Fortune Brands Innovations Inc (FBIN) 2014 Q2 法說會逐字稿

Good afternoon. My name is Leanne and I will be your conference operator today.

At this time I would like to welcome everyone to the Fortune Brands Home & Security 2014 Second Quarter Earnings and Results.

(Operator Instructions)

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 & Security quarterly investor conference call and web cast. We are pleased to be here today to provide an update on our progress during the second quarter of 2014.

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 the 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 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 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 for share or cash flow on today's call will focus on our results a before charges and gains basis as described in today's news release unless otherwise specified.

With me on the call today are Chris Klein, 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.

Our team's executed well and delivered a solid second quarter as the pace of new construction and consumer spending have gradually improved. We continue to gain share and we remain well positioned to deliver strong growth this year.

Our 2014 annual outlook has been updated to reflect a US home products market that we now expect to grow at a slower pace in the second half than our assumptions earlier in the year. However, our revised company outlook calls for continued profitable growth based on our share gains and the improving markets for new construction and repair and remodel activity through the balance of 2014.

Let me first take you through some of the second quarter highlights. Then I will discuss our recent actions to drive incremental growth. And finally, I'll tie it all together with our view of the current US home products market and our updated 2014 annual outlook.

Turning to the quarter, sales were up 10% and EPS was $0.55, up 34% from a year ago. Let me give you some highlights by segment. Sales for our Cabinets business were up 19% for the quarter. Cabinet sales growth was lid by mid-teens growth in the dealer channel where big ticket remodeling activity remained strong as well as nearly 10% growth in home center sales for our brands.

And again gained share on the Dealer Channel, where we continue to see growth across a fuller range of semi-custom and custom product lines resulting in a better mix with higher price points. Our share gains are coming from deeper relationships with existing customers as well as new dealerships.

Regionally in the South and the West continue to outpace the North and Midwest, which are improving versus the first quarter but at a more modest pace.

We've launched several new products this year including our Refresh Diamond line, new bath vanity offerings in home centers and a new Omega frameless custom line for dealers. These new products are selling well. Our Home Center business continues to benefit and gain share from the innovation we are bringing into the category.

I'll continue to leverage our proven structural competitive advantages to generate sustainable momentum. This is a complex business but our teams execute flawlessly against a business model that is tough to replicate. Our share gains across channels with improving margins reflect the tangible impact of these advantages.

For exclude the sales from wood crafters and the impact from last year's planned exit, a low margin builder direct business in the West, Underline Cabinet sales were estimated to be up 10%. Highly reported sales that were up 5% for the quarter led by growth in US wholesale and International.

In the second quarter of 2014, Moen faced challenging sales comparisons in the wholesale channel versus a second quarter 2013 that saw wholesalers bringing inventory in to support projected second-half demand. This year was different as wholesalers drew down inventories to some extent. Mix was better and we were able to support some price. Even with these dynamics, our sales grew mid-single digits and margins were strong.

Across both retail and wholesale, we are encouraged to see consumers continuing to select our innovative new faucet products for their new homes and repair and remodel projects, including new pull-out faucets which reflects self-retraction in our Walden, Kinzel, and Brookshire lines. Our MotionSense hands-free faucet which continues to be introduced in additional styles, and faucets with our micro-band finishes. Overall, we see continued strength in the more premium end of the market, supporting bigger remodel and renovation products.

Moen international sales were led by Canada wholesale and retail sales which increased high single digits and improved from a weak first quarter. China sales were up modestly over the prior year as new construction activity was weaker and direct to builder sale softer, but our 920 Moen stores continued to generate solid growth.

Windows and Doors reported sales were up 9% for the quarter. Both products saw a healthy sales growth of 11% driven by gains in new construction and ongoing distribution additions. We continue to see an increasing benefit from our distribution improvement and expansion in the western region that we put in place over the last couple of years.

Mixed sales improved especially with consumers selecting our new decorative glass designs and new door styles like our recently launched post line of modern entry doors. The Therma-Tru brand continues to perform strongly across all channels. Window sales were up 7% from the prior year with continued double-digit growth from the West and improved growth across the remainder of the country as the northern markets rebounded from a slower first quarter.

In the Security and Storage segment, sales declined 5% to the prior year and quarter. Security sales were up 1% led by increases in US retail and safety. Offset by some weakness in International. Store sales decreased by $9 million as we exited some lower margin accounts and the Father's Day promotional season was weaker.

Master Lock US retail sales continue to grow with program expansion with retailers. And Master Lock's roll-out of new commercial electronic access control solutions designed to secure high value sites such as cellular telephone towers and other storage facilities again contributed to our sales gains.

To sum up our results, our teams executed well and a modestly improving quarter. As we move in to the balance of the year, we remain positioned to continue our share gains and deliver a stronger full year of sales and profit growth.

