Q3 2022 Fortune Brands Home & Security Inc Earnings Call
Good afternoon, My name is Donna and I'll be your conference operator today at this time I would like to welcome everyone to the Fortune brands third quarter 2022 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 you May press star one on your telephone keypad, if he would like the opportunity to ask a question if.
If you require operator assistance during the event. Please press star zero on your telephone keypad I will now turn the conference over to Mr. Dave Berry Senior Vice President of Finance and Investor Relations. Thank you. Sir. Please go ahead.
Good afternoon, everyone and welcome to the Fortune brands home and security third 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. B 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.
Based on current expectations and market outlook and are.
Subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated.
These risks are detailed in our various filings with the SEC.
The company does not undertake any obligation to update or revise any forward looking statements, except as required by law.
Any references to operating 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.
Joining me on the call today are Nick Fink, our Chief Executive Officer, Pat Hallinan, Our Chief Financial Officer, and Dave Banyard President of our cabinets business.
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 our call today, our teams delivered a very strong third quarter with 20% EPS growth and improved margins across all segments.
Shifting demand landscape.
During the quarter, we saw a softening in U S single family, New construction and R&R is the federal Reserve's continued action on interest rates started to have its intended effect on housing demand.
We remain strong believers in the medium to long term market opportunity underpinned by attractive demographics, and a significant shortage of U S housing.
Our third quarter results demonstrate both the strength of our portfolio and the team's ability to deliver results regardless of the environment.
Despite these increasing challenges we once again made operating margin progress each segment versus last year.
We expect second half margin expansion versus the first half of the year inclusive of our digital investments are.
Strong performance demonstrates our ability to outgrow the market increased margins and make focused strategic investments and the challenging macro environment.
We are expecting a soft start to 2023 and are focused on driving outperformance, while executing a tight set of strategic priorities.
We remain strongly positioned and are well ahead of schedule in executing our planned separation into two world class companies. Our teams are working hard towards finalizing the separation before the end of this year.
I've invited Dave Banyard, who will continue to lead the cabinets business following the separation to join the call today.
Dave will provide an update on the progress with the separation and give his perspective on his teams transformational work as well as the exciting potential for the cabinets business as a Standalone company.
Thanks for joining the call today.
Turning to our third quarter performance, our teams delivered impressive results in a shifting macro environment, including 20% EPS growth versus the prior year.
Sales grew 3%, reflecting strong price realization offset by the continued normalization of channel inventory, coupled with comping against an exceptional third quarter of 2021.
As the unprecedented supply chain and demand environment of the Covid years begins to dissipate on the tree.
Basis, our three year organic sales and operating income CAGR of 10% and 17% respectively are proof points of the sustainable long term value created over this period.
Importantly, our consolidated operating margin was up 150 basis points over last year with each segment, making year over year operating margin improvement pricing.
Price and continuous improvement outpaced inflation in the quarter and we continue to invest in key strategic priorities such as our digital transformation.
Our digital initiatives are already yielding tangible results, including increased e-commerce sales improved app ratings and accelerated the procurement savings.
Our results are further testament to the strength of our brands the hard work of our teams driving transformation and the power of our fortune brands advantaged capabilities.
While our third quarter results were impressive we are facing increasing headwinds from shifting consumer behavior and response to housing affordability and macroeconomic uncertainty.
The fed's tightening monetary policy is having the intended impact on capital goods, including housing rising.
Rising interest rates are impacting single family, new construction permits and starts activity in our wholesale and retail channel partners Destocking inventory as customer traffic slows and lead times normalized.
The pace of impact is accelerating and we are revising our full year guidance to reflect the current environment.
We've managed through similar headwinds before undertaking thoughtful yet decisive action to protect our business are prioritizing investment in a tighter set of key strategic priorities to win for the long term.
Pat will provide more detail later in the call on how we intend to manage the P&L and balance sheet for an anticipated period of softness while protecting our long term growth and market leadership positions.
We constantly challenge ourselves to do better regardless of the macro environment.
We recently announced a redesign of the new Fortune brands organization, which will better position us to realize the many opportunities to drive growth and margin progression at an accelerated pace.
At the center of this exciting evolution, we are transitioning from a decentralized structure with separate businesses to a more aligned operating model that prioritizes activities that are core to brand innovation and channel Undershirt pfeifer.
Additionally, we have aligned all of our global supply chain resources under Ron Wilson, as our chief supply chain officer to fully leverage the scale and execution excellence of our total business pursue operational focused structure will better align the company's resources with our growth and productivity priorities following the separation.
This organizational redesign increases our ability to leverage best practices across the whole organization.
We will be able to further leverage before she brings advantage to drive increased productivity and capture additional growth at higher margins.
We look forward to unveiling more of this advantaged strategy highly anticipated investor day expected to take place in December 6th at the New York Soccer Strange we hope that you can all join us.
As is well documented there's a fundamental long term need for housing in the U S has a deficit of millions of homes exist in the current age of homes today remain at or near multi decade highs.
We believe the importance of the home remains as strong as ever as consumers continue to invest in party areas of the home, including the kitchen bathroom and the outdoors.
Our portfolio is targeted at the heart of the market is exceptionally well positioned to navigate the challenges ahead and capitalize on consumers' continued desire to upgrade their humps.
