Fortune Brands Innovations Inc (FBIN) 2013 Q3 法說會逐字稿

Good afternoon. My name is Rob.I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Home & Security third-quarter 2013 earnings call.

(Operator Instructions)

Mr. Brian Lantz, Vice President of Investor Relations and Corporate Communications, you may begin your call.

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security quarterly Investor conference call and webcast. We are pleased to be here today to provide an update on our progress during the third 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 Investor section of our FBHS.com website.

I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and of the 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, 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 at 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. We'll now turn the call over to Chris.

Thank you, Brian. Thanks to everyone for joining us today.

We delivered strong third-quarter sales and profit. We continue to leverage our structural competitive advantages and build on our momentum as the market for our products expands in both the new construction and repair and remodel markets. Importantly, based on our momentum and strong performance, we are again increasing our 2013 annual outlook.

Let me first spend some time on the quarter highlights and then I will discuss our increased annual outlook. For the quarter, sales were up 24% and EPS was $0.46 up 59% from year ago. Notably, sales for each of our segments were up double digits. Our three housing related segments saw total sales increase 26% as we continue to gain share in our categories and benefited from the WoodCrafters acquisition. Now, let me give you some highlights by segment.

Sales for our cabinets business were up 36% for the quarter. Importantly, even excluding WoodCrafters sales, cabinet sales were up 18%, well ahead of the market for our products as we grew market share in the segment. We exceeded our expectations and also benefited from a growing new construction market and a cabinet remodel market that continues to build momentum. The stronger pace of R&R spending in cabinets was a continuation of the momentum we saw in the second quarter. Mix continued to improve as we saw growth across a fuller range of semi-custom and custom product lines resulting in a better mix with higher price points. A gain share in both the dealer channel, where we are the clear market leader, and in home centers, where we saw strength in our semi-custom and in-stock cabinets, as well as our bath vanity programs. We are leveraging our structural competitive advantages including our portfolio brands, our leading position in the dealer channel, a continuous stream of innovation, and our service-oriented operating platform to generate sustainable momentum.

Also, the WoodCrafters integration is fully underway and right on track. This acquisition further builds on our competitive advantage in cabinets, particularly as the repair and remodel market gains momentum. WoodCrafters also establishes a leadership position for us in vanities and further strengthens our efficient and responsive North American supply chain. Notably, we grew our cabinet profits by $24 million in the quarter, nearly tripling last year's third-quarter profit. This performance again reflects our ability to successfully target profitable growth and leverage our efficient operating platform.

Plumbing sales were up 22% in the quarter. Moen saw broad sales gains in both wholesale and retail in the US and in China. Gains were again strongest in our US wholesale business driven primarily by the pace of new construction. Our leading market share with the top builders and wholesalers and our strategy over the past several years to expand in the multi-family segment are yielding share gains and solid profit growth. We also benefited from consumers choosing to upgrade faucet packages for their new homes, as well as sell-through on our new premium products, including the MotionSense hands-free electronic kitchen faucet, which is now available in our traditional Brantford line, contemporary kitchen pull-down styles in the align and stow collections, and our Arris modern suite. Moen also saw double-digit gains at retail, with our steady pace of consumer driven innovations, like MotionSense, our Microban antimicrobial finishes, and new traditional styles in our Ashville collection and more contemporary styles in our Gibson line.

Internationally, sales in China, where there are now more than 875 Moen branded stores, were again up strong double digits over the prior year, driven by the expansion of our store network, improved performance of the existing Moen stores, and the expansion of our direct-to-builder effort. 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. The Chinese consumer continues to spend in our category. Windows and door sales were up 14% for the quarter. Door products saw sales growth of 14% driven by gains in new construction and our ongoing distribution expansion. Window sales grew 15%, as the window repair and remodel market began to grow and as we gained share in our dealer west operation.

In the security and storage segment, our sales were up 10% to the prior-year quarter with strong profit growth. Security sales were up 7% to the prior-year quarter with strength in US, retail and international. Master Lock US retail sales grew with program expansions at large customers in spite of a relatively weak overall back-to-school period for retailers. Our rollout of a new line of commercial electronic access control solutions, designed to secure high-value sites such as cellular telephone towers and other storage facilities, also contributed to our sales gains. Tool and storage sales were up double digits in the quarter, as we continued to reposition the product line, but also benefited as the largest customer pulled forward some shipments into the third quarter ahead of the fourth-quarter holiday season.

