Fortune Brands Innovations Inc (FBIN) 2013 Q2 法說會逐字稿

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Home and Security second quarter 2013 earnings 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.

(Operator Instructions)

Thank you. I will now turn the call over to Brian Lantz, Vice President of Investor Relations and Corporate Communications. You may begin your conference.

Good afternoon, everyone, and welcome to the Fortune Brands Home and Security quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress during the second quarter of 2013. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investors section of our www.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 a 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 our SEC such as our Annual Report on 10-K. The Company does not undertake to update or revise any forward-looking statements which speak only to the time which they are made. Also, any references to operating profit, earnings per share, or cash flow on today's call will focus on our results on a before charges and gains basis as described in today's news release, unless otherwise specified.

With me on the call today are Chris Kline, our Chief Executive Officer, and Lee Wyatt, our Chief Financial Officer. Following our prepared remarks, we've allowed ample time to address any questions that you may have. I will now turn the call over to Chris.

Thank you, Brian, and thanks to everyone for joining us today. We delivered strong second quarter sales and profit growth that capped off a first half of the year that was even better than planned. We have developed solid momentum by focusing on profitable growth, as we continue to leverage the market recovery and our competitive advantages. We are now positioned to drive incremental shareholder value, and we are well-positioned for the second half of the year. Importantly, based on our strong performance, our continued positive outlook on the market, and our efficient closing of the WoodCrafters acquisition, we're again increasing our annual outlook.

Let me first spend some time on the quarter highlights, and then I'll discuss our increased annual outlook. For the quarter, sales were up 11% and EPS was $0.41, up from $0.29 a year ago. Importantly, for our three housing related segments, we saw total sales increase 13% for the quarter well ahead of the overall market for our products, as we continued to gain share in our categories.

Now let me give you some highlights by segment. Sales for our Cabinets business were up 13% for the quarter. We exceeded our expectations as we gained share in all channels and benefited from both new construction and repair and remodel. The pace of new construction remained a key driver, as we again saw strength with dealers and builders in our new construction lines. However as R&R spending improved over last year, we also saw growth more broadly across a fuller range of our semi-custom lines. We are leveraging our structural competitive advantages, including our portfolio of brands, a continuous stream of innovation, and our service-oriented operating platform to generate sustainable momentum. We gained share in both the dealer channel, where we're the clear market leader, and in home centers where we saw particular strength our in-stock cabinets and bath vanity programs. Notably, we grew our Cabinet profits by $17 million in the quarter, nearly doubling last year's second quarter profit. This performance again reflects our ability to successfully target profitable growth and leverage our efficient operating platform to improve profitability.

Plumbing sales were up 15% in the quarter. Moen again saw broad sales gains in the US and in our international businesses, particularly China. Gains were strongest in the US in our wholesale business, driven largely by the pace of new construction. Our leading market share with the top builders and wholesalers and our strategy to expand the multi-family segment are yielding share gains and solid profit growth. Moen also saw double-digit gains at retail with our steady pace of consumer-driven innovations, like MotionSense, a unique hands-free electronic kitchen faucet, our Microban anti-microbial finishes, and new styles like our Ashville and Banbury bath lines.

Internationally, sales in China, where there are more than 800 Moen branded stores, were again up strong double-digits over the prior year, driven by continued gains in direct-to-builder, performance of the existing Moen store footprint, and our continued store expansion. The team in China continues to build our business with a wider range of price points and with products uniquely tailored to the Chinese market, and the Chinese consumer continues to spend in our category.

Windows and Doors sales were up 11% for the quarter. Door products saw sales growth of 15%, driven by gains in new construction and our ongoing distribution expansion. Window sales were 6%, driven by a better repair and remodel market and share gains in our dealer [west] and home center channels.

In the Security and Storage segment, our sales were relatively even with the prior-year quarter with strong profit growth. Security sales were up mid-single digits to the prior-year quarter with strength in US retail, international, and global safety. Master Lock innovation continues to hit the mark in both retail and commercial, with new updated versions of well-established product lines and exciting new line extensions. We also continued to rollout our new line of commercial electronic access control solutions, designed to secure high-value sites such as cellular telephone towers and other storage facilities. Tool storage sales were down in the quarter, as we continued to reposition the business. However, sales for the second half of the year should be positive to prior year, as we begin to benefit from the first half repositioning.

To sum up the second quarter performance, I'm excited about our performance versus a market which continues to be lead by significantly stronger new construction and a repair and remodel market that continues to show signs of improved growth. This performance demonstrates the strength of our operating model and our ability to generate profitable growth as volume returns and we continue to gain share.

