areas like connected products. Our newly aligned and more efficient structure is intended to remove unnecessary duplication, accelerate our leadership in brands, innovation, and channel, and will allow us to more quickly deploy our Fortune Brands Advantage capabilities across the portfolio. Importantly, we also continue to be driven by our culture of doing the right thing. As evidenced by industry-leading safety records, leading ESG programs, and our focus on innovative products that help address some of the world's most pressing sustainability and safety issues. Turning to our fourth quarter performance, Consistent with what we signaled last quarter, our businesses saw demand levels decline abruptly following Labor Day. Fortune Brands Innovations net sales declined 7%, while operating margin improved 110 basis points to 17.3%. These sales results were driven by the slowing macro environment and channel inventory reductions, coupled with strong prior year comparables driven by industry-leading 2021 service level performance. Given these challenges, Our teams continue to focus on right-sizing the cost structure of the business as evidenced by margin performance in the quarter. Our sound balance sheet and advantage capital structure enabled us to strategically deploy capital, both organically and inorganically. In 2022, we repurchased $580 million of shares and completed three strategic acquisitions, namely Flow, Solar Innovations, and Aqualisa. Also, As we announced at the end of last year, we have signed a purchase agreement to acquire two world-class businesses from Assa Abloy, the Emtek premium and luxury door and hardware business, and the US and Canadian Yale and August residential smart locks business. This disciplined acquisition, which we continue to expect to close around mid-year, would be a strong accelerant to our connected product and luxury portfolio strategies. Turning to the remainder of our remarks today, first, I will share what we're seeing in our end markets. Then I will highlight key takeaways from our fourth quarter and full year results. Finally, Pat will provide highlights on our financial results, and Dave will share our thoughts around our future financial performance expectations for 2023, including how we intend to manage the P&L and balance sheet through the anticipated period of softness while advancing our previously communicated long-term goal of achieving a net sales growth CAGR of 6% to 9% operating margins of 20% to 22% and EBITDA margins of 23% to 25%. Now, turning to some thoughts on the market for our products. As anticipated, our fourth quarter was marked by accelerated reductions in demand and continued inventory destocking across the channel, as well as a return to typical seasonality of demand patterns. Orders for new single-family homes dropped precipitously versus prior year as consumers paused on new home purchases. As a reminder, in previous periods of mortgage rate increases, consumers and builders typically take two to four quarters to adjust to the new levels of affordability, and we believe this adjustment is currently underway. In repair and remodel, activity slowed following Labor Day and continued at a depressed pace through the fourth quarter as normal seasonal demand patterns returned to the industry. Finally, in China, the housing market continued to be soft as Chinese consumer confidence and continued COVID mitigation strategies weighed on investment. We expect these macro challenges to continue into 2023, driven by temporarily depressed new construction starts and housing turnover, reduced consumer spending, and continued channel partner inventory normalization in select parts of the business. However, as we've consistently stated, we have confidence in the underlying fundamentals of the housing market and believe our products and brands are uniquely positioned to outperform. As the Fortune Brands Innovations portfolio is now more heavily weighted towards smaller ticket repair and remodel items, or in the case of our security business, a more market agnostic, our products are less exposed to market cyclicality. Additionally, as we have previously discussed, Fortune Brands Innovation's product portfolio is increasingly focused on our supercharged categories, those parts of the market with the highest potential for growth due to their secular tailwinds. Our leading brands and quality products inspire loyalty and confidence in categories where brands matter, especially in challenging environments. Our brand power, innovation, and best-in-class service provides a unique value proposition. Our focus on innovative products and operations are drivers of growth, productivity enhancement, and margin expansion. And finally, our category management expertise and strong customer relationships give us insights into consumer and customer behaviors and trends that enables greater consistency and pricing discipline. Let me be clear. We are well aware of the challenges that we are facing in 2023, and we have already taken significant and meaningful action in anticipation of the environment. Importantly, we are doing so in a thoughtful and disciplined way. Our experience management team has successfully navigated through similar headwinds before. We will continue to protect our business while prioritizing investment in a tight set of key strategic priorities to win for the long term. Now let me turn to our fourth quarter and full year performance. Total company sales were down 7% in the fourth quarter, with full year sales down 2%. Uppering margins were 17.3% for the fourth quarter and 17.1% for the full year, an improvement of 110 basis points and a decline of 20 basis points, respectively. These results reflect a recalibration of many aspects of the macro environment, including a slowing market for our products, continued channel inventory reductions, a return to normal seasonality, as well as sales declines in China due to the continued COVID mitigation efforts. Looking forward, we believe that these headwinds will dissipate as the housing market stabilizes, inventory levels normalize, and inflation continues to decline to more manageable levels. While we still expect additional challenges, we believe we are prepared for the disruptions to come and are optimistic in our ability to outperform the market as it normalizes and returns to growth. Now turning to our individual businesses. Beginning with water innovations, Sales declined 9% in the quarter and 7% for the year, driven by lower-than-expected volumes, including lower sales in China and inventory destocking throughout the channel following our industry-leading 2021 service-level performance. Fourth-quarter declines were partially offset by the impact of the extra fiscal week and the Aqualisa acquisition, which is being rapidly integrated. Fourth-quarter Moen US POS was only down low single digits, and we saw continued POS growth in the U.S. for House of Roll. Water Innovation's operating margins were an impressive 24% for the quarter and 24.2% for the year, driven by continuous operating improvement, fixed-cost reduction initiatives, and price realization. While we focus on preserving our margins and returning to above-market growth across the segment, we continue to make critical investments in our key priorities. These investments in branding and innovation resonate with