Ah Brainpower innovation and best in Class service provides a unique value proposition that greatly resonates with the consumer and our channel partners.
These attractive attributes coupled with market leadership positions and advantaged channel exposure will provide stability and opportunity as we proactively manage the business through the near term macro environment.
Now I will turn to each of our segments to provide some color on what we're seeing.
Beginning with water innovations sales were down 14% in the quarter as channel inventory reductions and soft China market more than offset mid single digit Pos growth in the U S.
Upgraded melon and house of ROHL showroom displays are driving double digit Pos lift and our investments in brand and innovation continue to resonate with consumers and customers.
In our core U S market channel Destocking accelerated ahead of our expectations during the quarter and is continuing into the fourth quarter.
In addition to continued destocking at our major customers down channel inventory held at production Plumbers boulders and smaller wholesalers grew as lead times extended.
As our service levels recovered and construction and consumer activity slowed. This additional inventory has started to work its way out of the channels at an accelerated pace.
In China, economic and pandemic headwinds continue with new construction activity down almost 40% year to date.
Our team is doing an outstanding job right sizing our cost structure relative to the demand environment in China, and we remain positive on the opportunities for further innovation and long term growth in this market.
It is important to note that while the water innovations topline has been impacted by inventory destocking in China over the last two quarters U S. Pos has maintained mid single digit growth throughout the period. Additionally.
Additionally, the segment has delivered a three year organic sales CAGR in the high single digits, while expanding year to date operating margins by nearly 300 basis points over 2019.
We expect the Destocking dynamics to normalize in early 2023, and our sell in should approximately equal our sell out.
Notwithstanding the topline challenges our water innovations team took action in the quarter to preserve operating margin and delivered 10% decremental margins, resulting in third quarter operating margins of nearly 25%.
We continue to prioritize strategic investments, including the purchase of Echo lesa, and its leading smartwater and valve technology.
The business remains well positioned to outperform over the long term through strong brands innovation and industry leading service.
Turning to doors <unk> security business sales grew 6% driven by a powerhouse therma true brand, which grew at strong double digits.
It's one of the most recognized build their brands in housing they're mature continues to convert homeowners to advanced material fiberglass door systems from traditional would still alternatives.
Barton sales grew mid single digits as we continue to capture synergies as we integrate liaison offerings with the rest of our outdoor portfolio.
Security sales were down mid single digits, driven by retail inventory reductions, partially offset by commercial sales growth.
<unk> sales were down low double digits as Destocking continues in the wholesale channel while retail Pos remained positive during the quarter.
We continue to believe the value proposition of material conversion will drive long term secular growth in composite decking.
After some security operating margin was 16, 1% and improved 70 basis points sequentially, and 50 basis points versus prior year as price and cost actions continue to more than offset inflation.
Finally, our cabinets business delivered another exceptional quarter with sales growth of 20% because that transformational efforts continued to deliver and pricing actions become more fully realized in the P&L.
Our service levels and product offerings have enabled continued share gains across the channels.
Business will continue to work down excess backlogs through the fourth quarter and expects to end the year at normal levels.
Cabinets operating margin was up over 400 basis points versus prior year price and cost actions more than offset inflation and our team is strategically positioning the business to enter 2023 as a standalone public company with a cost structure that reflects the macro environment.
The transformational work continues as master brand drives this lean culture through its operational and supply chain strategy.
Cabinets tremendous results. This year are the product of several years' work to re platform their business into a world class performer.
The transformation is remarkable.
We believe there are still plenty of opportunities to pursue further value creation following the separation.
Our stakeholders should be excited about the increased agility resilience growth and profit potential of this market leader in its future journey ahead.
Summarize, it's been a strong quarter and our value creation algorithm remains fully intact.
In 2022, we expect to deliver another year of above market growth and margin progression even in the face of multiple headwinds.
We are already taking action in anticipation of softening demand and are laser focused on maintaining our margin journey and driving cash generation.
We'll proactively manage through the short term and are actively positioning both new fortune brands and master brand to win for the long term with above market growth and higher margins overtime.
We are well prepared to face any future challenges and we'll work to deliver on our commitments to all of our stakeholders.
Before Pat addresses our quarterly financial performance and financial guidance update in greater detail.
I would first like to turn it over to Dave Banyard to give his perspective on cabinets progress towards the separation and provide some insight into the transformational journey. He has led over the past three years.
Dave.
Thanks, Nick it's great to be joining you hear on today's call I. Appreciate the chance to provide you all with an update on the separation and highlight some of the exceptional work that the cabinets business has accomplished.
Youll see why I'm proud of our current performance, but I'm equally as excited about master brands future.
As Nick said, we're progressing well ahead of schedule on the separation.
<unk> is diligently worked to develop the infrastructure required to be an independent publicly traded company, which includes building on our current leadership team and adding key roles.
Our search for the best talent extends to Master brands future Board as we're finalizing a world class independent and diverse board of directors.
As we prepare for the separation, we continue to make progress on our strategic transformation, which began three years ago.
Master brand has a great history as a market leader, but there was an opportunity to improve.
Our culture of continuous improvement part of what we call. The Master brand way focuses on efficiency and the best use of our scale, which has allowed us to both increase manufacturing flexibility and improve margins.