To sum up the third-quarter performance, I am excited about our performance versus a market which continues to be lead by significantly stronger new construction and an improving repair and remodel market. This performance demonstrates the strength of our operating model and our ability to generate profitable growth as volume returns and we leverage our competitive advantages to gain share.

Let me now turn to our full-year outlook for 2013. Lee will then take you through our outlook in more detail in a few moments. From a market perspective, while higher home prices and mortgage rates appear to have slowed order rates, the new construction market is still on track to grow at 20% this year. Looking forward into 2014, most analysts are projecting growth as demand for new construction outstrips supply in many markets across the country. More importantly, given that repair and remodel is nearly 70% of our mix, it is particularly encouraging to see the improved pace of repair and remodel activity continuing into the fall remodel season. Notably, we are seeing strength in some areas that had been lagging such as bigger ticket, semi-custom and custom cabinets and replacement windows.

We're also seeing increased project size and stronger demand for more premium faucets in our Moen wholesale showrooms. These trends give us reason to be optimistic as we close out 2013 and prepare for 2014. Therefore, our revised full-year 2013 outlook is built on a fundamental assumption that the US home products market grows at a combined 9% to 10% annual rate. Based on our market assumption and continued shares gains, we now expect our 2013 full-year sales to increase at a 15% to 16% rate over 2012, with our home products businesses growing faster. We expect our 2013 EPS before charges and gains to be in the range of $1.47 to $1.49.

To sum up, we delivered strong third-quarter sales and profit growth the built on our first-half momentum. We remain confident in our ability to continue to outperform our market and we have again raised our outlook for 2013. Importantly, our strong brands, management teams and capital structure provide flexibility to both focus on profitable organic growth and drive incremental shareholder value, as our strong free cash flow by investing in our businesses, pursuing strategic accretive acquisitions and returning cash to shareholders.

Now would 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 third-quarter results. Sales were $1.125 billion, up 24% from a year ago, with our home product sales growing 26%. Consolidated operating income for the quarter was $122 million, up 67% or $49 million compared to the same quarter last year. EPS were $0.46 for the quarter, up 59%, or $0.17 versus the same quarter last year.

Now, let me provide more color on segment results. Our cabinet sales were $449 million up $119 million or 36% over the prior-year quarter, led by growth in dealers and home centers. Operating income for the segment almost tripled to $37 million, up $24 million as we benefited from higher sales volume running through our improving supply chain. Operating margin was 8.2%, 420 basis points higher than the same quarter last year. 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 and custom cabinet lines as R&R spending improved over the last year. Excluding WoodCrafters, sales grew 18%. Operating income increased $19 million to $32 million, more than doubling. Plumbing sales for the third quarter were $338 million, up $60 million or 22% versus the prior-year quarter. All channels again performed well, with US wholesale and retail and the China business all experiencing double-digit sales growth. Operating income was $66 million, up 36%, even as we made incremental brand investments in the US. Importantly, operating margin was the 19.5%, 210 basis points higher than the same quarter last year.

Windows and doors sales were $181 million up $23 million or 14% from the prior-year quarter. Within this segment, the door business experienced 14% sales growth while the window business grew 15%. Operating profit for this segment increased to $9 million, $2 million better than last year. Third quarter security and storage sales were $157 million, up 10% to the prior-year quarter. Security sales increased 7%. Sales of tool storage products were up 21%. However, approximately $5 million of the $7 million sales growth for storage in the quarter was the result of our largest customer pulling forward some fourth-quarter orders ahead of the holiday promotional period. Segment operating income increased 42% to $30 million, driven by a combination of sales gains and changes to our benefit structure, as we align all of our benefit programs ahead of implementation of the new healthcare law.

To sum up the third-quarter performance, we continue to leverage our structural competitive advantages to drive share gains. We're beginning to see better mix driven by an improving R&R market. During the quarter, we also took steps to better align the system strategy in our cabinet segment with its business strategy, focusing in more flexible systems that provide industry-leading content for consumers and superior tools for designers to deliver the best purchase experience in the industry. As a result of this shift in system strategy, we recognize net charges of $0.09, primarily non-cash charges related to abandonment of previously developed software.

