Fortune Brands Innovations, Inc. Q1 FY2020 Earnings Call

Good afternoon. My name is Mike, and I will be your conference Operator today. At this time, I would like to welcome everyone to Fortune Brands First Quarter 2020 Earnings Conference Call. I would now like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin our conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security first-quarter 2020 investor conference call and webcast. 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 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 a 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 profit, earnings per share or cash flow on today's call will focus on our results before charges and gains 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've allowed some time to address questions that you may have. I will now turn the call over to Nick.

Thank you, Brian, and thanks to everyone for joining us today. We hope that you and your loved ones are all staying safe during these extraordinary times. While our teams delivered strong sales and profit growth in the first quarter that were ahead of our expectations, we also took a number of proactive steps in the quarter to begin aggressively managing cash, capital and expenses and to further strengthen our balance sheet as the global economy began to feel the impact of the COVID-19 pandemic. These steps will not only help us mitigate the impact of the near-term demand challenges related to the pandemic but are designed to position us to accelerate share gains and deliver more profitable growth as we emerge from this recession. The COVID-19 pandemic has brought profound change to the world and to our team, and our hearts go out to all of those who have been impacted by it. During this challenging shelter-in-place period, products in our industry have been designated as essential. As we continue to manufacture and distribute our products, we've taken great lengths beyond WHO and CDC guidelines to protect our teammates. I want to express my sincerest gratitude to our Fortune Brands team all over the world, who've worked so bravely and so purposefully to continue to deliver our essential home and security products to our customers and consumers. By continuing to operate through this period, we have fulfilled our critical mission as part of the essential supply chain and have also, with few exceptions, mitigated the deep disruption of full facility shutdowns and subsequent ramp-ups. Hardwired into our DNA is the ability to thrive in the face of adversity and to use challenges to structurally reposition our business, to emerge even stronger and more competitive. Our history and track record demonstrate this. We were able to emerge from the financial crisis of 2008 to 2009 much stronger, capturing share and delivering profitable growth and shareholder value. Over the last three years, we've mitigated a volatile trade and tariff climate with exceptional results. In 2018 through 2019, we successfully managed through a pause in housing demand by continuing to evolve and improve the business. We not only drove solid above-market performance that positioned ourselves to deliver outsized possible growth as demand levels accelerated. Our exceptional first-quarter results demonstrate this. Our teams are now focused on navigating this current global crisis to emerge even stronger yet again. We are leveraging our most critical capabilities to ensure that we maintain our strategic advantages. We're accelerating operational transitions that were already underway. Our teams are pursuing permanent and temporary efficiency improvements to navigate virus-related demand decline and to emerge with an improved cost structure as growth returns. We're delaying capital significantly while still funding select critical initiatives to drive growth opportunities and take share. During our remarks today, first, I will briefly highlight key takeaways from our first-quarter performance. Second, I will discuss how we are approaching the immediate COVID-19 environment from a demand, supply, expense, and cash perspective, as well as how we are positioning ourselves to emerge even stronger. Then, Pat will provide color on our financial results, balance sheet strength, and liquidity and our thoughts around financial performance in this environment. Starting with the market and key takeaways from our first-quarter performance, we estimate that the global market for our products grew roughly 3 to 4% for the first quarter, with US new construction returning to high-single-digit growth. Builder sentiment in orders are strong, and we executed at a very high level as indicated by our Q1 results. Repair and remodel activity was healthy and advanced in the spring season. As COVID-19 spread through North America and the majority of national and local governments executed stay-at-home orders in March, we began to see reduced activity in key indicators around home construction and building product spending. In the quarter, total company sales increased 6% over last year and operating margin was up 140 basis points to 12.1%. Our successful results in the first quarter were driven by strong execution from our teams across our businesses, producing sales and margin growth in each segment, beating market and our expectations across the board. We saw operational outperformance across the company. In the first quarter, our cabinets group demonstrated that our pivot plan is delivering and that we are taking share at increasing margins. Sales growth versus a year ago was 8% with operating margin improving by 120 basis points to 9%, which is exceptional performance in our seasonally lower-margin first quarter. We saw strong sales growth across channels with high single-digit increases in dealer, builder, and within home centers. Value product lines, including our retail stock cabinetry, Aristokraft with the new construction and Mantra within our dealer network, are successfully taking share as Chinese imports exit the market and we realize the benefits of our multi-year expansion of products and low-cost capacity in this part of the market. Turning to plumbing, during the first quarter, the global plumbing group continued to outperform the global market with sales growth of 2.3% and operating margin of 22.3%. Excluding the impacts from the COVID-19 pandemic and foreign exchange in the first quarter, sales would have been up 9%. The majority of the impact was in our Chinese plumbing business. That business is rebounding, and we continue to expect strong top-line growth this year from our business in China, driven by the continued success of our category and channel expansion. GPG executed once again at a high level, driven by above-market growth in the US with particular strength in retail and e-commerce. We continue to expand our product offering with partnerships and adjacencies, which is resulting in accelerated share gains. Our reenergized Moen brand continued to deliver, reaching new highs on key brand metrics. Our innovation engine produced great results, including winning Best Smart Home Device across all categories at the influential kitchen and bath show for the second year in a row. Our fuel for growth initiatives continue to drive market-leading margins and incremental cash to reinvest in our best returning projects. Turning to doors and security, sales increased 6% over this quarter last year and operating margin improved to 10.4%. Our doors business experienced double-digit growth in both wholesale and retail channels with excellent operational performance. Importantly, our Fiberon decking business experienced double-digit growth during the quarter, ahead of our expectations as we continue to benefit from the conversion away from wood products, our distribution gains, and our continued strength in