Q2 2022 Fortune Brands Home & Security Inc Earnings Call
Good afternoon, My name is Diego and I will be your conference operator today.
At this time I would like to welcome everyone to the Fortune brands second quarter 2022 earnings Conference call.
All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there'll be a question and answer session.
To queue up for a question you can press star one on your telephone keypad and you can press star two to remove yourself from the question queue.
I would now like to turn the call over to Mr. Dave Berry Senior Vice President of Finance and Investor Relations.
You may begin our conference call.
Good afternoon, everyone and welcome to the Fortune brands home and security second quarter 2022 earnings call and webcast.
Hopefully everyone has had a chance to review the earnings release issued earlier.
The earnings release and audio replay of the webcast of this call can be found in the investors section of our F. P. H S Dot 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.
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 income 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've allowed time to address some questions.
I will now turn the call over to Nick.
Thank you, Dave and thank you to everyone for joining us on the call today I hope everyone is enjoying their summer.
Certainly been a busy three months of fortune brands and I would like to personally. Thank all of our associates, who continue to work above and beyond to move our business forward.
Once again, our teams delivered a strong quarter of results, including high single digit sales.
And EPS growth versus last year.
These results are continued customer the strength of our brands to the hard work of our team servicing our channel partners at industry, leading rates into the power of a fortune brands advantaged capabilities.
I'm also pleased to report that our previously announced plan to separate into two world class publicly traded companies is progressing ahead of schedule.
We've made exceptional progress in a number of key milestones and expect to file the initial draft of our form 10 with the SEC later this quarter.
A 9% sales growth compares very well against the stimulus fuel second quarter from a year ago.
And reflects improved labor and shipping availability together with higher price realization.
Importantly, each segment made year over year operating margin improvement in the quarter as price and cost actions more than offset inflation.
Consolidated operating margin was in line with our expectations, which included planned investments our digital strategy to create a transformational platform for future growth and margin expansion.
Our quarterly results were strong and much of our portfolio continues to see solid demand levels, which is supportive of our full year financial targets.
Consistent with the rest of the industry, we are starting to see signs of slowing consumer behavior in response to inflation and higher interest rates.
The rapid rise of the 30 year mortgage rate was cool, but toward pace of new and existing home sales.
As with prior periods of interest rate increases, we expect a period of adjustment as buyers and sellers realign pricing and value expectations.
We believe any slowdown in the housing market will be relatively short term funding.
The fundamental drivers of the housing market remain intact. The U S remains millions of homes under book demographics remain favorable and home equity levels remain at historic highs.
To ensure that we continue to drive value creation, we are taking proactive measures in anticipation of a period macro driven softness.
And we'll remain agile in the face of changing market conditions.
The long term outlook for housing supported by demographics in fundamentals is positive and we are well prepared to manage any short term pauses or softness that we encounter.
We've been here before and we will continue to execute and deliver best in class performance, including growing above market.
Liberty, when our cash flow and margin targets.
Our team knows how to create value in our second quarter is another proof point of this.
So as I mentioned earlier I'm impressed by the progress our teams have made on our future separation into two world class publicly traded companies.
As evidenced by its continued industry, leading performance the cabinets business is increasingly well positioned to stand independently.
Importantly, we're also making great progress on our strategic work around the art of the possible for new Fortune brands and I look forward to sharing that with you as it unfolds.
I'm confident that the separation will result in significant value creation opportunities both companies and their stakeholders.
Now I will turn to each of the businesses to provide some color on what we're seeing.
Beginning with water innovations sales were down mid single digits in the quarter due to the impact of the Covid shutdowns in China.
Excluding China sales growth was up mid single digits, driven by high single digit P O S.
This strong in our core U S market for both Boeing and house of ROHL as the strength of our brands and innovations continue to resonate with consumers.
We delivered these results while facing appeared channel Destocking is a continued industry leading service levels have enabled our customers to reduce safety stock and inventory positions.
Our teams have been working hard to overcome the supply chain challenges of the past couple of years, and we see signs of improvement across the board.
Backlog in service rates are nearing pre COVID-19 levels.
Water innovations operating margins were nearly 25% in the quarter driven by price and cost actions offsetting in place.
And proactive expense management.
We continue to prioritize strategic investments in the business remains well positioned to outperform any market environment.
Shifting tractors and security business sales grew 13% driven by price realization and volume growth of Terminator, which continues to gain share of entry openings by its leading portfolio of engineered doors driving conversion from wood.
<unk> sales grew high single digits tempered in part by robust wholesale inventory.
Security sales were up mid single digits, driven by strong double digit commercial sales growth.
Our security team continues to successfully diversify into broad based commercial applications leveraging connected technology to deliver mission critical safety products to our global customer base.
