Beam Therapeutics Inc.
Q2 2009 Earnings Call Transcript

Published: 24 Jul 2009

[Operator:]

At this time I would like to welcome everyone to the Fortune Brands second quarter earnings conference call. (Operator Instructions) A replay of the audio portion of this call will be available two hours after this call has ended. The replay number is 1-800-642-1687.

[Bruce Carbonari:]

Welcome to our discussion of Fortune Brands second quarter 2009 Results. Please note that our presentation includes forward-looking statements. These are subject to risks and uncertainties including those listed in the cautionary language at the end of our news release. Our actual results could differ materially from those targeted. Also, this presentation includes certain non-GAAP measures that are reconciled to the most closely comparable GAAP measures in our news release or on our Web site in the supplemental information link in the Web cast page. In the second quarter Fortune Brands continued to effectively navigate the challenges of the global recession and severe U.S. housing downturn. At a time when consumers are being very cautious, we are pleased that each of our businesses performed in line with our expectations for the quarter and that each is delivering industry-leading operating margins. While we continue to aggressively manage costs we are maintaining an appropriate level of strategic investment, which is paying off in innovative new products that are helping us succeed in the marketplace. We are also confident that our supply chain and balance sheet initiatives position us well to emerge from the downturn an even stronger company. Our spirits business benefited in the quarter from our breadth across categories and price points, higher pricing, and the return to volume growth for Jim Beam ready-to-drink products in Australia. Results in spirits also reflected the success of new products such as Red Stag by Jim Beam and Sauza Margarita-in-a-Box, as well as management and timing of brand expense. As anticipated, our home products business returned to profitability in the second quarter and sales declined at a more moderate pace as compared to the seasonally smaller first quarter. Despite lower year-over-year results, our home products business benefited from its dramatically lower cost structure, share gains with key customers, new products, and the favorable impact of the consumer tax credit for energy-efficient products. While we’re seeing significantly lower discretionary spending on golf in the U.S. and Europe, including for corporate custom golf balls, our golf business is sustaining its leadership in this environment with successful new products, including the new Pro V1 golf ball, 909 drivers and AP2 irons, plus continued success in Asian markets. Now let's take a closer look at the numbers for the quarter. Net income for the second quarter was $100.0 million, or $0.66 per diluted share. EPS was impacted by factors including lower sales, negative operating leverage in home and golf products, adverse foreign exchange, and modest charges from one-time items. Craig will touch on the charges in a moment. Excluding one-time items, diluted earnings per share before charges and gains, was $0.70, down from $1.25 in the year-ago period. These results were $0.06 ahead of Thompson First Call consensus estimate of Wall Street analysts. Net sales were $1.74 billion, down 17%. Sales would have been down 15% on a comparable basis, excluding excise tax, foreign exchange, the Cruzan acquisition, and the impact of required accounting related to spirits route-to-market initiatives. On both a reported and comparative basis sales declined at a more moderate pace that in the first quarter. Fortune Brands continues to benefit from the stability of our spirits business. Comparable net sales were flat in spirits, tempering the impact of a 14% decline in golf and a 23% decline in home and hardware. Reported operating income came in at $193.0 million. On a before charges and gains basis operating income was $204.0 million for the quarter. That's down 37%, largely reflecting declines in both home and golf due to lower volumes and adverse operating leverage. Reviewing our asset investment return measures, after-tax returns on net tangible assets before charges and gains was 15%. Working capital efficiency came in at 38%. After maturing inventories for spirits, working capital efficiency was 21%, only up modestly versus the prior year. Return on equities before charges and gains was 8% and return on investment capital before charges and gains was 6%. Fortune Brands benefited from its foundation of powerful and enduring brands that consumers have trusted for generations and as we've indicated before, we have two main goals for Fortune Brands in 2009

[Craig P. Omtvedt:]

