Good evening. My name is Rob, and I will be your conference operator today. At this time, I'd like to welcome everyone to Fortune Brands Third Quarter 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin our conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security Third Quarter 2020 Investor Conference Call and Webcast. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investors section of our fbhs.com website. I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and the 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 and our most recent Form 10-Q. The company does not undertake any obligation to update or revise any forward-looking statements, which speak only to the time at which they are made. Any references to operating profit 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 have allowed time to address some questions that you may have. I will now turn the call over to Nick for his remarks.

Thank you, Brian, and thanks to everyone for joining us today. We hope that you and your loved ones are all managing well and staying safe during these challenging times. In the quarter, total company sales increased 13% over last year, and operating margin was up 90 basis points to 14.8%. This performance was the result of excellent operational execution in an accelerating market while still managing a pandemic environment and prioritizing our employee safety. I'm extremely pleased with the strong sales and profit results that we delivered in the third quarter, which built upon an impressive year-to-date performance in the face of unprecedented challenges. Performance was strong across our businesses, while our teams delivered on our efforts to keep our people safe. We're working hard to serve our customers' needs as the fundamentally strong housing market is accelerating further as consumers invest in the home. While we are delivering ahead of expectations this year, we're also making long-term investments in our brands, innovation, core capabilities and supply chain capacity that will enable us to capture future opportunities and accelerate our share gains. I want to thank all of our dedicated team members who continue to work so hard to keep our people safe and our facilities operating. I'm so proud of our teams who are not only caring for each other, but who are doing so while serving increasing demand for home products. In the third quarter, all of our businesses saw impressive double-digit growth, and we drove overall margin improvement for the company by leveraging efficiencies enacted since the second quarter as well as delivering progress against our planned efficiency road map for the year. Our efficiency initiative is to create fuel for increased investment as we continue to improve the overall margin profile of Fortune Brands. We're…

Thanks, Nick. As a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing business performance. As Nick mentioned, we are very pleased with our team's performance. They prioritized safe operations, addressed accelerated demand and delivered exceptional results. Last quarter, I mentioned our priorities to build an even stronger company remain, including protecting the health and safety of our teammates, servicing our customers and positioning our business for share gains, delivering strong margin performance this year and accelerating progress on our profit objectives, while investing to sustain competitive advantages and maintaining a strong balance sheet. Our teams executed against these priorities across the board in the third quarter, which led to exceptional sales and margin performance. This high level of execution positions us to continue capturing share and increasing margins for the balance of 2020 and beyond. Now I will cover the specifics of our third quarter results. For the quarter, sales were $1.65 billion, up 13% from a year ago. We experienced double-digit sales growth in every business segment, a sign of the widespread consumer interest in R&R and new construction. Consolidated operating income for the quarter was $244 million, up 20% or $41 million compared to the same quarter last year. Operational excellence and volume leverage drove this strong income growth. Total company operating margin was 14.8%, up 90 basis points over the same quarter last year. Building on the efficiency gains initiated earlier in the year, we continue to accelerate our margin improvements and are on track to exceed our original margin plan for 2020. We expect to deliver full year operating margin of approximately 14%. EPS were $1.19 for the quarter, up 25% versus the $0.95 in the same quarter last year. Now on to segment…

Thanks, Pat. That concludes our prepared remarks on the third quarter. [Operator Instructions] I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

[Operator Instructions] And your first question comes from the line of Michael Rehaut from JPMorgan.

Congrats on the results, and hope everyone is safe and healthy. First question I had was on the Cabinet division. Obviously, continued great progress there, solid progress. And your comments around gaining share from both domestic and international competitors, I think, is pretty important. Obviously, still concern or questions that we receive a lot around import competition. I was hoping if you could delve a little bit deeper into where you feel you're gaining share from domestic competitors and which channels and perhaps new products as well as what you're seeing on the import market since the Chinese imports have diminished? Where does that stand right now in terms of a percent of the market and you're saying that you're much more competitive with the remaining set of importers as you talked about nonsubsidized with higher cost structures?