We continue to better align around customers and channels with products, specifically tailored to the needs of each part of the market.
This realignment has improved service levels increased customer satisfaction and delivered stronger financial performance.
These improvements were made during times of immense disruption to global supply chains and labor markets as demonstrated performance in challenging times gives us confidence in our ability to deliver as market conditions change.
Because of our strategic transformation, we've already aligned the cabinets manufacturing network in anticipation of the future demand environment, and we have flexibility to adjust further as market conditions change.
This flexibility will help preserve financial performance and allow us to continue to invest in our strategic initiatives, including in areas, such as digital and E Commerce, which will help drive incremental future growth.
I look forward to showcasing more operational success stories from our strategic transformation and details of our strategy at our upcoming Investor day.
Speak for the entire team when I say, how excited we are knowing the best days of Master brand are ahead of us.
I'll now turn the call over to Pat.
Thanks, Dave and thank you for joining the call today.
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 third quarter results sales.
Sales were $2 1 billion up 3% and consolidated operating income was $335 million up 14%.
Total company operating margin was 16, 3% an increase of 150 basis points.
P S were $1 79 up 20%.
Operating margins in the quarter improved in each segment as price and cost actions more than offset inflation.
Our third quarter sales growth reflects a challenging topline comp from a year ago.
Greater than anticipated channel Destocking.
Softness in China, and decelerating U S new construction and R&R activity. Our teams did an exceptional job managing expenses amid this dynamic demand environment to deliver strong margins in all segments and exceptional EPS growth.
Looking forward, we are committed to delivering a healthy and robust long term future for what will be two strong independent public companies.
We are keenly aware of the impact that the rapid rise in interest rates is having on the consumer in the near term.
We are acting now to maintain our strong margin focus and to convert inventory to cash as pandemic inventory cushions are no longer merited.
We have successfully navigated slowdowns before and have the experience to deliver results against any market backdrop.
Now let me provide some more color on our segment results beginning with water innovation.
Sales were $635 million down $106 million or 14%.
And also down 14%, excluding the impact of foreign exchange in our Aqua Louisa acquisition.
Sales were impacted by Destocking across all North American channels.
Continued market softness in China.
And a change in U S, new construction and R&R activity in the quarter and.
Importantly, U S. Pos was up 5% in the quarter.
Operating income was $157 million down, 6% or $11 million operating margin was 24, 7%. The result of better price realization and proactive expense management in both North America and China.
The team proactively manage the business to deliver an impressive 10% decremental operating margin.
As our Pls performance indicates consumers continue to gravitate to Mullen as the leader in the future of water in the home.
And the house of ROHL continues to delight consumers with its collection of artisan brands.
Our recent acquisition of Aqua Liza reflects our commitment to invest in leading secular innovation to support continued above market growth.
Turning to outdoors and security.
Sales were $560 million up $32 million or 6%.
5% adjusting for foreign exchange and acquisitions.
<unk> sales were up strong double digits driven.
Driven by higher price and continued material conversion tailwind.
Larson sales were up mid single digits in the period driven by price Larsen continues to work with sort of a true to achieve synergies as the two market leaders innovate offerings together across channels.
Decking sales decreased low double digits in the period.
Destocking in the wholesale channel continued throughout the third quarter.
Has continued into the fourth quarter. Our teams are working with channel partners to right size wholesaler inventory, we expect wholesale inventory adjustments to be complete by early 2023.
Retail Pos remains strongly positive in the quarter, we remain very confident in our long term conversion opportunity from traditional wood products as we have seen a similar conversion to advantaged materials play out over decades that third material.
Security sales were down mid single digits in the period strong commercial and connected product sales, partially offset retail destocking and softening sase demands.
Master lock remains of high visibility brand through which we can drive long term growth via the next evolution of safety and connected security products.
Outdoors and security segment operating income was $90 million up 9% or $8 million and segment operating margin was 16, 1% up 50 basis points.
Turning to cabinets.
Sales were $858 million, an increase of $142 million or 20% driven by price.
Stock cabinets grew in excess of segment performance, while make to order grew mid teens.
During the second and third quarters cabinets benefited from a strong backlog and orders during the fourth quarter, we expect to work through the excess backlog and for typical seasonality and market conditions to be driving revenue by year end.
The team continues to take proactive steps to prepare the business for 2023.
Operating income was $119 million up.
71% or $49 million.
Operating margin was 13, 8%, representing a 410 basis point improvement over last year.
This margin performance is indicative of the team's transformation efforts and we expect a similar year over year margin result, during the fourth quarter the.
The cabinets team has done an amazing job improving the competitiveness and margin production of the business.
As a public Standalone company. This team is poised to unlock even greater potential.
Turning to the balance sheet.
Our balance sheet remains strong with cash of $345 million.
Net debt of $3 billion.
And net debt to EBITDA leverage at two two times.
We finished the quarter with $537 million of total liquidity on our revolver.
Since the end of the second quarter, we have repurchased approximately $75 million in common stock, including $36 million within the third quarter.
Year to date, we have repurchased approximately $580 million in common stock, we remain committed to efficient and effective cash and balance sheet management.
Among our top 2023 priorities are maintaining a margin strength and converting our working capital investments to cash.
As mentioned earlier, the fed's interest rate actions are producing the intended outcome.
