Fortune Brands Innovations Inc (FBIN) 2014 Q3 法說會逐字稿

Good afternoon. My name is Dan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands 2014 third-quarter earnings results conference call.

(Operator Instructions)

I will now turn the call over to Mr. Brian Lantz, Vice President of Investor Relations and Corporate Communications. Please go ahead.

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 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 our fbhs.com website.

I would like 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.

Any references to operating profit, earnings per share or cash flow on today's call will focus in our results on a before charges and gains basis, as described in today's news release unless otherwise specified. Also window business results have now been reflected as a discontinued operation in all periods, and are therefore excluded from the results discussed on today's call.

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 have 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 teams delivered solid growth in the third quarter, in the face of tough comps and market that is currently running at the low end of our planning assumption.

We continue to gain share, our mix continues to improve, and our core businesses are performing well. We are also taking actions to strengthen our portfolio, and have invested in capacity and capabilities as we prepare our Company to deliver on higher growth, as we expect our markets to continue to improve in 2015 and beyond.

So let me first take you through some of the third-quarter highlights, and briefly discuss some of the steps we are taking to strengthen and focus our portfolio. Then I will comment on our view of the US home products market and our 2014 outlook.

Turning to the quarter, sales were up 5%, and EPS was $0.55, up 20% from a year ago. This performance is particularly strong, given the challenging comparison to the prior year quarter, when sales increased 24% in a more robust market.

Let me give you some highlights by segment. Sales for our cabinets business were up 1% for the quarter. Excluding the impact of both exiting builder direct business in the West, and the comparison to a large bath vanity product launch in the third quarter of 2013, core cabinets sales increased 10%. Core cabinets sales growth was led by mid teens growth in the dealer channel, where big ticket remodeling activity remained strong, as well as high single-digit growth in the home centers.

We again gained share in the dealer channel, where we continued to see growth across a full 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. Our new product launches, including our new Omega frameless custom line for dealers and new bath vanity offerings in home centers continue to sell well, and are driving share gains. Our refreshed Diamond line is performing well above expectations, and new finishes in our Aristokraft, Oak Crest and Kitchen Craft lines are also selling well.

Despite a challenging third-quarter comparison to product line review wins in the prior year, WoodCrafter's performance has been solid. From a revenue perspective, WoodCrafters products are selling well. They have captured new program wins in home centers, and begun to gain product placements in the dealer channel.

With the integration nearly complete, WoodCrafters is also begun to help our core cabinet business, by producing lower-cost componentry for our existing cabinet lines, with its low-cost North American manufacturing capacity. So overall for cabinets, we continue to leverage our proven structural competitive advantages to generate sustainable momentum. Our teams execute well against a business model that is tough to replicate. Our share gains across channels, with improving mix reflect the tangible impact of these advantages.

Plumbing reported sales that were up 2% for the quarter, led by growth in US wholesale and retail. In the third quarter of 2014, Moen faced challenging sales comparison in the wholesale channel. Wholesalers continue to reduce inventory, versus a third-quarter 2013 in which wholesalers carried inventory to support strong demand. Regardless, this year's mix was better, our sales grew, and margins were strong. As a result, our US plumbing business grew high single-digits across wholesale and retail.

We are encouraged to see consumers continue to select our innovative new faucet products for their new homes and repair and remodel projects, including new pullout and pulldown faucets with Reflex self-retraction in our Brookshire, Hensley and Etch lines, sip beverage and filtration faucets, and our Oxby bath accessories and faucets. Overall, we continue to see strength in the more premium end of the market, supporting bigger remodel and renovation projects.

International sales declined low single-digits, driven by weakness in Canada which was negatively impacted by a stronger dollar and in China. China sales declined modestly over the prior year, as new construction activity was weaker, and direct to builder sales softer. However, our nearly 950 Moen stores continue to generate solid growth, as we continue to add stores and rationalize lower performing stores to drive growth. We remain optimistic about both our long-term business model in China, and the growth potential.

Doors reported sales were up 13% for the quarter. For the first time, we are reporting doors by itself in this segment, as we closed on the sale of Simonton Windows in the quarter. In the quarter, door products saw healthy sales growth, driven by gains in new construction and ongoing distribution additions. We continue to see an increasing benefit from our expansion in the Western region that we put in place over the last couple of years. Mix also improved, especially with consumers selecting our new decorative glass designs and new fiberglass door styles, like our recently launched Pulse line of modern entry doors. The Therma-Tru brands continue to perform strongly across all channels.

In the security and storage segment sales increased 17% from the prior year quarter. Sales from the SentrySafe acquisition added significantly to the growth, while organic security sales increased 4%, and tool store sales decreased 3%. Master Lock security sales growth was led by mid single-digit increases in US retail, high single-digit increases in international, and solid double-digit growth in US safety. Master Lock US retail sales continued to grow, as program expansions at retailers during the back-to-school selling season. And Master Lock Europe continued to gain share in an European market that saw mixed results.

The SentrySafe acquisition is on track, and the teams are working hard to integrate the operation. We are excited about the opportunities we see between our Master Lock and Sentry businesses.

