Earnings Call Transcript - FBIN Q2 2021

Operator, Operator

Hello, my name is Tawanda, and I will be your conference operator today. At this time, I would like to welcome everyone to Fortune Brands' Second Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. David Barry, Senior Vice President of Finance and Investor Relations. Sir, you may begin.

David Barry, Senior Vice President of Finance and Investor Relations

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security second quarter 2021 investor conference 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.

Nick Fink, CEO

Thanks, Dave, and thank you to everyone for joining us on the call today. I hope that you're all enjoying your summer while continuing to stay safe and healthy. Our teams once again delivered an exceptional quarter, driving outperformance on both the top and bottom lines. Our second quarter results demonstrated that we are delivering market-beating growth and margin progression even in the face of numerous external challenges. We remain on track to achieve both our near and long-term performance objectives across all metrics. For the quarter, our company sales increased 41% in total and 32% organically, with all segments driving strong growth. That includes organic growth of 20% versus 2019 and over 9% sequentially versus our excellent first quarter of 2021. Current demand for our products remains robust and our teams continue to drive accelerated share gains across the portfolio. Operating margin increased 110 basis points to 15.4%, and earnings per share increased 66%. Headwinds from inflation and supply chain constraints were significant in the quarter, making these results even more remarkable. Across our company, we're diligently working to meet demand and keep our customers served with our industry-leading brands. On the back of a strong market and our accelerating outperformance, we are again increasing our full-year 2021 sales and EPS guidance while maintaining our operating margin goal of around 15%. Pat will go into further detail on our increased guidance later in the call.

