Good afternoon. My name is Jason and I will be your conference operator today. At this time I would like to welcome everyone to the Fortune Brands' First Quarter 2021 Earnings Conference Call. I would now like to turn the call over to Mr. Dave Barry, Senior Vice President of Finance and Investor Relations. You may begin our conference call. .

Good afternoon everyone and welcome to the Fortune Brands Home & Security First Quarter 2021 Investor Conference Call and Webcast. I'm Dave Barry and I recently became Senior Vice President of Finance and Investor Relations at Fortune Brands after spending the prior six years in our Plumbing segment, most recently as Chief Financial Officer.

I'm excited to be here and I look forward to working with you all in my new role..

Hey thank you and welcome and thank you to everyone for joining us on the call today. I hope that you and your loved ones are all staying safe as parts of the world begins to reopen. I couldn't be more proud of our first quarter results which reflect a broad-based acceleration of our remarkable 2020 performance.

Our business performed very strongly across the board. For the quarter our total company sales increased by 26% over last year with each business delivering double-digit organic growth. Operating margin increased 270 basis points to 14.8% and earnings per share increased 68%.

This performance is the result of exceptional execution by our teams in the housing market which we believe is in the early stages of a period of long-term sustainable growth. Our stellar first quarter results were meaningfully ahead of a strong market and lapped a very good Q1 in 2020.

Importantly we continue to drive market-leading growth while advancing our strategic agenda including accelerating our margin improvement initiatives. Our focus on execution efficiency and safety drove share gains and favorable operational leverage.

This focus allowed us to continue to service our customers and consumers with our industry-leading brands and innovation, while also increasing investment in the business..

corporate expenses of about $104 million to $106 million, interest expense of approximately $82 million to $86 million, a tax rate of between 23% and 24% and average fully diluted shares of approximately $140 million to $141 million. We expect a long runway of fundamental housing growth to result in prolonged market strength for our products.

We expect our sales to continue outperforming the market which will accelerate our margin progression. Our strong balance sheet allows for us to continue to assess further opportunities to deploy capital strategically. We see multiple paths of future value creation to pursue for our stakeholders.

Our company has never been better positioned to capture these opportunities. Our teams remain committed to driving market-beating sales performance and continued operating margin improvement. Our revised 2021 guidance is solidly on the trajectory of the three-year outlook reflected in our updated investor presentation.

This outlook contains a compound annual sales growth rate of 8% to 11%, and a 2023 operating margin target of 16% to 17% relative to a global market growth CAGR expectation of 6% to 8%. I will now pass the call back to Dave to open the call up for questions.

Dave?.

Thanks Pat. That concludes our prepared remarks on the first quarter. We will now begin taking a limited number of questions. Since there maybe a number of you who would like to ask the question, I will 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, will you please open the line for questions. Thank you..

Certainly. Your first question comes from the line of Phil Ng from Jefferies. Your line is open..

Hey, guys, congratulations on really impressive results and just broad-based strength across your portfolio. Last quarter I believe Pat you may have mentioned that by spring you should have better line of sight in the back half of this year in terms of growth. I think previously you were baking flattish sales just given the tougher comps.

So can you expand on your thinking now and essentially what your customers are saying in terms of outlook?.

Yes. So we definitely expect growth in the back half and we expect to outperform that growth.

If I put the market into context by half of the year, you heard our updated market guidance, which is, call it roughly 10% for the full year, I'd characterize the first half is kind of mid-teens or better and the back half is kind of mid-single digits or better from a market growth perspective.

And then, when you think about what that means for our sales across the halves of the year, we're thinking about reported sales growth in the first half averaging around 30% and reported sales growth in the back half averaging around 10%. So both, first half and back half strength versus the market.

And then, even on an organic basis a first half organic growth around 20% and a back half organic growth around high single-digit versus a mid-single-digit market. So we are expecting back half growth. We just see the strength in the housing market continue. We expect to continue to outperform it.

I'd probably further clarify LARSON is probably $450-ish million in there, with about $250 million of that coming in the first half, just to kind of give you the way we see the year unfolding right now.