I would now like to turn to our recent actions to drive incremental shareholder value with our cash flow and balance sheet. First, given the pull back in housing related equities through the second quarter, we have continued to opportunistically repurchase our shares.

As a result, we have now repurchased approximately $375 million of our shares year-to-date. These repurchases, along with our quarterly dividend, reflect confidence in our performance and our ability to drive long-term shareholder value.

Second, today we announced that we have acquired SentrySafe, the leading producer of personal safes and protective security containers. Sentry will become part of Master Lock. We are thrilled to welcome nearly 500 Sentry associates to the Master Lock family.

SentrySafe's global brand strength in the adjacent safes market enables Master Lock company to broaden its product offerings and leverage both iconic brands domestically and internationally. Both companies hold similar competitive advantages and produce products that protect people's most valuable assets. I'm excited about the growth opportunities we will now have together to drive innovation and leverage global distribution manufacturing.

These actions reinforce our commitment to create incremental shareholder value by investing in our businesses, pursuing a creed of acquisitions that meet our strategic criteria and returning cash to shareholders through dividends and share repurchases. I'm excited that we were able to identify opportunities and execute against our strategic priorities to drive this incremental value.

Now let me tie this all together with our updated full-year outlook for 2014, starting with our assumptions for the market. The demand for new construction continues to outstrip supply in many markets across the country. Housing inventory remains low.

Mortgage rates have remained stable over the past year and single-family homes are at historically affordable levels. We continue to believe that new construction will return to historic levels and that the R&R market will grow at 5% to 6% in a steady state.

In the repair and remodel market which is around 65% of our home products business, we've seen a continuation of the growth for bigger ticket semi-custom and custom cabinets as well as increased project size and stronger demand for more premium faucets in our Moen wholesale show rooms.

However, in the near term, the pace of repair and remodel demand has been recovering more gradually than we expected in the half of the country impacted by weather early in the year even though its demand has been solid for the remainder of the country.

New home construction, where our products are installed in the later stages has also been slower to reaccelerate since last fall. While demand for new construction and repair and remodel should show solid growth for the balance of the year, we expect the overall US home products market growth for the second half will be somewhat lower than we assumed on our last call.

Therefore, our updated 2014 annual outlook is built on a revised assumption that the US home products market grows at a combined 6% to 8% annual rate. Based on that US housing market projection, the assumptions we make for our other markets in continued share gains plus the SentrySafe acquisition we continue to expect solid top line growth for 2014.

With our full-year sales increasing at a 9% to 11% rate over 2013 and our home products business is growing faster and again outperforming the market for our products. Based on this market and sales growth and the benefit of share repurchases, our teams are focused on delivering full year EPS of $1.88 to $1.96.

So to sum up, we remain confident in our ability to continue to outperform the recovering home products market and intend to deliver strong profitable growth in 2014. We believe that 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 2014 outlook and on our recent capital allocation actions.

Thanks, Chris. As Brian mentioned, a 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 $1.14 billion, up 10% from a year ago.

Consolidated operating income for the quarter was $137 million, up 28%. Or $30 million compared to the same quarter last year. EPS were $0.55 for the quarter versus $0.41 for the same quarter last year, an increase of 34%.

Now let me provide more color on segment results. Our Cabinet sales were $468 million, up $76 million. Or 19% over the prior year quarter led by growth in dealers and improvement in home centers. As Chris mentioned, excluding the sales of $50 million from WoodCrafters and the impact of $13 million from the planned exit of low margin builder direct business in the west, underlying cabinet sales were estimated to be up 10%.

Operating income for the Cabinet segment increased to $46 million, up $11 million, or 31% as we benefited from higher sales volume, WoodCrafters, and our improving mix from repair and remodel growth. Operating margin for this segment increased to 9.9%.

Turning to Plumbing, sales for the second quarter were $340 million, up 5% led by US wholesale and international. Operating income increased $15 million to $70 million, up 26%. Operating margin for the segment was 20.6%.

The increase above the anticipated annual operating margin of 19% was due primarily to consumers purchasing upgraded faucet packages and the timing of expenses.

Windows and Door sales were $193 million, up $16 million or 9% from the prior year quarter. Operating income for this segment was $15 million, a $5 million improvement from the second quarter last year. Operating margin for the segment increased to 7.8%.

Security and Storage sales were $141 million in the second quarter, down 5% to the prior year quarter. Security sales increased 1% while sales of storage products decreased by $9 million. Segment operating income was only $20 million, due to the lower tool storage sales and investments in security growth initiatives. Operating margin for the segment was 14%.

So to sum up the second quarter performance, we continue to leverage our structural competitive advantages to drive share gains and we're continuing to see better mix driven by the improving R&R market. Before I turn to the balance sheet, I want to reiterate that we're continuing to make investments to begin building incremental capacity.