Near term slowing of consumer demand for capital goods, including home products.
While we delivered a strong third quarter and our execution. This year is commendable in the face of numerous headwinds.
We are seeing U S, new construction and R&R demand softening and continued channel destocking.
With these market factors in mind I will now provide an update to our 2022 guidance.
Our full year 2022, global and U S market outlook has been revised downward based on the factors outlined in my preceding comments.
Our global market outlook now reflects growth of 2% to 4%.
With the U S expected to grow 3% to 5%.
Within the U S. Our expectations are for single family, new construction to grow between down, 1% and up 1% and.
And R&R to grow between 4% to.
To 5%.
Given the changes to our market outlook, we have reduced our full year net sales growth guidance to four 5% to five 5% to reflect our strong year to date results offset by a softening market environment.
We remain committed to achieving Oi margin expansion this year and beyond and are targeting around 50 basis points of margin improvement, resulting in an operating margin of around 15% for 2022.
We are updating our 2022 EPS guidance to $6 26.
$6 30 per share to reflect the softening market and continued inventory destocking.
On a segment basis, we now expect for 2022.
Water innovations net sales down 5% to 6% with operating margin around 24%.
Outdoors and security net sales growth of five 5% to six 5% with operating margins of 14, 5% to 15%.
Cabinets net sales growth of 14% to 15% with operating margins of 11.5% to 12%.
This updated EPS outlook for 2022 includes the following assumptions.
Corporate expenses of about $130 million.
Including digital transformation investments of around $20 million and separation costs of up to $15 million.
Interest expense of $122 million to $124 million.
A tax rate around 24.5% to 25%.
And average fully diluted shares of approximately $131 million.
As our sales forecast reductions have occurred within supplier lead times and transit times have shortened materially.
Inventory levels remain higher than previously targeted.
As a result.
We expect 2022 free cash flow of approximately $400 million to $450 million.
Our free cash flow forecast includes capital expenditures of $250 million to $275 million as we adjust the rate of investment to reflect current market conditions, while continuing to enable future growth.
As we look to 2023, we acknowledge the impact housing affordability and macroeconomic uncertainty is having on the consumer.
It is not prudent to provide 2023 guidance today. However, today, we can share.
We are preparing for our 2023 characterized by a global market decline of low to mid single digits with the first half more challenged in the second half.
Our teams are preparing to drive industry, leading margin performance, including decremental margins should a global market decline occur.
Also our teams are focused on converting inventory to cash rapidly without compromising supply chain resiliency.
If 2023 market declines are mid single digit or better we expect to deliver decremental margins between 20% and 30% depending on the magnitude of market change in pace of inventory reduction by quarter.
Given our business model improvements.
And recent and pending efficiency actions, we expect 2023 to be another proof point, demonstrating our margin performance strength.
In summary, our strong quarterly and year to date results are reflective of what will be two strong companies focused on leveraging unique advantages.
Powered by brand innovation and channel in the case of new Fortune brands.
<unk> continued transformation and operational excellence at Master brand.
With both companies driven by an advantaged global supply chain and a focused organizational realignment.
Both companies will have strong balance sheets and ability to enhance returns via capital allocation.
Further both companies have strong cultures and commitments to strategic priorities prime to unlock a new level of earnings potential.
I'll now pass the call back to Dave Barry to conclude our prepared remarks and open the line for questions Dave.
Thanks, Pat that concludes our prepared remarks on the third 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 the floor is now open for questions. If you would like to ask a question. Please press star one on your telephone keypad at this time a confirmation tone will indicate your line is in the question queue. You May press star two if he 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.
Again that is star one to register a question at this time.
The first question today is coming from Adam Baumgarten of Zelman <unk> Associates. Please go ahead.
Hey, good afternoon, everyone.
I guess my first question is about maybe Nick if you could touch on the current demand environment out there and maybe some color on how the business performed throughout the quarter that would be really helpful.
Sure happy to Adam.
If you look at the demand environment in the quarter you certainly saw.
Flexion point inside of the third quarter, you said the macro housing data. So as you well know we are pulling orders turned sharply negative.
Starts have been on a downward trend.
So as we look out through the year, we'd expect single family new construction to be roughly flat.
Probably first half next year down.
In the second half of this year down.
I was wondering if you've looked at SC.
In our retail Pos data, which had been remarkably resilient through the course of the year I think notwithstanding.
Some pretty big labs inside of that and post labor day, we saw that come off quite a bit. So I think question remains to be seen how much of that as consumers pulled back how much of that is returned to regular seasonality.
Come off versus last year, if you track it against.
2020, where the back half are still pretty strongest kind of hanging in there. So we'll see as that unfolds as you heard.
My comments in Pat's comments here, we will plan.
For it to be challenged as we go into the first half of this year.
But you could definitely see that step up is.
You got into the.
Kind of post labor day environment, So as we think about that.
The question for Us is really.
We know the long term backdrop is excellent for housing right and we know all the fundamentals youre well versed in them.
And so how do we manage the business to continue to be set up to grow and take share in both incredible brands over the long run to take us through this short term headwind.
Your lover.
Around that we will operate in a very lean.