We also closed our WoodCrafters acquisition late in the second quarter. The integration is fully underway, and as expected the acquisition will add incremental sales and earnings per share in 2013. And as expected, we are on track for strong performance in 2014. We tend to continue to be efficient with our cash by investing in our businesses, pursuing accretive strategic acquisitions, and returning cash to shareholders through dividends and share repurchases, all with the single focus of increasing shareholder value. We are excited about the WoodCrafters acquisition which will allow us to build on our competitive advantage in cabinets, particularly as a repair and remodel market gains momentum. This is a great time to enhance our leadership position in cabinets and further strength in our efficient and responsive North American supply chain.

Let me now turn to our outlook for 2013. Lee will then take you through our outlook in more detail in a few moments. From a market perspective, we see an overall market for US home products that continues to show strong momentum in new construction and improvement in repair and remodel. New construction remains robust, as demand for new homes outstrips supply in many markets across the country. It is also encouraging to see the pace of repair and remodel activity improving, even in the areas that had been lagging, such as semi-custom cabinets and replacement windows. Our revised 2013 outlook remains built on a fundamental assumption that the US home products market grows at a combined 8% to 10% rate. Based on that market assumption, continued share gains, and the WoodCrafters acquisition, we now expect our 2013 full year sales to increase at a 13% to 15% rate over 2012, with our home products businesses growing faster and our Security and Storage business growing slower. We expect our 2013 EPS before charges and gains to be in the range of $1.35 to $1.43.

To sum up, we had another quarter of strong results and our first half sales and profit growth was better than we initially expected, due to an improving market and solid execution. We're confident in our ability to continue to outperform our market and we have again raised our outlook for 2013. We're also now positioned to drive incremental shareholder value and have closed on our first acquisition. Our strong brands, management teams, and capital structure provide flexibility to both focus on profitable organic growth and drive incremental shareholder value with our strong free cash flow. Now I'd like to turn the call over to Lee, who will review our financial performance and provide more details on our revised 2013 outlook.

Thanks, Chris. As Brian mentioned, the majority of my comments will focus on income before charges and gains which best reflects ongoing business performance. Let me start with our second quarter results. Sales were $1.04 billion, up 11% from a year ago with our home product sales growing 13%. Consolidated operating income for the quarter was $107 million, up 48% or $34 million compared to the same quarter last year. EPS were $0.41 for the quarter, up 41% or $0.12 versus the same quarter last year.

Now let me provide a little more color on segment results. Our Cabinet sales were $392 million, up $46 million or 13% over the prior-year quarter with growth in all channels. Operating income for this segment almost doubled to $35 million up $17 million, as we benefited from higher sales volume running through our improving supply chain. Our strategy of disciplined sales growth is working as planned, as we continue to exceed the overall cabinet market growth while improving profitability. We are seeing broader growth in our semi-custom cabinet lines as R&R spending improved over last year. Plumbing sales for the second quarter were $323 million, up $41 million or 15% versus the prior-year quarter. All channels again performed well with the US wholesale, US retail, and China businesses all experiencing double-digit sales growth. Operating income was $55 million, up 29% even as we made incremental brand investments. And importantly, operating margin was 17.1%, 190 basis points higher than the same quarter last year.

Windows and Door sales were $176 million, up $17 million or 11% from the prior-year quarter. Within this segment, the Door business experienced 15% sales growth while the Window business grew 6%. Operating profit for this segment more than doubled to $10 million, $6 million better than last year. For the full year, we see significant improvement over last year's profit. Second quarter Security and Storage sales were $149 million, relatively even with the prior-year quarter. Security sales increased 4% and were offset by lower sales of tool storage products. Segment operating income increased 25% to $26 million, driven primarily by changes to our benefit structure as we align all of our benefit programs ahead of implementation of the new healthcare law, less other investments in the business to support new product launches and line extensions.

Turning to the balance sheet, our June 30 balance sheet remains solid with cash at $124 million, debt of $386 million, and our net debt-to-EBITDA leverage is 0.7 times. We have $60 million drawn on our $650 million revolving credit facility. The June 30 balance sheet reflects the closing of the WoodCrafters acquisition for approximately $300 million and the payment of our first dividend. Additionally, in July we extended the maturity of our existing credit agreement to five years in order to maintain our flexibility. The facility capacity continues at $1 billion with a $650 million revolver and a $350 million term loan. We retained the same strong bank group and the favorable terms of the original agreement.