POS. Overall, while our exceptional first-quarter results may not be indicative of the business climate that we are currently facing, they do demonstrate that the business has reached a new level of operational outperformance, and that discipline will serve us well in a recessionary market. We enter this upcoming period of uncertainty from the strongest possible standpoint with all businesses on solid ground. In addition to our business being well positioned, we also have a strong balance sheet with ample liquidity, among the strongest in our sector. In April, out of abundance of caution, we increased liquidity further by adding a $400 million supplemental revolving credit facility to our existing arrangements. Pat will give further details on our balance sheet and the new facility in a few minutes. Now, I would like to turn my attention to focus on how we're going to address the remainder of the year, starting with demand. Our approach to operating in times of volatility is built upon our experience as a management team and is deeply embedded in our DNA. In the current landscape, we expect to not only manage cash and expenses to lower demand levels but also to permanently improve efficiencies across our footprint. Simultaneously, we will also seek to be flexible and nimble to capture revenue opportunities to gain share. We expect to accelerate that advantage further as the market recovers. As we look forward, we are acutely aware that demand in the US for our products had started to decrease as we were ending the quarter, and we are expecting to see further demand deceleration as people stayed home in the majority of states during the whole month of April and, in many cases, into May. That said, pockets of our business continue to see strong demand into April, and we work to meet that demand while prioritizing the safety of our teammates. We expect a long period of millions of people staying home, and the economic impact during the second quarter to significantly dampen demand for the quarter. As shelter in place orders are lifted, we expect a gradual return of demand for our products, the pace of which will be impacted by the extent and the shape of the COVID-19 related recession. We've been running numerous demand scenarios to prepare for this uncertainty and have run base case projections from mild to severe, including scenarios even worse than the global financial crisis of 2008 through 2009. Our teams have already reduced costs and cash deployment in advance of this uncertain environment, and we are building further variability into our cost structure that we can execute in response to changes in demand. We will also position our business from a cost and service perspective to capture additional growth and market share as demand begins to recover. As we manage through this new near-term reality, we will aggressively, and with urgency, attack our cost structure while maintaining the ability to accelerate share gains and drive profitable growth. These simultaneous top and bottom line efforts, combined with a healthy fortress balance sheet, should position us for long-term success. We intend to come out of this pandemic stronger than we came into it, with an even higher performing business. I would also like to share some thoughts from the supply chain perspective. As I shared earlier, our teams thrive in the face of adversity. Building on our team's successes in addressing duty and tariff challenges, we've been working our global supply chains since the start of the year to mitigate the effects of COVID-19 plant closures in China. As the pandemic shifted west, focus shifted toward our North American supply chain, and we've been working to implement best-in-class solutions around keeping our people safe and our operations safely open. In the first quarter, we successfully managed through Chinese supply chain issues with modest disruption to lead times and service levels. Currently, those issues have abated and supply chain centers in China have largely recovered. As the quarter ended and we entered April, supply chain issues were shifting to North America. As our industry has been deemed essential by the federal government and the vast majority of state governments, we've been able to safely operate. Operating in these circumstances is not without its challenges, and we've learned a lot about running safe facilities in this environment. Across our supply chain networks, we've been taking steps in excess of CDC and WHO guidelines to keep our workers safe. This includes requiring that employees work at home when possible; selecting attendance policies to provide more flexibility for our associates; establishing strict protocols for managing exposure; increased cleaning and sanitizing, including by third parties; providing cleaning products and tools for employees to use at work and home; instituting temperature and health checks; and multiple measures to increase physical distance within our facilities, such as adding extra shifts, staggering start-to-finish times, adjusting workstations to increase space, or adding barriers between stations. Those measures contribute toward employee safety but can also cause inefficiency at our locations. Other inefficiencies we have also experienced include: some shifts operating below optimal variable production levels as we relax those attendance requirements; a few hours of production per day for longer shift changes; we've also been adding time for regular cleaning, accommodating temporary shutdowns from time to time for more extensive cleaning; and in a couple of instances, like Sioux Falls, South Dakota and Waterloo, Iowa, where we saw community spread, we shut plants down entirely for a couple of weeks. These measures have resulted in temporary inefficiencies that will abate as these new safety measures become more routine and the shelter-in-place orders are lifted. At this time, the majority of our facilities remain open around the world. Specifically, the majority of North American, European, and Chinese locations are currently open. The only exceptions are our sellout facility and our Toronto DC within GPG, and our Waterloo, Iowa facility within our cabinets group. All are expected to reopen within the next week, although we will continue to prioritize the safety of our associates, which may require temporary shutdowns from time to time. If government orders in the US, Canada, Mexico, China, the U.K., and Italy remain as is, we anticipate a manageable supply chain environment for the balance of the year. Facilities in Mexico have been allowed to continue to operate safely but with some at reduced capacity. We've been commended by the local government for our safety protocols and are working with Mexican officials to expand operations as soon as safely possible to full levels. In the meantime, we're using other locations within the US to offset the disruption. As mentioned, we've closed facilities for short amounts of time, ranging from a couple of days to a couple of weeks, to disinfect and deep clean our facilities and some limited quarantine to keep our workers safe. It is also important to note that because we've not experienced a full production shutdown, we're not being confronted with large-scale restart challenges across our production network. While the shelter-at-home period has created temporary inefficiencies in March and into the second quarter, we expect to be through much of this period as we exit the second quarter. At the same time, as recessionary demand-driven challenges present themselves going forward, we will manage through changes in capacity and our cost structure to manage margins and flex to meet demand as needed. I will now turn the call over to Pat. After Pat concludes, I'll come back to sum up my thoughts before we take your questions.

