Fortune Brands Innovations Inc (FBIN) 2016 Q4 法說會逐字稿

Good afternoon.

My name is Mike, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Fortune Brands' fourth-quarter and year-end earnings conference call.

(Operator Instructions)

Thank you.

I would like to turn the call over to Mr. Brian Lantz, Senior 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 webcast.

We're pleased to be here today to provide an update on our progress during the fourth quarter of 2016 and provide of our 2017 guidance.

Hopefully, everyone has had a chance to review the news release issued earlier.

The news release and the audio replay of the webcast of this call can be found in the Investor section of our FBHS.com website.

I want to remind everyone that the forward-looking statements we make on this 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 income, earnings per share or cash flow on today's call will focus on our results on a before-charges-and-gains basis for continuing operations, with the exception of cash flow, 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 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.

In the fourth quarter overall sales growth accelerated, led by Plumbing, and our teams again delivered strong operating margin growth across all segments, driven by a continued focus on growing in the most attractive parts of our market.

For the full year we continue to execute our strategy of discipline profitable growth, as we increased earnings per share of 33% and sales growing 9% and our operating margin exceeding our plan for the year, rising 140 basis points to 13.2%.

We also saw early benefits from the recent formation of our Global Plumbing Group, where the strategy is to grow sales faster than the market while maintaining margin.

In addition we delivered incremental growth during the year as we completed the acquisitions of ROHL and Riobel, repurchased $424 million of our shares and again increased our quarterly dividend.

Our teams have continued to execute at a high level against our strategy, and the momentum we have built positions us well for continued strong performance heading into 2017.

Let me first take you through some of the fourth-quarter highlights and my thoughts on our full-year performance on 2016.

Then I'll discuss our view of the US home products market and our 2017 outlook for sales and EPS growth.

Finally I will discuss our upcoming CFO transition.

Beginning with the quarter, overall sales increased 6% versus the prior year, and 10% when we adjust for the negative impact of a calendar shift in our Cabinet segment.

Operating margin performance was strong, decreasing 130 basis points to 13.3% with solid performance across all operating segments.

Turning first to the Plumbing segment.

Plumbing sales were up broadly in the quarter, increasing 19% overall and low double digits, excluding our recent acquisitions.

[Development] in the quarter was driven by a number of changes we made to drive growth in the Plumbing business, starting in the fourth quarter of 2015.

Specifically, we began: focusing on growing sales in segments of the wholesale market with targeted customers; developing and accelerating the launch of new products at retail; employing more sophisticated online marketing tactics; bringing on a new ad agency and reinvigorating our brand positioning and marketing programs; investing in digital marketing capabilities; and deepening our pool of talent as we formed a new Global Plumbing Group and focused on the high-impact areas.

Together these changes helped drive strong sales performance in the fourth quarter and should continue to benefit us going forward.

We continue to emphasize product innovation, and are becoming more sophisticated in our marketing approach by focusing on digital content and mix across brands.

Overall for Plumbing in the fourth quarter, we experienced strong sales and profit growth across our channels.

US wholesale and Canada sales were up double digits, while US retail and China sales increased high single digits.

Going forward our strategy will continue to focus on growing sales above market while maintaining our operating margin, and on making accretive acquisitions under our newly formed Global Plumbing Group.

We have seen early benefits as we accelerated organic growth in the quarter and began to realize some of the potential from our acquisitions.

We continue to believe that we have the ability to reach $2.5 billion in Plumbing sales by 2020.

For our Cabinet segment, reported sales were down 1% in the quarter but grew 7% excluding the impact of the Cabinet Division calendar shift, which Lee will detail in a minute.

Excluding this impact, sales growth was strong in our core markets with the exception of continued softness at the luxury end of the market.

Importantly, due to our disciplined focus on profitable growth, we delivered strong operating margin improvement.

Let me cover our Cabinet highlights excluding the calendar shift to give you a sense of our core performance, which accelerated nicely from the third quarter.

Sales in our dealer channel turned it up, growing mid single digits overall.

Sales of our core stock and semi-custom dealer lines grew high single digits, driven by strength across the board in our Aristokraft, Homecrest, Schrock, Diamond, Kemper and Mid-Continent lines.

Sales at the luxury custom end of the market, where we saw our Omega, Decora and UltraCraft lines, were down modestly in the low single digits.

(Inaudible) in the second half of 2016 we experienced a two-year run of solid double-digit growth at this very high end of the market, which tends to be more discretionary, cyclical and tied to certain geographic markets.

The softness in the second half of 2016 was focused in the higher income geographic markets including South Florida, the Mid-Atlantic and the Northeast.

Our home center in-stock cabinets and vanity sales, which represent over 20% of our total cabinet sales, increased at a mid-teens rate, due largely to strong sell-through of new programs and product upgrades that launched earlier in the year.

The balance of our Cabinet business, which includes builder direct, home center special order and Canada grew 3%.

Sales in the builder direct channel were up double digits, driven by new construction activity.

And operating margin improved meaningfully, as we focused on the regions where we can achieve profitable growth.

In the home center special order channel, where our competitors were very aggressive on promotions, sales were down slightly.

The volume in this part of our business represented only 13% of fourth-quarter Cabinets revenue, and we remain focused on our strategy of disciplined profitable growth.