Very tight P&L management way, but we will not compromise on the key strategic investments, we need to make things like digital in order to continue to be healthy and win in the long run and we believe we've got the leverage to do that I think that the margin performance. This quarter demonstrates that you've seen us do it in the past and we'll do it in the future. It will continue to drive.
Above market topline performance and industry, leading margin appreciation. So that's really the flying formation as we look at this data we look forward and build a plan to kind of get through the short term headwinds.
All the good stuff is coming in the longer run.
Great. Thanks, and then.
Maybe on the water innovations margins really quite strong in the quarter.
Maybe some more color would be helpful. On how you were able to keep margins. So elevated in the face of volume deleverage input cost headwinds.
The incremental or I should say decremental margin profile of that business is maybe different than what you outlined for next year because of some of the actions you've taken.
Yes.
Kick off and then Pat will give us some specifics I mean, I'd just say philosophically.
I will touch on some of the.
As you think about some of the transformational changes we've made to the way we operate the business, we're really leaning more and more on our scale and our ability to drive excellence.
Throughout the organization and take our capabilities and drive them and did you get that scale player you get a lot more flexibility and levers throughout the business and so you're seeing business there.
That has had headwinds obviously from China I think eventually those will come round hazards to important part of the Chinese economy over time and a lot of inventory Destocking you briefly summit, which we hadn't seen was sitting at the production schlemmer, not just where it traditionally et cetera.
But he is able to respond to that environment continue.
Pos and invest behind that.
But act very rapidly to manage its cost basis with a tighter set of strategic priorities I would say, but.
But still investing in.
And then managing for for the future and so with that and partially mix.
As you've got a bit less China, which is still.
Just as a reminder, still double digit.
Income margin, but less in the U S. You've got some mix effect in there, but really putting on these levers going on to manage the business types of shared priorities and that's what's leading to this kind of margin performance.
Give me more color yes.
Kind of put into perspective, how we got from the <unk>.
Teens low <unk> to the mid <unk> and that is two fold a lot of the fortune brands capabilities around procurement.
Leverage.
Design for manufacture ability and design for value add.
And revenue growth management, along with SG&A leverage have been in combination the key and taking that business from a high teens margin business to a mid <unk> margin business and then to your question of how in a time of toughness.
Are we able to preserve the decremental margins in that just people being very perceptive of what's happening in the demand stream and being very quick to react on discretionary SG&A without compromising the key priorities and key among that has been our business in China staying profitable.
Despite a.
A couple of quarters, where they're down around 25%. So that's been the key to that I think.
Longer term as we look into next year, while we have a broader range is as we do right size inventory, which we haven't done enough of it yet.
We're going to have a different overhead absorption dynamic go through the system as we right size inventory and so.
And when we get towards the end of the year and we're providing the.
The detailed guidance for 'twenty, two we can narrow that range a bit but thats the difference between what youre seeing in the current quarter and what you would see on a full year basis for 'twenty three.
Got it thanks best of luck.
Thank you.
Thank you. The next question is coming from Mr. Wang of Jefferies. Please go ahead.
Hey, guys. Congrats on good results in a choppy backdrop.
My question for you Nick I've always thought of fortunate as a decentralized model obviously work for you guys quite well the results speak for themselves. The news on the realignment on the org structure help us understand the thought process on why now and what that lock unlock and also any color on the cap structure anticipated dividend from the spin.
Okay I'll take the first part and I am sure. They ran a little bit on the second part and I'll take the first part the first part first so why now and then I'll talk a little bit about what we're doing.
Why now.
So and I appreciate the comments on the quarter.
We pride ourselves and acting with urgency.
It's a big part of our ethos agility is one of our few key values and as you look actually at data around companies.
That has gone through separations and spins.
There's actually some fascinating about companies that move to reorganize themselves well ahead of the separation date outperformed the market over time and I think it sort of speaks to the culture, but also getting that fly information into place early and then out of the gates as you go and so that was for the timing.
The overall structure and you're right the <unk>.
Centralized structure has served us very very well over time.
Over the last two years, you've seen us introduce a fortune brands advantage across the portfolio, we've been able to get a lot of value out of that taking sort of key areas that could really drive incremental value and then leveraging across the portfolio and as we saw that work we could see the effect that you could get value out of doing things.
Across the portfolio.
But we can also see that we could go faster and harder on some of these initiatives.
If we didn't have the structural impediments that we had and so.
Early September we announced the spirit from a decentralized or to have more closely aligned operating model and what do we expect it will be to.
Drive growth right, because youre going to have our best in class capabilities across the whole portfolio, we could see pockets of things, we do really well all over the portfolio.
But being able to do them everywhere is going to drive growth and it's going to drive productivity, because youre going to have better capabilities and less duplication right. So you should get greater productivity, which will help us drive incremental fuel for investment as well as our margin journey.
So that's the that's.
That's the idea behind it.
Sure you are quite a bit more at the Investor day, but we're really excited really excited the organization's energized.
You can already see some of it just taking hold as people grab onto some of these opportunities and the last thing I'll note about it and I think this is a little bit different too. If you don't think you can remove just purely to centralized organizational full matrix organization a lot of these high performing functions.
Punctual areas will now report to me, they're going to report closest to the market, which kind of stays true to that decentralized ethos right sure Pfizer is going to have a global marketing function she's going to have.
Global innovation function.
Engineering function, because they're not needed across.