Now let me mention a couple recent actions, as we began to use cash to drive incremental returns to shareholders. First, as Chris mentioned, we closed our WoodCrafters Cabinet acquisition quickly, integration is fully underway, and the transaction will deliver incremental sales and earnings per share in 2013. Second, we paid our first dividend on June 19. The dividend reflects our confidence in ongoing cash flows. As we previously stated, over an assumed five-year time horizon beginning in 2012, for the housing market to return to a steady state, our strong free cash flow combined with our flexible balance sheet should provide over $2 billion of cash to drive incremental shareholder value.

Let me now provide further details on our revised outlook for 2013. As discussed previously, our approach to the 2013 planning and annual outlook begins with a market assumption. Our approach also includes continued share gains in addition to the overall market growth. Also, we now included 3% sales growth and $0.04 of incremental earnings per share to our revised annual outlook due to the WoodCrafters acquisition. Due to timing of costs associated with the acquisition, we should realize $0.01 in the third quarter and $0.03 in the fourth quarter. As we said last quarter, WoodCrafters' annual sales are approximately $230 million. For the full year 2014, the acquisition should add an incremental $0.11 to $0.13 of EPS to our overall performance. So based on our first half performance and market assumption, continued share gains, and the WoodCrafters acquisition, we expect our total Company full year 2013 sales to increase 13% to 15% compared to 2012. We should again outperform our market with all segments increasing. Our expectations for EPS are now in the range of $1.35 to $1.43. The midpoint of our guidance represents an increase of 56% over 2012 EPS of $0.89. 2013 free cash flow should be in the range of $240 million to $275 million, after CapEx of approximately $100 million.

In summary, our business model is performing well and we're pleased with our strong second quarter and first half performance. This momentum should continue into the second half of the year, as we benefit from our structural competitive advantages and the market recovery generates additional growth. Importantly, this sustainable momentum in both the housing market and in our business performance should allow us to create incremental shareholder value by making selective acquisitions and returning cash to shareholders through our dividend and share repurchase. I will now pass the call back to Brian.

Thanks, Lee. That concludes our prepared remarks for the second quarter. We will now begin taking your questions and we'll continue as time allows. Since there may be a number of you that would like to ask a question, I'll ask that you limit your initial questions to the 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?

(Operator Instructions)

Your first question is from the line of Stephen Kim of Barclays.

Thanks very much. Strong quarter, guys.

Thanks.

Just wanted to start off with a question about Kitchen and Bath Cabinetry. First of all, can you give us a sense for what we're seeing there, in terms of mix versus cost versus maybe a reduction in promotional actions? Obviously the margin improved handily. I just want to try to get some handle on how you would break the improvement in profitability up into those three categories?

Yes, so just a little bit of background. I think overall, we've seen promotion continue to decrease. As you know, we started back about a year and a half ago being a little bit more constrained on that and I think that's worked well. Across our channels, dealer continues to perform very strongly. We're seeing a good mix come out of there. On the home center side, we're also seeing strong performance in our in-stock category as well as our semi-custom side. On the builder side, there's a lot of demand out there on the direct-to-builder side but we also pick up a pretty good mix coming out of the dealer channel. That tends to be a little bit richer, even than on the direct-to-builder side. Lee, I don't know if you want to add anything else?

No, I think that's right. I think it's across-the-board. We're getting leverage on the volume and 9% operating margin in the quarter.

Yes, that sounds great. Sounds like it's pretty much strong across-the-board. I guess if I could ask another question related to what you're seeing in renovation, particularly residential, larger ticket remodel. You indicated that you were seeing some continued strength or continued signs of improvement in that market. Is there anything in particular that you would point to within the numbers? Obviously, if you look at the sales growth, it would seem to suggest things are picking up. But is there anything in particular, swimming beneath the numbers, that you would call out that gives you some hopeful sign or indicates a hopeful sign that we're starting to see an improvement in larger ticket residential remodel?

Yes, I'd say almost the encouraging thing is the semi-custom side of the market, which is special order at both home centers and kitchen and bath dealers. The heart of the market, semi-custom, is really picking up. I'd say if we're sitting here nine months ago, we're talking about the value end of that market which is still semi-custom. It's still designed for the project, but really it was much more pure value-focused. Now, we're actually starting to see a pick up in the higher-margin product, the richer mix. A lot of our innovation is getting picked up on finishes, different wood species, and so that's starting to improve. The thing that's the most different is probably that and that's an encouraging sign. It's not all the way back. I think we still have some headroom to grow. In fact, on the higher-end custom I think we're still away from where we should be steady state. But we could see some momentum coming through.

Great. That's very encouraging. Thanks very much guys.

Your next question is from the line of Dennis McGill of Zelman and Associates.

