Fortune Brands Innovations, Inc. (FBIN) on Q1 2022 Results - Earnings Call Transcript
Operator: Good morning. My name is I’ll be your operator for today’s call. At this time, I would like to welcome everyone to the Fortune Brands First 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. Thank you. I would now like to turn the call over to Mr. Dave Barry, Senior Vice President of Finance and Investor Relations. You may begin the conference.
Dave Barry: Good afternoon, everyone, and welcome to the Fortune Brands Home & Security first quarter earnings call and webcast. Hopefully, everyone has had a chance to review both the earnings release and the updated investor presentation that highlight the strategic rationale underpinning our pursuit of a separation into two companies via a tax-free spin of our Cabinet segment. The earnings release, investor presentation and audio replay of this call can be found on the Investors section of our fbhs.com website. I want to remind everyone today that the forward-looking statements we make on the call 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. This call will be formatted differently than recent prior calls given today’s news. Nick will begin with his prepared remarks, which will highlight the strategic separation announcement, our first quarter performance and topics relevant to today’s housing and economic environment. Pat will then highlight our first quarter financial results and provide an update to our financial guidance. Finally, we will return to Nick to discus today’s announcement in more detail. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick.
Nick Fink: Thank you, Dave, and thank you to everyone for joining us on the call today. We are excited to update you on what we expect to be the next phase of value creation for our great company and its stakeholders. As mentioned in today’s press release, our Board of Directors has authorized that we pursue a separation into two companies via a tax-free spin of our Cabinets business into a standalone publicly traded company. The result will produce two world class companies, which for the purposes of this discussion we will refer to as new Fortune Brands and Cabinets. We believe this decision is in the best interests of our investors, associates and customers. By separating these businesses, we can better maximize long-term value and unlock exciting opportunities for both companies. This move will enable each company to follow independent pods for value creation with fit-for-purpose strategies supported by thoughtful investments. New Fortune Brands will bring brand and innovation excellence to supercharged home, building products and security categories. Cabinets will continue to be the North American market leader driving operational excellence to deliver industry-leading performance. Both companies will be supported by powerful financial profiles setting each up to drive impressive results for investors. I will discuss the announcement in more detail later in the call, but for our valued associates, channel partners and customers, this should be exciting news. Additionally, we don’t expect any disruption to our operations as a result of the separation. Our same dedication, commitment to excellence and to delivering results will continue in both companies that approach produced our strong results in the first quarter and leads the company well-positioned to deliver an excellent 2022 and beyond. Turning to our first quarter results. Following 2021 a year in which Fortune Brands delivered exceptional results admits unprecedented challenges. Our teams once again performed well in a dynamic environment in the first quarter of 2022. Net sales of $1.9 billion were up 8% versus prior year. Demand remained strong and our teams worked tirelessly to fulfill that demand, providing excellent service to our channel partners. Our operating margin of 13% was in line with our expectations and we expect operating margin to expand sequentially across the balance of the year. We remain on track to deliver our 2022 margin expansion goals. Our sales growth and margin performance generated earnings per share of $1.31 in Q1. First quarter results look even stronger in the context of lapping the extremely strong performance from the first quarter of 2021. Our first quarter performance was the result of continued robust demand across our leading brands and advantage channels and continued excellence in execution by our teams. Strong performance from our trade and builder channel across multiple product categories continued past the start of the spring building season and remains robust today. Point of sale remains strong in line with last year’s risk pace and is rising seasonally. Notwithstanding our sustained demand, we are cognizant of the tightening of affordability and of proactively increased priority on cost controls and cash management within each of our businesses as part of our commitment to outperform for shareholders in all environments. We will remain agile in responding to evolving market conditions consistent with our proven track record of outperformance. That said, all signs point to continued strength for R&R and new construction based on fundamental demand drivers and favorable demographics. Turning to our segments. I’m excited to announce that in the past quarter, we renamed our Plumbing segment, Fortune Brands Water Innovations to better reflect our commit to innovating, engineering and designing products to help consumers manage and conserve one of earth’s most precious resources water. In the quarter, our Water Innovations business delivered net sales growth in all major markets with significant market outperformance from the House of Rohl. In Outdoors & Security, high-single digit sales growth was driven by double-digit growth doors and security and our doors and decking businesses continue to produce at full capacity. Finally, Cabinets delivered double-digit sales growth as price began to work its way from the backlog into the P&L and volume growth remained positive. While demand has remained solid across the portfolio, inflation continues across the input spectrum. Importantly, in Q1, we offset an inflation dollar for dollar with price and