Good afternoon. My name is Kelly and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Home & Security Fourth Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

[Operator Instructions] Thank you. I would now like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin your conference call..

Good afternoon, everyone and welcome to the Fortune Brands Home & Security quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress during the fourth quarter of 2018 and provide our 2019 guidance. 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 our market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated.

These risks are detailed in our various filings with the SEC such as our annual report on 10-K. The company does not undertake to update or revise any forward-looking statements which speak only to the time at which they are made.

Any references to operating income, earnings per share or cash flow on today's call will focus on our results on a before charges and gains basis for continuing operations, with the exception of cash flow unless otherwise specified. With me on the call today are Chris Klein, our Chief Executive Officer; and Pat Hallinan, our Chief Financial Officer.

Following their prepared remarks, we've allowed some time to address questions that you may have. I will now turn the call over to Chris..

Thank you, Brian, and thanks to everyone for joining us today. In the fourth quarter our sales growth in the overall market slowed. Despite the market, we made clear progress in our Cabinets business and saw continued strong results in Plumbing and Doors.

In general, however, consumers and channel partners adopted a more cautious stance at year-end and did not order at a typical rate period heading into the New Year. Concerns over trade wars, interest rates in the housing market itself had a clear impact on demand.

While we did not factor in the magnitude of the second half housing market pause earlier in the year, we now understand the key drivers and expect that the tax through the system over the next six-month and project a modest increase and second half growth. I will have more to say on the market and our outlook in a moment.

In 2018, our teams executed at a high level during a volatile year. Sales grew 4% and our operating margin was 12.8%.

While these results were below our initial expectations, we made significant strides across the company to address market and industry challenges and consciously increased our exposure to a more stable and predictable segments of our markets.

These actions reduced our fixed costs, significantly reduced our exposure to a potential 25% tariff and set us up for improved financial results and growth in 2019 and beyond. We'll give more detail on these actions directly from the division presidents and our operations leader at our Investor event in Boston next Wednesday.

On top of the changes we made inside of our businesses, we also delivered incremental growth during the year as we spent $470 million on the Fiberon Composite Decking acquisition. Repurchased $695 million of our shares and again increased our quarterly dividend by 10%. All in all, our teams have continued to execute well against our strategy.

We remain confident in our ability to outperform in a market that continues to show signs of strong underlying long-term demand based on the number of newly forming households, aging housing stock and underlying consumer confidence.

Importantly, our product and brand positions remain strong and the changes we have made and the businesses we have acquired set us up well for continued growth in 2019 and beyond. Let me first take you through our fourth quarter results – on our full year performance in more detail. Then I'll discuss our view of the U.S.

home products market, our 2019 outlook for sales and EPS growth and our thoughts on capital allocation. Beginning with the quarter, overall sales increased 3% with continued strength in plumbing and doors products, partially offset by general market softness across categories.

Importantly, our Cabinets business saw stability in sales with priority segments performing well and the significant changes we are making in that business began to show tangible results. Total company operating margin performance was 12.7%, led by a strong result in Plumbing our margins increased 150 basis points.

Our two other businesses were more impacted by the flow-through of lower volume and higher commodity and labor costs. Additionally, Doors & Security, had a few non-repeating items in security as we reposition parts of that business which Pat will cover later. Turning first to the Plumbing segment. Plumbing sales were up 4% in the quarter.

This was solid performance against two years of very strong fourth quarter comps and a softer market this year. The growth was driven by high single-digit growth in our core U.S. wholesale business driven by solid POS and some shipment timing favorability from Hurricane Florence in the third quarter.

Broad-based strength internationally in Latin America and China with sales rising double-digits in each region and the successful integration of our latest Plumbing acquisitions. The premium free standing tubs we sell under the Victoria and Albert brand.

As we see in China, we view continued category expansion and selling of a room in the path to continued market outperformance in our Global Plumbing Group. In 2018, the GPG performed exceptionally well in a tough environment and has delivered on our high expectations through its first two and half years.

The 22.3% operating margin we delivered in the fourth quarter is a signal that we can maintain our roughly 21% target operating margin and deliver above-market growth even in a slower market with significant input cost pressure. As we look into 2019, the GPG is bringing a lot of innovations into the market.

Some of these is our normal cadence of style and finished refreshment. In addition, we have a wave of adjacent categories products coming through supported by a number of strategic partnerships that we have entered into in the second half of 2018. You'll hear more about these partnerships next week.

I look forward to introducing you to Nick Fink in Boston. He will provide greater detail on how his team has delivered the exceptional results they have posted thus far and his team's plan for the future. Turning next to the recently formed Doors & Security segment. Sales were up 7% for the quarter.

Sales of Door products grew double-digits again as the furniture teams continues to innovate and drive growth even during the time of lower housing stock in the back half of the year.