As mentioned on our last call, these investments should enable us to expand capacity and infrastructure, to support sales growth as the housing market returns to steady state levels over the next three-plus years. We need to make these investments this year so that we're positioned to capture the potential growth and should begin to realize the benefits of these investments later next year.

In the second quarter these capacity investments were equal to approximately $0.02 of EPS and were mainly incremental capacity for the Cabinet and Plumbing segments. For the full-year approximately $0.08 of incremental investment spending is reflected in our 2014 EPS guidance, including the $0.06 that we've now invested year-to-date. We will pace additional investments with the pace of the recovering market.

Turning to the balance sheet, our June 30 balance sheet remains solid with cash of $145 million, debt of $605 million, and our net debt-to-EBITDA leverage is 0.9 times. We have $245 million drawn on our $650 million revolving credit facility. Our balance sheet reflects the impact of share repurchases and year-to-date capital expenditures of approximately $47 million.

Turning to our recently announced actions to drive incremental shareholder value, these actions confirm that our cash flow and balance sheet provide additional levers to generate incremental growth and navigate through any unevenness in the near-term home products market.

First, we've continued to opportunistically repurchase our shares. As of today, we've repurchased around $9.5 million of our shares year-to-date for approximately $375 million, with $112 million remaining on our current authorization. These repurchases represent nearly 6% of our outstanding shares and given our view on our potential performance over the next few years should represent a significant return.

The positive impact to earnings per share from share repurchases should be approximately $0.10 with $0.05 benefit in the second half of 2014 and an incremental $0.05 in 2015.

Second, our acquisition of SentrySafe in to Master Lock is a natural fit, providing annual revenue of approximately $150 million. The purchase price of $117 million should be equivalent to eight times 2014 EBITDA.

However, over the next couple of years, potential synergies resulting from the acquisition could reduce the purchase multiple to closer to six times EBITDA. Before synergies, Sentry could add $0.02 of EPS to our 2014 second half performance and an incremental $0.02 to $0.$0.03 in 2015.

Turning last to the details of our outlook for 2014, as Chris mentioned, based on our projected 6% to 8% US home products market growth, the assumptions we make for other markets and continued share gains, plus the SentrySafe acquisition, we now expect our full year 2014 sales to increase 9% to 11% compared to 2013. Actions taken this year should position us for above market sales growth in 2015 and 2016.

Our resulting expectations for full year 2014 EPS are now on the range of $1.88 to $1.96. The midpoint of our guidance was revised down only $0.02 and represents an increase of 28% over 2013 EPS of $1.50.

The impact from share repurchases and our recent SentrySafe acquisition nearly offset the impact of our lower market assumption. More importantly, these two value enhancing moves position us for above market EPS growth in 2015 and 2016.

Let me make a couple additional points regarding our 2014 annual outlook for sales and EPS in the second half. First, in the third quarter, we're faced with a challenging sales comparison against a 2013 performance that delivered robust 24% growth.

Second, both our recently announced acquisition of SentrySafe and our share repurchase actions will have more impact on the fourth quarter than the third quarter, therefore the fourth quarter will experience higher sales and EPS growth than the third quarter.

We expect 2014 free cash flow to be $225 million to $250 million for the full year after CapEx of approximately $130 million to $140 million as we begin to invest in incremental capacity to support long-term growth potential. Additionally, the board has authorized a September dividend of $0.12 per share.

In summary, our solid performance and the expected continuing market recovery not only give us confidence for the balance of 2014, but also for potential growth beyond 2014 as we continue to benefit from our structural competitive advantages.

Importantly, this sustainable momentum in both the housing market and in our business performance is allowing us to make selected acquisitions and return cash to shareholders through our dividend and share repurchase. These actions position us well for incremental growth in 2015 and beyond as we focus on maximizing shareholder value.

I will now pass the call back to Brian.

Thanks, Lee. That concludes our prepared remarks on the second quarter of 2014.

We will now begin taking your questions and we'll 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'll now turn the call back over to the operator to begin the question and answer session. Operator?

(Operator Instructions)

Your first question comes from the line of Dennis McGill from Zelman & Associates.

Midwest and Northeast regions not bouncing back as much as maybe you would have thought, particularly on the remodel side. Can you give order of magnitude what you did see in the quarter relative to the first quarter and offer any thoughts you might have as to why that might be either from your internal data or from customers?

This is Chris. We lost the first part of your question. I think your mute button might have cut off the first couple of words.

Sorry. The first part was just if you were to look at the Midwest and Northeast in the second quarter, how did that performance or the year-over-year growth compare to the first quarter? And then second part of it was any thoughts as to why it didn't accelerate more?

Midwest came back faster. Northeast, a bit slower, both in the positive range. We thought they'd come back a little bit faster than they did so I'd say it was fine, but it did set up a second half which might be a little slower as well. That was kind of our sense of looking at the balance of the year and the market assumptions that we're making. That's both new construction activity in those regions as well as the R&R activity.