We are committed to growing profitably with our home center customers in the segment by partnering with them in areas where we can leverage our sustainable competitive advantages, including product innovation, new styles and designer-focused tools and customer service [management].

Lastly, sales were down in Canada where the economy in the central provinces continued to be challenged by the earlier downturn in the energy market.

So overall for Cabinets, momentum picked up again in the fourth quarter.

Our teams continued to execute well and build on our structural competitive advantages.

As the largest Cabinet Company in the industry with the broadest portfolio of brands, price points, products and channels, we have the ability to target and consistently win in attractive segments of the market without resorting to excessive promotions.

Our consistent results reflect this focus, and I'm pleased by our ability to simultaneously grow and increase operating margin consistently over the last eight years.

Door's reported sales were up 6% in the quarter.

Door products saw sales growth driven by gains in both wholesale and retail.

The Therma-Tru brand continued strong performance across both channels, with mix and efficiency driving 170 basis points of operating margin improvement.

New products continued to be important to this business, and we have success with our new door styles as well as decorative glass.

Our team has been able to build momentum by enhancing the capabilities of our wholesale fabricator network and by building successful programs at retail.

In the Security segment, sales increased 6% for the quarter.

High single-digit increases in Master Lock US retail, commercial and international drove the growth.

Safe sales were limited in the quarter as we work to ramp-up volumes in the new facility.

Recent integration of SentrySafe into Master Lock continued to drive profit improvement, and we remain excited about the top-line opportunities we see in these two brands over the next few years.

So to recap the quarter, we executed our strategy very well in an improving US home products market, delivering solid sales growth and exceptional profit growth.

Reflecting on the full year, we delivered a very strong performance on multiple dimensions in 2016.

Against the backdrop of a steadily improving housing market, coupled with the stronger business model we have created, we just achieved one of our best years ever, capping an impressive five-year run of consistently increasing sales, earnings and operating margin.

While our teams have executed extremely well and delivered outstanding results in 2016, I'm even more excited about the foundation that we have built to drive both organic and incremental growth over the next five years.

Housing market demand drivers continue to be solid.

And with the highly capable Management Team and strategy we have in place, we're extremely well positioned, not just for 2017, but for the next several years.

Switching back to 2016, in the full year we grew sales by 9%, earnings by 33% and increased total Company operating margin by 140 basis points, which exceeded our plan.

Importantly, inside of each business we made a number of significant changes to enable us to continue to deliver profitable growth.

In Plumbing we created the new Global Plumbing Group, a key platform that will enable accelerated organic and incremental growth for years to come while maintaining the strong operating margins for the segment.

In Cabinets, we grew at above market rates in the parts of the market that we target for profitable growth and continued to improve mix and efficiency, which increased segment operating margin by 180 basis points.

In Doors, our full-year operating margin rose by 320 basis points, and we reached record levels of working capital efficiency.

We launched new products at wholesale and at retail and drove continued sales and operating income growth.

In Security we completed the integration of the SentrySafe supply chain into our operating platform, and have already begun to realize profitability improvement with full-year operating margin up 160 basis points.

Beyond these strategic actions we also deployed capital in value-creating ways as we completed two plumbing acquisitions, repurchased shares, and again increased our quarterly dividend.

Moving forward we'll continue to focus on creating meaningful incremental shareholder value by using our strong cash flow and balance sheet to make strategic acquisitions and return capital to shareholders.

Our acquisition pipeline continues to be active, and I'm encouraged by the number of things we are working on and the potential we have to create incremental shareholder value over time.

We are closely monitoring potential changes to regulatory, trade and other governmental policies, and that may make some opportunities we are working on more attractive and others less attractive.

Over the next two to three years, we believe we continue to have the potential to deploy more than $2 billion to drive this incremental growth in shareholder value.

Now, let me turn to our full-year outlook for 2017, starting with our view of the US home products market.

Our 2017 annual outlook is built on an assumption that the US home products market, which impacts over 70% of our sales, grows at a 6% to 7% rate, which is slightly less than last year's market growth, due to the challenging comps in the first quarter.

Within that overall assumption, we anticipate that the pace of repair and remodel demand in 2017 grows at a rate of 4.5% to 5%.

We see consumers continuing to demonstrate an appetite for stronger styling, product differentiation and project complexity, which will continue to improve mix across our categories.

New home construction is assumed to grow at high single digits in 2017.

Single family is expected to continue to grow faster than multifamily.

Single family entry-level activity is expected to continue to accelerate.

Our total global market, which includes assumptions for the US market as well as our other international and securities markets, is expected to grow at a combined 5% to 6% for 2017.

Based on that total global market assumption, continued share gains, plus the ROHL and Riobel acquisitions, we expect solid top-line growth for 2017, with our full-year sales increasing 6% to 8% over 2016.

With this market and sales growth, our teams are focused on delivering full-year EPS in the range of $2.95 to $3.05.

So overall, our 2017 outlook is based on reasonable market growth assumptions based on the basket of indicators that we monitor.

We will continue to execute on our growth strategy.

And I feel good about the winning momentum that our teams are carrying into the year.

Before I turn the call over to Lee, I want to talk about his transition to retirement at the end of the year and some of the things that we've been able to establish in the time he's been here.

Over the last 5.5 years we have significantly strengthen our Management Team, including all areas of the finance function.

We've added stronger functional leaders and created a more robust set of processes across all areas.

