Good afternoon. My name is Holly, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Third Quarter 2021 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded..

Now I would like to turn the call over to Mr. Dave Barry, Senior Vice President of Finance and Investor Relations. Sir, you may begin our conference call. .

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security Third Quarter 2021 Investor Call and Webcast. Hopefully, everyone has had a chance to review the earnings release issued earlier. The earnings release and the audio replay of the webcast of this call can be found in the Investors section of our fbhs.com website. .

I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated.

These risks are detailed in our various filings with the SEC..

The company does not undertake any obligation to update or revise any forward-looking statements, except as required by law. Any references to operating profit or margin, earnings per share or cash flow on today's call will focus on our results on a before charges and gains basis, unless otherwise specified..

With me on the call today are Nick Fink, our Chief Executive Officer; and Pat Hallinan, our Chief Financial Officer. Following our prepared remarks, we have allowed time to address some questions. .

I will now turn the call over to Nick. .

Thanks, Dave, and thank you to everyone for joining us on the call today. Our teams once again rose to the occasion to deliver an exceptional quarter, driving outperformance while facing tremendous supply chain headwinds, including challenges in labor, freight and material availability..

Demand for our products remains very strong, and we are working tirelessly to serve our customers while combating the global supply chain challenges facing most industries. The perseverance shown by our team members across our world-class brands has been nothing short of remarkable.

Our third quarter results demonstrate that we can deliver even in the face of significant challenges. We remain firmly on track for a record year with exceptional growth and margin improvement and to reach the long-term goals for Fortune Brands that were communicated earlier this year..

For the third quarter, company sales increased 20% in total and 14% organically, with all segments driving strong growth. This past quarter marked an all-time record in quarterly sales as we neared $2 billion. Operating income increased 20% and earnings per share increased 25%, incredible results especially given the current external environment..

Demand for our products in the quarter was and remains robust, and we expect growth to persist as consumers continue to invest in housing. Our leading brands are well positioned to capitalize on these tailwinds, and our teams continue to drive share gains across the portfolio.

Our mid-teens organic sales growth was complemented by LARSON, which is exceeding our expectations in terms of both performance and synergies..

I am proud of our team's ability to integrate this asset and drive performance, notwithstanding the challenging supply chain environment. Headwinds from supply chain, particularly in labor availability and freight and materials inflation, increased both during the quarter and relative to previous expectations.

We are addressing these challenges by leveraging our Fortune Brands Advantage capabilities and through incremental price. Across the company, we are diligently working to meet continued strong demand while keeping our customers served and employees safe..

As global supply chains, labor and other inflationary pressures all remain dynamic, we've updated our 2021 financial guidance as was highlighted in our earnings press release earlier today. Pat will provide additional detail later in the call.

Importantly, we remain on track to achieve exceptional growth and margin improvement in 2021 as well as towards our long-term targets communicated earlier this year..

Notwithstanding these external challenges, we continue to increase investment to drive the long-term growth and margin progression of the company.

In the quarter, we furthered our strategic agenda and made more than $30 million of incremental investments behind our digital journey, brand, innovation and Fortune Brands' Advantage capabilities, while also delivering an operating margin on par with prior year.

These investments were made in addition to the incremental investments made throughout last year..

For the full year, we expect to make operating margin progress of around 50 basis points versus a year ago while continuing to invest in our strategic priorities to drive long-term stakeholder value creation.

Our strategies are delivering in this environment, and those incremental investments should only accelerate our performance when the current pace of challenges moderates..

The company continues to generate high levels of free cash flow, and our balance sheet is strong. We're committed to efficient and effective capital deployment by investing in strategic capital projects, executing disciplined M&A transactions and returning dollars to shareholders via dividends and share repurchases.

Our leverage remains very healthy, and we have plenty of capacity to deploy additional capital for more value creation activity..

We recently chose to accelerate capacity investments in Moen, in The House of ROHL, Therma-Tru and Fiberon brands and expect excellent returns from these initiatives. Additionally, we repurchased $114 million of shares in the third quarter, and our year-to-date share repurchase total currently stands at over $380 million.

As the company celebrated its 10-year anniversary of its spin-off and public listing in early October, cumulative capital returned to shareholders through repurchases alone surpassed $2.5 billion. .

Importantly, throughout our 10 years, we have also worked to serve all of our stakeholders from developing sustainable, innovative products and processes, to our best-in-class safety records, to our commitments to advance diversity, equity and inclusion, ESG has long been a part of our culture.

This past quarter, we made some exciting advancements in our ESG journey and unveiled a new website with an enhanced focus on ESG. We continue to receive recognition for our best-in-class safety record, including multiple awards for the work we do, keeping our employees safe..

In honor of our 10-year anniversary, we announced meaningful partnerships with 2 outstanding affordable housing organizations. I can't think of a better way to celebrate our milestone anniversary and to make this commitment to help make the dreams of home more attainable for many families in our communities.

While there is more work to be done, I'm proud of what our team has accomplished..

Over the past decade, we have proven our ability to execute in any environment and to drive sustainable long-term shareholder value creation.

This is possible because of the team of exceptional people across our organization who continue to make a difference, putting safety first, going above and beyond to serve our channel partners and customers in operating with a commitment to excellence. They are the flag carriers of our culture, which drive our resiliency and results.

