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Executives

Bruce A. Carbonari – President & Chief Executive Officer

Craig P. Omtvedt – Senior Vice President & Chief Financial Officer

Analysts

Alexander Paris - Barrington Research

Stephen East - Pali Research

Ivy Zelman - Zelman & Associates

Eric Bosshard - Cleveland Research Company

Bryan Spillane - Banc of America Securities

[Todd Duvey - Bank of America]

Analyst for Jonathan Feeney - Wachovia Capital Markets, LLC

Analyst for Peter Lisnic - Robert W. Baird & Co., Inc

[Dennis McGill] - Zelman & Associates

Fortune Brands, Inc. (FO) Q2 2008 Earnings Call July 25, 2008 9:00 AM ET

Operator

Welcome to the Fortune Brands second quarter earnings conference call. (Operator Instructions)

Bruce A. Carbonari

Welcome to our discussion of Fortune Brands second quarter 2008 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 maturely from those targeted. This presentation also includes certain non-GAAP measures that are reconciled to the most closely comparable GAAP measures in our news release or on our website in the supplemental information linked to the webcast page.

Fortune Brands today announced results that came in at the high end of the targeted range we updated at the end of June. Second quarter results benefited from the higher shipments of premium spirits in the United States and the strong growth in Asian markets for our golf and home products brand. These factors partly offset the challenges we outlined in late June, which include the ongoing correction in the US housing market, the softening consumer environment in the US, higher commodity costs, and the unexpected excise tax increase in Australia on the ready-to-drink spirits products.

While we faced a tougher than expected environment in the second quarter, we remain intensely focused on two objectives: first, outperforming our product categories; and secondly, investing in the future to drive sustainable long term growth and returns. We’re benefiting from proactive cost reductions, productivity improvements and share gain initiatives in our home products business, where we have eliminated 25% of our facilities while maintaining supply chain flexibility and strategic spend. We’re continuing to build a high performance organization behind our spirits brands and we’re investing to creatively build premium brand equity to grow revenues faster than case volumes and we’re investing to grow our golf brands through innovation and expansion in promising international markets. We believe that these are the right moves to create long term value for our shareholders.

The action plans we’re pursuing benefited Fortune Brands in the second quarter. While our double digit increase in brand building investments and Australia RTD tax increase adversely impacted operating income for the spirits business, we drove solid revenue and volume growth for several key premium spirits brands in the United States and we also benefited from anticipated rebuilding of the US distributor inventories. Despite a US housing correction that has intensified, we continue outperforming key categories in the home products market on the success of our share gain initiatives while achieving expected savings from our proactive cost initiatives and our international growth initiatives helped drive double digit growth of our golf brands in key Asian markets, partly offsetting the impact of double digit increases in brand investment and the soft consumer environment in the United States.

Now let’s take a closer look at the numbers for the quarter. Net income was $136 million or $0.88 per diluted share, that’s compared to $1.48 in the year ago quarter. These are results reflect a net charge amounting to $0.37 per diluted share in the current year quarter. The net charge resulted primarily from a writedown of intangibles, partly offset by favorable tax revisions and a gain related to the repurchase of the minority interest in our spirits business. Craig will spell out the charges and gains in a few moments.

Diluted earnings per share before charges and gains for continued operations came in at $1.25, that’s off 17%. These are results are at the high end of the updated target range we announced in late June. That target range was for diluted earnings per share before charges and gains to be down at a high teens to mid 20s percentage rate. Our results also reflected a $0.05 per share benefit from the routine true-up of our year-to-date effective tax rate. Net sales were $2.1 billion, that’s down 9%. On a comparable basis, excluding excise tax and foreign exchange, total net sales would have been down 10%. The core operating income was a negative $16 million, down from the $416 million in the year ago quarter. The decrease reflects the net impact amounting to $341 million from the goodwill writedown and one-time items. On a before charges and gains basis, operating income was $325 million, down 24%.

Reviewing our asset and investment return measures, after tax return on net tangible assets before charges and gains was 22%. Working capital efficiency came in at 34%, return on equity before charges and gains was 13% and return on invested capital before charges and gains was 8%.

As you know, in late June we updated our earnings expectations for the second quarter and the full year due to the more challenging than expected near term conditions in our markets, including the RTD tax increase in Australia. The home products market has proven even more challenging than anticipated as the ongoing US housing correction has intensified. At the same time, consumer sentiment in the US has sagged as home values have fallen and fuel prices have soared. As a result, many consumers have deferred big ticket purchases ranging from golf clubs to major remodeling projects. Although the spirits market has remained resilient and growing in the US, albeit at a more moderate pace, the tax increase in Australia on ready-to-drink spirits products took the industry by surprise. We have a robust and profitable RTD business in Australia so this tax increase has adversely impacted our business. Even though these are factors outside of our control we aren’t content to simply suffer the consequences and will never be satisfied with lower results.

We’re proactively implementing initiatives across all three of our businesses designed to outperform our markets and optimize our results while positioning our businesses for long term value creation. As you know, the spirits industry is one that performs well in most economic conditions and the current economic environment is no exception. The US spirits markets, which accounts for about half of our spirits sales, remains healthy. While the American consumer has pulled back in many areas, premium spirits are still seen as an affordable luxury and consumers continue to trade up though at a more moderate pace. What we have seen is some shift in the consumer on premise, which as we describe as restaurants and bars, to consumption at home as consumers eat out less and we’ve also seen some softness and pockets hit hard by the housing correction, notably California and Florida.

Over the past five years, the US spirits market has grown volumes in the range of 2% to 4% and 2008 is likely to be at the low end of that historical growth range. We continue to see that through the good environment in which to invest in our premium spirits brands, both in the US and the growing international markets. Our investments are focused on building brand equity and consumer demand, driving profitable organic growth and creating long term value. As a result, we’re successfully driving revenue growth at a faster pace than volume growth. Our leading brands in key premium categories give us an excellent foundation for continued growth. Our marketing efforts reinforce the vision of our being a global spirits business, building brands people want to talk about. As we’ve discussed before, we’ve made significant investments to bring that vision to life in support of the Sauza, Canadian Club and Courvoisier brands and we believe we make good progress strength in any of these brands in the marketplace.