Lee's successor, Pat Hallinin, will step into a strong Finance Team.

He is deeply familiar with our approach and strategy, having worked in our two largest businesses, Cabinets, and most recently Plumbing.

He is a proven leader that fits in well with our high performance culture that is focused on creating shareholder value through a focus on profitable growth.

Because of the strong leadership and processes we've been able to establish, I see the eventual transition from Lee to Pat as seamless.

Additionally, Lee will be with us throughout the year to ensure a smooth handoff.

At the right time I will thank Lee for his many contributions to our Company and will wish him the best as he prepares for retirement.

However, we have a strong 2017 ahead of us with plenty of exciting opportunities unfolding, so I will hold off on those comments until later in the year when he steps away.

With that, I will now turn the call over to Lee, who will review our financial performance and provide more details on our (inaudible).

Thanks Chris, and good afternoon.

As Brian mentioned, to best reflect ongoing business performance, the majority of my comments will focus on income before charges and gains from continuing operations.

Let me start with our fourth-quarter results.

Sales were $1.3 billion, up 6% from a year ago, in spite of challenging comps from the prior year.

Excluding the negative impact of a calendar shift in our Cabinet segment, total Company sales increased 10%.

Consolidated operating income for the quarter was $173 million, up 18%, or $26 million compared to the same quarter last year.

Consolidated operating margin improved 130 basis points to 13.3%.

EPS were $0.71 for the quarter versus $0.56 for the same quarter last year, decreasing 27%, and were at the high end of our guidance range.

Now let me provide more color on segment results.

Our Plumbing sales for the fourth quarter were $426 million, up $68 million, or 19%, led by US retail, US wholesale, Canada and China.

Sales excluding acquisitions increased low double digits.

Our new Global Plumbing Group is executing our strategy.

In 2017 we expect Plumbing sales to grow by double digits for the full year, including the recent acquisitions.

Operating income increased $17 million to $88 million, up 23%.

Operating margin for the segment was 20.6%, up 80 basis points from the prior-year quarter.

For the full year, Plumbing sales increased 8.5%, operating income was up 14% over the prior year, and operating margin increased 100 basis points to 21.7%.

Turning to Cabinets.

Our Cabinet business had a favorable calendar shift in the fourth quarter of 2015 that increased sales for all channels.

More specifically, the fourth quarter of 2015 included nine shipping weeks prior to the Thanksgiving week while the fourth quarter of 2016 had only eight weeks.

These are the highest volume weeks of the season.

Additionally, the fourth quarter of 2015 included three more regular shipping days.

The full impact of this calendar shift was an additional $45 million in sales in 2015.

To best understand year-over-year business trends in this segment, it's necessary to exclude this impact.

Reported sales were $601 million, down $7 million, or 1% versus the prior-year quarter.

However, sales increased 7% for the Cabinet segment when you adjust for the calendar shift.

Reported dealer sales of $300 million were down 3% from the prior year, but were up 5% excluding the calendar shift, with strength across core product lines.

Reported sales in in-stock cabinets and vanities of $130 million increased 7%, but 15% excluding the calendar shift, driven by strong sell-through of new products.

Reported sales in the home center semi-custom, builder direct and Canada of $171 million, were down 4%, but increased 3% excluding the calendar shift, with builder direct up strong double digit and home center semi-custom and Canada down for the reasons Chris described earlier.

Importantly, margin improved in all of our channels.

Even in home center semi-custom, where sales declined modestly as competitors drove elevated promotional activity, we remained disciplined and chose to grow operating margin.

This improvement in margin across our channels is a sign that our strategy, which remained focus on disciplined profitable growth, is the right one for our business.

Operating income for the Cabinet segment increased 4% over the prior-year quarter, with operating margin increasing 60 basis points to 10.6%.

Operating margin increased 110 basis points to 11.1%, excluding an increase in bad debt reserve related to the Direct Buy bankruptcy filing during the quarter.

For the full year, reported Cabinet sales increased 10% over the prior year and operating income grew 33% to $260 million, with the operating margin increasing 180 basis points to 10.8%.

This significant increase in profitability was driven by our teams' disciplined focus on growing in the most attractive parts of the market and not chasing low-margin sales.

Overall, we remain pleased with the underlying strength in our Cabinet business and by our ability to drive margin improvement, and expect Cabinet sales to grow by high single digits in 2017 with continued operating margin improvement.

Door sales were $122 million, up $7 million, or 6% from the prior-year quarter.

Sales were up in all channels, and operating income increased $3 million to $16 million, up 22%.

Operating margin was 13.3% for the quarter, up 170 basis points.

For the full year, Door sales increased 8%, operating income grew 42% and operating margin increased 320 basis points to 13.2%.

We expect 2017 operating margin in the Door business to be over 14%.

Security sales were $153 million in the fourth quarter, up 6% to the prior year.

Segment operating income increased to $24 million, up 28%.

And the segment operating margin was 260 basis points higher at 15.6%.

The improved operating margin reflects the benefit of the SentrySafe integration.

For the full year, Security sales increased 5%, operating income increased 18% from the prior year, and operating margin was 14.1%.

We expect to increase operating margin in the Security business to around 15% for the full-year 2017.

To sum up consolidated fourth-quarter performance, sales increased 6% and EPS were at the high end of our range at $0.71.

Our total Company operating margin increased 130 basis points to 13.3%, with an incremental margin of 45% excluding acquisitions.

