Fortune Brands Home & Security Inc

LSE:0IRN

Earnings Call Transcript 2018-Q4

[Operator]

Good afternoon. My name is Kelly, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Fortune Brands Home & Security Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] Thank you.

I'd now like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin your conference call.

[Brian Lantz, executive]

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 2018 and provide our 2019 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 Investors section of our fbhs.com website.

I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and 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 Pat Hallinan, our Chief Financial Officer. Following our prepared remarks, we've allowed some time to address questions that you may have.

I'll now turn the call over to Chris.

[Christopher Klein, executive]

Thank you, Brian, and thanks to everyone for joining us today. In the fourth quarter our sales growth in the overall market slowed. Despite the market, we made clear progress in our Cabinets business and saw continued strong results in plumbing and doors.

In general, however, consumers and channel partners adopted a more cautious stance at year-end and did not order at a typical rate heading into the New Year. Concerns over trade wars, interest rates and the housing market itself had a clear impact on demand. While we did not factor in the magnitude of the second half housing market pause earlier in the year, we now understand the key drivers and expect it to pass through the system over the next 6 months and project a modest increase in second half growth. I'll have more to say on the market and our outlook in a moment.

In 2018, our teams executed at a high level during a volatile year. Sales grew 4% and our operating margin was 12.8%. While these results were below our initial expectations, we made significant strides across the company to address market and industry challenges and consciously increased our exposure to the more stable and predictable segments of our markets.

These actions reduced our fixed costs, significantly reduced our exposure to a potential 25% tariff and set us up for improved financial results and growth in 2019 and beyond. You'll hear more detail on these actions directly from the division presidents and our operations leader at our Investor event in Boston next Wednesday.

On top of the changes we made inside of our businesses, we also delivered incremental growth during the year as we spent $470 million on the Fiberon composite decking acquisition. We purchased $695 million of our shares, and again, increased our quarterly dividend by 10%.

All in all, our teams have continued to execute well against our strategy. We remain confident in our ability to outperform in a market that continues to show signs of strong underlying long-term demand based on the number of newly forming households, aging housing stock and underlying consumer confidence. Importantly, our product and brand positions remain strong and the changes we have made and the businesses we have acquired, set us up well for continued growth in 2019 and beyond.

Let me first take you through our fourth quarter results and my thoughts on our full year performance in more detail. Then, I'll discuss our view of the U.S. home products market, our 2019 outlook for sales and EPS growth and our thoughts on capital allocation.

Beginning with the quarter. Overall, sales increased 3%, with continued strength in plumbing and door products, partially offset by general market softness across categories. Importantly, our Cabinets business saw stability in sales with priority segments performing well as the significant changes we are making in that business began to show tangible results.

Total company operating margin performance was 12.7%, led by a strong result in plumbing where margins increased 150 basis points. Our 2 other businesses were more impacted by the flow-through of lower volume and higher commodity and labor costs. Additionally, Doors & Security had a few non-repeating items in security as we repositioned parts of that business, which Pat will cover later.

Turning first to the Plumbing segment. Plumbing sales were up 4% in the quarter. This was solid performance against 2 years of very strong fourth quarter comps and a softer market this year. The growth was driven by high single-digit growth in our core U.S. wholesale business driven by solid POS and some shipment timing favorability from Hurricane Florence in the third quarter, broad-based strength internationally in Latin America and China with sales rising double digits in each region, and the successful integration of our latest plumbing acquisition, the premium free-standing tubs we sell under the Victoria + Albert. As we've seen in China, we view continued category expansion and selling of a room as a path to continued market outperformance in our Global Plumbing Group.

In 2018, the GPG performed exceptionally well in a tough environment and has delivered on our high expectations through its first 2.5 years. The 22.3% operating margin we delivered in the fourth quarter is a signal that we can maintain our roughly 21% target operating margin and deliver above-market growth even in a slower market with significant input cost pressure.

As we look into 2019, the GPG is bringing a lot of innovation into the market. Some of this are normal cadence of style and finish refreshment. In addition, we have a wave of adjacent category products coming through supported by a number of strategic partnerships that we have entered into in the second half of 2018. You'll hear more about these partnerships next week. I look forward to introducing you to Nick Fink in Boston. He will provide greater detail on how this team has delivered the exceptional results they have posted thus far, and his team's plans for the future.

Turning next to the recently formed Doors & Security segment. Sales were up 7% for the quarter. Sales of door products grew double digits again as the Therma-Tru team continues to innovate and drive growth even during the time of lower housing starts in the back half of the year. The combination of wholesale growth through innovation and share gains plus the continued success and expansion of outdoors and the R&R program at retail, which has meaningfully increased our R&R mix within door products, offset the market-related headwinds. We expect this trend to continue in 2019 as the Therma-Tru team maintains its industry-leading ability to manage input costs and realize price.