Pat Hallinan, CFO

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. Let me start with our second quarter results. Sales were $1.94 billion, up 41% from a year ago. Organic sales growth excluding the Larson acquisition was up 32%. Consolidated operating income for the quarter was $298 million, up 51% or $101 million compared to the same quarter last year. Total company operating margin was 15.4%, up 110 basis points over the same quarter last year. EPS were $1.56 for the quarter, up 6% versus $0.94 in the same quarter last year. It is important to note that our associates focus on safety and a culture of outperformance drove these outstanding results. Demand has remained strong across product categories with growing strength in larger ticket and contractor-installed products, headwinds from increasing material and freight inflation as well as supply chain and labor inefficiencies are being addressed head-on as reflected in our results. We are taking additional actions during the second half, and our teams are working tirelessly to address these challenges. Our advantage business model of leading brands and channel positions across the portfolio of products is providing synergistic benefits as we navigate this environment. We are executing above market, and our Fortune Brands Advantage capabilities enable us to deliver strong results for the company and our stakeholders. Now, let me provide more color on our segment results beginning with Plumbing. Sales for the second quarter were $695 million, up $190 million or 38% or 33% adjusting for FX. Second quarter growth was up strong double-digits across all major brands, channels, and geographies. Plumbing operating income increased 37% to $169 million for the second quarter. Operating margin for the quarter was 24.3% despite significant investment during the quarter in our brands, strategic priorities, and to service our customers. We expect 2021 margins to be above 22% for the full year. Turning to Outdoors and Security; sales for the second quarter were $536 million, up $203 million or 61% driven by the addition of Larson, as well as strong double-digit growth in security and decking and continued double-digit growth indoors. On an organic basis, sales were up 26%. Door sales were up double digits in the quarter driven by consistently strong retail POS and an accelerating new construction market. Reported sales results would have been even stronger within the quarter if not for labor and material constraints, the latter of which faded the impact of the Texas storms. Decking sales were up strong double digits in the quarter as our distribution gains and wholesale continue to drive results. Demand continues to exceed production capacity, and we are selling every board we can make. We expect this will continue as additional capacity comes online in the fourth quarter, and we are accelerating future capacity expansion plans. Security sales significantly rebounded with over 40% growth in the quarter with continued strength in retail and a welcome pickup in the commercial market. Outdoors & Security operating income was $79 million during the quarter, up 64% over the same quarter last year driven by the addition of Larson and operating improvements in decking and security. Segment operating margin increased by 30 basis points versus the same quarter last year to 14.7%. Turning to Cabinet; sales for the second quarter were $706 million, an increase of 31% over the same quarter in 2020. We again saw strong growth of value-priced products, and sales of higher price made-to-order products accelerated in the quarter. This positive signal for big-ticket R&R reflects consumers' increased desire and ability to invest in their homes. Operating income in the second quarter was $77 million, up 74% or $33 million versus the prior year. Operating margin for the quarter was 10.9%, up 270 basis points versus the same period a year ago. Before turning to the balance sheet and our updated financial guidance, I would like to address the topic of increasing inflation as well as inefficiencies in supply chain and labor markets as we continue to execute in this period of long-term sustainable housing growth. While inflation headwinds were anticipated, they continued to strengthen throughout the quarter. As I mentioned earlier, we are taking incremental actions during the second half of the year to offset increased inflation. We always first challenge ourselves to drive enhanced cost savings, then when necessary, we utilize price. As inflation has intensified, we remain thoughtful regarding price increases. We seek to keep our channel partners' products competitive and to minimize disruption if and when off-cycle pricing becomes necessary. That said, our brands and products continue to demonstrate their ability to drive share gains while commanding additional price. Through this combination of cost and thoughtful pricing actions, we plan to offset all inflationary headwinds this year and expect to deliver 2021 operating margin improvement. We'll remain on our '21 and long-term margin improvement trajectory. Turning to the balance sheet; our balance sheet remains strong. With cash of $460 million, net debt of $2.1 billion, and our net debt to EBITDA leverage is now at 1.7 times. We ended the second quarter with approximately $430 million of available capacity on our revolver. We are in a strong financial position to continue to deploy capital to benefit our company and stakeholders. We have made and will continue to make significant investments, both in our core Fortune Brands Advantage capabilities as well as into our brands through continued innovation, production capacity, and distribution enhancement. We also recently announced an additional authorization to repurchase common stock. The new two-year authorization allows for the purchase of up to an incremental $400 million of common stock. We have purchased approximately $156 million through the first half of the year. As always, we will be strategic and opportunistic when purchasing shares. We remain focused on deploying capital effectively to accelerate stakeholder value creation. I would now like to address our updated market and financial outlook. Given our continued outperformance and a strong home products market, we are raising our market and financial outlook for the year of 2021. Based on the expectation that the global market for our products will now grow 10% to 12% with the US housing market growing 11% to 13% and within this market forecast, we now expect US new construction growth of 11% to 14% and US R&R growth of 11% to 13%. Based on these assumptions, our revised 2021 full-year sales growth is expected to be 23% to 25% or 16% to 18% on an organic basis. Our full-year operating margin is expected to remain around 15%. We expect second-half operating margin to average around 15%, similar to the 15.1% achieved during the first half. The third quarter is expected to experience modest margin compression, while the fourth quarter margin is expected to expand as mid-year actions reflect more fully in our income statement. We continue to target meaningful margin progress during '21 and are tracking to our long-term margin objectives, demonstrating our ability to accelerate value creation regardless of the environment. We now expect full-year EPS within the range of $5.65 to $5.85 on a before charges and gains basis, of which the implied midpoint equates to earnings growth of 37% over our record 2020. Specifically, our outlook for each business, as it relates to our updated guidance, includes plumbing net sales growth of 21% to 23% with operating margins above 22%. Outdoors and security net sales growth of 44% to 48% or 14% to 16% excluding Larson with segment operating margins of 15% to 16% or approximately 16% to 17% adjusting for purchase accounting. Cabinets net sales growth of 13% to 15% with operating margins approaching 12%. We expect 2021 free cash flow of approximately $675 million to $725 million, which includes additional investments in capacity to accelerate growth. We anticipate a cash conversion rate of 80% to 90%. The revised full-year EPS outlook includes the following assumptions: corporate expenses of about $104 million to $106 million, interest expense of approximately $83 million to $86 million. A tax rate of between 23% and 24% with the second-half tax rate more in line with our longer-term rate of around 25% and average fully diluted shares of approximately $140 million to $141 million. Our increased forecast represents the outperformance of our business and a strong market, including continued share gains and positive operating leverage. In addition, our relentless focus on internal improvement and driving synergies across our portfolio will enable us to extend our continued best-in-class track record. Our fortress balance sheet will continue to allow us to pursue internal and external growth, and we are actively assessing opportunities to do so. We expect to outperform in a long-term housing expansion and could not be more excited about the opportunities ahead. I will now pass the call back to Dave to conclude our prepared remarks.

