Greetings. At this time, I'd like to welcome everyone to the Fortune Brands Fourth Quarter 2022 Earnings Conference Call All lines have been placed on mute to prevent any background noise. [Operator Instructions]. I'd now like to turn the conference over to Leigh Avsec, Vice President, Investor Relations and Corporate Affairs. You may begin our conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Innovations' fourth quarter and full year 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 website, fbin.com. 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 may be required by law. Any references to operating income, margin, EBITDA, earnings per share or cash flow on today's call will focus on our results on a non-GAAP before charges and gains basis, unless otherwise specified. Please visit our website for a full reconciliation. Joining me on the call today are Nick Fink, our Chief Executive Officer, Pat Hallinan, our Chief Financial Officer; and Dave Barry who, as we recently announced, will be succeeding Pat as our next Chief Financial Officer in early March. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick.

Thank you, Leigh, and thank you to everyone for joining us today for our first earnings call as Fortune Brands Innovations. As we detailed during our recent Investor Day, Fortune Brands Innovations is a growth company powered by secular tailwinds, underpinned by leading brands, innovation and channel management and supported by our Fortune Brands Advantage. Before we begin, I want to thank the thousands of Fortune Brands Innovations team members across the globe for your continued dedication and commitment to excellence. Our people are the foundation upon which our business is built and you are the drivers of our next phase of growth. Additionally, I would like to recognize the MasterBrand associates who contributed so much to Fortune Brands. We wish you well on your exciting journey ahead. I also want to take a moment to congratulate Dave on becoming our next Chief Financial Officer. As part of our well-established succession planning process, Dave has gained finance leadership experiences throughout the company and has distinguished himself as a true partner to me and our teams. I'm excited for us to be working closely together. Finally, I want to sincerely thank Pat for his leadership and friendship over the last six years as CFO. Pat, while you will be missed, I know that we are in great hands with Dave. Our teams delivered an impressive year in the face of a challenging environment while also executing several key initiatives. The actions we took, including the separation of our Cabinets business and our reorganization into a highly aligned operating model, will enable Fortune Brands Innovations' continued long-term growth and sustained value creation. Let me speak for a moment about the 2022 results of Fortune Brands Home & Security, inclusive of Cabinets results through the full fiscal year. Our teams delivered net sales…

Thanks, Nick. I'm immensely proud of what Fortune Brands has accomplished over the last decade, and I am confident in the team's ability to continue to outperform the market and accelerate value creation. As a reminder, my comments will focus on results before charges and gains in order to best reflect ongoing business performance. Additionally, unless otherwise noted, the financial results presented will reflect Fortune Brands Innovations' performance from continuing operations. Finally, all comparisons will be made against the same period last year, unless noted otherwise. For the fourth quarter, sales were $1.1 billion, down 7% or down 9%, adjusting for FX and the impact of the 53rd fiscal week. Consolidated operating income was $196 million, down 1%. Total company operating margin was 17.3%, an improvement of 110 basis points. EPS were $1.07. For the full year, sales were $4.7 billion, also down 2%, adjusting for FX and the impact of the 53rd week. Consolidated operating income was $809.7 million, down 2%. Total company operating margin declined 20 basis points to 17.1%, with second half operating margin improving 80 basis points. Our EPS were $4.24. As a reminder, the company did not allocate any 2022 interest expense to Cabinets as part of the separation. To reflect, the year began with 10-year treasury rates below 2% and 30-year mortgage rates below 3.5%. Persistent inflation resulted in an unusual pace of interest rate increases from the Fed which sent treasury rates upwards, decreased housing affordability and slowed demand for housing following Labor Day. In the face of this rapidly changing environment, our teams took actions to protect the business while preserving investment in key strategic priorities. We remain highly focused on driving outperformance over time, including above-market growth and margin progression. I am confident the company will achieve the long-term targets set…