Starting with spirits, sales came in at $600.0 million, and that's off 1%. Sales were flat on a comparable basis and that smoothed the impact of foreign exchange, excise taxes, the Cuzan acquisition, and the impact of required accounting related to our route-to-market initiatives. Geographically, sales in the United States were off at a mid-single-digit rate, following a double-digit increase in the first quarter. And I would highlight here that these rates were primarily a function of priory-year swings in distributor inventory movements. When you look at us on a year-to-date basis here in the U.S., sales are actually up 3%, excluding excise taxes and I think that's a more normative, descriptive percentage. On a constant currency basis, Q2 sales outside the U.S. were relatively flat, excluding excise tax and gains in Australia, Spain, Mexico, Brazil, and Canada and India offset soft results in markets such as the U.K., Germany, and duty-free. Operating income in spirits came in at $140.0 million, up 1% on both a reported and a comparable basis. At the OI line we continue to benefit from higher pricing as well as the timing of brand spend, which compared favorably to the prior-year period when brand spend increased double digits. These items more than offset the incremental increases in route-to-market investment. Turning to the markets, in the U.S. year-to-date depletion case volumes are off at a low single-digit rate as increases from Makers Mark, Hornitos, Laphroaig, and several value-price brands have tampered declines for other brands. Thanks to price and mix, U.S. depletion revenues for our global brands are up 2%. In international markets, depletion case volumes improved versus the first quarter and are not off at a high single-digit rate year-to-date. Key highlights here. The tax increase in Australia on ready-to-drink spirits products annualized mid-quarter. Our volumes in Australia have now returned to growth and are up modestly for the year. Our volumes are also up at a low single-digital rate in the challenging Spanish market and in Canada. On a year-to-date volumes remain down in Mexico. They did bounce back in the second quarter, following the transition to new distribution in that market. Volumes also remained down in the U.K., Germany, and global duty-free channel, but we are seeing signs of improvement in the U.K. The results in Germany primarily reflect softness for regional brands. Looking at the year-to-date performance of our key brands, and again, this is on a constant currency basis and it excludes excises taxes, starting with bourbon, where we're the global leader, global volumes for Jim Beam are off at a single-digit rate and in line with our expectations. Jim Beam case volumes are up 1% in the U.S. but up 5% on a depletion revenue basis, reflecting the benefit of higher pricing. The brand is also benefitting from the Red Stag line extension introduced in June. International results continue to reflect softness in the duty-free channel as well as the impact on volumes, particularly in the first quarter, of the Australia RTD tax. Jim Beam RTD volumes trended positive in the second quarter, as the tax increase annualized. The brand is also gaining share in Germany. Makers Mark continues to grow at the super premium end of the category, with double-digit depletion revenue growth in the U.S. supplemented by double-digit international growth. In tequila, Sauza volumes were up in the quarter and are down at a single-digit rate for the six months. Sauza results reflect a first quarter decline in Mexico in advance of our change of distributors there, as well as softness for Sauza Gold and Blanco in the U.S. On the upside, Sauza is benefitting from the brands new distribution in Mexico, as well as growth in the U.S. for Sauza's high-end Hornitos, 100 Anos and 3G’s Expressions. Volumes for Canadian Club are up modestly as softness in the U.S. is offsetting growth in Canada. Here in the U.S. depletion revenues for Canadian Club are up 2%. And again, up 2%. Our value-price Windsor Canadian whisky brand is growing solidly. In a challenging cognac segment, global volumes for Courvoisier are off at a double-digit rate. Cruzan is up double digits, and Laphroaig is lower, though the world's number one Islay malt whiskey trended favorable in the quarter. In cordials, continued growth for Souaz in Europe is partly offsetting lower volumes for Dekuyper in the U.S. Looking to the back half of the year, we continue to feel good about the spirit category stability in this economic environment and we feel good about the progress we are continuing to make. A couple of points here. First, as Bruce indicated earlier, while we have held back brand spending the first half, results in the back half will reflect higher brand spend as new brand-building programs ramp up to align with the seasonality of consumer purchases and the shift to off-premise. And second, as we discussed last quarter, full year results in spirits will reflect two factors

[Bruce Carbonari:]

As we look ahead, while the economic downturn may be moderating, we expect our markets will remain challenging throughout the year. In this environment we will keep executing the initiatives that are enabling us to succeed in the marketplace and position Fortune Brands for strong growth when the economy recovers. As we've discussed, these priority initiatives include adjusting to the evolving consumer, developing innovative new products and brand-building programs, reducing cost structures while enhancing our supply chain flexibility, and of course, aggressively managing our cash. We suspect that we continue to benefit from our ability to deliver value to consumers with our trusted brands, quality products, innovations, and excellent positions up and down the price ladder across our businesses. Our first half results and our ongoing initiatives enhance our confidence in achieving full year results within our EPS targeted guidance. With six months now behind us and a clearer picture of our markets, we are in a position to refine our full year EPS target. Because the high end of our range was dependent on some measures of improvement in our markets and because conditions in the home and golf products markets remain as challenging as they are, we are now targeting EPS, before charges and gains, to be in the range of $2.00 to $2.30 for the full year. This full year target, which is in within our original guidance, continues to reflect our assumption that results in our home products and golf segments will lower, partly offset by underlying growth in our spirits business, which now represents more than 70% of our operating income before charges. Our growth rates in the second half will also benefit from comparison to last year's progressively soft result, predominantly in the fourth quarter. Thank you again for joining us. Now Craig and I will be happy to take your questions.