Sales of Security products were down double digits in the quarter, driven by decline in international sales due to softness with key European retailers and several nonrepeating prior year fourth quarter promotions in our U.S. Retail business. Our nonrepeating items caused sales and margins to slip in the quarter. The good news is that we have completed the product upgrade to the more secure ball bearing locking technology for our core padlock lines and the operational and manufacturing challenges of the summer are now behind us.

Prices addressing material inflation and tariffs as we enter 2019 and under the new leadership of Brett Finley, we're implementing some of the same success drivers in Master Lock that have significantly accelerated Therma-Tru results over the past 3 years. You'll hear more about these initiatives to simplify, focus and grow the business directly from Brett on Wednesday during our Investor event.

In composite decking, our Fiberon unit added about a 1 point of growth in the quarter with Q4 being the seasonally slowest period for deck sales. Fiberon was slightly dilutive to EPS given deal costs, some incremental investments and lack of seasonal leverage during the short time have owned it. Integration is progressing rapidly and smoothly. As we get deeper into the category and its potential overlap with our existing portfolio in distribution, we remain excited about the opportunity to grow in the outdoor living segment of the market.

In our Cabinet segment, sales were flat in the quarter and up 2%, excluding strategic business exits. Similar to recent quarters, sales of value products were stronger than the overall market, as home center in-stock cabinets and vanities and builder direct businesses were both up high single digits in the quarter. Sales in our largest channel, dealer, grew low single digits led by the value product lines. Sales were lower in home center special order and in Canada, when the market continues to trend softer than what we see in the U.S. Our cabinet business is reversing the negative sales trends we saw earlier in the year even after including the headwinds from the exited business. Although the middle of the market remains somewhat sluggish, our margin associated with these products is trending positively, as we have successfully increased price, reduced our levels of promotion, move forward with 2 fewer plants and continue to aggressively migrate our supply chain.

As direct results of the aggressive actions are margin reflected some improvements, a tangible sign that we continue to be on the right track in pivoting the business. Regarding our cabinets pivot, it's clearly we have parts of the business that are performing very well, particularly value products where we have over $1 billion in sales annually. The margin associated with these products continues to be very attractive despite the low price points since we have access to a large low-cost production platform specifically designed for these products, that doesn't come with the cost or complexity associated with more custom made-to-order products. Our unique capabilities in Mexico facilitate this business. As we continue to execute on our pivot actions, we are reopening the path to margin expansion beginning in 2019, even as the share of value products grows within our overall cabinet mix.

For middle of the market semi-custom cabinets, we continue to undergo a complete transformation that began in the second half of 2017 and will continue into this year. In 2018, we closed 2 facilities, invested in capacity for lower-priced products, migrated our supply base and footprint and took headcount and spending reductions across the board.

In 2019, we'll take even more actions to balance the cost structure, and at the same time launch a broader range of value semi-custom products.

So to sum up cabinets. Sales growth in the quarter improved and had good margins despite the inflation and continued tariffs on plywood. As we look forward, we see growth in 2019 for our Cabinets business in the mid-single digits, inclusive of the market dynamics we see and repositioning actions associated with our pivot. In addition to improving our financial results, our actions have increased our exposure to areas of more stable and predictable growth within the cabinet industry.

Lastly, as we enter 2019, we're covering inflation with price and supply chain initiatives. Next we will hear from our Cabinet leader, Dave Randich, who will go into greater detail on the industry, the progress on our pivot plan and our 2019 and longer-term outlook for this business.

Turning to our total company performance for the full year. In 2018, we executed well against our strategies in a volatile uncertain year. We grew our sales and earnings despite a softer market. We also deployed a significant amount of capital in an opportunistic way and added exposure to the outdoor living market in a way that we believe will create significant value for shareholders moving forward. This outperformance in the face of much a softer second half housing market, a spike in inflation, tariffs and interest rates, a severe hurricane that shuttered our U.S. plumbing operation and some cabinets plants for several weeks and persistent uncertainty on trade policy.

In the full year 2018, we grew sales by 4%, earnings by 8% and delivered total company operating margin of 12.8%. Importantly inside each business we made significant progress in our strategies to enhance our sustainable competitive advantages and achieve profitable growth.

In Plumbing, we proved our GPG strategy can perform through a volatile and softer demand environment, while maintaining a strong operating margins for this segment. In Doors & Security, our continued share gains with doors gave us a broader platform to build upon. And our 2019 plan now includes investments to accelerate even more growth with the acquisition of Fiberon.

We expect solid margin improvement in 2019 as our leadership and new focus in security takes hold and we introduce new electronic products, particularly in the commercial channel.

