Good afternoon. My name is Diego and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Second Quarter 2022 Earnings Conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. Dave Barry, Senior Vice President of Finance and Investor Relations. You may begin our conference call.

Good afternoon, everyone and welcome to the Fortune Brands Home & Security second quarter 2022 earnings call and webcast. Hopefully, everyone has had a chance to review the earnings release issued earlier. The earnings release and audio replay of the webcast of this call can be found in the Investors section of our 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 income or margin, earnings per share or cash flow on today's call will focus on our results on a before charges and gains basis unless otherwise specified. With me on the call today are Nick Fink, our Chief Executive Officer; and Pat Hallinan, our Chief Financial Officer. Following our prepared remarks, we've allowed time to address some question. I will now turn the call over to Nick.

Thank you, Dave, and thank you to everyone for joining us on the call today. I hope everyone is enjoying their summer and it's certainly been a busy three months at Fortune Brands, and I would like to personally thank all of our associates who continue to work above and beyond to move our business forward. Once again, our teams delivered a strong quarter of results, including high-single digit sales, OI and EPS growth versus last year. These results, a continued testament to the strength of our brands to the hard work of our team servicing our channel partners at industry-leading rates into the power of the Fortune Brands advantaged capabilities. I'm also pleased to report that our previously announced plan to separate into two world class publicly traded companies is progressing ahead of schedule. We have made exceptional progress in a number of key milestones and expect to file the initial draft of our Form-10 with the SEC later this quarter. Our 9% sales growth compares very well against stimulus fueled second quarter from a year ago and reflects improved labor and shipping availability together with higher price realization. Importantly each segment made year-over-year operating margin improvement in the quarter as price and cost actions more than offset inflation. Consolidated operating margin was in line with our expectations, which included planned investments in our digital strategy to create a transformational platform for future growth and margin expansion. Our quarterly results were strong and much of our portfolio continue to see solid demand levels which is supportive of our full year financial targets. That said, consistent with the rest of the industry, we are starting to see signs of slowing consumer behavior in response to inflation and higher interest rates. The rapid rise of the 30 year mortgage rate has…

Thanks, Nick. As a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing segment performance. Additionally, all comparisons will be made against the same period last year, unless otherwise noted. Let me start with our second quarter results and overall thoughts on the quarter. Sales were $2.1 billion, up 9% and consolidated operating income was $320 million, up 7%. Total company operating margin was 15.1%, and included year-over-year margin expansion across all three segments. EPS were $1.67 for the quarter, up 7%. As Nick mentioned, the company produced a strong second quarter driven by our leading brands and dedicated teams, delivering high single-digit sales growth while comping unprecedented levels of government stimulus from a year ago is especially impressive. Labor and supply chain constraints eased during the quarter, enabling our teams to service demand across the portfolio and work through order backlogs to realize incremental price. Operating margin in the quarter improved year-over-year in each segment and increased sequentially by 210 basis points. Price and cost actions more than offset inflation in each of our segments. Additionally, we continue to invest behind our key strategies, including our digital transformation journey, which will drive future outperformance. Looking forward, we are committed to delivering a healthy and robust, long-term future for what will be too strong independent public companies. And are keenly aware of the impact, the rapid rise in interest rates will have on the consumer in the near term. While demand remains resilient across much of the portfolio today, we are acting ahead of a potential slowdown to maintain our margin progression and deliver strong cash flow. We have successfully navigated slowdowns before and have the experience to deliver results against any market backdrop. Now let me provide more…

Thanks, Pat. That concludes our prepared remarks on the second quarter. We will now begin taking a limited number of question. Since there may be a number of you who would like to ask a question, I'll ask that you limit your initial questions to two and then re-enter 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 question. Thank you.

Thank you. And our first question comes from Susan Maklari with Goldman Sachs. Please state your question.

Thank you. Good afternoon, everyone. My first question is around the spin. Nick, you mentioned that it's actually moving ahead of schedule. Can you just give us a bit more color on how that's coming together and any other details that you have that you can update us with?