Turning to the balance sheet, our September 30 balance sheet remains solid. Our cash position increased in the quarter to $157 million. Even as we opportunistically repurchase $30 million of shares in the quarter, debt decreased to $356 million. 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 annual outlook begins with a market assumption, but also includes continued share gains in addition to the overall market growth. So, based on our market assumption and our performance through the third quarter, we now expect our full-year 2013 sales to increase of 15% to 16% compared to 2012. Our expectation for full-year EPS are now in the range of $1.47 to $1.49. The midpoint of our guidance represents an increase of 66% over 2012 EPS of $0.89. It is important to note that within our EPS guidance, we intend to continue to make strategic investments across our businesses in the fourth quarter. In order to prepare for significant growth opportunities in 2014 and beyond. We expect 2013 free cash flow to be approximately $300 million for the full year, after CapEx of approximately $90 million. We should end the year with the net debt to EBITDA around zero.

In summary, our business model is performing well. We are pleased with our strong third-quarter and year-to-date performance. This momentum should position us well for 2014 as we continue to benefit from our structural competitive advantages and the recovering market for our products. Importantly, this sustainable momentum in both the housing market and in our business performance should allow us to create incremental shareholder value by making select acquisitions and returning cash to shareholders through our dividend and share repurchase.

I will now turn the call back to Brian.

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

(Operator Instructions)

Dennis McGill, Zelman and Associates.

Chris, I was just thinking on the first question. Can you maybe dig a little bit further on windows, seeing the acceleration there 2Q to 3Q and knowing that, that business is both repair/remodel and then custom new construction? Any more color you can give as far as what is driving that and what you're hearing from customers?

Thanks, Dennis. It's really more heavily R&R. What we saw was, finally, a bit of momentum coming back on the R&R side of windows. I'd say that, in general, I guess the big theme here in the third quarter for us is really a strong R&R demand coming back into our businesses. I think the window side saw that.

We also picked up a little business out west through our dealer network out there, so that contributed as well. We talked before about windows and that it's lagged the energy tax credit of a couple of years ago, sucked up some demand, and that eventually we'd see some more demand coming through windows. I think we're pleased that we're finally seeing a little bit of demand flow through that business.

So, if you exclude the business that you picked up out west, if you were to look at constant customer business, is that still seeing acceleration?

Absolutely. It's primarily through short-line distribution and it was across the board, across markets. That was pretty good. I'd say it was a steady building really from June onward, so we only saw a little bit of it in the second quarter. Then, it continued through the whole third quarter.

Okay. Then separately, back to the new construction comments you mentioned earlier that people like us in the public markets are talking about the order slowdown that some of the publics are seeing. If you just look at some of your leading indicators, are you seeing any signs, either from wholesale inventories or orders that you would see more on the front side, of that type of slowing?

Yes. I think the third quarter, across the board, was strong in new construction. September was a strong month. So, we saw good activity in September. October, there's only a couple of weeks, so it's hard to tell. I would expect, eventually, there'd be a little bit of that flow through.

Inventory levels are whirring to POS, so we don't see a lot of accumulation of inventory. It's been like that really since May/June. We haven't seen a lot of that impact flow through the business.

Okay, great. Thank you, guys.

Robert Wetenhall, RBC Capital Markets.

This is Desi filling in for Bob. Congrats on a great quarter.

Thank you.

When you look at your portfolio, I believe you're starting to see improvement in product mix across the business and as the outlook for repair and remodel spending improves.

Yes, absolutely. I think that is -- I think the thing that moved the needle the most here was product mix within R&R. We started talking last quarter about the fact that you look at cabinets business, the heart of market semi-custom, not the value end but really more of the traditional semi-custom cabinet business.

We were seeing strong momentum in that. That definitely continued through the third quarter. Our strength in the dealer side of that business was really good.

I know the faucet side, we saw a shift in mix up to really more premium product. I'd say that was in new construction as well as R&R, so mix was -- there was plenty of volume, but mix was quite good. I think that drove part of the profitability that you see as well.

Okay. And then, from a manufacturing logistics perspective, how do you think about balancing price increases for your products versus volume growth given the surge in demand that you have experienced year to date?

I think we're pretty disciplined. We've been focused for a while now on profitable growth. The reality is we could probably see even more top-line growth, but we want quality growth.