Hi, thanks. Chris, just on the Cabinet, the incrementals if you look at the first half of the year, the incrementals are above what you've talked about that business maybe normalizing to and what you've seen historically. Any sense that you're becoming more optimistic that you can see better leverage than what you've seen historically with a couple quarters of growth behind you, and able to see what the business does and how the volume drops down?

It tends to ebb and flow a little bit. We're certainly encouraged with the kind of leverage we're seeing. But I'm not sure that it's a straight line up because some of it is mix. I'm not sure that you can just extrapolate it through. But I'd say we are encouraged. As we've talked about, we should be seeing leverage between 25% to 30% and we should be moving toward a steady state margin in the 14% to 15% range. I think we're encouraged that we're headed toward that and you can see a stronger quarter. You could see it back off a little bit. But I look at it over more of a rolling average and on that basis, I think we're encouraged.

Would it be fair to say that the leverage you've seen in Cabinets through the first half of the year is better than you would've expected for that given the level of sales at the beginning of the year?

Yes, back to what I was talking about earlier, the mix we're seeing coming out of that core semi-custom is stronger than we would have thought at the beginning of the year. That's encouraging. I think if that continues, we'll be on a better pace than we thought. That's probably the most significant change from where we were in the beginning.

Okay. Then, you mentioned double-digit growth at retail for the Moen brand. Is there any differentiation between shipments and POS?

No, I think it's actually pretty healthy. I'd look across both retail and wholesale and say it's pretty healthy. There's not a lot of inventory build out there. On the wholesale side, which is feeding new construction, we're shipping it in and they're selling it out so it's a pretty good velocity in turn there. On the retail side, I think we've talked and the home centers have talked about, they've been pretty disciplined about making sure there's enough inventory in the system but not getting too far out ahead. I'd say the most encouraging thing on our growth at Moen retail is just that our new products are really driving a lot of that. The pick up on new products is encouraging because that tends to be our stronger performing.

Just last question, kind of wrapped into that. Are you seeing inclusive of new products a favorable mix within the faucet category as well?

Yes, I think it's good. We're not driving growth as maybe some others are in the industry by just selling in at a lower cost. We're getting a good rich mix come through as we'd hope. I think it's as we thought it would be and it's quite strong.

Okay, thanks guys. Appreciate it.

Your next question is from the line of Bob Wetenhall of RBC Capital Markets.

Hi, nice quarter, gentlemen. Just wanted to ask, and maybe this is more directed towards Lee, I was trying to understand what's driving the increase in SG&A. It's like up $23 million, $24 million year-over-year. I was just trying to think how much operating leverage is there, or what's your ability to leverage the SG&A line going forward?

Yes, Bob, when you look at the quarter, SG&A is up about $25 million, about 10%. If you look at just the normal volume and inflation piece of that, that's about 4.5% of the 10% increase, so very manageable level. What we have done in the quarter is continue to invest in our initiatives to drive future growth. That specifically means Moen advertising. We increased Moen advertising in the quarter about $8 million so that's the other big chunk of that, that we did. We have some M&A consulting that drove it up. I think net-net, about 4.5% of the 10% growth was core things that you're leveraging. Those others were discretionary decisions to invest in the business.

Got it. That's very helpful. If you could just give us an update on the WoodCrafters acquisition, in terms of integration and what you're seeing in terms of potential opportunities, on a broad general sense that would be terrific. Thanks so much.

Sure. I'll take that. We closed WoodCrafters about a month ago and it's proceeding as planned. Everything is on schedule. It's terrific. They're a great group of associates joining us, many of them based in Mexico. We've been working closely with them on integration and in working with our bigger customers and it's terrific. I think everything's on track. We're starting to develop the plans for further opportunities. But the biggest concern right out of the gate is just making sure that it's as we thought it would be. So, I can report back no surprises and everything's all systems go. It's terrific. We're very excited about it.

Thanks very much.

The next question is from the line of Dan Oppenheim of Credit Suisse.

Thanks very much. I was wondering, you'd talked about the Storage business and some of the repositioning, the benefits to come in the second half, at least from a revenue perspective. I was just wondering if you can comment at all, in terms of just how we should think about that, in terms of any impact on margins initially, as some of that helps the revenue there?

Yes, within that business, we're doing a number of things in the beginning of the year to really launch some new products, better mix. Some of that started to flow through second quarter, but that's really positioning for the second half. That's a seasonal business and a lot of the impact comes in the October, November point of the year. We were setting up a lot of new programs to really give ourselves a lift there. We should see some positive impact second half. Really, we saw the second quarter as really more of a repositioning quarter to set up that stronger second half.

Okay, thanks. Within the Plumbing business, there's been a tremendous difference in the growth there and also the margin front. Is there further room in terms of expansion of the margins there, in terms of pricing power? How do you think about that?