For the full-year 2016 sales increased 9% and EPS grew 33% to $2.75, including $0.16 of tax benefit related to the accounting change for equity compensation.

Total Company operating margin was 13.2%, 140 basis point improvement.

We're well on track to reach our long-term goal of approaching 15% operating margin when the housing market returns to steady-state levels.

Turning now to capital deployment.

During 2016 we repurchased $424 million in shares, including $61 million in the fourth quarter, and we've bought an additional $27 million in January this year.

We spent $260 million on Plumbing acquisitions, and approximately $100 million on dividends and increased the 2017 dividend rate.

2016 free cash flow was $531 million and reflects the benefit of over $80 million of reduced working capital.

Even after this significant level of capital deployment in 2016, our December 31 balance sheet remains solid.

Cash was $251 million, debt was $1.4 billion and our net debt-to-EBITDA leverage was 1.5 times.

Additionally, we have significant capacity under our revolving credit facility to continue to the deploy capital to drive incremental growth.

Turning last to the details of our outlook for 2017.

Based on our projected 6% to 7% US home products market growth and our total global market growth of 5% to 6%, as well as continued share gains in our areas of strategic focus, we expect full-year 2017 sales to increase 6% to 8% compared to 2016.

Our resulting outlook for 2017 EPS are in the range of $2.95 and $3.05.

The midpoint of our EPS outlook reflects an increase of 14% when you exclude the benefit of the accounting change for equity compensation on our tax rate of $0.16 in 2016 and $0.05 in 2017.

The annual EPS outlook includes the following assumptions.

Interest expense of around $50 million, a tax rate of around 32.5%, and average fully diluted shares of approximately 157 million.

In summary, the fourth-quarter and full-year EPS had strong growth.

The solid performance of the business for the year, the platform we have created with the Global Plumbing Group and the expected continued market recovery give us confidence in continued solid growth in the coming years.

Importantly, the 140 basis point operating margin increase in 2016 and continued increase in our 2017 outlook place us on track, if not ahead of, our timeline for achieving our long-term operating margin targets.

Also, as demonstrated by the Riobel and ROHL acquisitions, share repurchases and the dividend rate increase, we remain focused on using our balance sheet and cash flow to drive incremental shareholder value.

Our credit facility agreement provides significant flexibility to continue to drive incremental shareholder value.

I will now pass the call back to Brian.

Thanks, Lee.

That concludes our prepared remarks on the fourth quarter of 2016 and our full-year 2017 outlook.

We will now begin taking a limited number of questions.

(Caller Instructions)

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

Operator?

(Operator Instructions)

Philip Ng from Jefferies.

Congrats, Lee, and looking forward to working with you the rest of the year.

First question for me.

As you pointed out in the release, the political uncertainty adds a little noise to the recovery.

And with interest rates going up, just wanted to get your view on where we are in the cycle, the shape to recovery as we look at 2017.

The last time I think rates did go up off a very low base, there seemed to be some prebuy ahead of that and demand faded.

Just wanted to get your thoughts on how you are positioned this year?

Thank you.

If we looked across a whole number of drivers that we follow, I'd say interest rates are certainly important, but everything else we're looking at continues to point up.

Consumer confidence is up, household formations continue to expand beyond where we are building to.

If you look at assessing the household formations, around 1.4 million in 2016 plus 200,000 in demolitions.

We're not building at a level of 1.6 million at this point in the cycle.

Unemployment is down, purchase loan activity is up, availability of credit is good, household debt levels are low.

Certainly there was pick-up in rates, but all the other things that we follow look like positive.

Fourth quarter definitely saw increase in starts, to track the home builders, looked like order rates continued to be strong throughout the fourth quarter into the first quarter.

So on the new construction side, we're actually looking at 2017 as being a good year.

We think it will be in aggregate like 2016 but the weighting will be a little bit different.

By the time it starts to kick in will be later in the first quarter and then second quarter, third quarter we should see some very strong performance coming through on that side.

On the R&R side, I think we're looking at R&R growth for the year around 5%.

First quarter, probably a little soft on that because we had such strong comps last year, and then probably a little better than 5% quarters two, three, four.

I think the market is setting up to be okay.

Obviously, a little tick up in interest rates, but we don't think it's going to suck the air out of the marketplace.

Okay, very helpful.

Switching gears to Cabinets, constructive and encouraging to say high single-digit growth for the full year.

Can you provide a little more color on the competitive activity you called out in the home center channel?

I think you did called out a little weakness in luxury as well.

Do you expect that to have any impact as we think about this year?

Is there anything we need to be mindful in terms of the calendar shifts that you saw in 2016, what the impact would be this year?

Thanks, and good luck in the quarter.

I will start with the last piece, the calendar shift is behind us so we should have comparable calendars this year.

Lee can talk about -- give you a little more detail on that.

I think as we look at a comparable apples-to-apples quarter results, 7% for Cabinets, strong growth in dealer, semi-custom, and the heart of the market, they were up high single, low double, there.

In-stock vanities, the teams, builder director, you mentioned that the home center promotional activity, that's about 13% of our sales for the quarter.

And I guess if I look back over the last eight years, from time to time one of our competitors or the other of our large competitors, will go very aggressive on promotions.

We've been disciplined and have really focused on taking the business that is at a good margin.