The combination of wholesale growth through innovation and share gains plus the continued success and expansion of our doors and the R&R program at retail which has meaningfully increased our R&R mix within door products offset the market related headwinds.

We expect this trend to continue in 2019 as the furniture team maintains its industry-leading ability to manage input costs and realize price.

Sales of Security products were down double-digits in the quarter driven by decline in international sales due to the softness with key European retailers and several non-repeating prior year fourth quarter promotions in our U.S. retail business. Our non-repeating items caused sales and margins to slip in the quarter.

The good news is that we have completed the product upgrade to the more secured ball bearing locking technology for our core padlock lines and the operational and manufacturing challenges of the summer are now behind us.

Prices addressing material inflation in tariffs as we enter 2019 and under the new leadership of Brett Finley, we're implementing some of the sales success drivers in Master Lock that have significantly accelerated furniture results over the past three years.

You'll hear more about these initiatives to simplify, focus, and grow the business directly from Brett on Wednesday during our Investor event. In composite decking, our Fiberon unit added about a point of growth in the quarter with Q4 being the seasonally slowest period for deck sales.

Fiberon was slightly dilutive to EPS given deal costs, some incremental investments, and lack of seasonal leverage during the short time have owned it.

The integration is progressing rapidly as -- as we get deeper into the category and as potential overlap of our existing portfolio in distribution, we remain excited about the opportunity to grow in the outdoor living segment of the market. In our Cabinet segment, sales were flat in the quarter and up 2% excluding strategic business exits.

Similar to recent quarters, sales of value products were stronger than the overall market and sales in our in-stock cabinets and vanities and builder direct businesses were both up high single-digits in the quarter. Sales in our largest channel, dealer grew low single-digits led by the value product lines.

Sales were lower in the home center special order and in Canada where the market continues to trend software than what we see in the U.S. Our Cabinet business is reversing the negative sales trends we saw earlier in the year even after including the headwinds from the exited business.

Although the middle of the market remains somewhat sluggish, our margin associated with these products is trending positively as we successfully increased price, reduced our levels of promotion, move forward with two fewer plants, and continue to aggressively migrate our supply chain.

With direct result of the aggressive actions have marginally affected some improvements and tangible sign continue to be in the right track in pivoting the business. Regarding our Cabinets' pivot, it's clearly parts of the business that are performing very well, particularly, value products where we have over $1 billion in sales annually.

The margin associated with these products continues to be very attractive, despite the low price points since we have access to a large low-cost production platform specifically designed for these products. It doesn't come with the cost or complexity associated with more custom make to order products.

Our unique capabilities in Mexico facilitate this business. As we continue to execute on our pivot actions, we're reopening the path to margin expansion beginning in 2019, even as the share of value products grows within our overall Cabinet mix.

For middle of market semicustom cabinets, we continue to undergo a complete transformation that began in second half of 2017 and continue into this year. In 2018, we closed two facilities, invested in capacity for lower-priced products, migrated our supply base and footprint, and took headcounts and spending reductions across the Board.

In 2019, we'll take even more actions to balance the cost structure and at the same time, launch a broader range of value semi-custom products. So, to sum up Cabinets, sales growth in the quarter improved and had good margins despite inflation and continued tariffs untitled.

As we look forward, we see growth in 2019 for our Cabinets business in the mid-single digits inclusive of the market dynamics we see and repositioning actions associated with our pivot. In addition to improving our financial results, our actions have increased our exposure to areas of more stable and predictable growth within the cabinet industry.

Lastly, as we enter 2019, we are covering inflation with price and supply chain initiatives. Next week you will hear from our Cabinet center, the advantage. We’ll go into greater detail on the industry, the progress in pivot plan, and our 2019 and longer-term outlook for this business. Turning to our total company performance for the full year.

In 2018, we executed well against our strategies and evolve in certain areas. We grew our sales in earnings despite a softer market. We also deployed a significant amount of capital in an opportunistic way and added exposure to the outdoor living market in a way that we believe will create significant value for shareholders moving forward.

Solid performance in the face of a much softer second half housing market, a spike in inflation, tariffs and interest rates, a severe hurricane that shuttered our U.S. plumbing operation and some cabinet plants for several weeks and persistent uncertainty on trade policy.

For the full year 2018, we grew sales by 4%, earnings by 8% and delivered total company operating margin of 12.8%. Importantly inside each business we made significant progress on our strategies to enhance our sustainable competitive advantages and achieve profitable growth.

In Plumbing, we proved our GPG strategy can perform through a volatile and softer demand environment while maintaining a strong operating margins for this segment. In Doors & Security, our continued share gains with doors gave us a broader platform to build upon.