Our work in commercial safety is well aligned with our ESG strategy.
We're very excited about how the security portfolio is developing and being received by consumers and customers.
Our doors <unk> security operating margin improved 400, plus basis points sequentially, and 70 basis points versus prior year as price and cost offset inflation and labor availability and supply chain constraints improved from an impacted first quarter.
Finally, our cabinets business delivered an exceptional quarter with sales growth of over 21% as our pricing actions became more fully realized in the P&L volume growth remained positive and our transformational efforts continued to deliver.
Order patterns remained strong across our stock and semi custom price bands.
Toby's backlogs remain elevated and labor shifting towards completing homes, which will provide continued tailwind for our business.
We did not hire and premium products market conditions appear to be impacting aggregate demand and our teams are acting to rightsize, our capacity and cost structure.
Cabinets operating margin was up 200 basis points sequentially, and 60 basis points versus prior year pricing.
Price and cost actions more than offset inflation in our.
Waiting environment continued to improve its labor availability and supply chain constraints eased.
Our transformational work to reposition the business towards the heart of the market with efficient scalable and flexible capacity continues to generate results.
Our cabinets team continues to win in the marketplace and its ongoing transformation will position the business for continued outperformance.
As the team prepares to leave their own independent public company. They have never been on a stronger footing for future success.
Across the portfolio as a result of our teams market leading service levels.
Inventory positions have improved through the past few quarters.
We're working closely with our suppliers and channel partners to ensure the right levels of inventory exist throughout the value chain as we move through a period of expected short term shocks.
By leveraging our fortune brands advantaged capabilities, we will continue to proactively manage working capital and cash flow.
Now I'd like to add some additional thoughts on the current housing market.
As I've said before while the timing of housing can be discretionary housing itself is not.
There has been no change to the fundamental need familiar into more houses to be built or does it satisfy household formation and growth trends over the coming years.
However, persistently high inflation and aggressive interest rate increases by the fed have begun to impact the pace of buying and selling homes.
As a result, we do expect some softness or an air pocket in new construction, which could materialize towards the end of this year or into 2023.
In the meantime, though this continued to complete the much needed starts that were undertaken as demand soared during the pandemic.
Much of our product portfolio coming in towards the end of the construction process.
With persistently strong R&R interest we remain confident in the strength of our business.
Our home affordability due to higher interest rates and price appreciation poses a challenge to home sales offsets do exist.
Capable home equity continues to increase from its current all time high.
Additionally, the majority of homeowners have a fixed rate mortgage under 4% we.
We expect these factors combined with continued low supply of homes and higher cost to move will provide tailwind continued R&R spending and our portfolio of industry, leading brands remains well positioned.
Secular growth trends across both water innovations and our doors and security propel our strong brands, which are further driven by our innovation engine.
The value proposition that we deliver to our consumers is backed by best in class innovation quality standards and service levels, which provides our portfolio with added resiliency and is a significant differentiator versus private label alternatives, which do not deliver upon that same promise.
As we've seen during prior slowdowns the strength of our total offering continues to attract consumers even in more difficult environments.
This formula of strong brand innovation and service will be the firepower that accelerates performance and what would be the new fortune brands.
And within cabinets, we continued to gain share and improve margins by bunching of transformation through optimizing our product offering in a manner that appeals to customers and enables cost structure improvement.
We believe that our ongoing operational efficiency improvements and increasingly flexible capacity.
This is well in any market environment.
We are adjusting our full year 2022 guidance to recognize the incremental expenses related to the separation.
Well also scenario planning and taking actions where required to preserve and improve margins and generate cash now and into 2023.
We're doing so in a thoughtful measured way and remain committed to maintaining a long term margin goals, while still making important strategic investments to drive future growth.
In summary, our impressive quarterly results support what we expect to be a strong year for the company with above market topline performance and margin accretion despite ongoing inflation less than perfect supply chain environment and dedicated investments in critical fortune brands advantaged capabilities.
We have successfully navigated a challenging environments before including as recently as 2020 to 2018 and are well equipped to deliver sustainable growth for our shareholders by proactively managing through any slowdown.
Any share and accelerating in the areas of opportunity.
We will do so while maintaining our commitment to being a leader in corporate responsibility and ESG as the products, we make improve the quality of life every day for millions of people and deliver on our purpose of fulfilling the dreams palm.
Yes.
I would now like to turn the call over to Pat to go through our quarterly financial performance in greater detail Pat.
Thanks, Nick as a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing segment performance.
Additionally, all comparisons will be made against the same period last year unless otherwise noted.
Let me start with our second quarter results and overall thoughts on the quarter.
Sales were $2 1 billion up 9% and consolidated operating income was $320 million up 7%.