So to sum up our results, our teams executed and continued to gain share in a lower growth market. As we wrap up 2014, we remain positioned to gain additional share, and deliver strong sales and profit growth in 2015.

I would now like to turn to the additional steps we are taking in 2014 to strengthen our portfolio, and position us for the growth we expect in 2015 and beyond. First in the third quarter, we decided to sell the Simonton Windows business, and we were able to close on that sale more quickly than planned. The Windows business was subscale within our portfolio, and it is better positioned to grow inside a larger windows business. Meanwhile, we are very focused on driving profitable growth for our Therma-Tru door business, as you can now see more clearly with these third-quarter results.

Second, I am excited about the growth opportunities that we have in our security business with the addition of SentrySafe. These opportunities include driving sales and innovation, by reaching global distribution and generating cost synergies.

Going forward as we integrate Sentry, the security segment will operate separately from the tool storage business. As a result of integrating Sentry and separating the tool storage business, we recently implemented a global workforce reduction of 9% in the security business.

In the tool storage business, we are reviewing long-term strategic options given the challenges this segment has seen over the past few years. This business currently has annual sales of approximately $150 million, and will be reported separately in the future. Third, we have continued to invest in capacity and capabilities to allow for additional growth beyond $6 billion in sales. We believe that the new construction market is gradually returning to historical levels in support of household formations, and that the R&R market will grow annually at 5% to 6% in a steady-state.

So in 2014, at the same time that we have been taking share and delivering growth in a market that has been growing slower than we assumed earlier in the year, we have also been taking key steps to position ourselves for the growth that we see in the future. Given our strong positions in these markets, even a modest improvement in market demand gives us a significant impact.

Now let me turn to our updated full-year outlook for 2014, starting with our assumptions for the market. In the near-term, the pace of repair and remodel demand has been recovering more gradually than we expected earlier in this year. New home construction, where our products are installed in the later stages has also been slower to reaccelerate since last fall, but continues to pick up pace. And now we have a better view into a good portion of the fall season, for both R&R and new construction.

So while demand for both new construction and repair and remodel should still show growth for the balance of this year, we expect the overall US home products market growth for the balance of 2014 will be lower than we assumed in July. Therefore, our updated 2014 annual outlook is now built on a revised assumption that the US home products market grows at a combined 4% to 5% rate in the fourth quarter.

Based on that US housing market projection, the assumptions we make for our other markets and continued share gains, plus the SentrySafe acquisition, we continue to expect solid top line growth for 2014 with our full-year sales increasing at approximately 8% rate over 2013, and our home products businesses again outperform the market for our products. Based on this market and sales growth and the benefit of share purchases, our teams are focused on delivering full-year EPS of $1.84 to $1.86.

So to sum up, we remain confident in our ability to continue to outperform the recovering home products market. We are gaining share. Our core businesses are strong, and because of actions we are taking in 2014, we are well-positioned to deliver even higher growth in 2015 and beyond, as the housing market continues its recovery. We also continue to 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 would like 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, to best reflect ongoing business performance, the majority of my comments will focus on the income before charges and gains from continuing operations. Also the closing of the sale of the Simonton Windows business was accelerated into the third quarter, which reduced our reported EPS for the third quarter by $0.02. The window business is now reflected as a discontinued operation, and its results are excluded for all periods.

Let me start with our third-quarter results. Sales were $1.1 billion, up 5% from a year ago. Consolidated operating income for the quarter was $138 million, up 15% or $18 million compared to the same quarter last year. EPS were $0.55 for the quarter, versus $0.46 the same quarter last year, an increase of 20%.

Now let me provide more color on segment results. Our cabinet sales were $453 million, up $4 million or 1% over the prior year quarter.

To better understand the performance of our cabinet business in the third quarter, it's necessary to exclude both the impact of the planned exit of the builder direct business in the west that was $15 million last year, as well as a $14 million inventory level in the third quarter of last year due to a large WoodCrafters bath vanity product launch. Excluding these two items, the underlying cabinet sales were up 10%.

While operating income for the cabinet segment was even with the prior year quarter, it was depressed by $6 million to $7 million by the impact from actions to expand capacity and flexibility across multiple plants. While these actions pressured profit in the quarter, they should provide strong returns beginning in 2015. Operating margin for the quarter was 8.1%. Full-year operating margin is now expected to increase nearly 100 basis points, compared to 2013.

Turning to plumbing. Sales for the third quarter were $346 million, up $8 million or 2% led by US wholesale and retail. Operating income increased $10 million to $76 million, up 15%. Operating margin for the segment was 22%. The increase above the anticipated annual operating margin of 19% was due primarily to the timing of expenses and improving product mix.

Door sales were $114 million, up $14 million or 13% from the prior year quarter. Operating income for this segment was $12 million, a $5 million improvement from the third quarter last year. Operating margin for the segment increased to 10.6%.

Securities and storage sales which now includes SentrySafe, were $185 million in the third quarter, up 17% to the prior year quarter. Organic security sales increased 4%, while sales of storage products decreased by 3%. Segment operating income was $28 million, and operating margin for the segment was 14.9%. As Chris mentioned, now that we are integrating SentrySafe into our security business and are beginning to align our cost structure to future growth, we intend to focus separately on a strategic plan for the tool storage business.