And in Cabinets, we stayed disciplined and focused on profitable growth, while navigating the promotional environment, continued trade labor constraints, positive tariffs and elevated demand for low price points and simpler projects. With our disciplined, strategic approach, we are committed to accelerating sales and profit despite the challenging market backdrop and some changes in mix. And we are focused on leveraging our industry leadership, supply chain and scale.

Now let me turn to our full year outlook for 2019 starting with our view of the U.S. home products market. Our outlook for 2019 is for modest U.S. home products market growth of 2% to 4% with a slower start to the first half. This industry growth rate is slower than we were predicting last year and incorporates the consumer reaction to the interest rate environment, which is stabilizing, the home price inflation, which is moderating at higher levels, and more modest economic growth in the U.S. economy. We're balancing these forces as constraints to underlying fundamental demand, which would otherwise support higher growth rates for housing and home products.

Within that overall assumption, we anticipate the pace of repair and remodel will be more resilient, but will slow somewhat as well to roughly 4% versus 5% in prior years.

New home construction is assumed to grow at 2% to 3% in 2019. Single-family is expected to continue to grow a bit faster than multifamily. And single-family entry-level activity is expected to remain stronger. Our total global market, which include assumptions for the U.S. market as well as our other international and security markets is expected to grow at a combined 2% to 4% rate for 2019. Based on that total global market assumption, continued internal improvements and the recent Fiberon acquisition, we expect solid top line growth for 2019, with our full year sales increasing 6% to 7.5% over 2018 or approximately 3% to 5% on an organic basis.

With this market in sales growth, our teams are focused on delivering full year EPS before charges and gains in the range of $3.53 to $3.77. This is an outlook we have linked tightly to the softer market we saw in the second half of 2018. We're also assuming we will address tariffs and continued inflation with expense control, supply chain actions and pricing in order to deliver on our plan.

So in summary, our 2019 outlook is based on more moderate market growth assumptions. We'll continue to execute on our growth strategy and I feel good about the momentum that our teams are carrying into the year.

On top of the improvements we made to our core portfolio, 2018 was a solid year for capital deployment. We acquired Fiberon, repurchased $695 million of our shares, and again, increased our quarterly dividend.

Additionally, I'm very pleased with the timing of our $600 million investment grade bond deal and the rate that we were able to secure on the financing. We'll continue to focus on creating meaningful incremental shareholder value by using our strong free cash flow and balance sheet to make strategic acquisitions and return capital to shareholders.

In 2019, however, we anticipate the overall pace of M&A activity to be quieter in the first half. And for the year, you will likely see us balance continued share buyback, modest M&A and some natural deleveraging given our planned EBITDA and cash flow growth. We currently have $414 million remaining on our existing authorization for share repurchases. Regarding acquisitions, we continue to look for long-term opportunities that makes sense strategically, with a focus on plumbing and outdoor living. We have a strong pipeline of opportunities, but sellers may be apprehensive in the current environment, especially in the first half of the year. If market growth improves throughout the year and there is more clarity on trade, M&A activity could pick up.

With that, I will now turn the call over to Pat, who will review our financial performance and provide more details on our guidance.

[Patrick Hallinan, executive]

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 operation.

Let me start with our fourth quarter results. Sales were $1.4 billion, up 3% from a year ago, despite a softer second half market, which impacted all of our businesses.

Consolidated operating income for the quarter was $181 million, down $5 million or 3% compared to the same quarter last year.

Consolidated operating margin declined 70 basis points to 12.7%, as lower volumes, inflation and onetime items in security impacted margins. EPS were $0.86 for the quarter and grew 8% versus $0.80 the same quarter last year.

For the full year, EPS were $3.34 versus $3.08 last year increasing $0.26 or 8%. These results were below our plan and expectations and reflect a market that was significantly softer in the second half of the year than we anticipated even 90 days ago. As we enter 2019, all of our businesses are prepared to manage expenses and capital tightly during what we expect to be a soft first half. Further, we are focused on growing in the most promising portions of the respective markets. Our 2019 expectation is to grow above market and drive margin improvement, and we are well-positioned to do so.

Now let me provide more color on segment results. Our Plumbing sales for the fourth quarter were $488 million, up $19 million or 4%, driven by strength in U.S. wholesale and China. Acquisitions and FX roughly offset each other, with each having roughly a 1-point impact on sales.

Operating income increased $11 million to $109 million, up 12%. Operating margin for the segment was 22.3%, an extraordinary result driven by excellent management of inflation and expense as the market softened throughout the second half of the year.

For the full year, Plumbing sales of nearly $1.9 billion increased $163 million or 9%. Operating income of $396 million was up $30 million or 8% versus the prior year. Operating margin was 21%, again, a great result given the extreme inflationary pressure throughout the year. The Global Plumbing Group is continuing to deliver on our strategy of growing sales of our market, while maintaining an operating margin around 21%. In 2019, we expect Plumbing sales to grow mid- to high single digits. The Plumbing Group continues to target operating margin of around 21%.

