Good afternoon. My name is Kelly and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Home & Security Fourth Quarter 2018 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. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin your conference call.

Good afternoon, everyone and welcome to the Fortune Brands Home & Security quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress during the fourth quarter of 2018 and provide our 2019 guidance. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investor section of our FBHS.com website. I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and our market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC such as our annual report on 10-K. The company does not undertake to update or revise any forward-looking statements which speak only to the time at which they are made. Any references to operating income, earnings per share or cash flow on today's call will focus on our results on a before charges and gains basis for continuing operations, with the exception of cash flow unless otherwise specified. With me on the call today are Chris Klein, our Chief Executive Officer; and Pat Hallinan, our Chief Financial Officer. Following their prepared remarks, we've allowed some time to address questions that you may have. I will now turn the call over to Chris.

Thank you, Brian, and thanks to everyone for joining us today. In the fourth quarter our sales growth in the overall market slowed. Despite the market, we made clear progress in our Cabinets business and saw continued strong results in Plumbing and Doors. In general, however, consumers and channel partners adopted a more cautious stance at year-end and did not order at a typical rate period heading into the New Year. Concerns over trade wars, interest rates in the housing market itself had a clear impact on demand. While we did not factor in the magnitude of the second half housing market pause earlier in the year, we now understand the key drivers and expect that the tax through the system over the next six-month and project a modest increase and second half growth. I will have more to say on the market and our outlook in a moment. In 2018, our teams executed at a high level during a volatile year. Sales grew 4% and our operating margin was 12.8%. While these results were below our initial expectations, we made significant strides across the company to address market and industry challenges and consciously increased our exposure to a more stable and predictable segments of our markets. These actions reduced our fixed costs, significantly reduced our exposure to a potential 25% tariff and set us up for improved financial results and growth in 2019 and beyond. We'll give more detail on these actions directly from the division presidents and our operations leader at our Investor event in Boston next Wednesday. On top of the changes we made inside of our businesses, we also delivered incremental growth during the year as we spent $470 million on the Fiberon Composite Decking acquisition. Repurchased $695 million of our shares and again increased our…

Thanks, Chris, and good afternoon. As Brian mentioned, the best reflect on-going business performance, the majority of my comments will focus on income before charges and gains from continuing operations. Let me start with our fourth quarter results. Sales were $1.4 billion, up 3% from a year ago despite a softer second half market which impacted all of our business. Consolidated operating income for the quarter was $181 million, down $5 million or 3% compared to the same quarter last year. Consolidated operating margin declined 70 basis points to 12.7% as lower volumes, inflation and onetime items insecurity impacted margins. EPS were $0.86 for the quarter and grew 8% versus $0.80 same quarter last year. For the full year EPS were $3.34 versus $3.08 last year, increasing $0.26 or 8%. These results were below our plan and expectations and reflect a market that was significantly softer in the second half of the year than we anticipated even 90 days ago. As we enter 2019, all of our businesses are prepared to manage expenses and capital tightly, during what we expect to be a soft first half. Certainly, they’re focused on growing in the most promising portions of the respective markets. Our 2019 expectation is to grow above market and drive margin improvement and we are well-positioned to do so. Now let me provide more color on segment results. Our Plumbing sales for the fourth quarter were $488 million, up $19 million, or 4% driven by strength in U.S. wholesale and China. Acquisitions and FX roughly offset each other with each having roughly a one point impact on sales. Operating income increased $11 million to $109 million, up 12%. Operating margin for the segment was 22.3% an extraordinary resulted driven by excellent management of inflation and expenses as the market softened…

Thanks, Pat. That concludes our prepared remarks on the fourth quarter of 2018 and our full year 2019 outlook. We will now begin taking a limited number of questions. [Operator Instructions] I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

[Operator Instructions] Your first question comes from the line of Susan Maklari from Credit Suisse. Please go ahead. Your line is open.

Thank you, good afternoon.

Hi.

I guess, to start out with given all the perspective that you have, can you just talk to what you guys are seeing in the market. We've, obviously, had a lot of crosscurrents as it relates to the new home side of the market, the consumers. So I think maybe your perspective in terms of what you've been seeing could be really helpful?