Sure. I'd be happy to talk about that. So at a high level, on to your first question, I mean the share gains really are across the board. And you'll see that come through with 11% sales in the quarter and still building backlog in certain elements of the portfolio. And so you look on the one side at value cabinetry, that performed really well across all channels and continued the double-digit growth rate that we've seen for a while. But then, as we said in the prepared remarks, make to order, we really saw recover in the quarter and then actually return to growth. And I'll tell you it's coming into the fourth quarter with some backlog both there as well and is performing -- that part of the business is performing very, very well from a margin perspective with excellent capacity utilization. So we look at that and go, well, we're pretty confident that the share gain is across. Now why? Well, you go back, I mean, we've talked a long time about the pivot plan. The pivot plan is reaching its inflection point. I mean it is now delivering for us. And part of the pivot plan was not just a rebalancing of capacity. It really was to launch a suite of products at the heart of the market, right? And so while the antidumping case was ongoing, we weren't sort of sitting on laurels going. Well, if this happens, volume will flow back to us. We were really launching products at that sweet spot in the marketplace, where we had to win whether that case was successful or not, right? And as we've done that, we've really found that a lot of volumes flow back to us and that whether it be in big box retail…

That's great. Thank you, Nick, for that rundown. It's very helpful. I guess, secondly, just to switch to Plumbing. Obviously, another very strong top line result. The margins continue to be plus 20%, but a little bit down sequentially. Still kind of on track, as you alluded to, around the 22% full year margin goal. But you talked about a little bit about some onetime costs impacting the third quarter. I was hoping maybe you could give a little bit more kind of numbers around that. What was the rough impact? And -- but also bigger picture, should we expect this 22% to persist, then you just have this continued strong reinvestment into growth?

Sure. Why don't I kick it off, I'll give you some perspective, and then I'm going to hand it to Pat, and he can give you some more particulars around the numbers. But I would start -- obviously, really pleased with the top line -- continued top line performance, not just the blood, but I mean, this business is now into its fourth year of this kind of market-beating performance. And we saw it continue to gain share and a credit to [ Sherry Pfeiffer ] and her team, I mean, working so hard to satisfy our customers and to meet the demand. And it will be a while before we've kind of fully rebuilt customer inventories. And so a lot of that in the backdrop. Now notwithstanding that when we have a business that can perform at this kind of level as consistently as it has and we have seen the strength come through really even in the latter part of Q2 into Q3 and what we see ahead of us, we're going to take the opportunity to invest and drive the business. And so that is the starting point. Now there are also some inefficiencies we can touch on and, in fact, to give you a bit more color on. But we saw an opportunity to accelerate investment in this business because we want to continue to drive that top line growth. And we did material increases in investment in sales and marketing, investments in capabilities, particularly, on e-commerce, some supply chain capabilities, some things that you're going to see us do around innovation. And we expect those to deliver. And to be able to make the step-up in investment that we did and still deliver a 22% margin for the year is something we're really pleased with. And so that's what really focus is kind of the landing point for the year and the direction that the business is pointing going forward, while we're really investing heavily to continue to drive that top line. And just before I end, I'll say, we're also seeing pretty big returns on those investments. I mean Moen for a long time has been the #1 brand in the market in terms of awareness, purchase intent loyalty. I mean we've even now seen a step change higher in our data on the brand's performance, particularly, as we drove the refresh to really focus it on the key millennial consumer. And so we're really pleased with those investments, and it gives us confidence to lean in further. Pat?

