Good afternoon. My name is Holly, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Third Quarter 2021 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. Now I would like to turn the call over to Mr. Dave Barry, Senior Vice President of Finance and Investor Relations. Sir, you may begin our conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security Third Quarter 2021 Investor Call and Webcast. Hopefully, everyone has had a chance to review the earnings release issued earlier. The earnings release and the audio replay of the webcast of this call can be found in the Investors section of our fbhs.com website. I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These 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 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. I will now turn the call over to Nick.

Thanks, Dave, and thank you to everyone for joining us on the call today. Our teams once again rose to the occasion to deliver an exceptional quarter, driving outperformance while facing tremendous supply chain headwinds, including challenges in labor, freight and material availability. Demand for our products remains very strong, and we are working tirelessly to serve our customers while combating the global supply chain challenges facing most industries. The perseverance shown by our team members across our world-class brands has been nothing short of remarkable. Our third quarter results demonstrate that we can deliver even in the face of significant challenges. We remain firmly on track for a record year with exceptional growth and margin improvement and to reach the long-term goals for Fortune Brands that were communicated earlier this year. For the third quarter, company sales increased 20% in total and 14% organically, with all segments driving strong growth. This past quarter marked an all-time record in quarterly sales as we neared $2 billion. Operating income increased 20% and earnings per share increased 25%, incredible results especially given the current external environment. Demand for our products in the quarter was and remains robust, and we expect growth to persist as consumers continue to invest in housing. Our leading brands are well positioned to capitalize on these tailwinds, and our teams continue to drive share gains across the portfolio. Our mid-teens organic sales growth was complemented by LARSON, which is exceeding our expectations in terms of both performance and synergies. I am proud of our team's ability to integrate this asset and drive performance, notwithstanding the challenging supply chain environment. Headwinds from supply chain, particularly in labor availability and freight and materials inflation, increased both during the quarter and relative to previous expectations. We are addressing these challenges by…

Thanks, Nick. And as a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing business performance. Additionally, all comparisons will be made against the same quarter last year, unless otherwise noted. Let me start with our third quarter results. Sales were $1.99 billion, up 20%. Organic sales excluding the LARSON acquisition, were up 14%. Consolidated operating income for the quarter was $293 million, up 20% or $49 million and total company operating margin was 14.8%, in line with the prior year period. EPS were $1.49 for the quarter, up 25%. These results reflect our team's tremendous performance in a highly disruptive environment, a testament to our culture of safety and outperformance across the organization. Now let me provide more color on our segment results, beginning with Plumbing. Sales for the third quarter were $741 million, up $151 million or 26% or up 23% adjusting for FX. Our Plumbing business continues to gain share and drive growth across all major brands, channels and geographies. Plumbing operating income increased 36% to $168 million. Operating margin for the quarter was 22.6% despite significant investment during the quarter in our brands, strategic priorities and to serve our customers. Turning to Outdoors & Security. Sales for the third quarter were $528 million, up $122 million or 30%, driven by the addition of LARSON and mid-single-digit organic growth. On an organic basis, sales were up 6% against an elevated comp from the shift of sales from the second quarter to the third quarter last year in doors and decking, as our wholesale channels reopened following the COVID shutdowns these channels experienced. Door sales were up mid-single digits in the third quarter, driven by wholesale and would have been up mid-teens adjusting for the shift of…

Thanks, Pat. That concludes our prepared remarks on the third quarter. 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, will you please open the line for questions? Thank you.

[Operator Instructions] Our first question will come from the line of Stephen Kim with Evercore ISI.

Appreciate all the color and good results. I was particularly intrigued by your comment about the 75 basis points of operating margin improvement in fiscal '22, I think you said beginning in the first quarter as well. Can you give us a sense for how that kind of -- how you kind of walk to that? How much of that might be from improving cost mix? How much of it might be from incrementals -- volume incrementals and things like that?