Turning to Doors & Security. Sales were $307 million, up $20 million or 7% for the prior year quarter. Sales growth was led by another double-digit increase in doors and the Fiberon acquisition, partially offset by a double-digit decline in security. Throughout the second half of the year, we moved decisively and aggressively to reposition the security business around its best growth opportunities and setup margin expansion. These actions have included upgrading the leadership team, improving manufacturing and service levels, discontinuing some noncore business and low-margin promotional events and recognizing onetime charges as we reset the business and position it for a strong 2019. Excluding the nonrepeating items and seasonally-low Fiberon's stub period, operating margin was 13.3%. For the full year, Doors & Security sales increased 8% to $1.2 billion, operating income was down 5% to $155 million and operating margin came in at 13.1%.

The security product upgrade we made during 2018 presented greater operational challenges than anticipated. Extreme inflation exacerbated the situation. New leadership has improved operational performance and service levels and is addressing price commodity more effectively. We expect the security business to return to growth and margin expansion in 2019. As Chris mentioned, the president of this group, Brett Finley, will address these efforts next week in Boston.

In 2019, we expect total Doors & Security sales growth in the high-teens, inclusive of the Fiberon acquisition. We expect mid- to high single-digit organic growth as doors completes its retail rollout and security reignites growth. Operating margin next year is expected to improve by 100 basis points, reflecting the operational and commercial improvements in security and a full year of production from, and lapping of the acquisition costs associated with, Fiberon.

In Cabinets, sales for the fourth quarter were $625 million or flat versus the prior year quarter. Excluding business exits, Cabinet sales were up 2%. Sales of in-stock cabinets and vanities grew high single digits on continued solid demand for these products, excluding the exit of U.S. home center business. Dealer sales increased 1% and saw high single-digit sales growth in stock products, primarily sold into new construction as we took share with builders in certain parts of the country. Further, direct sales were also up high single digits. Home center special order sales were down in the quarter, but less so than in earlier in the year as we applied targeted promotions of a higher price base.

Cabinet operating income in the quarter was $62 million, down 7% and operating margin was 10%. Operating margin was 11.3% adjusting for an additional week this year. Our operating margin continued to demonstrate sequential improvement. And in the fourth quarter, our operating margin exceeded the prior year on an apples-to-apples basis.

In Cabinets, the Europe transition was expected, but the market was weaker than anticipated in the second half. However, our in-stock and stock product lines continue to pose solid high single and mid-single digit growth, respectively, even in a softer market. We continue to make progress in expanding the share of these product line. For the balance of our cabinet portfolio, we continue to improve the cost structure to enable margin expansion in 2019 and beyond. In 2019, we expect Cabinet sales to grow approximately 3% to 4% and margins to improve by approximately 70 basis points.

To sum up consolidated fourth quarter performance, sales increased 3% and EPS were $0.86. The results were below our plan and expectations. However, we are well positioned to deliver a solid 2019 in what is expected to be a softer market. Our Plumbing & Doors teams continue to outperform the industry and our Cabinets pivot has us starting 2019 with an improved cost structure. Importantly, we have taken the price and strategic steps necessary to deliver improvement in 2019. For the full year, sales increased 4% and EPS grew 8% to $3.34. Total company operating margin was 12.8% or 80 basis points lower than the prior year.

Now turning to capital deployment. During 2018, we repurchased $695 million in shares. We spent approximately $470 million on the Fiberon acquisition and approximately $115 million on dividends, and increased the 2019 dividend rate by 10%. 2018 free cash flow was $465 million, reflecting a conversion rate of 95%. Even after a meaningful capital deployment in 2018, our December 31 balance sheet remains solid. Cash was $263 million, debt was $2.3 billion and our net debt-to-EBITDA leverage was 2.4x. Additionally, we have significant flexibility to finance investments and deploy capital to drive incremental value. Our proven ability to generate solid free cash flow allows us the flexibility to continue to deploy capital to create shareholder value or to de-lever naturally over time.

Turning last to the details of our outlook for 2019. Based on our assumption of the U.S. housing and global market growth, both in the range of 2% to 4% and continued solid performance by our Plumbing & Doors teams that continue to outperform the market, we expect full year 2019 sales to increase 6% to 7.5%, inclusive of the Fiberon acquisition. Excluding Fiberon, we expect 2019 organic sales growth between 3% and 5%.

Our resulting outlook for 2019 EPS are in the range of $3.53 to $3.77. The midpoint of our EPS outlook reflects an increase of over 9%. This 2019 EPS outlook excludes any incremental capital deployment and includes the following assumptions. Interest expense of around $94 million, a tax rate between 25% and 26% and average fully diluted shares of approximately 142.5 million.