We’ve relaunched the super premium Sauza Hornitos line and recently repositioned the core Sauza Gold and Blanco line with new packaging and new expect fresh campaign. Year-to-date US depletions for Hornitos are up double digit and Gold and Blanco are up at a high single digit rate. The damn right campaign has encouraged consumers to take an entirely new look at Canadian Club brand. As a result, year-to-date depletions in the United States are solidly higher, reversing years of slow decline and a new consumer engagement campaign for Courvoisier in the U.K. has helped drive double digit volume growth for the brand in its second largest market.

Just this month, we activated a new campaign in the US designed to build momentum for our flagship Jim Beam brand. Building on our original stuff inside matters most campaign, this is a less traditional campaign in which Jim Beam will celebrate and support people and organizations that share its own values and have the right stuff inside. The campaign aims to get consumer buzz actively engaged in the brand, to create buzz around Jim Beam and what it stands for. In addition to traditional advertising vehicles, the campaign will include an unprecedented focus on social media and stark conversation. We invite you to learn more about the campaign at TheStuffInside.com site.

So that’s activate and executing a unique marketing strategy. We’re also continuing to create the highest performing organization possible. The focus is on bringing the organization closer to the consumer and bringing their vision to life. We’ve also made some changes in our US distribution organization that we believe will strengthen our focus on activating brand programs in the marketplace as well as add focus on national

accounts and super premium opportunities. About half of our spirit sales come from international markets and we’re also continuing to invest in the combination of brands and markets that offer the best prospect for possible long term growth. That includes investing to expand key brands in Brazil, Russia, India and China; all markets with a very promising long term growth potential.

One very important international market is Australia; it’s the world’s second biggest bourbon market. Jim Beam is the number one spirits brand in all of Australia and our Jim Beam ready-to-drink products are extremely popular there. As we’ve previously discussed, the 70% excise tax increase on RTD products took the industry and Australia consumers by surprise. The price of RTD products to Australia consumers increased about 25% as a result of the higher tax. In the last two months of the quarter, we saw sales of our RTD products decline more than 30%. That was only partially offset by a bump in sales of full-strength Jim Beam bottles. We’re moving quicker to reposition our market-leading RTD products to complete in the new tax environment but we do not expect our recovery action to have a material impact on this year’s results. The impact of the RTD tax will annualize next April and is reflected in our targets for the balance of 2008. Even with this challenge to our high margin RTD products, we continue to enjoy margins among the very best in the spirits industry and we like our prospects to properly grow this business in the years ahead.

Transitioning to our home products business, clearly the US housing market has been the biggest headwind we’ve faced and it has been more challenging than we anticipated three months ago. Most of the inventory of unsold homes remain at extremely high levels. Credit markets have tightened and mortgage costs have increased, reducing access and affordability for home buyers and as home prices and consumer confidence continue to decline, prospective buyers remain on the sidelines waiting for the right time to jump into the market. In this difficult environment, both the replace or remodel and new construction segments have been below our previous projections. We have been budgeted for the home products market in aggregate to be down at a low double digit rate. Given the intensification of the housing correction, we now anticipate the housing market will be off in the range of the mid-teens in 2008. We successfully outperformed the home products market over the course of the downturn and that includes outperforming in the second quarter and we’re continuing to aggressive actions that help us drive sales and project operating margins.

The action plans we have implemented have successfully reduced the business of cost structure while opportunistically building flexible, scaleable, cutting-edge supply chains that we believe will give us a competitive advantage when the market recovers. In doing so, we closed one quarter of the facilities in the home and hardware business, reduced the number of positions by 20% and realized supply chains to maximize our industry-leading lead times and customer service. While reducing costs, we’ve also ramped up productivity initiatives, including greater use of lean manufacturing techniques, distributive assembly, global sourcing and better inventory management.

As we’ve discussed before, we’ll also maintain a healthy level of strategic spend to help us gain share in the environment. As a result, we’ll continue to innovate, enter products, enter adjacent product categories and expand internationally. We continue to have long term confidence in the home products market and we do not believe the current correction, as deep as it is, is a fundamental change. The long term trends for household formations and aging housing stock remains strong and the desire for home ownership remains high. Fortune Brands is positioned in the most attractive consumer orientated categories and our strength in the replace and remodel segment, our supply chain advantages further underpin our confidence in the long term.

Now let’s talk about golf. The US has proven to be a challenging market for the golf industry this year. Adverse weather has impacted rounds of play in certain areas. On top of that, weak consumer sentiment has reduced demand for discretionary purchases such as golf clubs. Although the US market has been soft, we’re investing to drive strong growth in international markets, which now represent 40% of our golf sales; that includes key Asian markets led by Korea and Japan, as well as China. Taken together, we’re driving double digit growth in these markets. We’re also investing to fuel sustained innovation across product lines. As a result, we’re benefiting from hot new products like Titleist AP2 irons, Scotty Cameron Studio Select putters and new shoe models from FootJoy. Backed by our brand of experts in R&D, a new product pipeline is fully loaded with next generation products that we’ll be talking about in future quarters.

In addition to our focus on outperforming our markets and positioning for sustainable long term growth, we’re also committed to returning immediate value to shareholders. We have significant financial flexibility to create value in many ways and that includes attractive dividends and share repurchases. Today, we announced a 5% increase in the dividend to an annual rate of $1.76 per share. This dividend increase underscores the strength of our balance sheet and our confidence in Fortune Brands’ ability to deliver strong results over the long term. Notably, this is the 12th year in a row we’ve increased the dividend since the company began trading as Fortune Brands and our dividend currently offers a yield of approximately 3%. We also see our share price as an extremely attractive high-return opportunity and we’ve moved aggressively to repurchase shares of Fortune Brands to create additional value for shareholders. Since implementing a new share repurchase authorization on March 31, we repurchased more than 4.3 million shares of Fortune Brands stock. We recognize that this is a difficult stock market for a lot of companies and we are pleased we can put our financial flexibility to work to buy back our shares.