continuous improvement initiatives driven by our Fortune Brands Advantage capabilities. We expect margin to expand sequentially beginning in Q2 as price and continuous improvement will cover inflation at accretive margins. Importantly, the price taken to help offset inflation has not negatively impacted demand for our products, highlighting the strong pricing power that our brands carry in the marketplace and with our consumers. Labor availability and supply chain challenges both significant headwinds in the back half of last year and into the early part of the first quarter moderated as the quarter progressed. In China, our key suppliers remain open and producing goods, and we are working with our teams to ensure that inventory positions on key components and SKUs remain elevated to buffer potential outages. In the first quarter, we continue to invest in our core Fortune Brands Advantage capabilities, which are driving margin resilience and creating future fuel for growth. Our digital transformation efforts are proceeding as expected with particular focus on e-commerce, connected products, data insights, and indirect sourcing. We continue to make further investments in our key strategic priorities. We’re taking action to position ourselves for the future. And that includes making progress on key ESG focus areas. I recently released 2021 ESG report highlights initiatives and programs related to safety, diversity, equity and inclusion, community, sustainability and climate. Additionally, we’ve set carbon emissions and renewable energy targets to pursue in the years ahead. Those climate goals and expanded environmental disclosures are contributing to improved ESG ratings. That said, while we have a lot to be proud of today, I see even opportunity for us to make a larger positive impact for our people, our consumers, our partners, and our communities. To complement our operational results, we opportunistically repurchased $405 million of shares year-to-date and close on our Solar Innovations acquisition. Our cumulative capital returned to shareholders since the 2011 spin has surpassed $4 billion with another $3 billion deployed by accretive acquisitions. We will continue to deploy capital to drive value creation and are actively looking at further opportunities to bolster the portfolio and drive returns. Now, I’d like to turn to some thoughts on the current housing market. Demographic and demand drivers remain favorable for long-term housing growth. Our rising interest rates and continued inflation are potential impediments to the pace at which new homes and building products get consumed. There are some stark differences between today’s environment and that of 2018 and housing experience a short-term slowdown. The supply of homes remains near all time lows. The consumer is in a strong financial position with tremendous home equity and continues to demonstrate sustained interest in investing in and upgrading their home. With so few homes available for sale, many buyers are rethinking their existing space and are undertaking significant R&R projects to turn what they have into what they need. The current age of housing stuck at nearly 40 years old on average is perpetuating the need for this action. As we are experiencing, big ticket items in priority rooms such as the kitchen, bath and outdoors remain strong from a POS and order perspective. The builder community being governed by the same labor and supply chain issues impacting the broader economy is working through a backlog of unfinished starts while experiencing continued high demand in many markets. This dynamic extends the fundamental need for supply to multi-year opportunity as we remain millions of homes under built. Short-term affordability and supply chain pressures will eventually abate and long-term fundamentals in favorable demographics will spur growth. Ultimately, the only further soul for the supply and demand and balance in housing is to build more homes. While rising interest rates and increasing home prices have tightened affordability for consumers. Home price appreciation has driven home equity values to nearly $10 trillion as of the end of 2021. Consumers continued to demonstrate an elevated interest in spending on the home. Recent Google Search trend data over the past two months shows that queries on home renovation, bathroom remodel, and kitchen remodel remain 20% to 50% above pre-COVID search trends. Additionally, when queried 65% of the respondents from a recent consumer survey indicated that they would continue their higher spending levels on the home. As evidenced, the consumer remains healthy and housing remains an in focus category for investment. We continue to believe in a sustained runway for housing expansion driven by demographics and fundamentals and underpinned by low supply and aged homes. This multi-year runway for growth provides a significant long-term opportunity for new construction and R&R. We intend to outperform the strong market and will stay agile to capture opportunities and quickly respond if short-term headwinds materialize. We have the experience and the team to create value and outperform in any market environment. In summary, in 2022, we put a plan together to continue to grow above market, offset all inflation and in the face of expected continued headwinds, achieve margin progression for the full year while still investing for the long-term. After the first quarter, we remain on target to achieve these goals. Our 2022 outlook, which Pat will address later in the call included a prudent and conservative set of volume assumptions and a clear line of sight to backlogs and embedded price. The first quarter, which included war in Ukraine and a COVID outbreak in China has not altered our expectations for the year. We are a 100% focused on value creation through any cycle and we will say agile and flexible to meet any opportunities and challenges that may arise. We’re accelerating that pursuit of value creation with today’s separation announcement. It could not be more excited for the future of these two great companies. Before I address that further, I would like to turn it over to Pat to go through our quarterly financial performance in greater detail. Pat?