For 2019, we expect the first half to present a soft start to the year. We expect first half market growth of 2% to 3%. For the first half, we expect EPS growth of roughly 6% to 7% on sales that are roughly 5% to 6% reported and 3% to 4% organic.

To sum up, fourth quarter and full year EPS were below our expectations, but our overall business model was more flexible and resilient as a result of the changes we have made in response to a softer market and inflation.

Accordingly, our 2019 growth projections are based on modest market assumptions. The momentum we have created with the Global Plumbing Group and the new growth avenues we have opened in outdoor living with the Fiberon acquisition give us confidence in continued solid growth and margin expansion in the coming years. Accordingly, we are targeting a 50 basis points consolidated operating margin increase in 2019. You will hear more about our long-term operating margin target for each business next week.

I will now pass the call back to Brian.

[Brian Lantz, executive]

Thanks, Pat. That concludes our prepared remarks on the fourth quarter of 2018 and our full year 2019 outlook. We will now begin taking a limited number of questions. [Operator Instructions]

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

[Operator]

[Operator Instructions] Your first question comes from the line of Susan Maklari from Crédit Suisse.

[Susan Maklari, analyst]

I guess, to start out with, given all the sort of perspective that you have, can you just talk to what you guys are seeing in the market? We've obviously heard a lot of cross currents as it relates to the new home side of the market, the consumers. So I think, maybe your perspective in terms of what you've been seeing could be really helpful?

[Christopher Klein, executive]

Sure. On the new construction side, I'd say, we saw some softening in the third quarter and when we last talked with you 90 days ago, we, obviously, revised down the outlook. It fell off more significantly in November, December, which I think is, pretty widely understood now. And I think we just saw consumer pullback out of the market, both on the new construction side and on the existing housing stock turnover side of the market. And if you look back and if you look at where interest rates were coming into September from that point up through middle of November, they moved up in the incremental 50 basis points. You saw a cumulative impact of a lot of housing inflation, really hit kind of tipping point into October-November. And so as you saw the consumer pulling back, equity markets pulling back, it hit that side of the marketplace. R&R remains somewhat resilient, although it came off as well. So I'd say we R&R weaken in the quarter as well. So we took all of that and as we were building our plans for '19 given that we lagged especially on new construction side, we approached the marketplace for '19, I'd say, in a -- I don't know if I want to say sober or conservative way. I'll choose sober. So I think, we kind of came end of the year and assumed that some of the carryover effect of the new construction side will carry over into the first half or especially the first kind of 3, 4 months of '19. So clearly kind of a flat, very modest growth on the construction side. R&R probably continues to be resilient, but at a little softer pace 3% to 4% for the first half. And then, we think the market will pick back and get its kind of sea legs underneath it and move back through in '19. So that's we build our plans. We were tight on costs. We've got a lot of growth coming through. But we just said, we're going to be looking at a sober start to the year and then roll it through. And I would say, okay, we are sitting at the end and of January, which is about as soft as it gets in terms of December and January are the quietest periods in the construction market. But market is about as we thought. And so I would say you look the landscape and there certainly is activity that's starting up again. But it's kind of still early in the year. So our outlook as we kind of projected out for the year, looks pretty good as we sit here at the end of January. So I think to summarize it, surprised that it got quite a bit softer in the fourth quarter. The underlying fundamentals of the market we're still comfortable with in terms of the drivers of housing activity, household formations, the age of the housing stock, disposable income, even consumer confidence. Although the overall consumer confidence Index ticked down, the housing-related portion of that was positive. So I'd say, we're optimistic long-term, and we're optimistic second half, but I'd say we kind of want to come into the year and just be realistic about how things start out. So I hope I answered what you were looking in there?

[Susan Maklari, analyst]

No, that's very helpful. And I guess just as a follow-up there, you made a lot of progress in 2018 in terms of the pricing really kind of across all segments of the business. As we think about this lower growth environment, how -- or what do you think your ability is to kind of retain and hold onto a lot of the progress that you made last year? And then, I guess, within that, too, can you talk to some of the benefits that maybe you can see as we move through '19, as it relates to some of the commodities coming off and could that possibly be somewhat off an offset?

[Christopher Klein, executive]

Yes, I'll take the first part, and then I'll let Pat give you a little more detail. I think we talked about pricing last year as, I guess, taking a lot of small bites at the apple. And so that served us well as it we brought it through. And I'd say, it was pretty sticky what we've taken on both in terms of pricing and reduced promotional levels. And so I'm not concerned. Pat will give you a little more detail on our outlook on commodities. I think we're in a very good spot relative to the pricing we took to cover off on the commodities we saw. On tariffs, we've planned for and are absorbing the 10% level, and we're planning on having to address the 25% level. Obviously, it's been suspended for now, but again, back to our real sober look at the marketplace we are anticipating if it's going to hit us on March 1, that we'll take actions to offset that even in the slower-growth environment. So Pat, maybe you want to give a little more detail on just commodities in general.