Total company operating margin was 15, 1% and included year over year margin expansion across all three segments.
EPS were $1 67 for the quarter up 7%.
As Nick mentioned the company produced a strong second quarter, driven by our leading brands and dedicated teams.
Delivering high single digit sales growth, while comping unprecedented levels of government stimulus from a year ago is especially impressive.
Labor and supply chain constraints ease during the quarter, enabling our teams to service demand across the portfolio and work through order backlogs to realize incremental price.
Operating margin in the quarter improved year over year in each segment and increased sequentially by 210 basis points price and cost actions more than offset inflation in each of our segments. Additionally, we continued to invest behind our key strategies, including our digital transformation journey, which will drive future outperformance.
Performance.
Looking forward, we are committed to delivering a healthy and robust long term future for what will be two strong independent public companies.
And are keenly aware of the impact the rapid rise in interest rates will have on the consumer in the near term.
While demand remains resilient across much of the portfolio. Today. We are acting ahead of a potential slow down to maintain our margin progression and deliver strong cash flow we.
We have successfully navigated slowdowns before and have the experience to deliver results against any market backdrop.
Now, let me provide more color on our segment results beginning with water innovations.
Sales were 650 million down 45 million or 6%.
We're down 5%, excluding the impact of foreign exchange.
The second quarter was impacted by localized coronavirus related shutdowns in China excluding.
China growth was up 4% driven by strong P. O S for both Mone and the house of ROHL in the U S.
Operating income was 162 million down 4% or $7 million.
Operating margin was 24, 9% the result of better price realization and proactive expense management.
Looking forward, we expect water innovations third quarter sales growth to be down low to mid single digits. Due to continued disruptions in China and Comping a prior year channel inventory build associated with service lower recovery.
We expect water innovations margins will remain strong.
The water innovations portfolio remains as vibrant and resilient as ever delivering high single digit P. O S. During the quarter.
Consumers continue to gravitate to Mullen as the leader in the future of water in the home and the house of ROHL continues to enjoy growth expansion as our collection of artisan brands delights consumers.
Turning to outdoors and security sales were $605 million up $70 million or 13%.
Thermal Q sales were up strong double digits as improved labor availability and shipping efficiencies helped drive performance.
Single family, New construction completions, continuing to catch up to starts.
And builders continue to view therma true as the composite material alternative to wouldn't entry doors.
Lars and sales were down low single digits in the period, driven by retail channel Destocking and softening retail DIY activity Larsen continues to work with throw at you to promote a strong future together within our growing doors franchise.
Decking sales grew high single digits in the period, we continue to believe conversion from wood will drive long term adoption of advanced composite materials and decking as has been the case for our thermal shoe business.
Decking wholesale channel inventories remain robust and we will continue to monitor demand trends and adjust our capacity plans accordingly.
Security sales were up mid single digits in the quarter commercial sales now accounting for over a quarter of securities revenue grew over 20% in the period.
Our momentum in connected and ESG products will benefit security in a significant way now and into the future.
Outdoors in the security segment operating income was $93 million up 19% or $15 million versus a year ago.
Segment operating margin was 15, 4% up 70 basis points over 2021.
Turning to cabinets.
Sales were 856 million, an increase of $150 million or 21%.
Stock cabinets grew strong double digits and make to order cabinets grew low teens as labor availability and supply chain improved throughout the quarter.
While price primarily drove sales growth volume growth was also positive in the corner.
Overall backlogs remain elevated and demand remains resilient across most price points as.
As we prepare this business as a standalone as a public company Master brand continues to execute at a high level and is on track to widen its lead at higher margins overtime.
It is an exciting time for this business with operations leadership and execution all heading in the right direction.
Operating income in the second quarter was 99 million up 28% or 22 million.
Operating margin was 11, 5% for the quarter, representing a 60 basis point improvement over last year.
We expect to deliver further margin progression during the back half of the year as price and continuous improvement offset inflation at accretive margins to support our full year and long term goals.
Turning to the balance sheet.
Our balance sheet remains strong with cash of $361 million net debt of 3 billion and net debt to EBITDA leverage at 2.3 times.
We finished the quarter with $564 million of total liquidity on our revolver.
We also purchased 125 million in stock during the quarter, which brings our total purchases through the first half of 'twenty 'twenty $2 million to $505 million.
We remain committed to efficient and effective cash and balance sheet management.
Our teams are already acting to manage our working capital and capital expenditures in light of the recent and expected future Central Bank actions.
Continued high inflation and the response from the fed produced the expected outcome of near term slowing of consumer demand, including for home products.
While uncertainty exists we are acting now to maintain our margin journey and deliver strong cash flow our teams have executed throughout challenging environments in the past and we will do so again to deliver shareholder value.