Specifically on the R&R, any thoughts as to whether it's more of a kickout or reasons why it didn't come back more?

It built back but it's slower. We talked a little bit in the first quarter about the fact that especially a big project, big kitchen, bath remodel project takes a while to engage the designer to do the work to come to the point where you're making the order. So there's a timeline around that which it's taking a little while longer.

We're seen plenty of activity in the showrooms. I think we have reason to believe the second half is going to be busy and we're prepared for that. But I think we expected a little bit more momentum just coming in. And the other parts of the country West, Southwest, South, it was really kind of just a continuation of what we were seeing. So that pattern looked pretty good.

And then second question, you talked about the dealer business being very strong and even excluding share gains, it seems like a strong number. Mix in the plumbing segment, both of those things would seemingly be R&R related. As you look at a change in the outlook in the second half of the year, can you maybe split how much of that was driven by the pace of what your seeing in new construction versus remodeling?

I think it was more on the new construction side. I'd say that was the bigger impact. Maybe it was half a point on the R&R to really cover kind of the regional slowness Northeast. I think the thing that we're excited about is the mix continues to hold up strong. These aren't just kind of value-type purchases but we're seeing good mix across not just cabinets but faucets and entry doors and we've got some pricing power.

So it feels pretty good actually, and coming in to the second half really setting up 2015 and 2016. We're excited about what's coming at us over the next two, three years and I think we look for those kinds of stable points in the market which mix is a good indicator of. People got to learn this. Once they're in a project, once they're willing to take something on, they're spending money. So that's a good sign. That's really a lot better than we were a couple years back.

I appreciate it.

Your next question comes from the line of Stephen Kim from Barclays.

Thanks very much, guys. Congratulations on a good quarter in a tough environment.

Thank you.

So I had two questions. Let me follow up on Dennis' question regarding the big ticket, I want to clarify one thing. In your prepared remarks it sounded like you were talking about continued strength and bigger ticket. But you kind of commingled that with a statement about how you were seeing more custom, higher price point.

And I just want to make sure that what I'm hearing from you is not just that you've seen the benefit of some higher end skew but also that just in general, larger kitchen remodel-type works or bath remodel type work, irrespective of how much luxury or entry level it may be, just that you're continuing to see more demand for larger projects, up or down the price spectrum.

Yes, I'd say it is up and down the price spectrum. I think the mix shift on the higher end is encouraging. But we also saw, especially within the home center, some good kind of hard of market type volume. Some of that would be some new products we brought in so that might be share gain as well that we picked up in that segment of the market. I'd say there is still some appetite on the value end of the market and we're certainly seeing demand for that and then we're seeing that mix on the higher end.

So I'd say we're encouraged. Kind of coming off of a weak first quarter into the second quarter, seeing that kind of mix come through, and on a base level, looking at the cabinet business being up 10% over what wasn't a bad second quarter last year. There's a lot of things that are going right to have that happen.

Yes, that's very encouraging and certainly better than what we've heard from some others.

I want to ask about plumbing if I could next. You made the commentary that margins in the quarter were higher than your expected annual 19% rate that it sounds like you're still holding to due to better mix and deferred expenses.

By virtue of the fact that you are not changing your 19% outlook for the year, I assume that a hefty dose of this was the deferred expenses which will then hit in a later quarter. I was wondering if you could talk about how much was it the deferred expenses, how much is a better mix and why you are not raising your outlook for the year?

It starts with our operating margin last year at 17.8% and then on our first quarter call this year we said that we could pick up we thought, given the way we saw the business, another hundred basis points which starts approaching 19%. So that was we thought a good estimate then. We think it's a good estimate now.

A lot of the expenses within Moen was just purely timing. A large portion of that 20.6% difference between the 19% and the 20.6% was just timing of expenses and those will come back in the second half. So we still think 19% is a good percent, still lets us invest in the business, do what we need to do from a marketing and other investment perspective. We think 19% would be a great operating margin for the year.

Sure, nothing shabby about that. Thanks very much, guys. Appreciate it.

Your next question comes from the line of Mike Dahl from Credit Suisse.

Wanted to ask a couple questions on the Sentry business. I think you talked about a current snapshot of what the business is and from a top line perspective and the EBITDA multiple. But could you talk to some color around as a stand alone business what the trajectory has been for sales and margins in that business and what you think about as a good growth rate going forward?

So we look at 2014 and we basically said, to frame it, sales of around $150 million. Got operating margins around 8% right now. EBITDA margins closer to maybe a little under 10%. Good sales growth in the past. What we're really excited about is the opportunities that we have with Master Lock and the growth that can come from with brand stratification. SentrySafe is a great brand. Coupled with Master Lock it'll give us a lot of opportunities.