[Patrick Hallinan, executive]

Yes, one pricing, then I'll go to commodities. I would say as we addressed the inflation of 2018, we did it with supply chain and price and the pricing most of it was not per se tied to a tariff scenario, so we don't expect pricing to erode as we head in '19 in any way, shape or form. As I reflect on '18, we had roughly $90 million of inflation hit our P&L in '19. About $70 million of that was material inflation, inclusive of tariff pressures and not just the 10% 301 tariffs but plywood tariffs and steel and aluminum tariffs earlier in the year and that the balance of that about $20 million was freight and logistics. And we covered it with supply chain actions and with price. And supply chain actions actually offset a considerable part before it ever hit our P&L. Like, just for example, a 10% tariff has roughly, on an annualized basis, a $50 million impact to our P&L, but we offset 3/5 of that with supply chain actions before it ever came at us. As we look into 2019, you have a wide range of potential inflation scenarios depending on what happens with any additional tariffs. I would say without a 25% tariff, we're looking at $55 million to $60 million of inflation or call it, roughly $0.30 of EPS, with $20 million to $25 million of that be in freight and logistics and probably $10-plus million being just continued adjustment to the realities of the new plywood market as we shifted materials and supply base. And then the balance being all other inflation. So the all other bucket relatively modest inflation without other tariffs. If there were 25% tariffs, the estimate is still consistent with where we were in the third quarter. We would say the net hit to us on an annualized basis of 25% tariffs is around $45 million. Of course, we don't expect a full year of that, but all of our teams are prepared to address if it materializes, and they will address it with a combination of supply chain and pricing. And all of our teams have scenarios prepared for that to happen. And of course, as the first half of the year unfolds, we can update you on how that plays out.

[Operator]

Your next question comes from the line of Phil Ng from Jefferies.

[Philip Ng, analyst]

Appreciate seasonally slow to start the year, but after a soft patch, you saw in the second half, have you seen any sign there was any pickup, having customers come back and restock any inventory? I know you're expecting things to reaccelerate a bit in the second half. Is it easier comps or are they any initiatives you have in place that kind of gives you the confidence things will pick up?

[Christopher Klein, executive]

So thanks for highlighting. The inventory issue kind of hit us in parallel with the softer market. So as the fourth quarter softened, our channel partners pulled back on inventory as well. So the ordering rate was below POS throughout fourth quarter. So it was kind of a multiple effect on sales overall. That likely won't persist as the market resumes some growth, you'll see inventories matching, at a minimum POS, and if there is an acceleration they typically will buy in a little bit more to cover what they anticipate as they grow. So the first half, second half, it really it comes down to carryover effect from the way we exited last year. We -- our categories lag the overall construction cycle and R&R doesn't really start to pick up until March. So we just, I'd say, brought forward what we saw as we exited the year in the first part of this year. And that accounted for a slower start. And I think, the back half of the year, it is more about performing against the market. We've got a lot of initiatives irrespective of market. But we're assuming that there is some modest level of growth that resumes in the second half of the year. So -- and we're not looking for a huge spike, we're actually looking more like 4% to 5% growth in the second half, if the first half is 2% to 3% growth. So kind of that's the range we are operating in. Reasonably, consistent R&R, but the big swinger is softer new construction in the first half, which then picks up. And yes, obviously, there's going to be a bit of a softer comp in the second half too. So I think, it ties out. In general, we're not making any big leaps of faith here, we're looking at the market in a very conservative way and saying, okay, we'll run our business against that, and we're going to grow EPS at midpoint, 9%, and we've built our plans, cost structures and CapEx and otherwise that can deliver on that. So that's a little bit of the logic that flow through all that.

[Philip Ng, analyst]

Okay. That's really helpful. And was the investments you made in Cabinets, can you give us a sense how you're thinking about growth and just incremental margins into that business? And have you seen any new wins on the value side offering that you have out there? And should we think of any overhang on the margin front because it sounds like you still had some initiatives you're trying to work through in 2019?

[Christopher Klein, executive]

I'll take on the market side. We continue to perform really well in the in-stock cabinet and vanity side of the market as well as the soft part of the business that goes into builder and simpler R&R through dealer. So that part of market we are picking up share and we expect we will continue to pick up share. If I look at the overall pivot plan in cabinets, a lot of it is we're just going to emphasize the places we've had success and are continuing to have success. So we expect that will continue and continue to bring new products to that part of the market. Pat can tie off of second part of that question.