So to sum up the third-quarter performance, the housing market growth was at the low end of our previous guidance. The impact of expanding capacity put pressure on profit. We continue to leverage our structural competitive advantages to drive share gains, and our core businesses performance remained solid.

Before I turn to the balance sheet, I want to reiterate that we are continuing to make investments to build incremental capacity and flexibility. 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 are positioned to capture the potential growth, and should begin to realize the benefits of these investments later next year. In the third quarter, these capacity investments were equal to approximately $0.03 of EPS, and mainly impacted the cabinet segment.

Turning to the balance sheet. Our September 30 balance sheet remains solid with cash of $175 million, debt of $684 million, and our net debt to EBITDA leverage is 1 times. With $155 million drawn on our $975 million revolving credit facility, our balance sheet reflects the impact of share repurchases, and year-to-date capital expenditures of approximately $82 million.

Turning to share repurchases. We have continued to opportunistically to repurchase shares, with year-to-date repurchases of $440 million, compared to the $375 million reported on last quarter's call. Additionally, the Board of Directors has authorized an additional $250 million of repurchases over the next two years. Together with the prior authorization, the remaining unutilized authorization is approximately $300 million. Given our cash flow and balance sheet profile, these repurchases should not limit any potential M&A activity in the future, as we continue to actively pursue accretive acquisitions.

Turning last to the details of our outlook for the fourth quarter of 2014. As Chris mentioned, based on our projected 4% to 5% US Home products market growth in the fourth quarter, the assumptions we make for our other markets and continued share gains, plus the SentrySafe acquisition and the sale of Simonton Windows, we now expect full-year 2014 sales to increase approximately 8% compared to 2013.

Importantly, the investments made in capacity and flexibility and other actions taken this year should position us to continue with above market sales growth in 2015 and beyond. Our resulting full-year outlook for 2014 EPS are in the range of $1.84 to $1.86. This outlook includes the impact of third quarter actions, including the acquisition of SentrySafe, the sale of Simonton Windows, and share repurchases. It also assumes that our fourth-quarter tool storage profit is flat to prior year, as we complete a strategic review of that business in the fourth quarter

The reduction from our July guidance range is primarily the result of divesting the window business, and the market growth assumption being at the low-end of our previous expectations, now that we have better visibility to the fall selling season. We expect 2014 free cash flow to approach $200 million for the full year after expected CapEx of around $120 million, as we invest in incremental capacity to support long-term growth potential. Additionally, the Board has authorized a December dividend of $0.12 per share.

In summary, the performance of our core business, the investments we have made, the steps we are taking to position our portfolio for future growth, and the expected continuing market recovery, give us confidence in continued growth beyond 2014. Importantly, we remain focused on using our strong balance sheet and cash flow to make acquisitions, and return cash to shareholders through our dividend and share repurchases. We are well-positioned, 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 third quarter of 2014. We will now begin taking your questions, and we will continue as time allows. Since there may be a number of you who would like to ask a question, I will ask that you limit your initial questions to two, and then reenter the queue to ask additional questions.

I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

(Operator Instructions)

Bob Wetenhall, RBC Capital Markets.

Hey, good afternoon, and thanks for taking my question. I wanted to ask Chris.

Chris, speaking to the core business and excluding M&A activity in the past year, what has changed in your outlook since July? What are you seeing in October sales, and how you feel about demand trends in the core business heading into year end? Just trying to understand what you are expecting from the consumer as you close out the year?

Thanks, Bob. Yes, the core business is actually performing quite strong. There is a lot of stuff obviously going on in the quarter with Simonton going out, Sentry coming in, an aggressive comp from last year, 24% up.

But if we look at the core, the cabinet business was up 10% across the US. Dealer up mid teens. Home center up high single, the plumbing business up high single, mix improving. We saw doors, for the first time we reported kind of up low teens. And so, what we see is some real health in the end market.

If I look at the quarter, July was a little soft, and really the pickup was August September. And through October, we are seeing the same trends we saw in September, so a good steady cadence for us. I think there is a bit of share gain in all that. So I would say, the market is okay, and we are picking up share across our core markets.

And I would say, the consumer -- you got to kind of segment it a little bit. We still see the higher-end consumer wading in the mix. It looks good for the projects that are happening, I think there is still some latent demand out there, from entry-level both new constructions as well as R&R. And so, we think that is going to be coming in 2015, 2016.

So overall, I feel good about the quarter, and I think we feel good as we sit here at the end of October. The other thing is I guess, the final thing is in the fourth quarter we have seen different trends over the last few years. Sometimes business slows down by the middle of November. Sometimes it keeps going through early December.

So we are going to wait and see if some of this momentum doesn't continue through November. So I would say we feel pretty good about things.

that is great update. Thank you.

I wanted to ask Lee, it looks like you are tweaking capital spending down a little bit. I think you are lowering free cash flow guidance for this year, down as well. I wanted to understand the reduction in free cash flow?