[Operator:]

(Operator Instructions) Your first question comes from Peter Lisnic - Robert W. Baird & Co.

[Peter Lisnic:]

On the taking down the top end of the range, can you weight that for us by segment? It sounds like home and hardware and golf, and I'm guessing home and hardware is the biggest slug of that, is that the right way to think about it?

[Craig P. Omtvedt:]

Yes, it is. As you look at where we're at right now, our expectation is that we will basically be in line with plan in the spirits business and then with the home business being softer than we originally were targeting, I mean, you will recall at the beginning of the year we said we were targeting that we'd be down in the range of 20%, 20% to 25%, and now we're saying down in the range of 25%, so that's a bit worse. And then clearly the golf business, with the slowdown in discretionary spend, is a bit more challenging.

[Peter Lisnic:]

If I look at that home business, I'm guessing it's volume or top-line related, because, at least relative to our expectations, that second quarter margin you put up was a bit stronger. And just if I can look at that number that you threw up in the second quarter there, that sequentially the incremental margins were around 40%, and I'm guessing that could be a bit stronger as you realize more of these cost savings initiatives. Is that the right way to think about it? Is 40% kind of a just starting to see the benefits and should we see better incremental as we go forward?

[Craig P. Omtvedt:]

I think that's hard to call. You know, obviously there's variability, quarter to quarter, in terms of the timing of spend and so on and so forth. I think 40% is on the aggressive side. I mean, if you look back at what has been a sequential margins, looking back here over the last several quarters, it's run anywhere in the range of kind of 30% to 40%. So I would say 40% is too aggressive at this point.

[Peter Lisnic:]

Pricing in terms of the home and hardware business, can you give us a sense of what an overall impact might have been on top line? And then there's talk about obviously deterioration or pressure as volume continues to be under pressure, what you're seeing there, what you're expectations are.

[Bruce Carbonari:]

First, generally, in the retail side of the business, obviously consumers are shopping for value and much more selective. What we're seeing, though, probably more is the size of projects that they're undertaking, so a shift to more repair or smaller remodel. Especially seeing that in the cabinetry business, where the bigger remodeling projects would be when you blow out a wall or you're shifting the whole design, we're seeing more recall boxes in than boxes out so you are replacing exactly what you had before. So the average size of the remodeling projects are smaller. Actually, the average sale price is pretty consistent, mostly because people are adding on functionality, such as storage inside the box and so forth. So the actual mix and pricing per box is staying about the same. In the faucet category we're seeing a bit of trading down. Probably a price point. And the same thing happening in the door business.

[Peter Lisnic:]

And is the net of that effectively that margins are under some pressure from price in the trade down or are you kind of maintaining?

[Bruce Carbonari:]

We're kind of maintaining. Again, we've been very aggressive around the cost side. That's helping. And we've been able to have some wins in the marketplace as well, which are helping the volume side of it.

[Operator:]

Your next question comes from Analyst for Michael Rehaut - J.P. Morgan.

[Analyst for Michael Rehaut:]

I was wondering if you could talk about some of the sales trends by segment throughout the quarter and if you can comment on anything so far through July.

[Bruce Carbonari:]