Thank you to all who work so hard each day, standing proudly behind our world-class brands that make an increasingly positive impact on people's homes, safety and communities..

Turning to the remainder of our remarks today. First, I will discuss what we're seeing in the home products market. I will then highlight key takeaways from our third quarter and provide additional color on what drove the results.

Finally, Pat will provide highlights on our financial results, balance sheet strength and liquidity as well as thoughts around our updated guidance to our financial outlook for the full year..

Now turning to our view on the housing market. Long-term fundamentals for housing and home products remained very favorable. The significant deficit of homes available for sale and the structural underbuilding that is contributing to the current housing situation has been elongated by increasing labor, supply chain and material availability headwinds.

While these challenges have made global headlines and will take time to normalize, it will take much longer, years, in fact, to work through the significant undersupply of up-to-date homes relative to demand. .

We saw some moderation in the pace of home sales versus Q3 of 2020. We view this moderation as a net positive, as it allows for a more sustainable long-term expansion of housing products while still driving very strong demand. Notwithstanding the moderation, demand for our products continue to persist ahead of supply.

We also experienced some rebalancing of demand across channels. And between the rebalancing and the very strong but moderating home purchasing market, we believe the overall marketplace is on an even healthier footing for long-term sustainable growth than it was this time last year..

Within both the new construction and repair and remodel markets, we continue to see consumers focusing investment on the home. Demand for larger ticket and pro-oriented projects remains elevated, which squarely aligns with much of our product portfolio.

These product categories are sold mostly through the trade, wholesale and builder channels, and we experienced strong, sustained momentum since before the pandemic.

With our excellent relationships and preferred positioning in those channels, coupled with market leadership for our premium brands, we expect this momentum to continue and demand for our products to remain robust. .

We also saw consumers continue to spend up the price spectrum into premium offerings. We have seen this multi-quarter trend in both plumbing and cabinets and are also seeing this trend play out within our premium offerings in decking and doors.

This sign of continued consumer confidence to invest in the home reflects both the health of the consumer and household balance sheets as well as consumers' growing aspirations for what the home can become..

Whether it be a new construction or repair and remodel markets, we believe we are optimally positioned to capture accelerated share leveraged by the best home products portfolio in the U.S. and have leadership positions in all of our brands.

Driven by an advantaged set of channel positions, significant growth capital to deploy, and supported by our world-class people, we could not be more excited about the future..

With that market backdrop, some thoughts on the recent quarter. We had a stellar quarter even in the face of incremental supply chain headwinds. Demand was robust through the quarter and remains strong today across the whole portfolio.

Our teams are working tirelessly to offset the numerous supply chain and labor constraints, and we're taking incremental actions to deliver both near-term results and long-term growth and margin objectives. .

Cumulatively, labor shortages and freight constraints were our most acute pressure points across the portfolio and are more challenging than even 90 days ago. We are responding with stronger measures in human capital attraction and retention strategies.

At the same time, we're also leveraging our Fortune Brands Advantage capabilities to reduce complexity and minimize dependence on labor. We're also utilizing our scale and capabilities in global sourcing and logistics to optimize freight efficiency..

We're further developing and deploying our Fortune Brands Advantage capabilities and are funding strategic investments in key growth priorities, including in our digital journey, brand building and product innovation as well as in capacity and distribution expansion.

These investments are contributing to our resiliency and as conditions normalize, we expect to continue to increase sales and margin, allowing for stronger capital deployment and investment which will drive our perpetual outperformance engine for the long term..

Now let me turn to our individual businesses and how we're positioning for long-term growth, starting with Plumbing. Our Global Plumbing Group once again significantly outperformed the global and U.S. markets this past quarter, taking share in every geographic region in which we operate.

The business continues to fire on all cylinders with sales growth of 26% or 23% excluding FX. Our strong Plumbing sales drove operating leverage, resulting in a 22.6% operating margin for the quarter, notwithstanding increased investment in brand, innovation and improved customer service..

Our North American wholesale and e-commerce channels delivered strong double-digit growth, and we continue to grow in retail despite very elevated comps from the prior year. We are winning share and generating incremental investment dollars to pursue further above-market growth and margin..

In North America, our Plumbing business has never been stronger. We continue to be an industry leader in both innovation and key metrics on brand awareness, purchase intent and loyalty among customers.

Moen continues to lead in innovation and design and push new on-trend styles and functionality, including the recently launched Nebia by Moen's Quattro product line.

This cutting-edge shower gives consumers the power to customize their experience while incorporating the Nebia by Moen's proprietary water saving technology, delivering on our water saving initiatives and ESG strategy..

As our business grows, we are also investing in incremental capacity across the supply chain, including a new distribution center opening this quarter. In China, Moen achieved strong double-digit growth, as our investments behind the Moen brand, category expansion and innovation continued to resonate with the Chinese consumer.

Given our broad product offering, diverse channel exposure and increasingly relevant consumer brand, we see continued growth in China despite headwinds from a slowing new construction market..

As we've demonstrated in the past, our sales growth is driven by our innovation and category expansion efforts and is not tied tightly to the overall market. Additionally, we've built a resilient China business with a cost structure that could flex to preserve margin delivery.

While we anticipate that there may be interim slowing of that marketplace, we are well equipped to outperform as we did during the last slowdown in 2017. .