Sure. On the new construction side, I'd say we saw some softening in the third quarter and when we last to talk to you 90 days ago, we obviously revised down the outlook. It fell off more significantly in November, December, which I think is pretty widely understood now. And I think we just saw a consumer pullback out of the market both on the new construction side and on the existing housing stock turnover side of the market. And if you look back and if you look at where interest rates were coming into September from that point up through middle of November, they moved up an incremental 50 basis points. You saw a cumulative impact of a lot of housing inflation really hit kind of tipping point into October, November. And so you saw the consumer pulling back, equity markets pulling back. It hit that side of the marketplace. R&R bridges that remain somewhat resilient, although it came off as well. So I'd say we say R&R weaken in the quarter as well. So we took all that and as we were building our plans for 2019 given that we lag especially new construction side, we approached the marketplace for 2019, I'd say in a -- I don't know if I’d say sober or conservative way, I'll chose sober. So I think we kind of came into the year and assume that some of the carryover effect of the new construction side will carry over into the first half or especially the first kind of three, four months of 2019. So, really kind of a flat very modest growth in the construction side. R&R probably continues to be a resilient, but at little softer pace 3% to 4% for the first half. And then we think the market…

Yeah. No. That's very helpful. And I guess just as a follow-up there, you made a lot of progress in 2018 in terms of the pricing really kind of across all segments of the business. As we think about this lower growth environment how or what do you think your ability is the kind of retain and hold onto a lot of the progress that you made last year? And then, I guess within that to, can you talk to some of the benefits that maybe you can see as we move through 2019, as it relates to some of the commodities coming off? And could that possibly be somewhat off an offset?

Yes. I'll take the first part and then I'll let Pat give a little more detail. I think we talked about pricing last year as, again, taking a lot of small bites of the apple. And so that served us well as we brought it through. And I'd say, it was pretty sticky what we've taken on both in terms of pricing and reduced promotional levels. And so, not concerned -- Pat will give you more detail on our outlook on commodities. I think we are in a very good sport a relative to the pricing we took the cover off on the communities we saw. On tariffs, we've planned for and absorbing the 10% level and we're planning on having to address the 25% level. Obviously, it's been suspended for now, but again back to our real sober look at the marketplace we are anticipating, if it's going to hit us on March 1, we will take actions to offset that even in the slower-growth environment. So Pat, maybe you want to give a little more detail on commodities in general.

Yeah. One, on pricing and then I'll go to the commodities. I would say as we addressed the inflation of 2018, we did with supply chain and price and the pricing most of that was not per se tied to tariffs scenario. So we don't expect pricing to erode as we ahead into 2019 in any way shape or form. As I reflect on 2018, we had roughly $90 million of inflation hit our P&L in 2019, about $70 million of that was material inflation inclusive of tariff pressures and not just the 10% 301 tariffs, but plywood tariffs and steel and aluminum tariffs earlier in the year and the balance of that about $20 million was freight and logistics. And we covered it with apply chain actions – supply chain actions actually offset considerable parts before that hit our P&L. Like just for example at 10% tariff has roughly on an annualized basis $50 million impact to our P&L, but we offset three-fifth of that for the supply chain action before it ever came out. As we look into 2019, you have a wide range of potential inflation scenario depending on what happened with any additional tariffs. So I would say without, a 25% tariff, we're looking at $55 million to $60 million of inflation, or call it roughly $0.30 of EPS with $20 million to $25 million of that be in freight and logistics and probably $10-plus being just continued adjustment to the realities of the new plywood market as we shifted materials and supply base and then the balance of being all other inflation, so all other bucket relatively modest inflation without other tariffs. If they were 25% tariffs, the estimate is still consistent with where we where in the third quarter we would say the net hit to us on an annualized basis of 25% tariffs is around $45 million. Of course, we don't expect a full year of that, but all of our teams are prepared to address, if it materializes and they would address it with a combination of supply chain and pricing and all of our teams have scenarios prepared for that to happen. And of course, as the first half of the year unfolds; we can update you on how that plays out.