Consistent with our previous announced intentions, I’m also pleased to report that we’ve completed the repurchase of the equity minority interest in our spirits business previously held by the V&S Group. Our partnership agreement with V&S provided for a third party evaluator to determine the sales price of the minority interest. An independent evaluator established $455 million plus accrued dividends as the price to repurchase the preferred shares which, as we previously disclosed, could not be sold to another company and had unique shareholder rights as a preferred security. The price established for the repurchase of the equity minority interest is good news for our shareholders and reflects unique features of the preferred shares held by V&S as well as the debt structure of being global. Because this valuation was below the $543 million value we carried on our books, we have recorded a gain in our second quarter results. With this transaction now complete, we look forward to benefiting from the entire financial performance of our highest profitable business.

Now here’s Craig with a closer look at the second quarter performance for each of our segments.

Craig P. Omtvedt

Starting with spirits, sales for spirits brands reached $608 million; that was 1% shy of the year ago quarter when sales grew 6%. On a comparable basis, excluding excise taxes, FX, divestitures and a third party bottling contract, spirits sales would have been down 5%. Sales were adversely impacted by factors including the lower demand in Australia for our RTD products following the excise tax increase, as well as soft results in Mexico and Spain. By way of background, in Spain, we’re facing a weak economy and in Mexico our distributor is undergoing an internal restructuring of its organization and that’s caused some disruption. Even so, we’re expecting results in both markets to improve in the back half of the year. Operating income before charges was $150 million, 14% below the year ago quarter. The lower OI reflects our planned double digit increase in brand spending as well as the adverse impact of the Australia tax increase on our high margin RTD products.

At the top line, net sales were up at a high single digit rate in the US as shipments rebounded from the larger than usual distributor inventory takedowns in the first quarter. We’re also benefiting from higher pricing, reflecting our focus on driving value growth. On a revenue basis, year-to-date depletions are growing significantly faster than depletion case volumes, reflecting the price benefits of our brand building initiatives and favorable mix. Year-to-date depletion revenues and case volume are collectively higher in the US for our key premium brands.

In international markets, after a strong increase in the first quarter sales in constant currency were down high single digits as the dynamics we discussed in Australia, Spain and Mexico, along with timing issues in select markets, more than offset the double digit increase in the U.K. Looking closer at the year-to-date performance of our global premium brands in constant currency, net sales excluding excise tax for Jim Beam bourbon remain up at a low single digit rate on modestly lower volumes. Brand results include the impact of the RTD tax in Australia, where higher sales of standard bottles of Jim Beam have not offset the lower sales of our market leading ready-to-drink products.

Let me also note that while US depletions for the Beam brand are off year-to-date, we’ve only just begun rolling out the new brand building campaign that Bruce outlined earlier. Largely due to the distributor issue in Mexico, net sales and global volumes for Sauza Tequila are off single digits year-to-date. I’d like to underscore here that the health of the Sauza brand is strong in the US and our repositioning work on Hornitos, Gold and Blanco is building equity for the brand. In the US, year-to-date depletions for Sauza are up at a high single digit rate and are outpacing the category. Net sales for Canadian Club are up mid single digits on a low single digit volume increase. Courvoisier is the number one cognac in the U.K. and their strong performance in that market has helped worldwide net sales for Courvoisier climb at a double digit rate on a low single digit volume increase. Growing super premium and ultra premium brands, such as Maker’s Mark, Knob Creek and Laphroaig continue to perform well. In cordials, strong growth for the Sourz brand in Europe is helping offset a modest decline in year-to-date net sales for DeKuyper in the US

As we look to the balance of the year, our view of the spirits market remains unchanged. Consumer demand in the US will likely remain at the low end of the 2% to 4% growth range we’ve seen over the past five years and consumers will continue to trade up to higher end spirits, though at a more modest pace. While there are pockets of softness internationally, we also continue to see promising opportunities to accelerate growth in targeted global markets and we’re investing to capitalize on them. Our premium positions and brand investments in attractive categories position us well in this environment. We’ll also benefit from the fact that our stepped up brand investments have now largely annualized, easing comparisons in the second half. Primarily reflecting the impact of the Australia tax increase on our high margin RTD products, we’re now targeting operating income before charges and spirits to be flat to up at a low single digit percentage rate for the full year.

Now, home and hardware. Sales for our home and hardware brands came in at $1.04 billion, 14% below the year ago quarter. That’s in an environment where the new home construction segment is off more than 30%. At the same time, we estimate the larger replace and remodel segment is down mid single digits, which is below our earlier expectations. Even so, our strong presence in the more stable replace/remodel segment and our share gain initiatives have positioned us well in the challenging market. Operating income before charges for home and hardware was $127 million, off 30%. The wide performance reflects adverse operating leverage as well as higher raw material costs.

While we had previously aimed to limit our full year decline in home and hardware operating margins to about 100 basis points, it’s now clear that full year margins in home will decline more than that largely due to the increased headwinds of the overall market as well as higher than anticipated commodity costs. We’re working hard to protect margins and we now expect that our productivity and restructuring initiatives, price increases and share gain initiatives will help limit margin declines in home and hardware to approximately 250 basis points for the full year.