Thanks, Nick. As a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing business performance. As Nick indicated, since the virus crisis began, our focus has been prioritizing the safety of our associates and managing through the crisis in a manner that makes our company stronger. During the last economic downturn, we led by taking aggressive actions to adjust the business to economic realities. We positioned the business to take share during and after the downturn. Our focus is the same during this period of virus-driven challenges. Among our recent priorities has been assessing liquidity and taking actions to enhance decremental margins should expected sales declines materialize and persist. We entered this period from a position of business performance and balance sheet strength and believe we have the liquidity to navigate this virus crisis, and we have already taken actions to aid margin performance and cash management. I will address these topics in more detail later in my comments. First, I would like to cover our first-quarter results. While we are aware we have much to navigate during the balance of this year, we believe our first-quarter results prove our business' potential and that our strategies and execution are producing exceptional results. For the first quarter, sales were 1.4 billion, up 6% from a year ago. Consolidated operating income for the quarter was 170 million, up 20% or 28 million compared to the same quarter last year. Total company operating margin was 12.1%, up 140 basis points over the same quarter last year. EPS were $0.81 for the quarter, up 29% versus the $0.63 we earned in the same quarter last year. We remain pleased by our team's continued ability to grow sales and earnings ahead of market and plan. Next to segment results. Turning to Plumbing. Sales for the first quarter were 469 million, up 10 million or 2%. Absent the pandemic's effects, primarily in China where we were shut down for six weeks, as well as adjusting for foreign exchange, sales would have grown by 9%, beating market and plan. Continued strong market share momentum in the US drove the quarter with particularly strong first-quarter results in retail and e-commerce. Plumbing operating income increased 15% to 104 million for the current quarter. Operating margin for the quarter was 22.3%, an excellent result, driven by cost discipline and sales growth leverage. Our plumbing business was our first to experience COVID challenges in China. This operating result illustrates our commitment to margin management in a time of challenge. Turning to doors and security. Sales for the first quarter were 314 million, up 17 million or 6%, driven by double-digit growth in doors and decking. Doors benefited from a strong new construction environment and decking benefited from the distribution gains achieved last year. Operating income in doors and security was 33 million during the quarter, up 25% over the same quarter last year. Segment operating margin increased 160 basis points for the quarter over the last year to 10.4%. Now, turning to cabinets. Sales for the first quarter were 620 million, showing a strong year-over-year increase of 8%. We continued to experience strong growth of value-priced products in all channels. Sales of higher-priced products were flat during the quarter. Operating income in the first quarter was 56 million, up 11 million versus the prior year. Operating margin for the quarter was 9%, up 120 basis points versus the respective 2019 period, which was a strong comp seasonally. Income results were driven by value price cabinet volumes and the benefits of pivot strategy efficiency improvements associated with higher-priced and Canadian products. Turning to the balance sheet. Our balance sheet remains strong. We entered this pandemic from a position of balance sheet and business performance strength. Further, we have recently increased liquidity out of an abundance of caution and in keeping with our objective to emerge from this crisis stronger and prepared to grow. At the end of the first quarter, we had cash on the balance sheet of 360 million, net debt of 2.1 billion, and our net debt-to-EBITDA leverage stood at 2.2 times. We have been assessing our liquidity throughout this crisis and will continue to do so. Our liquidity testing has included scenarios even more challenging than circumstances experienced during the last downturn. Even under such circumstances, we expect to have ample liquidity to navigate this recession using our long-standing 1.25 billion revolving credit facility. In addition, given the uncertain nature and duration of this pandemic, we expanded our liquidity by adding a new additional 400 million one-year revolver. This was a proactive step taken out of an abundance of caution to provide ample liquidity to navigate through this pandemic. Turning to our previous financial guidance, demand has been volatile since late March and the demand outlook for the balance of 2020 remains significantly more uncertain than usual. Due to this demand uncertainty, it is prudent for us to suspend financial guidance until the demand outlook clarifies sufficiently. In the meantime, our business teams are working tirelessly to protect the great share and margin performance of the first quarter and to proactively manage expenses and cash in a manner that optimizes margin and balance sheet strength during a period of expected demand headwinds. Our teams are focused on delivering margin performance better than that produced during our industry-leading management of the last downturn. As sales headwinds intensify, our objective is to limit decremental margin to between 30 and 20% for the year, assuming sales headwinds are most intense during the second quarter and early third quarter and are contained to full-year sales decline of 20% or less. These metrics are not intended to be financial guidance, nor do they reflect an updated sales forecast. In fact, our present sales trends are more favorable. These financial metrics are intended only to indicate our margin objectives and business planning in an uncertain demand environment during which sales declines are expected. Within the first quarter, we initiated significant expense and cash management actions in pursuit of our margin and liquidity objective, and we will be expanding these actions throughout the second quarter and balance of the year in anticipation of demand challenges. During the second quarter, our decremental margins are expected to deviate from our target range unfavorably as we absorb the impact of safety measures taken to aid our associates, temporary facility shutdowns, and the transition inefficiencies incurred as our facilities are rebalanced to new levels of demand. Later in the year, we expect our margin performance to be at the favorable end of the target range or better as we are through a greater portion of transition inefficiencies and are managing capacity to meet demand. We fully expect to do everything we can to preserve margin, no matter how near-term demand and supply disruptions impact our business. We are focused on continuing to prioritize the safety of our associates and on managing our margins and balance sheet through and after the crisis proactively and effectively. We are committed to coming out a stronger, leaner business on the other side of the COVID-19 pandemic positioned to resume growth by outperforming in a manner which we're known for. I will now pass the call back to Nick for some closing remarks.