I think that it's really mix-driven. I think as long as we continue to see the strong mix out of our wholesale group into new construction which has been good and the mix on the retail side, to the extent it's supporting new products, that tends to be pretty strong too. Those are the two real big drivers in the business. We have a steady cadence of new products that are going to continue to come into the market. I'd expect that will continue. As long as the market holds up, we're set to deliver against it, and yes, it's performing quite well this year.

Thank you.

Your next question is from the line of Michael Rehaut of JP Morgan.

Hi, it's actually Will Long on for Mike. How are you guys?

Hi, Will. How are you?

Good. My question is on the current M&A environment. I was wondering if you guys could talk about any potential areas where you could see a potential M&A, and just what the market looks like currently?

I'd say it's starting to wake up and we get to see a lot of things. We're one of the most obvious strategic buyers for a number of different companies out there, so we're looking at a number of different things. Given we just completed one, I don't know that anything else is imminent. We're pretty deliberate. We're really trying to drive shareholder value here. We're disciplined in terms of how we look at everything. So, I'd say the environment's picking up. I think there's more to come. I'd look out over the next 12 to18 months and say it'll probably pick up even more. There are a number of companies that are family-owned that I think as they start to see some of the benefit of the recovery, will then think about maybe selling. There are some private equity-owned companies that may be out there too. I'd say we're going to take our time. We're going to continue to be disciplined and really focus on just building the best company and driving shareholder value. That's the key to it all.

Okay. Then, have you talked about the Storage business in terms of repositioning in the second half. Just longer term, what is the future plan for tool storage?

Strategically, the category hasn't been that strong. We're looking at further opportunities to expand into the garage. We do have a line of garage storage cabinetry and other organizing type products. We continue to look for opportunities to grow in that category. The core category of tool storage is in a very slow decline. We're managing it today really for profitable growth and focused on cash generation. We look at something like repositioning the line to generate greater cash flow in second half and say that's really where that business sits. It's where the business is within the portfolio.

Okay. Great, thank you.

The next question is from the line of David MacGregor of Longbow Research.

Congratulations on a good quarter guys. Can you just talk about wood price inflation in the Cabinet business? And if possible, can you quantify the impact on the second quarter results?

We would say that we have seen some inflation in the wood side. Remember, we're more hardwoods than we are just the lumber to build homes. We're seeing some inflation of course but I'd say overall, its been very manageable. With our brand strength and our service proposition, we have the ability to take price to offset those. So, we feel very good about that, that over time, we'll manage any inflation. But I would say that overall, general inflation for our Company has been pretty modest in the quarter.

Is there any chance of quantifying that for us? Was it neutral or was it small inflationary influence?

I would say that in the quarter that we basically offset any inflation with modest price increases.

Okay, great. Then secondly, you talked about share gains across your various businesses. I wonder if I could get you to elaborate a little further on that, maybe talk about where you thought you gained the most, and how you see that going forward?

We can go through it by business. If you look at Cabinets, we're looking at sales of 13% in the quarter. That category is probably high-single digits. There was some significant movement there within that. I'd say dealers are strongest. We're picking up individual dealerships. We're expanding within dealerships to multiple lines, and we're seeing more activity there. On the home center side, we're very active selling directly into the designers. That's something we've been really focused on over the last 12,18 months and moving away from just that heavy discount promotional environment, into more closer collaboration. That's paying off.

Those types of things, as you start to get a little more market momentum, frankly you start to see the benefits of a lot of the position gains that we made over the last three years or so. You're just seeing volume flow through there. With Moen, we've got a heavy representation with the large builders and within wholesale. They're disproportionately winning relative to the overall market. Then on retail, I talked about some new products that are really helping us along there.

Windows and Doors, the biggest news there is we worked hard over the last two or three years to really expand distribution. We're under-represented in some regions across the country. It was pretty deliberate. Again, now you're seeing volume flow through that market. You're seeing share gains that they are really the result of extending distribution deeper into the marketplace. Those are really the highlights and we've always grown a little bit farther ahead of the market. I think as you see volume coming through the market, it tends to extend that out a little bit.

If I could just add-on to that last one, within the Windows and Doors business, is your private label business in Doors expanding? Or do you feel you're gaining share through that franchise?

I think it's doing fine. I don't think it's growing any faster than the overall market. It's keeping pace. I think the real piece there is through two-step wholesale distribution, the Therma-Tru branded door. We're a leader in the fiberglass at the high end and that is doing quite well. Our distribution is very strong and so that's what's really setting the mark out there.

Okay. Again, congratulations. Thanks very much.

The next question is from the line of Eric Bosshard of Cleveland Research.