Finally, the House of ROHL sales grew very strong double digits in all regions. Momentum in the luxury category has remained robust, and we expect demand to continue as consumers' willingness to invest and spend into larger ticket R&R remains significant.

To keep up with this demand, we recently approved an investment to modernize and add capacity to our House of ROHL manufacturing facilities. .

Turning to Outdoors & Security. Sales increased by 30% and operating margin was 15.6%. Organically, sales increased 6% and were impacted by the very elevated comps due to the shift of sales from Q2 to Q3 last year in doors and decking as our channels reopened following COVID shutdowns.

Material and labor availability headwinds increased through the third quarter, and continue to impact operations across all brands, including material shortages caused by Hurricane Ida. Our teams are hard at work to offset these challenges, which have restrained us from achieving targeted output. .

Doors delivered mid-single-digit sales growth in the quarter, reflecting constraints in labor and materials and very elevated comps due to the shift of sales from Q2 to Q3 last year, as our channels reopened more fully after COVID shutdowns. Adjusting for the shift, sales increased mid-teens.

Production interruptions to key component suppliers caused by Hurricane Ida affected supply in the quarter, though we worked diligently across our supply chain to resolve these challenges going forward. Underlying demand remains strong across channels, and we continue to work to service our customers at a high level..

Turning to Decking. Fiberon sales grew mid-single digits off of a very strong quarter last year that also included the shift of sales from Q2 to Q3 due to channel reopening. Adjusting for 2020 shipment cadence, sales increased around 20%.

Our strategy of leveraging our deep customer relationships to partner with the leading distributors in each region continues to pay dividends as we remain in a sold-out position. We will be bringing incremental capacity online before year-end, and we expect fourth quarter sales growth to eclipse 25%..

We continue to leverage Fortune Brands' Advantage capabilities and other internal synergies to increase output and streamline costs. Our eco-friendly composite decking continues to resonate with consumers and remains in high demand as we take additional share from traditional wood decking. .

As I mentioned earlier, integration of LARSON continues to progress well, and the business is performing above expectations. Our teams across outdoors and security are working together to advance integration while capturing planned synergies..

Finally, within Security, we experienced continued success and momentum with high single-digit sales growth in the quarter as commercial, back-to-school and travel markets continue to rebound. Our key North American retail market for both locks and safes continues at levels stronger than prior to the start of the pandemic.

The business is delivering on the Fortune Brands' Advantage investments made over the last couple of years and is now generating incremental fuel for reinvestment..

Now turning to Cabinets. Our Cabinets operations again delivered strong performance in the past quarter, with sales growing over 9% and operating margin of 9.7%. In an extremely tough environment, sales grew sequentially off of the strong Q2 and margins performed at industry-leading levels.

Demand was equally strong on both stock and make to order, with the strongest momentum continuing in our premium offerings..

While labor challenges, material and freight inflation increased further, all are manageable and we continue to take price and deploy continuous improvement initiatives to offset these headwinds.

Cabinets' margin performance in such a challenging and fast-evolving environment is a testament to how well our pivot plan and Fortune Brands Advantage capabilities are delivering. As the pace of challenges moderates and our pricing actions take further hold, the business will accelerate its progress towards its long-term margin objective..

Labor shortages and freight availability remain the biggest challenges impacting performance in margins in our Cabinets business. Our teams are deploying lean methodologies and complexity reduction strategies to ease these supply chain and labor limitations. Significant order backlog exists across the business and will be worked through into 2022.

We remain committed to our long-term margin goals for Cabinets, and the business simplification progress that we made this year within our facilities will prove beneficial as we continue to solve our labor challenges and price realization catches up during the fourth quarter and into early 2022..

In summary, we continue to see very strong demand for our products and believe this housing cycle is being further elongated by current short-term acute headwinds. We're very focused on overcoming challenges and delivering in the short term. and we have built this company and its strong culture to win for the long term.

Our commitment to excellence, each other and our brands, leveraged by innovation, investment and most importantly purpose, drives everything that we do. Our products positively impact people's lives every day, and we do not take that for granted. We are committed to growing stronger together and will do so in a sustainable way..

As we near the end of 2021 and look to 2022 and beyond, the actions that we are taking now and the investments that we are making and expect to make in the future should drive above-market growth and a stronger margin profile. We have a strong balance sheet and the ability to deploy a significant amount of capital over the next few years.

We're excited about the housing market and for the future of our company. We will remain steadfast in our mandate to create value, regardless of the environment. .

With that, I will turn the call over to Pat, who will speak to our financial results and updated guidance.

Pat?.

Thanks, Nick. And as a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing business performance. Additionally, all comparisons will be made against the same quarter last year, unless otherwise noted..

Let me start with our third quarter results. Sales were $1.99 billion, up 20%. Organic sales excluding the LARSON acquisition, were up 14%. Consolidated operating income for the quarter was $293 million, up 20% or $49 million and total company operating margin was 14.8%, in line with the prior year period. EPS were $1.49 for the quarter, up 25%.

These results reflect our team's tremendous performance in a highly disruptive environment, a testament to our culture of safety and outperformance across the organization..

Now let me provide more color on our segment results, beginning with Plumbing. Sales for the third quarter were $741 million, up $151 million or 26% or up 23% adjusting for FX. Our Plumbing business continues to gain share and drive growth across all major brands, channels and geographies. Plumbing operating income increased 36% to $168 million.