Pat Hallinan: 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 period last year unless otherwise noted. Let me start with our first quarter results. Sales were $1.9 billion, up 8% and consolidated operating income was $249.6 million, down 5%. Total company operating margin was 13% consistent with our first quarter expectations. EPS were a $1.31. Our teams continue to advance our strategic priorities and have been resolute in overcoming headwinds. As Nick mentioned earlier, we offset inflation dollar for dollar in the first quarter with price and continuous improvement initiatives though the result was dilutive to margin, which was further impacted by investments and by labor and shipment driven operating inefficiencies. Beginning in the second quarter, we expect price and continuous improvement to fully offset inflation and contribute to margin enhancement and expect to deliver second quarter operating margin of around 15%. Importantly, we remain on track to deliver our full year margin expansion objective of 70 basis points to a 100 basis points over last year. First quarter performance was in line with our plan and leaves us well-positioned to deliver our 2022 guidance. While geopolitical tensions have spurred another round of inflation, our teams have responded with incremental price and continuous improvement actions required to achieve our outlook. Additionally, we are managing our fixed cost structure to prepare for a continued near-term volatility while making the strategic investments to deliver long-term value creation. Demand remains strong across our leading brands, which demonstrates their pricing power and appeal to consumers and pros. Labor availability and supply chains have incrementally improved, providing some relief to our elevated backlogs. Now let me provide more color on our segment results. Beginning with Water Innovations. Sales were $644 million up $22 million or 4% with no material FX impact in the period. The first quarter was driven by strong double-digit growth from the House of Rohl and POS growth ahead of sales across our North American channels. China sales grew mid-single-digits in the quarter, as COVID driven lockdowns did not materially impact the period. Looking forward, given what is known today, our teams expect to manage the impact from China lockdowns to achieve our stated full year guidance. While the second quarter may be impacted by the current COVID disruptions as evidenced by the last major lockdown in China during the first quarter of 2020, pent-up demand drives recovery once the lockdown is lifted. Excluding the lockdowns, housing fundamentals in China have improved as the government recently lowered a key interest rate and loosen select restrictions. We have confidence in our team’s ability to successfully navigate short-term disruptions and remained focused on creating long-term value in China, a market that will continue to see household formations and increasing R&R. Water Innovations operating income was approximately flat with last year at $150 million, operating margin was 23.3%, impressive given the current inflationary pressures and notwithstanding continued incremental investment across the business. Demand remains strong for our Water Innovations business and our brands and innovation continue to resonate with consumers. Our strategic value creating investments, including in distribution capacity are delivering results ahead of our expectations. Turning to Outdoors & Security. Sales were $497 million, up $35 million or 8%, driven by double-digit growth in doors and security. Door sales were up mid-teens and benefited from price and the continued strong new construction environment. Labor availability and supply chain were disrupted early, but improved as the quarter progressed. And we continue to sell every door that we can make. Realizing the value and benefits of advanced materials over traditional options, consumers continue to drive material conversion in home and building products. Therma-Tru remains advantageously positioned to capitalize on the secular trend as the market leader in fiberglass exterior doors. Larson sales were down high single digits in the period as the business comped an extra week in the prior year quarter associated with an acquisition stub period. Excluding that extra week, sales grew mid-single-digits and our integration and synergy realization efforts remain on track. Decking sales grew over 3%, coming off a very strong comp of over 40% a year ago. Demand remained strong as consumers continue to desire larger, multifunctional outdoor spaces and are increasingly turning towards advanced materials such as composite decking. We continue to expect Fiberon to grow about 20% in 2022. Security’s momentum continued with low-double-digit sales growth for the second consecutive quarter. The North American retail market drove the performance and commercial and international sales were also solid as our connected security products resonate with customers and consumers. We expect sequential sales growth and margin progression throughout the year for security. Outdoors & Security segment operating income was $56 million down 10%, segment operating margin was 11.2%. Early in the quarter, labor and shipping inefficiencies drove higher cost into the P&L. We expect year-over-year margin expansion in the second quarter as price and continuous improvement initiatives, offset inflation at accretive margins and as labor availability and shipping efficiency improve. We experience these favorable dynamics in March and expect them to continue. Turning to Cabinets. Sales were $777 million, an increase of $89 million or 13%. Stock cabinets grew strong double digits and make to order grew mid-single-digits as labor availability and shipping challenges persisted, but improved throughout the quarter. While price primarily drove sales growth, volume growth was also positive in the quarter. Overall, backlogs remain elevated and demand remained strong into the second quarter. Operating income in the first quarter was $74 million, down 1%. Operating margin was 9.5% for the quarter, representing a 60 basis points sequential improvement over the fourth quarter. We expect to deliver year-over-year margin improvement in the second quarter and further margin progression during the back half of the year, as price and continuous improvement offset inflation at accretive margins and labor availability enables plant productivity improvements to be reflected favorably in reported results. As Nick will highlight shortly, this business is set up for a strong future of standalone success, including outperformance in sales and margin progression for the long-term. Turning to the balance sheet. Our balance sheet remained strong with cash of $378 million, net debt of $3 billion and net debt to EBITDA leverage at 2.3 times. We finished the quarter with $553 million of total liquidity on our revolver. We expect leverage to be reduced throughout the year with the typical seasonality of our operating cash flow generation. This past quarter, we took proactive steps to strengthen our investment grade balance sheet and extend our capital structure duration by pricing a $900 million bond offering. We also announced a $750 million share repurchase authorization and bought back approximately $380 million of shares in the quarter and $405 million year-to-date. Cumulative capital return to shareholders since the 2011 spend has surpassed $4 billion with another $3 billion deployed via accretive acquisitions. We continue to be committed to maintaining a strong financial profile, enabling pursuit of above market growth while prioritizing the best returning opportunities for value creation. Today’s separation announcement should have no diminution of Fortune’s credit quality. To summarize the quarter, we delivered results in line with our expectations in a challenging environment. Demand has been and remains robust while supply chain and COVID headwinds have persisted, this reality was reasonably in line with our expectations. As a reminder, our initial financial guidance included prudent volume assumptions, price and continuous improvement actions taken to support our sales and margin goals and continued watchouts for inflation, interest rate increases and the comp of last year’s stimulus payments. As we sit here with almost one-third of the year complete, we feel good about our approach and our outlook for the year. With that in mind, I’ll now provide an update to our 2022 guidance. We believe that strong demand fundamentals in our core markets continue to support a multi-year housing expansion. As today’s press release indicated we are increasing the midpoint of our EPS guidance by $0.05 to the range of $6.40 to $6.60 to reflect the recent share purchases, net of incremental interest expense and a higher effective tax rate. This guidance assumes that we remain a single company for the duration of 2022. Importantly, our operating performance and margin outlook remain on track for 2022 and beyond. I will now pass the call back to Nick to discuss the separation announcement in greater detail. Nick?