Okay. Thank you very much for the color.

Your next question comes from the line of Phil Ng from Jefferies. Please go ahead. Your line is open.

Appreciate seasonally slow to start the year, but after soft patches on the second half, have you seen any signs there's in a pickup, have the customers come back and restock in the inventory? I know you're expecting things we accelerate it bit in the second half is it easier comps or are there any initiatives you have in place that kind of gives you the confidence things will pick up?

Thanks. The inventory issue kind of hit us in parallel with the softer markets. So as the fourth quarter softened, our channel partners pulled back on inventory as well. So the ordering rate was below POS throughout fourth quarter. So, it was kind of negative [ph] effect on sales overall. That likely won't persist. So, as the market resumes and grow, you will see inventories matching at a minimum POS and if there's an acceleration, they typically will buy-in a little bit more to cover with anticipated some growth. So the first and second half, it really comes down to carryover effect from the way we exited last year. Our categories lack the overall construction cycle and R&R doesn't really start to pick up until March. So we just let's say brought forward what we saw as we exited the year in the first part of this year and accommodated for a slower start. And I think the back half of the year; it is more of our performing against the market. We've got a lot of initiatives irrespective of market. But we are assuming that there is some modest level of growth that resumes in the second half of the year. So, -- and it went up looking for a huge future spike -- we're actually looking for more like 4% to 5% growth in the second half if the first half is 2% to 3% growth. So, kind of, that's the range we're operating in. Reasonably consist R&R, but the big swinger is softer, new construction in the first half which then picks up and yeah, obviously, there's going to be a bit of a softer comp in the second half too. So, I think it ties up. In general, we're not making any big leaps of faith. We're looking at market in a very conservative way. And saying okay we're going to run our business against that and we're going to grow EPS at midpoint 9% and we've built our plans, cost structures, and CapEx and otherwise in a way that can deliver on that, so a little bit of logic to flow through all that.

Okay, that's really helpful. And with the investments you made in Cabinets, can you give us a sense how you're thinking about growth and just incremental margins into that business? And have you seen any new wins on the value side offering that you have out there? And should we think of any overhang on the margin front because it sounds like you still had some initiatives you're trying to work in 2019? Thanks.

I think on the markets side, we continue to perform really well in the in-stock cabinet and vanity side of the market as well as the soft part of the business that goes into builder and simpler R&R through dealer. So, that part of market we are picking up share. And we expect we will continue to pick up share. If I look at the overall pivot plan cabinets, a lot of it is we're just going to emphasize the places we've had success and continue to have success. So, we expect that will continue and continue bringing new products in that part of the market. Pat can tie off second part of that question.

Yes. To add onto the sales and the growth perspective of it, the part of the value segment of the market that you're referring to where we traditionally have been very strong in home centers and in-stock cabinets and vanities. We are taking that supply chain and bringing it to our broader set of the market and as we talk about next week or day will from our Cabinets group deploying that cost structure and capability into our product launch that takes place in April. So we plan to leverage the capability we have to grow that business, but we do expect Cabinets industry to grow a bit slower than the rest of the overall building products industry just as consumers' trade to a different price point of Cabinets and you use fewer boxes in their design. So, that's why we're targeting Cabinets growth of roughly 3% to 4% and we think that's roughly going to be the dollar growth of the U.S. market over the near to medium term. In terms of margin percentage, we felt like we did all of the cost structure things this year we wanted to do. Volume was little bit softer in the back half. We didn't see it as much, that's why we talked about it on an adjusted basis. And we feel like we left the year with a nice cost structure. We do expect next year -- to finish next year with a 70-plus basis point increase, would get us into that 10.3% range for the year. And we expect to start seeing that right out of the gate in the first quarter, not a 10% in the first quarter, because first quarter is seasonably low, but obviously a big improvement off of a very soft 2018 start to the year. And then as Chris mentioned and you referred to, we do have more change coming, but we're going to pace that change thoughtfully. We know investors want to see as a drive both sales growth and margin improvement in that business, and so we are going to be pushing to do that consistently each of the next three years, while also absorbing some of that change and not letting the change swamp out the growth. So you should expect us to grow that business then in the low to mid-single digits and to drive 70-plus basis points of margin improvement across each of the next three years.