Looking at the performance of our key home products brands, sales for our kitchen and bath cabinetry brands were off at a mid teens rate, benefiting from relative strength in our biggest channel: kitchen and bath dealers. Sales for Moen were down at a mid single digit rate. Growth in retail and commercial channels and double digit sales gains in Canada and Asia partly offset lower sales to wholesale customers who primarily serve home builders. Retail sales for the number one faucet brand in North America benefited from the rollout of new products at major home centers. Sales for our Simonton windows and Therma-Tru door brands were down in the range of 25%. While Therma-Tru results reflect significant exposure to new construction, the brand continues to benefit from its presence in a home center channel as well as its exit from the U.K. market. Among our storage and security brands, Master Lock continues to be a bright spot. The world’s number one padlock brand posted a double digit sales increase and that was benefiting from strong back-to-school shipments, successful extension into the commercial safety segment and international growth in Europe and Latin America. Master Lock’s higher sales more than offset lower sales of Waterloo tool storage products.

Looking at the back half of the year, we’ll continue pursuing the initiatives that have helped us outperform the market including development of new products, extension of brands into adjacent categories, growth in international markets and superior customer service and lead times. We’ll also remain focused on the cost containment and productivity initiatives that are helping protect operating margins. With an expectation for the US home products market to be down in the mid teens, the resulting adverse operating leverage and raw material cost increases, we’re now targeting operating income before charges and home products to be down at a mid 20s to mid 30s percent rate for the full year.

Now golf. Sales in golf came in at $452 million; that’s off 5% from the year ago quarter when sales grew 12%, partly due to the timing of new product introduction. High single digit growth in international markets was more than offset by a low double digit revenue decline in the US. On a year-to-date basis, our worldwide golf sales are up 1%. At the operating income line, operating income was $68 million; that’s down 23%. The steeper decline in OI is largely a function of our double digit increase in brand investments as well as closeouts on certain products in advance of new product introduction. Sales of golf balls were modestly lower in the second quarter, reflecting lower rounds of play in the US due to poor weather in certain markets. After a double digit increase in the first quarter, sales of golf clubs were lower at a double digit rate.

The second quarter reflected a challenging comparison to the year ago quarter when we launched several new products as well as a soft US market for clubs. FootJoy grew shoe sales at a double digit rate. The number one shoe in golf is gaining share with successful new models, including in the DryJoys and Contour line. While golf gloves were slightly lower, sales of accessories such as headwear and golf bags grew at a double digit rate. We continue to feel very good about our position in golf and about the long term fundamentals of the golf industry. However, given the soft environment in the US market and continued long term brand building investments we now expect full year operating income before charges in golf to be down at a high single digit to low teens percent rate.

Now, before turning things back to Bruce, a few additional items. First, a note on commodity costs. Back in the first quarter, we highlighted a total potential exposure from raw materials of $15 million to $20 million, net of pricing, and that we were working to offset that impact. Unfortunately, as you know, raw material costs have risen further since April. In addition to increased fuel and other petroleum-base materials, we’re also seeing further increases in steel, glass, particle board and grains. We’re continuing to work hard to offset these increases, but with the bar rates higher what was an exposure is now a reality and we see about $15 million to $20 million of raw material costs that we don’t expect to offset in 2008. That expectation is factored into our earnings targets.

Now, turning to one-time charges. During the quarter, we recorded a non-cash writedown of $324 million of goodwill and identifiable intangibles, primarily related to our door brands. As many of you are aware, GAAP requires us to evaluate goodwill and identifiable intangibles on a current fair-value basis. While we continue to be very positive about the long term prospects for our door brands, the accounting standards necessitated this non-cash writedown. We also recorded a net cash writedown of $25 million primarily to reflect our share of Maxxium’s writedown of goodwill associated with the forthcoming departure of Remy Cointreau from the international spirits distribution joint venture. As you recall, Remy previously announced that it would exit Maxxium in early 2009 and this non-cash writedown reflects the expected impact of their exit, including anticipated exit penalties. We also recorded after-tax restructuring and restructuring related charges of $11 million associated with our spirits and home and hardware businesses.

On the credit side, as Bruce indicated, we repurchased V&S’s equity minority interest in our spirits business. Given that determined by a third party evaluator the amount was below our carrying value, we recorded a gain of $82 million after transaction costs. We’re also pleased that we received congressional joint committee signoff including the tax matters we’ve previously discussed; that is a capital loss carryforward position that benefited our 2001/2002 tax returns and also our gain related to the sale of wine business and the US rights to the Del Mar last year. As a result, we returned $205 million to income, $107 million of which is reflected in discontinued operations.

With regard to our tax rate, our second quarter effective tax before charges gains came in at 28.5% and that’s reflecting the routine true up of our worldwide tax positions. On a diluted EPS basis, that benefited the quarter by approximately $0.05. We now expect our full year effective tax rate to come in in the range of about 30.3%. Lastly, with regard to cash flow and reflecting our softer than anticipated results we now anticipate free cash flow, and again, that’s after dividends and capital expenditure, will be in the range of $500 million versus our previous target of $500 million to $600 million. Now, that said, I think it’s worth noting here that combining our current free cash flow target with our dividend amounts, that amounts to a total yield of 8.5% at our current stock price.

Now let me turn it back to Bruce.

Bruce A. Carbonari

As we look to the back half of the year we’ll continue to outperforming our markets and ensuring a strong foundation for sustainable long-term growth. While we still face the headwinds of the intensified US housing direction, the weakness of the US consumer confidence, and the Australian ready-to-drink tax increase, we expect to benefit from share gains, growth in international markets, a position in relatively stable premium spirits market, the analyzation of our step-up brand investments in spirits, and company-wide cost controls and productivity initiatives.

For the third quarter we’re targeted diluted earnings per share before charges and gains to be down at a mid-teens to mid-20s percentage rate compared to $1.34 in the year ago quarter. For the year we continue to expect diluted earnings per share before charges and gains to be down at a high single-digit to a high teens percentage rate compared to $5.06 in 2007.

Thanks again for joining us, and Craig and I will be happy to respond to your questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Alexander Paris - Barrington Research.

Alexander Paris - Barrington Research

Just to get a feel on the international business. You already said I think that spirits is 50% and golf is 40%. Home is still fairly small? Can you give us that percentage?