So we haven't chased them down the rabbit hole and just thrown money after it.

We'd rather invest our money in product and service and training for the designers.

There is a little bit.

The reality is, once they came off promotion, volume came back to us.

I'd rather do that and take the business that I got at good profit margins and let the other guys chase -- throw money at promotions and chase it.

On the very high end and custom, which is about 10% of our Cabinet business, there we saw softness the whole second half, really, the industry did.

If you looked at -- KCMA did, and it was reported (inaudible) that KCMA, these are smaller regional guys reporting in that in parts of the market, South Florida, the Northeast and Atlantic, we saw some weakness in that very high end of the market.

That's off of two very strong years.

We had a two-year surge in that part of the market.

A lot of that R&R activities coming out savings, equity market, there's not a lot of borrowing in that part.

And there seemed to be a pause.

Based on the traffic that we're seeing in the showrooms and talking with our dealers, it appears to be coming back.

It's early, it's January, so we will see how it unfolds.

I'd say a little soft, but the in-house [small it is] for our total business didn't (inaudible) too bad.

Clearly we were able to continue to drive margin improvement in the core of the business because the mix held up throughout.

Okay.

Tim Wojs, Baird.

Good afternoon, guys.

Maybe first question.

As you look at the cadence through the year, could we just -- maybe it's a percentage of full-year EPS or something like that.

Is there way to think about what Q1 should look like relative to maybe historical patterns as a percentage of the full-year EPS or revenue or margins?

Yes.

I Think as you -- you'd start with first quarter of 2017 as going against a tough comp, obviously, with the market being up, with the additional good weather days we had in the first quarter of 2016.

When you think about our full-year sales, the range of 6% to 8%, I would say the first quarter probably is at the low end of that.

I think as you get to the second half, you are at the high end of that, kind of a natural progression in terms of sales.

In terms of EPS, if you back out this impact of the accounting change on the tax rate, which was $0.16 in 2016 and will be $0.05 in 2017, if you back that out and you should have that by quarter, what you see is a pretty consistent EPS growth quarter over quarter.

So somewhere from -- on average for the year it's 14% up.

I think you'll see anywhere from 10% to 15% on a quarterly basis throughout the year, with the first half being at the lower end of that and the second half being at the higher end.

Okay.

When we think about incrementals, just the back of the envelope I got about a 25% or so incremental margin on sales.

One, is my math right there?

Two, how are you guys thinking about just price cost and maybe some of the mix impacts?

I know Chris, you mentioned entry-level's picking up a little bit on the new construction side.

How should we think about price cost and mix in 2017 on margins?

Incrementals, I think if you were still annualizing the two acquisitions on the Global Plumbing Group, I think if you backed that out, incremental margins are a little over 30% on at the midpoint of our guidance.

So we think that's good and it reflects this disciplined process of growth.

I think at the midpoint of the guidance you'd see an operating margin approaching 14%.

We were at 13.2% this year, a little bit ahead of ourselves because annually we went about 100 basis points.

We were about 140 basis points growth Companywide in 2016, maybe it's 80 or 90 in 2017, which gets us around that 14%, which says we're right on track.

A lot of that, that's coming out of price mix.

We see that across all of the businesses.

Looking across Plumbing, continuing to see improving mix there.

Within Cabinets, even as you said, if we're going more entry-level, we continue to drive mix up in that part of the market.

Seeing Doors continue the attachment rates on glass, [tempered] glass is into there.

We've been able to achieve that mix improvement across the whole board.

Great.

Bob Wetenhall, RBC Capital Markets.

Lee, I didn't think you were a day over 50, so I'm kind of shocked.

(Laughter).

He's still sitting upright, Bob.

We are watching him.

(Laughter)

I've got one word, Botox.

(Laughter).

Bob, thank you for that.

You can have three questions.

(Laughter).

I will keep it to two, but thank you.

When I look back at 2016, I think the highlight for me is the margin expansion that you guys continued to deliver, irrespective of the operating environment.

It's 130 basis points year over year, speaks to strong execution and having a very attractive portfolio.

What do we -- Chris or Lee, if you jump off, going into next year, can we still expect 100 basis points of operating margin expansion?

What should expectations be after a very strong 2016 on the margin side?

Yes.

I think if you looked again at the midpoint of our guidance, that's around 14% operating margin.

You take the two years, 2016 and 2017, that would be 240 basis points improvement.

We are right on track in terms of margins.

We're right on track, probably a little ahead of our long-term perspective of 14% to 15% operating margins at steady state.

It all comes back, Bob, and Chris can elaborate, on this focus on profitable growth, on improving mix and efficiencies across all of our businesses.

And it's really, it's within -- If you think about it for second, it's within the businesses and then across the portfolio.

Within the businesses, if I look at Cabinets, we continue to drive that margin improvement by improving the mix and the proportion of business that's coming through more attractive parts of the market.

We are managing that within the portfolio, stuff gets through the skinny on margin.

We're not too aggressive on that, and that's part of the reason why we're not going to be too aggressive on some of this promotional activity you see.

If you also look across the portfolio, as we're growing plumbing faster than the market, and we've got very good margins in that part of the market and clearly demonstrating we are putting that business on a higher growth trajectory, that shifts the overall balance of the margins within the portfolio a little bit more toward that part of the market and that benefits us.

Inside of Doors, inside of Security, we continue to manage that.