Nick Fink: Thanks, Pat. As I mentioned to start the call, we are very excited to be announcing our intent to pursue a separation into two world class independently traded public companies with attractive investment profiles. New Fortune Brands will be a brand and innovation leader, driving accelerated growth in supercharged categories in home, security and building products, including water management, outdoor living, material conversion and science, and connected products. Consistent with our history, we expect this business to outperform the market and drive already industry leading margins to new highs by leveraging our Fortune Brands Advantage capabilities and powerful market leading brands, complimented by strategic inorganic opportunities. With continued focus on areas such as safety, water conservation, and development in and use of recycled and sustainable materials, New Fortune Brands will be a leader in sustainability and ESG. Cabinets will continue to be the number one industry leader in North America, delivering top tier performance through operational excellence and an emerging leading end to end consumer experience. Under Dave Banyard’s leadership, our Cabinets team continues to execute transformational initiatives doing at the heart of the market, optimize and enhance our operational capabilities and fortify our global supply chain. These efforts coupled with our leading dealer network have widened the moat between us and domestic and import competition. Our leading market share and ongoing transformational efforts, favorably position the business to execute its strategy as a standalone company. I’m also delighted to announce that Dave Banyard has agreed to continue to lead the company as its CEO once the separation is complete. So why do this now? As we’ve discussed in the past, we routinely perform a deep dive strategic review of the entire portfolio with our Board of Directors. Our entire business has made tremendous progress over the past few years to become more focused on our value creating strategies to drive excellence through our Fortune Brands Advantage capabilities and to repeatedly deliver results. All businesses are performing at a high level with significant future opportunity to create further value for stakeholders. This separation will give investors the exposure to two high performing businesses with scale and favorable tailwinds while enhancing strategic and management focus. It is the logical next step in the Fortune Brands story. Both companies are financially sound with exciting but different strategic priorities and with different value creation paths. It is also important to note that all of the attractive characteristics that investors appreciate within our businesses today should be accentuated by driving increased value creation as we pursue our differentiation in a more focused way. Within New Fortune Brands expect best-in-class financial performance with above market growth and expanding industry leading margins, brand and innovation excellence, and secular growth tailwinds in digitally enabled products and platforms. These strong tailwinds will be further bolstered by increasing opportunities for inorganic growth in attractive categories. And within Cabinets expect the industry leader, executing strategic transformation to drive growth and margin progression, a focused multi-brand strategy to drive unmatched value creation, leveraging North America’s largest dealer network and a flexible supply chain and lean expertise to drive operational excellence. Specifically for Cabinets, the ongoing enhancement and positioning of our business as market share leader has enabled it to stand on its own to pursue its growth and margin objectives without having to compete for capital and resources as part of a larger portfolio. All of our associates feel motivated and empowered to take the business’s future into their own hands to create even more value in the years ahead. The business today has never looked stronger or better positioned. Our core set of Fortune Brands Advantage capabilities will be a common point for each of the new companies. Each business leverages these capabilities in different ways and Cabinets will be able to continue with their internal efforts to drive efficiencies and create additional fuel for margin and investment prioritized to their needs. Pursuing the strategy allows for enhance strategic and management focus and provides for the opportunity to pursue highly attractive yet diverging paths to value creation with fit-for-purpose strategies. This will drive tailored efficient capital allocation for each business and creates too exciting, distinct investment opportunities for our investors. Both companies will be well capitalized and able to pursue their growth and margin objectives. Our management team is developing detailed plans for our boards further consideration and final approval, and we expect the separation to be complete in approximately 12 months. In summary, the proposed separation is consistent with our long history of building great businesses and creating value for all stakeholders. We’re all very excited for the future. And as I mentioned before, our associates of both future companies should be excited as well. For our customers, channel partners and associates will largely be business as usual, but with even more potential. As too strong independent companies, our bright future will become even brighter. Let’s turn the call back to Dave to open the line for questions.
Dave Barry: Thanks, Nick. That concludes our prepared remarks on the first quarter and on the proposed transaction. We will now begin taking a limited number of questions. Since there may be a number of you who would like to ask a question, I will ask that you limit your initial questions to two and then reenter 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 questions? Thank you.
Operator: Thank you. Our first question we have Adam Baumgarten from Zelman. Adam, your line is open.
Adam Baumgarten: Hey, congrats guys. Nick, maybe just start, could you go over the strategic rationale and maybe the timing of the separation in a little more detail?