Thanks, Pat. To sum it up, we do not take the challenge that lies ahead of us lightly. It is an unprecedented event in modern times, with more unknowns than knowns. What we do know is that we are well equipped to manage what unfolds in our markets and our business. As an industry, we started from a solid foundation. Our sector is far healthier than it was at this juncture of the global financial crisis. Housing in the US is significantly underbuilt versus household formations, unlike the overbuilding leading up to 2007 and 2008. Home equity levels are almost 50% higher than they were then, and months of inventory levels are 40% lower. Our key customers, builders, retailers, and wholesalers are in good financial shape. Our millennial consumers are just coming into their key buying years, and we believe that the pandemic will further drive household formation and R&R activity, similar to the impact of 9/11 on our sector. And while our industry had good real momentum coming into this period, we were still just trying to catch up with the need for housing in the United States. There is no doubt that a recession and a blow to consumer confidence and financial uncertainty will have an impact on our industry. But as the economy recovers, with low interest rates, low inventory, good home equity, and high household formation, housing is in a great place to help lead a US economic recovery. And if our industry is well positioned, then our company is even more so. We enter this time, not with hubris, but with the confidence of a business that is demonstrating performance at its highest level. Our cabinet pivot plan, Moen's brand reinvention, Fiberon integration and distribution gains, and doors and security performance are all delivering for us in a way that will help us execute aggressively in the downturn. Our years of tackling tariffs and trade, rapidly changing consumer preferences and market slowdown and reacceleration have built a deep management DNA of facing into change and using it to make the business stronger. And that is exactly what we intend to do. We've built a fortress around the already strong balance sheet. We've taken swift action to reduce expenses and capital and generate cash, and we have built successful ways of performance improvement initiatives that are intended to minimize decremental margins, making our business even more competitive in a recovery. We will preserve and grow our position as market leaders in our product categories. We are working with seriousness and urgency, and we will manage the downturn and then capture outsized market share at leading margins as the economy recovers. Our experience and track record will be reflected in our results. Importantly, we will continue to do everything we can to protect our team as we manage through the COVID-19 pandemic, going beyond CDC and WHO guidelines to provide safe working environments for our associates. I could not be prouder as we work tirelessly to do our part as a provider of essential products. I will now pass the call back to Brian.