Two questions for you. First of all, on the revenue guidance, can you go back to how you would break apart the remodel and new construction within that? I know you've talked about remodel up, I think, 4%, 5%, and new up 25%, within the updated guidance. Any change in the mix or growth rates within those two?

Not really. Overall, we rolled it together and it's about 8% to 10%. R&R might be a tick higher and new construction might be about the same. It's not certainly any higher there. To the extent there's any incremental in the marketplace, it's probably just a little bit better on R&R. I think for us, it's a combination of obviously bringing WoodCrafters in, in the second half and then there is a little bit of improved mix obviously, we talked about especially on the Cabinet side. Then, in the second quarter, we outperformed where we thought we would be. I think you roll all that together and that really is the underpinning of the guidance.

Great. Secondly, the incremental margins in Cabinets I know were, again, ahead of what you've guided but were a little bit less than the big numbers that you saw in 4Q and 1Q. I appreciate the comments that it can ebb and flow. But any guidance or thought you'd give us on why it was a little bit less upside in the incremental margin this quarter than the prior two quarters?

To frame the whole discussion, it's always we talk about 25% to 30% increment on an ongoing basis which gets us back to that 14%-plus total Company operating margin. Recall the first quarter, overall Company, I think we were at 45% incremental, 55% in Cabinets, but that was on a very low volume base. You get oversized leverage against the fixed costs in that first quarter which is our lowest volume quarter. In the second quarter, we saw overall leverage at about 33% and we saw Cabinets at 37%. We always think as we leverage Cabinets, they'll be at the high end of that. So, they were at 37%. That seems pretty reasonable to us. I think we also said on last quarter's call that we'd be probably closer to the higher end of that 25% to 30% for the full year, and I think we're tracking there. But it does ebb and flow, and you can see it's coming down in Cabinets 55% to 37% in the second quarter, getting much more reasonable.

Okay, Great, thank you.

The next question is from the line of Jim Barrett of CL King and Associates.

Hi, everyone. Chris, I had a question on WoodCrafters. It appears to be a very strong, high-quality acquisition at an attractive price. Given your acquisition pipeline and the quality of the companies that you're evaluating, should we think of WoodCrafters as a top quartile type acquisition, in terms of fit and brand quality? Or do you see other acquisition candidates of similar quality out there?

Well, we always aspire high. I'd say if we could complete others with the profile of WoodCrafters, we would be delighted. It's a terrific company and it fits very nicely within the Cabinet business. It's a segment of the Cabinet business and bath vanities that we were in, but it greatly extends our product line and our reach in that part of the market. It checks a lot of boxes in terms of criteria. That's why I say we'd be delighted if we could check all those boxes every time. I think it really speaks to our discipline. We will look for things that look more like that, than not, is the way I'd say that and so might you pay a little bit more for something different? Yes, you might but it would have to maybe check a couple different boxes and add some value in some other ways.

I think it's a good representation of, you buy a business. You're clear going in about where the opportunities are, where the synergies are. You get executing on it right away, and in the end, it should flow pretty nicely. I think those are the types of things that we're looking for and looking at. As the pace picks up, I think we're going to see a number of things that look like that.

And your general sense of competition for assets like WoodCrafters?

I think if it's a really tight fit with our business then we're going to probably have the best look at it. I think if it's a pretty general asset then a number of others will take a look as well. Hard to say. It depends. You can never know whose looking at what, but I can say we're seeing a lot of things and don't really know beyond that.

Okay, well that's helpful. Thank you very much.

The next question is from the line of Ken Zener of KeyBanc Capital Markets.

Gentlemen. Can you perhaps describe a little bit how the dealers, talking about the Cabinet dealers, how they're describing the shift at the higher margin semi-custom product? In the past, you've talked about is actually being a later cycle but very margin accretive product. Are they seeing more people coming in? Are they saying people are getting home equity loans? Could you give us a little sense there? Because some higher ticket discretionary items, like appliances, had a very big inflection in the second quarter. I just want to get a better sense of how you guys might be picking that up, in terms of backlog before it shows up.

We started to see and hear of a lot of shopping really, I'd say, in the six months leading up to the quarter. If you go back last fall, there was a lot of talk over a lot of shopping, a lot of proposals being put together. You could feel there were consumers out there in the marketplace. I think we're starting to see some of that convert into orders. And again, I'd go back and say it's the heart of the market, semi-custom. So, it's not really the high-end yet but it's not value. It's the middle market and it's the heart of the market. That feels pretty healthy because it doesn't suggest that requires a lot of borrowing, a lot of leverage. You may need to borrow something or you may be able to put it on a credit card. If you look back to 2005 to 2006, it's the very high end of the market. There, you saw a lot of leverage and people doing extraordinary things. I think you're still seeing a reasonable mix come through. I'm just highlighting that it's the middle of the market, as opposed to the lower-value end of the market. So that's encouraging. I think the dealers are encouraged by that. These dealers are benefiting from new construction business that's flowing through their dealerships as well.