I think if you look at the results, you see a good balance between top line and strong leverage profit coming through. That is a little bit unique relative to some of our competitors.

I think we've balanced that appropriately. I'd say it's less about just getting price, but there is quality business out there and a quality business is the business that we are really working hard against.

Great. Thanks a lot.

Stephen East, ISI Group.

Congratulations, guys. Nice quarter.

Thank you.

Chris, you mentioned that construction, you never saw any slowdown. I guess in our world there is a lot of concern that the slowdown over the last five months and the government shutdown affecting consumer confidence, et cetera, also weighed on the remodel market, or would start weighing on it. If I listen to you, it sounds like you all are not seeing any of that. What would you see initially if you started to see a wobble from the consumer in the remodel business?

I think you'd see a slowdown in showroom traffic. You'd see a slowdown of consumers coming in with ideas on projects. The reality is, that is a multiple-month cycle. Meaning if they're going to do a big kitchen remodeling, bathroom remodel, replacement project on their windows, they think about it months ahead they start working on it.

The good news is, all that is still flowing. To the extent you would see a slowdown, it wouldn't be until, I don't think, the next real remodel cycle, which would be into next year.

Right now, folks aren't stopping. The volume continues to flow on the R&R side. We haven't seen that fall-off that folks are looking for.

Okay. If you look at your strong revenue growth and what you are projecting for the fourth quarter, I guess two different questions here. One, how do you split apart -- at least directionally -- price, mix, and volume? Then, your fourth quarter, the implied incremental out margin is lower than what we have seen in any other quarter so far. It doesn't really match up with -- at least the way that I'm thinking about it, with what you have been talking about with mix moving up. So, maybe you can reconcile those two things.

This is Lee. When we think of price, historically, price makes up, on an annual basis, about 1% of our sales growth, and I think that's consistent for this year.

Okay.

Everything else is mix and units. I think both are growing nicely, especially driven by this increased repair and remodel market and specifically with big-ticket items. So, we don't break that out, but both are very favorable.

Okay.

In terms of operating margins, I think if you take the midpoint of our guidance for the fourth quarter, you see some were 8.5% to 9%. That is higher than the first quarter and that is higher than the prior year significantly. Fourth quarter is actually always a little bit lower margin quarter for us than the second and third. So, we do not see that as being unusual at all.

Okay. That is very helpful. Just one quick other question. Your dealer and retail, you said both are growing. Which one are you seeing the faster growth in?

I would say dealer is very strong. We are strong across both. It's quite encouraging to us that we've been so disciplined in terms of the promotional activity on the retail side and home centers, and yet we continue to grow share there.

Then on the dealer side of the market, we are a leader in that market. We have continued to pick up dealerships. We are going deeper into the dealers, meaning they are carrying multiple lines. We're just seeing great order patterns.

I think it is a multi-year investment in, really, the service around that channel. We are pleased with both. I think they're a little unique in terms of behavior, but they have both been very strong through this quarter.

Okay. Thanks a lot, guys.

Ken Zener, KeyBanc Capital Markets

Chris or Lee, I wonder if I could just -- question Steve just asked around volume for cabinets. I think it was generally for the Company, but could you break out the 18% organic? How much of that was volume and then price mix?

Because I think there is some widening dispersion we are seeing. What was the industry growth rate, do you think, for cabinets in the quarter?

We don't really break that out. It was a combination of both for us. There was healthy volume coming through.

We did see a movement upward in mix going from our value lines more into the heart of the market, stronger per box priced semi-custom lines and even a pick up on the custom side of the market. So, I think it was a combination of both as you look at us to get to that kind of growth. That will then reflect through on the margin side as well.

Okay. Then I think, Lee, when you were making the comments here on cabinet organic, you said that was, obviously, the up 18% and that it was a $32 million organic number, implies an 8% margin. Which would have, when you back out, looks like the WoodCrafters is in that 8% margin range.

I thought that was going to be a higher-margin business. Can you talk about the margins implied in that acquisition and how long they will stay at that lower rate than it had been running historically?

Yes, just to quote the facts, the cabinet margin was 8.2%. Woodcrafters was actually about the same margin, about 8% in the quarter. In the third quarter we had this accounting adjustments, because this is the first quarter that we included them.

We had to markup inventory and so when you think about future quarters, historically, their operating margin is going to be 13% to 15%. So, they're very profitable, it's just that they were depressed in the third, which I think we talked about last quarter.