We paid $117 million at about a $14 million EBITDA. That's about 8 times. We think over the next two years, and probably in the second year more than next year because a lot of these are revenue synergies, we think we'd get that back up to Master Lock kind of operating margins of 13%, 14%, 15%. So pretty excited about what we can do with it and get it down to in a couple years a purchase price multiple around 6 times. We're very fortunate to find this one.

That's great. And then I guess for modeling purposes, since this was inter-quarter, is there any guidance around what the top line impact should be for 3Q, 4Q?

Sure, in our guidance we said for the full year of sales up 9% to 11%, about 180 basis points of that is SentrySafe. It's about $75 million in the second half. Now you'll get more just from a quarterly standpoint, the seasonality of their business, there will be substantially more sales in the fourth quarter than the third but we'll get a benefit total of about $75 million. That's about $0.02 after some amortization from the acquisition. We'll get about $0.02 this year in the second half. Next year, we'll get an incremental $0.02 or $0.03, so net of $0.05 before any synergies next year.

Thank you.

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

Thanks for the color and congratulations on the acquisition. Question for Lee. In your updated guidance, what should we assume in terms of share buybacks?

At this point I think we would not assume any share buybacks. We will, from a practical matter, be very opportunistic but we bought 9.5 million back, shares year-to- date, so we wouldn't put anything in there for share repurchases in the future. The benefits will roll out nicely though. We'll get $0.05 for this year and because of the averaging under a fully diluted methodology, you'll get another $0.05 next year.

It will continue to give even through 2015. So well positioned. But don't plan on any more this year. Doesn't say we won't do it. We'll always be opportunistic and we'll balance share repurchases and we'll balance the M&A pipeline and those things.

Okay. And just taking with that share repo question, Lee. In your new guidance it looks like you're going to have free cash flow of $225 million to $250 million. You already got a really clean balance sheet.

What's the acquisition outlook from an M&A standpoint going forward? What should we expect? Which categories of product should we be looking for you guys to make purchases and how should we think about magnitude and timing? Thanks very much. Good luck.

I think we're encouraged, it's becoming a busier market. Beginning of the year I said I thought that over the next 12, 18 months things would start to look up and as we sit here in July, we've had a pretty good flow coming through. We're really excited about the SentrySafe acquisition. It's a terrific complement to the Master Lock business. But there's other things we're looking at. I can never forecast how many of those will come to fruition. I can just say that there's more activity now than there has been. So we're encouraged by that.

I think we're pleased that we had the opportunity to buy back some shares but now we're seeing that there could be some M&A opportunities so maybe focus there a little bit and see how all that plays out over the next six to nine months. So, I'm kind of encouraged that maybe that market's gone a little bit and there's a number of things that could come in.

I'd say where we're looking is really across the businesses and there's various opportunities across. Might not do anything in Master Lock right now given that we've just done something, but I think the other categories could be fair game and certainly looking at different opportunities within each of them.

Thanks very much.

Your next question comes from the line of Kenneth Zener from KeyBanc.

Good afternoon, gentlemen. Wonder if you could expand a little bit on your cabinet comments. The 10% organic, what was the relative split there between these weather impacted areas and not and between the dealer and the big box or retailer, however you feel comfortable describing? Just give us different rates of growth in those three categories including new. Thank you.

I think we saw good growth across the country, better growth in the West, Southwest, South, that became the fastest growth area, Midwest in the middle and Northeast a bit slower. But all seeing positive signs.

In terms of channel I'd say kind of mid-teens on the dealer side, roughly 9%, 10% on the home center side and direct to builder probably a little bit less than that. So pretty good kind of spread across the whole piece. I think the strongest momentum was on the dealer side but the home center business was actually pretty reasonable as well. So hope that helps in terms of breakout.

That's very good. And related to the walk away business that you described as $13 million, is there a way we can kind of think about that headwind given the organic baseline tapering off?

And would you mind describing that 10% revenue growth? If you could kind of split that or give us a sense of price and mix as opposed to volume? Thank you very much.

Your next question comes from the line of Michael Rehaut from JPMorgan.

Thanks. Good afternoon, everyone, and nice quarter. My first question just around the cabinet margins, I believe previously you had guided for the full-year to a 10% number or approaching 10%. Just want to know if that's still the case and perhaps as part of the answer to that if you could describe what you see in terms of the promotional environment at retail, if that continues to be stable or how would you characterize the trends there?

Sure. For our cabinet business, the quarter was operating margin of 9.9%. We said on the last call we thought we could approach 10% for the year. I think we're still in that range, somewhere 9% to 10%. So we have not fundamentally changed that look.