Yes. Yes, Mike, I think, speak a little bit to the numbers, but I'll come back to the key point is we feel confident we're positioned to deliver 22% this year, and that's after delivering 21.5% last year. We do think the business is positioned to drive above it 21% we've been talking about for a while. So I think you should expect that the margin in this business remains strong, healthy and consistent. The variance to 22% in the quarter was roughly $7 million. So that's the delta between 22% and 20.8%. If you look at onetime items, things like airfreight that we're absorbing to support our channel partners or things we're doing to recognize our associates during this COVID period, that alone there was more than the $7 million. And then if you add incremental increase in brand investment during the quarter, you're more than 2x of that $7 million. The cost structure is very much intact and absorbing some onetime items in this quarter and some increased brand investment, but very much positioned to deliver 22% to have that kind of cost structure in place or a profit structure in place going forward. I think the other thing I'd say is if you pan out a bit and you look at quarterly performance from the beginning of 2018 all the way through the third quarter this year, 11 quarters in a row, and you look at that performance, we've basically been performing every single between 20% and 25% operating margin in every single quarter for those 11 quarters. So when you look at the consistency of the performance of this business, it's absolutely breathtaking because over that 11 quarters, we've had multiple tariff waves, we've had order shutdown between the U.S. and Canada and Mexico and we've had global pandemic. So I think this team has done just an exceptional job of not just driving industry-leading margins, but delivering it with unbelievable consistency in the face of really, really astounding macroeconomic challenges over the last almost 3, 4 years.

Your next question comes from the line of Phil Ng from Jefferies.

Congrats on a very strong quarter. Top line was really robust. So my question is, just from a capacity standpoint as well as inventory, if we see continued momentum and potentially a spike in 2021, how are you guys set up from a capacity standpoint? I think one of the areas that I'm a little more concerned about would be decking and maybe even cabinets, but any color there would be helpful.

So you're asking specifically, you said spikes -- continued COVID spikes or just capacity generally?

Spike in demand. If we see really strong continued momentum in demand, do you have enough capacity to kind of meet that? And from an inventory standpoint, are you well set up because, if I heard you correctly, 40% growth in decking sounds pretty impressive and, obviously, you've done some restructuring on the Cabinet side? I just want to make sure you guys have that supply to kind of meet that demand if that continues.

Yes. It depends, particularly, where you look. I mean, as Pat said in his remarks, I mean, in decking, capacity really stretched in the third quarter, but more capacity coming online here in the fourth quarter. And so what I'd tell you is we certainly have the capacity to hit the guidance that we just gave. And we're working very hard to add capacity and supply chain flexibility, right? It doesn't just have to be sort of big CapEx investments. It's a lot of supply chain flexibility and making our network more agile as we go through here into 2021. And I think that with the work that our team has been doing, and I'll tell you our supply chain team has been nothing short of heroic this year in both managing COVID, keeping people safe and building in capacity. I'm pretty confident that we will have the capacity to manage what comes at us in 2021.

Okay. Great. And then Plumbing, really strong growth. You called out the retail channel in China and I think e-comm, in particular, are you starting to see momentum rebuild in the trade channel as well as the builder side of things? And have you seen any restocking as of 3Q and maybe potentially in the fourth quarter as well?

Yes. So obviously, as I mentioned, there are very strong growth in those 3 areas: U.S. retail, e-commerce and China. The wholesale channel and a lot of our builder business goes through -- all of that builder business goes through the wholesale channel, really did start to pick up. And so we saw come back and then accelerate as we went into the quarter, not quite at the pace of retail or e-commerce. But what was really encouraging was as wholesale open up and this builders really sort of got to work, we didn't see much let up in the retail channel at all or in e-commerce. One of the questions we had for ourselves in kind of Q2 is as channels we opened up, was it maybe you're just going to see a lot of channel shift back and forth and now we saw a really sustained amount of performance in retail, which was really encouraging. As the wholesale and trade channels opened back up, we were able to meet demand, and probably filled a little bit of the inventory whole that have been created. But I think, by no means, was there a big inventory build in the quarter. To be honest, just from a customer service perspective, we would like to be able to help our customers go back. But I think, as I said on the last call, it's probably going to be a few quarters. And I think all the way through Q1, if not into Q2 of next year to really build back inventories that were pretty severely depleted. And so -- and I think it's going to happen at a pretty steady pace versus a spike in sale. We work hard to really track the point-of-sale growth, and we've been satisfied with our ability to do that and keep people tracking to their point-of-sale and then rebuild that inventory slowly over time as our supply chain permits.