Correct. So it will be flowing through at that higher historical rate, now that you have done the inventory adjustments in this first quarter?

Yes, sir. The good news is all this flushes out in the third quarter, so by the fourth we're the old run rate margins.

Excellent. Then, could you -- now that we're seeing the strong door and window growth, can you talk to the margin spread, if you will? Or how we should think about the profitability there? Doors is obviously more profitable. You guys are doing some OEM work. Windows, a bit more supply in the channel, but with this type of volume. How should we think about that kind of run rate?

I would say it is still a case where the door business is generating much of the segment profit, because it has been a steadier cadence, if you will. On the windows side, we are just now starting to see the growth come through. Over time, that will convert better into profitability. I think that is the balance between those two right now.

Thank you.

Stephen Kim, Barclays.

Congratulations on a good quarter. Wanted to ask you a little bit more about cabinets. That information on WoodCrafters was very useful.

But, I wanted to ask you a little bit about what you -- what we saw in the quarter with respect to the Chinese plywood issue. I know that you guys have been doing a pretty good job around that.

I was curious if you could comment on what impact you think that may have had in the third quarter. Or how that impact may play out for you at all in the fourth quarter or beyond.

Sure. First of all, the issue has really been slow to develop over the last 18 months, so we saw this coming on the horizon all the way until it's about to have some impact. It didn't impact the third quarter. In the fourth quarter, we don't think it's going to have any material impact.

What we're doing is working with different suppliers to try to mitigrate some of that impact, and that is both across China, the rest of Asia, as well as North American suppliers. We have got a lot of scale, obviously, being the leader in the industry on the cabinet side. Frankly, the WoodCrafter acquisition helped that as well. So, we're doing all we can to try to mitigrate it.

I think, to the extent that there is some pricing that then would need to come in, in addition, we'll be in a strong position to take the pricing that we need. But, we're not going to need to take all the pricing that perhaps may flow through the overall industry. The good news is, this was not a surprise. We've been active in working and talking with suppliers and I think we will manage through it just fine.

Well, that is really encouraging. Also, if I could ask you a question about your overall incremental margin. One of the things that we focused on was in a recent presentation, I guess, you had changed your disclosure on incremental margins as you get to a steady state. At that time I think that you were basically implying an incremental margin that could be achieved of roughly 35%.

This quarter -- and I know that there were some issues, but it looks like you were probably in the low to mid-20%s. I was curious if you could comment on whether you do -- just, do you look for a 35% incremental margin opportunity as you get back to a steady state? And if so, how do you envision that growing from here up until -- up to that level? What do you see the flight path or the trajectory of that incremental margin looking like?

We'll start with the third quarter. A strict calculation would be about 22% or 23% incremental margins. But WoodCrafters being in here for the first quarter, will reduce your incremental margin. If you exclude the WoodCrafters' impact, they carry a very good run rate operating margin, but it does take down your incremental.

So, if you exclude WoodCrafters, we were at 28% incremental margin for the quarter, which is right in the middle of our 25% to 30% annual growth. We feel good about that and it fits where we thought.

In terms of longer term, we have talked about 25% to 30% as we get back to that 14% operating margin when we hit steady state, which is 1.5 million housing starts and 5% to 6% R&R. We're pacing nicely. If you take the midpoint of our guidance on operating margin, this year it is going to be 9%, 9.5%. That is all good.

We've really -- just to be clear, we've never said that incrementally we would move to 35% to get back to that steady state. 35% is a calculation that if you get to $800 million of EBITDA right at $5 billion. It might take us $5.1 billion. It may take us $4.9 billion or $5.2 billion.

So, 25% to 30% is where we see the incremental margin during this period of getting back to that steady state. We feel very good about our margin in the quarter, and we feel very good about where we are moving as we get back to steady state.

Okay, that's very helpful. Thanks, Lee.

Michael Rehaut, JPMorgan.

Congrats on the quarter, everyone.

Thank you.

First question, just to go back to the incremental margins for a moment, and appreciate the clarity that I guess you are reiterating, that, in fact, it is still the 25% to 30% on a consolidated basis over the next couple of years, or as we get back to normal. But, the cabinet margins this year went from 56% incremental in the first to 36% in the second. I believe if you adjust for WoodCrafters, it's 32%.