Thanks, Pat. Before turning to the details of our outlook for 2023, let me first provide some thoughts on the market backdrop and our approach to creating value regardless of the environment. We believe that strong demand fundamentals in our core markets support a multiyear housing expansion. However, we expect near-term housing affordability issues will result in a challenging 2023. If history is any indication, it is during challenging periods that Fortune Brands distinguishes itself through exceptional performance. We will confront such instances in 2023, as we have in the past, by appropriately managing our P&L and balance sheet while preserving strategic growth investments. Our focus for 2023 will be on delivering market-beating sales performance, preserving margins and generating cash. By executing against these priorities, Fortune Brands Innovations will be well positioned to reaccelerate our growth and margin improvement journey when the housing market normalizes. With that backdrop, let me discuss the specifics of our 2023 outlook. We expect the global market for our products to be down between 6.5% and 8.5%, with the U.S. housing market also declining 6.5% to 8.5%. Within this market forecast, we expect U.S. R&R declining between 4% and 6%, U.S. single-family new construction declining between 18% and 22% with starts down around 25%, and the China market for our products to be down between 15% and 20%. Based on these assumptions, we expect full year net sales to be down 5% to 7% with operating margins between 16% and 17%, implying decremental operating leverage of between 25% and 30%. We also expect EBITDA margins of between 19% and 20%. We expect decremental leverage in the first half of the year to be higher than the full year target as onetime production inefficiencies and stranded costs from our inventory reduction efforts impact the P&L disproportionately…

Thank you. We will now begin taking a limited number of questions. [Operator Instructions] Our first question is coming from Susan Maklari from Goldman Sachs. Your line is now live.

Thank you. Good afternoon, everyone. My first question is a bit higher level. Obviously, 2022 was a very big year for the business. You did a lot around the reorganization, the Cabinets spin. Can you just give us an update, as we come into the first couple of weeks of this year, how things are progressing with that? And I guess, how is the changes that you've made impacting how you're thinking about the forward trajectory of the business and the ability to continue to outperform?

Susan, great questions. So why don't I take that from the top? Certainly, you saw challenges emerging in the second half of last year while we were doing an enormous amount of work right around both the portfolio and then the go-forward structure of the business. And so while our work is really long term in nature we also sort of leaned into what we saw was going to be a very tough environment to allow us to streamline, take cost out and really make the business faster, more agile and even more responsive than it has been historically. And so certainly saw that slowdown, as Pat referred to, even more so through across the Labor Day period. And we're very, very clear, 2023 is going to be a challenging year. Then you saw our view about what we expect the market to do. But that said, we've got the team and we've got the experience to manage challenging times. With our new aligned structure, we've now got tools than ever. And what I mean by that is you've seen what we've been able to do with the Fortune Brands Advantage, right, since 2020, which is deliver market-leading growth and offset headwinds all through the COVID period while driving margins up. This new structure allows us to take those capabilities and play them across the entire portfolio with far greater speed than we had when those capabilities were purely siloed inside of different businesses. And so it is an efficiency play for sure, but it's far more than that. It's an effectiveness plan, it's a growth play, because we know that we have very, very strong world-class capabilities in different pockets of the business, and now we're going to drive them with absolute speed. So as we come out of this, ergo, it's going to be a tough market. But I look back at the last three years, and the CAGR of the business is north of 8%, margins have grown 270 basis points over that period. And we've had to digest so much in terms of a slowdown and an acceleration and supply chain challenges and inventory piling up at our customers' customers that was even hard to see, and then taking that out. Now as you look into 2023, it's going to be a tough market. But I think we're going to have to digest a lot of that noise, and we can phase into a tough market just clear eyed, knowing exactly what we need to do. And as Dave said in his remarks, it's during times of challenge that this company truly distinguishes itself. And I think with this new structure, we're going to be able to get after that even faster and then come out of this period with truly accelerated growth going forward. So somber about the market but excited about what this company can do.

Okay. That's very helpful color. And then I guess, digging a bit more specifically about 2023, can you talk to the expectations around input costs? What are you seeing from an inflationary perspective? And the ability to hold price against that, you obviously made a lot of progress on the price side in 2022, how are you expecting that will come together this year?