Sure, Susan and good to hear from you. Happy to talk about it. I'd say, when we announced last quarter's call. Here we kept at a very, very tight, very small group of us that we worked on it, and so it was really in a post announcement that we began really scoping answer, the speed of execution in the granularity of getting through the audit and drafting the Form-10 et cetera., and know I mean I'd like to say no surprises with that but on the confidence in our team but we also benefit from the experience of this is a team that many corporate have been through this before and know how to do it and they just got off to an exceptionally fast start. I think that coupled with a lot of good management of our financials and processes and systems over the years has allowed us to move through it pretty quickly. So we're not targeting filing the Form-10 this quarter, which is well ahead of schedule and that's coming together. And so that's from a process standpoint, what's happening, let's say, from a strategy standpoint, you could certainly see in the Cabinets results the delivery now against the strategy are really building out this business system of much more flexible and agile capacity really starting to bear fruit and that team has a ton of energy behind them right now, I really, really believe they are just getting going and what they can do and even as they look into a slowing down in their reaction to that is great. That gives us more time to really get off to some of these business simplification initiatives that they wanted to get after. And then on the new Fortune Brands side, we've really use the last quarter to start to re-imagine art of the possible, what can we do with even more focus on brand and more focus on innovation and more focus on our channel management, and we're excited about how that's coming together and I think we'll update you more as that unfolds. And as we get towards the end of this year, but we really believe that it's going to allow us to tightly focus and double down and invest further things that our investors have appreciated about the business and the things we've been able to deliver. And I think you see a really, really strong brand and innovation leader emerge on that side of the house. And so by buy and larger, we're very excited about where things are heading in the pace at which they are having there.

Yeah. Okay. That's great to hear. As a follow-up, there is clearly been a lot of focus on the consumer and I appreciate all the commentary that you gave, but perhaps could you talk a little further reduced to the state of the consumer, how it changed during the quarter the mix shift that you perhaps saw in there? And then how you're executing on that macro playbook that you mentioned a couple of times where we are today and what you're watching for, to determine future steps or potential future steps?

Yeah. I'd be happy to talk about it. Hope its enlightening for you, -- I'm not sure we stare at a lot of data on across our whole portfolio and over the last couple of years as we've come through this digital transformation going to started, we've really been able to pull more and more data into our data link and really start to get a good consumer. I guess the headline from a start point is, I do think the consumer has still been surprisingly resilient. As I said on the last call, we've seen POS dollars tracking along with last year absent a giant stimulus that continued all the way through the quarter. In fact, all the way through last week, we actually saw an inflection upward. In spend, I wouldn't take any one week to the bank, but the fact that you're still seeing that degree of positivity is really interesting. Now, I think as we look forward, you can see some pockets of softness and some pockets of strength and so we're still waiting. I think as that unfolds, we certainly do see the home sales data and read about the foot traffics through builders and I think we're going to gear ourselves for -- as we said in the prepared remarks in an unexpected air pocket that materializes if new home construction comes off. But again, I say from a consumer perspective. So pretty resilient and then answer your questions is, how are we executing against it? I think it's two-fold. Really in the first part, it's internally how do we manage and prepare the business for that. And we have some healthy paranoia here. So we are already taking steps to look at expense management, CapEx management, capacity management, and really preparing ourselves and…

Okay. That's great color. Thank you for everything, and good luck.

Thank you.

Thank you.

Our next question comes from Stephen Kim with Evercore ISI. Please go ahead.

Yeah. Thanks very much guys. I believe you made a comment in the Cabinets business when you're going through the various kinds of price points, you were talking about the high end. I think maybe being a little bit more impacted by some macro concerns relative to stock and May to order, which seem like they were they did much better. And I guess I'm curious, did you see this dynamic or maybe differentiated performance across the different price, maybe at the high end, maybe a little greater weakness at the high-end in other segments or across your portfolio or was it simply limited to cabinets?

Yeah. It's pretty much limited to Cabinets and it's a little bit I wish you could just give it a bit of advances one way through the other. But no, we saw House of Rohl continue to have some real strength through the quarter and that seems to be unabated. And so, it was more limited to Cabinets and I think as, is that machine rolls forward, we've gotten our service levels in quality at a really, really great spot in the Security (ph) value side of the business. The semi-custom side, and now I think the team is using a little bit of the respite that they're getting because for the last couple of years there hasn't been a whole lot to work on some simplification in the premium side that should allow for even better service and delivery, which we think is going to help drive that part of the business.

Okay. That's helpful. Thanks for that. And then earlier, I think you also mentioned that you're working to proactively manage to the right level of inventory with your customers anticipating that there may be a little bit of a hiccup in light of the buyer strike we have going on in housing. And I guess, I was curious, I know obviously you don't have a crystal ball on exactly whether that's going to materialize or not, but or how severe it might be, but can you talk about what this management process, proactively managing to the "right level of inventory." How might this look different across your different segments. If you can give us some insight into how you're going to be managing that?