Sure. The spirits business continues to hold up well. We are actually seeing there that the volumes are a little bit higher than we initially expected them or that we've been talking about 1% ends are up more toward the 2% range. I'm talking about the United States, first of all. The actual mix has stabilized. We saw an earlier shift from super premium down a price point to premium and standard down to value and so forth. That has basically stabilized between the first and second quarter and actually improved a bit from the fourth quarter of last year. So all of that is very positive. And we just see a lot of stability in that market, which we are very happy to see. The Western Europe market is kind of a mixed bag, although the U.K. economy is challenging, the spirits business is holding up well there, whereas Spain where about this time last year we saw quite a reduction in the economy, mostly driven by the housing correction there, we have now seen a stabilization. Actually in the second quarter we saw a little bit of stock build up in the channels again, which was positive. In the emerging markets, again are pretty all strong except for Russia. Russia is down quite a bit. And then, of course, Australia for us, we annualize through the RTD, through the May period this year, and we're seeing growth back again in that market. The whole market, again, we see it down about 25%. Again, that's pushed. Basically we haven't seen much improvement at all. Again, what I talked about earlier, about the remodeling and types of projects that are going on, are probably the most significant shift we've seen for the last quarter. And in the golf business, the discretionary spend, especially related to clubs, and then I guess shoes as well. What's surprising us a little bit is that the rounds of players still up through May. That's a May number in the U.S. and we think that will be down for the full year. But people are playing and when they play they use, obviously, a lot of our products, because we're more skewed to the consumerable products, the shoes, gloves, and balls than we are to the clubs. Internationally, Western Europe is not as down as far as the U.S. and then Asia continues to grow very strong.

[Craig P. Omtvedt:]

The only thing I would add to that is coming back to the home business, we've seen some stability in terms of order patterns. And while the overall market is going to be down in the 25%, that's still more in line with the overall range that we're looking at. But the real aspect of us taking down the full range is more the fact that the markets haven't improved, or we're not going to see some of the improvements that potentially we thought might be there.

[Analyst for Michael Rehaut:]

I guess like through July then, trends are pretty much in line with the second quarter?

[Craig P. Omtvedt:]

Yes.

[Bruce Carbonari:]

Pretty much consistent.

[Craig P. Omtvedt:]

Now, as you look at the back half of the year, particularly in home again, I would remind everybody that the fourth quarter of last year is when we saw the steepest decline. So this year, with things at kind of a run rate basis, it'll make the fourth quarter an easier comp for us, and I think people should be mindful of that.

[Analyst for Michael Rehaut:]

Just turning back to the home and hardware margins, to get some more color on there. Given current demand levels, how much incremental cost cutting do you think you can do there, and then where do you expect margins to trend sequentially?

[Craig P. Omtvedt:]

Obviously I think we've done a first-rate job of taking costs out of that business, when you think that we've taken out 40% of the people and 40% of the facilities, and that's in line with the downturn. We continue to look at this in terms of what should be the right size of the cost structure on a run rate basis. But as we've said repeatedly, what we're not going to do is take out a dollar today and find out that we have to spend two dollars to put it back in place. So we're continuing to track the market, look at it. There are some additional levers we could pull if we deemed it appropriate, but that's something that we're continuing to watch carefully. I think that the other point that I'd make is that in addition to cutting costs, it hasn't just been cutting costs. We've been very careful to maintain our national footprint. We've used this as an opportunity to put additional flexibility in our global supply chain so that when the market comes back we're in a position to be able to come up with the innovative products that consumers are going to be looking for and to be able to adjust to kind of the demands when we get there.

[Bruce Carbonari:]

And the key of being able to deliver extremely well when volume returns.

[Craig P. Omtvedt:]

Yes, and the third aspect of this is that as things come back, as we look at it from an investment standpoint, the first phase will be adding back shifts, then secondly, as we need more equipment we'll take equipment out of mothballs, so we're not going to have to go out and buy equipment. And with the footprint that we have, we don't see a significant investment in brick and mortar. So we think we're extremely well positioned at this point.

[Operator:]

Your next question comes from Lindsay Mann - Goldman Sachs.

[Lindsay Mann:]

Even if I take your 25% full year home products outlook for the industry, it's tough to get to the back half EPS numbers that your guidance implies, especially considering the inventory rebuilding spirits, the lower tax rate, the favorable FX and all that sort of stuff. So can you talk through some of the items that I might be missing are that are driving the very weak EPS performance in the back half of the year.

[Craig P. Omtvedt:]

Well, I'm not sure how you're modeling this, but again, to just kind of come to the year and just starting with home, for the first two quarters here we've been at a run rate that's, for the market, down in the range of kind of 25% to 30%. In the first quarter our reported sales were down 32%, they're down 25% now. We think the third quarter obviously is going to continue to be challenging with the overall market down in the range of say 25% or so. We've got some things that we think we can outperform, and I just mentioned, when you get to the fourth quarter, with the weakness of last year's fourth quarter, that's going to be an easier comp. Now when you look at spirits, again, as I said earlier, our expectation is to kind of track to what was our full year target so we think we're in line there. We're benefitting from price increases. Obviously that's offset a little bit by what's going on with FX and with our investment in those markets. But the reality is FX for the full year will be less impactful than we originally planned. And then as you look at the golf business, as we've already discussed, we've got some softness there. But overall, without knowing exactly what's in your model, I can't specifically comment. But obviously we wouldn't put out a range unless we were comfortable with it.