On a promotional side, in the home center market, it's actually quite stable, maybe even surprisingly so. We haven't really for ourselves moved over the last really two years relative to where we are today, kind of took it down early and then we've held. We're really competing more on product, on service, on the time we spend with the designers to help them work on our projects. So we're not as reliant upon promotion. I'd say for us at least it hasn't changed materially.

I appreciate that. And then secondly, switching to the Security and Storage margins, and I apologize if I missed this earlier. If you could describe, if you had touched on it maybe a little bit more granularly, the driver of the margin decline on a year-over-year basis for Security and Storage? What was the biggest driver to that and if you'd expect that to continue in the back half of the year?

On Security and Storage, our longer-term margins have been 14% to 15%. We drop down to 14% in the second quarter driven by two things. One was the volume decline in our tool storage business. We lost some leverage there.

And while Master Lock margins continued to be good, we started investing in some growth initiatives, part of it on top of thinking about this acquisition and some other things. So we wanted to build a little more infrastructure. That put a little pressure on the Master Lock segment margins but their still very good. The 14% operating margins in the quarter is very good. There's no real messages there in that.

Thank you.

Your next question comes from the line of Mike Wood from Macquarie.

Hello, guys. This is Adam in for Mike. Can you talk us through how sales trended month by month throughout the quarter and what you're seeing now in July?

Sure. April started out with a little bit improved from March and then gradually built throughout the months of -- June, finished up pretty good. July is fine. July's traditionally a quiet month. We're coming up against a quarter where we were up 24% last year. I'd say July is fine but it's kind of early to read the whole quarter.

Traditionally, the third quarter starts to come in kind of August and then really builds momentum toward the end of August into September. It's a heavy R&R season. I'd say it's early to say. Certainly no warning signs. I think it's tracking as we would expect it. But it's kind of too early to get a solid read until we get into August and September.

Great. Thanks, guys.

Your next question comes from the line of Tim Wojs from Baird.

Two housekeeping questions. On the corporate expense line, I think it's been about $30 million year-to-date there. What should we expect the pace of that in the back half of the year to be? And then secondly as we look at the $0.08 of investments in 2014, how should we think of those investment levels as we get into 2015?

I'd say I'd start with on the corporate side, I think a run rate of assuming no one time charges for M&A transactions, we think we're in the $62 million range. We're lower this year than last year because we had some one-time items and around WoodCrafters acquisition and some other consulting around that. I'd say if you think about a $62 million annual run rate with no one-time items that kind of gets you there.

Then the $0.08, we've talked about it at the beginning of the year, things that would hit the P&L, not depreciation, but things that hit the P&L directly, the planning and the design things around the capacity expansion would be $0.08 this year. We spent 0.04 in the first quarter, $0.02 in the second. We think we'll have a couple cents left this year. Next year, haven't really done that math yet. I think the heavy spending was probably this year but we may still have some next year.

Incrementally, some of that might go away a little bit but some of it might stick around.

We'll talk about that when we give annual guidance next year.

Great. Thanks.

Your next question comes from the line of Kenneth Zener from KeyBanc.

Ken, I'm sorry we got cut off. Would you just repeat those questions? (Laughter)

We weren't ignoring you.

I think I asked about the 10% organic rate that you referenced and I appreciate your channel commentary. But if you could A, kind of give us a detailed feel of that volume price/mix? Is that something you're talking about so we can understand underlying volume? Then the $13 million headwind from walked away business. Could you kind of give us a sense of when or the magnitude of that headwind deceleration as we look into the back half? Thank you.

Sure. So on the price/mix volume question, price net of inflation was less than 1% in the quarter. So we got some price to offset inflation. We are seeing some modest in place. So we did get surprised. The bigger driver here is always for us is mix and volume. So I'd say price is the smallest, volume and mix would be the two larger items.

In terms of the business, the Cabinet business, builder direct in the West that we walked away from, you can think about it for the full year to be in the $55 million to $60 million range. We had about $10 million reflected in the first quarter results. We had about $13 million reflected in this second quarter. The balance will be spread in the second half. Then we'll be finished at the end of the year generally.

Thank you.

Your next question comes from the line of Garik Shmois from Longbow Research.

Just wondering if you could talk a little bit how you're thinking about the capacity program that you've outlined, the $0.08 a share that's set in place for future growth. The slowdowns in the building products opportunity this year, it all changed your thoughts on how quickly you're going to have to add back the capacity moving forward?

I'd say it's a question of pacing at the individual segment level. So we talked about this a little bit at the beginning of the year, these are discrete expansions around individual facilities so it's maybe adding a line, expanding out the size of a footprint. So I think certainly there's a pacing issue in there. All of the work that we're doing this year was making sure that we're understanding exactly where and how we're going to be building out and we started to put some capital in but certainly the pacing of our capital is a little bit slower.