And our 2019 plan now includes investments to accelerate even more growth with the acquisition of Fiberon. We expect solid margin improvement in 2019 as our leadership in new focus and security takes hold and introduce new electronic products particularly in the commercial channel.

And in Cabinets, we stayed disciplined and focused on profitable growth and navigating the promotional environment, continued trade labor constraints, private tariffs and elevated demand for low price points in simpler projects.

With our disciplined and strategic approach, we are committed to accelerating sales and profit despite the challenging market backdrop and some changes in mix and we are focused on leveraging our industry leadership, supply chain and scale. Now, let me turn to our full year outlook for 2019, starting with our view of the U.S. home products market.

Our outlook for 2019 is for modest U.S. home products market growth of 2% to 4% and a slower start to the first half.

This industry growth rate is a slower than we were predicting last year and incorporates the consumer interactions to the interest rate environment were just stabilizing, the home price inflation, which is moderating at higher levels and more modest economic growth in the U.S. economy.

We are balancing these forces as constraints to underlying fundamental demand, which would otherwise support higher growth rates for housing and home products. Within that overall assumption, we anticipate the pace of repair and remodel will be more resilient, but will slow somewhat as well to roughly 4% versus 5% in prior years.

Construction is assumed to grow at 2% to 3% in 2019. Single-family is expected to continue to grow a bit faster than multi-family and single-family entry-level activity is expected to remain strong there. Our total global market, which includes assumptions for the U.S.

market as well as our other international and security markets is expected to grow at a combined 2% to 4% rate for 2019.

Based on that total global market assumption, continued internal improvements and the recent Fiberon acquisition, we expect solid top line growth for 2019 with our full year sales increasing 6% to 7.5% over 2018 or approximately 3% to 5% on an organic basis.

On this market, the sales growth, our teams are focused on delivering full year EPS before charges and gains in the range of $3.53 to $3.77. This is an outlook we have linked tightly to the softer market we saw in the second half of 2018.

We're also assuming, we want to address tariffs and continued inflation with expense control, supply chain actions and pricing, in order to deliver on our plan. So, in summary, our 2019 outlook is based on more moderate market growth assumptions.

We continue to execute on our growth strategy and I feel good about the momentum that our teams are carrying into the year. On top of the improvements we made to our core portfolio, 2018 was a solid year for capital deployment. We acquired Fiberon, we purchased $695 million of shares, and again increased our quarterly dividend.

Additionally, I'm very pleased with the timing of our $600 million investment credit bond deal and the rate – secured on the financing. We'll continue to focus on creating meaningful incremental shareholder value by using our strong free cash flow and balance sheet to make strategic acquisitions and return capital to shareholders.

In 2019, however we anticipate the overall pace of M&A activity to be quieter in the first half, and for the year you will likely see us balance continued to share buyback, modest M&A and some natural deleveraging given our planned EBITDA and cash flow growth.

We currently have $414 million remaining on our existing authorization for share repurchases. Regarding acquisitions we continue to look for long-term opportunities that make sense strategically with a focus on plumbing and door.

We have a strong pipeline of opportunities, but tellers maybe apprehensive in the current environment, especially in the first half of the year. If market growth improves throughout the year and there is more clarity on trade M&A activity could pick up.

With that, I will not on the call over to Pat who will review our financial performance and provide more details on our guidance..

Thanks, Chris, and good afternoon. As Brian mentioned, the best reflect on-going business performance, the majority of my comments will focus on income before charges and gains from continuing operations. Let me start with our fourth quarter results.

Sales were $1.4 billion, up 3% from a year ago despite a softer second half market which impacted all of our business. Consolidated operating income for the quarter was $181 million, down $5 million or 3% compared to the same quarter last year.

Consolidated operating margin declined 70 basis points to 12.7% as lower volumes, inflation and onetime items insecurity impacted margins. EPS were $0.86 for the quarter and grew 8% versus $0.80 same quarter last year. For the full year EPS were $3.34 versus $3.08 last year, increasing $0.26 or 8%.

These results were below our plan and expectations and reflect a market that was significantly softer in the second half of the year than we anticipated even 90 days ago. As we enter 2019, all of our businesses are prepared to manage expenses and capital tightly, during what we expect to be a soft first half.

Certainly, they’re focused on growing in the most promising portions of the respective markets. Our 2019 expectation is to grow above market and drive margin improvement and we are well-positioned to do so. Now let me provide more color on segment results.

Our Plumbing sales for the fourth quarter were $488 million, up $19 million, or 4% driven by strength in U.S. wholesale and China. Acquisitions and FX roughly offset each other with each having roughly a one point impact on sales. Operating income increased $11 million to $109 million, up 12%.

Operating margin for the segment was 22.3% an extraordinary resulted driven by excellent management of inflation and expenses as the market softened throughout the second half of the year. For the full year, Plumbing sales of nearly $1.9 billion increased $163 million, or 9%.