It's across the board inside the businesses as well as how we manage it across the businesses.

I'd say we are on a good track.

We've been executing on this strategy, really the last four or five years.

Once we got through the point where volume was going to cover fixed cost, we explicitly said we're driving profitable growth, we're driving it in every corner of the business.

And you can see quarter over quarter, year over year, our performance shows that.

Yes, it was a great quarter.

You definitely deserves some serious recognition.

Wanted to switch gears for second.

You did two M&A transactions on the Plumbing side following before that SentrySafe, but it seems like the emphasis on building out the Plumbing platform.

Where are you what are you seeing in the pipeline?

Do you think if you buy something it's a public market or private market vehicle?

There is a lot of questions about taking the legacy businesses you have now and what can be done to get them to the GPG growth targets you talked about.

I'm just trying to understand, is there enough opportunity, is the opportunity set big enough on M&A that you are going to be able to achieve those GPG growth targets you laid out?

Yes.

I think we're very active.

We are looking in the plumbing sector.

We're looking in some other sectors, but we are definitely focused in plumbing.

If you look at the organic growth and growing faster than the market, a portion of that target is going to come, at least half of it from organic growth.

And then a portion is going to come out of acquisitions.

So there's not a huge hurdle to meet on acquisitions.

The reality is, if we're successful there, it could move in excess.

I think we've targeted a balance between those two.

So if you look at the trajectory Plumbing is on coming out of fourth quarter, and say, okay, factoring that into the next few years, I can see where you'd meet a portion of that organically as well as what we're looking at.

The other part of your question was, how much of this is private, how much is public?

I'd say it's a mix depending on sector.

We're looking at a couple of public situations.

I can't go into anymore detail on that.

And then a lot of assets around the world are still privately held, and those are in long-lead times we've been working for a long time, and you just are going to see where the catalyst in the market that could make some of those things happen, continued to work those situations.

Just to confirm, how do you feel about the pipeline?

Is it full, or do you feel like there are some (multiple speakers).

I feel good.

One of my comments in my prepared remarks was that we are taking stock of any regulatory trade, tax impacts.

Some of those may be quite positive, meaning that we are a large US manufacturer with assembly operations, manufacturing operations in the US.

70% of our employees are in the US, and we are a big US taxpayer.

We have 32% effective tax rate.

So that may change and make some things even more attractive for us as we look at M&A.

There are other things that by way of mix could be less attractive.

We are factoring that in.

I wouldn't say that is slowing us down.

There are things that we're working on that were to respective for certain things that those changes could impact.

We are taking stock of that.

Got it.

Nice finish to the year.

Good luck.

Thank you.

Michael Rehaut, JPMorgan.

First question.

Just wanted to drill down a little bit on your comments on the first quarter and first half versus the second half.

Lee, I think you alluded to first-quarter sales growth potentially being at the lower end of the 6% to 8% range, which would be pretty impressive given the comp of a 16% growth rate there.

Likewise in cabinets, the lights-out performance you had, 30%-plus there.

Just trying to get a sense of drilling down by segment.

Would you expect Cabinets to be positive in the first quarter because, again, also with high single-digit growth for the full year, which is a little more than we were expecting as well, just trying to get a sense of, perhaps, what's driving that high single-digit growth number?

Because clearly it would seem that there is some nice market share gains built in there, and how that fits into your first-quarter outlook?

I think as you look at being at the low end of that range, it could be 5% to 6%.

It's in that range.

I think Cabinets does have a challenging comps.

But, I think they will be okay.

Is that 4%, 5% or 6%?

It's probably in that range.

Keep in mind on the Global Plumbing Group we are annualizing the acquisitions of ROHL and Riobel.

That would cause them to be probably double-digit growth when you include that acquisition activity.

Then I think Doors and Security are at kind of the low end.

I'm comfortable saying we will be somewhere in that vicinity of the low end.

Is it 5% or 6%?

It's all in there.

The Global Plumbing Group will give you a nice boost.

Certainly, we were definitely counting on that.

Just second question on capital allocation, and specifically share repurchase.

We were maybe expecting a little bit more share repurchase in the fourth quarter, given the pullback in the stock.

I think historically you've been pretty opportunistic when you've had decent pullbacks in the stock like you saw in the fourth quarter.

At the same time, you alluded or referenced to your intent focus on growing out GPG, and maybe being on the -- maybe being a little bit of a wait and see mode with regards to the regulatory environment.

So just trying to -- in piecing it all together.

How should we interpret more of a, call it, lighter share buyback relative to the pullback.

Should we be thinking about it more that the acquisition pipeline, like you said, is still pretty active and there are things that may hit sooner than later?

Or you are really just trying to play it a little more conservative until some of the regulatory backdrop clears up?

It's just a combination of things.

Clearly, we were active in the fourth quarter and in January in buying back shares, and we will continue to monitor where the market's trading.

And we think that, as you see by our actions, that press level's a little bit lighter than where we are.

Those are good points for us and we will be opportunistic, as we have been.

On the other hand, there are things we're looking at that we can deploy capital against on the acquisition side, and we will keep investing internally.

If I look back, really, over the five years, we've been very consistent in saying we are going to be very efficient with our cash flow and appropriately aggressive.

I think we've deployed quite a bit of capital over the last five years on a pace of slightly more into acquisitions then on share repurchases with consistency in the dividend.