[Lindsay Mann:]

And turning to spirits, first of all, the grocery store data, the scanner data shows that you're taking pretty strong pricing but your volume share trends have been pretty week, so I was curious if you could talk about the rationale for the meaningful price increases you're taking when perhaps you're losing some volume share to competitors.

[Bruce Carbonari:]

We have gone out selectively and put price increasing up there in the beginning of the year and part of our program in the end of last year as well. We actually think it's been very successful when you look at the bottom line. So, yes, we have given up a little volume but the price realization has been excellent. Now there are a couple of cases where we probably were a little too aggressive but all in all we're very happy with the program. Again, I think we talked about Jim Beam volume being off 1% but the value being up 5%. That's an equation we like. So we've been very selective about it and very controlled about it. It wasn't anything that we did just to, you know, obviously build for the short term. These are brands that have equity that we think the pricing could realize behind. Again, there are some that maybe we were a little too aggressive on and we've made some adjustments there the latter part of the second quarter and you'll see into the third quarter, but the majority we're very happy with.

[Craig P. Omtvedt:]

The thing I would add to that is that while clearly there will likely be some fine-tuning, that's driven more by what's going on with call it competitive activity out in the marketplace. So we'll take care of that. But at the same time, with the fact that we've now got direct control of our sales organization and then that's coming forward, we feel pretty comfortable with how we're tracking. Again, some of this is still in transition, but nonetheless, it's tracking as we would expect.

[Lindsay Mann:]

Would you consider issuing equity to either further strengthen your balance sheet or perhaps go after some attractive acquisitions that might be out there?

[Craig P. Omtvedt:]

Obviously issuing equity is a pretty expensive proposition and I wouldn't speculate on that. Obviously if we saw something where the value-added proposition and the returns justified it, yes, we would consider it. But at the same time we consider, from an intrinsic standpoint, our stock is still undervalued. But I think more importantly, I think as you look at the actions that we've taken here over the first half of the year, I think we've been pretty measured and pretty effective in terms of first of all, taking the steps to increase our cash flow to allow us to use that to help pay down debt. You look at the bond issue that we just did, we have significantly strengthened our liquidity position, and as I outlined in the prepared comments, our expectation right now is the revolver will be paid off by the end of the year and actually we could be in a cash position. So as you think about what we will do in terms of putting a new revolver in place, you think about the cash flow generation next year, we're very comfortable in terms of how we think we're positioned to take care of the debt maturities coming due in 2011 and that takes us all the way out to 2013. So, we'll see how things play out. But anything that we might do with equity will be a very thoughtful, careful, measured discussion.

[Bruce Carbonari:]

You've got that exactly right, Craig. I would take it from the other side as well. A lot of what we would be looking at strategically from an acquisition standpoint in this particular market would really have to be a diamond. I think with a lot of the businesses, especially in the home space, and a little bit in the golf as well, a lot of these businesses have to go through significant restructuring to match up with the market and with the uncertainty of the market, it's just a harder acquisition proposition. I would also say in the spirit side, there are diamonds out there but some of the multiples out there are still very high. And we look at where we're trading and where those multiples would be, and we would be diluted from day one. So they would really have to be a very strong proposition strategically to make an acquisition. Effen was one of those which was a rough diamond and it has a lot of upside potential that we basically could trade another brand for and a little bit of cash. So right now our position today, from the cash flow that we're generating, and I think you've seen how we exceeded expectations in the second quarter, our default position is to pay down debt.

[Operator:]

Your next question comes from Stephen East - Pali Capital.

[Stephen East:]

If we look at the spirit side, sequentially your profitability came down. Could you walk through what the drivers were and whether we should expect, looking forward over the next several quarters, for the profitability to look more like the first quarter or more like the second quarter?