With that in mind I'll now provide an update to our 2022 guidance.
Our full year 2022 global and U S market outlook remains unchanged.
With first half U S R&R strength.
And new construction and R&R backlogs offsetting challenges in China and slowing retail DIY.
Our global market outlook remains at growth of 3% to 5%.
With the U S still expected to grow 4% to 6%.
With more than half the year behind us we have tightened our full year net sales growth guidance to six 5% to seven 5%.
To reflect strong year to date results.
And a continued dynamic market environment heading into the second half of the year, including expected channel inventory reductions.
We remain committed to achieving Oi margin expansion this year and beyond for.
For 2022 we continue to target approximately 70 basis points of Oi margin expansion.
We are updating our 2022 EPS guidance to.
The $6.36 to.
To $6 50 per share to account for incremental costs associated with the separation.
And updated full year interest expense tax rate and share count.
On a segment by segment basis, we now expect for 2022.
Water innovations net sales growth of down 1% to up 1% with operating margins around 24%.
Outdoors and security net sales growth of 10% to 12% with segment operating margins of 15, 2% to 15.7%.
Cabinets net sales growth of 10% to 12% with operating margins of 11.5% to 12%.
This updated EPS outlook for 2022 includes the following assumptions.
Corporate expenses of about $138 million to $142 million.
Including digital transformation investments of around $20 million and separation costs of up to $15 million.
Interest expense of $120 million to $122 million.
A tax rate around 25% and average fully diluted shares of approximately $131 million.
Over the next few years, we will optimize SG&A in both new fortune brands and cabinets as we deploy lean operating models and both companies to enable strategic investment for growth and continued margin expansion.
We expect 2022 free cash flow of approximately $590 million to $630 million and anticipate a cash conversion rate between 70% and 75%.
Our free cash flow forecast includes capital expenditures of $300 million to $330 million as we adjust the rate of investment to reflect current market conditions, while continuing to enable future growth.
In summary, our strong quarterly results have contributed to our better than anticipated first half of the year.
And our full year outlook remains intact.
We remain focused on proactively managing the business through any market conditions, while actively pursuing our margin objectives.
Long term housing fundamentals supported by demographics remain attractive and.
And we are well positioned to capture value across our portfolio for all of our stakeholders for years to come.
I will now pass the call back to Dave to conclude our prepared remarks and open the line for questions Dave.
Thanks, Pat that concludes our prepared remarks on the second quarter.
We will now begin taking a limited number of questions.
Since there may be a number of you who'd like to ask a question I'll ask that you limit your initial questions to two and then reenter the queue to ask additional questions.
I will now turn the call back over to the operator to begin the question and answer session.
Operator can you. Please open the line for questions. Thank you.
Thank you and at this time I would like to remind everyone that in order to ask a question. Please press star one on your telephone keypad.
Confirmation tone will indicate that your line is in the question queue. You May press the star key followed by the number two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
And our first question comes from.
Susan Mcclary with Goldman Sachs. Please state your question.
Thank you good afternoon, everyone.
My first question is around the spin you know Nick you mentioned that it's actually moving ahead of schedule can you just give us a bit more color on how that's coming together and any other details that you have that you can update us with.
Sure sure.
Good to hear from you.
Happy to talk about it.
Say you know when we announced our last quarter's call here, we've kept very very tight very.
A very small group of us.
The work done on it. So it was really you know post announcement that we became really sculping onto a speed of execution and the granularity of getting through the audit in draft form 10 et cetera.
I'd like to say no surprises because I have a ton of confidence in our team, but we also benefit from the experience of.
This is a team that you know many at corporate have been through this before and know how to do it.
And they just got off to an exceptionally fast start I think that coupled with you know.
A lot of.
Good management of our financials and processes and systems over the years has allowed us to move through it pretty quickly. So you know we're not targeting filing the form 10, this quarter, which was well ahead of schedule and that's coming together and so that's you know from a process standpoint.
What's happening I would say from a strategy standpoint, you can certainly see in the cabinets results. The delivery now against the strategy of really building out this business system.
More flexible and agile capacity really starting to bear fruit.
And that team has a ton of energy behind them right now and I really I really really believe they are just getting going and what they can do and you know even as they look into a slowing down and their reaction to that it's great that gives us more time to really get after some of these business simplification initiatives that they wanted to get after and then on the new Fortune brand.
Side, you know, we've really used the last quarter to start to re imagine the art of the possible.
And what can we do with even more focus on brand and more focus on innovation and more focus on our channel management.
And we're excited about how that's coming together and I think we'll update you more as that unfolds and as we get towards the end of this year, but we really believe that it's going to allow us to tightly focus and double down and invest for the other things that you know our investors have been appreciated about the business.