Craig P. Omtvedt

Yes, it’s about 10% to 15%. It’s a small part of our business.

Alexander Paris - Barrington Research

Is it possible to expand that? Are you focusing on expanding overseas? I know a lot of your products are not amenable to long shipments.

Craig P. Omtvedt

Yes, we are actually. The Moen is doing quite well both in China and now expanded this year or actually late last year into India as well as Master Lock. But the kitchen business is one that’s more of a North American orientated product today. Especially in Asia the kitchen hasn’t developed yet in the home as it has here in North America and Europe and just the profile of Europe itself is not really a growth market for a lot of our products. So windows, doors, cabinets is a little tougher to get outside of North America.

Alexander Paris - Barrington Research

In the spirits overseas, someone from China told me recently that some of the major spirits people are trying to expand fairly heavily in China. Do you have some strong efforts there, too?

Craig P. Omtvedt

Yes, we do, actually in all the brick countries. China is right now predominantly what we call a brown spirits country, meaning that our Courvoisier and Beam, our bourbons are the ones we’re trying to position. That’s true in India as well as Brazil. Russia’s a different story. That’s more of a white spirits, the heritage of vodka, so there we’re doing some things with Beam but predominantly working with Sauza and developing that tequila market in Russia. So yes we are. The brick is a major focus and we’re seeing in all of them the premiumization to be very strong from a lot of the national brands that have been dominant for years.

Bruce A. Carbonari

And Alex, I’d add it’s probably worth noting that particularly in Russia and China for Beam and for the total spirits business, it’s off a small base but we’re growing nicely.

Alexander Paris - Barrington Research

Are you selling through in Asia and India and China through Maxium or through specific distributors?

Craig P. Omtvedt

They’re all different set ups there. We do direct into India. China is Maxium. And Brazil I believe is -

Bruce A. Carbonari

Perno.

Craig P. Omtvedt

In Perno. We share distribution with Perno in Brazil.

Operator

Our next question comes from Stephen East - Pali Research.

Stephen East - Pali Research

The first question is sort of an all-encompassing cash question. What type of cash proceeds did you receive from V&S Spirit and is that included in the $500 million guidance? And then as you look at the disposition other than the dividends and share repurchase, what are you seeing on the acquisition front? Are you seeing a lot of distressed opportunities, etc? I’m thinking in the home and hardware that you could allocate cash too?

Craig P. Omtvedt

I’ll take the cash piece and Bruce will do the acquisitions. In terms of V&S we’re paying the $455 million for their 10% interest in Beam, so that’s going to be a debt issuance for us. So that’s not in our cash flow. That’s not in the $500 million number that I talked to but the accrued dividend amount is part of the cash flow numbers.

Alexander Paris - Barrington Research

And roughly how much would that be?

Craig P. Omtvedt

In terms of the accrued dividend?

Alexander Paris - Barrington Research

Right.

Craig P. Omtvedt

I don’t have that number in front of me right now. Tony, do you know what that number is?

Anthony J. Diaz

It’s minor.

Alexander Paris - Barrington Research

And then on the disposition and acquisitions and all of that?

Bruce A. Carbonari

First off, again to give you a little backdrop here. Our main focus is on internal growth. That’s our best return. And then when we get to acquisitions we look for things that are obviously in our core areas that we have competencies in and we’ve said this a million times now, we are focused on the home business and the spirits business as far as acquisitions. So let me take each one of those.

In the spirits business as you know we continue to look for acquisitions that would help our portfolio or round out our portfolio both in gaps that we have or enhance some of the positions we currently have in certain categories as well as acquisitions that would help us in the emerging markets, those markets being what we believe will be the high growth markets.

In the home space, it’s an interesting time. I think that there’s a number of assets that either now or soon, maybe in the next six to 12 to 18 months, I’m not sure exactly a timing, we think that may break loose, that we will be interested in it again, and we’ll be looking mostly on businesses that are near to our core today that we can add value by operating them better and obviously positioning them better. And we’ll also be looking for acquisitions that would help us expand internationally as well.

We weigh that obviously against our share buy-back programs and we look at that and compare acquisitions against share buy-backs all the time. And with our stock price where it is, we think buy-backs are pretty attractive so we’re always doing that analysis as well.

Alexander Paris - Barrington Research

One last question, Bruce. As you looked at the home and hardware trends during the quarter, did you see a meaningful deterioration or was this just an ongoing thing?

Bruce A. Carbonari

Yes and yes. I think we did see a bit of a deterioration. I look at that market and there are really three things that have to happen for us to get back to some normality. The first is the inventory that’s out there. We have an inventory supply, I guess the word that’s been used around the industry is overhang, and there’s a fairly high level of both existing and new homes out there. And even with the price adjustments that we’ve seen out there, it’s been a situation where we haven’t seen the flushing out of the inventory as quickly, although the builders have done a nice job of reducing the production and adding to it. It’s the foreclosure pieces that have added to the inventory that are offsetting it.

And then you look at credit markets. That would be the second thing. Liquidity, is there a credit market that can support the consumer here today. And now with mortgage rates going up more recently I think the banks are trying to figure out where they are and hopefully with this bill passing to get some stability to Freddie and Fannie, we need to have a mortgage market out there that’s stable that the consumers have confidence in and access to.

And then the last is the consumer. This all overlays with the pricing that we’ve seen, reductions with their lack of ability to get credit, and just a general psychology and confidence. I think they need to both first look at their personal income statements and make sure that the fuel and the food and whatever else that’s hurting their month-to-month budget gets stable as well as they see some stability in the assets that they own, particularly their homes.

So in all those areas I have not seen much progress. As a matter of fact, I would say in the credit markets and the consumer we see more deterioration. And that’s reflected both in continued softness in the new construction market and the R&R side of the business.

Operator

Our next question comes from Ivy Zelman - Zelman & Associates.