Yeah. I think it's on a couple of vectors. I'll give you some perspective, Pat may have some color to add. But first and foremost, I think it's, it seemed through we're trying to have a good lens of where the consumer is and where the right inventory levels are. And so, taking a step back -- I think as hard as we were on ourselves through the course of last two years about our service problems we subsequently learned from customers, whereas we were serving the customers well ahead of a lot of the competitive set. So as a result of that we've got customer's inventory levels into a good spot. I think sooner than you see cross-industry, which also permitted some customers start to take safety stock down. Now you see a bit of effect of that in plumbing right in the second quarter. And so as we work through that part of what we need to do is use the insights that we're getting from the consumer point of sale to make sure to work with customers try to make sure they aren't under inventory and to share that data with them and we really been as part of the Fortune Brands advantage, investments building out the category management capabilities that we have to try to provide those insights to our customers and make sure that we are doing it in a rational way and not a knee-jerk reaction and generally, I think we've been pretty successful at that. The other piece is to the extent that they are going to come down, trying to get transparency, so we can match working capital to match our investments to it and pace accordingly. Now again, I think you've really seen a fair amount come out in this last quarter, I expect there'll be a bit more in Q3 as people anticipate some softness here, combined with the ability to take out some safety stocks. But I think as long as we stay close to where the consumer is and help share that information and then help run the business with capacity, expense management et cetera., to where we see customers going into those are a couple of vectors in which we manage that.

Okay. Great. Thanks very much guys.

Yeah. Sure.

Thank you. And our next question comes from Michael Rehaut with JP Morgan. Please go ahead.

Thanks. Good afternoon. Thanks for taking my questions. First, I just wanted to actually circle back on the inventory, but from another angle. I think you kind of mentioned earlier that POS in Water Innovations was up 9% and sales of ex-China was up 4% and so just trying to get a sense in both Water Innovations and perhaps in your other segments. How much the inventory reductions have had an impact on 3Q -- I'm sorry, 2Q from a revenue standpoint and if you are also within your guidance on a full year basis, contemplating or incorporating any continued inventory reduction in the back half?

Yeah, Mike. I would tell you, in the quarter, it was probably about a point of headwind to sales growth in the quarter. And obviously, it tends to be in the products with the longest supply chains for us and for our channel partners, and we did in this quarter start to see across many product lines in channel partners people ordering below POS already. You can imagine not only do people have the uncertainty of the future on their mind, but the cost of inventory has gone up with the inflation of commodities and with interest rates. So people are being as expected proactive channel partners that is are being as expected proactive on inventory. And I would expect for the balance of the year for the second half at least a point or two of headwind to the second half of the year for the same dynamic and that's in our script, and what would Nick was just referring to what Stephen is, we're just going to be proactive and be thoughtful, so that we have the right inventory in place to maintain our position to compete for market share, but also to be prepared for the likely result of the lack of foot traffic and new construction that is happening right now. And you have to put it in a dimension from a balance sheet perspective, probably on the order of $250 million to $300 million of working capital reduction. By the end of the year will be kind of a balance sheet dynamic of it and that's consistent with what we've been saying is when the time is appropriate we'll start backing our working capital back down to more traditional levels and we would expect to be doing that throughout the back half of this year and as we head into next year.

Right. No, that's helpful. I appreciate it. Secondly, just to shift gears towards decking. I believe you had 3% growth in the first quarter, you talked about high-single digits this quarter. I believe last quarter you talked about an expectation of still around 20% growth or last quarter you said 20% plus growth for the year. Wanted to know if that's still part of your thinking. Obviously, you did raise full year sales growth guidance for the segment and if that is the case, we have heard from one of the big players that there is also some concerns around inventory reduction and how you're thinking about the health of that business also from a pricing standpoint, given some of the capacity additions that have come on in the business in the industry.