[Bruce Carbonari:]

We had a lot of moving parts in there, because again, keep in mind that we have the route-to-market expenses that both in the fourth quarter last year for the U.S. and then beginning April 1 in the international side, as a component of that, as well as the FX impact. So first let's talk about the route-to-market piece. The route-to-market piece we estimate to be in the $30.0 million incrementally. I don't think you're going to see that flow through the course of the year. And as Craig had mentioned earlier, the FX impact, too, of being annually about $20.0 million. Bu the business, as we see it from just a volume and gross margin standpoint, it's very stable. The pricing has helped us, we don't see much inflation in the business. The mix hurts a little bit but definitely the pricing has offset that. So I don't see a lot of variation. The brand expense is probably the biggest piece that you will see as we make more investment in the second half on the brand side.

[Stephen East:]

On the free cash flow estimate, I assume you are including working capital change in that.

[Craig P. Omtvedt:]

We are. Of course.

[Stephen East:]

And on the home and hardware, you talked a lot about what trends you're seeing on the retail side. Are you seeing any changes during the quarter, does it look like the housing side of the market is trying to show some signs of life, are the builders talking any differently, trying to line up capacity any differently?

[Bruce Carbonari:]

Not really. I think, again, it's very geographic. There are certain markets that I have seen, the ones basically that have been hurt the most and the prices have come down the most, that you see the most activity. I think the builders, especially the big builders, have done a great job of moderating their production and also trying to re-engineer their footprints in the cost of a home. We participated and helped them with that, with a lot of our national contract with the big builders. But I think they're being very cautious, as they should be, as we are, about what the new construction market is going to look like and how it will progress and how it will recover. But single family homes are at the 300,000 to 400,000 rate, which is extremely low considering we were over 2.0 million just three years ago. So they, like us, are waiting to see these, if you will, green shoots coming out and eventually they will get back into a more aggressive production program. But I think everybody is being cautious right now.

[Stephen East:]

Are they still trying to trade down in all of their trades or are you seeing a stabilization in the type of product that they are requesting.

[Bruce Carbonari:]

Pretty much a stabilization. This has been going on now for three years so we've done a lot of re-engineering, especially for the opening price point products. So a lot of that is behind us. I think we'd all like to get back to building some homes. To see how these new designs and these new programs are put together and how well the consumer receives them.

[Craig P. Omtvedt:]

Let me just come to your point on spirits, because I just want to reinforce the point here and be clear, as you look at the back half of the year, with some ramp up that we're planning in terms of brand spend to kind of reinforce our positions out in the marketplace and the reality that FX was a little more favorable to us, I mean still negative but more favorable in the first half, it's going to be more challenging in the second half. We are going to see the OI comparisons be somewhat softer in the back half than they were in the first half. But still overall, we're tracking in line with our expectation for the full year.

[Operator:]

Your next question comes from Analyst for Ivy Zelman - Zelman & Associates.

[Analyst for Ivy Zelman:]

I was curious with your obviously long experience in the housing market and kind of compare and contrast this cycle to others, without thinking about when the cycle bottoms, when it does start to come back, do you have an opinion of the shape of given of probably where the consumer is, where foreclosures are, are we going to see something rapid and v-shaped or is it going to be more shallow. How do you think about that as you align your capacity.

[Bruce Carbonari:]

Well, this is one man's opinion because there are a lot of opinions out there. First of all, as you said, I've been in this business a long time but this is nothing like we've ever experienced before, so I don't think you really can compare it to anything that we saw in the 80s or 90s or even early 2000s. So this is its own unique animal. My bet here is that it's going to be slower. It's not going to be a "v". The reasons why really have to do with just the availability of credit and the type of credit that will be available and the ability of the consumer to digest that. We're 20% down on 30 year mortgages or the lack of debt equity they used to have in their homes to do remodeling projects, I just think it's going to be a slow recovery. I'm very pleased that we're seeing consumers save more now and really try to get their net worth and their own personal balance sheets straightened out. And it will be build. There is an underlying demand there but I think it's going to be more of a slow build than us sky-rocketing back to 1.4 million housing starts in a 12-month period. I think it's going to be more stable, stable growth. But the long-term attractiveness of the market is still there. We still need housing and we need good quality housing to feed and help the growing population and the household formations. We have corrected, maybe over-corrected to some extent, but I think until the consumer feels comfortable enough to really go out and spend or trade up or trade around for different housing or different remodeling, it's going to take a little while for all that to come together.

[Analyst for Ivy Zelman:]

And I assume about the capacity, you've obviously planned accordingly for that type of environment. Do you feel like on the margin side in home that it will be tougher climb back to a double-digit range if the industry or your competitors are looking for something that's more on the v-side?