That concludes our prepared remarks on the first quarter. We will now begin taking a limited number of questions. I will now turn the call back over to the operator to begin the question-and-answer session.

Thank you. Your first question comes from Phil Ng from Jefferies.

Thanks for all the great color. Can you give us a little more color on how to think about April sales trends? And based on some of the color on the shape of the year, it sounds like the trough 2Q, 3Q sales could potentially be down 30 to 40%. So, just want to get a little perspective if we're thinking about that correctly and how some of the different businesses may perform in this environment.

Hey, Phil. This is Nick. Hope you are doing well. Why don't I start, and then I'll pass it to Pat. He can talk in a bit more detail about some of the trends. I would say, into April, it's been fairly choppy. There have been parts of the market that are down, as you would expect, and then other parts that are showing more resilience than we would have expected. And so, our approach is really to be very flexible and nimble, both as we look at cost reduction capacity so that we can capture the parts of the market that are working for us. We're seeing particular strength around the value offerings that we have in cabinets, Moen, decking, and doors from a price point perspective. From a channel perspective, we're really seeing strength in retail and e-commerce. If you think about the portfolio, just as a reminder, 24% of the business is US new construction. We would expect, and we are seeing more resilience in R&R into China and our security business. I think the fact that we've also bolstered the portfolio around that value sweet spot is why we're continuing to see that resilience there. So, it's tough lead into April; particularly given the stay-at-home orders, you're seeing weeks that are very strong, then weeks where it falls off, and weeks that are strong again. I think that's just as people kind of move in and out of retail home improvement projects. So, it's pretty early to get a read-through. But as we look at it, we continue our commitment to beat the market, and that's where we think we are. So, I'll hand it to Pat to talk a little bit about your question around forecast.

Yeah. What I would echo in Nick's statement is across product lines and across channels, we've seen at least a measure of stability. By that, I mean it seems like across the board, irrespective of product line and channel, we're no longer trying to find new loads. Things are either flattening out or recovering. As Nick said, I'd say, particularly showing some strength in retail and e-commerce. I think what's going on in trade-centric channels is less of a problem and more of just there's fewer outlets that are open in that arena, and those are a lot of privately held companies that have to manage their balance sheet, so they manage their inventory pretty tightly. In terms of looking at the quarter, obviously, we're not giving strong forward guidance, but I would say a range in enterprise for the quarter of down 10 to 20% seems like the plausible range at this moment in time with what we're seeing in terms of POS inbound orders and shipments. I see more like mid-teens to low teens seems like the more plausible realm of that spectrum. Obviously, things change every day in this world, but that seems to be where we are, and we're not seeing anywhere near the 30 or 40% that you referenced in your question that's across the portfolio.

That's really helpful information and much better than what many people were anticipating, especially regarding the Cabinet side. Pat, could you also provide insight into the decrementals? The 20 to 30% for the full year is quite impressive. Can you elaborate on the expected impact for the second and third quarters, considering there will likely be additional costs due to supply disruptions? Does this also take into account any decrease in input costs?

Yeah. I'd say on the full year, 30 to 20%, that's a great achievement that we are targeting to deliver, and we're confident that we're tracking in that direction. Realize our gross profit margin is 36%, roughly enterprise-wide. So, that means we're beating our gross profit margin. It does include, to your question, some assumption of some favorable commodities that will start hitting our P&L in the third quarter and fourth quarter as they come off our balance sheet. In terms of the second quarter, you're right. Given the safety measures and capacity rebalancing we're going through and some temporary shutdowns, be they set by government order or on our own safety decisions, we're going through a bit more inefficiencies; I'd say decrementals in the second quarter are probably 40% plus or minus 5 percentage points in either direction depending on how volumes and how choppy the quarter is. But that we would expect the back half of the year to be trailing at the more favorable end of our range.

I would like to note that half of the cabinets business is now positioned at that value price point, which reflects the successful execution of our pivot plan. This is where we are currently seeing results. As we look ahead, particularly at the end of Q1 and into Q2, our experience with decremental margins can be viewed in two segments. The first segment involves keeping people safe, a process we have been navigating, albeit not efficiently. We believe we have managed this aspect well. As we eventually move forward beyond the health-related issues arising from the COVID-19 recession, we will face stranded costs and capacity challenges, which we have successfully dealt with in the past. This process will integrate into our margins, but it essentially comprises two distinct phases. We are beginning to emerge from the first phase now. Even if a second wave occurs later, by that time, we will have implemented all necessary safety procedures and gained valuable insights, placing us in a stronger position to handle the health-related aspects moving forward.

Got it. Thanks a lot, Nick and Pat. Appreciate the color.

Our next question comes from Justin Speer from Zelman & Associates.