So, I just wanted to get a sense for that business overall. I believe you've talked about it in the past as being above average and even this quarter that would be the case. Is something more in the low 30%s a reasonable way to think about that business going forward?

Just again to restate the facts, you're right. On a calculation basis, incremental margins for cabinets were about 20% in the quarter. Back out WoodCrafters, it is about 32%, just as you state. As you think about the year, we will be, in cabinets, above 30%.

A lot of that has to do, as we, in any given quarter or any given year, we talk about it could spike above the 25% to 30%. You're seeing that now, and you're seeing it a lot around R&R as it comes back and you get the big-ticket lag starts to stop or disappears. We're seeing that, and that will cause it to spike a period of time.

But, over time, 25% to 30% makes sense for the total Company and somewhere in that range, over time, for cabinets. But, yes, you can see it spike above 30%, and we'll see it above 30% this year, we think.

Okay. Just so I got the math right also on the inventory adjustment on WoodCrafters. That is a $3.6 million or so. That is about an 80 bp hit. That's more one time, is that fair to say?

It's fair to say. That's a little high. The inventory -- actual inventory adjustment is closer to about $2 million.

Was that the entire adjustment, or were there other adjustments? Because you said that normally would have been 13% to 15% and it was at 8%, so.

Yes, I think if you look on a run rate, just looking at a business that's $230 million plus, I think you'll see, on average, a 14% operating margin. There is also amortization of the goodwill associated with it, but I would plan around 14% operating margins in that business.

Okay. Just one other technical question, if I could. the benefit -- change in benefit plans that affected the Security & Storage segment, could you just break out what benefit that was exactly? And, is this a one-time positive impact? Or should we be modeling this higher, the margin benefit from this change as an ongoing phenomenon?

Yes, we are taking the cost down there in some of the benefit programs. It will be a multi-year benefit, so it will not just be this year. You will see it for several years. You could continue to model that in. We'll build that into overall guidance when we give you guidance for 2014.

Okay. Thank you.

Dan Oppenheim, Credit Suisse.

Wondering if you can talk about your thoughts in terms of the use of cash given the comments about where the balance sheet will be at the end of this year? Certainly a good problem to have.

How do you think about that in terms of the upside for acquisitions here? And, desire for them and opportunities that you're seeing available right now?

Sure. We've been consistent in how we've thought about it and remain the same place, which is first priority is to invest in the business, prepare for what we see as a multi-year expansion in both new construction, but also R&R. Make sure that we're investing in the business appropriately. We then would look out and say, to the extent that we see accretive acquisitions that can build the business, we will give those consideration.

If not, we'll be in the market buying back shares or increasing our dividend. Our intention is not to stock pile cash. Obviously, we don't have a lot of debt. We will, over time here, utilize the balance sheet efficiently to create the value that we can create. We'll be looking at the situation as we come into the year.

Right now, the M&A market isn't that active, but there are a few things out there. Over time, we expect that the pace of that will increase over the next 18 to 24 months. To the extent there aren't things that look like we want to do near term, then we'll be more aggressive in our dividend or share repurchase.

Great. Thanks. In terms of the share repurchase, how should we think about that moving forward? Is that something based on opportunistically during the third quarter, based on dips in the stock? Or are you planning to put to work a similar amount in terms of dollars on a quarterly basis here? Any thoughts there?

Yes, in the short term, we'll use probably share repurchases more just on an opportunistic basis until we understand the broader market for M&A and where to really maximize our use of cash to drive shareholder value. As we learn more about M&A, we may do more of that. At some point, once we understand the M&A market over the next 6 to 18, 24 months, we may increase share repurchases. But, that would just be as a way of maximizing shareholder value when we had more facts.

Thank you.

Garik Shmois, Longbow Research.

Just wondering first off, if you could talk about the impact on plumbing margins from the growth in China?

Plumbing, as we've said, we're investing and growing. We have over 875 stores now, so we're growing that. The margins are lower than the Moen business in the States because we continue to invest so it is lower. It's still very positive. We like that business. It's a great growth opportunity.

When we stop opening as many stores, then obviously the margins will pop back up. A little dilutive on margins, but still very positive. It is hard to criticize anybody who doesn't have the margins of our Moen wholesale business. They're so strong.