I think that's our plan coming into the year.

I don't know that you should expect that much different from the way we've been playing it out.

If I look over the last three years, it's probably a good template for how we're going to play out the next couple of years in terms of a combination of things.

And that obviously tilt it more aggressively toward acquisitions.

We are busy at looking at a lot of different things, but I never force it there.

To the extent that we are successful on a number of the things that we are working on, tilt it more so on the acquisition side.

That's about as much specificity as I can provide.

Great.

I appreciate it, Chris.

Best of luck in 2017.

Thank you.

Scott Rednor, Zelman & Associates.

Chris, I was hoping you could just talk about how quickly you could move or adjust your capacity in two scenarios.

One would be if interest rates did cause new residential construction to slow materially.

How quick could you adjust the plans and how quick could the business respond?

Similarly, if there were some kind of border tax adjustment, just how much of a footprint is in Mexico or abroad?

And could you change the sourcing level in that scenario?

We've got a lot of flexibility in what we build.

If I go all the way back to in the downturn we restructured and made decisions around what hubs we were going to build as we came back up again.

Within that footprint we can staff up and staff down, and we've had to do that throughout the last eight year of recovery, it hasn't been a straight line.

There are quarters or parts of the year we've had to pull back and we've had a surge in staff.

We are good at that.

I'd say on that, we watch it very closely.

We watch a lot of the macro factors and then we also watch inside of our own business and adjust staffing appropriately and to the extent we need to move aggressively, we move aggressively.

We are on the side of moving harder and stressing the system as opposed to waiting patiently.

And that's kind of been the way we've run the business.

I feel really good about that.

We've got a great team and we are on it.

In terms of the outcome of any other proposals being talked about, we're looking at all of it very carefully.

We are not making any decisions until things get sorted out.

And I think there's some competing proposals on the table.

I'd start with, we are a big US manufacturer.

We've got about 70% of our people in the US.

We've got another 10% in Canada.

If I look outside the US and Canada, you are talking about roughly 20% between China, Mexico and Europe.

We've got flexibility in those operations.

And we just have to see how the impact of any of these changes are going to collectively hit us in terms of, obviously, a reduction in tax rate.

We're paying in the 30%s.

Anything anybody's talking about is going to take it down.

And we're also looking at the strength of the currency one way or the other.

We're looking at any other taxes or tariffs.

We will be pretty deliberate about making changes, but we have flexibility in the system, we could repurpose facilities where we shift things and move accordingly.

I feel good about where we sit competitively.

I think it actually could present some interesting opportunities for us, again, starting with the fact that we are a big US employer with a big US -- I should say a big, fat tax rate.

While that hasn't been competitively a great advantage, it looks like that may be going forward.

We are, again, looking at things from a fact based way.

We're waiting for things to unfold, and as they unfold we're going to be taking some pretty deliberate actions around it, as you could imagine.

I appreciate the lengthy response.

Lee, did make any comment about Plumbing margins in 2017?

Then just quickly, if there is still a benefit on the tax line, it sounds like it's still $0.05.

Why would the full-year tax rate go all the way back to 32.5%?

A couple of things on the operating margins at the midpoint of the guidance.

I think going up, let's call to 14%, you'd see all the operating companies improve their margin.

The one that might be flattish or slightly down potentially could be the Global Plumbing Group.

Remember, our strategy there is to grow faster than the market and maintain operating margin.

Anything around 21% operating margins for Global Plumbing Group, if we were driving sales above market, would be very successful.

So that's the one you could see flat to maybe even slightly down, if we're growing above market nicely.

That is the strategy.

Overall, going from 13.2% operating margin to around 14% is a pretty strong year.

On the tax rates, remember that we had $0.16 benefit in 2016, basically driven around the -- and that's all in that equity comp accounting change.

In looking at what we think what options might get exercised, it's really hard to estimate that obviously.

We think that's about $0.05.

That benefit in 2016 was about 400 basis points in our tax rate.

You think about a tax rate that was 28.7% in 2016.

You add 420 basis points back for the impact of that accounting change, and you get to 32.9%, 33%.

That was the rate without that.

You do the same thing in 2017, we have a -- we talk about a 32.5% tax rate at the midpoint of the guidance.

You add back the impact of $0.05, it gets you to around 33% or so, 33.5%.

Slightly up, but very consistent in terms of our base tax rate.

Thank you.

John Lovallo, BofA Merrill Lynch.

The first question, just following up on the border tax question.

More specifically, just on the Plumbing business where a lot of the manufacturing is done overseas.

If there was a border tax, are there strategies that you could have to mitigate the impact?

Ultimately, do you think the cost is going to be passed onto consumers?

Yes.

It's probably too soon to say where the cost is going to go.

If you look at our Plumbing business, we've got a global supply chain that feeds components into our assembly operation, which is based in North Carolina.

So that model sources from around the world.

Who knows how uniform tariffs are going to be, where the application of taxes are going to be?

As an industry, we'll all be sourcing components similarly, I think.

Proportionally, we are advantaged because we're doing assembly for the US market in the US.

And I would say there's a lot of finished goods that are coming into the plumbing market that are actually assembled overseas.

So our proportion of that tariff or tax will be lower than our competitor.

That's why I made the comment earlier that there are things that could actually benefit us because we've got this base of, in the case of the plumbing assembly operation.