Good afternoon, everyone. Thank you. I have a couple of questions. Do you have any information on the percentage of your customer base that is currently or temporarily shut down or disrupted across each of your businesses due to social distancing measures and stay-at-home orders?

Justin, I don't know that you could nail a percentage. I mean I think it would be kind of in the pockets where you might expect, as Pat would reference, I mean, you certainly are aware that the large retailers and e-commerce portions continue to function and have been pretty resilient. When you look at some of the trade-related and wholesale channels in cabinets and dealers, you've seen a number of small dealers shut down for the period. And in plumbing wholesale, what we've seen is a lot of counters remain open, but showrooms are closed. On the door side, in the two-step distribution world, a lot of our big distributors have remained open down tier from them. Some of their smaller distributors have been closed. So, I think that's how I encourage you to think about our actual percentage, but it's kind of the trade-related channels, particularly where you have smaller points of distribution where you might see closures. And I think that's where you're seeing some of the larger demand hits and probably some of the offset then coming into retail and e-commerce.

All right. And then, another question for me is just the inventories in the channel, particularly at retail to the degree you have any visibility there, to get some sense across your business, how those are faring. And how you expect that will shape this quarter, next couple of quarters?

Yeah. I'd say on the wholesale side, as Pat referenced, we did see destocking. Inventories weren't inflated coming into this, right, and it has been managing fairly lean. And so, we've seen some advanced destocking ahead of what people anticipate is going to come at us in Q2 and I think the early part of Q3. That seems to have leveled out. Now we're standing in April. There's a very volatile situation. We'll see what happens in May. But as we look at that today, we kind of saw it in the early part of the month and then it started to level out. On the retail side of the business, I think inventory kind of sits at a fair spot depending on the category. But again, because those channels have been pretty resilient, I think there's probably room to actually build some inventory over time, but we'll see how your consumers continue to act and pros continue to act as they come in and out of those channels.

Interesting. And I guess last question for me is on that DIY versus pro side of the ledger. Do you guys have any insights into the behavior, particularly for some of those product categories that require getting into the home? You're noticing any distinction in behavior and demand trends that you can point out?

I've read a lot of conjecture about it, and I think the conjecture is probably fairly accurate where you assume that people can do something on their own. They might have been getting off to those projects and they're where they might have to bring somebody into the house. Perhaps it's been slower, but that's not the read-through that we're getting when I look at the product portfolio. I mean, particularly cabinets are not necessarily DIY-friendly products, but we're seeing a lot of strength there. Now, that might be coupled by the fact that we've also seen a lot of reduction in subsidized Chinese cabinetry coming out of the market. We've got products sitting right at the sweet spot. So where there is a need or people need to complete a project, they're getting it done. So, while I've read a lot about what you're referring to, and it does make sense, I wouldn't say that we're necessarily seeing that distinction in our portfolio.

Thank you, guys.

Your next question comes from John Lovallo from Bank of America.

First question is the 10 to 20% sales decline that you're thinking about for the second quarter that would seem to be pretty solidly above market. I mean, am I thinking about that correctly? Or are you guys expecting some pretty significant outperformance? And if so, are there certain segments that would kind of lead the charge there?

I'm going to start and then I'll pass it on to Pat, John. This relates to the strength we're seeing in our value offering compared to the market, which is something we've been working on for several years to strengthen our position in value cabinetry and enhance the Moen brand. Fiberon and decking perform well at the entry level, and we've also improved our door offerings, which are holding up nicely. That's why our forecast of a 10 to 20% decline reflects our bottom-up analysis. It's challenging to gauge the market since it fluctuates weekly as consumers shift between channels. It will take some time before I can definitively say whether it will exceed expectations. However, looking at Q1, we won't take our success for granted, but we are very confident in our strong performance on both revenue and profit. We are outpacing the market because our products resonate with consumers and the value we offer at the price point is appealing. This trend will continue, and we will keep outperforming the market, regardless of its fluctuations. We're also committed to operational excellence, which will be reflected in our margins.

Yeah. Hey, John, what I'd add to that is we're seeing all of our businesses perform within that range. It's no one business salvaging another. They're all kind of in that range, and there's sources of strength in all the businesses, including some of the one like doors or cabinetry that you might not intuitively expect, given what happened during the last downturn. In cabinetry, we set out a year for a plan that basically, there was some skepticism when we set out the year around could we achieve the planned targeted growth rates, but it was predicated on a high single, low double-digit growth of value price point cabinetry and the rest of the portfolio being flat. Now, obviously, we're not in the planned environment, but we're still seeing strength in entry price point cabinetry, as Nick said, I'm sure in part helped by the absence of subsidized Chinese imports. In plumbing, the POS, both globally and in the US in the quarter was really strong. It was roughly mid-single digits globally and high single, low double digits in the first quarter, and that POS continues to be strong. Plumbing in China, which was a little bit slow in its initial comeback stages, has really accelerated. It's come back. And then, the distribution gains in decking, but I'd say the strength in doors would lead us to believe that builders, because that's largely a new construction product, probably where the most new construction exposure we have from a percentage is they must be stretching out the orders they had from the fourth quarter and the first quarter because we still see stable and respectable demand in doors.