Yes. Phil, wholesale was probably mid-single-digit POS to give you kind of a feel for kind of where they're running from POS in all North America shipments like all brands, all channels, we're approaching the team. So the health was across the business just being led by retail in China.

Okay. Yes, that's really encouraging. You still have that opportunity on retail and the builder side coming back and some restocking optionality en route.

There is much more confident -- we really are seeing a very strong wave of both homebuilding and renovation because -- I mean, you've seen the step from the homebuilders, and you're going to see that pull-through the wholesale channel. But you're still seeing consumers and pros come into both wholesale channel and other channels, and they're doing projects at a level we haven't seen in a long time.

Your next question comes from the line of Ken Zener from KeyBanc.

I would like you to perhaps because you have, obviously, DIY product, let's say, plumbing at Home Depot, but you also have the higher ticket project costs that require labor and comfort with COVID to have things installed like cabinets. Can you talk about -- if the nation started shutting down in March, it's now October. We have 7 months. Can you talk to your experience here about how that cabinet demand and the dealers being open is reflecting customers and contractors' ability to actually deliver the product into the customer's house? Because it seems like there's a large tailwind building out, not only on the inventory, but you talked about in plumbing. But really just about these deferred projects and cabinets is not a better category to assess that, so can you talk to the comfort of customers as opposed to the macro trends that drive demand like home appreciation?

Yes, sure. I'll give you a couple of perspectives on that because it's actually a fascinating question as you peel the data apart. I'll tell you with perhaps a kind of like maybe -- the exception of maybe a week or 2 in March, and I'm not even sure it was that much, we really didn't see cabinet sales let up in open channels. And so if you go back to kind of March, April on the first wave of what happened, we had dealer channel shutdown. We had a lot of designer shutdown even within retail. And so you weren't getting orders through kind of make-to-order part of the business. And as you suggest, you're probably building quite a bit of backlog, but we were seeing our in-stock cabinetry really fly off the shelves. And so that told us that notwithstanding shutdowns to shelter at home, there are some -- either some very advanced DIY-ers out there or a lot of consumers that were figuring out how to get contractors into their home safely. And what we heard back through the channel is they were figuring it up. They were like, "Okay, you go work over there." And by the way, the trades have to be comfortable, too, and the trades are saying, "Look, I'm going to be in the kitchen for the next 7 hours. Don't come in here. This kind of part of your house is now off limits while I work." And so we really saw some continued strength, which suggests to us that people were comfortable with pros, and I think way more comfortable than a lot of people may have expected fairly early on, and they figured out how to make it work. That, however, did not change the fact that a lot of designers were shut down and a lot of dealers were shut down. And as those started to open up, we saw that business kind of flow back into dealers, and we saw it flow back into the retailers in their make-to-order desks as they brought their designers back. And I'd agree with your sentiment there that a lot of those projects that require designers probably had an air pocket in Q2 where they just didn't get done and are probably backlogged as people now have to sort of not just coming to get the design work done, get them manufactured and through the whole supply chain, but then actually have to get people to be able to come in and solve them. Pat, any other perspectives in there?

No, I would say -- I mean, I'd say, in the case of cabinets, as you picked up, it was a twofold complexity because you have to sit down with the designer, that's almost in closer proximity than a contractor. And so the Cabinet business had to work through both of that. But we could really see the acceleration now in the interest of make to order, especially as you've seen 2 months of really, really strong existing home data, right, existing home sales data. And so to your point, that existing home sales data stays strong and persist. That's a great tailwind for the Cabinet business.