Ivy Zelman - Zelman & Associates

Realizing it’s really tough to maybe give me an exact figure on homes, just to understand sort of what’s going on-on the pricing front, my first question relates to the pricing pressure you may be feeling year-over-year in cabinets and faucets and maybe it’s not as severe as people thing but any color there or any quantification?

Bruce A. Carbonari

I would say Ivy that yes. It’s an interesting market from the standpoint that the commodities are just increasing dramatically in certain categories. We’ve seen powerful board; steel has been a huge one in the last six months; and then copper and zinc which are more stable this year but it has gone up dramatically. I think when the industry sees commodities go up like they have, everybody’s out there trying to get price increased, so we’ve actually been able to get that to offset a majority of a lot of these commodity increases. But generally it’s very competitive out there. I think that we haven’t seen, we’re seeing it in different forms, not just pricing, it’s coming in the form of promotions. I’d say in the big retailers, the Depots and the Lowes of the world, they’re trying to get foot traffic so the promotion activity has accelerated and make sure the weekend flier has something that would stimulate somebody to walk in the store and using some of our product categories to do that. But we continue to lead with new products and innovation and trying to get positioned there and keeping our pricing up as best we can, especially in the commodity front.

Craig P. Omtvedt

And Ivy, I think the thing I’d jump in and just add there is that year-to-date our price increases are covering the commodity price increases that we have. In the $15 million to $20 million that I said will become a reality, we’re looking at that as just something that because of lag effect between the timing that we get increases and we put price increases through is just something we’re going to have to eat. I mean clearly it’s getting more challenging but our objective here is to continue to cover those commodity cost increases both through price increases as well as further productivity initiatives.

Ivy Zelman - Zelman & Associates

Secondly, just probably a housekeeping item. You maintained your EPS guidance, maybe you already said this and I apologize if you did, but you lowered your cash flow guidance. So can you explain what the drivers are? And the last question just to throw it out there for you, Bruce, given your long history at Moen realizing that this cycle as many cycles are always different, how would you compare in contrast what you’re seeing from your experience and tenure in the business?

Bruce A. Carbonari

Sure. Craig, why don’t you take the first one.

Craig P. Omtvedt

Yes, let me deal with that. Ivy, we haven’t maintained our EPS guidance as we came out with in the preannouncement. We had an EPS guidance that was targeting us to originally be flat to down high singles and with the preannouncement we came out and said diluted EPS would be down high single digits to high teens. So going to the lower end of the cash flow target we had going to the 500 level versus the 500 to 600 syncs up with that and it is principally a function of just the lower net income expectation.

Bruce A. Carbonari

Ivy, to answer your second question, I’ve been in the house side of this industry for 20 to 25 years or so and lived through a number of cycles. The big umbrella themes are all the same of affordability and access. This one is different from the standpoint of how quickly it went down and I would say the difference, too, here I think is the credit markets, the banks and the mortgage piece and the write-offs. We had the S&L back when in the late 80s or early 90s. That was a smaller piece. It wasn’t across the board, the whole credit market. I think that’s the biggest difference. The consumer psychology and the confidence is always you see in the cycles and you always have the inventory overhang and you have to work through the inventory. But the credit markets and how the banks both domestically and internationally are trying to re-establish those markets and that’s the one thing that I’d say is a little different than some of the ones in the past.

Operator

Our next question comes from Eric Bosshard - Cleveland Research Company.

Eric Bosshard - Cleveland Research Company

The spirits business, any change in the US performance or feedback from your distributors or folks in the channel following the V&S news within the quarter?

Bruce A. Carbonari

No. There’s a lot of discussion about what’s next from the standpoint of “Are we going to look at another acquisition?” and things like that, that noise. But we always get that kind of buzz around the industry. It’s a pretty tight industry. I think the questions they’re looking for is “How are we going to support our brands going forward?” and this increase that we’ve had, this double-digit increase in brand spend, really talks to how and what we’re going to be doing in the future and how we’re going to talk to our audience a little bit differently than we have in the past. And they like that and they’re supporting it because it is different. We’re still very big; we’re number two or three depending on how you do the math in the US, and with most of our distributors we’re usually the largest vendor they have. So the relations are very strong, we’re well positioned in the US with some of the best distributors, and I think it’s business as usual. We have great brands and those brands work well especially in the US.

Eric Bosshard - Cleveland Research Company

Secondly, the golf performance in the quarter, the year-over-year profit decline was pretty severe and the full-year guidance for call it roughly 10% profit decline in golf is more than we’ve seen in a while. Is there anything going on with share or structural profitability in the category that is different or concerning?

Bruce A. Carbonari

Eric, no. I would tell you that we’ve chosen this time to really step up our investment in two areas in the business. One is in the emerging markets. We have been looking at, especially in Asia and especially China, and it’s been a big question mark out there about how will that market develop. And what we have seen through a lot of our research is that market is developing very well and with that we’ve decided over the course of actually the last 12 months make some significant investments in organization and distribution and in teaching. We do need to bring people into the game there and one of the things that we’ve learned in our history here in the United States is that when you’re first of mind, when people come into the game, there’s a lot of loyalty. And we’re trying to position that way and it costs money to do that.

The second thing we’re doing investment-wise is our relative share in the Titleist club business is one that was I would say underrepresented and we’ve beefed up our organization and our product line support. The first one that’s come out of that has been the AP1 and AP2 products. It’s irons. They are in a very tough consumer market out there, they’re on fire. We’re in four to six week backlogs. We can’t get the product fast enough.

So I would tell you that I’m very encouraged by what we’re doing but in order to growth a lot of times you need to invest and you need to invest in people or processes or geographic expansion. And we chose to do that about 12 months ago and we’re starting to see the benefits of that but when you go year-over-year it’s tough on a comparison basis. But we feel very confident we’re doing the right thing so we have fabulous brands and those brands are very expendable into these markets and into product categories that we aren’t as strong in.

Eric Bosshard - Cleveland Research Company

The quarter was at the high end of your preannounced guidance. What ended up running better than expected that put you at the high end of the guidance?

