Nicholas Fink
Chief Executive Officer at Fortune Brands Home & Security
Thank you, Dave, and thank you to everyone for joining us on the call today. I hope everyone is enjoying their summer and it's certainly been a busy three months at Fortune Brands and I would like to personally thank all of our associates who continue to work above and beyond to move our business forward. Once again, our teams delivered a strong quarter of results, including high-single digit sales, OI and EPS growth versus last year. These results, a continued testament to the strength of our brands to the hard work of our team servicing our channel partners at industry-leading rates into the power of the Fortune Brands advantaged capabilities.
I'm also pleased to report that our previously announced plan to separate into two world-class publicly traded companies is progressing ahead of schedule. We have made exceptional progress in a number of key milestones and expect to file the initial draft of our Form-10 with the SEC later this quarter. Our 9% sales growth compares very well against simules fueled second quarter from a year ago and reflects improved labor and shipping availability together with higher price realization. Importantly each segment made year-over-year operating margin improvement in the quarter as price and cost actions more than offset inflation. Consolidated operating margin was in line with our expectations, which included planned investments in our digital strategy to create a transformational platform for future growth and margin expansion.
Our quarterly results were strong and much of our portfolio continue to see solid demand levels which is supportive of our full year financial targets. That said, consistent with the rest of the industry we are starting to see signs of slowing consumer behavior in response to inflation and higher interest rates. The rapid rise of the 30-year mortgage rate has cooled the torrid pace of new and existing homesale, consistent with prior periods of interest rate increases we expect a period of adjustment as buyers and sellers realign pricing and value expectations. We believe any slowdown in the housing market will be relatively short term as the fundamental drivers of the housing market remain intact. The US remains millions of homes under book, demographics remain favorable and home equity levels remain at historic highs.
To ensure that we continue to drive value creation, we are taking proactive measures in anticipation of a period of macro-driven softness and will remain agile in the face of changing market condition. The long-term outlook for housing supported by demographics and fundamentals is positive and we are well prepared to manage any short-term pauses or softness that we account. We've been here before and we will continue to execute and deliver best-in-class performance, including growing above market and delivering on our cash flow and margin target. Our team knows how to create value and our second quarter is another proof point of this. As I mentioned earlier, I'm impressed by the progress our teams have made on our future separation into two world-class publicly traded companies. As evidenced by its continued industry-leading performance the Cabins business is increasingly well-positioned to stand independently. Importantly, we're also making great progress in our strategic work around the art of the possible for new fortunate brands and I look forward to sharing that with you as it unfolds. I'm confident that the separation will result in significant value creation opportunities for both companies and their stakeholders.
Now I will turn to each of the businesses to provide some color on what we're seeing. Beginning with water innovations, sales were down mid-single digits in the quarter due to the impact of the COVID shutdowns in China. Excluding China sales growth was up mid single digits, driven by high single-digit POS. Sales were strong in our core US market for both Moen and House of role as the strength of our brands and innovation continue to resonate with consumers. We delivered these results are facing a period of channel destocking as our continued industry-leading service levels have enabled our customers to reduce safety stock and inventory positions. Our teams have been working hard to overcome the supply chain challenges of the past couple of years and we see signs of improvement across the board.
Total backlog and service rates are nearing pre COVID level. Water innovations operating margins were nearly 25% in the quarter driven by price and cost actions offsetting inflation and proactive expense management. We continue to prioritize strategic investments and the business remains well positioned to outperform in any market environment. Shifting to Outdoors and Security business, sales grew 13% driven by price realization and volume growth at Therma-Tru which continues to gain share entry openings by us leading portfolio of engineered doors driving conversion from wood. Decking sales grew high single digits tempered in part by robust wholesale inventories. Security, sales were up mid single digits, driven by strong double-digit commercial sales growth Our security team continues to successfully diversify into broad based commercial applications, leveraging connected technology to deliver mission critical safety product to our global customer base.