And I do think at least, it seems like its tracking this way for the first half, but it seems also likely to track this way for the back half of the year where, on a quarter-by-quarter basis looking at it in stacked margin versus those averages are helpful ways to look at these..

Yes, that's really helpful, Pat. Good to see demand really bounce back in your made-to-order Cabinets business. Curious to get your thoughts on how you're positioned with some of the reshuffling you've done on the capacity side. And then appreciating, from a dollar margin perspective, value is higher.

But on an EBITDA dollar contribution, I think, semi-custom is probably pretty additive. But just wanted to help us think about what this bounce back in big ticket, what that means for you and then, obviously, on the value side as well. .

Sure, Phil. Yes, we're equally encouraged to see it. I mean, what you stated it's true for Cabinet. It's true for the entire portfolio. I mean, the strength was just so broad-based across all products, channels and geographies. So it was really impressive.

Really nice to see it come through in make-to-order Cabinets side and really being -- as we said in the prepared remarks, really led by premium, which I think tells us something about how the consumer is thinking about investing in their house. The confidence that they have in home values and liquidity. And so, that's rolling through very nicely.

Now, as we've talked about previously, I mean, we did a lot of work around the supply chain. We talked a lot about the work that we did on the value side to create a highly competitive global supply chain.

We've also done a lot of work on the made-to-order side, to kind of take out unnecessary complexity, simplify wherever we can, commonize where we can and that is helping compound a lot of the margin accretion in the business. The work is far from done. Dave Banyard and his team continue to identify more and more opportunities to go after that.

But it's well underway and it's well understood. And so as you start to see volume flow through that made-to-order, we'll see benefit there, certainly, as you point out on a dollar perspective and then also have plans to drive the margins further.

So Pat, do you want to add anything to that?.

Yes. I think the thing I'd add, Phil, is I think it's a great sign for housing in general and for our business right? When people are buying more premium-priced cabinetry, it just shows the confidence they have in their home, in their home values and their willingness to invest in their homes.

So I think it's a great overall kind of market strength signal. I think, when you talk about percentages, the Cabinets team is trying to drive both the make-to-order and the stock business to the mid-teens margin of the whole Cabinet portfolio.

As you point out though, in the make-to-order side you sell in the boxes at 2 to 3 times, sometimes even more than 3 times the cost of the stock boxes. So the dollar profit is quite substantially higher, which allows you to leverage SG&A much more significantly.

So to the extent the level of strength we're seeing continues, that will be a powerful SG&A leverage and kind of upside to the next couple of years..

And does some of the streamlining you guys have done on the made-to-order side of things, just lead times just really extended for everything, does that kind of give you an advantage to service your customer better and that it helps you potentially gain share?.

Yes. Over time, for sure. Because you're just removing unnecessary complexity. And at the end of the day, you have a network that allows you to move things through the network and put it in different places. I mean, today, as we speak today, the whole system is pretty strained. It's a high-quality problem.

And so you have seen lead times for the whole industry extend out. We work very hard to keep our lead times inside of competitors' lead times, so that we can continue to gain share.

But as we were to build out the system, you're absolutely right, it becomes a very powerful business system, where you're leveraging a whole network, not one facility at a time..

Super helpful, guys. Thanks a lot..

Sure. Thank you..

Your next question comes from the line of Stephen Kim from Evercore ISI. Your line is open..

Hi, guys. This is Joe Ahlersmeyer on for Stephen Kim. Thanks for taking my questions..

Sure. Hi, Joe.

How are you?.

Good. So great quarter. Just wanted to further discuss your prepared remarks on capacity within composite decking. You're saying, you're selling everything you can make today which is great and probably supportive of positive pricing, which the industry traditionally hasn't seen.

And certainly, the investments you've previously made in distribution are helping you out with that.