Yes. I guess the natural follow up to that would be, when would you anticipate that the cadence of the sales growth from your store openings to slow and in turn margins to trend up closer in line with the legacy business?

That's something we look at quarterly. This year we were very disciplined in terms of both opening stores, as well as closing stores that weren't performing up to our standard. I'd say we slowed the pace of net expansion in doing that, to make sure we're getting the right throughput in each location. Having said that, we did obviously continue to increase.

At some point, it will really be determined by the market. If the market slows down in terms of where the opportunity is or if we feel like we have saturated the markets that we are focused on, then we will back that off. The natural consequence of that will be higher profit levels, but probably not as robust a growth trajectory. Although, expect to continue to be positive.

We've built this business from scratch over the last 17 years, and we came in and built it one at a time. I think that is the characteristic of developing an organic market is it has that kind of a pattern. At some point we want to turn it into more of a strong profit contributor as well as a growth contributor.

Okay. Thanks for that. Just a follow up on cabinets and raw material costs. Was there any impact of raws on cabinets in the third quarter?

Yes, I'd say, generally, in terms of inflation across cabinets and the business, very modest overall inflation in the quarter. We did see, in terms of the wood and the plywood and particle board, we did see some inflation more in that mid-single digits, but very manageable. Very manageable on the cabinet side all around.

Great. Thanks so much.

Peter Lisnic, Robert W. Baird.

On the cabinet business, as you look at the mix moving to semi-custom and custom, a little bit of that needle moving, can you give us a sense as to how far off we are from normal in that mix? And then, what that might mean as you move more towards a more normal semi-custom and custom mix, what that might mean from a margin perspective?

Yes, I would say in general terms, we're not there yet. We're probably not even halfway there yet. The market, I would characterize over the last three, four years, has been very value focused.

The price points around, I'd say value, semi-custom, significantly less than where the market is starting to shape up right now. Consumers are now focused more on quality, durability, getting the right look that they want and that moves them up into the heart of the market, semi-custom markets. I'd say we're not even halfway there.

As it moves forward, yes, you will see improved mix and improved profitability as we come through there. I'd just characterize it as being within the movement of the 8% margin we are seeing today up to that 14%. A lot of that improvement is driven by this part of the market.

We're primarily an R&R-focused cabinet company in the dealer network, home center market. That really is what drives us from that 8% to that 14%.

Okay, perfect. Thanks for the color on that one. Then just one quick one. The asset impairment charge that you recorded in the quarter, can you give us a little bit of detail on what that was?

Yes, it is just part of our normal process of aligning our IT strategies with our business strategies and adjusting business strategies. So, we basically looked at the kitchen cabinets, basically, and we said we need more flexible systems. That's where we're going to invest.

We have got some systems developed over the last several years that we don't really want to -- we won't use because they're not as flexible to really drive the good customer experience that we need. We're always going to keep our balance sheets clean, so we took a charge, about $0.09. It's all non-cash for things developed over several years. It's just a matter of just continually positioning ourselves for growth and being the number one in the industry.

Okay, got it. Perfect. Thank you for the time, and nice job.

Thank you.

Keith Hughes, SunTrust.

My question has been answered. Thank you.

Nick Coppola, Thompson Research Group.

Yes, a lot of my questions have been answered, too. Just thinking at a high level, thinking about your leadership in the dealers' space in cabinets. Obviously, it's a high margin, desirable channel. There are a lot of competitors jockeying for that position. How do you think about, or what are you seeing competitively? What kind of moats do you have there in the dealer space?

Yes, the dealer market is a long-term game. As we sit here today, we've got real structural competitive advantage in that market. We've built that business over many, many years. We've got deep relationships with the individual dealers. We work hard to bring them across multiple lines. We support them.

These are literally thousands of customers across the country. There's small business owners. We've done a lot to help them survive and we've done a lot to help them grow. There's really great relationships through the whole system.

We do that, and then on top of that bring in new products, great customer service, a terrific quality. We are close to market in terms of manufacturing. We have got semi-custom plants throughout North America, close to the end market. They've got great service from that.

We think we're really well positioned in that market and our results continue to show that. We're obviously concerned about any competitor who shows up, and we will keep executing and doing what we do well everyday and I think the results will continue to be positive for us.

Yes, I'd agree, you expect others would continue to focus on the market, but I like where we are. I'd expect we're going to continue to see success.