Hey, Sue, this is Dave. I can handle that one. So I'll start with your inflation/deflation question and then get to price. We're expecting, I'd say, modest deflation but not banking on deflation by any means to deliver the margin targets both this year or long term. So if you think about our COGS base for Fortune Brands Innovations, which is roughly $2.8 billion, we see freight and material deflation of roughly one percentage point of that at the high end, though this is offset by continued inflation elsewhere in the business. So labor inflation has been pretty sticky, some indirect items that we purchased, inflation has been pretty sticky. And I think it's important to note that our key metals, such as copper and zinc, have given back a lot of their declines from the middle part of 2022. And so we're not seeing a significant benefit at this point in the metals side, maybe a bit in freight, but kind of coming in, I'd say, second quarter into the second half of the year. So kind of modest deflation and not banking on a big tailwind. And then on the price side, as we've taken price to cover inflation, I think we've also taken price based on the strength of our brands and innovation. And consumers, we've talked about in prior calls, consumers have been willing to continue to purchase our products, and we see our sales rates at the POS perform ahead of market. So the consumer is getting value as well with our price increases. And so as we look at the year, we expect low single-digit growth from price, and about half of that is going to be carryover price, and about half of that is new price. And most of the new price is coming in the Water segment as we see the world right now.

Okay.

I'll just give a little color, Sue, on pricing, how we think about pricing strategy because I think it's an important part of your question. Over the last few years, we've invested in building pricing capabilities inside of the business and invested in data and tools and pricing analytics. And that really allows us to know kind of where and how to take price in a way that delivers not just for us but for our channel partners. Part of our goal is to deliver margin enhancement for our channel partners and to keep the equation in the favor of the consumer by driving brand value and innovation to the consumer. And so you can sort of see -- and I go back to that three year CAGR, which Dave went through in his remarks, has outperformed the market probably by 200, 250 basis points, all while growing margin. You can see the consumers returning kind of the pricing equation. As long as we're continuing to drive brand and drive innovation, that kind of sits in their favor. And so as we get into, I think what will be a tougher market, we're going to stay clear-eyed about getting paid for the value that we want to invest in driving brand, in driving innovation and set the business up to continue to do that. And if that means you got to cede a little bit in a quarter here or a quarter there to win share and drive consumer demand over the long term, that's certainly what we'll do.

Great. That's very helpful. And I just finally want to congratulate Pat and wish him best wishes in his new role. It's been great working with you, and best of luck.

Thank you, Sue.

Thank you. Next question is coming from Matthew Bouley from Barclays. Your line is now live.

Hey, good evening, everyone. Thanks for taking the question and I want to pass along my best wishes to Pat as well. So a question on how you're seeing the year play out, 2023, in terms of cadence. You've got the 6.5% to 8.5% market decline for the full year, and then you also made the comment that you see decrementals as kind of less favorable in the first half than in the full year with those inefficiencies in Q1. So I guess it would be helpful if you could put some color specifically on that Q1 outlook, and then kind of outline how you're thinking about sort of top line cadence and the resulting margin progression through the year. Thanks.

Yeah, hey, Matt, it's Dave. I'll take that one, and then Nick and Pat can add on. I'd say we typically don't give quarterly guidance, but there's some unique attributes in the first quarter that we alluded to that it's worth expanding upon. So let me start with the first quarter, and then I'll also provide some color on first half, second half cadence and how we're seeing the year progress per your question. So in the first quarter, we expect sales to decline low double digits, really driven by market softness and select channel inventory reductions primarily in Outdoors and Water. As we said on the call, we expect to be through most of the channel inventory declines by the end of the quarter but still will be a headwind in the first quarter. And then within each segment specifically, we'd expect low double-digit sales declines in Water and Outdoors and low single-digit at Security as they're less exposed to kind of the housing market as the channel inventory declines. On an operating margin standpoint, and this is where there's a bit of departure here from the full year and so I'll talk to that in a minute, but operating margin, we expect the first quarter to be at 12.5% to 13%. And that includes roughly $30 million of cost coming into the P&L from impacts of our production curtailments and stranded fixed costs related to our inventory reduction efforts. So we said on the call, what we said earlier, we're targeting inventory reduction of about $175 million to $200 million. About $65 million of that actually occurred in the fourth quarter, but we're hanging up some unfavorable cost from production curtailments that will come off the balance sheet into the P&L in the first quarter. So if I…