And the things, we've been able to deliver and I think you'll see a really really.
Strong brand and innovation.
Leader emerged from that side of the house and so you know buying larger we're very excited about where things are heading in the patient, which they're having there.
Okay. That's great to hear follow up there's clearly been a lot of focus on the consumer and I. Appreciate all the commentary that you gave that perhaps could you talk a little further just to the state of the consumer and how it changed during the quarter then mix shift that you perhaps are in there and then how you're executing on that macro playbook.
But you mentioned a couple of times, where we are today and what you're watching for to determine future steps or potential future steps.
Yeah, I'd be happy to talk about it.
Hope, it's enlightening free I'm not sure.
Sure.
A lot of data across our whole portfolio and you know over the last couple of years as we've gone through this digital transformation kind of started we've really been able to pull more and more data into our data Lake really start to get a good cross section consumer I guess the headline here from a starting point.
Do you think the consumer is still been surprisingly resilient as I said on the last call. We've seen Pos dollars tracking along with last year absent a giant stimulus that continued all the way through the quarter in fact, all the way through last week, we actually saw an inflection upward.
And spend I wouldn't take any one week to the bank, but the fact that you know you're still seeing that degree of positivity.
Is it is really interesting.
Now I think as we look forward you can see some pockets of softness in some pockets of strength and so we're still waiting.
Waiting I think as that unfolds, we certainly do see the home sales data and read about the foot traffic through builders and I think you know we're going to gear ourselves for as we said in the prepared remarks and unexpected air pockets that materializes, if new home construction comes off.
But again I say from a consumer perspective.
So pretty resilient and then to answer your question. So how are we executing against it I think it's twofold.
In the first part its true internally, how do we manage and prepare the business for that.
We have some healthy paranoia here. So we are already taking steps to look at expense management Capex management capacity management, and really prepare ourselves and we've been through this before in terms of entertainment and through 'twenty. If you recall in Q2 of 2020, our decremental margin was 12%.
That's a good example of how the team can execute when they choose to go after it and so that's really that internally looking piece and I have absolute confidence that the team can execute through any air pocket really well, while still preserving investment in key strategic parties.
Externally facing piece, it's really gearing our product at the heart of the market understanding where the consumer is growing using the insights we have across the whole portfolio.
And making sure that we have the right product there at the right margins to continue to meet the consumer and I think that's where the strength of the portfolio has really played out over the last few years and you've seen it I mean, you got three years back when we saw millennials really coming into entry level.
Homes, when we had the portfolio there to meet them.
As they started to move up into us dollars flowed in and you saw a.
Real trade off over the last couple of years, we could stretch the portfolio to meet them, there and we have that kind of flexibility in the.
The product set and we can do so pretty EBIT margins across and so that's how we think about it from a consumer perspective.
We will continue to meet them, where they are and I think if you look at the home equity that's out there the amount of mortgages under 4% the age of homes, we're going to continue to see some robust R&R strength going forward.
Okay. That's great color. Thank you for everything and good luck.
Yes.
Our next question comes from Stephen Kim with Evercore ISI. Please go ahead.
Yeah, Thanks, very much guys.
I believe you made a comment in the cabinets business when you were going through the various.
Price points, you were talking about the high end I think maybe being a little bit more impacted by some macro concerns relative to stock and made to order, which seemed like they were they did much better than I guess I'm curious did you see this dynamic or maybe differentiated performance across a different price maybe at the high end, maybe a little greater weakness.
At the high end in other segments or across your portfolio or was it simply limited to cabinets.
Yeah. It was really much more limited to cabinets and it's.
A little bit on <unk> question I wish you could just give a definitive answers one thing or the other but no. You know we saw house of ROHL, a continued to have some real strength.
Through the quarter and that seems to be unabated and so.
More limited to cabinets and I think as is that machine rolls forward you know we've gotten our service.
Our service levels and quality.
Really really great spot.
In the soccer value side of the business the semi custom side and now I think the teams using a little bit of a spike that they're getting because you know for the last couple of years, there hasn't been a whole lot to work on some simplification in the premium side that should allow for even better service and delivery, which we think is going to help.
Drive that part of the business.
Okay. That's that's helpful. Thanks for that.
And then earlier I think you also mentioned that you're working to proactively manage to the right level of inventory with your customers you know anticipating that there may be a little bit of a hiccup in light of the buyer's strike, we have going on in housing.
And I guess I was curious I know, obviously, you don't have a crystal ball on exactly whether that's going to materialize or not but oh, how severe it might be but can you talk about what this management process proactively managing to the quote unquote right level of inventory how might this look different across your different segments. If you can give us.