Operating margin for the quarter was 22.6% despite significant investment during the quarter in our brands, strategic priorities and to serve our customers..

Turning to Outdoors & Security. Sales for the third quarter were $528 million, up $122 million or 30%, driven by the addition of LARSON and mid-single-digit organic growth.

On an organic basis, sales were up 6% against an elevated comp from the shift of sales from the second quarter to the third quarter last year in doors and decking, as our wholesale channels reopened following the COVID shutdowns these channels experienced..

Door sales were up mid-single digits in the third quarter, driven by wholesale and would have been up mid-teens adjusting for the shift of sales from the second quarter to the third quarter in 2020.

Reported results would have been even stronger within the quarter were it not for labor and material constraints, the latter the result of Hurricane Ida..

Decking sales were up mid-single digits in the quarter as Fiberon continued to sell out. Sales were up around 20% adjusting for the shift in sales from Q2 to Q3 last year. We expect incremental capacity to come online in the fourth quarter and are also increasing throughput by deploying process improvement.

We expect fourth quarter decking sales growth to exceed 25%. .

Security sales continue to trend nicely with high single-digit growth in the quarter, driven by returning strength in commercial, back-to-school and travel markets. Outdoors & Security operating income was $82 million during the quarter, up 24%, driven by the addition of LARSON and operating improvements in decking and security.

Segment operating margin decreased 80 basis points to 15.6%, primarily driven by inefficiencies caused by labor and material constraints in the quarter impacting doors and decking. .

Turning to Cabinets. Sales for the third quarter were $717 million, an increase of over 9% over the same quarter in 2020. We, again, saw strong demand across all price points during the quarter. Backlogs and lead times have extended during the quarter, and demand for contractor-led projects such as cabinets, remains very healthy. .

Operating income in the third quarter was $69 million, down 13% or $11 million. Operating margin for the quarter was 9.7%, down 250 basis points versus the same period a year ago as price increase realization trailed inflation and labor and material availability resulted in inefficiencies.

We expect this relationship to improve significantly during the fourth quarter. .

By the first quarter of 2022, we expect continuous improvement and pricing actions to offset inflation fully and our rate of margin enhancement in cabinets to reaccelerate to our targeted objective. We remain well positioned to win in North America versus domestic competitors and imports.

We expect to win increasing share and achieve our long-term margin objectives..

Before turning to the balance sheet and updated financial guidance, some thoughts on demand, supply and the current environment. Demand continues to be strong across the portfolio. Increasing headwinds from labor, freight availability and certain supply-constrained materials are being addressed.

We are and expect to stay nimble as the situation warrants. We have made significant investments to serve continued strong demand and to increase service levels. We are also making further progress in deployment of our Fortune Brands Advantage capabilities to leverage synergies across the portfolio in sourcing and other improvement initiatives..

We are keenly focused on the current dynamic environment, contributing towards rising COGS and freight inflation. The decisive actions we are taking will allow us to offset fully these headwinds, maintain our long-term margin trajectory and will put us in an advantaged position for 2022. .

Through a combination of continuous improvement and thoughtful pricing actions, we plan to offset all inflationary headwinds during the first quarter of 2022 and to continue to target around 75-plus basis points of margin improvement during 2022. .

Turning to the balance sheet. Our balance sheet remains strong, with cash of $461 million, net debt of $2.2 billion, and our net debt-to-EBITDA leverage is now 1.7x. We ended the third quarter with approximately $410 million of available capacity on our revolver.

We are advantageously positioned to deploy capital to the highest returning opportunities..

Year-to-date, we have repurchased over $380 million of shares and have repurchased over $2.5 billion in common stock in 10 years as a public company.

Our investment-grade balance sheet and strong free cash flow provide fuel for continued investment into our businesses, propelling the flywheel of outperformance on the top line and accelerating common capability building and deployment across our portfolio to achieve higher margins..

I would now like to address our updated market and financial outlook. Demand for our products remain strong in a sound housing market.

However, increasing headwinds from labor shortages, supply chain challenges and inflation have adjusted our expectations for full year 2021, based on the expectation that the global market for our products will now grow 11% to 12%, with the U.S. housing market growing 12% to 13%, and within this forecast, we now expect U.S.

new construction growth of 11% to 12% and U.S. R&R growth of 13% to 14%. Based on these assumptions, our revised 2021 full year sales growth outlook is expected to be 24.5% to 25.5% or 17.5% to 18.5% on an organic basis. .

We continue to target meaningful margin progress and expect to deliver around 50 basis points of margin improvement during 2021, despite inflation that is almost 3x what we expected at the beginning of this year. We are tracking to our longer-term margin objectives, demonstrating our ability to accelerate value creation regardless of the environment.

We now expect full year EPS within the range of $5.63 to $5.73 on a before charges and gains basis, of which the implied midpoint equates to earnings growth of 36% over our record year in 2020. .

Specifically, our outlook for each business as it relates to our updating guidance includes Plumbing net sales growth of 24.5% to 25.5% with operating margins at or above 22.5%.

Outdoors & Security net sales growth of 43% to 45% or 14% to 16%, excluding LARSON, with segment operating margins of 14.5% to 15% or approximately 100 basis points higher adjusting for purchase accounting. Cabinets net sales growth of 14% to 15%, with operating margins between 10% and 11%.