But how much additional breathing room do the investments that you expect to come online mid-year give you this year, given that it sounds like you're already sort of eyeing additional investments? Could you just go into a little more detail on the runway you have and the plans to support multi-year growth in a category that doesn't seem to be showing any signs of slowing down?.

a investing to get more capacity and more efficiency out of the assets we have. I think under Fortune Brands ownership we're getting a far greater efficiency level out of those assets and have plans to continue to increase that. And then as we add capacity, for us it's sort of a extruder at a time.

And so it's a very manageable approach to adding that capacity. These are not giant, giant big bites that we have to take. That said, there may come a time where we do want to add an incrementally larger footprint. But that's also something we know how to do.

I mean we open facilities all the time and so I think we feel we can do that fairly efficiently. And so we feel good about what we're adding this year. That said, I'm pretty bullish. It sounds like year or two in the category, so I don't expect that we'll find ourselves overcapacitized anytime this year or next year. Our plans are to meet the market.

But as we continue to gain share we continue to sell out at the capacity we have.

Pat, any color you'd add from a timing standpoint?.

I would kind of echo your sentiments. I think first, we've stated we're working to get this business to $400 million by 2023. So we're very much on that track if not ahead of that track. I think Nick's comment signals, if anything we wish we are putting in more capacity faster.

Last year, we grew this business about 25% selling every board we can make and we're probably going to grow this business this year 20%, 25% selling every board we make. And we're just going to be constantly working to get more out of the assets we have and raise new assets to the forefront.

I think to Nick's point most of our stuff is adding modest increments of assets at a time. They're digestible. And you can obviously slow things down as well if that were to be needed. It doesn't seem like that's going to need to be the case. And so we're not -- at this point in time we're going to end up in an over-capacitized industry situation..

Yeah. Fantastic. Obviously a business with great prospects. Just a quick one if I could fit it in here on the acquisition of LARSON. The tailwind in the quarter sort of implies that it was a little bit more than 25% of the run rate sales that was discussed around the acquisition.

Is there anything -- I mean, I know there was the accrual account for kind of the last couple of weeks of 2020, but it still doesn't really seem large enough to explain the sales in the quarter.

So was it just a stronger spring selling season in the Doors category, or how should we think about I guess the cadence of the tailwind for the rest of the year?.

Yeah. I think as I said in my remarks to Phil just before this. I think it will be a business that's at about $450 million or more for the full year. It was a bit under $400 million last year. And it's probably going to be about $250 million or thereabouts for the first half and then about $200 million for the back half.

And it's about people just kind of recovering on inventory and a busy first half of the year across the industry..

And I'd add it just fits so well into the outdoor living envelope. As we looked at this business and sort of first -- ask the question what's the primary use of a LARSON door? The first answer is to let light in and the second was to let air in.

I mean, it might be a category that kind of originated in installation, but it's really moved into letting the outdoors into your house. And so we see that trend just attach to the trends that we're seeing in people wanting to better the quality of their kind of outdoor/indoor experience and their outdoor living spaces.

And so as I said in the prepared remarks, the acquisition has been even better than expected. The team is fantastic and they're integrating really, really well. And the business is performing at a really high level while we're still going off to sort of value creation synergies that we had identified. So we're feeling very good about LARSON..

Thanks. Good luck guys..

Thank you..

Your next question comes from the line of Truman Patterson from Wolfe Research. Your line is open..

Hi. Good afternoon guys, and thanks for taking my question. Appreciate it. First, I wanted to touch on Fortune Brands Advantage. You mentioned that there are a handful of major initiatives to help offset some inflationary pressures that are flowing through.

Could you just elaborate on what a few of those initiatives are maybe one from each segment?.

Sure. I'm happy to do that and then I'll pass to Pat to give you some more particulars on it.

But we saw -- as we looked across the portfolio and really did this as a team late 2019 or early 2020 we've said what could we do from a business model perspective across Fortune Brands to really elevate the whole? And as we did that we identified pockets of things that we were actually a doing really well and b investing behind.

I mean, we're not just doing it very good at it, but we were doing it well because we were putting the dollars and the people behind building capabilities. But we were doing it in pockets and yet these were things that were easily leverageable across the whole business.