Our working commercial safety is well aligned with our ESG strategy, we are very excited about how the security portfolio is developing and be received by consumers and customers. Outdoors and Security operating margin improved 400 plus basis points sequentially and 70 basis points versus prior year as price and cost offset inflation and labor availability and supply chain constraints improved from an impacted first quarter. Finally, our Cabinets business delivered an exceptional quarter with sales growth of over 21% as our pricing actions became more fully realized in the P&L, volume growth remained positive and our transformational efforts continue to deliver.
Order patterns remains strong across our stock and semi custom price bands. Builders backlogs remain elevated and labor shifting towards completing homes, which will provide continued tailwinds for our business. Within our higher-end premium products market conditions appear to be impacting aggregate the month and our teams are acting to rightsize our capacity and cost structure. Operating margin was up 200 basis points sequentially and 60 basis points versus prior year. Price and cost actions more than offset inflation and our operating environment continued to improve labor availability and supply chain constraints eased. Our transformational work to reposition the business towards the heart of the market with efficient, scalable and flexible capacity continues to generate results.
Our Cabinets team continues to win in the marketplace and its ongoing transformation position the business for continued outperformance. As the team prepares to leave their own independent public company, they have never been on a stronger footing for future success. Across the portfolio as a result of our team's market-leading service levels channel inventory positions have improved through the past few quarters. We're working closely with our suppliers and channel partners to ensure the right levels of inventory exists throughout the value chain as we move through a period of expected short-term softness. By leveraging our Fortune Brands capabilities we will continue to proactively manage working capital and cash flow.
Now I'd like to add some additional thoughts on the current housing market. As I've said before while the timing of housing can be discretionary housing itself is not -- housing itself is not. There has been no change to the fundamental need for millions of more houses to be built in order to satisfy household formation in growth trends over the coming years. However, persistently high inflation and aggressive interest rate increases by the Fed has begun to impact the pace of buying and selling homes.
As a result, we do expect some softness or an air pocket in new construction which could materialize towards the end of this year or into 2023. In the meantime, builders continue to complete the much-needed starts that were undertaken, as the month sort during the pandemic. I'm not sure our product portfolio coming in towards the end of the construction process and with persistently strong R&R interest. We remain confident in the strength of our business. While home affordability due to higher interest rates and price appreciation poses a challenge to home sales. Offsets do exist. Capital home equity continues to increase from its current all-time high. Additionally, the majority of homeowners have a fixed rate mortgage under 4%.
We expect these factors combined with continued low supply of homes in higher cost to move will provide tailwinds for continued R&R spending and our portfolio of industry-leading brands remains well positioned. Secular growth trends across both Water Innovations and Outdoors & Security propel our strong brands, which are further driven by our innovation engine. The value proposition that we deliver our consumers is backed by best-in-class innovation, quality standards and service levels, which provides our portfolio with added resiliency and is a significant differentiator versus private label alternatives, which do not deliver upon that same promise.
As we've seen during prior slowdowns, the strength of our total offering continues to attract consumers even in more difficult environments. This formula of strong brand, innovation, and service will be the firepower that accelerates performance and what will be the new Fortune Brands. And within Cabinets, we continue to gain share and improve margin by advancing our transformation through optimizing our product offering in a manner that appeals to customers and enables cost structure improvement. We believe that our ongoing operational efficiency improvements and increasingly flexible capacity will position us well in any market environment.
We are adjusting our full-year 2022 guidance to recognize the incremental expenses related to the separation. We're also scenario planning and taking actions where required to preserve and improve margins and generate cash now and into 2023. We're doing so in a thoughtful, measured way and remain committed to maintaining our long-term margin goals while still making important strategic investments to drive future growth.
In summary, our impressive quarterly results support what we expect to be a strong year for the company with above-market top line performance and margin accretion despite ongoing inflation, a less-than-perfect supply chain environment, and dedicated investments in critical Fortune Brands advantage capabilities.