And what are your thoughts about capital allocation, and using - - how you intend to use the balance sheet to create value as we head into next year? Thanks a lot.

Yes, we, in terms of our terms our forecast for free cash flow, we have come down. It's, we now say approaching $200 million, before it was over $200 million. That is just the result of just taking the expectations, the guidance down for the year. Nothing significant in that reduction.

That does include taking CapEx for the year down, from about $140 million down to $120 million. That is a combination of some timing, and it is also the result of just taking down our expectations for what we are going to have to spend. Recall the last quarter, we said we could probably spend $140 million in 2014 and $140 million in 2015.

Now as we have just sharpened our pencil, and got more -- a little more efficient on this, we think we will probably spend somewhere over $120 million in 2014, probably $125 million in 2015. So just getting sharper on the pencil on those, and just really understanding what we need to spend. So that is actually good news.

And sorry, just a follow-up. Thoughts on using the balance sheet for M&A or share repurchases, and what you are looking for leverage? Any clarification or prioritization would be great? Thank you.

We still feel strongly that we need a little more leverage to drive shareholder returns here. We ended the quarter around 1 times net debt to EBITDA. We still think that at the middle of the recovery we are now, we could lever up to 3, 3.5 times. By the end of -- kind of get to steady-state, our preference would be 1 to 2.5 times. So have a lot more to do.

We -- if you think about 2 times leverage at the end of when we get to steady-state, that is about $3 billion. And all the actions we taken to date, we have only committed about $1 billion of that. So we have got a lot of room left.

We still like acquisitions if they are accretive, and we can get the kind of benefits that we have gotten out of the SentrySafe, and out of the WoodCrafters, we would do a lot of those. We are still repurchasing shares opportunistically. We have now repurchased $440 million, about 11 million shares, so almost 7%. So we are going to do that opportunistically.

But so it is still a combination of let's look for good acquisitions, because we think those can drive the most value. But let's still opportunistically repurchased shares as we have done this summer.

Got it. Thanks very much, and good luck.

Thanks.

Steven Kim, Barclays.

Thanks very much guys. Hello, I wanted to ask you guys about the cabinets first.

So I think you had indicated that the exit of the builder direct and the vanity launch last year was $29 million. But I don't think that gets you all the way -- that doesn't completely bridge the gap to get to a 10% organic. I was wondering if there is anything else in there, or if I heard those number is wrong?

And then also you had said, that last year I think in the fourth quarter call last year, you said that you thought that the cabinet capacity, or the capacity expansion in general in cabinets and plumbing, would be about $5 million a quarter -- as kind of -- evenly throughout this year. I was wondering whether that has actually come in more lumpily than you had expected, and maybe that has what drove something here in the third quarter margin, which was lower than we thought?

Yes I will take the first piece on the 10% growth in the core cabinet business. Basically if you take out the builder west exit, which was about $15 million last year in the quarter, obviously zero this time. If you take out the $14 million on the inventory movement at WoodCrafters, and then there is about $3 million or $4 million other in there kind of related to WoodCrafters. If you do that, you get to the 10%. So if you take out basically the WoodCrafter change and the builder west, you should be at 10%.

Okay.

And your second point was around capacity. Interesting, we kind of came into the year planning on capacity additions, and had some tremendous success with the launch. We relaunched the Diamond line, and some other product enhancements, and saw some very strong demand coming in second and third quarter.

So we accelerated some things, basically the expansion of some facilities, putting additional lines in to produce a different kind of the extension off of a part of our semi custom line. So we incurred a little bit more expense to do that. Kind of a high-class problem, we were trying to service all of the demand that is coming in. And so, we are through all that. We are in good position now coming into next year.

So we still have some incremental things we are doing within cabinets, some expansion on the WoodCrafter side around components down in Mexico, and some of the things we are doing. But on kind of the big part of the SDK expansion, we actually moved through that a little bit harder, and a little bit faster this year. So we are pretty well set coming into the next year.

Okay. Could you quantify those at all, like how much more was 3Q versus let's say 2Q?

In terms of the overall expense for capital, and the expenses associated with capacity enhancement. We are up actually, and projecting it will be up a little bit versus where we were before. We were going to come in about $0.08, we are now projecting it will be about $0.12 for the total year. And capital was projected at $140 million, and it will now be about $120 million.

So we elongated across the whole business, a couple of parts of the capital and capacity increase. But specific to cabinets, we actually accelerated some of that work, so we can handle the very strong demand coming off of this Diamond relaunch.

Okay. Well, great. Thanks very much guys. Appreciate it.

Michael Dahl, Credit Suisse.

Hello, thanks. Lee, I wanted to ask I guess, conceptually about the way that you think about guidance. I know you try to be as straightforward as possible with some of the market and share gain assumptions, but realizing that this is now a couple of quarters in a row where you have had to take down sales a bit. And is probably a period where there's unusually low visibility in some of the channels.

Is there anything that you can be doing differently to gain a little more clarity into the top line? Or how do you think about baking in some cushion in the near-term, as we do continue to deal with market that is not quite certain here.