Bruce A. Carbonari

Craig, do you want to take that?

Craig P. Omtvedt

Yes. First of all I think that as you look across the business, the golf overall in terms of margins was a little bit better, we had a little bit better mix in the home business, and in terms of the spirits business, part of it was just simply timing of expenses.

Bruce A. Carbonari

Also the tax rate helped. We had that routine true-up Craig that was worth about $0.05.

Craig P. Omtvedt

Yes. You’re right. That took us to the [125 million?] that put us above guidance or put us above consensus. I was basically carving that out, but you’re right, that’s an additional point.

Bruce A. Carbonari

If you take that $0.05 out, we’re above [20 million?].

Operator

Our next question comes from Bryan Spillane - Banc of America Securities.

Bryan Spillane - Banc of America Securities

I may have missed this in the prepared remarks, but I’m just trying to get a sense for how the spirits business performed sequentially in the second quarter versus the first quarter both in the US and international. Do you have a depletions figure for the second quarter and how that sort of measured up versus the first quarter? And if in international you could strip out the impact of the RTD business, that would be helpful.

Bruce A. Carbonari

Sure. I’ve got to dig for the depletion numbers and I’ll have them in a second for you. But let me talk about generally the market and then our performance of the market. This market I think as we said we’ve seen a certainly 2% to 4% growth, that’s on a volume basis, we’re seeing market-wise again Bryan we’re seeing it roughly about 3% year-to-date. And we’re performing in line with that and it’s up and down. Our DeKuyper brand’s a little softer here in the states mostly because Apple Pucker was on fire for a number of years and it’s not as hot of a drink right now and that’s the one that’s hurting our DeKuyper brand. But in general the market’s holding up well and although the premiumization has slowed, it continues to be the fastest part of the market and as you know we participate well in that category.

International markets are a little different story. The merchant markets, the brick that I talked about before, still very, very strong. We’ve seen Spain which is a heavy on-premise environment, almost 70% on-premise, become very soft during the quarter. And I think actually the housing market there has gone through a bubble as well and we’ve seen that impact. And we see a little softening in the UK coming as well. But I think the bigger question in third quarter is how Western Europe will perform here, in general the economies and then what will happen with the spirits business.

So if you looked at our first and second quarter depletions, they are similar in the first and second quarter. We’re basically flat year-to-date and in the second quarter in the US. And again what I’ve got to emphasize is because this is an important part of our strategy, one of the things that we’re trying to do with this brand spend is to build equity in our brands especially the Allied brands that we acquired, brands that had not had a lot of support for a long time. So when you look at our depletion volume rate at flat, you also have to look at the value rate and that’s up 3 to 4 points faster on a depletion basis. And that’s exactly what we’re trying to do because obviously the economics of getting dollar value to the bottom line is greater. So it impacts the OI more significantly.

Operator

Our next question comes from Todd Duvey - Bank of America.

Todd Duvey - Bank of America

Craig, a couple of questions for you on the balance sheet cash flow. Still you’ve got very solid free cash flow. No qualms there. I guess my question is, and you talked about it a little bit in terms of free cash flow priorities, acquisitions and share buy-backs, can you just talk about remaining authorization for share buy-backs and if you plan to primarily use the free cash flow the back half of the year for share buy-backs absent any acquisition opportunities?

Craig P. Omtvedt

Yes. First let me just cover the specifics here. As Bruce mentioned, year-to-date we’ve purchased 4.3 million shares. We have an outstanding authorization for 15 million so just taking the difference there; we have the authorization to purchase potentially another 11 million shares. What we will or won’t do as we’ve said repeatedly is not something we would speculate on at this point. Obviously we see the stock prices and share repurchases highly attractive and so the one thing I can say with definitiveness is that we will indeed purchasing additional shares but at this point wouldn’t speculate on exactly what that amount will be. We obviously have gone out now and we’ve repurchased the D minority interests for $455 million so that’s going to add to our debt level. The only thing I would say to you at this point is that our default position continues to be one of saying that being investment grade is important to us and as I’ve said repeatedly, we like what that does for us in terms of access to markets as well as the cost of debt. So beyond that there’s not much else I would say at this point.

Bruce A. Carbonari

Let me just add, Todd, to that. Again I go through our priorities because I think for all of you have been with us for a long time, we’re very disciplined and that discipline is focused on first, cash is to be used for organic growth. Organic growth gives us the best return. From there, we then look at moving our businesses into adjacent markets and other categories, again in their organic fashion. Then you get to that sort of third level and you have acquisitions versus share buy-back and we do that analysis against each other to see basically is the strategy and the business case worth the not buying shares back, if you will. And then the fourth we go right to the dividend and we just as you heard today we had an increase in our dividend. So that combination is one that we’re very disciplined about. At the end of the day we’re still in the mid eights, 8.5% to 8.7% and when you look at our total yield both cash and dividends, so we think that a healthy yield for our shareholders today, but also with our flexibility in our balance sheet we’re allowed to do other things like the acquisitions and the share buy-backs. And the last one I’ll make here before I turn back to the next question is one of the things I really like where we are right now is our balance sheet because we have flexibility to do stuff and I think that’s critical for us during these times to have that type of flexibility. I think we really have an opportunity to create value and have the opportunity to selectively look at a lot of different options.

Craig P. Omtvedt

And Todd, I just reinforced from kind of the standpoint that I know you come from, I think we’ve consistently demonstrated a responsible approach in what we do.

Todd Duvey - Bank of America

Just one quick follow up questions with respect to that, you’re going to have a little more debt on the balance sheet compared to what was reported and your leverage is going to be up a little bit. You’ve got about $1 billion in short-term debt plus the debt related to the Beam stake buy-back and then you’ve got a maturity coming up in January. Are there any plans to pay down any of the debt or would you look to refinance that?

Bruce A. Carbonari

That’s something we’re evaluating right now. We just haven’t decided whether to stay with fixed and do swaps or go commercial paper and swap the other way. We’re still evaluating that so it would be premature to try to comment.