Great. And just the next question for Fiberon, given you're basically selling out, obviously, a lot of the larger competitors are adding capacity. How are you balancing this secular growth with execution risk?

Yes. I mean we -- and we've been saying for the last couple of years as we were and still are working to get that business to $300 million by 2022 or sooner, which has been the game plan we've been talking to for the better part of the last 2 or so years since we acquired Fiberon. We already had a CapEx plan in place that was pretty significant. We've talked about $35 million to $45 million a year of CapEx as early as 18-plus months ago. We're probably accelerating that considerably being at the $50 million plus a year. So I think it's marginal acceleration from an aggressive plan we already had to support the business' growth. But you're seeing this year, the business outperformed its annual plan and do so in the face of a pandemic that was quite disruptive to absenteeism in plants and so forth. So it's always nontrivial to grow a business at that pace, especially when you have to layer in the CapEx to do so. But I think this year demonstrates the team's ability to do so and do so facing quite a jolt from a pandemic.

And I'd just add that we talked a lot about the synergies that we've unlocked from the shared route to market between doors and decking and the power of putting those 2 things together. And we've talked less about the synergies that we've unlocked by putting that operations team together. And the Doors team absolutely best-in-class of the decking team are phenomenal at what they do, and I think that's proving out in the marketplace. By bringing those 2 teams together and having them work together, we've been able to unlock additional capacity out of what we had in addition to the capital that we're putting in to add kind of more extrusion capacity to the business. And so it's operating at an even more efficient level while we add more to it. And so we're feeling pretty good about our ability to execute. And the kind of the sweet spot of the market in which this business was built, which is that sort of entry-level composite that board is what Fiberon has really been built on. And so it's something that we do very, very well, and we've done for a long time. And we've been able to continue to supply the market with, what I'd say, our industry-leading lead times even throughout this pretty disruptive few months.

Your next question comes from the line of Stephen Kim from Evercore ISI.

Appreciate it. Just one quick question here on the commodities. I think last quarter, you suggested the commodity headwind might be in the neighborhood of $25 million to $30 million. I was curious if you could give us an update on that. And then in an answer to, I think, Mike's question about investments, I thought I heard you mention airfreight employee recognition that you threw out $7 million and $15 million together, that would be about 370 basis points on the margin. So I was just wondering if you could just clarify that. I thought maybe I took it out of context or something.

Yes, Stephen. For inflation in total, we're still consistent. Our full year outlook is still consistent with where we were for the last call, which is we have about 1 percentage point of full year inflation, which is still in that ZIP code of $30-ish million that you referenced. I'd say this year, it's turning out to be predominantly driven by tariffs annualizing and logistics costs. I'd say there's select puts and takes inside of commodities separate from tariffs that are relatively neutral. Obviously, anybody watching copper and zinc of late will see it's up about 10%, 11% over prior year at this time. But that cost will reread more next year than in the present income statement, but we'll be able to handle that with a combination of cost and price actions like we always do. So I would say this year, we're managing that level of inflation, including some of the recent logistics inflation very handily with a mix of supply chain and pricing actions as we typically do. In terms of Cabinets margin -- our Plumbing margins, as you were referring, yes, I would -- we always know whenever we're 1 millimeter below 21%, there's lots of interrogation on the Plumbing margin. And so what we're trying to do would simply say, if you do the simple math on $590-ish million sales quarter, the variance to 22% was about $7 million of expense. And we had more than $7 million of expense for things like airfreight and things we're doing to keep our employees safe and recognize. And then we did have, as we will, for the year, have investments -- increase in brand investment. You put those 2 things together, it's over $14 million. So yes, I mean, you're talking over 200 basis points. I don't know that I'd get quite to 300 basis points, but within that range.

Okay. Got it. Yes, I just wanted to clarify that. I appreciate it. And then you mentioned in Doors & Security, the Security segment had a back-to-school effect, which obviously makes sense. I was curious if you could quantify that in any way in terms of the sales impact and/or the profitability impact.