Yes. I think there's a couple of observations we try to be down the middle, and always start with our market assumption. And then we add our share gains to that and give you our sales. So we are not candidly, big hedgers. We try to be down the middle of the road on it.

One of the issues we always have at the end of the second quarter, when you are setting at the end of July, trying to give guidance is when 65% of your business your home business is R&R, you are setting in July and you haven't started, and you really don't have good visibility to the fall R&R season, which is significant for us. So that is one of the issues giving guidance at the end of July.

You really don't -- you really can't understand the fall R&R season, really until you get into October. Because it's generally September, October November is the fall season. So that is one of the challenges we have, and we tried to call that out. But it is always going to be a challenge giving guidance at the end of the second quarter.

We are generally going to be better, when we give guidance at this end of the first quarter, and at the end of the third quarter, because those we are in the middle of the R&R season. So that is just part of our industry.

But given that, we don't try to hedge a lot, even though in July we don't know. We just try to give you our best guess at the market. You can challenge that, and if you agree or disagree, you can adjust our performance accordingly in your estimates. But we try to be pretty straight up, and down the middle-of-the-road and pretty transparent on all that.

It is the same philosophy we followed really since we came out three years ago, as a standalone company. And that is to say, here is what we are looking at as the market. But we know we are not the best forecasters. We do our best, but here is what we are assuming. And then here is how we will perform in that market.

And if anybody takes a different view of the market, well, now we have given them the metric to make the adjustment to say, oh you said you were going to be -- the market was going to be up X percent, and you are going to be X plus 2%. Okay, great. Now I know to change it, if I believe were conservatively that the market will go in a different direction. So that is kind of the philosophy that we have tried to carry through.

The other thing that has been a challenge this year is just with that first quarter weather impact, especially as it relates to R&R, that was just very challenging. And I think it's, it has made understanding the normal patterns for R&R at least in 2014, a little challenging. Because we have never had that situation where the weather has been that difficult. And is actually kind of broken the process for planning large R&R big-ticket items. So it's -- this has been a challenging year, no doubt.

That is helpful. And certainly understand and appreciate the challenges on that side.

Just shifting gears, the strategic options on the storage side. I guess, what are the options here? Assuming there aren't so many buyers of a business like this currently. What are the things, any color you could give around potential outcomes here?

Sure. Yes. That is a business that has not been strategic for a while, but has remained profitable. So it represents not even 4% of our total sales.

We decided as we are making some significant moves with Master Lock and Sentry putting those businesses together, and really focusing that segment hard on the security side, that it was the right time to really kind of separate the storage business. And really look at the parts of that business that are performing better. And that is really kind of the commercial and industrial or higher end consumer side of that business, versus maybe some of them were value parts of the business. And really kind of thinking through some different scenarios around a go-forward plan there.

So we just kicked that work off over the last month and half. We will talk more about in January, but we will be very clear about a plan going forward. We don't want it to be a distraction. So that is why we are going to separate it away from the security business.

And that segment, that security business with Master Lock and Sentry is going to look nice going forward. You are going to see some good growth in margins, and it will be very easy to understand. So we think it's the right time to take all that under review.

Okay. Thank you.

Dennis McGill, Zelman & Associates.

Hello. Thanks so much.

This first question is just on the cabinets business. Of course, with the addition to capacity and the actions you guys have taken this year, as you look forward to next year, if the top line looks somewhat similar to this year, let's say 4% to 5% organic growth, does the business lever like you have always thought about it levering? Or do you need more growth in that, because you have added capacity?

We feel good about the capacity we added. I think we saw some surges this year in demand around some of the new products we are bringing in, really the new programs we are bringing in. So we think we have paced at the right pace. And so, we do believe will see that kind of leverage that we have talked about, 25% to 30% leverage.

The reality is we are gaining some significant share. On the dealer side, this year so far, we signed up 300 new dealers.

We are only shipping to 20% of them right now, and we will start -- the remaining in the fourth quarter and into next year. We are having some very strong success at the home centers.

And so, we are just looking out and saying, you don't have to believe the market is going to go up that much. With the success we are having out there, we want to make sure that we can service the customer, that our lead times stay in line,. And we have appropriately expanded, meaning you are bringing lines into existing facilities.

You are not opening up new plants, requiring huge slugs of business to get the right kind of leverage. So the incrementals look good. I feel good about it. I think, the reality is if we, as I said earlier we accelerated some of the work this year, and work through some of that a little faster than we thought. And I think that is great, because we will be ready next year and into 2016, 2017 as well. So that is business is performing well, and I like the fact that we added some capacity.

So I guess, and said another way, the lack of market growth or the weakness in the market growth relative to maybe what would have been expected at the end of part of the year, really hasn't impacted that if anything. The share gains that you have had, have justified those decisions?:

Yes. And the volume kind of came in the latter part of the second quarter, into through third quarter, and we think it will continue to ramp for us, and into next year. So it's coming at the same time, the capacity is coming up online, so it has kind of been matched up pretty well. So I think it ha come together in the right way.