Some insight into how you're going to be managing that.
I think it's.
A couple of vectors. So I'll give you some perspective, Pat may have some color to add but first and foremost I think it's you know it seemed through and trying to have a good lenses, where the consumer is and where the right inventory levels are so high.
When you step back.
Yes, I think as hard as we were on ourselves through the course of last two years about our service all of those will be subsequently learned from customers, whereas we were serving the customers well ahead of a lot of the competitive set.
As a result of that we've got customers inventory levels into a good spot I think sooner than you would see a cross industry, which also permitted some customers to start to take safety stock.
You see a bit of effect of that in plumbing right in the second quarter and so as we as we worked through that part of what we need to do is use the insights that we're getting from the consumer point of sale to make sure to work with customers trying to make sure they arent under inventory.
And to share that data with them and we've really been it's part of a fortune brands advantage.
Investments building out our category management capabilities that we have to try to provide those insights to our customers and make sure that you know we were doing it in a rational way and not a knee jerk.
Reaction and generally I think it's been pretty successful at that know the other piece is to the extent that they are going to come down I'm trying to get transparency. So we can match working capital to match, our investments and pace Accordingly, no again I think we've.
<unk> already seen a fair amount come out in this last quarter I expect it'll be a bit more in Q3 as people anticipate some softness there combined with the ability to pick up some safety stocks, but I think as long as we stay close to where the consumer is.
And help share that information and then you know help run the business.
With capacity expense management et cetera to where do we see customers growing into those with a couple of doctors of which we manage that.
Okay, great. Thanks, very much guys.
Sure.
Thank you and our next question comes from Michael Rehaut with J P. Morgan. Please go ahead.
Thanks, Good afternoon, and thanks for taking my questions.
First I just wanted to actually circle back on the inventory, but from another angle.
I think you kind of mentioned earlier that.
P O S and water renovations was up 9% and sales ex China was up four.
And so.
So just trying to get a sense in in in both water innovations and perhaps in your other segments. How much you know the inventory reductions have had an impact on.
Three key I'm, sorry to Q from a from a revenue standpoint, and you know if if you're also within your guidance on a full year basis.
Contemplating or.
Incorporating any continued inventory reduction in the in the back half.
Yes, Mike.
I'd tell you.
In the quarter. It was probably about a point of headwind to sales growth in the quarter.
And obviously it tends to be a in the products.
With the longest supply chains are for us and for our channel partners.
And we did in this quarter start to see and across many product lines and channel partners people ordering below Pos already you can imagine not only do people.
Have the uncertainty of the future on their mind, but the cost of inventory has gone up.
With the installation of commodities and with interest rates. So.
People are being.
As expected proactive channel partners that is are being as expected proactive on inventory and I would expect for the balance of the year for the second half.
Leased.
A point or two of headwind into the second half of the year for the same dynamic in and that's in our script and what with Nic was just referring to what Stephen as you know, we're just going to be proactive and be thoughtful.
So that we have the right inventory in place to maintain maintain our position to compete for market share, but also be to be prepared for that.
Likely result of the lack of foot traffic and new construction that is happening right now.
And you have to put it in a dimension from a balance sheet perspective.
Yeah, probably on the order of 250 to 300 million of working capital reduction.
By the end of the year will be.
Our balance sheet dynamic of it and thats consistent with what we've been saying is.
When the when the time is appropriate we will start backing our working capital back down to more traditional levels.
We would expect to be doing that throughout the back half of this year and as we head into next year.
Right.
That's helpful. I appreciate it.
Secondly, you know just to shift gears towards the decking.
I believe you had 3% growth in in the first quarter, you talked about high single digits. This quarter I believe last quarter, you talked about an expectation of still around 20% growth or.
Last quarter, you said, 20% plus growth for the year wanted to know if that's still part of your thinking obviously you did raise the full year sales growth guidance for the segment.
And you know.
And if that is the case.
We have heard from one of the big players that you know there is also some concerns around inventory reduction.
How are you thinking about.
The health of that business.
Also from a pricing standpoint, given some of the capacity additions that have come on in the business in the in the industry.
So I'll give you some color and pet may jump in with some more color I would say overall as you look out to the full year, we may have come off that expectation a bit but not a ton I think it will still be solid.
Double digit growth hopefully mid to high teens is kind of the zone that we're targeting and really impacted by what you're describing I think that's the other place where we pointed to plumbing here seen some inventory come out I think that's the other place where we are watching inventories in and making sure they're at the appropriate level, but.
But we're hearing that are downstream in wholesale there, they're pretty full yet at a P O.
POS level, we're still seeing some strength and you know quite a bit of strength I should say indexing in some healthy pull through and also looking across the mix.