Operating income of $396 million was up $30 million or 8% versus the prior year. Operating margin was 21%, again a great result given the extreme inflationary pressure throughout the year. The Global Plumbing Group is continuing to deliver on our strategy of growing sales of our market, while maintaining an operating margin around 21%.

In 2019, we expect Plumbing sales to grow mid-to-high single digits, but Plumbing Group continues to target operating margin of around 21%. Turning to Doors & Security. Sales were $307 million, up $20 million or 7% for the prior year quarter.

Sales growth was led by another double-digit increase in doors and our Fiberon acquisition partially offset by a double-digit decline in security. Throughout the second half of the year, we moved decisively and aggressively to reposition the security business around its best growth opportunity and setup margin expansion.

These actions have included upgrading the leadership team, improving manufacturing and service levels, discontinuing some non-core business and low-margin promotional events and recognizing one-time charges as we reset the business and position it for a strong 2019.

Excluding a non-repeating items and seasonally low Fiberon acquisition, operating margin was 13.3%. For the full year, Doors & Security sales increased 8% to $1.2 billion, operating income was down 5% to $155 million and operating margin came in at 13.1%.

The security product upgrade we made during 2018 presented greater operational challenges than anticipated. Extreme inflation exacerbated the situation. New leadership has improved operational performance and service levels and is addressing price commodity more effectively.

We expect the security business to return to growth and margin expansion in 2019. As Chris mentioned, the President of this group, Brett Finley will address these efforts next week in Boston. In 2019, we expect total Doors & Security sales growth in the high-teens inclusive of the Fiberon acquisition.

We expect mid-to-high single-digit organic growth as doors completes its retail rollout and security reignites growth. Operating margin next year is expected to improve by 100 basis points reflecting the operational and commercial improvements in security and full year of production firm and lapping of the acquisition costs associated with Fiberon.

In Cabinets sales for the fourth quarter were $625 million or flat versus the prior year quarter. Excluding business exits, cabinet sales were up 2%. Sales of in-stock cabinets and vanities grew high single-digit on continued solid demand for these products, excluding the exited U.S. home center business.

Dealer sales increased 1% and saw high single-digit sales growth in stock products primarily sold into a new construction, as we took share with builders in certain parts of the country. Total direct sales were also up high single-digits.

Home center special order sales were down in the quarter, but lesser than earlier in the year, as we applied targeted promotions of a higher price base. Cabinet operating income in the quarter was $62 million, down 7% and operating margin was 10%. Operating margin was 11.3% adjusting for additional week this year.

Our operating margin continues to demonstrate sequential improvement and in the fourth quarter our operating margin exceeded the prior year on an apples-to-apple basis. In cabinets, a year of transition was expected, but the market was weaker than anticipated in second half.

However, our in-stock and stock product lines continue to post a solid high single and mid single-digit growth respectively even in a softer market. We continue to make progress in expanding the share of this product line. For the balance of our cabinet portfolio, we continue to improve the cost structure to enable margin expansion in 2019 and beyond.

In 2019, we expect cabinet sales to grow approximately 3% to 4% and margins to improve by approximately 70 basis points. To sum-up, consolidated fourth quarter performance, sales increased 3% and EPS were $0.86.

The results were below our plan and expectations, however, we are well-positioned to deliver a solid 2019 what is expected to be a softer market. Our Plumbing and Doors teams continue to outperform the industry and our cabinet business has a starting 2019 with an improved cost structure.

Importantly, we have taken the price and strategic steps necessary to deliver improvement in 2019. For the full year, sales increased 4% and EPS grew 8% to $3.34. Total company operating margin was 12.8% or 80 basis points lower than the prior year. Now turning to capital deployment, during 2018 we repurchased $695 million in shares.

We spent approximately $470 million on the Fiberon acquisition and approximately $115 million on dividends, an increase the 2019 dividend rate by 10%. 2018 free cash flow was $465 million reflecting a conversion rate of 95%. Even after meaningful capital deployment in 2018, our December 31 balance sheet remains solid.

Cash was to $263 million, debt was $2.3 billion and our net debt-to-EBITDA leverage was 2.4 times. Additionally, we have significant flexibility to finance investments and deploy capital to drive incremental value.

Our proven ability to generate solid free cash flow allows us the flexibility to continue to deploy capital to create shareholder value or to de-lever naturally over time. Turning last to the details of our outlook for 2019. Based on our assumption of the U.S.

housing and global market growth, both in the range of 2% to 4% and continued solid performance by our Plumbing and Doors teams that continue to outperform the market, we expect full year 2019 sales to increase 6% to 7.5% inclusive of the Fiberon acquisition. Excluding Fiberon, we expect 2019 organic sales growth between 3% and 5%.