We expect 2021 free cash flow of approximately $625 million to $675 million, which includes additional investments in working capital to improve service levels and capacity to accelerate growth. We anticipate a cash conversion rate of 80% to 85%..

corporate expenses of about $108 million to $110 million; interest expense of approximately $83 million to $86 million; a tax rate of approximately 23% and average fully diluted shares of approximately 139 million to 140 million. .

While short-term market challenges persist, we have the talent and capabilities to manage and offset these headwinds and we'll continue to adjust quickly to the dynamic environment as merited. We delivered a record year in a challenging 2020 and we'll deliver a record year again in 2021.

We are doing the hard work and making the critical investments necessary to outperform the market and to achieve our margin objectives. You can count on us to capture value and effectively manage the business regardless of the speed bumps along the way..

I will now pass the call back to Dave to conclude our prepared remarks. .

Thanks, Pat. That concludes our prepared remarks on the third quarter. 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, will you please open the line for questions? Thank you. .

[Operator Instructions] Our first question will come from the line of Stephen Kim with Evercore ISI. .

Appreciate all the color and good results. I was particularly intrigued by your comment about the 75 basis points of operating margin improvement in fiscal '22, I think you said beginning in the first quarter as well.

Can you give us a sense for how that kind of -- how you kind of walk to that? How much of that might be from improving cost mix? How much of it might be from incrementals -- volume incrementals and things like that?.

Steve, it's Pat. Our reference to that was the full year objective. We remain on track for our longer-term objectives in what has been a challenging year and a particularly challenging back half. We wanted to be very clear on that..

And we have, as a team, already been working on cost improvement and pricing actions to address some of the back half inflation.

And when we looked to the first quarter of '21, we could see with the actions we have already put in place or are being put in place right now, and we expect very much to be in place in the early part of this quarter, that we're fully covering inflation in the first quarter with cost improvement and pricing actions in the first quarter..

And I would say, as we look to not just '22 but beyond, I would tell you, we continue to drive that formula margin improvement pretty equally across 3 levers, whether that's innovation and brand building, structural cost change in addition to the marginal cost improvement we do with Fortune Brands' capabilities, we still have structural levers we plan to pull across a number of our businesses and then also leverage from volume.

It is not purely a leverage from volume formula nor is it purely a pricing formula. .

Okay.

Pat, just to clarify, though, the 75 basis points you were referring to, was that just from price mix improvements? Or is that sort of including these other 3 levers as well?.

Including those other 3 levers. And it's full year '21 to full year '22. .

Got it. Okay. Excellent. The second question... .

And I -- I'm sorry, to evolve of the longer-term margin journey, and so we sort of laid out this road map of Fortune Brands Advantage capability is really helping drive the combination of margin accretion and fuel for reinvestment, a lot of which we've deployed this year. We've significantly upped investment in our strategic priorities.

And so it builds on 50 basis points of improvement this year, targeting 75 basis points of improvement next year and then staying on track, consistent with the long-term goals that we laid out earlier. .

Yes. Thanks for that, Nick. Yes, it was impressive that you achieved what you did despite these investments, particularly in Plumbing. The second question relates to just the general environment.

I think -- I was curious if you could provide some color as to which categories do you see demand having the most sustained momentum? And what are the fundamental drivers behind this relative outperformance that you foresee for some of these -- for some of those categories?.

Sure. Let me take that kind of 2 parts, where we're seeing it and what's driving that performance. I'd tell you, just at the highest level, the demand has really been solid across the board, both across categories, price points and channels. I mean it's probably some of the most consistent demand we've seen anywhere..

And it's still backed by the long-term favorable trends we've talked about for a long time. The demographics continue to drive a lot of people into housing of boomers moving longer. The market is significantly underbuilt. You've got an aging housing stock. And so people are taking record levels of home equity and reinvesting.

And all of that continues to be true..

And I think as we -- look, it was very interesting through the quarter because there were some laps from some really heavy comps this time last year as channels start to reopen. And I said we never saw the growth stop. It moderated for a little bit as we work through those comps and then picked right back up and sent them again..

So we're seeing it continue to hold very sustainably, and we're seeing it really kind of across the board. And I think that really speaks to the confidence that consumers have as well as just the fundamental need for either new or updated housing..

We are seeing elevated demand for pro-oriented projects, as well as a lot of demand, I think, for premium offerings. We talked a bit about that. I think last quarter, we said that continue to ring true. And again, it speaks to consumers' level of confidence in the home..

And then what's delivering the sustained momentum and outperformance for us? I think it's a combination of factors. I mean, one, we talked about taking funds and really driving reinvestment. We've set out a number of strategic priorities, brand, innovation, Fortune Brands Advantage.

That incremental investment year-to-date, we've spent just shy of $80 million, right? And so it's not for naught. That is going to drive the top line harder. I mean you see the Plumbing results, and those organic numbers are just outstanding. We've had that flywheel gone for a while..

And then the other part, I think, is really across the supply chain. I mean it's been painful. We're tough on ourselves.

But I think the fact that we've continued to perform at these elevated levels and the fact that we continue to gain share speaks to the fact that we are most likely outperforming from a supply chain perspective as well in serving customers and consumers.

And so I think when you bring those 2 things together, the performance that we had at this pricing level as well as the performance in driving brand innovation, category management type capabilities across the top, you're getting the results that you're seeing now. .