Nick Fink: Sure, Adam. I’d be happy to. Why don’t I – I’ll just start a little bit with timing and kind of line now and then touched on some of the strategic rationale. But you sort of look at the businesses and you look at how we’ve been developing the strategy for each over the last couple of years. You can see with the lens of the Fortune Brands Advantage, we’ve really been driving brands and innovation on one side of the portfolio are very hard and the operational excellence on the other side of the portfolio. And it is tied together by the Fortune Brands Advantage and common set of capabilities. But as we have driven that pretty hard and you’ve seen results coming back, you could see two sides of the house really performing very, very well, but with increasingly divergent strategy. And so you come to a point where the business or both businesses are in really firm footing, performing well, clear industry leaders. And then you add to that over the last few years, we’ve built the management teams capabilities and scale to really allow Cabinets to thrive as an independent entity. And then you look at the backdrop of fundamental tailwinds, which are very strong for all the businesses. We just felt that this was a point at which the businesses are really well positioned to succeed now and well into the future yet with increasingly divergent strategy. So we’re really, really excited that this is a great moment. The strategy themselves stay a little bit more. Tell us the first part of your question, you look to Cabinets, it’s going to continue to build on a strong foundation and really accelerate its transformation that’s been underway for last two years to operational excellence as well as really differentiated capabilities around its end to end customer, consumer experience. And so leveraging the dealer network, its lean capabilities, the innovation that they’re driving in that customer experience all key to that. On the other side, New Fortune Brands really focused on bringing branded innovation excellence to supercharge categories inside of home, security and building products, right? So areas like water management, outdoor living, material conversion and science, and connected products. And so very specific focus there and leveraging the capabilities like, brand management innovation, a digital leadership ESG leadership and then of course the lens of M&A on top of that. We think we can drive what has already been a pretty phenomenal returns profile even harder. And so timing made sense, strategy makes sense. I think the investment profile for investors will be very attractive for both businesses and make sense. We’re – I got to tell you just incredibly excited and incredibly proud to be on a point, where we can take this next step in the Fortune Brands story.
Adam Baumgarten: Great. Thanks. And then I guess my second question would be probably for Pat, but is there any change from last quarter and how we should think about the flow of earnings as we move throughout the year?
Pat Hallinan: No. I mean, I think the big part of what we’re communicating is we’re tracking to our full year guidance. And we expect all parts of the portfolio to continue tracking to their individual parts of the guidance. I think with some of the lockdown in China, obviously, that will impact Water Innovations sales during the second quarter. We would expect to recover some or all of that in the back half of the year. But we’re going to expect in the second quarter, the overall sales growth to be mid-single-digits with an OI around 15%. And then the back half of the year, you’re going to see mid-single-digits with OI above 16.5%, getting us to our 70 plus basis points for the year. And in that second quarter, certainly Water Innovations could be flattish plus or minus depending on how China plays out. But the team has already been preparing to manage that situation and still stick with a 23% OI margin for the year and manage the OI impacts of China throughout the year. And we think longer term, we’re still bullish on the ability to create value in China and we can manage the near-term effects of that. But I would say, while there’s going to be puts and takes with obviously we took a little bit more price to handle inflation, that price will go into the forecast having Cabinets and O&S towards the high side of their sales guidance. The China effect probably pulls plumbing down towards the low side of its sales guidance, but the overall margin outlook and the overall result for the year being sound. We took EPS up to reflect appropriately the thoughtful capital allocation that we did. You buying about a $405 million of shares net of the incremental interest expense and tax rate.
Adam Baumgarten: Got it. Thanks a lot. Best of luck.
Pat Hallinan: Thank you.
Operator: Our next question we have Susan Maklari from Goldman Sachs. Susan, your line is open.
Susan Maklari: Thank you. Good afternoon, everyone and congratulations on all the news and the quarter today.
Nick Fink: Yes, thanks.
Susan Maklari: My first question is, I guess, when you think about the legacy Fortune business that will be after this transaction comes through. Can you talk a little bit about how you think – of the strategy there, obviously, you’ll have Plumbing or Water Innovations, you’ll have Outdoors & Security in there. What will be the real focus areas within that anything that’ll change? And I guess with that, is there anything else that could be divested over time or maybe we’ll change within the portfolio?
Nick Fink: Sure. Yes. I’d be happy to talk about that. And so you think about that portfolio, right? There’s points of commonality, very powerful points of commonality across the portfolio. And really – at the highest level, it’s brand management and innovation, right? And under brand management, like everything from marketing to pricing to management of the shelf and category, right? And those are very powerful drivers of what will be the New Fortune Brands portfolio. And they really sort of ladder back to the Fortune Brands Advantage, which is something we’ve been working on for a few years. And so you think about complexity reductions so that we can drive more innovation through global supply chain management, right? It’s going to be less sort of heavy domestic manufacturing more, balance with our global supply chain management. And then finally, Category Management, which is really understanding where the consumer is, how to build the shelf, how to innovate for the consumer, et cetera. Those threads will be true across the entire portfolio. And then the exposure, to what we’re calling supercharge categories, whether they be in water or outdoor living or connective products are driven by very, very similar drivers of kind of brand innovation and technology. And so what we really want to do is accelerate our central investment behind the Fortune Brands Advantage increasingly the digital investments that we’re making, which do require scale to really drive and use that to take this portfolio, which is already performing at a very high level and accelerated even further. And so I think against that backdrop and a pretty consistent strategy will then see more M&A opportunities and, if anything, I think we’ll be adding to that portfolio and using the central capability that we’re building and intend to go deeper on to drive it even harder and faster.
Susan Maklari: Okay. That’s great color. Thank you. And then my second question is, Water Innovations had a very, very impressive margin this quarter, despite all the headwinds and obviously the moving parts in there. Can you talk a little bit about one, what drove that? And how we should be thinking about the cadence going forward? I know you kept your guide for the year still around that 23% for the segment, but given where you’re coming into this year. Is there the potential for maybe some further upside there?