Our resulting outlook for 2019 EPS are in the range of $3.53 to $3.77. The midpoint of our EPS outlook reflects an increase of over 9%. This 2019 EPS outlook excludes any incremental capital deployment and includes the following assumptions.

Interest expense of around $94 million, a tax rate between 25% and 26% and average fully diluted shares of approximately $142.5 million. For 2019, we expect the first half to present a soft start to the year. We expect first half market growth of 2% to 3%.

For the first half, we expect EPS growth of roughly 6% to 7% on sales that are roughly 5% to 6% reported and 3% to 4% organic. To sum up, fourth quarter and full year EPS were below our expectations, but our overall business model is more flexible and resilient as a result of the changes we have made in response to a softer market and inflation.

Accordingly our 2019 growth projections are based on modest market assumptions. The momentum we have created with the Global Plumbing Group and the new growth avenues we have opened in outdoor living with the Fiberon acquisition give us confidence in continued solid growth and margin expansion in the coming years.

Accordingly we are targeting a 50 basis points consolidated operating margin increase in 2019. You will hear more about our long-term operating margin target for each business next week. I will now pass the call back to Brian..

Thanks, Pat. That concludes our prepared remarks on the fourth quarter of 2018 and our full year 2019 outlook. We will now begin taking a limited number of questions. [Operator Instructions] I will now turn the call back over to the operator to begin the question-and-answer session.

Operator?.

[Operator Instructions] Your first question comes from the line of Susan Maklari from Credit Suisse. Please go ahead. Your line is open..

Thank you, good afternoon..

Hi..

I guess, to start out with given all the perspective that you have, can you just talk to what you guys are seeing in the market. We've, obviously, had a lot of crosscurrents as it relates to the new home side of the market, the consumers.

So I think maybe your perspective in terms of what you've been seeing could be really helpful?.

Sure. On the new construction side, I'd say we saw some softening in the third quarter and when we last to talk to you 90 days ago, we obviously revised down the outlook. It fell off more significantly in November, December, which I think is pretty widely understood now.

And I think we just saw a consumer pullback out of the market both on the new construction side and on the existing housing stock turnover side of the market. And if you look back and if you look at where interest rates were coming into September from that point up through middle of November, they moved up an incremental 50 basis points.

You saw a cumulative impact of a lot of housing inflation really hit kind of tipping point into October, November. And so you saw the consumer pulling back, equity markets pulling back. It hit that side of the marketplace. R&R bridges that remain somewhat resilient, although it came off as well. So I'd say we say R&R weaken in the quarter as well.

So we took all that and as we were building our plans for 2019 given that we lag especially new construction side, we approached the marketplace for 2019, I'd say in a -- I don't know if I’d say sober or conservative way, I'll chose sober.

So I think we kind of came into the year and assume that some of the carryover effect of the new construction side will carry over into the first half or especially the first kind of three, four months of 2019. So, really kind of a flat very modest growth in the construction side.

R&R probably continues to be a resilient, but at little softer pace 3% to 4% for the first half. And then we think the market will pick back and get its kind of sealing underneath it and move back through in 2019. So that's how we build our plans. We were tight on costs. We got a lot of growth coming through.

But we just said we're going to be looking at sober start to the year and then roll it through. And I'd say, okay, we’re sitting at the end of January which is about soft as it gets in terms of December, January are the quietest periods in the construction market. But market is about as we thought. And so I'd say, you look across landscape.

And there’s certainly is activity that's starting up again. But it's kind of still early in the year. So our outlook as we kind of projected out for the year looks pretty good as I sit here at the end of January.

So things summarize it, surprise that it got quite a bit softer in the fourth quarter, the underlying fundamentals of the market where still comfortable with in terms of the drivers of housing activity, household formations, the age of the housing stock, disposable income, even consumer confidence, although, the overall consumer confidence index tick down the housing-related portion of that was positive.

So I would say we're optimistic long-term and we're optimistic second half, but I'd say we kind of want to come into the year and just be realistic about how it might start out.

So I hope I answered what you were looking in there?.

Yeah. No. That's very helpful. And I guess just as a follow-up there, you made a lot of progress in 2018 in terms of the pricing really kind of across all segments of the business.

As we think about this lower growth environment how or what do you think your ability is the kind of retain and hold onto a lot of the progress that you made last year? And then, I guess within that to, can you talk to some of the benefits that maybe you can see as we move through 2019, as it relates to some of the commodities coming off? And could that possibly be somewhat off an offset?.

Yes. I'll take the first part and then I'll let Pat give a little more detail. I think we talked about pricing last year as, again, taking a lot of small bites of the apple. And so that served us well as we brought it through. And I'd say, it was pretty sticky what we've taken on both in terms of pricing and reduced promotional levels.