Yes. There's many moving parts. What I would say, we're not going to -- because we start breaking stuff like that, we end up having to do it in perpetuity is that's a business we would expect that business to grow mid-single digit on a full year basis in most quarters. And it grew in that mid-single-digit range in the quarter. And that was with back-to-school being less than half of its normal self and the commercial business, which is safety and security inside of mostly factories being negative. So the rest of that came from retail growth that was not back-to-school growth.

Your next question comes from the line of Adam Baumgarten from Crédit Suisse.

I'm just curious if lower promotional activity played a role in the margin performance in Cabinets this quarter?

I don't -- there was -- I don't think it was an overly promoted quarter, particularly, given safety concerns are not driving gazillion people into stores and then be the fact that the top line has been so strong. I think the channel probably feels less need to promote. But the driver has really been all the work that we've put into the pivot plan around getting the portfolio centered at the right point of the market, getting our benefit of scale across the entire portfolio, commonization of the chassis and the ability to then kind of shift volumes around. And so we saw a lot of that come through, which we're really excited by. It's by no means done. There's a lot of opportunity ahead of us. And [ Dedani ] and his team have gotten at it, I'd say, at an accelerated pace. But what we're really feeling is the benefit of all that work over the last couple of years, really starting to deliver and bear fruit now, but identifying more yet to go. And it's not inconsistent with some of the work that we're doing across the entire portfolio now. If you look at how we've taken approach on, I'd say, a leaner and more choiceful operating model at the core and then rolling out some core capabilities across the entire portfolio to drive things like global supply chain management, category management, business simplification, those are being applied to Cabinets. But they're actually being applied across the entire portfolio. And as we do that, we'll continue to free up incremental margin, some of which will be reinvested to take share and drive top line consistent with our strategy and some of which will be delivered to the bottom line. But it's really paying dividends at Cabinets, but it's a consistent approach across the entire portfolio.

Got it. That's helpful. And then just on the acquisition pipeline, maybe what that looks like? Your appetite to do deals going forward if you're focused in any specific part of the portfolio, that would be helpful.

Sure. As Pat mentioned, the sound cash flow and the health of the balance sheet, for one, put us in a position to really manage the business prudently and weather the storm as we've gone through it. But the cash generation and free cash flow also does create the opportunity to accelerate shareholder value. Now our priorities have not shifted. And we'll continue to focus on CapEx and investment within our own business. Those tend to drive the highest returns. And next, we'll look at accretive M&A. And third, we will return cash to shareholders. What I will tell you is, never kind of predict that on a single thing that, but we do look at the pipeline and sort of judge the activity. It was debt in Q2. We have seen the pipeline heat up quite a bit as we come towards the end of the year here. And what's interesting about it is it really does give you some insight into how businesses perform in a variety of circumstances. We kind of hold it against our own portfolio. I mean our portfolio has performed well. I think we're demonstrating that now that the portfolio and this management team can deliver in markets where a lot of volumes coming at us and we can deliver in markets that are more anemic. And as we look at the M&A pipeline, we're now able to see how companies have performed through some pretty challenging quarters. So it is heating up. I won't predict whether we get something or not, we'll be disciplined about it, and we have to do it on the right terms as to whether there's a particular area we will look across the portfolio. And in addition to having to get a business at fair value, the other standard we hold ourselves to is we have to be able to create value with it. It's not enough just to get it. And so we look across the portfolio and say, where do we think we can leverage either our brands, our routes to market or these common core capabilities to drive value. And I think the most recent one is Fiberon and that's a great example of having taken something that was actually somewhat adjacent to what we were doing, but it is shared route to market and by bringing it in, sharing that route to market, sharing some ops capability and our capabilities, we've been able to create a lot of value to shareholders. And we'll continue to look for other opportunities like that.

We have reached our allotted time for questions. Thank you for joining today's conference call. You may now disconnect.