Got it. That's super helpful, Dave. I really appreciate that. Second one, just zooming into the very near term, you made those comments about kind of year-to-date trends. And you just mentioned at the top, in the response there, that you do expect some destocking in Water and Decking, I think, through Q1. I think I also heard you say in the prepared remarks that, in some cases, you're seeing customer inventories returning to a more normalized level. So I'm just curious, any more color on that kind of destocking outlook, how confident are you that it will be complete by Q1 across your businesses? And if you have any color on what you're seeing in POS year-to-date that would be helpful as well. Thank you.

Hey, Matt, it's Nick. Why don't I start and then I'll hand it to Dave, he can give a bit more color. On the inventory thing, as I said earlier, a lot of that build is at our customers' customers, which is unusual, particularly in Water, right, with our exposure to the production plumber as they saw the surge in new construction. And so most of that, we believe unwound itself in 2022. But there could be some trickling out in the first part of '23, maybe a little bit at retail, a bit more Decking, although we think that's mostly through. And if you look at Decking, at the end of the day, it's probably down mid- to high single digits '22 and then flattish to slightly down in '23. And Dave can give a bit more color about that. But you got to -- as you, I think, are pointing out, you sort of put that against point-of-sale growth. And as we said in the prepared remarks, we saw that come off quite a bit after Labor Day. Interestingly though, in January, as I'm sure you've read elsewhere, it was slightly better than expected. So coming through our POS retail data, for example, it kind of matched 2021 almost dollar for dollar, week for week, sort of flattish for the month, which I think is better than we're feeling about the year. We'll see how it unfolds, but we're going to prepare the business for a much more challenging POS performance than that and see where it goes.

And Matt, this is Dave, I would just add. I think Nick did a good job of summarizing it. But as we move through the second half of last year, our teams got a lot closer to our customers with what's happening with their inventory and their customers' inventory. And so as we look going forward and continue to have those conversations, it's one of the things that gives us confidence that, hey, based on our market expectations for right now and our sales forecast for the year, there are some pockets of inventory in the channel that need to come out to normalize in the first quarter, as I mentioned, within Outdoors and Water. But otherwise, we feel like we are getting to normalized levels. And then as we progress from the second quarter on, our sell-in will more approximate our sell-out in the business.

Wonderful. Well, thank you Dave, thanks Nick. Good luck guys.

Sure.

Thank you. Next question is coming from Adam Baumgarten from Zelman. Your line is now live.

Hey, everyone. Thanks for taking my question. Just curious on the acquisition front, sort of what you're seeing out there, if you're seeing any multiples come down, if the pipeline is pretty full. Also just your general kind of appetite for M&A in this type of environment as we look forward.

Yes, I'd say certainly, multiples have compressed from where they were kind of '21 and even part of '22. I think you saw that a lot more risk-off environment in the later part of last year, and I expect it will be the same this year. Although, as we pointed out and we got three smaller deals done over the course of last year. We feel very good about those and integrations are going really well. And I think kind of have a prudent capacity to take good assets and put them on the platform continues to deliver for us. And I'll add that this new structure really creates a much stronger acquisition platform because now we can play all of our capabilities across acquisitions, which is exciting. And so there are some things out there, but we've also got this pending transaction for the Emtek and the U.S. and Canadian Yale smart lock business, which we're really excited about because they are very supportive of our existing connected home strategy and our existing luxury strategy, and so they'll be great strategic accelerants. And so we're continuing to move towards what we hope will be a midyear closing date. We're kind of deep into integration planning, cooperating with the Department of Justice as they work through their case and anticipate that, that will close midyear. So I think we're probably going to be watching that closely and, of course, watching the balance sheet closely in a tough environment to make sure that we keep the strength of our balance sheet intact as we move towards hopefully closing that. And if that goes as planned, it would be great. If not, there are other opportunities that are very interesting out there.

Got it. Thanks. And then just on the China revenue guide of down 15% to 20% you're assuming for the year. I guess, is that -- should that improve kind of similar to the overall business, a bit tougher in the first half and then improve as we move through the year? Or is it fairly balanced throughout the year in your assumption?