Steve, it's Pat. Our reference to that was the full year objective. We remain on track for our longer-term objectives in what has been a challenging year and a particularly challenging back half. We wanted to be very clear on that. And we have, as a team, already been working on cost improvement and pricing actions to address some of the back half inflation. And when we looked to the first quarter of '21, we could see with the actions we have already put in place or are being put in place right now, and we expect very much to be in place in the early part of this quarter, that we're fully covering inflation in the first quarter with cost improvement and pricing actions in the first quarter. And I would say, as we look to not just '22 but beyond, I would tell you, we continue to drive that formula margin improvement pretty equally across 3 levers, whether that's innovation and brand building, structural cost change in addition to the marginal cost improvement we do with Fortune Brands' capabilities, we still have structural levers we plan to pull across a number of our businesses and then also leverage from volume. It is not purely a leverage from volume formula nor is it purely a pricing formula.

Okay. Pat, just to clarify, though, the 75 basis points you were referring to, was that just from price mix improvements? Or is that sort of including these other 3 levers as well?

Including those other 3 levers. And it's full year '21 to full year '22.

Got it. Okay. Excellent. The second question...

And I -- I'm sorry, to evolve of the longer-term margin journey, and so we sort of laid out this road map of Fortune Brands Advantage capability is really helping drive the combination of margin accretion and fuel for reinvestment, a lot of which we've deployed this year. We've significantly upped investment in our strategic priorities. And so it builds on 50 basis points of improvement this year, targeting 75 basis points of improvement next year and then staying on track, consistent with the long-term goals that we laid out earlier.

Yes. Thanks for that, Nick. Yes, it was impressive that you achieved what you did despite these investments, particularly in Plumbing. The second question relates to just the general environment. I think -- I was curious if you could provide some color as to which categories do you see demand having the most sustained momentum? And what are the fundamental drivers behind this relative outperformance that you foresee for some of these -- for some of those categories?

Sure. Let me take that kind of 2 parts, where we're seeing it and what's driving that performance. I'd tell you, just at the highest level, the demand has really been solid across the board, both across categories, price points and channels. I mean it's probably some of the most consistent demand we've seen anywhere. And it's still backed by the long-term favorable trends we've talked about for a long time. The demographics continue to drive a lot of people into housing of boomers moving longer. The market is significantly underbuilt. You've got an aging housing stock. And so people are taking record levels of home equity and reinvesting. And all of that continues to be true. And I think as we -- look, it was very interesting through the quarter because there were some laps from some really heavy comps this time last year as channels start to reopen. And I said we never saw the growth stop. It moderated for a little bit as we work through those comps and then picked right back up and sent them again. So we're seeing it continue to hold very sustainably, and we're seeing it really kind of across the board. And I think that really speaks to the confidence that consumers have as well as just the fundamental need for either new or updated housing. We are seeing elevated demand for pro-oriented projects, as well as a lot of demand, I think, for premium offerings. We talked a bit about that. I think last quarter, we said that continue to ring true. And again, it speaks to consumers' level of confidence in the home. And then what's delivering the sustained momentum and outperformance for us? I think it's a combination of factors. I mean, one, we talked about taking funds and really driving reinvestment. We've set out a number of strategic priorities, brand, innovation, Fortune Brands Advantage. That incremental investment year-to-date, we've spent just shy of $80 million, right? And so it's not for naught. That is going to drive the top line harder. I mean you see the Plumbing results, and those organic numbers are just outstanding. We've had that flywheel gone for a while. And then the other part, I think, is really across the supply chain. I mean it's been painful. We're tough on ourselves. But I think the fact that we've continued to perform at these elevated levels and the fact that we continue to gain share speaks to the fact that we are most likely outperforming from a supply chain perspective as well in serving customers and consumers. And so I think when you bring those 2 things together, the performance that we had at this pricing level as well as the performance in driving brand innovation, category management type capabilities across the top, you're getting the results that you're seeing now.

Our next question will come from the line of Michael Rehaut with JPMorgan.

First question, just wanted to get a little bit of some of the -- maybe a little better clarity in terms of price cost timing. And obviously, as you kind of noted before, Nick, despite tremendous incremental investment, the margins that you're putting are strong, but you highlighted the fact that you have the further opportunity to better offset inflation in the fourth quarter into the first. So I just wanted to be clear, maybe as a clarification that when you say in Cabinets, I believe you said -- or by the first quarter fully offset. To me, that means flat. I don't know if that's not what you meant, but -- and then for the full year of '22, I guess, on a consolidated basis as well, the 75 bps would then obviously result in something stronger than 75 bps in the coming quarters. I just want to make sure it's the right way to think about that and if that even then provides further momentum into '23?