Yes, I think that makes sense and the results speak for themselves. One more question, also kind of high level. How do you think about the impact of the modestly higher interest rates we've seen for your business? And interplay with new construction activity?

I guess I look at it -- obviously, you are going to have short-term shocks to any business. I would look at it over the medium term and just say, I like the overall picture of the market. Keeping in mind, we underbuilt on the new construction side for many years.

So, the market is building to satisfy that demand. Interest rates are still historically very low and affordability is very good. You look at those fundamentals and say, if I look out to 2014, if I look out to 2015, my expectation is you'll continue to see healthy growth rate in new construction.

On the other side of the business, on the R&R side, a lot of the renovation is being driven, really, by people investing in their homes. Not a lot of borrowing, as far as we can see. I think there is some borrowing against it.

As people's equity in their homes improve, they'll have more to draw upon, which will probably be more powerful than a 75-basis-point movement in the interest rates. I think the availability of credit is important. I just look at rates and say, historically, mortgage rates are still pretty good at 4.25%, 4.5%, relative to historically where they have been.

That's how we run our business. That's how we plan. We look at the macros. We look at the longer run and play it out over the next year and three years, and we see good growth ahead of us. Frankly, we're planning for how we going to fulfill against all that terrific growth.

Right. I think that make sense and we definitely agree with you there. Thanks for taking my questions.

Mike Wood, Macquarie.

Can you frame for us the growth that you saw in the semi-custom cabinet markets? And whether or not there was any deceleration or acceleration in the stock cabinets?

Yes. The stock option was strong and consistent throughout the quarter and remains strong. On the stock side, there's a couple of categories here.

There's stock cabinets that go into new construction on our Aristokraft line, and then there's in-stock cabinets that we sell into home centers. I'm not sure which one of those that are you are questioning.

I guess I was more curious if you saw that mid- to high- teens growth that the segments all are identically in the semi-custom side.

I'd say just from the data, we saw strong double digits across the board in all those categories and did not see deceleration. We had seen early growth in the year in the stock, and now we are just, in this quarter, seeing, really, the strong growth in the semi-custom and custom. So, they were all strong double-digit growth.

Okay, thanks. In the faucet shift to the premium products, would you characterize that as being market driven? Was it specific to product launches or shelf space that you gained?

It's both. I think it's both new products we brought out that are selling through strongly. Then, I also think that if you're looking at a better mix both on the R&R side, bigger projects, and we saw that on the cabinet side, too. That translates into a more premium faucet package, more premium bathrooms, showering. I think it's both of those things flowing through.

We're fortunate to have continued to invest in new products and new innovations. When a consumer shows up in our showroom, our stuff looks great. When they want to move up into a higher price point, we can meet that need because we've got new finishes, new features, styling that appeals to their demands. I'd say those two things are working hand in hand and we're capturing the benefit.

Okay. Thank you.

Jim Barrett, CL King.

Chris, could you discuss the level of promotional activity, year over year in the quarter, among the home centers and dealers? What is your outlook for 2014 in that regard?

I'd say we're very pleased that, that level of promotional activity has come down. I think it's down to a level that, while I don't think it is as low as it might have been in 2006, it's come significantly down to a point where it is sustainable where it's at. I don't think it is going to increase going into the next year. Frankly, I think there's enough fundamental consumer demand that folks don't need to be doing it.

There's also pretty good capacity utilization through the industry. If those were the drivers over the past couple of years, those drivers aren't there anymore. I'd say it's a pretty good environment just in terms of the level of promotion and the overall level of pricing in the market.

Okay. Did I hear you correctly that the rate of sales growth in cabinets was higher among dealers and home centers than among homebuilders?

I think what Lee was saying was it picked up. They're now at about an equal level, but accelerated as R&R picked up, really, over the last four months.

The homebuilders were on a separate track, obviously, throughout the first half of the year, strong growth. R&R was lagging there, especially big ticket was lagging. But over the last three, four months we have seen that pick up, so now they're running at about the same level.

Okay. Well thanks again, very much.

Now, I will now turn the call back to Brian Lantz.

We would like to thank everybody for joining us today. We look forward to speaking with all of you very soon. Thank you.

Ladies and gentlemen, thank you for your participation. This concludes today's conference call and you may now disconnect.