Our next question will come from the line of Michael Rehaut with JPMorgan. .

First question, just wanted to get a little bit of some of the -- maybe a little better clarity in terms of price cost timing.

And obviously, as you kind of noted before, Nick, despite tremendous incremental investment, the margins that you're putting are strong, but you highlighted the fact that you have the further opportunity to better offset inflation in the fourth quarter into the first.

So I just wanted to be clear, maybe as a clarification that when you say in Cabinets, I believe you said -- or by the first quarter fully offset..

To me, that means flat. I don't know if that's not what you meant, but -- and then for the full year of '22, I guess, on a consolidated basis as well, the 75 bps would then obviously result in something stronger than 75 bps in the coming quarters.

I just want to make sure it's the right way to think about that and if that even then provides further momentum into '23?.

Mike, it's Pat. What I would tell you is for the group, for our enterprise and for Cabinets, it will more than offset. In the first quarter it's not flat because we'll be playing a bit of catch-up. And we had some inflation in the first quarter of last -- of this year, which we'll be lapping.

So it will be more on a year-over-year basis will more than offset with cost improvement and pricing actions, the inflation we anticipate in the first quarter of next year..

And I would say that's true for the full year. But that's not the only lever that's going to help the 75 basis points of growth next year. We'll also be pursuing other cost improvement and structural cost improvement initiatives in the business, plus we'll be growing better than mid-single digits next year..

I'm not here to give '22 guidance, but we'll get some volume leverage. I wouldn't expect an even 75 basis points of margin improvement each quarter next year. That's not what we're trying to say, and I wouldn't interpret it that way. I would just say that we'll end this year with 50 basis points of margin improvement or thereabouts.

And then off of that point, we'll make about 75 basis points of margin improvement through next year..

You will see a sound next year. I would expect next year to be somewhere in the 14% to 15% margin range in the first half. Across the first half, probably on the higher side of that 1 percentage point range there. So that's the way I would interpret it. .

And then absolutely, to your point about it carrying into 2023, we are making long-term structural improvements to the business consistently, and that is very much part of the strategy that we've laid out starting in '20 with the Fortune Brands Advantage. And so those things are sustaining and then continue to deliver for us.

And really set up to accelerate because as they drive incremental margin, they also drive incremental dollars from the investment back into similar programs. So my sense is we're just getting going on some of those opportunities.

We need to stay prioritized and focus in order to be able to deliver consistently, but it absolutely carries through and there's room for us to continue to accelerate. .

Great. Secondly, I wanted to just circle back to some of your comments on positive mix. Clearly, encouraging and often will be an additional driver of both sales and margins when that occurs and encouraging, obviously, amid the -- some of the demand trends that you guys continue to see..

I was curious if you're able to give us a sense of a rough quantification of perhaps how much that might have been benefiting you at least in the third quarter, either a sales or a margin perspective? And which segments have you seen it? You said -- you highlighted several product areas, but I'm just curious if certain segments or product categories you've seen it more than others?.

Yes, Mike, a couple of things related to that, right? So -- and we've been consistent on this because we think it's an important part of our of our long-term growth strategy is we're driving attractive margins across price points at percentage basis and continue to work to make the margin percentages across our points as consistent as we can across our business..

Obviously, when you have premium products, it's bigger dollar margins. And all I would say is we have a business in plumbing. It's performing this year. It's going to be growing in the low 20-some percent, with a healthy contribution from the House of ROhL.

And we're seeing throughout this year in Cabinets made-to-order cabinets growing at a percent that's consistent with the stock business.

And those are things we point to as consumers' confidence in the value of their home and they're willing to invest in their home and they're willing to do contractor products as opposed to it's the overall driver of our margin journey..

Now what I would say happened in the quarter is Plumbing was particularly strong in the quarter. It has been particularly strong all year, and it will be that way in the fourth quarter as well. And Plumbing having a disproportionate mix in our quarter across our businesses definitely helped the margin profile of the quarter.

We guided at the end of the second quarter we would have been down 30 to 60 basis points in the third quarter. And largely, that was offset by a really exceptional both sales and margin performance by the Plumbing business..

But that, I think, speaks to the strength of Plumbing, inclusive of high-end premium brands. I wouldn't guide our journey this year, next year or beyond as a journey that's predicated on a mix of premium brands.

That is not -- we're going to get the portfolio to the 16%, 17% margin percentage by 2023 that we laid out, kind of irrespective of the customer mix. We just referenced product mix, rather. We referenced it as a sign of consumers' confidence in the value of their home and their willingness to invest. .

And I'll just add to that. I think you can take from that, that the portfolio is positioned at the heart of the market, right? As we talked the last couple of years how we'd really position the portfolio very well to capture the entry of the homebuyers. Saw that first sort of wave of millennials coming in and had that there.

And then over time, we've built out the House of ROHL. We've maintained our premium offerings in Cabinets. We've rolled out more as we move decking from entry price point up now to much more in a special order oriented products.

Some of the stuff at LARSON and Outdoor & Security has launched as well, just positions the portfolio really well to meet the consumer where they are. As Pat said, we work very hard to make sure that the margins are exceptionally strong across all of those price points. .

And our next question is going to come from the line of Mike Dahl with RBC Capital Markets. .