Mike, it's Pat. What I would tell you is for the group, for our enterprise and for Cabinets, it will more than offset. In the first quarter it's not flat because we'll be playing a bit of catch-up. And we had some inflation in the first quarter of last -- of this year, which we'll be lapping. So it will be more on a year-over-year basis will more than offset with cost improvement and pricing actions, the inflation we anticipate in the first quarter of next year. And I would say that's true for the full year. But that's not the only lever that's going to help the 75 basis points of growth next year. We'll also be pursuing other cost improvement and structural cost improvement initiatives in the business, plus we'll be growing better than mid-single digits next year. I'm not here to give '22 guidance, but we'll get some volume leverage. I wouldn't expect an even 75 basis points of margin improvement each quarter next year. That's not what we're trying to say, and I wouldn't interpret it that way. I would just say that we'll end this year with 50 basis points of margin improvement or thereabouts. And then off of that point, we'll make about 75 basis points of margin improvement through next year. You will see a sound next year. I would expect next year to be somewhere in the 14% to 15% margin range in the first half. Across the first half, probably on the higher side of that 1 percentage point range there. So that's the way I would interpret it.

And then absolutely, to your point about it carrying into 2023, we are making long-term structural improvements to the business consistently, and that is very much part of the strategy that we've laid out starting in '20 with the Fortune Brands Advantage. And so those things are sustaining and then continue to deliver for us. And really set up to accelerate because as they drive incremental margin, they also drive incremental dollars from the investment back into similar programs. So my sense is we're just getting going on some of those opportunities. We need to stay prioritized and focus in order to be able to deliver consistently, but it absolutely carries through and there's room for us to continue to accelerate.

Great. Secondly, I wanted to just circle back to some of your comments on positive mix. Clearly, encouraging and often will be an additional driver of both sales and margins when that occurs and encouraging, obviously, amid the -- some of the demand trends that you guys continue to see. I was curious if you're able to give us a sense of a rough quantification of perhaps how much that might have been benefiting you at least in the third quarter, either a sales or a margin perspective? And which segments have you seen it? You said -- you highlighted several product areas, but I'm just curious if certain segments or product categories you've seen it more than others?

Yes, Mike, a couple of things related to that, right? So -- and we've been consistent on this because we think it's an important part of our of our long-term growth strategy is we're driving attractive margins across price points at percentage basis and continue to work to make the margin percentages across our points as consistent as we can across our business. Obviously, when you have premium products, it's bigger dollar margins. And all I would say is we have a business in plumbing. It's performing this year. It's going to be growing in the low 20-some percent, with a healthy contribution from the House of ROhL. And we're seeing throughout this year in Cabinets made-to-order cabinets growing at a percent that's consistent with the stock business. And those are things we point to as consumers' confidence in the value of their home and they're willing to invest in their home and they're willing to do contractor products as opposed to it's the overall driver of our margin journey. Now what I would say happened in the quarter is Plumbing was particularly strong in the quarter. It has been particularly strong all year, and it will be that way in the fourth quarter as well. And Plumbing having a disproportionate mix in our quarter across our businesses definitely helped the margin profile of the quarter. We guided at the end of the second quarter we would have been down 30 to 60 basis points in the third quarter. And largely, that was offset by a really exceptional both sales and margin performance by the Plumbing business. But that, I think, speaks to the strength of Plumbing, inclusive of high-end premium brands. I wouldn't guide our journey this year, next year or beyond as a journey that's predicated on a mix of premium brands. That is not -- we're going to get the portfolio to the 16%, 17% margin percentage by 2023 that we laid out, kind of irrespective of the customer mix. We just referenced product mix, rather. We referenced it as a sign of consumers' confidence in the value of their home and their willingness to invest.