And so we really organized, as a whole executive team, against the Fortune Brands advantage to leverage these capabilities. And so things like category management. I mean if you look at our categories, right, we're – with very few exceptions we're the leader. And in those other exceptions, we're a top three in all of our categories.

And so as such, we should be able to bring category insights, understand how a shelf is set, how we engage consumers, what works best for them, where the innovation lies, price elasticities. And so how do we become really a category management leader and build that up. The other is global sourcing. I mean, we're a manufacturer and a global sourcer.

We have a very complex global supply chain. There are sourcing skills and capabilities that can really not just improve the cost basis and they can do that in a very big way but also the quality and resiliency of the sourcing base in a business. And so, we've invested quite heavily and centrally to build out teams to go off those opportunities.

And when I say investment, this could be single-digit million but really that's driving double-digit millions over time.

And then the third one today is really around business simplification and leveraging tools likely and like 80/20, but doing it in a more consistent way across the business, consistent training, speaking the same language, understanding the value chain and where we're going to get value.

And so the vision is as we really drive these over time, these will just be the language we speak, these will be the skills we have the capabilities.

We'll embed them into the business and then be able to kind of germinate new capabilities under the Fortune Brands Advantage umbrella that are going to help drive growth, right? And we're looking really hard right now at investments we're making in digital.

We have unique insights across the very broad portfolio that we have about what's happening in the housing market that we can drill down to. We built the data lake across all of our products. You can see POS in everything that we do and start to fare that trend very quickly. So we're very excited about this.

And I think we wanted to start concretely get some wins on the board and then really build momentum behind this business model over time..

Okay. Thanks for that.

And then in the prepared remarks, I don't believe, I heard this but could you give an update either on a percentage basis or a dollar headwind, your raw material inflation expectations across the portfolio and the cadence in which it hits your P&L? And then finally, I believe you all said that you would be able to offset it either through pricing or some of these initiatives that you're working on.

Will that be more real time, or do you think that you'll be trailing some of these cost pressures before kind of making it up at year-end?.

Yes. Truman, inflation has been intense across materials and freight. For us specifically, things like metal, hardwood and freight have probably been the most extensive but certainly petroleum-based resins have been challenges as well, as much from the Texas storm as from different places in perspective.

So if you tease them out, last year 2020, our full year COGS base was about $3.9 billion. And I'll tell you that inflation this year is going to be in the kind of 4.5% to 5% of COGS range. And much of that is yet to come. I mean we probably have less than 20% of that flow through our Q1 P&L.

Much of it therefore you're talking more than 80% is going to flow through the balance of the year. And we are – we're going to offset it with a combination of cost actions and where necessary price over the balance of the year. I think you should expect that across all four quarters. We'll show a measure of margin improvement.

It will be tightest during Q2 in part just because, freight really surged again kind of at the very end of last year and in Q1. And we're going to be doing things to expedite components and other products for our customers. We'll be absorbing some unique levels of freight inflation in the second quarter.

But we do expect to make margin progress in the second quarter and make margin progress for the full year..

Well that's – sorry go ahead..

And I was just going to say I'd be remiss if I didn't call out how heroic our supply chain teams have been.

I mean everything from being able to secure the freight, being able to secure the raw mats, being able to – as Pat referenced, resins and ready to find new resin suppliers get them tested and through the system really quickly and get that behind us. Really remarkable.

And I think as you see the market gap to our performance and you see the outperformance of our business increase in an environment like this a lot of that is really attributable to that team and their ability to keep our customers supplied. And they've been at it for a long time now.

I mean, if you go back to plywood tariffs in 2017, where we had to change out $100 million with the buy, out of China into other geographies and do it very quickly, they've really become world-class experts at managing this. And so they're just excellent. And that's what gives us the confidence to basically say, we'll manage this..

Yes. I think the team has been incredible. As Nick referenced, I mean I think since the second half of 2017, they've been facing some extreme challenge, whether it's tariffs, pandemic disruption of Asia or the latest surge of inflation.