So I'll give you some color and Pat may jump in with some more color. I would say overall as you look out to the full year, we may have come off that expectation a bit but not a time. I think it will still be solid double-digit growth. Hopefully, mid to high-teens is kind of the zone that we're targeting. And really impacted by what you're describing, I think that's the other place here, we've pointed to plumbing here seen some inventory commodity, I think that's the other place where we are watching inventories and making sure that the appropriate level, but are hearing that downstream in wholesale, they're pretty full. Yet at POS level, we're still seeing some strength in quite a bit of strength, I should say in decking in some healthy pull through and also looking across the mix, it's been pretty evenly spread as well and so we're -- I think being mindful around the capacity adds there, completely committed to the long-term plan that we've discussed and we've set out. But I think if you so both less this year. will adjust accordingly. And as we pointed out in the last call the capacity investments we are making a very flexible capacity investments and so we'll time them with what we see to be the growth. And so in some I'd say it's still be a very strong year maybe not in the '20s maybe more and a mid to high-teens. But it is pulling through and we're watching the wholesale inventory as we go. Pat, anything you'd add.

Yeah. The things that are driving the sales guidance in that segment up for the year is the excellent performance of the Therma-Tru doors product line and the commercial product line and security. Those are the things driving the guidance up and more than offsetting a slight reduction in the expectation of decking and that would be true in the quarter as well. Therma-Tru had a particularly strong second quarter. So that's what you're seeing that product line continues to resonate very strongly. It continues to compete in its respective marketplace very successfully and builders are trying to get completions done and so that's nice tailwind for that business.

And Michael second part of your question was price. We're very committed to the price that we've been able to achieve with decking and when you look at either on total project value or on a product basis, it's still of huge value to the consumers. And so our focus is going to be much more around getting the innovation into market, getting it right, serving our channel partners really, really, really well and making sure that we're going to get paid for it as we move forward.

Great. Thank you so much.

Our next question comes from Truman Patterson with Wolfe Research. Please state your question.

Hey. Good afternoon, everyone. Thanks for taking my questions. Pat on last quarter's call, I think you pseudo guided to maybe 6% of pricing and I think about $450 million of raw material freight and labor inflation, I'm just hoping you can give us some color on how you're viewing inflation in pricing as we sit today. And then, we've seen brass costs come down recently. I'm hoping you can help us think through that dynamic as a potential tailwind moving into '23?

Yeah. Happy to comment on both. So certainly, I think the last call, the range of material and logistics and inflation that we provided was the dollar amounts you had were roughly correct. It was 9% to 10% of prior year COGS. I'd say it's ticked up a point or so, it's a like 11% to 12% of last year's COGS will be material and logistics inflation that probably get you closer to about $580 million, again about $350 million of that was carry in from last year. So about 60% carry in and 40% new to 2022 in the drivers of the change from last quarter, this quarter have been predominantly ground freight hardwood and resins. So unsurprisingly, things that are oil-related or hardwoods. And for the -- I'd say labor inflation probably across the board, probably adds another $110 million of that. And then from a continuous improvement and price standpoint, we did in this quarter inflect to fully covering it and avoiding margin dilution and expect that to be the case through the next two quarters of the year to persist into '23 that has of that a high single-digit pricing for the year and roughly price being 80% of the price cost equation there. In terms of brass, what you're referring to mostly is copper, copper has been down about 30% somewhat recently. It will take about six months for those dynamics to flow into our financial statements and so it may show some signs of the very end of this year but it will be mostly an early 2023 phenomena that obviously we would expect to see that type of material deflation starting to hit our financial statements, early part of next year.

Okay. And then, if I'm doing my math correctly it looks like China plumbing might have been down like 40% to 50%.

Closer to 50%.

50%.

Closer to 50% on a quarter.

I take it that's the primary driver weighing on your new guide for revenue growth in plumbing and then, you all are maintaining an elevated op margin guide for '22 in plumbing as a whole. But it's been well over a decade since the last downturn, I'm just trying to get an idea of how we should think about decremental operating margin potentially whether there's been any real shifts in the plumbing industry or your business that might soften that decremental op margin.

No. We would expect all of our businesses, plumbing included water innovations to be very proactive in managing their business. If there were to be a downturn and I would tell you as a team, we would be trying to be no worse than 20% decremental margin we working to beat that, but that's really not the dynamic playing out at Water Innovations right now, but the change to guide is just as you stated, it's China, it was down 50% in the quarter. It's probably going to be down 10% to 20% for the year, that's our primary driver of the updated guidance to the Water Innovations Group. I think the other two forces that are worth noting is you're probably getting about 40 basis points on a consolidation basis but it's our Water Innovations level closer to a point or point in a quarter that is FX driven. And then it's the one area in addition to our security business where we would expect the destocking to be playing out the back half of the year. If you really look at something like, like in the quarter wholesale POS of plumbing you're talking high-single digits, and you're talking very robust POS across most of that business and you're just seeing channel partners try to get ahead of uncertainty with destocking you're seeing FX and you're seeing China. So the Water Innovations business is very healthy. China is a market, we like long term. China is a market that's going to grow at or above U.S. levels. For us it's a profitable market. It's a great place for us to innovate, because we have -- we're much closer to the route to market and the consumer, we can get new product into that market sooner and that team has done a great job as much as they've had the headwind you read about in China. They've offset the sales headwinds they face with expense management in China. So, we'll navigate China through at least this year, if not into the barrier part of next year. But China is a market we like and there is nothing going on with the Water Innovations business that really changes the dynamic of growing above market and having really strong operating margins. So that's what we would expect going into next year .