I just wanted to follow up again about the cost dynamics as we think about the next year. Obviously, as you've experienced and continue to experience, it's a fairly dynamic environment, so things moved against you in the second half.

So I guess what -- when you're talking about kind of offsetting inflation or more than offsetting inflation next year, what is your underlying base assumption for incremental inflation in 2022? And kind of a part 2 would also be could you just clarify kind of quantify how much the labor and freight issues affected Cabinets in 3Q and in your 4Q guide?.

I'll talk to both of those at a higher level on the second of your question. So Mike, first of all, I'd start with this year because I'm not -- we're not here today to give you a '22 guidance, especially not at the piece point level.

What I was referencing was the first part of '22 and our outlook for that first part of '22, just to give people a sign of where the run rate is..

So when I look at '21 -- fiscal '21, we're probably approaching about 7% inflation on last year's COGS base, which is starting to get almost to $300 million, pretty extraordinary. Where we were on the last call, we would have said around 6%. And so we've had a pretty appreciable increase since the second quarter call.

And when I'm speaking here, I'm speaking to material, freight and tariffs only, like this is not even the labor part of things, which we largely offset with continuous improvement.

And some of the bigger surges in the back half have been freight, in particular ground freight, and/or the mix of having to use spot rate containers, select metals, in particular aluminum, copper and zinc, and then hardwood and a few select resins that were affected by the Gulf..

And those are the things that surged in the back half more than we would have anticipated. We probably had about $40 million of that inflation impact in the back half since our second quarter guide.

It's really affected all of our businesses but businesses like Cabinets and Therma-Tru and decking where you don't build up big inventories of components and/or finished goods and the inflation tends to course through your income statement in real time a bit more, that's why you're seeing the pressure in our updated guidance showing up in a slight margin refresh on Cabinets and Outdoors & Security because unlike Plumbing, it doesn't really go on to the balance sheet..

But there's inflation happening in Plumbing in things like copper that are just going on to the balance sheet. And so we are taking incremental actions to offset them. We would have told you in the second quarter, we were positioned to offset everything within this year. But given the back half surge, it will take through to Q2.

And we're confident we're going to offset it in the front part of next year..

And as next year plays out, we will provide you with updated inflation guidance and offsetting inflation guidance as part of our '22 guide. All I would say about '22 inflation instead of getting in to the specific levels of it as we are expecting inflation in '22. We are not expecting deflation. We are expecting an inflationary environment.

We're prepared for that.

We do think it's going to be much more moderate than the middle part of this year when you had, in a very short period of time, trillions of dollars of government funds flowing into the economy and driving demand off of fixed cost base or supply base and an already stretched global freight environment, even if the government does pass some measure of additional stimulus that's going to be over multiple years..

And so we've had a considerable surge in the spring and summer of this year. Government funding into consumer demand, that has really pushed inflation. We don't expect that level next year. So we expect to be able to offset it.

And like I said, the challenges that you're seeing in our margin outlook for Cabinets and for O&S in the back half of the year, have to do with that inflation.

They also have to do with the fact that labor, both because of the Delta variant and just because of the tight labor market, you have more labor turnover, more new employees and that ramp rate, both of bringing new people on and then getting them trained comes with some inefficiencies. So that's in our outlook as well. .

Inflation is a challenge. I wouldn't understate that. But it's really been the pace of inflation in the back half, because it just takes time to get the sales in place and it takes time to get the pricing in place. And we're going to do our very best not to blow up our customers along the way. And so we want to do our price increases, respectfully..

They may not always agree, but -- that we are, but we're trying to do that. And so there just is a pace to getting it done the right way that's going to be sustainable and allow us to continue to gain share. And I think the pace at the back half of this year was pretty extreme, fully anticipated inflationary environment.

The pacing of it may allow for a little bit more time for resolution between when inflation hits and when we put sales into place. .

That's really helpful. And then, Nick, my second question, you made some interesting comments about China. And obviously, that's been top of mind for a lot of people given some of the headlines around housing both on the new construction side and on some of the mortgage side impacting just overall home sales there..

Can you just go into a little bit more detail about what's giving you kind of conviction in your outlook for continued growth in that market? And maybe talk about whether it's an existing project backlog or some more detail around kind of the expansion that you've got there?.

Sure, absolutely. And the other thing -- just firstly starting with Evergrande, I mean we've long had our eye on Evergrande. And so any Evergrande exposure could be very, very, very de minimis for us. And so that's not been a concern. And so we really looked through the whole market..

And we had some time in China, and we've got a phenomenal homegrown team there that's been with us for a long, long time. And so we really understand the cycles of that market. And we went through a cycle in 2015, we went through a cycle in 2017.

And if you go back and look at those numbers, you'll see new home sales plummeted and yet our business continued to grow..

And so why is that? Well, it's a couple of things. Firstly, it just starts with our footprint. Our footprint is very focused on Tier 1 and Tier 2 cities. We've never overexposed ourselves to the more speculative construction in Tier 3 and Tier 4, which is where you see the kind of the ghost towns, the big empty skyscrapers..

And so what do you have in Tier 1 and Tier 2? I mean these are various established cities where you kind of have a mix of new construction, but you've got a big mix of R&R. And you look to a city like Shanghai where we have very substantial share and you got an aging housing stock.

So you're not just going to have the new construction development business, you're going to have a lot of turnover in that space..