And so, not concerned -- Pat will give you more detail on our outlook on commodities. I think we are in a very good sport a relative to the pricing we took the cover off on the communities we saw. On tariffs, we've planned for and absorbing the 10% level and we're planning on having to address the 25% level.

Obviously, it's been suspended for now, but again back to our real sober look at the marketplace we are anticipating, if it's going to hit us on March 1, we will take actions to offset that even in the slower-growth environment. So Pat, maybe you want to give a little more detail on commodities in general..

Yeah. One, on pricing and then I'll go to the commodities. I would say as we addressed the inflation of 2018, we did with supply chain and price and the pricing most of that was not per se tied to tariffs scenario. So we don't expect pricing to erode as we ahead into 2019 in any way shape or form.

As I reflect on 2018, we had roughly $90 million of inflation hit our P&L in 2019, about $70 million of that was material inflation inclusive of tariff pressures and not just the 10% 301 tariffs, but plywood tariffs and steel and aluminum tariffs earlier in the year and the balance of that about $20 million was freight and logistics.

And we covered it with apply chain actions – supply chain actions actually offset considerable parts before that hit our P&L. Like just for example at 10% tariff has roughly on an annualized basis $50 million impact to our P&L, but we offset three-fifth of that for the supply chain action before it ever came out.

As we look into 2019, you have a wide range of potential inflation scenario depending on what happened with any additional tariffs.

So I would say without, a 25% tariff, we're looking at $55 million to $60 million of inflation, or call it roughly $0.30 of EPS with $20 million to $25 million of that be in freight and logistics and probably $10-plus being just continued adjustment to the realities of the new plywood market as we shifted materials and supply base and then the balance of being all other inflation, so all other bucket relatively modest inflation without other tariffs.

If they were 25% tariffs, the estimate is still consistent with where we where in the third quarter we would say the net hit to us on an annualized basis of 25% tariffs is around $45 million.

Of course, we don't expect a full year of that, but all of our teams are prepared to address, if it materializes and they would address it with a combination of supply chain and pricing and all of our teams have scenarios prepared for that to happen. And of course, as the first half of the year unfolds; we can update you on how that plays out..

Okay. Thank you very much for the color..

Your next question comes from the line of Phil Ng from Jefferies. Please go ahead. Your line is open..

Appreciate seasonally slow to start the year, but after soft patches on the second half, have you seen any signs there's in a pickup, have the customers come back and restock in the inventory? I know you're expecting things we accelerate it bit in the second half is it easier comps or are there any initiatives you have in place that kind of gives you the confidence things will pick up?.

Thanks. The inventory issue kind of hit us in parallel with the softer markets. So as the fourth quarter softened, our channel partners pulled back on inventory as well. So the ordering rate was below POS throughout fourth quarter. So, it was kind of negative [ph] effect on sales overall. That likely won't persist.

So, as the market resumes and grow, you will see inventories matching at a minimum POS and if there's an acceleration, they typically will buy-in a little bit more to cover with anticipated some growth. So the first and second half, it really comes down to carryover effect from the way we exited last year.

Our categories lack the overall construction cycle and R&R doesn't really start to pick up until March. So we just let's say brought forward what we saw as we exited the year in the first part of this year and accommodated for a slower start. And I think the back half of the year; it is more of our performing against the market.

We've got a lot of initiatives irrespective of market. But we are assuming that there is some modest level of growth that resumes in the second half of the year. So, -- and it went up looking for a huge future spike -- we're actually looking for more like 4% to 5% growth in the second half if the first half is 2% to 3% growth.

So, kind of, that's the range we're operating in. Reasonably consist R&R, but the big swinger is softer, new construction in the first half which then picks up and yeah, obviously, there's going to be a bit of a softer comp in the second half too. So, I think it ties up. In general, we're not making any big leaps of faith.

We're looking at market in a very conservative way. And saying okay we're going to run our business against that and we're going to grow EPS at midpoint 9% and we've built our plans, cost structures, and CapEx and otherwise in a way that can deliver on that, so a little bit of logic to flow through all that..

Okay, that's really helpful.

And with the investments you made in Cabinets, can you give us a sense how you're thinking about growth and just incremental margins into that business? And have you seen any new wins on the value side offering that you have out there? And should we think of any overhang on the margin front because it sounds like you still had some initiatives you're trying to work in 2019? Thanks..

I think on the markets side, we continue to perform really well in the in-stock cabinet and vanity side of the market as well as the soft part of the business that goes into builder and simpler R&R through dealer. So, that part of market we are picking up share. And we expect we will continue to pick up share.

If I look at the overall pivot plan cabinets, a lot of it is we're just going to emphasize the places we've had success and continue to have success. So, we expect that will continue and continue bringing new products in that part of the market. Pat can tie off second part of that question..