That's helpful. And then, maybe just on the decking side quickly, realizing that there is a distribution gain there. But are you guys getting the sense or is it too early that folks after being stuck at home for five, six weeks here, are looking to make their living spaces, even their outdoor living spaces, more livable? And do you think that that's an opportunity, perhaps longer-term for composite decking?

Look, that's the feedback we're getting anecdotally through the channel. I think it'd be early for us to tell you've seen it in the numbers, although what we are seeing is there's a lot of confidence around the forecast. So, what we are hearing through the channel is that there's a lot of excitement that even as shelter-at-home orders are relaxed, people are going to be more likely to entertain at home and use their outdoor spaces than they are to go out to restaurants or entertainment venues and that the channel itself is feeling pretty confident that outdoor living and that decking will have some tailwind.

Thanks, guys.

Your next question comes from Mike Wood from Nomura.

Hi, good afternoon. First question, wondering if you can give us some information on whether the glut of Chinese cabinet inventory had cleared before COVID-19 hit and what that current situation looks like?

Sure. I'll kick it off. It's very hard to read. We know there was a big build of Chinese inventory during the course of last year. Our estimate, and you could fairly consist on this, is that we would see that come out sometime in Q1. Our sense is that's probably happened. I mean, it's hard to nail down exactly, but we think it's largely come out, and we're probably not seeing the benefit of that. If you look at the import data, you are seeing an increase in some Southeast Asian imports. We look at that very, very closely. We know where the capacity is. We use a chunk of that capacity; there is not a ton of it. In fact, some of the countries on the import data likely don't have much cabinet capacity at all. As we look at that, we're leveraging out where it benefits us, but we're also monitoring it very closely and working with customs who are proving to be very cooperative around looking at anybody who's not necessarily adhering. So, short answer is, we think it's come off, and we haven't seen it come back and swamp. If anything, there's been a big pull on the product that we've positioned at that part of the market.

And what are you hearing from dealers in terms of whether they're still able to meet with customers for kitchen design? Or is it being done virtually? Will there be any extension in lead times as a result?

There has been some extension in lead time, and that's been slated. I think there's us and others who have put safety provisions around. We've been able to continue to operate pretty much everywhere, although I don't think that's always been the case. Some others have had to also extend lead times with respect to that. And I do think some of the dealers, particularly some independent ones, are closed. I think it is more challenging, and I don't know how that design process is advancing. I suspect that we are going to see a period here in Q2 where there is a lull in the custom side of the business as people were unable or unwilling to go in the store and get a design done. Some of that's moved online, but I think a large chunk of it will just be delayed.

Thank you.

Your next question comes from Mike Dahl from RBC Capital Markets.

Could you provide an update on cabinets and your earlier comments regarding the health of channel partners? Specifically, on the dealer side, are you noticing any issues with receivables or bad debt? Have any of your channel partners faced shutdowns from a customer perspective? What are your expectations in this regard?

It's something we're monitoring deeply across all of our businesses. Many of us were around in the last downturn. So, as soon as this virus spread west, that was among our initial considerations. Right now, we're not seeing things that leave us feeling like we have any kind of big or material exposures, but it's something we are tracking and managing very proactively. We don't anticipate something right now that is material or significant just because we got on it early.

And as a quick follow-up, are you doing anything specific to partner with people to either extend credit or terms proactively?

We are not looking to act as a bank for the channel, not due to a lack of friendliness, but because we have established relationships that we intend to maintain. Our focus is on collaborating with our channel partners to help them succeed, but we will not be broadening our risk exposure in this area.

My second question is about China plumbing. Can you provide more detail on the extent of declines, and perhaps quantify the monthly changes in China? Also, you mentioned the recovery started slowly; could you give us an update on your current status compared to the previous year?

Yeah. Well, I'll give you some color, and Pat can provide some additional granularity. The starting point is we shut down for six weeks in China. The nature of their shutdown was more severe, and that was reflected in the Q1 number for plumbing. As that started to come back, what we initially saw was strength in e-commerce and strength in developers as they got back onto job sites and started to get back to work. I would say in the first few weeks once the economy started to reopen, it was probably tracking at 70th percentile versus what we would have anticipated as COVID. Over the last couple of weeks, though, it really has started to ramp. You've seen traffic back in the big building products mall to start see traffic in showrooms, which is positive. Our developer partners are kind of closer to the 90, 95% of what we would have expected from a construction standpoint.