We have successfully navigated challenging environments before including as recently as 2020 and 2018 and are well equipped to deliver sustainable growth for our shareholders by proactively managing through any slowdown, gaining share, and accelerating in areas of opportunity. We will do so while maintaining our commitment to being a leader in corporate responsibility and ESG as the products we make, improve the quality of life every day for millions of people and deliver on our purpose of fulfilling the dreams of home.
I would now like to turn the call over to Pat to go through our quarterly financial performance in greater detail. Pat? Thanks, Nick. As a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing segment performance. Additionally, all comparisons will be made against the same period last year. Unless otherwise noted. Let me start with our second quarter results and overall thoughts on the quarter. Sales were $2.1 billion, up 9% and consolidated operating income was $320 million, up 7% total company operating margin was 15.1%, and included year-over-year margin expansion across all thre segments. EPS were $1.67 for the quarter, up 7%. As Nick mentioned, the company produced a strong second quarter driven by our leading brands and dedicated teams, delivering high single-digit sales growth while comping unprecedented levels of government stimulus from a year ago is especially impressive labor and supply chain constraints eased during the quarter. Enabling our teams to service demand across the portfolio and work through order backlogs to realize incremental price. Operating margin in the quarter improved year-over-year in each segment and increased sequentially by 210 basis points. Price and cost actions more than offset inflation in each of our segments. Additionally, we continue to invest behind our key strategies including our digital transformation journey, which will drive future outperformance. Looking forward, we are committed to delivering a healthy and robust, long-term future for what will be too strong independent public companies. And are keenly aware of the impact, the rapid rise in interest rates will have on the consumer in the near term. While demand remains resilient across much of the portfolio today, we are acting ahead of a potential slowdown to maintain our margin progression and deliver strong cash flow. We have successfully navigated slowdowns before and have the experience to deliver results against any market backdrop. Now let me provide more color on our segment results, beginning with Water Innovations. Sales were $650 million, down $45 million or 6%. We're down 5% excluding the impact of foreign exchange the second quarter was impacted by localized Coronavirus-related shutdowns in China. Excluding China growth was up 4% driven by strong POS for both Moen Moen and the House of Rohl in the U.S. Operating income was $162 million down 4% or $7 million. Operating margin was 24.9%, the result of better price realization and proactive expense management. Looking forward, we expect Water Innovation's, third quarter sales growth to be down low to mid-single digits. Due to continued disruptions in China and comping a prior year channel inventory build associated with service level recovery. We expect Water Innovations margins remain strong. The Water Innovations portfolio remains as vibrant and resilient as ever, delivering high single-digit POS during the quarter. Consumers continue to gravitate to Moen as the leader in the future of water in the home and the House of Rohl continues to enjoy growth expansion as our collection of Artisan brands, the lights consumers. Turning to Outdoors & Security. Sales were $605 million, up $70 million or 13%. Therma-Tru sales were up strong double digits as improved labor availability and shipping efficiencies help drive performance. Single-family new construction completions continue to catch up to start and builders continue to view Therma-Tru as the composite material alternative toward an entry doors. LARSON sales were down low-single digits in the period driven by retail channel destocking and softening retail DIY activity. LARSON continues to work with Therma-Tru to promote a strong future together within our growing Doors franchise. Decking sales grew high single digits in the period. We continue to believe conversion from wood will drive long-term adoption of advanced composite materials in Decking as has been the case for our Therma-Tru business. Decking wholesale channel inventories remain robust and we will continue to monitor demand trends and adjust our capacity plans accordingly. Security sales were up mid-single digits in the quarter. Commercial sales now accounting for over a quarter of securities revenue grew over 20% in the period. Our momentum in connected and ESG products will benefit security in a significant way now and into the future. Outdoors & Security segment operating income was $93 million, up 19% or $15 million