And I'd say even labor inflation is more challenging than it typically is as well, given the demand dynamics and the government program dynamics. We're going to offset it, as I said this year. They've been doing a heroic job and cost is a big part of it. We're not leaning just on price.

The cost is contributing equally to that equation because we want to keep our products competitive and we want to keep our channel partners competitive. .

That’s very encouraging. Thanks for taking my questions and good luck on the coming quarter..

Your next question comes from the line of Susan Maklari from Goldman Sachs. Your line is open. .

Thank you. And let me add my congratulations as well on a great quarter. My first question is really around thinking about the second quarter appreciating the guidance that you've given us year.

But when we think about the upcoming quarter specifically, given the fact that the comps are just so abnormally low given the shutdowns that we had last year, how are you thinking about that coming together? Is there any color you can give us on it?.

Yes. As I said a little bit earlier in the call too I think stacked growth quarter-by-quarter will be pretty helpful way to look at things. So if you recall last year we were down about 9% top line in the second quarter. And as I said, we're going to be averaging about 30% across the first half in terms of reported sales growth.

So backing that up that means down 9% last year second quarter then up about high 30s to approaching 40 this year getting to that stack 30% for the second quarter. And then similarly on the organic basis kind of averaging about 20% across the first half of the year.

The one thing I would point out is, last year while we were down 9% in the second quarter we had really good expense and cash management in that down quarter and our operating margin last year with sales down was 14.3%. So we managed our bottom line very effectively during the second quarter.

We'll still make a margin progression this quarter because all of our teams are working very hard on driving the business forward and contributing to the full year margin expansion of around 100 basis points, but it will be 50 basis points or less during that second quarter, I'd say in terms of margin expansion. .

Okay. That's very helpful. My second question is a bit more long term in nature. It seems like across the business you are seeing a positive mix shift. You -- we talked about cabinets. You mentioned that ROHL saw 25% growth in the quarter.

Can you give us some sense of the positive mix shift, what role that's playing in the margins that you're expecting? And maybe not just for this year but as we think about those 3-year targets that you outlined in the slides how are you thinking about mix within that? And is there a potential that we actually get some lift if the mix ends up shifting slightly more positive than what your base case assumption is?.

Yes. I'll take it and maybe Nick could give some color.

I'll start with what is the mix signal about the market and I think as especially as you've seen housing activity in suburbs in the Northeast Mid-Atlantic Upper Midwest where you have people moving from cities out into suburbs at housing price points that are relatively high and having a lot of confidence in the ability of both housing value to sustain and their desire to invest in their home because they're going to probably be spending a bit more time there than they expected to be it gives a lot of great signal at the housing market in terms of people investing in larger single-family homes than doing it in a premium fashion is well underway.

And it's nice relative to the last housing expansion. This is really not happening with unsustainable home equity loans or something like that. This is people for the most part using cash to do it. So I think it's a great signal for the market.

I think in terms of mix and how to think about it from our business we've been working as we've been preparing for the millennial generation to make entry price point and mid-price point products on a percentage basis every bit as attractive as premium-priced products.

So we've been trying to make across our portfolio, our ability to increase margins a possibility even if it was a lot of millennials buying opening price point product. So we try to not overplay mix.

But as we talked about with some of the questions I think we got to with Phil on an absolute dollar basis if you're selling a $1000 faucet instead of a $200 faucet even that's a same percentage margin obviously it's a lot more dollars. And so I think the upside that you're pointing to is it really allows you to leverage your fixed cost base.

And so, if we were to see a pronounced and sustained mix in premium there'll probably be upside to some of the figures we've given out there because it'd be reasonable to assume, it's kind of new news and therefore it's kind of not in our multiyear assumption some massive mix shift.

And if that does perpetuate and sustain at the levels, it's had recently it would be upside. Just leveraging fixed cost base off of higher absolute dollar contribution per unit. .

And Sue, I'd just add as you think about it what we're seeing is-- I mean shifts, I guess, the term in terms of the fact that it's the total and how it comes together, but it's really additive. So we're not seeing any abatement in the trends in, kind of, the core portfolio. All of this is coming in addition to which is really positive.