And so we're going to continue to see growth just from redecoration and R&R in addition to what I call more sustainable new construction. But that's -- our footprint, so therefore, is less exposed to some of that speculative stuff..

The second piece is we've started 30-plus years ago with kind of the core loan business and of all of our businesses it's the one that's both the greatest category adjacencies. I mean we have the #1 sink brand in China. We have both sanitary ware.

It's been a resounding success and yet -- and our penetration is in the single-digit market penetration of sanitary ware. And so a lot of room to kind of grow that over time..

And so that -- those category adjacencies will continue to power the business. And then there are also channel adjacencies as we shifted between developer to e-commerce channel. Our showroom position continues to be very strong.

We've made sure to -- a few years ago, not really focused on adding showrooms, but really improving the quality of showrooms and so that's really been the focus over the last couple of years..

And so those are good drivers.

And then finally, you just have a team that's running a profitable business that have really built out their pricing and CI capabilities over the last, I'd say, 2 to 3 years and have much greater ability to flex the P&L to reinvest as they have been over the last couple of years but then to know when to be able to flex it to continue to drive margins..

So you take those 3 things as kind of our footprint, our adjacencies and then the capabilities that we have there.

We're feeling confident that while the market may slow, and I think, frankly, is actually now going to start to migrate to being a more kind of stable, slower growth but more stable over time market, and we're actually quite enthusiastic about that shift. Our exposure is really good, and we'll continue to grow with it. .

And we have time for one final question. Our last question will come from the line of Truman Patterson with Wolfe Research. .

Just wanted to follow up on the Evergrande situation in China. Nick, I believe in your prepared remarks, you mentioned a platform in China where you could flex the costs up and down to relatively maintain margin.

I was just hoping you could elaborate on that a little bit?.

Yes. So I'll give you some perspective, and Pat maybe have some color to add. But we've had this business in China, phenomenal growth and a really great team and culture there, and as part -- we interact with them very frequently, and we're coming out of mistakes together.

And a few years ago, we sort of challenged them that notwithstanding the great growth that they were putting up, that they really needed to think as highly disciplined business operators and have the business on a continuous margin improvement journey really so they could generate their own fuel for growth..

And so we hired in capability. We've gotten much better at revenue growth management there, a continual CI looking at the whole supply chain. And that team did exactly that. They started to push up their contribution margin, their OI margin and actually freed up a lot of incremental dollars to reinvest.

We've been reinvesting in growing the Moen brand and then building that brand and creating more and more of a pull environment..

And so that just gives you a lot more optionality in P&L management. I mean we don't have to invest heavily. I think if the market were to slow, we probably won't invest in brand building there as heavily as we have over the last couple of years. That gives us a lot of options.

You've seen the brand building come through as we've talked about some of the incremental spend that we've had here on strategic projects..

And then also, it just means that you've got scope during the business to continue to be able to chase CI, to chase offsetting COGS inflation and be able to pull the levers of the P&L to deliver continuously.

And so -- but, glad we put those in, but it's really predicated on having strong discipline in the business because we want the business to be sustaining over the very long term. .

Okay. Okay. And then you all had some pretty nice growth in the quarter, despite facing the supply chain issues that everybody is facing right now. Nick, as well, you mentioned some of the internal actions that you all took during the third quarter.

Hoping you can discuss those a little bit more in depth, whether it be getting more suppliers approved, finding alternative materials, improving to an extent labor availability. Just hoping you could dig into that a little bit more. .

Sure. And it's a little bit all of the above. I mean we've had to work across many, many fronts to deliver this kind of performance.

I mean, I'd say, first and foremost, it just starts with safety and the safety measures and investments that we've put into our facilities that have allowed us to manage through the pandemic and then also hopefully be attractive to continuing to attract and retain talent. I think that's been well appreciated..

We have continued to work hard. I mean, we referenced Hurricane Ida. We had to qualify a number of suppliers very, very quickly on some very specialized products. And I think the team is really evolving to moving really in an agile fashion to -- inside of weeks to do things like that..

And then when we talk about the Fortune Brands Advantage, if you recall kind of the 3 pillars are complexity reduction, global supply chain management and category management and you take the first 2, complexity reduction and global supply chain management, I mean they've been invaluable.

And so complexity reduction, I mean, we've used tools like lean 80/20, design-to-value, we're doing standard work to reduce our need for incremental headcount.

And so really by using those, we've been able to actually eliminate just open positions that otherwise we would have had to fill and therefore, with a more simple business, been able to kind of get after hitting these kinds of numbers. And I think that's going to be a very positive structural change in the business..

We're going to continue to drive that very, very hard because that just takes waste out. And so whether it's in this environment or in an easier environment, that's going to pay a lot of dividends. And then the global supply chain management has allowed us to leverage kind of everything we do across Fortune Brands..

So whether it's talking to suppliers, kind of across categories for direct or indirect, whether it's looking at freight lanes, either ocean freight or domestic freight, and seeing where we can leverage kind of the scale of the entire enterprise, all of that has come to bear. .

So -- it's actually worth a shout out to our supply chain team who have absolutely been heroes this year, pulling on all those levers as well as our HR team and others. But it's the work that's done across. And I think it starts with the people and the safety, but then it builds on this Fortune Brands Advantage that we've been talking to you about. .

And with that, that will conclude today's conference call. Thank you for joining. We do appreciate your participation. You may now disconnect..