Adam, it's Dave. I'll handle that one. So let me give you a bit of context around China, and then I'll get to your question specifically. But if we look at the market there, it continues to be challenged, especially in new construction. So new starts in China are down 40% and new sales were down 30% in '22. And so it's a challenging environment. As we said, our team did a great job delivering decrementals that preserve profitability and rightsizing the business and the level of investment for the current environment. But we expect that the market environment will continue to weigh on sales growth into 2023 because, if you think about China in the new construction side, the lag from kind of a start to our product is closer to 12 to 18 months versus where in the U.S., it's coming closer to three to six months. And so the headwinds that we saw come through in '22, it will continue to be a hangover into '23. The team has plans in place to beat the market. It's a consistent theme across our business heading into '23 with focused plans to beat the market. And longer term, we see China that market, transitioning more to an R&R market, just much like the U.S. And we feel like our business is taking steps now to remain really well positioned to grow with our brands, innovation and channel relationships to win in the long term. But I wouldn't -- I think it's too early to say that China going to get better as the year progresses just given the hangover we're going to have from their new construction declines last year.

Hey, guys. That's helpful. Thank you.

Thank you. Next question is coming from Stephen Kim from Evercore ISI. Your line is now live.

Yeah, thanks a lot guys. Just a housekeeping point, when you talk about POS, are those numbers adjusted for the extra week? Or are they inclusive for the extra week? And then when you talk about the U.S. new construction market, I think you said down 18% to 22%, single-fam starts, down 25%. This might be a tough question, but I'm wondering what kind of mortgage rate assumption you're sort of embedding in that outlook. And yeah, then I have a follow-up.

Steve, this is Dave. I'll handle both of those. So POS, no impact from the 53rd week, so that's just kind of calendar year over calendar year, so that is adjusted out. It's a clean comp on that. And then on your -- on the housing starts, I mean we're not forecasting much relief on the mortgage rate. So assuming the Fed continues with their actions this year and that mortgages stay somewhere in the 6%, if not north of 6% for the year. And so we're -- forecast is 25% down in starts, as you pointed out, and it's a bit of an improvement from what we've seen in builder order patterns recently, right? So we are expecting that builders are either repricing or the consumer is kind of adjusting their expectations, and we're getting to more of an equilibrium. So we got to get to improvement to get to the 25% down starts in the year, but we're not expecting on a big mortgage rate change in that assumption.

Got you, yes. And that was kind of where I was going. I think you mentioned that POS in January was actually flat year-over-year. So it sounded like it was better than, obviously, the outlook that you're laying out here. And so I guess, if you see, the industries see, let's say, better results in 1Q and 2Q, would that be a benefit to you as soon as the back half of the year or even sooner? I was a little surprised to hear that POS improved in January because that was really just when we started to see housing doing a little bit better there, and you saw it like almost immediately. So I'm just kind of curious, what kind of a lag do you think we're thinking about or we should be thinking about if housing does better than you think?

Yes. And with our market forecast, Steve, and I'll give you a little bit of context behind our market forecast. We're actually, if you recall, we forecast our product consumption, right? And so we're actually -- single-family is getting worse from our standpoint as we move through the year because there is a, call it, three to six month lag, maybe a bit longer, given the completions backlog is going to move the declines that we saw last year and just translating into our product demand. Now I do think R&R will remain a bit of a wildcard. Though our market assumption, exit the year with R&R still down low single digits, I think if the consumer -- if the economy, the general economy, gets to something of like a soft landing or consumer confidence is going to remain strong, maybe R&R has some upside to it, but we're again not seeing that necessarily right now. We did have a good month. There was decent POS in January, but one month isn't making the quarter or the year, and there's still some challenges ahead of us.

No doubt. Yes, okay. Great. That's really helpful. Appreciate all the color here. Thanks guys.

Sure.

Thank you. We reached the end of our question-and-answer session. And ladies and gentlemen, that does conclude today's teleconference. You may now disconnect. We do thank you for your participation today.