[Bruce Carbonari:]

First of all, with what we've done in the supply chain, I'm really proud of what our guys have done. Obviously we took a lot of cost out but we really had an idea of what the future footprint should be and our operating model should be and it's a lot more flexible or even, if you will, a variable cost structure. So we could flex up and down much more quickly. We also believe that, and we've modeled this obviously, at certain points that we will lever very well. So as long as the pricing and the environment and volume comes back at a reasonable level, we should return to very solid margins back in this business.

[Analyst for Ivy Zelman:]

My question is can you do that in the face of competitors that maybe haven't adjusted their cost structure like you have?

[Bruce Carbonari:]

I think so because the other thing we've done is continue to keep the consumer excited. We have continued to develop new products and bring out new programs, enhance our services. And right now we're getting recognized for that with some of our market share gains at Moen and the cabinetry side. So I even think tomorrow when these companies who haven't done their restructuring and pretty much killed the new product development engine, have to restart all that and recreate that, it's going to be a tough engine, tough for them to do. But keep in mind, with our flexibility, as Craig had said, we can go from one shift to two shift to three shifts. We have the equipment that's been mothballed so it's just a matter of training the people and bringing them back up to speed, that we can get to really decent capacity levels.

[Analyst for Ivy Zelman:]

The comment you made earlier, windows seemed to be declining less than the overall is, is that a category that is benefiting from some of the tax incentives or can you go through why that isn't down as much as something like doors, given the discretionary nature there as well.

[Bruce Carbonari:]

Exactly. We do believe with the energy tax credit we did see a pop in the business. And consumers are very active. And one of the interesting things is that we don't see much trading down there, as well. The mix is very strong. So people are out there, because of the tax credit, and they are doing the things that they need to do as far as energy efficiency for their homes. So that's why it's a bit different than the door business and some of the other businesses.

[Craig P. Omtvedt:]

And you're also benefiting from the repositioning that the team has done in terms of the overall organization and how we're dealing with various markets and various products and kind of moving more strongly into some of our channels with customers. I mean, it's all playing to give us a better positioning.

[Operator:]

Your next question comes from Ann Gurkin - Davenport & Co.

[Ann Gurkin:]

On the spirit side, related to inventory build, where is inventor right now at the retailer level and where do you see it going for the holiday season?

[Bruce Carbonari:]

Are you talking about the United States?

[Ann Gurkin:]

Yes.

[Bruce Carbonari:]

I would say the retail level is pretty good. I don't think we've seen much swings at either the distributor or retail level here in the second quarter. Again, we made some significant adjustments in the portfolio last year with our distributors and I think over time the retailers have just sharpened themselves up as well. So that's pretty much, I think we're very much in line. Going into the third quarter, really the end of the third quarter is really the build for the holiday season. It will be interesting. I think the holiday season will be a healthy year this year. How the distributors and how the retailers play that as far as inventory goes, it's a guess. Mostly because I think they will be sharper and smarter and won't buy as aggressively as maybe they had in the past, but we'll be ready to respond quickly when they want to reorder and so forth. And I think most of the spirits manufacturers are in that same position as well.

[Ann Gurkin:]

What are you expecting for a competitive price environment in the second half?

[Bruce Carbonari:]

Again, it depends. I think that premium and super premium, I don't think you'll see much pricing there. I think you will see it more on the standard side of the business. Much more at the high volume items. But I would say those are going to be more in the form of promotions and mostly on the off-premise side.

[Ann Gurkin:]

You expect a heightened promotional environment coming up?

[Bruce Carbonari:]

Not heightened, I think just probably a healthy one. There are certain times, certain parts of the season that you see certain products that go on promotion and probably with the consumption at home, we see the 1.75 liters growing as well and seeing a little more promotion on those to attract the consumer at home. So I think it's we're already seeing it. I don't think it's going to be much different in the second half of the year.

[Ann Gurkin:]

Could I get your read on the likelihood for an increase in excise tax on spirits in the U.S.