Okay. I'm sorry. Pat, just for clarity. The 20% decremental op margin, that's kind of for the new Fortune Brands, correct?

Yeah, I speak for Dave Banyard and it is going to stay, but I'm going to assume that he's going to manage this business aggressively like we do and also be working to have very attractive decremental margins that certainly beat his contribution margin. So, I'm sure we'll talk more about that maybe on Investor Day, but I would expect all of our businesses to be managing that way through the uncertainty we faced the balance of this year, the early part of next year.

I think if you’re sort of working, what if scenarios or worst-case scenarios, to answer your earlier part of your question is, is the structure of the business different than it was in '08 answer is absolutely, I mean lessons were learned, business has rebuilt in a far more flexible way and I'd point you to Q2 of 2020 as the proof point when you compare that decremental margin to the decremental margins we saw in '08, it's night and day different and yet the speed at which we had to respond in 2020 was a 10 times faster than it was back then. And so do that because the team's great, but because we bought the tool over that time in both the flexibility to be able to do it and so structurally very, very different.

Perfect. Thanks guys for the time.

Sure.

Thank you. And our next question comes from John Lovallo with UBS. Please state your question.

Hey, guys. Thank you for taking my question. The first one is pricing has obviously been a really solid lever and there hasn't been a trade down to date that you've spoken of, but you get the sense that we might be approaching that pivot point where consumers you start kind of going for a lower end product?

Yeah. John, it's a great question. I mean, you certainly seen it in the consumable categories, right. I think you're hearing about it in the categories where you might have trade downs and daily consumables that consumers view is fungible. But these are products that they research and they're going to live with for a long, long time and so we haven't yet -- we haven't seen consumers move off and I think to the earlier question about, if you see this question about, are we seeing kind of premium price trade down across the portfolio. We're not. We're seeing parts of the portfolio that are premium to luxury and continue to be very, very strong. And so at least substance at this point, I think consumers are choosing to invest in these categories and I'm going to choose quality and innovation and brand over mere compromise on the trade-down. Now I implied that inflation is it turned out to be more predictable than it was 12 or so months and now being more predictable is also starting to moderate. And so the consumer that is going to have an easier time of it and I think that's just a net positive for the consumer. But all through this process, I mean as we've had to take price we rewarded the consumer. We've been in innovation and the net debt has been that we've taken price and taken share, and that says that the equation has been in the favor of the consumer and not in our favor and they're rewarding us with more share now the fact that we're taking price. So we'll be measured about it going forward, but we completely believe in committed to the price that we've taken and that we were awarded the consumer return and that we can build from here.

Great. That's helpful. And then, you've talked about the improvement in channel inventory tonight curious if you could parse out how much of that do you think is demand moderating versus actual improvement in the supply chain or labor availability?

Yeah, I'll start and Pat may have some more color. But I think it's much more the latter. So you're having certainly much higher levels of supply chain performance which allows people take safety stocks. I think that's a measure of it and then you are having some come out as Pat said, we're seeing wholesalers. I think take inventory down in anticipation of softness that may come, but we've not yet seen it necessarily through, POS, right. And so we talked a little bit about inventory management. That's where we're using our category insights to also work customers to say, hey, you don't want to be at a point where you don't have enough inventory to even service level. So I think there is an element that can come out just because service officers are so high, right now, as we've invested heavily in service and working capital. But until you're actually seeing that demand slowdown. I would be careful at the channel level not I think a two-fold.

No. I would concur. I would say that to date it feels mostly like people getting ahead of what they perceive as uncertainty that will go in a certain direction.

Got you. Thank you.

Thank you. And ladies and gentlemen, that's all the time we have for questions today. And that concludes today's call. Thank you for joining our conference call. You may now disconnect. Have a great day.