Yes. To add onto the sales and the growth perspective of it, the part of the value segment of the market that you're referring to where we traditionally have been very strong in home centers and in-stock cabinets and vanities.

We are taking that supply chain and bringing it to our broader set of the market and as we talk about next week or day will from our Cabinets group deploying that cost structure and capability into our product launch that takes place in April.

So we plan to leverage the capability we have to grow that business, but we do expect Cabinets industry to grow a bit slower than the rest of the overall building products industry just as consumers' trade to a different price point of Cabinets and you use fewer boxes in their design.

So, that's why we're targeting Cabinets growth of roughly 3% to 4% and we think that's roughly going to be the dollar growth of the U.S. market over the near to medium term. In terms of margin percentage, we felt like we did all of the cost structure things this year we wanted to do. Volume was little bit softer in the back half.

We didn't see it as much, that's why we talked about it on an adjusted basis. And we feel like we left the year with a nice cost structure. We do expect next year -- to finish next year with a 70-plus basis point increase, would get us into that 10.3% range for the year.

And we expect to start seeing that right out of the gate in the first quarter, not a 10% in the first quarter, because first quarter is seasonably low, but obviously a big improvement off of a very soft 2018 start to the year.

And then as Chris mentioned and you referred to, we do have more change coming, but we're going to pace that change thoughtfully.

We know investors want to see as a drive both sales growth and margin improvement in that business, and so we are going to be pushing to do that consistently each of the next three years, while also absorbing some of that change and not letting the change swamp out the growth.

So you should expect us to grow that business then in the low to mid-single digits and to drive 70-plus basis points of margin improvement across each of the next three years..

Your next question comes from the line of Justin Speer from Zelman & Associates. Please go ahead. Your line is open..

Thanks, guys.

Just a point of clarification on the tariffs within your guidance, are you embedding a 25% or a 10% tariffs in your kind of segment margin assumption?.

We're embedding expected increase to 25% in March. So we're assuming that that's going to happen and that we have to recover that, both through supply chain actions and pricing actions.

Supply chain actions are, frankly, well underway and well underway to address 10%, and so that's just full on and it's going to recover that portion of it, which is substantial. And then, the pricing piece of it will take effect when we know for certain when that's going to kick in.

So there's a little bit of lag, but it's covered off and anticipated in our guidance. So our guidance, just to be clear, some 10% tariff through March 1 and then pick up to 25% March 1 and for the balance of the year..

So if we end up being at 10%, let's say, the thing is extended and it's a 10%.

And then potentially, if there's a resolution, does that change the calculus in terms of your margin assumptions for the balance of 2019?.

Yes. Back half, I mean, because the recovery actions on pricing are back half weighted, it changes some back half math. So it'll be interesting to see how it transpires as the 10% go away. I mean, we're not assuming that would necessarily happen either, and resolution could be that there is some tariff remaining, I think the market still waiting.

Bigger markets are waiting for the tariffs to follow off, assuming aluminum coming out of Canada. But those are still picking up there. We just reacted to the stuff that’s going on and I'd say are being very clear eye, and our plans are constructed for 2019 that way..

One follow-up in -- I'm sorry, in plumbing….

Go ahead, Justin..

In Plumbing, is there any risk of mix now in the business? And if so, what's the margin risk from that potential dynamic? Is that in your calculus at all?.

Yeah. Within Plumbing, it's interesting, because the market has been reasonably stable for us. I think for us, it's a mix between wholesale and retail. And so, our strength, frankly, over the last 18 months has been stronger on the wholesale side. And that is not just a construction depended.

That's just stronger performance on that side of the marketplace. So that tends to be richer mix. Within the construction, consumers still trade up off of where the base package has been even through the second half of the year.

So the mix is, I'd say the one piece of the market has been weaker is at a very high end, luxury part of that market is a little softer. But that's a small part of the overall. So I would say, we are not making heroic improvement in mix. I think we are just being realistic by segment of what we see coming out of it..

Thank you very much..

Your next question comes from the line of Steven Kim from Evercore. Please go ahead. Your line is open..

Yeah. Thanks very much guys. Just had another point of clarification here, I think you talked about on the margin side in couple of your segments, in Doors & Security you talked about the Fiberon's stuff impact and the nonrecurring cost being in total 460 bps, I think margin.

What was just the Fiberon's stuff portion? And then in your Cabinets business, I think you talked about the 130 basis point impact from the 53rd week, was wondering if you could just elaborate a little bit more what that was? And why did that just hit the Cabinets and not the other segments?.

Well we have 53rd weeks of Cabinets first. We had 53rd weeks in most of our businesses as most of our businesses with the exception of doors 13-week quarterly calendar underneath our corporate umbrella which is on a fiscal month-end calendar.