Okay, WoodCrafters. There's some other private cabinet companies out there that have very different margin profiles right now than the larger public companies. It gets to the earlier question, in terms of the pipeline and perhaps the characteristics. Some of these private family companies that have products in similar categories as the public guys are actually performing better. Is that what we could expect, I guess, from what you're going to be targeting? I know you don't want to buy a fixer-upper, but are there quite a few companies that are outside the public equity domain that you are looking at and vetting? And what might be market cap sizes that might limit you, or regional components?

I wouldn't characterize it as we're looking at many, many companies right now. I think that there are opportunities out there and they could be across Cabinets. It could be across our Plumbing segment. It could be across Window/Door. It could be in Security. I think it's a sampling of those. I don't think it's that heated, as your question might suggest, that it's a heated market. There's a number of those folks who are coming. I think they could be down the road. I think we'd look for quality businesses.

From a geographic standpoint, it could be in parts of the country maybe that we're not as strong. We've got a strong national footprint, but there may be places that we would like to add to more than others. That would certainly play into it. I think we'd look at a product line and say it has to be healthy. You're right, I don't really want to be fixing up or trying to drive gross margin improvement because there's something fundamentally wrong with whatever business that we're looking at.

Then, I guess to find a perhaps a weak spot in a stellar quarter, China with the slowing GDP, financing, whether it's [formal or informal] out there, in terms of new construction. I know you guys have obviously had good growth rates. I think you said it, but if you could just restate it between the US and China, what the growth rates were. Could you just give us what would be a bad scenario? If China were to have had a very hard landing, I know these flats, apartments aren't done, finished, you'd still have some lag there. But if there was really some type of big deceleration, how would that flow through your production channel, in terms of the falling volume versus improving US market? Thank you.

Sure. China's going great for us, so I wouldn't characterize it as any sort of a dark spot in the quarter. It actually was quite strong. The thing about the China market is a lot of the housing is built and it doesn't have plumbing installed. Fixtures aren't installed so showers, faucets, sinks are not -- they're roughed in. But the consumer has to, once they acquire the unit, go into household shopping malls and select what they want installed, and so it's after they acquire the property. There are also a lot of properties that were acquired that haven't been lived in, that once they're sold to somebody who's actually move in is a source of demand for us. In many respects, we'd lag the general construction market. General construction market continues to move along. We all read about the parts of the market that are over-inflated but they're still building a lot of units throughout the country. We're still seeing strong flow, same-store sales, as well as the new units that we open up. China, at least in our category, continues to be strong.

There's also some emerging R&R where you've got consumers who maybe moved into a unit, 7 to 10 years ago, and put in more commodity-like, lower-end faucets. Showers are now coming back and retrofitting, putting in a premium brand like Moen in the market. We're the number three faucet in the market and it's very much perceived as more of a premium faucet. The newspaper reports certainly would show China having a lot of issues. I think our business is quite healthy there. We're quite pleased with the progress that we're making in that market.

Thank you.

The next question is from the line of Keith Hughes of SunTrust.

Thank you. Question on the Window and Doors segment. You had highlighted the difference between the two products, in terms of growth in the quarter. Can you make some comments on profitability in the quarter between those two as well?

Yes, obviously, when you have 15% growth in the Door business and you have premium product, your margins are very good and your mix is very good. It's better profitability there, but Windows actually had a fine quarter. We grew from $4 million of overall profit in the segment to $10 million, so we more than doubled. Windows did fine and having 6% growth there, and remember, the Window business is more R&R driven.

Our window business is predominantly big ticket R&R. We looked at 6% as being an encouraging sign in a category that has been a little bit still asleep, that we're trying to get to wake up. It woke up a little in the second quarter, so we're happy with that.

Both pieces of both businesses' profits were improving. Obviously, Doors were a little better with the 15% sales growth.

And pricing, specifically on Windows, have you seen any movements in the positive direction there, given R&R improvement?

Not so much. There was a little bit of pricing that came through to recover some commodity cost, back half of this year and rolling into the first half this year. Given that it's slowly growing, it isn't yet to a point where there's a lot of pricing in that market. It may come down the line.

Okay, thanks.

Your next question is from the line of Peter Lisnic of Robert W. Baird.