[Patrick Hallinan, executive]

Yes. To add onto the sales and the growth perspective of it, the part of the value segment of the market that you're referring to where we've traditionally been very strong in home centers and in-stock cabinets and vanities. We're taking that supply chain and bringing it to a broader set of the market and as we'll talk about next week, or Dave will, from our cabinets group, deploying that cost structure and capability into a product launch that takes place in April. So we plan to leverage the capability we have to grow that business. Now we do expect the cabinet industry to grow a bit slower than the rest of the overall building products industry just as consumers trade to a different price point of cabinets and you are -- use fewer boxes in their designs. So that's why we're targeting cabinets growth of roughly 3% to 4%, and we think that's roughly going to be the dollar growth of the U.S. market over the near- to medium-term. In terms of margin percentage, we felt like we did all of the cost structure things this year we wanted to do. Volume was a little bit softer in the back half. We didn't see it as much. That's why we talked about it on an adjusted basis. And we feel like we left the year with a nice cost structure. We do expect next year -- to finish next year with a 70-plus basis point increase would get us into that 10.3% range for the year. And we expect to start seeing that right out of the gate in the first quarter, not a 10% in the first quarter because first quarter is seasonably low. But obviously, a big improvement off of a very soft 2018 start to the year. And then as Chris mentioned, and you referred to, we do have more change coming, but we're going to pace that change thoughtfully. We know investors want to see us drive both sales growth and margin improvement in that business. And so we are going to be pushing to do that consistently each of the next 3 years, while also absorbing some of that change and not letting the change swamp out the growth. So you should expect us to grow that business in the low- to mid-single digits and to drive 70-plus basis points of margin improvement across each of the next 3 years.

[Operator]

Your next question comes from the line of Justin Speer from Zelman & Associates.

[Justin Speer, analyst]

Just a point of clarification on the tariffs within your guidance. Are you embedding a 25% or a 10% tariff in your kind of segment margin assumption?

[Christopher Klein, executive]

We're embedding expected increase to 25% in March. So we're assuming that, that's going to happen and that we have to recover that both through the supply chain actions and pricing actions. Supply chain actions are, frankly, well underway and we're underway to address the 10%, and so that's just full on and it's going to recover that portion of it, which is substantial. And then the pricing piece of it will take effect when we know for certain when that's going to kick in. So there's a little bit of the lag, but it's covered off and anticipated in our guidance. So our guidance just to be clear, assumes 10% tariff through March 1 and then pick up to 25% March 1 and for the balance of the year.

[Justin Speer, analyst]

So if we end up being at a 10%, let's say, the thing's extended and it's a 10% and then potentially if there's resolution, does that change the calculus in terms of your margin assumptions for the balance of '19?

[Christopher Klein, executive]

Yes, back half, I mean, because the recovery actions on pricing are back half weighted, it changes some back half math. So it'll be interesting to see how it transpires. Does the 10% go away? I mean, we're not assuming that would necessarily happen either and resolution could be that there is some tariff remaining. I think the market is still waiting for the tariffs to fall off steel and aluminum coming out of Canada. But those are still ticking up there. So I guess, we just are reacting to the stuff that's going on and I'd say are being very clear eyed, and our plans are constructed for '19 that way.

[Justin Speer, analyst]

One follow-up in Plum -- I'm sorry, in plumbing...

[Christopher Klein, executive]

Go ahead, Justin.

[Justin Speer, analyst]

In Plumbing, is there any risk of mix now in the business? And if so, what's the margin risk from that potential dynamic? Is that in your calculus at all?

[Christopher Klein, executive]

Yes. Within Plumbing, it's interesting because the market has been reasonably stable for us. I think for us, it's a mix between wholesale and retail. And so our strength, frankly, over the last 18 months, has been stronger on the wholesale side. And that is not just new construction dependent, that's just stronger performance on that side of the marketplace. So that tends to be a richer mix. Within new construction, consumers still trade up off of what the base package has been even going through the second half of the year. So the mix is -- I'd say, the one piece of the market has been weaker is the very high end luxury part of that market is a little softer. But that's a small part of the overall. So I would say we are not making any heroic improvement in mix. I think we're just being realistic by segment of what we see coming out.

[Operator]

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

[Stephen Kim, analyst]

Just another point of clarification here. I think you talked about on the margin side in a couple of your segments. In Doors & Security, you talked about the Fiberon stub impact and the nonrecurring cost being in total 460 bps, I think, to your margin. What was the -- just the Fiberon stub portion? And then in your Cabinets business, I think, you talked about the 130 basis point impact from the 53rd week. I was wondering, if you could just elaborate a little bit more what that was? And why did that just hit the Cabinets and not the other segments?