Pat Hallinan: Yes. The business, I think deserves a lot of credit for being able to manage that high margin across a lot out of conditions. Because they still invested in brand and digital transformation this first quarter and delivered a 23% margin. So they’ve been – at the forefront of driving cost improvement and pricing in the industry, while maintaining investment for future growth, both in brand and technology. And so the team’s done a great job. I think Sue for the year, we’re targeting 23%. Is there a chance of some upside there? Yes. We’ll see how the situation in China plays out. The team is really focused on delivering the OI dollars and the margin percent irrespective of that. And from a forecasting and planning perspective, I would expect us to be bouncing around 23% per quarter plus or minus 50 bps in any given quarter.
Susan Maklari: Okay. All right. Thank you very much and good luck with everything.
Pat Hallinan: Thank you.
Operator: And for our next question we have Stephen Kim from Evercore ISI. Stephen, your line is open.
Stephen Kim: Thanks very much guys. Lot to talk about. Let’s start with the separation announcement. I guess, you talked about maybe some divergent past the value enhancement. I know you’ve talked a little bit additionally on that. But I was specifically wondering if you could talk about maybe differences that we might expect between the two in terms of optimal leverage, CapEx needs. I get the sense capital allocation priorities will be different with the New Fortune Brands, a little bit more focused on M&A opportunities. So maybe you could just give us a little bit of color about what you’re thinking of in terms of differences along those lines.
Nick Fink: Yes. I’ll start Stephen and then hand over to Pat you can add a little bit more color. But you think about just back up for a sec, you think about these strategies that were sitting under our Fortune Brands Advantage umbrella, but one that was just increasingly about really driving operational excellence. And I think that the team at Cabinets have been proving that out. I mean, two years of just incredible headwinds and yet they put up this just market beating performance that, when you kind of peel the onion a little bit of what’s under that is just eye wateringly good. And are just kind of getting started on that journey between the performance they’re putting up, what you’ll see even happen this year and then as we describe it further kind of their plans a lot of value to be created through their strategy, really first driven by business transformation, simplification, leading into the ability to drive that manufacturing excellence. That is one set of strategies. On the other hand, you have brand and innovation, which is going to set investment priority. That’s going to be more around, further dollars into innovation. Our R&D capability, material science digital will play a very big part of that. And so all of those – I think exist today under the umbrella, we haven’t starved any of our businesses of investment, but this will allow them, I think, to push harder and foster. And in a more focused way against the opportunity set that that sit there for each business. So I know Pat, he can talk a little bit about just how we’re thinking about leverage, CapEx and setting these businesses up to be really healthy going forward.
Pat Hallinan: Yes, Stephen. I think – first of all, I’d remind you that we’re initiating this from a position of strength. All the businesses are performing well. They’re all on a margin journey and achieving that margin journey. And our annual cash flow generation is usually 2x to 3x, what our internal CapEx and other investment needs are. And we would expect that to continue where the businesses are putting out way more cash than they need for organic growth and CapEx. Our CapEx outlook is unchanged by this announcement, like the CapEx that we’re investing in the business, because the strategies are staying the same for the businesses in the near and medium term. A number of capital structure considerations would come with a transaction like this. I think for clarity, we expect no change to the current Fortune Brands home and security, dividend and dividend policy, which is $0.28 a share per quarter. We expect that to continue. We expect both companies upon the spin to have sound capital structures that allow them the flexibility to manage the current macro environment and to invest for growth organically and inorganically. We expect the Fortune Brands ability to support its current credit quality to persist for sure both during and after the spin. And we’ll decide as we get farther down the road, the final capital structure for the Cabinets business, which we expect would be sound and there would probably be a one-time dividend from Cabinets to Fortune Brands. But at a leverage ratio that still allows the Cabinets business, the flexibility to navigate the macro environment and invest for growth. That business is set to succeed. We expect and are going to help it succeed. So I don’t see very big changes in the way we’re managing our capital structure. But each business will have a separate cash capital structure that is appropriate upon spin.
Stephen Kim: Okay. Yes. That’s helpful. Thanks. Thanks guys. Second question you made a – I thought I heard you mentioned that maybe supply chains have started to improve. Just not sure I heard that, right. I just wanted to see if you could elaborate a little bit on that.
Nick Fink: Sure. I’d be happy to give a little bit of color. Yes, a couple things we saw in the quarter. Firstly, I would say, as we started the quarter out January and February were pretty tough from an absenteeism standpoint in a number of pockets in the business, particularly indoors and cabinets. And we saw those rights radically improve as we moved into March and that sustained. So that’s been pretty positive. And it seems to be largely COVID driven, whether it’s that people are just getting to a point where there’s a degree of comfort with living with it or whether rates really better in communities. But that has been really key. Second point, we’ve talked amount about logistics, availability, particularly kind of near shore logistics. And we saw that ease trucking, ease a little bit in the latter part of the quarter and that has sustained, that’s been positive. And then the third one I’d call out is, we did see a trans specific ocean freight ease, and we saw a number of our suppliers be able to supply us at a more rapid rate in the quarter, which was a really healthy improvement as well as our shipping rates improve as a consequence of us being able to get more of a contracted rate onto the ocean as opposed to – having to push spot through. And so all of those are positive indicators, now we’re watching from a supply chain perspective, the situation in China very carefully to make sure that it doesn’t go the other way and that there isn’t any further interruption. But we built that supply chain very carefully with fair amount of redundancy in it and to date we’ve not seen any interruption and if anything, we’ve kind of doubled down on some safety stock just to ensure that we would be covered in the event of an interruption. And so after last two years, I’d say cautiously optimistic about calling any supply chain easing it’s been an unbelievable two years, but it was good to finally see some easing as we got through the quarter and that’s helped through this month.