And it is it's been pretty evenly spread as well and so.
You know, where I think being mindful around the capacity adds there I'm completely committed to the long term.
The plan that we've discussed and we've set out, but I think give us a little bit less this year, well adjust accordingly, and as we pointed out in the last call you know the capacity investments, we're making a very flexible capacity investments in several time them with what we see to be.
The growth and so you know in some I'd say, it's a it's still be a very strong you're not maybe not in the twenty's, maybe more kind of mid to high teens, but it is pulling through and we're watching the.
The wholesale inventory as we go.
Anything you'd add.
The things that are driving the sales guidance in that segment up for the year.
Is the excellent performance of the.
The therma Tru doors product line and the commercial product line and security right. Those are the those are the things driving that guidance up.
And more than offsetting a slight reduction in the expectation of.
Decades, and that would be true in the quarter as well.
There are two at a particularly strong second quarter. So that's what you're seeing today that that product line continues to resonate very strongly it continues to compete.
In its respective marketplace very successfully and builders are trying to get completions done in such a nice tailwind for that business.
Micro second part of your question was price.
We're very committed to the price that.
We've been able to achieve.
We are attacking and when you look at it either on a total project value or on a product basis, it's still a huge value to the consumer and so our focus is going to be much more around getting the innovation and to market and getting it right serving our channel partners really really really well and making sure that we're going to get paid for it.
As we move forward.
Great. Thank you so much.
Yeah.
Our next question.
<unk> comes from Truman Patterson with Wolfe Research. Please state your question.
Hey, good afternoon, everyone. Thanks for taking my questions pad on last quarter's call. Our I think it pseudo guided to maybe 6% of pricing and I think about $450 million of raw material freight.
Freight and labor inflation I'm, just hoping you can give us some color on how you're viewing inflation in pricing as we sit today and then you know we've seen brass costs come down recently.
I'm, hoping you can help us think through that dynamic as you know a potential tailwind moving into 'twenty three.
Yes happy to comment on both so you know certainly I think I think the last call the range.
Material and logistics inflation inflation that we've provided was that the dollar amounts you had were roughly correct. It was 9% to 10% of prior year Todd is I'd say, it's ticked up.
A point or so it's like 11% to 12% of last year's Cogs would be a material and logistics inflation that probably gets you closer to about $580 million.
Again about $350 million of that was carrying from from last year or.
So about 60% carry and then 40% new to 2022 and in the drivers of change from last quarter. This quarter had been predominantly ground freight hardwoods and resins.
So unsurprisingly things that are oil related or hardwoods.
And for the end I'd say labor inflation, probably across the board probably adds another 100 110 million to that.
And then from a <unk>.
Continuous improvement and price standpoint.
We did in this quarter.
In flack to fully covering it and avoiding margin dilution and expect that to be the case through the next two quarters of the year to persist into 'twenty three.
That has us at.
High single digit pricing.
For the year.
And roughly.
Our price being 80% of the price cost equation there.
Turns of of brass you know, what you're referring to mostly is copper copper has been down about 30% somewhat recently.
It will take about six months.
For those dynamics to flow into our financial statements.
And so it may.
Show some signs at the very end of this year, but it will be mostly in early 2023 phenomenon.
You know that that obviously, we would expect to see.
That type of materials deflation starting to hit our financial statements are a part of next year.
Okay, and then if I'm doing my math correctly it looks like.
China plumbing might've been down like 40% to 50%.
Sure.
15, sorry.
I I I I take it that is the primary driver weighing on your new guide for revenue growth in plumbing and then you know you all are maintaining a and elevated op margin guide for 'twenty two in.
Plumbing as a whole, but you know it's been you know well over a decade since the last downturn I'm just trying to get an idea of how we should think about decremental operating margin potentially whether theres been any real shifts in the plumbing industry or your business.
That might soften that decremental op margin.
No.
You know, we would expect all of our businesses plumbing included water innovation.
To be very proactive in managing their business, if there were to be a downturn.
I'd tell you as a team we.
We would be trying to be.
No worse than 20% decremental margin that we've been working to beat that but.
That's really not the dynamic playing out in one renovations right now, but the change. The guide is just as you stated it it's China. It was down 50% in the quarter, it's probably going to be down 10% to 20% for the year. That's the primary driver of the updated guidance to the water innovations group I think the.
There are two forces that are worth noting as you are probably getting about 40 basis points on a consolidation basis, but it's a water innovations level closer to a point or point and a quarter that is FX driven.
And then it's the one area. In addition to our security business, where we would expect the destocking to be playing out in the back half of the year.
If you really look at something like like in the quarter wholesale P O S.
Plumbing, you're talking high single digits and you're talking.
Very robust a P.