In the quarter, we experienced a seven-point decline in plumbing due to COVID and foreign exchange impacts. About 4 million of the decline was related to foreign exchange, while the remainder was due to COVID. Our facility in China, which supplies products to customers, was closed for six of the 13 weeks in the quarter. Once China began to reopen in late March, coinciding with the situation here, some major developers were quick to resume operations, while retail initially lagged. However, retail is now starting to recover, and developers are operating at approximately 90 to 95% of their projects. The market is showing positive signs of recovery, and we anticipate a strong performance in the second quarter.

OK. Thanks. Pat. Thanks, Nick.

Your next question comes from Seldon Clarke from Deutsche Bank.

Hey, guys. Good afternoon. Can you just talk about the range on the decremental margin framework that you provided? And kind of just give us a sense of what might cause you to be on the lower or higher end of that range. And whether this includes any cost savings in terms of corporate expenses or production rationalization or anything along those lines?

Okay. I'll begin and then pass it to Pat. I'll focus on the production aspect, which is crucial when considering various companies and industries. One reason for setting our target where we did revolves around the two hubs. One hub is about maintaining safety and health, while the other relates to adjusting capacity due to recessionary demand. It's important to note that the federal government deemed the industry essential from the outset, and we've been actively working at the local level to keep our facilities operational and our employees safe. We've collaborated with local health experts and plant leadership to swiftly resolve issues. This experience has taught us a lot, and we will continue to adapt, which has helped us avoid a complete shutdown and the subsequent ramp-up. Although we are not at our preferred efficiency levels, with some facilities running at 60% or 50%, it's certainly better than a total shutdown. This approach has allowed us to prioritize safety without incurring the significant costs of a complete halt and restart. As we adjust to reduced demand in a recessionary environment, we have prepared a series of cost actions. We have already tackled many of the simpler options by the end of Q1, but we are also looking at a broader set of actions tailored to respond to shifts in demand. All these strategies are intended to strengthen our company now and in the future. We aim to achieve top-tier decremental margins as we navigate through this period and to enhance our leverage as we emerge from it. Therefore, we are considering not only temporary but also permanent adjustments to our cost structure, and we plan to act urgently on this front.

Yeah. Just to kind of put the numeric stuff around it, during the last economic downturn, over the three years from 2006 to 2009, which is kind of our sales peak to sales trough, our decrementals over that 3-year period cumulatively were about 35%. So, our objective is to beat that and beat that handily. It is a challenge, but we're committed to addressing it, right? If we do nothing to address volumes, our decrementals could easily be 50-plus percent. If you just leave stranded costs in production and distribution facilities and don't do anything to your corporate costs, you could easily be 50-plus percent. So, then your question to kind of what puts you at the more favorable end of that 30 to 20% range, it depends on how early the demand headwinds come and stabilize. So, the earlier they come and stabilize, the sooner we can adjust capacity, both in production and distribution facilities, and the sooner we know the magnitude of action in corporate expense and can get that into our run rate. But later in the year those happen, all the more choppy they are, the more difficult the equation becomes. There will be SG&A reductions. That is already underway and we'll continue to move with demand reality in order to get us to a decremental margin that is below our gross profit margin.

A lot of this is permanent in nature. I mean, there are the variable costs that you size but there are permanent changes that will make us stronger, leaner and better, both going through it again as we emerge, and that is something that we take very seriously. At the same time, we will very strategically make sure that we have the capacity to continue our outside share gains, which we think will actually accelerate through an event like this. That capacity will be there, and we will be able to flex it, to take advantage of opportunities that come our way. We are seeing our biggest customers coalesce around their strongest suppliers, and so we will look to make changes that really improve us from an efficiency perspective. That's how I think about it.

OK. That's really helpful. And then, just as my follow-up to that, given everything you're looking at and doing on the cost side, as we think about things normalizing into 2021, realize this is a little bit far away and somewhat of an unprecedented situation. Given everything you're doing on the cost side, is 20 to 30% incrementals as we get into a more normalized year and modest mid-single-digit revenue growth, something along those lines? Is that the right way to think about it? Or given all these cost actions you're taking, you could see something closer to that 30% into your range?

Well, I would say, part of the way we're going to work on delivering this year is where we can cut back on investment expense without harming our ability to compete for share. I think as we get out of this, you probably expect the incremental margins coming out of this to be in the 20% to 25% range, which were consistent with our strat plan, was around 25%. There might be a little catch-up because you sat on your wallet in some respects. But our longer-term trajectory on incremental margins is in a growth mode, about 25%. I'd say we'd be working to get back there pretty quickly. There are periods where we get up around 30%, but that tends to be where we're leveraging latent capacity more than anything. Where we're investing in innovation and brand, we tend to be tracking more closely to that 25%.

I believe our performance in the first quarter clearly shows what the business can achieve when we receive higher volume and execute effectively across all areas, leading to market share gains. We're observing leverage significantly above 30%.

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