In Cabinets, we are actually building cabinets here in the US quite significantly.

We've got a huge employee base and a big manufacturing operation.

While again, you may sourcing some components around materials globally, a huge proportion of the value added that we are bringing into that product is here in the US.

You've got to look at it competitively and say, where are we relative to who we're competing against by segment.

And then where's the impact, and how much of that get passed through the system.

I guess we will see what form it takes as it's coming at us.

That's helpful.

Last year you may have given a free cash flow and CapEx outlook.

I was wondering if you guys might provide that?

This year net CapEx in 2016 was $145 million.

I think we'll probably be in that $140 million range this year.

Free cash flow, very strong obviously in 2016, $531 million.

And we actually had a couple of things that really drove improvements in working capital.

Actually in 2016 working capital improved to a positive for the year of $80 million, as we did a couple of things.

We cleared some inventory that we had built during our transition of the Global Plumbing Group, some of the age of manufacturing.

For the Security, the transition of the SentrySafe.

We build safety stock there.

We've now taken that down.

We also looked at the just the need to focus on working capital.

Our WCE is down to about 15% right now.

So we had some good one-time benefits in 2016 that won't repeat for the same level.

I would say, probably, and we are still working to be honest on that free cash flow plan.

I think you could see $425 million, $450 million of free cash flow next year.

That's assuming we go back to a normal growth in the working capital.

Still very, very strong growth and strong free cash flow.

Okay.

Thank you very much.

Stephen Kim, Evercore ISI.

Good job on the quarter.

First question is talking about the political environment and the regulatory environment.

You had mentioned a very sensible sort of approach to how you might handle any kind of border tax issues or domestic tax policy.

And you sort of said that you'd move fast, hard and fast, but you'd also wait for some certainty.

I guess I was thinking that probably that same kind of balance would inform the way you would approach acquisitions, perhaps, which would suggest that we might be forestalling any actual direct action there until maybe the back half of the year.

I wanted to see if I have that wrong, and if you could correct me on whether that's the right or wrong way to be thinking about your M&A strategy this year?

There are things we are working on right now that work irrespective of changes that are going to be made.

There are things that may be more domestic, which if we are taking domestic and adding it to domestic.

Or if we're operating in a country and we're going to that country, it's within the parameters of that country.

I think anything that has a cross-border component, we'd want to make sure where things are tracking and whether we are bringing things in here to benefit from our manufacturing, or whether they've got a global supply chain that would have to be reoriented around my earlier comments.

Those are the things if there is uncertainty and it looks like it could be significant that you might wait on.

But it doesn't mean that our M&A strategy is a wait and see.

We're active on some things right now that could materialize in the first half of the year if things line up okay.

It's just clearly we're not going to jump into something that might be subject to changes in trade policy or changes in tax policy until that gets sorted out.

I don't know how quickly that will get sorted out, so we are not going to -- we'll just be aggressive in watching that and understanding how it impacts both our current business as well as anything else we're looking at.

That makes a lot of sense, okay.

Thanks very much for that.

I forgot to mention that, Lee, we will definitely miss you, but glad you are sticking around for a while so we can continue to pass through you.

We appreciate you giving us a chance.

You will get a few more shots at him.

(Laughter).

Great.

Second question I had related to your special order business in Cabinets.

Could you help us on the big picture try to contrast the situation that you see in the home center special order cabinet business too, what was emerging, or what evolved in the builder direct business, which obviously you took a step out of, a couple of regions and things like that.

Could you contrast the situation as you see it between these two businesses?

Sure.

Home center special order is an important business to us.

It's in proportion to the total.

We've got very strong programs at all three home centers.

We invest a lot in product development, in innovation, in training.

There's a consistency to that business that we approach it with.

We take a very straightforward profitable growth, tight mindset.

We try to partner with each of the home centers and say, we'd like to expand your offerings.

We'd like to introduce new product extensions, and we want to provide a lot of service and reliability to you.

It's a really good partnership with all three of them.

And we like that business.

That's just running as a constant through the system.

From time to time, one of the other of our competitors will, for a short period of time, surge on promotions.

Our consistency and the way we approach this says, we are not going to follow them on that.

We will let it return back to normal.

So therefore there is a proportion, there is a share, there's a market share of that that we like to have.

And that's a good profitable and attractive business.

And those home center partners enjoy having us in there as well.

I contrast that with, on the builder side of the market and builder direct, there was a lot of cost over the years that had been added to that segment because of the level of support that we needed to provide to builders to be able to support them with direct programs, which is designer services, which is insulation services, and spread across the entire country, which meant we had a lot of infrastructure required to support that business dedicated specifically to that channel.

We took a step back three years ago, even longer really, but took some actions three years ago to say, we can't really support on the margin structure of that business all that infrastructure.

We simultaneously took out some infrastructure in the west -- as well as then couldn't support that business, and so exited.

In the East we kept infrastructure in place.

Margin structure was better.

And since restructuring that business, we've been growing in the east, it's east of the Mississippi, so it isn't just East Coast, and that's very nice profitable business.

It has to do with the composition of how you service that business and the competitive environment around that.

That's the difference between those two.

Okay, great.

That's very helpful.

Thanks very much, guys.

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

Thank you, everybody.

I want to thank everyone for attending the call today.

We look forward to speaking with you all again very soon.

This concludes today's conference call.

You may now disconnect.