Kind of a corporate level supply chain everywhere HR everywhere right. So those reporting to me, but we really wanted to drive these as close to the March was possible to retain as agility that you've seen from a decentralized structure. So hopefully we're going to get the best of both boats out of this but as you can hear I'm pretty excited about it.
And Phil in terms of the cabinets capital structure and related dividend.
We're well underway with that.
As we said in the script.
With the press release, we're ahead of schedule and working hard to get everything done this year, including.
The capital structure and related dividend.
We're working with our existing.
Fortune brands Bank group, they have been great and very supportive of this transaction and we're appreciative of that that's obviously been.
A very tumultuous time in the credit markets.
As we've expressed in prior calls we are expecting to pursue all bank financing or mix of our revolver and a term loan a.
And we would still expect the dividend to come out of that to be in the range that we've communicated previously of $500 to $1 billion likely towards the higher side of that range.
We still expect to get that done and get that done this year and to leave cabinets with an appropriate amount of financial flexibility.
To navigate 2023, which you heard us.
Express, we certainly expect some challenges at least the first half of the year, if not the full year.
And then the cabinets business has been exceptional are doing their part.
To drive.
Profit growth and margin, yes, there are likely to finish this year with pre tax operating income in that 390 to 400 ish million dollar range, and then depreciation and amortization, that's probably about $60 million on top of that so their drive to drive.
The profit that supports debt capital structure, and they're doing a great job of it.
And so I think it'll be.
Coming across the finish line much as we expected.
When we talked on the second quarter.
That's great color and just one last one for me on the decremental margins guidance you called out for 2023, Pat It sounds like the front half is going to be probably closer to the top end as you kind of worked through inventory Destocking and maybe as you kind of fine tune your.
This cost profile I guess in the back half maybe on the lower end are we thinking about that right and then certainly you are starting to see your raw fall like that all PBC and hardwood is that something you guys are accounted for is that potential upside from a margin standpoint, thanks, a lot guys.
Yes, I would say youre thinking about it correctly and I think the raws are contemplated within that.
The challenge for us will be.
And as we position ourselves for the longer term market and given the labor market dynamics, how much capacity do we hold on to thoughtfully.
And how quickly do we unwind.
Inventory potentially leaving some capacity less utilized than it might otherwise be and so that's why we have that range and then when those raws flow off our balance sheet and into our income statement will have a better line of sight to what on a perfect line of sight, but a better line of sight three months from now so we'll provide an appropriate upped.
Date, when we provide official guidance, but I think that range is appropriate for now and I think you're thinking of it correctly with it being a bit higher in the first part of the year and a bit tighter the back part of the year.
And Phil I'll, just add onto that.
Cost actions.
To which you referred we will have taken this year right and so reading the same thing here really tried to get off to a as quickly as possible and moved on a number of things this year.
M is to get as much of that into good shape as we round out the year and kind of start next year in a good spot.
Got it got you very helpful. Thanks, a lot.
Thank you. The next question is coming from Michael Rehaut of Jpmorgan. Please go ahead.
Thanks.
Good afternoon, everyone and.
Thanks for taking my questions.
I wanted to.
Zero in a couple of areas first just on the.
Yeah, Walter innovations on the topline and talk about Destocking in China.
Now a quarter or two maybe even where there's a decent amount of contrast between.
The top your topline results and your largest competitor that.
Reported this morning, and it sounds like you.
You had mentioned that Pos.
We're still trending positive.
Perhaps you haven't lost market share, but certainly.
We didn't see or hear of inventory destocking.
As well as the declines in China.
Your reporting.
You know from.
So across the aisle I guess, if you want to say.
So I was hoping if you could just kind of dragged down in a little bit of perhaps what those differences are why why they're occurring and I think you were also expecting quite a moderation of those trends in the fourth quarter.
If you're talking about a full year sales down 4% to 5% I believe you said.
That would imply something in the fourth quarter closer to flat.
Hey, Mike It's Pat I'll start and then maybe Nick will add to the color. So it is certainly unusual for us to report a sales decline in our water innovations business, but I think the important thing is first is the brand healthy and competing in the marketplace and we saw that.
With mid.
Mid single digit positive Pos in the quarter, but I, even I would step back from that and say.
As a business over the three years using 2019 as a basis you are talking about a business that has no by the end of this year, even if you cut it off in the third quarter, but it will be about the same at the end of the fourth quarter up three year sales growth CAGR of about 9% and a profit CAGR of about <unk>.
14%. So the business is performing over the long term I think what youre seeing in the results that are reported in this quarter than in the previous quarter is really more to do with the strength of our supply chain over the back half of 2020, one and some of the unique mixed dynamics of our.
Business.
In the U S and North America broadly, we have really strong share in new construction.
So that business.
There was lots of lots of angst around supply chain hassles and new construction over the last two plus years and that drove a lot of wholesale inventory buildup, even in lower levels of the value chain outside of our main wholesalers of production plumbers and so forth.
And so youre seeing that come out of the system now.
And then in China, we're mostly of our residential new construction business were not a hospitality new construction business in China, and you're seeing most of the pressure of the government is putting on the.
Construction in China is in residential new construction. So I think those are some unique mix elements of our business and I think the unique supply chain strength, we add.
In.