consumers and help highlight our value proposition during a time in which consumers may be more selective about their product choice. Additional investments in capacity and distribution, including our recently announced West Coast Distribution Center, will allow us to better serve our customers and improve our already best-in-class service experience. Despite the headwinds experienced by Water Innovations in 2022, our results over the last three years give us confidence in the segment's ability to outperform the market. Our three-year net sales growth CAGR is 8%, both organically and inorganically, which compares to market performance of around 6% during this same time. During this three-year period, we also saw 270 basis points of margin expansion. We remain confident that the business will maintain its market-beating top-line performance with margin appreciation over time. In addition to consistently producing excellent products backed by a brand people trust, Moen is well positioned to capture the outsized growth associated with the secular tailwinds of connected products and ESG. At the recent CES show, we introduced the newest member of our integrated smart water network, the Moen Smart Sprinkler Controller and Smart Wireless Soil Sensors. This product has incredible water conservation potential and is already receiving a lot of positive attention and external recognition and awards. Importantly, it adds another note to our own smart water ecosystem, which continues to deliver increasing value to consumers. I encourage everyone to visit our website to learn more about how we are revolutionizing the way people connect with water. Our House of Roll portfolio is performing very well as our brand, product, and showroom strategy increasingly resonates with luxury consumers. The House of Roll generated mid-teen sales growth for the year and remains well positioned to capture increasing share of the luxury plumbing market in 2023 and beyond. Finally, in China, sales declined approximately 30% as COVID mitigation efforts impacted new construction activity and consumer confidence. Due to the quick and decisive actions of our team, the business remained profitable. Despite the external challenges, the team continued to execute their strategy of pivoting towards growth from R&R and category expansion, which will deliver for us as the market stabilizes. Turning to outdoors and security, sales were down 5% for the fourth quarter and increased 6% for the full year. Operating margin for the segment was 14.8% in the fourth quarter and 14.5% for the full year, driven by pricing. Our results reflected the soft market for decking and inventory destocking across the segment as more typical seasonality returns. Our decking business is increasingly optimized for operational and sales outperformance as we accelerate our journey to refine the Fiberon brand. Our POS indicates that we have maintained our overall share of a market that we continue to believe will gain in popularity as consumers increasingly understand the value proposition of our advanced material decking products. Our Thermature and Larson brands continue to remain the brands of choice for consumers and professionals, and our recently acquired Solar Innovations brand is integrating well, finishing the year with very strong performance. Consumers and customers gravitate towards the value proposition that these brands bring, including innovative features, dependability, and attractive designs. We are exploring new synergistic product offerings between these brands which we expect to drive incremental future growth. Finally, while sales for our overall security business were down low single digits due to destocking of locks and safes, our commercial security business remained strong, with low double-digit growth in the fourth quarter. As expected, our outdoor and security brands faced significantly softened demand this past quarter. We have already taken actions to streamline the businesses, positioning us well for the future. Longer term, We continue to be confident in the secular tailwinds driving outdoor living and the conversion to advanced materials, as well as the inherent ESG tailwinds and growth in the commercial security space as safety continues to remain a critical topic for employers across the world. We will be focused on expanding our presence in these highly attractive categories. The segment's long-term performance is impressive and demonstrates our ability to outperform even in the face of challenging environments. Our three-year net sales growth CAGR for the segment is 17% or 9% on an organic basis, compared to market performance of around 6% during the same time. During the same period, we also saw 140 basis points of margin expansion. We remain confident that over time, the business will produce above-market sales and margin appreciation. To reiterate, 2022 was a year of transformation for Fortune Brands. We took steps to reshape the business while also preparing for an expected downturn. I'm immensely proud of everything our teams achieved this past year, while also delivering impressive results in an increasingly challenging macro environment. We successfully executed a spinoff of our cabinets business well ahead of our timing expectations, which we expect will unlock greater shareholder value for both companies by allowing us to focus on and invest in our unique growth opportunities. We rebranded our entire company with our new identity reflecting our evolution as a business focused on driving accelerated growth in our categories through brand and innovation. To enable this focus and better leverage the Fortune brand's advantage capabilities, we reorganized the company from a decentralized structure with separate businesses to a more aligned and efficient operating model. These transformative changes will enable us to deliver on the long-term growth and margin targets we set forth during our investor day and will also help us navigate the short-term challenges that we will face in the year ahead. In 2023, which Dave will speak to in greater detail, we expect to successfully navigate the challenges ahead while focusing on driving above-market growth, preserving margin, and generating cash. We will proactively manage through the short-term while actively positioning Fortune Brands innovations for the future and expect to be an even stronger, more efficient business when the markets return to strength. I'm confident in our ability to perform because we have already proven our ability to perform through all cycles, including over the last three years. Our team has executed exceptionally well, including growing the company above market through a monumentally disruptive period. We believe that we have already digested a great deal of the impact from these disruptions. As we begin 2023, we're seeing supply chains and customer inventories starting to return to more normalized levels. In short, we expect a challenging external environment in 2023. However, we are facing into it with focus, alignment, and ambition. We're confident in both the long-term fundamentals of the housing market and Fortune Brands innovation's potential for accelerated outperformance when the market returns to growth. I will now turn the call over to Pat to summarize our 2022 results, and then Dave will talk about our 2023 outlook. Pat?