Stephen Kim: Yes, absolutely. Thanks very much guys.
Nick Fink: Yes. Thank you
Operator: For our next question, we have Phil Ng from Jefferies. Phil, your line is open.
Phil Ng: Hey guys, good quarter. I guess Nick, you kind of alluded to this certainly the business is holding up really good. But certainly some concerns the consumer could be a little softer given all inflation that’s out there. Can you remind us how much line of sight do you have in your business and any color on any change in order patterns, especially some of your bigger ticket categories and any color on the channel site as well?
Nick Fink: Yes, absolutely. I’d be happy to. So I – so we got pretty good line of sight. I mean I’d say kind of as broad of anyone in the industry. And as we’ve really built out our digital capabilities under the Fortune Brands Advantage, we’ve really haunted that light of sight. And so we actually have data like it gives us live POS across most of the retail universe plus others that report POS to us. And we can see that down to category store region, et cetera, and slice and dice it any which way. And then obviously line of sight to a degree into wholesale and of course, into e-commerce as well. And bottom line is the consumer’s been unbelievably resilient. I mean we came in I think a little bit cautious about the lap of what was a giant stimulus injection into the economy this time last year. And if you look at the weekly and monthly POS consumption, right, I’d say, ultimately that’s probably the most important data point going through the question that you’re asking. It’s kind of tracking dollar for dollar with last year without the benefit of that stimulus, right. And we’re seeing that weekly dollar rate grow as it should seasonally. And so kind of answering the question for us, we’re going to see a big drop off as we left that and to date we haven’t. And so a lot of consumer resilience and as I noted in my prepared remarks, you’re continuing to even see it through consumer insight data like Google Searches being up 20% to 50% versus pre-COVID depending on the category or 60% some of consumers saying they intend spending more on remodeling now than they did pre-COVID notwithstanding the fact that affordability’s tighten. And so still a really strong consumer. Wholesale has also continued to be strong inventory and backlogs have evened out and are more balanced, I would say a little down in certain places. And so we expect that to continue to strong pull through, particularly when you look at builder backlogs, which are pretty significant and builders still reporting very strong interest in driving that. And so all around, we keep probably it as you just did with your question around any consumer softness, but have not seen any yet. And there really seems to be very strong consumer interest in home renovation, home purchase. And whether you’ve seen that through the insight worker, through actual POS that we pull out of our data like and with our partners, it just showing itself to be very robust.
Phil Ng: That’s great color, Nick. And then from a margin standpoint, it was a little lighter in outdoor living. Can you expand on what’s driving that and how that kind of plays out through the course of the year? And then I guess, bigger picture, certainly we’re seeing pretty broad base inflation. Maybe Pat give us some color on how you were thinking about inflation come into the year versus now. And then from a pricing standpoint, how should we think about it? What’s embedded in your guidance? Because I think your full year guide last quarter the way you kind of characterized it was mostly price and more of flattish volume, so just any color, how to think about those components as well.
Pat Hallinan: Yes. So yes, the quarter overall at 13% roughly in line with what we expected in our plan for the quarter as is the 15% we’re targeting for the second quarter. You’re I think understandably noticing a lighter outdoors and security. As Nick said that was a business, particularly hard hit doors and decking just like our Cabinets business with a lot of absenteeism in January and February because of COVID. And also during that period, lots of freight and efficiency as we were trying to keep service levels up shipping less than full truckloads. And so that that was a drag on the quarter, we had a little bit better pricing and expense management to offset that, but a lot of inefficiencies. As Nick mentioned, knock on wood the COVID driven absenteeism is something behind us. So we really see plant productivity and freight efficiency that me – freight efficiency meaning ground, freight outbound ground, freight efficiency in the U.S. improving. And right now, we’re at the point where we’re working through backlogs and we’re getting the full price coming on newer orders that we priced more richly. So that’s what gives us confidence. We’re seeing a very strong March and we shipped a lot in March. And so we have confidence in our margin progression for the year, I mean as we said, when we gave our initial guide in the Q&A in the last call, our full year sales guidance of 5.5% to 7.5% is still our guide. And as we said then for the full year and for virtually every quarter in the year that growth is going to be predominantly price with volumes roughly flat. And I’d tell you, Phil that’s still where we are today, that’s where the first quarter was that’s what we’re expecting in the second quarter. And that’s we’re expecting for the balance of the year. When we think about inflation and price and cost improvement for the year, we’re expecting material and freight inflation of around $450 million for the year. That’s a full year number on material and freight. And that’s about 9% to 10% of inflation on 21 COGS. There’s maybe about another $50 million or so of laborer inflation in there. And then between continuous cost improvement and pricing in the year, you’re probably going to be seeing something north of $600 million on the two of them by that’s what’s going to be necessary to drive not just coverage of the price but to contribute to margin accretion through the balance of the year. And that’s up a bit from a price in inflation from where we were but we were – we had a pretty heavy assumption going into the year. We carried in as I said a full year inflation of $450 million, we carried about $350 million of that in just from the fourth quarter of last year.
Phil Ng: Super, thanks a lot. Appreciate the color.