And I have always said, we can project in the aggregate, but then you have got to break it down into the individual lines that are growing, and the successes we are having in certain parts of the market. And are you matched up on capacity? So we have got different capacity of around vanities and stock cabinets versus semi-customer high-end custom. And so, that is going to depend on the success we have in the market, and do we have enough matched up.

So I think we did a pretty good job of matching up this year. And I feel good about coming into next year, that we are going to able to handle what is going to come at us.

Okay. And Lee, in the fourth quarter did you give a number that has -- or guidance that embeds any cost for capacity additions of those programs?

Yes, probably modest. Probably, it's a $0.02 in the fourth quarter. Chris mentioned $0.11 to $0.12 for the year, there's probably $0.02 or so in the fourth quarter.

But we are also having a little easier comps on some of the -- because we had made some, and starting to make some investments in the fourth quarter last year. So year-over-year, we put $0.02 in -- in EPS impacted. Probably won't -- you won't really see it in the fourth quarter. I expect fourth-quarter results to be better.

Okay. Thank you guys.

Tim Weiss, Baird.

Yes, hey guys. Good afternoon.

Just looking at the plumbing business, you've had two quarters there where margins have been above 20%. So just as we look forward, what do you think is more of a sustainable run rate in that business? And maybe how much did some of the international weakness this quarter impact the margins Q3?

Yes, that was a part of it. So to the extent, it kind of slowed down a little bit, and we had strength in the US on wholesale and retail. That mix is going to impact profit.

And then we also -- there was just some timing on some advertising spend. We rolled some new programs into the fourth quarter. We thought we might spend that in the third quarter, but it ended up just rolling into the fourth quarter. So those two things elevated it, kind of above 20%.

We think that is probably a kind of a high teen, 20% is probably about where it should be longer-term. And we look obviously at where we are making investments and what the mix is going to be.

The other thing that kind of continues to perform well, is just overall mix. So not just geography, but a higher end product is selling through. As I said earlier in my comments, there is some strength here at the higher end remodel that -- that we have certainly seen in cabinets, but we see in faucets too.

Consumers selecting up, and that mix continues to go up. Same with entry doors, mix continues to shift up. So all that rolled together contributes, but we are not targeting something kind of in the 22% range going forward.

It's a little high. And at some point, we would rather be investing back into the business, and driving for more growth than make that trade-off. That is kind of what the trade-off becomes, so.

Okay. No, that is helpful. And then, just in cabinets in Q4 I think the comp and year-over-year basis from organic growth perspective is pretty similar. Are there any other one-time items in the year ago period in Q4, just to be aware of from a growth perspective?

Yes. It, the fourth-quarter comps for cabinets was 34% last year, and even if you back out WoodCrafters, it was 18% I think -- the only -- the one thing that is beneficial for this year's fourth-quarter is we were starting to make some investments, as I mentioned earlier in the fourth quarter. So I think you will see the fourth-quarter for cabinets being better operating margin performance than the third quarter.

And then maybe just in terms of growth?

Yes, I think the growth will probably be similar to the third quarter.

Okay.

The things that -- some of the -- say the WoodCrafters load in, some of that is going to recur. Not as -- not to quite the same extent, but it is still in the fourth quarter. So we will see that for the entire second half. So I would say --

For the last quarter of the builder west, will come out through the fourth-quarter.

Yes, there is probably another $13 million of that. We will be about $50 million for the year, and then the Builder West exit will be over by the end of the fourth-quarter. But both of those things are going to be re-occurring. So again, I think modest growth, similar to the third quarter, but profits higher.

Okay. Thanks for the help.

Michael Reno, JPMorgan.

Hello, it is actually [Will Long] on for Mike. How are you guys?

Hello.

So my question is with regards to the competitive environment in cabinets, especially with regards to the home center channel. One of your public competitors recently talked about being more aggressive with regards to pricing and promotions. And I just wanted to get your thoughts around that, and how you guys are expecting to respond to that sort of strategy? Or if you are seeing any sort of elevated levels of promotion at this time?

Yes, it is interesting. It has been almost two years since we started to really back down from promotional levels, and we have held them down that level. We have been executing strong, just on the basics of the business, new products and programs, quality, reliability, service, support to designers. And with a lower level of promo than both of our competitors in the home centers, we continue to gain share. I mean, it was pronounced in the third quarter.

And I just say, I guess there is periods of time when we are succeeding, and competitors feel like they -- the only thing have got left is to promote. And we are ready for that, because of our execution. I would say, we would rather be investing our resources in product, in service, in some capacity, and in working with designers. And that is a good use of our expense to long-term build the business, as opposed to one-time promotions.

So we will continue to hold the line and be tough, because it is working and we are winning. So that is about all. Obviously, we react to whatever competitors are going to do in the marketplace, but I feel pretty confident, because we got some really good teams out there in the market, doing great work, so.

Okay, great. Appreciate that. And I -- just with regards to the M&A pipeline, just wondering how you are seeing that stack up relative to July? And also, sort of your confidence level in terms of maybe a bolt-on acquisition, in the next 12 or 18 months? Thank you.

Yes. I mean, the M&A market continues to be -- there is opportunities out there. There is things that we are working on. I would note that we did sell Simonton in the quarter, and brought Sentry. So the team was kind of busy over the summer, and but they are continuing to look at other things.