Your next question comes from the line of Justin Speer from Zelman & Associates. Please go ahead. Your line is open.

Thanks, guys. Just a point of clarification on the tariffs within your guidance, are you embedding a 25% or a 10% tariffs in your kind of segment margin assumption?

We're embedding expected increase to 25% in March. So we're assuming that that's going to happen and that we have to recover that, both through supply chain actions and pricing actions. Supply chain actions are, frankly, well underway and well underway to address 10%, and so that's just full on and it's going to recover that portion of it, which is substantial. And then, the pricing piece of it will take effect when we know for certain when that's going to kick in. So there's a little bit of lag, but it's covered off and anticipated in our guidance. So our guidance, just to be clear, some 10% tariff through March 1 and then pick up to 25% March 1 and for the balance of the year.

So if we end up being at 10%, let's say, the thing is extended and it's a 10%. And then potentially, if there's a resolution, does that change the calculus in terms of your margin assumptions for the balance of 2019?

Yes. Back half, I mean, because the recovery actions on pricing are back half weighted, it changes some back half math. So it'll be interesting to see how it transpires as the 10% go away. I mean, we're not assuming that would necessarily happen either, and resolution could be that there is some tariff remaining, I think the market still waiting. Bigger markets are waiting for the tariffs to follow off, assuming aluminum coming out of Canada. But those are still picking up there. We just reacted to the stuff that’s going on and I'd say are being very clear eye, and our plans are constructed for 2019 that way.

One follow-up in -- I'm sorry, in plumbing…

Go ahead, Justin.

In Plumbing, is there any risk of mix now in the business? And if so, what's the margin risk from that potential dynamic? Is that in your calculus at all?

Yeah. Within Plumbing, it's interesting, because the market has been reasonably stable for us. I think for us, it's a mix between wholesale and retail. And so, our strength, frankly, over the last 18 months has been stronger on the wholesale side. And that is not just a construction depended. That's just stronger performance on that side of the marketplace. So that tends to be richer mix. Within the construction, consumers still trade up off of where the base package has been even through the second half of the year. So the mix is, I'd say the one piece of the market has been weaker is at a very high end, luxury part of that market is a little softer. But that's a small part of the overall. So I would say, we are not making heroic improvement in mix. I think we are just being realistic by segment of what we see coming out of it.

Thank you very much.

Your next question comes from the line of Steven Kim from Evercore. Please go ahead. Your line is open.

Yeah. Thanks very much guys. Just had another point of clarification here, I think you talked about on the margin side in couple of your segments, in Doors & Security you talked about the Fiberon's stuff impact and the nonrecurring cost being in total 460 bps, I think margin. What was just the Fiberon's stuff portion? And then in your Cabinets business, I think you talked about the 130 basis point impact from the 53rd week, was wondering if you could just elaborate a little bit more what that was? And why did that just hit the Cabinets and not the other segments?

Well we have 53rd weeks of Cabinets first. We had 53rd weeks in most of our businesses as most of our businesses with the exception of doors 13-week quarterly calendar underneath our corporate umbrella which is on a fiscal month-end calendar. But we have to keep all of the businesses inside of fiscal close week of one another, and so we have to take a 53rd week every once in a while. And Cabinets it's particularly onerous because you have a fixed cost structure where you're paying out fixed cost for that week but you’re shipping almost nothing because it's a holiday week. So specifically in Cabinets it was around $15.5 million of sales in the week that was incremental because of the extra week, but it was actually about a $6.6 million hit to profitability. So that's what going on there. All of our businesses take them and we try not to talk about them. In particular with cabinets the reason we wanted to call it out here is we wanted to give people of viewpoint of how the business was really exiting the year on a run rate performance, given all the cost take out it did during the year. In the case of Fiberon, Fiberon was about 100 basis points of that adjustment that you referred to. It was in the quarter about, I want to say $29-ish million in sales and maybe an unfavourable $2 million in profits based on some of the cost associated with acquisition like inventory step-up amortization and so forth. We expect that business to be accretive to next year.