Operator: For our next question, we have Truman Patterson from Wolfe Research. Truman, your line is open.
Truman Patterson: Hey, good afternoon, everyone. Thanks for taking my questions. So first, just wanted to dive into Cabinets, I’ve heard of some negative channel checks out there, but I’m hoping you can discuss a little bit further of your demand outlook, what you’re seeing in the backlog, if it remains healthy. And then finally on the margin front, could you maybe elaborate on how the structure of your business might be different than some of the smaller peers in the industry or any internal initiatives that are maybe helping you navigate this inflationary environment a bit better?
Nick Fink: Sure. Let me – I’ll give some perspectives and Pat will jump in as well. I’ll tell you from a demand and channel perspective, I mean certainly what we’re seeing is some pretty continued strength and we talked about the stock part of the Cabinets kind of double-digit growth and then mid-single digit for the make to order part of the business. And I think that’s continued to be true. We’ve actually seen some picking up on the premium end. And so you’ve sort of got this effect where you’ve got the value end performing very well, the premium end performing very well and then some good performance around the middle and so that from our perspective, we continued to see consumers really leaning in. So I’m not sure the channel text you might be seeing, I don’t know if that’s supply driven or for others, but we’re not significant to – sorry, go ahead.
Truman Patterson: Yes. Those weren’t my channel shocks per se, but I think investors have been hearing of some of those, but could you possibly just elaborate on the structure of your business maybe…
Nick Fink: Yes, that’s where I was going to go Truman, which is maybe – it might be that the structure and the supply chain are leading to a differentiated result for our Cabinets business. And if so stepping back and I touched on it a little bit with the strategy is that the team’s really been driving business transformation strategy around simplification of the portfolio, commonization and ability to leverage that into manufacturing excellence. And so, as these challenges have come our way of late, we’ve really been able to leverage the fact that we have a simple portfolio and the scale to secure what it is we needed to keep our service levels really high. Now, at times it’s been very challenging, particularly, the higher you go off the price spectrum, the more complexity there is but even there it’s massively improved over the last few months. And then at the stock end, I mean, that’s performed really well and the teams outperformed by far. And so it’s really been that differentiated strategy and ability to execute with scale that I think has led to the high service levels, which in turn have probably led to the superior performance in the market, which is why we’re not necessarily hearing at negativity. I think it’s a – we’re able to supply and able to supply as needed. Now, a note, and what’s interesting is, I’ll tell you that while the team has progressed immensely over the last couple of years, there is plenty of room to go on that strategy, right? And so I’ve taken a lot of complexity out of the business. There is a lot more to come, and then as they get that, that’s going to permit them to really press on a differentiated end-to-end customer experience that will set them even further apart. And so it’s using the scale to drive simplification and a better experience and I think that’s what you’re seeing in the numbers now that are really driving the performance, but a lot yet to come.
Pat Hallinan: Yes. And hey Truman, I’d add, our guidance and Cabinets for the year that we gave at the end of last quarter was 4.5% to 6.5% sales growth and 11% to 12% margin performance on the full year. Those are full year numbers. And I would tell you Cabinets is tracking towards the high side of that guidance and was seeing kind of that kind of a margin run rate as they were coming out of the back part of the first quarter. So to Nick’s point, they’ve done the team there deserves a lot of credit, and it’s one of the reasons why the timing now is appropriate is they set the business up for long-term success. There’s more room to go but they’re driving commonality of chassis and components to get procurement scale and simplification of manufacturing. And then they’ve also combined the appropriate part of a NAFTA plus an agent footprint to get the best cost structure in the marketplace. So there’s a lot going right for that business and that’s why we’re very proud of it and very excited about its future.
Truman Patterson: Okay. Okay. Thanks for that. And then final one for me, just on that $450 million inflation number, anyway you could help us think through it by segment and then with all this pricing that you all have been pushing, are you seeing any mix trade down at all in any product category?
Nick Fink: Sure. Why don’t I’ll start with the pricing question, which is short answer, no. It’s – the consumer’s been remarkably resilient around it. And I think it’s if anything spoken to the pricing power of our brains in our positions. And so it has been a lot of price that’s been driven through all of the businesses to offset the inflation, that’s come our way, and we’ve worked very hard to drive continuous improvement to the extent we can as well. But in short answer, now the consumers continue to be there. The businesses are seeing a lot of demand and in certain parts of the business, even where I would say we’ve had some of our highest pricing moves, we’re still completely sold out and producing everything we can. And so as we think forward, that ability to have pricing power and have brands that consumers want and innovation that people want and are willing to trade up for will be a big part of the strategy. So Pat, if you want to talk a little bit too.
Pat Hallinan: Yes. We – Truman, we don’t really break out the inflation and price by segment for a number of reasons. But it – I’d say just because the dollars of COGS are a little more heavily weighted towards Water Innovation. The dollars of inflation are a little bit more weighted by that. Just because there’s a lot of valuable metal in those products and that tracks it. But I would say all of the businesses are seeing a similar order of magnitude of inflation when you talk about percentage of their COGS. And they’re all having to take about the same order of magnitude of cost improvement and pricing action to fight it.
Truman Patterson: All right. Thank you all.
Nick Fink: Thank you.
Operator: Thank you for joining today’s conference. You may now disconnect.
Nick Fink: Thank you.