I think we're still on track and I still would highlight that we still believe we're headed toward a longer term steady state through construction, at the $1.4 million, $1.5 million level, 5% to 6% R&R if that's six months pushed out or trending a little bit longer, we still want to be prepared with the capacity. We're certainly able to handle the business that's coming at us today. But as we look out through now you'd say second half of 2015 into 2016, we want to make sure that we can continue to service the business.

That's one of the reasons why we're able to grow in these kinds of markets. If you look at our Cabinet business and how it's able to continue the service business, keep lead times short, [those things is], we don't want to be chasing -- we're not putting in capacity so far ahead of when we'd use it but certainly don't want to be chasing it on the back end.

Same would be true for Moen and Therma-Tru. We just want to make sure that we're prepared as it's coming in because one of our hallmarks is our service and our ability to stay on top of this stuff. So [that's the eye]. But certainly, pacing, we're kind of looking at it month to month, quarter to quarter, making sure we're not getting too far out ahead.

I guess as a follow-up question to the SentrySafe acquisition. If you could talk a little bit about the opportunity costs and the timing around the deal? You said the deal pipeline for other opportunities is starting to pick up. Just wondering with respect to the timing and the business that you picked up obviously it is accretive but how did you weigh this opportunity versus others?

We've got a pipeline of things we're looking at all the time and really it's a question of when we're able to come to an agreement and when the company is wanting to sell. So something like SentrySafe we've been aware of, looking at, hoping for, for a while. The time was now for it to be ready.

It doesn't preclude other things and in fact, we've got a team that's working things in parallel across a number of different sectors. And so I wouldn't say there's an opportunity cost of this versus that. I'd say when its ready we'll do it and we're able to handle more than one thing at a time. We're excited.

SentrySafe is really a terrific adjacency to Master Lock. They're both market leading brands and they've got some complementary product applications. We think there's places we can take the Master Lock product that Sentry's in and vice versa.

It's really one of those adjacencies that is a quite natural thing for Master Lock. And we've got a very strong team at Master Lock that's able to take this on and really bring it into the Master Lock family. I'd say in terms of trading off other things, I think it's all complementary and we certainly handle multiple things at the same time.

Your next question comes from the line of Eli Hackel from Goldman Sachs.

Thank you. First question just going back to -- I guess more of a broad question talking about who's spending money. Do you think you're seeing the broad spectrum of consumers increasingly spend money? Or how would you weigh more of the high end versus middle end versus low end and how they're coming back in this recovery so far? It sounds like you're seeing a nice trade-up and you're making it sound like it's sort of across the board. If you're reiterating or clarify that, that would be helpful.

Sure. There's probably a -- on balance its probably skewed toward the higher end right now. We're encouraged that we're seeing more of that value side continue to be in the market.

The one piece that's probably missing is the more credit dependent consumer who traditionally would finance. I think that's improving relative to where it was if you look at statistics on home equity lending, they are improving. There's more home equity lines out there and people are drawing on those home equity lines.

There's in store credit, there's dealer sponsored credit. There is credit coming back into the market and that's helping support that level of the younger household. By younger, it's mid-30s to mid-40s which traditionally does need credit to do a big remodel project. That's the piece that I think is still coming. And we still have more ahead of us on that.

People who got the means either through savings or through trading out of the equity market are spending. And when they're spending, they're putting the money they want to into the project so that's kind of getting lift on the higher end. I'd say it's not too bad in that middle segment but there's probably more to come as you get more lending into those households. Consumers are getting more comfortable borrowing against the equity that's starting to build in the homes as values improve across the country.

So the ingredients are there. You'd always hope it'd be come along a little bit faster but we're not discouraged by the pace. We think we're all making good progress here over a reasonable timeline.

And then second question on Moen in China. You mentioned it's still positive. Are you seeing trends there continue to decelerate, have they stabilized or are they starting to reaccelerate?

So the Moen business, we've got two parts of that business. We've got our retail stores, over 900 of those. And those service both new construction and repair and remodel market. In the quarter we still saw good growth coming there so either that's a combination of people coming in and doing some R&R work or they're fitting out units that they had bought that were constructed years before and now finally people are moving into them so they have to fit them out.

On the direct to builder side, so we do sell some business directly to the big builders there. That's the piece that was down and that's where we do see weakness given the slowdown in construction and a lot of the markets around China.

Kind of balance those together, we're up a little bit. My outlook for the rest of the year would be, I think we'll continue to see some good growth on the corporate retail side of the business and the direct to builder piece will be more tied to the general construction pace in China.

Thank you very much.

Your next question comes from the line of Stephen East from ISI Group.

Thank you. Chris, if you look at the Cabinet business and Plumbing business, your two big businesses, could you talk about what you think was going on with market share in each of those?

On the Cabinet side, at both the dealer and the retail do you think you were picking up market share pretty usefully or are you starting to see an acceleration of that business?