But we have to keep all of the businesses inside of fiscal close week of one another, and so we have to take a 53rd week every once in a while. And Cabinets it's particularly onerous because you have a fixed cost structure where you're paying out fixed cost for that week but you’re shipping almost nothing because it's a holiday week.

So specifically in Cabinets it was around $15.5 million of sales in the week that was incremental because of the extra week, but it was actually about a $6.6 million hit to profitability. So that's what going on there. All of our businesses take them and we try not to talk about them.

In particular with cabinets the reason we wanted to call it out here is we wanted to give people of viewpoint of how the business was really exiting the year on a run rate performance, given all the cost take out it did during the year. In the case of Fiberon, Fiberon was about 100 basis points of that adjustment that you referred to.

It was in the quarter about, I want to say $29-ish million in sales and maybe an unfavourable $2 million in profits based on some of the cost associated with acquisition like inventory step-up amortization and so forth. We expect that business to be accretive to next year..

Got it. That's very helpful. Thanks for that. And then I guess my second question relates to sort of the outlook for this year. I think you painted it out pretty well. I think you have been very clear, you think the first half of the year is going to be slower to back half; you’re anticipating sort of a normalization.

You're being conservative in incorporating the tariff assumption in there as well.

I guess, I was just wanting to clarify a little bit, are you -- is it also your view that 1Q is going to be within that softer first half, that the 1Q would be particularly softer and maybe Q2 will be ameliorating a bit? And then also, I was wondering if you could lay out what if anything you have seen or incorporating in our outlook for the government shutdown, maybe on back pay for load workers through coming through along with tax refunds in the near future, anything related to the shutdown of our tax refunds in your outlook?.

I would take the second of that two-piece question. We don't have any specific assumption in our plan for the government shutdown or for a tax reform as it affects consumers. I would….

One thing that was beneficial was, throughout they said the tax refunds wouldn't be impacted and new attractive data, as well as we do, tax refunds turn out to be a source of R&R funding. So that was good news. So it could have impacted it, but hopefully it did not, but Pat you can take the second part of the question..

And then -- so, yes, we do expect the first quarter to be, at least from a U.S. and Canadian new construction, we expect the first quarter to quite possibly be negative, because of just the starts momentum that was playing out through the back half of 2018, in particular the starts momentum that all of us saw in October or November.

None of us have yet seen December, but if December's anything like October-November, it kind of drives through a negative new construction scenario for Q1 in both the U.S. and Canada modestly so, because we would kind of take a combination of starts and completions across that horizon.

And then, we think and the second quarter should get us back to flat to slightly below flat for the whole first half on the new construction front. And we would expect R&R to be reasonably resilient, kind of 4% bouncing, plus or minus 50 basis points throughout the year.

So R&R, the linchpin, prevents whole things from going negative in the first half..

Got it. Thanks very much. Appreciate it..

Your next question comes from the line of Timothy Weiss from Baird. Please go ahead. Your line is open..

Hey, good afternoon, everybody. Maybe just going back to cabinets and the margins, I think that the midpoint of the growth in margins gets you to maybe a 30% incremental. You took out some fixed costs in the year in 2018.

How much of the profit improvement next year is really that from cycling through a lot of that fixed cost versus what might be volume related? Just trying to see how much visibility you have for the cost lines in cabinets this year?.

Yes. I'd say, it's half the benefit of fixed cost low forward, and then half the fact that -- while we covered off in cabinets, actually cabinets is a division where they covered more than their total inflation during 2018.

Much of that happened in the back half of the year, because they will hit very severely in the first half of the year with plywood tariffs, initially hardwood plywood, and then soft plywood was added to that.

And so they are going to be about half price commodity, about half fixed costs as they manage through all of the supply chain changes related to plywood. But that business is still good and you're close. I want to say the incremental leverage maybe more like 28%-ish 29%-ish year in the ballpark there..

Okay. And then that’s good.

And then on Plumbing just on the inventory reduction was that in also end retail or was it one of the two channels? And do you expect that to happen again in the first quarter, I just want to be cognizant that the comp in the first quarter Plumbing is kind of particularly tough?.

Yeah. We got a across channels. There was probably a little bit more retail than in our wholesale but it was across channels and it kind of unfolded throughout kind of November, December. It was twofer as the market was – demand was coming off – they were already – even had a weaker rate than that. I think stable it's at a stable rate right now.

There is a point where weeks of inventory falls below stocks out and other situation that isn't good for either of us. So I expect – certainly there couldn’t be a little bit, but I don't expect – there'll be a significant move up, I think you're going to run it above POS..

And POS – that was about 6%-ish?.

Yeah..

…in U.S. performing..

Yeah..

Great. That’s helpful. Look forward to meeting you guys next week..

Okay. Thank you..

And that concludes our conference for today. Thank you for joining..