And where -- you look at where it's coming from and as Pat referenced some of those markets are a lot healthier home equity levels are high. There's a degree of confidence.

Also some of our builder partners have pointed out where there's, sort of, first few years of the millennial buyer was really focused on that entry-level price point you're now having some first-time homebuyers for millennials, but are fairly deep into their careers and are buying homes that were previously considered kind of, second upgrade-type homes and, sort of, coming in and really building out those houses with sort of every option available.

And so that I think combined with some of the value that you're seeing the Boomer Generation Gen X, kind of, put back into homes as their confidence has increased and the home is really, really generally a very aged.

Housing stock gives us more and more confidence around the premium of that portfolio so it's very exciting, but margins are fairly comparable. But certainly dollars are higher and a lot of design cues come out of having that portfolio that we leverage across everything. .

Got you. Okay, that’s very helpful color. Thank you and good luck with everything..

Thanks, Su..

Thanks, Su..

Your final question today comes from the line of Keith Hughes from Truist. Your line is open..

Hi, Keith..

Yes. Hi. This is Dennis in for Keith Hughes.

How are you?.

Good, Dennis.

How are you?.

Great. Thank you. Thanks for squeezing me in. So I just wanted to ask a quick question on fiber on specifically pricing. Just wanted to ask whether you'd be anticipating doing a mid-year price increase or something along those lines? And then just one other one.

In cabinets if we're seeing some imports come back is that having an effect on your business? Thank you..

All right. Dennis, I'll give you some color on the -- firstly, we don't comment on particular timing of price increases kind of on a product-by-product basis. But I would refer you in my comments earlier that you have seen Fiberon start to really take a leadership position on pricing in the category.

And this is a product that we -- when we purchased it, it really had built out its business at the entry level of deck board and our opportunity was really to move up the price spectrum. And as we built out the wholesale distribution that supports that not just in wholesale, but also in retail which fills special order through our wholesale partners.

And so there's both a pricing opportunity in decking as well as a really good mix opportunity in decking. And just to come in the earlier conversation that we're having this is an area where you see better margin as you move up the price spectrum. And so we think that is a nice opportunity. And so I think on both you may see some tailwinds.

With respect to the imports if you look -- a couple of things I'd point out. One is broadly stabilized from a volume perspective.

And so from a volume perspective, kind of, comparable to where it was pre -- there was a big run up in imports of -- to the antidumping cases filed as importers try to bring a ton of inventory in where it's stabilized now is well below that. It's sort of the volume -- the sort of dollar levels where it was running previously.

A couple of things that are different though. While dollar levels are the same our read on pricing in the market is that it's significantly higher than it was, kind of, back in 2018. And so we believe that volume is a lot less than it was. And secondly, we make up a greater share of those imports to our global supply chain than we did then.

And so on a volume perspective, while dollars have stabilized and have been coupled to that period volume we think is quite a fair amount down.

But the really important thing about it and why it isn't impacting us is while to a degree it's been replaced, it's been replaced by importers who have product with longer lead times, less few availability and more cost.

And whether it's more cost because they're legitimately competing or whether it's more cost because their tranche-shipping it doesn't really matter. It's adding enough cost to the system. And we always said that we were going to build a global supply chain. It didn't rely on government intervention. It was going to be cost competitive no matter what.

And so it's proving to be very cost against imports and we find that dealers are continuing to come to us looking for replace the product at an accelerating rate. The other thing I'd call out is customs is really ramping enforcement against the tranche shippers.

And I think that's going to even have a further damping effect on imports as we go forward. So the combination of that antidumping case, but more importantly the work that we did when we platformed our whole global supply chain has had the intended effect. And you've seen that come through in both the top line and margin numbers now. .

Okay. Thank you..

At this time, I turn it back to management for closing remarks. .

Okay. Well, I would just say thank you everyone. I appreciate the questions very thoughtful. Please stay safe out there and we look forward to talking to you soon..

Thank you everybody for joining today's conference call. You may now disconnect..