Good afternoon, gentlemen. On Plumbing, the multi-family initiatives, you talked about some opportunities there. Can you give us a sense as to where that business is, and the opportunities there and how you're focusing on that piece of Plumbing at this point?

Actually, I'd go back four or five years, and we really invested in that sales team on the multi-family side and have had a steady cadence. It's both new construction and also multi-family. There's a lot of churn in that channel. As you get a lot of tenants coming in and out, and occupancy rates are pretty high these days, so there is a lot of movement. A lot of times you're churning faucets out of those units as well. So, it's a combination of new construction as well as the churn that we see in that category. I'd say it's really the benefit of the last four or five years' investment in there, in that sales team and that focus. Then we also have a product line, CFG, which is really dedicated to that. We've got the right product at an attractive price point going into the channel, with some investment we made on the sales team. With some volume coming through, that helped us in the quarter.

But is it safe to say that there's still a pretty substantial opportunity to penetrate that specific piece of the marketplace, as you look forward?

Yes, I think our penetration there, relative to single-family, isn't as high. We can continue that momentum. I think we've made obviously great strides over many years on the single-family side. We're performing well in multi-family but I do think there is more headroom there, yes.

Okay. Any chance you could give us an order of magnitude, as to the quality or depth of opportunity there?

No, not really.

Okay.

Sorry about that.

No, I've got to try, right? Just to go back to the China question, if my memory is correct, your store count there I think is about doubled over the past year, maybe 18 months or so. How do we think about that store count number and the investment associated with it, when we look to China over the next one to three years, assuming that things continue to roll on there from a macroeconomic standpoint?

Yes, it's probably doubled over the last four years, more like three or four years. But it has been at a steady clip, and we're adding, we continue to add. I think you'll reach a plateau point here and I'm not ready to call it because it will be very much dependent upon the market, and really the expansion of the market. We're well penetrated in the Tier 1 cities. We continue to look at that footprint. It's expansion in the Tier 2, Tier 3 cities -- continues to expand and they're building more in those markets that we're in. You could add multiple locations in those markets. Once you're pretty well serving the geography, then it's just a harder focus on same-store sales and increasing the velocity in those locations.

We watch it. We really do review it a couple times a year to make sure that we're at about the right pace. I wouldn't say the investment is extraordinary per location, but if we stop expanding locations in a meaningful way, you would definitely see the profitability increasing.

Okay. Just to clarify, did I hear the number right, around 900 stores? Is that correct?

We're over 800 right now. We could be near that number 900 towards the end of the year, or early part of next year.

Okay. Perfect. Thanks for the info and the clarification.

Sure. That's great.

We have one more question. Your last question is from the line of Stephen East of ISI Group.

Thank you. Chris, I know we beat the incremental op margin quite a bit, but just one more question along those lines. With semi-custom coming back a bit faster than you thought, I'm interested to see, one, how much benefit does Plumbing typically get from that? And this faster pace, has it changed your thought process on what's sustainable incremental op margin?

I don't think it changes our perspective on what the standalone incremental op margin is. If you're asking, does a stronger heart of the market R&R cabinet market translate over into better mix on the faucet side? Yes, it probably does. To the extent folks are starting to do bigger projects, you're going to see a better mix and greater volume on the faucet side as well. Those two things are correlated over time. Lee, I don't know if there's anything else on the margin side you want to add?

Yes, Moen's been in the first two quarters of the year pretty consistent. They were 29% operating margin in the first quarter and they were 30% this quarter, so at the higher end as we've said, but pretty steady for them.

Okay. Then, just looking at your free cash flow, you've got strong free cash flow generation. If you sit here and run, say, for the next year or so without finding meaningful acquisitions, do you continue to sit on the cash? How would you likely deploy it, if that were the case?

Our goal is to drive shareholder value and we will evaluate the environment we're in, whether it's M&A or increasing a dividend or buying back shares. By year-end, I think we've said that net debt-to-EBITDA by the end of this year would be less than 0.5 times. We will have a lot of cash. We will do whatever we can do to drive shareholder value. But we'll be patient and thoughtful and very analytical in how we approach it.

I think we've talked before that we're not going to stockpile cash. We've got a very lean operating structure and we don't have a lot of leverage on the balance sheet so we can be very efficient. If acquisitions aren't materializing, then we'll be efficient in the other ways that Lee highlighted, but we don't intend to build a war chest. We're all about just creating as much shareholder value as we can.

All right. Thanks, guys.

I will now turn the call back over to the presenters.

Thank you. This is Brian. We'd like to thank everybody for attending our quarterly call today, and we look forward to speaking with all of you again very soon.

This concludes today's conference call. You may now disconnect.