[Bruce Carbonari:]

I think the big thing with excise tax, and especially it's really at the state level. There really is no federal excise tax increase currently pending in the U.S., it's really all at the state level and each of the states have their various different budget deficit issues. We have seen, right now to date, excise tax increases threats in 33 states. 24 have been defeated. We have seen some increases in Kentucky, Illinois, New Jersey, Oregon, South Dakota, and Vermont. So we think a lot of it is behind us. There are still obviously a number of states out there and something that obviously we fight diligently with the industry as well. But it is something that we adjust to. When the states do have the excise tax increases, the one that we have had so far, we really haven't seen a change in consumption level. So that's healthy as well. So it's out there. Obviously the states are struggling to figure out different ways of solving their budget deficits and the ones that have adopted it we haven't seen much impact on the consumption level and we've already had 24 states defeat it.

[Operator:]

Your next question comes from Derek Leckow - Barrington Research.

[Derek Leckow:]

Just a follow-up on the comments about the brand-building expense. Could you help us calibrate that a little bit and it sounds like it's going to be weighted more toward the third quarter than the fourth quarter. Is that about right?

[Craig P. Omtvedt:]

We don't get into specific commentary on quarter by quarter for competitive reasons, but so I'll just have to leave as we're certainly going to have increases here over the balance of the back half.

[Bruce Carbonari:]

Keep in mind that the consumer is more active in the spirits category in the back half of the year. So we think it's just diligent and smart to be there when they're there.

[Derek Leckow:]

You get better pay off in the back half of the year is the point. But in the third quarter is there sort of a spending level that doesn't get that same benefit and should we think about the fourth quarter being one where you get most of the benefits and more of the expense in the third quarter?

[Craig P. Omtvedt:]

That's a little hard to call in terms of some of the timing of some of the things that we're going to do, but clearly, I think as you think about it, it's going to start to ramp up, we've got the advertising kind of longer-term brand building that's kicking off here but then we've also go the king of the market initiatives that are going on and that will start to pick up here over the course of the third quarter and into the early days of the fourth. So I just wouldn't try to put a precision to that that you're looking for. I understand where you're trying to go with that but there's a variableness to this that I just can't call at the present time.

[Bruce Carbonari:]

Consumption trends don't know about quarters.

[Derek Leckow:]

What I'm trying to get to here really is last year's spend you kind of pulled back a little in the fourth quarter I thought, and so I'm looking at this from an incremental increase. Could you help us by telling us how much of an increase you're looking for?

[Bruce Carbonari:]

No. Because that's all competitive stuff that we just don't want to have out there right now.

[Derek Leckow:]

On the golf business, we have seen a lot of consolidation in the retail channel there, and the big season is behind us but do you still have some exposure to additional consolidation of the retail channel.

[Bruce Carbonari:]

Say that again. I'm sorry.

[Derek Leckow:]

I'm looking at the retail channel in the golf business. We've seen a lot of consolidation here and I wondered if you had more exposure in the second half of the year to any further consolidation? What are your thoughts about further consolidation of the retail channel?

[Craig P. Omtvedt:]

Actually, the real strength for us is on-course, the on- and off-course segment, not so much the retail, which has traditionally been our strength. So as we look at the retail, I would say to you right now that even with the consolidation, our run rate in the back half should more or less match where we were in the first half. But you've got to remember that it's just very fragmented, even though you've seen some level of consolidation.

[Operator:]

Your final question comes from Karen Lamar - Federated Investors.

[Karen Lamar:]

Can you give us a little color, by business unit, on your inventory quality and levels and maybe any changes that you might plan, given your sales trends and your outlook.

[Craig P. Omtvedt:]

I would say to you that as we look at the spirits business right now we are very comfortable with how we are positioned. We have obviously taken a very thoughtful look at what we think the future sales trends are and the requirements. As you look at our inventory levels this year, we've ramped up a bit in terms of distillings for maturing inventories. So we are fine there. You look at the home business, you almost have to go kind of group by group but as an example, in the cabinet business, there's no inventory out in the trade. They place an order and then we build it.

[Bruce Carbonari:]

We build a kitchen at a time. The same thing with windows. We don't have any finished goods inventory.

[Craig P. Omtvedt:]

So across our home business, we feel comfortable. Golf obviously we've got a little bit of work to do with the slowdown in sales that we've seen. We're a little higher with our inventory levels than ideally we would have liked to have been at this point in time. But the group has done a great job of kind of managing us for the position we're in and our expectation is that we will manage that over the back half of the year. So all in all, I would say we're in good shape.

[Bruce Carbonari:]

Thanks again for joining us. The people at Fortune Brands are working hard every day to navigate this difficult economy and we look forward to discussing our progress in the third quarter results with you in October.

[Operator:]

This concludes today’s conference call.