David Barry, Senior Vice President of Finance and Investor Relations

Thanks, Pat. That concludes our prepared remarks in the second quarter. We will now begin taking a limited number of questions. Since there may be a number of you who would like to ask a question, I will ask that you limit your initial questions to two and then re-enter the queue to ask additional questions. I will now turn the call back over to the operator to begin the question-and-answer session. Operator, will you please open the line for questions? Thank you.

Operator, Operator

Thank you, ladies and gentlemen. Our first question comes from the line of Michael Rehaut with JP Morgan. Your line is open.

Michael Rehaut, Analyst

Thanks. Good afternoon, everyone, and congrats on the results. First question, I wanted to perhaps get a little bit more color, if we could, on the back half margin outlook appreciating the fact that in an increasingly inflationary environment, you continue to offset. I was hoping to get a sense of, you mentioned that you're pursuing some incremental actions to offset the incremental inflation in the back half. I was hoping, and you always kind of talk about balancing cost savings with price increases, I was hoping maybe to get a sense of when you think about the incremental headwind that you're seeing in the back half, how much are you expecting to offset through cost versus price and also perhaps more broadly, if you could talk about perhaps on the cost side and operational excellence, productivity, how some of the Fortune Brands Advantage programs and initiatives are contributing to that ability to offset?

Nick Fink, CEO

Sure, Mike. This is Nick. I'll start and give you some thoughts conceptually, and Pat can influence some of the detail, but as you all know and as you've noted, I mean, the business continues to perform and demonstrated its resilience notwithstanding the environment. Therefore, we are seeing really strong market conditions and experiencing large inflationary pressures, as well as supply chain disruption that continues given this has been widely reported. Yes, if you step back for a second and consider how the business continues to perform, a lot of it comes from the fact that we are on a margin improvement journey and are doing this programmatically and very deliberately by leveraging it across the whole business. So if you were to take us as static and just hold the line, you might see buffering from outside forces but since the business is so geared towards a continuous improvement mindset and effectively deploying our Fortune Brands Advantages throughout the business, we can see those benefits come through even in a challenging environment. For example, we had significant plans to leverage and enhance our business simplification and global sourcing capabilities throughout this year, and these initiatives have allowed us to drive cost improvement while also navigating complex supply chain challenges. The suppliers that work with us and meet the input cost we’re looking for tend to be the better suppliers. Therefore, where we implement these programs, the business is actually more resilient at lower costs. This progress we have made is substantial. That said, if it doesn't cover everything, we will take price when necessary. Our strategy has allowed us to take price without sacrificing our market share, demonstrating that consumers still find value in our offering and our innovations.

Pat Hallinan, CFO

Yes, Mike. Hearing your question, trying to get to the numbers of it all. When we talked at the end of the last quarter, we discussed commodity freight and tariff inflation in the range of 4% to 5% of COGS. We're probably now in the range of 6% of COGS. You're starting to talk a dollar amount that's approaching $250 million with all components. Tariffs are a pretty minor part of that, but both freight and commodity inflation contribute significantly to offsetting it. We expect to fully offset these inflationary pressures this year. About 70% of our inflation will occur in the second half, and we will still be targeting the margins we've stated. Our long-term target remains 16% to 17% margin by 2023, which is consistent with our current performance, including a trajectory of margin improvement. We expect to maintain momentum through the year, despite the fact that the third quarter may present some challenges. We have been achieving year-over-year quarterly margin growth for eight consecutive quarters, and while we anticipate some margin compression of 30 to 60 basis points during the third quarter, we expect a rebound in the fourth quarter driving strong performance into next year as we aim for full-year margins around 15%.