Got it. That's very helpful. Thanks for that. And then I guess my second question relates to sort of the outlook for this year. I think you painted it out pretty well. I think you have been very clear, you think the first half of the year is going to be slower to back half; you’re anticipating sort of a normalization. You're being conservative in incorporating the tariff assumption in there as well. I guess, I was just wanting to clarify a little bit, are you -- is it also your view that 1Q is going to be within that softer first half, that the 1Q would be particularly softer and maybe Q2 will be ameliorating a bit? And then also, I was wondering if you could lay out what if anything you have seen or incorporating in our outlook for the government shutdown, maybe on back pay for load workers through coming through along with tax refunds in the near future, anything related to the shutdown of our tax refunds in your outlook?

I would take the second of that two-piece question. We don't have any specific assumption in our plan for the government shutdown or for a tax reform as it affects consumers. I would…

One thing that was beneficial was, throughout they said the tax refunds wouldn't be impacted and new attractive data, as well as we do, tax refunds turn out to be a source of R&R funding. So that was good news. So it could have impacted it, but hopefully it did not, but Pat you can take the second part of the question.

And then -- so, yes, we do expect the first quarter to be, at least from a U.S. and Canadian new construction, we expect the first quarter to quite possibly be negative, because of just the starts momentum that was playing out through the back half of 2018, in particular the starts momentum that all of us saw in October or November. None of us have yet seen December, but if December's anything like October-November, it kind of drives through a negative new construction scenario for Q1 in both the U.S. and Canada modestly so, because we would kind of take a combination of starts and completions across that horizon. And then, we think and the second quarter should get us back to flat to slightly below flat for the whole first half on the new construction front. And we would expect R&R to be reasonably resilient, kind of 4% bouncing, plus or minus 50 basis points throughout the year. So R&R, the linchpin, prevents whole things from going negative in the first half.

Got it. Thanks very much. Appreciate it.

Your next question comes from the line of Timothy Weiss from Baird. Please go ahead. Your line is open.

Hey, good afternoon, everybody. Maybe just going back to cabinets and the margins, I think that the midpoint of the growth in margins gets you to maybe a 30% incremental. You took out some fixed costs in the year in 2018. How much of the profit improvement next year is really that from cycling through a lot of that fixed cost versus what might be volume related? Just trying to see how much visibility you have for the cost lines in cabinets this year?

Yes. I'd say, it's half the benefit of fixed cost low forward, and then half the fact that -- while we covered off in cabinets, actually cabinets is a division where they covered more than their total inflation during 2018. Much of that happened in the back half of the year, because they will hit very severely in the first half of the year with plywood tariffs, initially hardwood plywood, and then soft plywood was added to that. And so they are going to be about half price commodity, about half fixed costs as they manage through all of the supply chain changes related to plywood. But that business is still good and you're close. I want to say the incremental leverage maybe more like 28%-ish 29%-ish year in the ballpark there.

Okay. And then that’s good. And then on Plumbing just on the inventory reduction was that in also end retail or was it one of the two channels? And do you expect that to happen again in the first quarter, I just want to be cognizant that the comp in the first quarter Plumbing is kind of particularly tough?

Yeah. We got a across channels. There was probably a little bit more retail than in our wholesale but it was across channels and it kind of unfolded throughout kind of November, December. It was twofer as the market was – demand was coming off – they were already – even had a weaker rate than that. I think stable it's at a stable rate right now. There is a point where weeks of inventory falls below stocks out and other situation that isn't good for either of us. So I expect – certainly there couldn’t be a little bit, but I don't expect – there'll be a significant move up, I think you're going to run it above POS.

And POS – that was about 6%-ish?

Yeah.

…in U.S. performing.

Yeah.

Great. That’s helpful. Look forward to meeting you guys next week.

Okay. Thank you.

And that concludes our conference for today. Thank you for joining.