Operator

Our next question comes from Analyst for Jonathan Feeney - Wachovia Capital Markets, LLC.

Analyst for Jonathan Feeney - Wachovia Capital Markets, LLC

I was hoping we could just drill down real quickly into the areas you specifically called out as being soft on the spirits side, Florida and California. Two questions on that subject. First, can you quantify just how much worse those softer spots are relative to the total spirits performance? And as a follow up to that, how does that force you to do business differently in those regions and are you able to take a different strategic approach to those foreclosure hotspots where the consumer’s really hurting?

Bruce A. Carbonari

To quantify it exactly, I can tell you what’s happening and how it affects our brands and how we’re attacking the market differently than what we have before. In general those markets are as I suggested before markets that have been hit highest by the housing bubble. I think what you see there and where we see it the most is people there are not going out to restaurants, not going to bars, so the on-premises has gotten softer. Some of the inner bigger cities like San Francisco and L.A., not as much, and Miami but when you go to the other, the Orlandos, the Stocktons, you see that the casual dining side especially is much softer. You’re also seeing trading down more in those states than in other states and in some cases that helps us and in other cases it doesn’t help us. So obviously our response centers around what is the consumer doing, what’s the consumer appetite, how are we running our promotions, the point of sale material, and making sure we’re matching up to that change in consumer behavior, what they’re buying and how they’re shopping and where they’re going. And we’ve adjusted our businesses in conjunction with our distributors who are also seeing it to realign that to whatever the consumer behavior is. And that’s an ongoing process because it’s a market that’s changing quickly.

Analyst for Jonathan Feeney - Wachovia Capital Markets, LLC

One quick follow up, the trading down you reference in your response there, more specifically is that sort of the slowing of premiumization within spirits or through you and some competitors we get the sense that there’s also a shift going on at least in those foreclosure hot spots that consumers are quicker to pick up beer maybe instead of high end spirits as they feel the [inaudible]. Are you seeing that more so in those foreclosure regions as well?

Bruce A. Carbonari

Actually not. The overall spirits and beer numbers when you look at April and May and in fact it’s through the first half of the year, the spirit numbers have continued to outperform the beer numbers significantly. So we feel that that’s not the case. In particular I have not gone back and looked at particular states and how beer is performing against wine or against spirits in general, but we look at it under the macro market basis of the US and spirits continues to be strong. Premiumization is still the highest growth area but it’s at a slower rate than it had been performing last year.

Operator

Our next question comes from Analyst for Peter Lisnic - Robert W. Baird & Co., Inc.

Analyst for Peter Lisnic - Robert W. Baird & Co., Inc

You talked kind of about the steps for home and hardware to stabilize and it’s kind of dependent on the credit markets and other things. Given that there’s potential for that to take a while, are there still further cost reductions you can take out or are you really going to start hitting the long-term growth potential of the company if you say cut another 5% of facilities out or another 5% of headcount?

Bruce A. Carbonari

We continue to look and evaluate that as it gets harder year after year when you, we’re doing now our third year, so it’s never easy first of all, but I mean it’s easier the first year and the second year because it’s harder to strip things back. The bigger question I think is do we have the right supply chain for whatever the demand level is, not just for this year but for the future. And that’s the thing that we continue to say is that we don’t want to cut out a dollar today to pay $2.00 tomorrow and that’s something we’re evaluating continuously. I think there may be a few opportunities out there but we’ve done a lot. We’ve been ahead of the game if you recall if you look back to what we did in 06 and 07 in the fourth quarters. We were very aggressive ahead of the market to get ourselves positioned and that’s a continual process that we do with each of our businesses and each business is in kind of a different stage of it. What we won’t do is back down on our new product innovations and we won’t back down on our brand positioning and we won’t back down on our expansion to adjacent and international markets because that’s the future and we need to make sure that that’s well positioned. And again as Ivy had said earlier I’ve been through this a number of times and it’s a great opportunity to gain shares and reposition your company. And we have the strength of the balance sheet and the strength of our breadth and the balance of our portfolio should allow us to do that.

Analyst for Peter Lisnic - Robert W. Baird & Co., Inc

When you mentioned commodity costs, I think there was grain cost in there. Given the aging that you have to do for most of your products and I think you’re on [FIFO] for that, is that actually hitting results or is that something you’re going to see a year or two down the line?

Bruce A. Carbonari

Actually it’s a two-parter. The grains we were talking about relate to purchasing wheat for some of the other products that we have so as we look at the cost increases that we have in spirits right now, we’re paying more for glass and then obviously wheat for the products that are distilled and sold currently. The higher corn costs as you rightly outlined are going into obviously the product that’s aging and we’ll see that four years out. But in terms of impact on aggregate of cost of goods sold four years out, currently it’s not going to be a meaningful number.

Operator

Our next question comes from [Dennis McGill] - Zelman & Associates.

[Dennis McGill] - Zelman & Associates

On the share repurchases, I’m sorry if you gave these numbers, but do you have the split between what you bought in the second quarter and what you bought in July or is all that in the second quarter?

Bruce A. Carbonari

Yes, through the end of June we had purchased approximately 2 plus million shares and then subsequent to our preannouncement we purchased an additional approximately 2 plus million or 2.3 million, it’s in that band width.

[Dennis McGill] - Zelman & Associates

Do you have an average price for the whole 4.3 million?

Bruce A. Carbonari

Yes, as it stands right now we’re at about $61.60 or so as an average price.

Operator

There are no further questions at this time. Mr. Carbonari, do you have any closing remarks?

Bruce A. Carbonari

I do. Thanks again for joining us. We’ll continue to work hard to outperform in our categories and investing in the future to drive sustainable long-term growth and returns. We look forward to speaking to you again in October. Thanks for your time.

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Source: Fortune Brands, Inc. Q2 2008 Earnings Call Transcript
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