Michael Rehaut, Analyst

That's great. And I appreciate all the quantitative color there. It's really helpful. I guess maybe taking a step back, strategically, you mentioned your free cash flow deployment while evaluating share repurchase and M&A. In the last few years, you've really bolstered the outdoor and security segment and previously focused on plumbing. How should we think about the opportunity set over the next few years across your different segments? It seems like cabinets have been on the quieter side since the last significant move several years ago. Just curious if there's anything left to think about or expect on the plumbing side or is it really more about opportunistically bolstering the outdoor portfolio?

Nick Fink, CEO

Sure. I'm happy to give you some perspectives, and you're right to point out our robust cash generation. We are being very thoughtful about how to create value for our stakeholders, and our priorities remain the same. First, we look at our business and the capital expenditures available to drive our strategic priorities. I think you know at this level of growth there are opportunities to continue to invest in the core business. As for M&A, we will remain focused on disciplined acquisitions where we see viable opportunities and continue to return cash to shareholders. Our pipeline is as strong as I've seen it and it remains robust. Areas of interest continue to be doors and security, and we are particularly excited about the opportunities to further expand our outdoor space. Specifically regarding product categories, we are exploring opportunities in places where we can create strong brands and sustainable competitive advantages. We believe there's a significant value add in synergistic combinations of properties like Larson with our existing door business. Similarly, plumbing presents opportunities that align with our goals and address adjunct markets such as residential water management systems.

Michael Rehaut, Analyst

Great, thank you.

Susan Maklari, Analyst

Thank you. Good afternoon, everyone, and congrats on a great quarter. My first question is around your play margins that have been impressive - they came in well ahead of our expectations for the second quarter in a row. Even understanding the investments there, you were nearly flat year-over-year. Can you talk about what's driving that outperformance and the sustainability of it? Also, the guidance of plus 22% for the year suggests a decent deceleration sequentially, which I know there are inflationary pressures, but I'd like to hear how we should be thinking about that and what the major factors continue to drive that margin?

Pat Hallinan, CFO

Yes, Su. First, the team there is doing a great job of managing its business by simultaneously driving growth and margin while making the right investments. But you're correct in observing the second quarter was particularly strong, in part due to foreign exchange effects where we experienced about a $7.5 million benefit to operating income. That was mostly in plumbing with the strength of the Chinese currency against the US dollar. While this boosted margin, they did make double-digit brand investments in the quarter compared to last year and will continue to accelerate brand investments through the back half of the year. Furthermore, the FX benefits will fade in the back half as those investments ramp up. Hence, the back half may align closer to our longer-term margin projections of above 22%. So that's the context for expecting the guidance to ease as we incorporate these variables moving forward.

Nick Fink, CEO

To add to that, I mean, we have a business on track to grow organically in 21% to 23% with margins above 22%. Furthermore, seeing the business produce these types of margins while increasing our brand investments significantly on top of this year speaks to the continued strength of our top line growth.

Susan Maklari, Analyst

Okay, that's very helpful color. My second question revolves more around the R&R spend. You mentioned expectations for R&R to grow about 11% to 13% this year. Clearly, some channel checks pointed to deceleration on the consumer side in the second quarter. Can you elaborate on what you're observing across the business and provide us with your confidence around that 11% to 13% for the full year?