And I would say, it's a reasonable market and there is discussions that we are having. And I can't ever project whether those will be fruitful or not.

But I would just say that if the pace of discussion are out there, and there is a number of different things that we are looking at. If any of those come to fruition, that is great. So I would say there is some activity. It has picked up relative to where we were kind of at the beginning of the year, and expect that pace will continue over the next 18 months. So we will continue to look -- both in our kind of our core businesses and near adjacencies, and we do see some opportunities out there, so.

Ken Zener, KeyBanc.

Afternoon, gentlemen. Lee, if you could clarify just two housekeeping questions before I ask my bigger one. But you talked about the security margin in the fourth-quarter, I picked up the word flat.

Was that EBIT, was that a margin, could you clarify? And what you expect the full year diluted share count to be?

Yes. What we said was in giving our guidance, we are assuming for just the tool storage business, that the fourth-quarter profit will be equal to last year. Because we are beginning that strategic review. So at this point the easiest thing for guidance is just to say, let's assume it's flat with last year. So that is what we meant.

It is not Master Lock, it's not Sentry, it is just a tool storage. And I would say for next year, I would say shares on a fully diluted basis, right now it looks like 161 million to 162 million shares.

You were referring, you said next year, you mean 2014?

Well, for 2014, I would say, for the fourth-quarter I would use 162 million roughly. (Multiple Speakers).

Yes.

So you don't get the full average. I think we are going to use the 166 million for the full year of 2014

Correct.

And I think next year is a lot more like the fourth-quarter, 161 million or so.

Good. Thank you.

I wonder -- realizing your investing in the business for growth. Is there a way that you could kind of talk about maybe --you talked about the builder business cabinets in the West or load-ins or plumbing. Is there a way, or the long-term kind of 30% incrementals which you have done quite well delivering, over time I would say.

And if you call out kind of these one items, we still kind of get tot that range. Is there something that you are aware of -- we are in October, as you look into the kind of the first half of 2015, that would kind of cause a lot of variance off of that roughly 30% incrementals that many people think about for your business operations? I mean, is there anything that you kind of just -- on the horizon to highlight us, so we don't necessarily have margin -- below lower margin incrementals than one might think that you know of currently?

Yes, what we will -- remember our planning assumption is around 25% incremental margins, until we get back to kind of steady-state housing market. And that is our planning assumption.

As we give guidance at on the next call for 2015, we will generally tell you then what we -- what our expectations for the incremental margins are. And it historically been 25% to 30%. It is 30% if we are not investing as much. It is 25% if we are investing fully.

So we will tell you at the end of the next quarter, when we give you our guidance.

Right. And I believe for kitchen cabinets, for this year you did talk about you expected margins to up roughly a 100 basis points year-over-year for the fiscal year, on moderate growth in the fourth-quarter. Right?

Yes.

Thank you, sirs.

Mike Wood, Macquarie.

Hello, thank you. Could you just clarify, so we know the scope of the fourth-quarter change in your view? The 4% to 5% end market forecast, what were you assuming previously?

And I am curious what the dealers are telling you now, in the sense of earlier, it seems like they were pointing to traffic growth that didn't materialize. So was that sort of -- do you view that as pent-up or does that -- maybe we are in the lower growth backdrop?

Yes, when we gave our guidance at the end of July, we were looking at a US home market for the full year of 6% to 8%. So for this -- when we just gave guidance, it is really now just about the fourth-quarter. So we said 4% to 5% in the fourth quarter.

I think if you the second half of the year, we are saying it is probably 4% to 6% for the entire second half. So it was 6% 8% before. Now it's kind of this 4%, 4.5% to 6%. That is when we said, we are kind of at the low end of our market guidance before.

In terms of the cabinet business on the dealer side, the dealer business was up mid teens for the quarter. There is still pretty good traffic going through the showrooms. The home centers, special order was up high single-digit.

So that is about what we would have expected, so I don't think it's softer than expected. Some of that is share gain, but I do think there is activity out there. Is it at a kind of rapid pace? No. I mean, I think there is still some upside there, but I wasn't disappointed with the activity kind of flowing through the showrooms, and setting up a reasonable fall season for us.

Okay. And just to clarify, I think last quarter you discussed in plumbing, the margins were helped by promotions that got deferred into the third quarter from second quarter. And it just seems like you probably didn't see those with 22% margins. Can you just clarify that?

Yes, it wasn't promotions, it was ad spending primarily. So as we looked at our business, we basically said it probably makes more sense to run the ads in the fourth-quarter.

The last time, when we reported the second quarter, we said probably happens in the third. As the guys looked at it a little closer, they said, let's just bundle into fourth-quarter. So it was is just really the timing of some of the annual ad spending is really what drove that.

The other thing that drives it candidly, is in our business you have to earn expenses and investments. So when your top line is little slower, we spend a little less. But so 22% is high, I would say for the fourth-quarter. I would think it would be 20% or less. And for the full year, it will be somewhere between 19% and 20%.