[Patrick Hallinan, executive]

Well, we have 53rd weeks of -- I'll take Cabinets first Stephen, we have 53rd weeks in most of our businesses because most of our businesses with the exception of doors are on 13-week quarterly calendars underneath our corporate umbrella, which is on a fiscal month-end calendar. But we have to keep all of the businesses inside of a fiscal close week of one another. And so we have to take a 53rd week every once in a while. In Cabinets, it's particularly onerous because you have a fixed cost structure where you're paying out those fixed costs for that week, but you’re shipping almost nothing because it's a holiday week. So specifically in Cabinets, it was around $15.5 million of sales in the week that was incremental because of the extra week, but it was actually about a $6.6 million hit to profitability. So that's what's going on there. All of our businesses take them and we try not to talk about them. In particular, with cabinets, the reason we want to call it out here is we wanted to give people a viewpoint of how the business is really exiting the year on a run rate performance given all the cost take out it did during the year. In the case of Fiberon, Fiberon was about 100 basis points of that adjustment that you referred to. It was in the quarter about, I want to say, $29-ish million in sales and maybe an unfavorable $2 million in profit based on some of the cost associated with the acquisition like inventory step-up amortization, and so forth. We expect that business to be accretive to next year.

[Stephen Kim, analyst]

Got it. That's very helpful. And then, I guess, my second question relates to sort of the outlook for this year. I think you painted it out pretty well. I think you've been very clear. You think the first half of the year is going to be a little slower, the back half, your anticipating a sort of a normalization. You're being conservative in incorporating the tariff assumption in there as well. I guess I was just wanting to clarify a little bit, are you -- is it also your view that 1Q is going to be -- within that softer first half, that the 1Q will be particularly softer and then maybe 2Q would be ameliorating a bit? And then also if -- I was wondering if you could lay out what if anything you have seen or incorporating in our outlook for the government shutdown, maybe on back pay for furloughed workers coming through, along with tax refunds in the near future. Anything related to the shutdown or tax refunds in your outlook?

[Patrick Hallinan, executive]

I would say, the second of that two-piece question, we don't have any specific assumption in our plan for the government shutdown or for a tax reform as it affects consumers. I would...

[Christopher Klein, executive]

The one thing that was beneficial was throughout they said that tax refunds wouldn't be impacted, and you track this data as well as we do. Tax refunds turn out to be a source of R&R funding. So that was good news. And so that could have impacted us, hopefully, it did not. But Pat, you can take the second part of the question.

[Patrick Hallinan, executive]

And then, yes, we do expect the first quarter to be -- at least from a U.S. and Canadian new construction, we expect the first quarter to quite possibly be negative because of just the starts momentum and that was playing out through the back half of 2018, in particular, the starts momentum that all of us saw in October, November. None of us have yet seen December, but if December is anything like October, November, it kind of drives through a negative new construction scenario for Q1 in both the U.S. and Canada, modestly so because we would kind of take a combination of starts and completions across that horizon. And then we think, the second quarter should get us back to flat to slightly below flat for the whole first half on the new construction front. And we would expect R&R to be reasonably resilient kind of 4% bouncing plus or minus 50 basis points throughout the year. So R&R id kind of the linchpin kind of prevents the whole thing from going negative in the first half.

[Operator]

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

[Timothy Wojs, analyst]

Maybe just going back to cabinets and the margins, I think that the midpoint of the growth and margins gets you to maybe a 30% incremental. You took out some fixed costs in the year in '18. How much of the profit improvement next year is really that kind of cycling through a lot of that fixed cost versus what might be volume related? Just trying to see how much visibility you have for the cross lines in cabinets this year?

[Patrick Hallinan, executive]

Yes, I'd say, it's half the benefit of fixed cost roll forward and then half the fact that -- while we covered off in cabinets -- actually cabinets is a division where they covered more than their total inflation during 2018, much of that happened in the back half of the year because they were hit very severely in the front half of the year with plywood tariffs. Initially hardwood plywood and then soft plywood was added to that. And so they're going to be about half price commodity, about half fixed cost as they manage through all the supply chain changes related to plywood. But that business is feeling good. And you're close, I want to say the incremental leverage maybe more like 28-ish percent, 29-ish percent, but you're in the ballpark there.

[Timothy Wojs, analyst]

Okay. I rounded up. Okay. And then that's good. And then, on Plumbing just on the inventory reduction, was that in wholesale and retail or was it one of the 2 channels? And do you expect that to happen again in the first quarter? I just want to be cognizant that the comp in the first quarter in plumbing is kind of particularly tough?

[Christopher Klein, executive]

We saw it across channels. There was probably a little bit more retail than in wholesale, but it was across channels and it kind of unfolded throughout kind of November, December. It was a two-for. As the market was -- demand was coming off they were ordering even at a weaker rate than that. I think it had a stable rate right now. There is a point where weeks of inventory falls below even with stocks-outs and other situation that isn't good for either of us. So some expect -- it doesn't mean that it couldn't be a little bit better, I would expect there'd be a significant move off, I think you're going to run at about POS.

[Patrick Hallinan, executive]

And POS was about 6-ish percent in U.S. performing.

[Christopher Klein, executive]

Yes.

[Operator]

And that concludes our conference for today. Thank you for joining.