versus a year ago. Segment operating margin was 15.4%, up 70 basis points over 2021. Turning to Cabinets sales were $856 million, an increase of $150 million or 21%. Stock cabinets grew strong double digits and make to order Cabinets grew low teens as labor availability and supply chain improve throughout the quarter. While price primarily drove sales growth, volume growth was also positive in the quarter. Overall, backlogs remain elevated and demand remains resilient across most price points. As we prepare this business standalone as a public company, MasterBrand continues to execute at a high level and is on track to widen its lead at higher margins over time. It is an exciting time for this business with operations leadership and execution all heading in the right direction. Operating income in the second quarter was $99 million up 28% or $22 million. Operating margin was 11.5% for the quarter representing a 60 basis point improvement over last year. We expect to deliver further margin progression during the back half of the year as price and continuous improvement offset inflation at accretive margins to support our full year and long-term goals. Turning to the balance sheet. Our balance sheet remains strong. With cash of $361 million, net debt of $3 billion and net debt to EBITDA leverage at 2.3 times. We finished the quarter with $564 million of total liquidity on our revolver. We also purchased $125 million in stock during the quarter, which brings our total purchases through the first half of 2022 to $505 million. We remain committed to efficient and effective cash and balance sheet management. Our teams are already acting to manage our working capital and capital expenditures in light of the recent and expected future central bank action. Continued high inflation and the response from the Fed produce the expected outcome. A near-term slowing of consumer demand, including for home products. Well uncertainty exists. We are acting now to maintain our margin journey and deliver strong cash flow. Our teams have executed throughout challenging environments in the past and we'll do so again to deliver shareholder value. With that in mind. I'll now provide an update to our 2022 guidance. Our full-year 2022 global and U.S. market outlook remains unchanged. With first half U.S. R&R strength and new construction R&R backlogs offsetting challenges in China and slowing retail DIY. Our global market outlook remains at growth of 3% to 5% with the U.S. still expected to grow 4% to 6%. With more than half of the year behind us, we have tightened our full year net sales growth guidance to 6.5% to 7.7% to reflect strong year-to-date results and a continued dynamic market environment heading into the second half of the year including expected channel inventory reductions. We remain committed to achieving OI margin expansion this year and beyond for 2022, we continue to target approximately 70 basis points of OI margin expansion. We are updating our 2022 EPS guidance to $6.36 to $6.50 per share to account for incremental costs associated with the separation and updated full year interest expense tax rate and share count. On a segment-by-segment basis, we now expect for 2022 water innovations net sales growth of down 1% to up 1% with operating margins around 24%. Outdoors and Security net sales growth of 10% to 12% with segment operating margins of 15.2% to 15.7%. Cabinets net sales growth of 10% to 12% with operating margins of 11.5% to 12%. This updated EPS outlook for 2022 includes the following assumptions. Corporate expenses of about $138 million to $142 million including digital transformation investments of around $20 million and separation costs of up to $15 million. Interest expense of $120 million to $122 million. A tax rate around 25% and average fully diluted shares of approximately $131 million. Over the next few years, we will optimize SG&A in both New Fortune Brands and cabinets as we deploy Lean operating models in both companies to enable strategic investment for growth and continued margin expansion. We expect 2022 free cash flow of approximately $590 million, to $630 million and anticipate a cash conversion rate between 70% and 75%. Our free cash flow forecast includes capital expenditures of $300 million to $130 million as we adjust the rate of investment to reflect current market conditions while continuing to enable future growth. In summary, our strong quarterly results have contributed to a better than anticipated first half of the year and our full-year outlook remains intact. We remain focused on proactively managing the business through any market conditions while actively pursuing our margin objectives. Long-term housing fundamentals supported by demographics remain attractive and we are well positioned to capture value across our portfolio for all of our stakeholders for years to come. I will now pass the call back to Dave to conclude our prepared remarks and open the line for questions, Dave?