Great. And just finally, I am curious if you would even comment, in terms of how much of the share gains you are seeing in cabinets is coming from the Diamond launch, versus just other general product innovation? And within these dealers, are you actually gaining shelf space, or is it just consumers flocking to your products?

So it is a combination of things. The Diamond launch is specific. That is primarily flowing through the home center channel.

The dealer side was not that heavily impacted by that. So the dealer side was just more fundamental demand. And I think, there it is both us picking up new dealers, as well as going deeper into the dealers that we have.

So if we had one line there, expanding that the two lines or three lines incrementally. And that is just something we have been working on for the four or five years.

But we saw some pretty good success with it this year, in particular in that marketplace. So you set it up. These are kind of on at a time, and you are working through it. And as we perform well, and deliver on expectations, they give us more business. And so, kind of earned our way through all that.

Okay. Thank you.

Stephen East, ISI Group.

Thank you. Chris, if you look at your business, with all the moving pieces that are going on, and also the slowdown in the new construction. What would you say your split of business is now, moving forward with new construction versus R&R?

We are at probably 65/35 right now, R&R, new construction. I think going into next year, we will talk a little bit about where are assumptions are. But you could see some pickup on new construction, that would shift some of that.

The only other moving piece in all that was, Simonton was a little more R&R, so that will come out. But Therma-Tru is also growing at a pretty significant pace, and that is more tilted toward new construction. So that might tilt us a little bit more toward new construction, but not dramatically more.

Okay. I have got you. And then just two other questions.

When you look at that mid teens improvement in the dealer network, how much of that do you think is actually incremental demand flowing through that channel, versus you all taking market share?

Yes, I think it's both. I mean, I think there is some incremental demand. If I look at kind of the strength across product lines and segments, from all the way to high-end, in Omega and Decora, down through the middle of the market, and then down into our stock programs, Aristokraft, you are kind of competing against different folks at each of those, and we are picking up share across.

So I would say some of it is, we are taking it away from some individual competitors. But some of it's just more widespread strength, of us working with the best dealers in the markets that we are in, working hard with those dealers and executing well.

So it's -- and dealers, just it's thousands of accounts. So you have got to be doing a lot of things right, in a lot of places to see that kind of improvement on a consistent basis.

And we have been -- we would look at our comp last year, and overall in the cabinet business, even taking WoodCrafters out, we were up 18% in the third quarter last year. And so, it will be up again mid teens in -- on the dealer side of the market. So we are just doing a lot of the things year-over-year, and taking advantage of whatever growth there is out there.

Yes, I have got you. And then, just a last question. You mentioned in your prepared remarks, talking about SentrySafe, you thought there was some -- you didn't use the word synergy, but I will use that. I guess, as you look at integrating between Master Lock in Sentry safe, what are the opportunities when we sit here, and look at revenues, manufacturing, overlapping sales, marketing forces, that type of thing?

Yes, and it is early. We just closed on it in late July, but we see opportunities across all those. On the revenue side, there are product applications that work with locks and security devices on a Master Lock, that also work within the safe. So electronics is a big area that we can leverage across both. There is distribution. So there is some cross-pollination on distribution that we can leverage between the two, that should give us some incremental revenue growth.

On the cost side, there will be some synergy. We took some expense out of Master Lock, as we reprioritized some things even here in the fourth quarter. And so we see some rationalization there, both back-office as well as kind of the manufacturing side.

So we think bringing those two together -- frankly, it will be easier to understand now, moving storage side out. You will have a clear picture of both revenue growth there. And we will talk about that next call, about kind of our outlook on the business. But we will be more specific about where those opportunities are. But I am pretty excited about that business. I think the two of them together are going to yield some pretty good impact.

Okay. Thanks.

Eli Hackel, Goldman Sachs.

Thanks. Just want to go back to the market adjustment changes. How much of the change was due to R&R versus the new construction? You sound pretty positive on R&R, at least how that is coming through last couple of months, so want to understand that better?

And then, just on cabinets, clearly facing headwinds this quarter and next quarter. Is this -- is cabinet growth or the market growth in the low -- or not the market -- but your growth in the low single-digits, was that close to what you are expecting? Or was it much -- were you expecting much better than market growth, was just lower? Thank you.

Yes. I would say on the reduction in the market outlook in our guidance, I think we are fairly positive on R&R. I think -- we took it down a little. I would call it 50 basis points or something, from in the second half from what we had originally thought. New construction, we took down much more.

And in terms of the cabinet growth in the fourth quarter -- and in the third quarter, it's relatively close to what we thought -- once we understood the R&R. Remember, that it is the R&R market that drives so much of that cabinet business for us,. And it's through that dealer channel. So as we understood more, it felt right.

We had some headwinds, as we have talked about with the inventory builds in WoodCrafters, and exiting the builder west that we knew. So we -- those are right on track, what we thought. So it came in pretty much where we thought, given that the market is a little softer.

That is great. Thanks so much.

We reached the allotted time for questions for today's call. I will now turn it back over to the presenters.

Thank you. This is Brian. I would like to thank everybody for attending the call, and we certainly look for to speaking with many of you again very soon. So thank you again.

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