And I'll just add to that. I think you can take from that, that the portfolio is positioned at the heart of the market, right? As we talked the last couple of years how we'd really position the portfolio very well to capture the entry of the homebuyers. Saw that first sort of wave of millennials coming in and had that there. And then over time, we've built out the House of ROHL. We've maintained our premium offerings in Cabinets. We've rolled out more as we move decking from entry price point up now to much more in a special order oriented products. Some of the stuff at LARSON and Outdoor & Security has launched as well, just positions the portfolio really well to meet the consumer where they are. As Pat said, we work very hard to make sure that the margins are exceptionally strong across all of those price points.

And our next question is going to come from the line of Mike Dahl with RBC Capital Markets.

I just wanted to follow up again about the cost dynamics as we think about the next year. Obviously, as you've experienced and continue to experience, it's a fairly dynamic environment, so things moved against you in the second half. So I guess what -- when you're talking about kind of offsetting inflation or more than offsetting inflation next year, what is your underlying base assumption for incremental inflation in 2022? And kind of a part 2 would also be could you just clarify kind of quantify how much the labor and freight issues affected Cabinets in 3Q and in your 4Q guide?

I'll talk to both of those at a higher level on the second of your question. So Mike, first of all, I'd start with this year because I'm not -- we're not here today to give you a '22 guidance, especially not at the piece point level. What I was referencing was the first part of '22 and our outlook for that first part of '22, just to give people a sign of where the run rate is. So when I look at '21 -- fiscal '21, we're probably approaching about 7% inflation on last year's COGS base, which is starting to get almost to $300 million, pretty extraordinary. Where we were on the last call, we would have said around 6%. And so we've had a pretty appreciable increase since the second quarter call. And when I'm speaking here, I'm speaking to material, freight and tariffs only, like this is not even the labor part of things, which we largely offset with continuous improvement. And some of the bigger surges in the back half have been freight, in particular ground freight, and/or the mix of having to use spot rate containers, select metals, in particular aluminum, copper and zinc, and then hardwood and a few select resins that were affected by the Gulf. And those are the things that surged in the back half more than we would have anticipated. We probably had about $40 million of that inflation impact in the back half since our second quarter guide. It's really affected all of our businesses but businesses like Cabinets and Therma-Tru and decking where you don't build up big inventories of components and/or finished goods and the inflation tends to course through your income statement in real time a bit more, that's why you're seeing the pressure in…

Inflation is a challenge. I wouldn't understate that. But it's really been the pace of inflation in the back half, because it just takes time to get the sales in place and it takes time to get the pricing in place. And we're going to do our very best not to blow up our customers along the way. And so we want to do our price increases, respectfully. They may not always agree, but -- that we are, but we're trying to do that. And so there just is a pace to getting it done the right way that's going to be sustainable and allow us to continue to gain share. And I think the pace at the back half of this year was pretty extreme, fully anticipated inflationary environment. The pacing of it may allow for a little bit more time for resolution between when inflation hits and when we put sales into place.

That's really helpful. And then, Nick, my second question, you made some interesting comments about China. And obviously, that's been top of mind for a lot of people given some of the headlines around housing both on the new construction side and on some of the mortgage side impacting just overall home sales there. Can you just go into a little bit more detail about what's giving you kind of conviction in your outlook for continued growth in that market? And maybe talk about whether it's an existing project backlog or some more detail around kind of the expansion that you've got there?

Sure, absolutely. And the other thing -- just firstly starting with Evergrande, I mean we've long had our eye on Evergrande. And so any Evergrande exposure could be very, very, very de minimis for us. And so that's not been a concern. And so we really looked through the whole market. And we had some time in China, and we've got a phenomenal homegrown team there that's been with us for a long, long time. And so we really understand the cycles of that market. And we went through a cycle in 2015, we went through a cycle in 2017. And if you go back and look at those numbers, you'll see new home sales plummeted and yet our business continued to grow. And so why is that? Well, it's a couple of things. Firstly, it just starts with our footprint. Our footprint is very focused on Tier 1 and Tier 2 cities. We've never overexposed ourselves to the more speculative construction in Tier 3 and Tier 4, which is where you see the kind of the ghost towns, the big empty skyscrapers. And so what do you have in Tier 1 and Tier 2? I mean these are various established cities where you kind of have a mix of new construction, but you've got a big mix of R&R. And you look to a city like Shanghai where we have very substantial share and you got an aging housing stock. So you're not just going to have the new construction development business, you're going to have a lot of turnover in that space. And so we're going to continue to see growth just from redecoration and R&R in addition to what I call more sustainable new construction. But that's -- our footprint, so therefore, is less exposed to some…

And we have time for one final question. Our last question will come from the line of Truman Patterson with Wolfe Research.