2021 in the second half of 2022, or rather 2020 are whats driving what youre seeing in the second and third quarter of this year. So for example in this quarter alone of our 14 points down 12 points was North American Destocking.
So it's mostly about in this quarter in North American Destocking, but the brand is performing youre seeing that in the past and then your comments to the fourth quarter roughly correct, though recall.
Our.
Our water innovation business and our <unk> businesses have a 50 <unk> week in there. So it's roughly flat to down 1% on a reported basis, but you have about two points in the quarter that that's a 50 <unk> week. So it's more like on a like for like basis about three or four down in the quarter.
And that's a deceleration of the Destocking you are seeing so lots of moving parts there I'd step back and say the brand's performing as you see in the pass the three year CAGR of sales growth and profit is outstanding and a lot of what youre seeing in these quarters in the middle of this year is really the strength.
The supply chain last year.
Yes, well I think Pat now that I mean, I'd say, Mike just.
We've stayed focused on the long term that market outperformance driven nine on the top of the 14 on the bottom that Pat referenced to almost 200 basis points of operating margin improvement over that time that that business has been able to deliver.
As we've always said, we will outperform the market will grow margin we've done it and we continue to do it.
And then just to dig a bit more color on that supply chain.
Different that Pat referenced those service levels, which we're pretty proud we're beating ourselves up a lot of last year, because we were getting like a 70% fill rate and towards the end of the year.
Our biggest customers are telling us the industry average was closer to 40.
You have a huge dichotomy there that allowed us to serve customers and consumers, which is one of them.
Our focus areas.
They were building some inventory downstream to serve builders and make sure that our house never got held up because of the plumbing right and as that slow you see that inventory come out it will correct, but as Pat said, you know, we keep looking to that healthy Pos and know that overtime.
This is a very very strong growth business with a lot of.
Value generation.
As John will continue to do that and then China. Our businesses is large and broad right and so it's going to have broad exposure to the Chinese economy, but as Pat said the teams kept it.
Hospitable and they are amongst the most agile teams, we have and so they you know they will quickly pivot.
To where the growth is going to come as that market starts to settle down now and returned to growth will be there to capture that.
Oh, that's great. Appreciate the detailed answer that that definitely helps a lot and in piecing it together or deconstructing.
Secondly, I just wanted to drill down also on the call.
Comments around 2023, and Decrementals and kind of working off of Phil's question before.
I was little surprised to hear that you know the $20 to 25% Decrementals are inclusive of any.
Likely a raw material tailwind that I think.
You'd likely experience next year.
Are those decrementals, therefore, a little better.
Excuse me than you would normally see in other words I think maybe you've already typically framed the decrementals I wanted to say closer to 25% to 30%.
So maybe if you could just kind of guide me, they're a little bit because if you're talking about full year decrementals in the 2025% range.
And you don't have that raw material lift.
It would seem like obviously, you're talking about margin contraction next year unless there are other factors that.
Would prevent that.
Yes, so Mike I would tell you.
Empower toddlers CES, where the bulk of the.
The market gyrations in the inventory changes or less we would typically probably be aiming for somewhere in the 20% to 25% range next year or one were not giving guidance today and second we're giving ourselves some room to maneuver for the inventory Destocking we've put.
The pandemic broke somewhere on the order of $500 million to $600 million of working capital investment onto our balance sheet, which is pretty considerable considering we started with a base that was around $900 million to $1 billion in total.
And so the reason I'm, saying that there is.
Some.
Raw material deflation held within that is it'll take us a while to bleed off the inventories and get to that raw material deflation that won't be hitting us right away and then when you look at what's really come through the system in terms of deflation year to date, while there has been some.
<unk>.
It's been mostly around ocean freight and.
Parts of ground freight.
Everything else has been pretty modest to date so.
We're not yet in.
What I would call a significant deflationary wave, especially at the rate it's flowing through our P&L, because we have quite a bit of inventory is still on our balance sheet. So all you are picking up there is we have a meaningful amount of inventory to work off the balance sheet next year probably in the.
$200 million to $400 million range somewhere in there depending on how the year unfolds and what's the most appropriate way to manage our capacity and our vendor relationships.
And that will that will affect the rate at which any kind of raw material change impacts our income statement.
Not just that we don't think our business on deflation.
If we see what we see today.
If the global economy slows could there be more expected deflation I think theyre, probably could and as that comes that will be a positive impact probably in the later half of next year as we worked through the inventory that Pat referred to but we got to deal with the set of facts that we got particularly in environment that we've experienced which has been incredibly volatile.
Over the last couple of years, where we wouldn't bake the business on anything and work within what's within our own guests really and the levers that we have to deliver the best result, and so those are the assumptions under which we run.
If things end up being a bit better because of the economy slows foster.
Foster and you see increased deflation come through.
And you know that that.
That won't be a bad thing for the P&L.
Great. Thank you.
Okay.
Thank you.
The next question is coming from Stephen King Kitten, sorry, Stephen Kim of Evercore ISI. Please go ahead.
Yes, thanks, very much guys.
I appreciate all the color so far.
Just on the Destocking issue I was wondering if there was any impact from the euro effect from the new distribution Center that you opened up and then also when you talk about the decremental margins I was wondering whether it would be any meaningful difference or variability across the segments in terms of that 20 to 30 range you gave.