Nick Fink, CEO

Yes, I'll start, and Pat may add some color. We see the same noise that you're probably seeing regarding decelerating trends. There has been some deceleration in big-box retail channels while other channels have risen. However, our perspective is founded on a broad view of housing products. Our internal tests and indicators show that we are not experiencing deceleration; still, we are seeing demand exceeding supply. Backlogs continue to grow as our team works tirelessly to meet customer needs. We believe these fundamentals remain strong. People need housing, and there’s a deficit in new construction alongside an aged housing stock in urgent need of renovation. Additionally, homeowners’ equity levels are high, which supports sustained spending and renovations, contributing further to our revenue outlook.

Pat Hallinan, CFO

To offer context regarding our expectations on US R&R specifically beyond DIY channels, we anticipate mid to high single-digit growth in the back half of the year. We're estimating that the first half reflected growth in the high teens to low twenties. Hence, we believe that the steady growth trend will support our full-year guidance of 11% to 13%.

Tim Weiss, Analyst

Hey guys, good afternoon and nice job.

Nick Fink, CEO

Thanks, Tim.

Tim Weiss, Analyst

Starting big picture, you mentioned several times in your prepared remarks that you're at capacity in various areas of your business. Can you talk about your capacity availability as you consider growth over the next couple of years and where you might need to add incremental fixed capacity versus adding labor shifts?

Nick Fink, CEO

Sure. To a degree, capacity has been constrained more by labor availability than hard asset availability, which has presented its own challenges. Transportation has also been a concern. However, we are seeing some labor flow back in certain regions as unemployment benefits start to lessen. We're interested to see how these dynamics play out in the fall. Long-term, we're making investments across the board, especially in cabinets where we've recently opened a facility and are currently ramping that up. Similarly, we are planning to scale decking capacity as demand continues to surge.

Pat Hallinan, CFO

To put some numbers around it, last year, we had a low CapEx year at about $150 million. Historically, it's been in the $175 to $200 million range for the past three years. We plan to increase that this year to the $225 to $250 million range, and next year we're looking at the range of about $250 to $275 million. This increase in spend will disproportionately go towards decking and plumbing distribution, as well as luxury plumbing capacity. Though the short-term pinch points right now are primarily through labor and logistics, we remain focused on capacity assessments and are taking proactive measures to ensure we keep a steady supply.

Tim Weiss, Analyst

Okay, that's great. Thanks for that. Is there a way for you to think about the carry-over impact of inflation next year? If we see input cost start to moderate, can you discuss how you might keep pricing and the productivity offsets that you're using this year?

Pat Hallinan, CFO

I’m not prepared to comment on next year's inflation rates. Earlier this year, we would have anticipated inflation in the range of 2.5% to 3.5%. Given the reality of our situation today with 6% inflation, we are likely carrying in excess inflation contributing toward our future planning. However, we are managing through it now and expect to manage next year as well. Our guidance expresses optimism in our margin journey, and we will take a similar approach with our channel partners while managing any deflation that might occur going forward.

Adam, Analyst

Hey guys, thanks for taking my question. Just curious about the anticipated third-quarter margin decline. Are any of the segments impacted more than others, or is it pretty much across the board?

Pat Hallinan, CFO

It's pretty even across the board. The team is focused on mitigating it, and we didn’t want to flag any unrealistic expectations overall. The expected headwinds from inflation occasion a real challenge for the upcoming quarter, but our teams are adept at managing these complexities.

Adam, Analyst

Got it, okay. Thank you. Just a follow-up on decking: you mentioned being sold out and seeing continued strong demand; are you hearing any signals on the DIY side? Is there any weakness there that we should be aware of?

Nick Fink, CEO

No, I wouldn’t say we’re seeing weakness there. The growth rates compared to a year ago remain robust, and while the comps were high, we continue to see solid performance in both the DIY channel and through the wholesale side too. As we continue to invest in distribution gains and capitalize on existing relationships, our sales management team is taking strong market share.

Adam, Analyst

Got it, thanks. Good luck.

Operator, Operator

Ladies and gentlemen, that concludes our call for today. Thank you for participating. You may now disconnect. Everyone have a wonderful day.