Just wanted to follow up on the Evergrande situation in China. Nick, I believe in your prepared remarks, you mentioned a platform in China where you could flex the costs up and down to relatively maintain margin. I was just hoping you could elaborate on that a little bit?

Yes. So I'll give you some perspective, and Pat maybe have some color to add. But we've had this business in China, phenomenal growth and a really great team and culture there, and as part -- we interact with them very frequently, and we're coming out of mistakes together. And a few years ago, we sort of challenged them that notwithstanding the great growth that they were putting up, that they really needed to think as highly disciplined business operators and have the business on a continuous margin improvement journey really so they could generate their own fuel for growth. And so we hired in capability. We've gotten much better at revenue growth management there, a continual CI looking at the whole supply chain. And that team did exactly that. They started to push up their contribution margin, their OI margin and actually freed up a lot of incremental dollars to reinvest. We've been reinvesting in growing the Moen brand and then building that brand and creating more and more of a pull environment. And so that just gives you a lot more optionality in P&L management. I mean we don't have to invest heavily. I think if the market were to slow, we probably won't invest in brand building there as heavily as we have over the last couple of years. That gives us a lot of options. You've seen the brand building come through as we've talked about some of the incremental spend that we've had here on strategic projects. And then also, it just means that you've got scope during the business to continue to be able to chase CI, to chase offsetting COGS inflation and be able to pull the levers of the P&L to deliver continuously. And so -- but, glad we put those in, but it's really predicated on having strong discipline in the business because we want the business to be sustaining over the very long term.

Okay. Okay. And then you all had some pretty nice growth in the quarter, despite facing the supply chain issues that everybody is facing right now. Nick, as well, you mentioned some of the internal actions that you all took during the third quarter. Hoping you can discuss those a little bit more in depth, whether it be getting more suppliers approved, finding alternative materials, improving to an extent labor availability. Just hoping you could dig into that a little bit more.

Sure. And it's a little bit all of the above. I mean we've had to work across many, many fronts to deliver this kind of performance. I mean, I'd say, first and foremost, it just starts with safety and the safety measures and investments that we've put into our facilities that have allowed us to manage through the pandemic and then also hopefully be attractive to continuing to attract and retain talent. I think that's been well appreciated. We have continued to work hard. I mean, we referenced Hurricane Ida. We had to qualify a number of suppliers very, very quickly on some very specialized products. And I think the team is really evolving to moving really in an agile fashion to -- inside of weeks to do things like that. And then when we talk about the Fortune Brands Advantage, if you recall kind of the 3 pillars are complexity reduction, global supply chain management and category management and you take the first 2, complexity reduction and global supply chain management, I mean they've been invaluable. And so complexity reduction, I mean, we've used tools like lean 80/20, design-to-value, we're doing standard work to reduce our need for incremental headcount. And so really by using those, we've been able to actually eliminate just open positions that otherwise we would have had to fill and therefore, with a more simple business, been able to kind of get after hitting these kinds of numbers. And I think that's going to be a very positive structural change in the business. We're going to continue to drive that very, very hard because that just takes waste out. And so whether it's in this environment or in an easier environment, that's going to pay a lot of dividends. And then the global supply chain management has allowed us to leverage kind of everything we do across Fortune Brands. So whether it's talking to suppliers, kind of across categories for direct or indirect, whether it's looking at freight lanes, either ocean freight or domestic freight, and seeing where we can leverage kind of the scale of the entire enterprise, all of that has come to bear. So -- it's actually worth a shout out to our supply chain team who have absolutely been heroes this year, pulling on all those levers as well as our HR team and others. But it's the work that's done across. And I think it starts with the people and the safety, but then it builds on this Fortune Brands Advantage that we've been talking to you about.

And with that, that will conclude today's conference call. Thank you for joining. We do appreciate your participation. You may now disconnect.