T O S across most of that business and you're just seeing channel partners trying to get ahead of uncertainty with Destocking, you're seeing FX and Youre seeing China saw the.
The water innovation business is very healthy.
China is a market we like long term.
China is a market that's going to grow at or above U S levels for us its a profitable market is a great place for us to innovate because.
We have a we're much closer to the route to market and the consumer or we can get new product into that market sooner and that team has done a great job as much as they've had the headwind you read about in China, they've offset.
The sales headwinds they face with expense management in China. So.
Yeah, well, we'll navigate China through at least this year if not into the very early part of next year, but China is a market we like.
And there's nothing going on with the water innovations business that really kind of changes the dynamic of growing above market and having really strong operating margins. So that's what we would expect going into next year.
Okay.
I'm sorry.
Pat just for clarity the 20% decremental op margin that's kind of for.
The new Fortune brands correct.
Yeah.
I'll speak for Dave Banyard, and its future state, but I'm going to assume that he is he's got to manage the business aggressively like we do and also be working to have a very attractive decremental margin that certainly beat as contribution margin. So you.
I'm sure, we'll talk more about that maybe on Investor day, but I would expect all of our businesses to be managing that way through the uncertainty we face the balance of this year. The early part of next year.
For sure.
We're sort of working we don't know what if scenarios or worst case scenarios in your to answer your earlier part of your question is is the structure of the business different than it was in a way. The answer is absolutely I mean lessons were learned business was rebuilt in a far more flexible way and I'd point you to Q2 of 2020 as the proof point when you compare.
Pair that decremental margin to the decremental margins, we saw in Norway.
Night and day different and yet.
Speed at which we had to respond in 2020 with Tenex Foster than it was back then.
And so you know do that because it seems great, but because we bought the tool over that time in both the flexibility to be able to do it so in the structurally very very different.
Perfect. Thanks, guys for the time.
Sure.
Thank you and our next question comes from John Lovallo with UBS. Please state your question.
Hey, guys. Thank you for taking my question. The first one is you know pricing has obviously been a really solid lever and there hasnt been a trade down to date that doesn't you've spoken of but do you get the sense that we might be approaching that pivot point, where consumers start kind of going for a lower end product.
Yeah. It's.
John It's a great question I mean, we've certainly seen it in the consumable categories right I think you're hearing about it in other categories, where you might have a trade downs in a daily consumables that consumers view as fungible.
But these are projects that they you know they research and Theyre going to live with for a long long time, and so you know we haven't yet we haven't seen consumers move Austin I think.
The earlier question about discretionary but are we seeing kind of a premium price trade down across the portfolio. We're not seeing parts of the portfolio that are premium to luxury I continue to be very very strong and so you know at least for ipsen to this point I think consumers are choosing to.
To invest in these categories and they're going to choose you know quality and innovation.
And brand you know over.
We are compromising on the trade down no I am glad that inflation as it turned out to be more predictable than it was.
<unk> 12, or so months.
Now I'd be more predictable is also starting.
Starting to moderate and so you know the consumer I think it's going to have an easier time of it and I think that's just not positive for the health of the consumer but all through this process I mean, as we've had to take price we rewarded the consumer with branding and innovation and the net net has been that we've taken price and taken share and you know that.
Says that equation has been in the favor of the consumer they're not in our favor and they're rewarding us with more share notwithstanding the fact that we're taking price. So we'll be measured about it going forward, but we completely believe and are committed to the price that we've taken and then we've rewarded the consume return and that we can build from here.
Great. That's helpful. And then you've talked about the improvement in channel inventory Tonight I'm curious if you know if you could parse out how much of that do you think is demand moderating versus actual improvement in the supply chain or labor availability.
Yeah, I'll start and Pat May have some more color, but I think it's it's much more the latter so.
You're having.
Certainly in a much higher levels of supply chain performance, which allows people take some safety stocks I think thats a measure of it and then you are having some come out as Pat said.
Where we're seeing wholesalers as they take inventory down in anticipation of softness that may come, but we're not yet seeing that necessarily through Pos right and so you know we talked a little bit about inventory management, that's where we're using our category insights to also work with customers to say Hey, you don't want to be at.
Where you don't have enough inventory to even service levels. So I think there is an element that can come out just because service levels are so high right now because we've invested heavily in service and working capital, but until you actually see that demand slowdown I would be.
Careful at.
At the channel level not to not to go to FID.
No I would concur I would say that.
To date, it feels mostly like people getting ahead of what they perceive as uncertainty that will go in a certain direction.
Got you. Thank you.
Thank you.
And ladies and gentlemen, that's all the time, we have for questions today.
And that concludes today's call. Thank you for joining our conference call. You may now disconnect have a great day.