Then on the Plumbing, the reverse, I know you said you saw some inventory draw down but how long do you think that plays out? And were you giving up any share there?

I'll start with the Moen side. I do think it is tied to inventory. As we look at POS data we're certainly seeing much stronger performance there than what we'd see in sales for the quarter which says that we're doing pretty well especially in showrooms and on the retail side of the market.

I think inventory was down a little bit which I don't tend to get too worried about it. It tends to then come back to us down the road as they bring it back in for the subsequent quarter. I'm encouraged. We think we still picked up some pretty good share at Moen, both wholesale and retail. We're bringing in new products, they're selling well. And we continue to execute well. Strong showroom business. So I think there we're positive.

On the Cabinet side, it's probably more so. We're still very encouraged both on the dealer side and in the home centers. In dealers we've talked before about the fact this is a ground game. It's one dealer at a time. It's working within that dealer one sale at a time and we're just so good at being in the market and with our sales and service teams, bringing products in, just executing every day, day in, day out. The cumulative impact is we're just picking up share and we just have a great reputation in the market.

On the home center side it's more of there's kind of three big guys there and again, you have to keep executing. We have brought in some new products, refreshed some things, and just been consistently executing and we're picking up share there too.

I think that if you look at a steady state, 10% growth, taking the noise out, we think that's stronger than the market was overall and so that would reflect those share gains.

Okay. Thanks.

You've talked in the past about you would be comfortable taking your net debt to total cap around 40% or so. As you look at where you are in the cycle now, some of the acquisitions you've made, some of the share repurchase you've made, any changes in how you view that particular level?

No, we feel good about our cash flow generation in our business model. So longer-term through the cycle, 2 times debt is we're very comfortable with.

For the right acquisitions, for the compelling acquisitions, our group of acquisitions in this mid-cycle now, we can lever up with the knowledge that we can always lever back down as we generate so much cash. So I think run rate, you'd say long-term 2 times debt-to-EBITDA but clearly for the right acquisitions could go higher.

Okay. What would you feel comfortable with on that metric?

I think you can clearly go to 3. You could approach 4 for the right acquisition. In the right time of the cycle.

Thanks.

Your next question comes from the line of Keith Hughes from SunTrust.

Two questions. One, you referred in the release on your expectations for the home improvement market for the year. Can you kind of split that up of what you think it grew in the first half of the year, that could be tough to nail down in this industry. Number two, what was the ending share count in the second quarter?

Let me take the share count. At the end of the second quarter was 161 million shares. We started the year-round 167 first day of the year. Second quarter 161. By the end of July though we did quite a few share repurchases in July. We were down to about 158 million.

And then in terms of market growth, first half you're right, it's tough to pin down. A lot of the data gets revised almost on a weekly basis. It's hard to know. I think overall market between R&R and new construction may have been around 3% in the second quarter. That's kind of what we thought.

It could have been 5%, 6% first quarter. Not sure. We're still sorting that through but those are the working data and then as we project that out. We're going to tie out to that 6% to 8% for the full year which implies second half, 6%, 7%, third quarter, to 11% fourth quarter type growth. That's kind of the net basis of getting to 6% to 8% overall.

And the big acceleration in the fourth quarter, is that just more remodeling coming back in to the market? Is that the question of starts? What would be the drive around that pickup?

The market itself was slow in the fourth quarter. So this is relative to that growth in the fourth quarter last year. You saw actually a pretty strong third quarter market. Then the fourth quarter was when you started to see the impact of the slowdown on new construction that started in the summer kind of hit it in the fourth quarter.

It's just relative to where we were in 2013. I'd say on an aggregate basis you could see momentum building in the third quarter and carrying into the fourth quarter. I actually think we'll see some better business for ourselves in fourth quarter.

Our last call comes from Eric Bosshard from Cleveland Research.

Good afternoon guys, this is Tom on for Eric.

I wanted to ask about the cabinet incremental margin in the quarter, below the levels you guys had seen, in the first half it seems to be below the levels you guys had seen over the last couple of years. You talked about getting some price there and strong mix there. What are the other moving pieces on that margin line that we need to be considering?

Yes, I would say for the cabinet business, the first half the incremental margins were lower. We've been started making the investment. This is where some of the investments that we talk about in terms of the $0.08 for the year and year-to-date $0.06.

There's a little bit of inefficiency as you start moving these around but this is where the investments are. When you look at cabinets for the full year we see an incremental margin that's right in our sweet spot. The 25% to 30% will be where we'll be for the year. We really don't have an issue there. It's more the timing of the investments.

Great, thanks.

I will now turn the call back over to Brian Lantz for closing remarks.

Thank you, Leanne. We'd like to thank everybody for attending our quarterly call today and very much look forward to spending time with you in the coming weeks. Thank you.

And this concludes today's call. This call will be available for replay in approximately two hours. Thank you. You may now disconnect.