I'll take the first one on impact and touch on the second one.
So as you're pretty astute too to remember that distribution center. So good for you.
I guess, yes in the sense that that distribution center, absolutely allowed us to keep service levels very very high last year that when people are just getting crushed reopened that bigger performed right off the bat at really high levels of both you know moving service levels as well as efficiency.
And you know.
A non factor we've experienced in the posture where.
We were able to provide really.
High service levels, we tend to be the first place that our customers will go well.
They need to manage inventory and so it's sort of no. Good deed goes unpunished Shneur things that's fine you Digest, it and you move through it.
But those service levels in that distribution center would be part of those service levels I think certainly allowed our customers more flexibility.
And I'd say on Decrementals, all businesses will be working.
Towards similar objectives, I think what will differ is how each of them is experiencing demand relative to capacity relative to inventory right sized and quarter by quarter I think that if you see a difference it's because of the circumstances that the business has faced are unique to the business as opposed to they're inherently structurally.
<unk>.
Different or pursuing different objectives.
Okay, Yeah that makes sense.
Talking about the circumstances in the set up next year I believe you kind of gave some commentary about single family. Rajiv I was wondering whether you had a handy way of describing your outlook in terms of single family starts let's say.
And existing home sales.
As you look into fiscal 'twenty, three what kind of ranges are or levels or are you kind of thinking about as you contemplate your guidance yeah. So it all kind of remind you and others.
As always in the new construction side of things just lagged starts three or four months, but for the last three or four years, we've kind of been using.
An average of a lagged starts plus completions to think of it simply as starts lag three months plus completions divided by two is kind of like that are simple algorithm because builders to us appear to be swinging labor between starts and completions.
Well our expectations. This is early days, so we reserve the right to update this as we get towards the end of the year is.
No.
Starts next year single family starts in the U S likely down in that 15% to 20% range.
But the completions because of the backlog somewhere closer to flat I mean could they be down a bit maybe but closer to flat you kind of.
Those two things together and you're you're.
Down like minus 10 ish new construction.
And then R&R somewhere from flat to down low single digits, maybe mid single digits, but low single digits and if you think of just the simple algorithm of our business.
A quarter to a third new construction and the balance R&R.
It gets you to about a mid single digits.
Yeah.
<unk>.
I wouldn't tie it specific existing home sales into that exists.
Existing home sales is one of many variables we look at for R&R.
But thats the simple high level math, we're using right now that kind of gets us around that mid single digits or better because full year with R&R down three it would be pretty will be a pretty significant development certainly think starts will contract pretty.
<unk> the first half of the year just by the order rates we're seeing.
Today is kind of directionally in that same order of magnitude.
Yeah, that's very helpful.
If I could just follow up on that specifically, though on the existing home sales are the EHS.
Across the marketplace. So it seems like there was say across the investing landscape. There is a lot of.
Folks who are focused on the fact that mortgages that are in the installed base. The average rate that homeowners have is much lower than the prevailing rate and so therefore, you're going to have a bit of a locked in effect. That's something that I know folks are very focused on and so that has led people. Some people to think that existing home sales could be down very dramatically.
It was sort of plunging to levels that we have not seen.
Really in the last 20 years and I'm curious if you are sympathetic to that idea or if you believe that.
We should not be too.
<unk> extreme and our views around how low EHS can go and so that was really kind of what one of the things I was hoping you could maybe touch on.
In your comments I, just noticed that 40% of homeowners don't have a mortgage at all another 10% probably you don't have very much better borrowing on their balance and so I'm sort of thinking that existing home sales may do a little better than folks think but I just wanted to get your sense on that.
Yeah, I don't know that I have a specific number in mind like relative to five ish $5 5 million that would normally transact.
I would say is.
We would agree that because of the near term effect.
Mortgages locked in many well below 4%.
That friction is going to exist for part if not all of next year, how low it will plunge that level I don't know, but I will.
To us has often resulted in if people are more committed to the homes are already in because of their mortgages could translate into reasonable set of R&R activity in two thirds of our business is R&R activity. So.
I don't want to say we're indifferent.
One of the many variables that swirling out there.
People staying in their homes is not per se bad for our product demand.
The confidence they have in their homes and how important their homes are in their life, which in a hybrid work environment has certainly changed so.
It's a variable we have our eye on.
But in.
And it will play out, but it could end up playing out to be favorable to R&R. So I don't I don't think we sit here and say it is definitively a bad thing no matter what.
Where we are I, just actually I mean, one of the things that we look at as we pulse.
Consumer interest by Google search.
Home renovation that activity still 25% higher.
Is that it was pre COVID-19 and our latest rates the store got your 25% more.
Activity was not dollars activity around <unk>.
Renovation searches people doing work and.
And so we're quite goes between existing home sales people are in harm's way to renovate those homes.
After 29 trillion.
Homeowner equity and how that might be deployed I think it would be some of the fascinating stuff that we've learned.
Next year, but that consumer interest to us is still very very important.
As you plan to next year and see how this all unfolds.
Yeah. Thanks, very much guys that's really helpful.
Sure.
Ladies and.
Gentlemen, Unfortunately, we have run out of time and this brings us to the end of our question and answer session.
Thank you for your participation and interest in Fortune brands you may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.
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