Fortune Brands Innovations Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2023

There are 10 speakers on the call.

Operator

My name is Shamali, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Call.

Operator

I would like to turn the call over to Leigh Avszak, Vice President of Investor Relations and Corporate Affairs. You may begin the conference call.

Speaker 1

Call. Good afternoon, everyone, and welcome to the Fortune Brands Innovations Second Quarter Earnings Call. Call. Hopefully, everyone has had a chance to review the earnings release and our web posting for additional information on our most recent acquisition call as well as our supplemental financials. The earnings release and our audio replay of this call can be found in the Investors section of our f call.

Speaker 1

I want to remind everyone that our forward looking statements we make on the call today, either in our prepared remarks or call. The associated question and answer session are based on current expectations and market outlook and are subject to certain risks and uncertainties call that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC. Call. The company does not undertake any obligation to update or revise any forward looking statements except as may be required by law.

Speaker 1

Call. Any references to operating profit or margin, earnings per share or free cash flow in today's call call. We will focus on our results on a before charges and gains basis, unless otherwise specified. Please visit our website for our reconciliations. Call.

Speaker 1

With me on the call today are Nick Fink, our Chief Executive Officer and Dave Barry, our Chief Financial Officer. Call. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick. Nick?

Speaker 2

Call. Thank you, Lee, and thank you to everyone for joining us today. On this call, I will walk through the highlights of our 2nd quarter performance call and offer some thoughts on the macro environment. I will also discuss our recent acquisition and how we expect these leading brands to call. I'll then turn the call over to Dave for a discussion of our financial results call and how we are thinking about the remainder of 2023 including the upward revisions to our market forecast and increase to our full year call.

Speaker 2

Turning to our 2nd quarter performance. Call. Our results and the actions we took this quarter demonstrate the resilience and strength of Fortune Brands innovations. Call. Our teams delivered solid sales and strong margin results amidst an external environment that remains dynamic.

Speaker 2

Call. Our leading brands are focused on meaningful innovation and our advantage channel relationships positioned us well call. I want to thank all of our associates for your dedication and pursuit of excellence, and again welcome our newest associates call. Together, we are going to continue to build an exceptional company. Call.

Speaker 2

Net sales of $1,200,000,000 in the quarter were down 7% versus the prior year and our operating margin call. Our top line results were 50 basis points above our estimates for our market. Call. These results demonstrate our ability to grow above the market, protect margins and invest in key strategic growth initiatives even in a challenging environment. Call.

Speaker 2

Our sales and margin performance generated earnings per share of $1.07 Call. As we discussed on our last earnings call, heading into the Q2, we knew that we were coming up against uniquely challenging year over year comparisons. Call. As we expected, we saw sequential point of sale dollar growth versus the Q1 of 2023. Call.

Speaker 2

It was not at the same exceptional levels of ramp up that we experienced in 2022. As a reminder, the slowdown in the market for our products call. And major inventory destocking began in the second half of twenty twenty two. In fact, our Q2 2023 organic sales results call. We're 19% higher than in the Q2 of 2019, demonstrating that consumers continue to be interested in investing in their homes.

Speaker 2

Call. Our results this quarter reflect our unwavering focus on our growing the market, preserving margins call. And generating cash, all while continuing to prioritize key investments, including brand building, thoughtful capacity additions, call. I believe that we are very well positioned as we head into the second half call. Turning now to some thoughts on the current U.

Speaker 2

S. Housing market and the market for our products. Call. As we have consistently stated, demand outstrips supply in the U. S.

Speaker 2

For housing, which creates a market opportunity for our products in both new construction call. There is significant pent up housing demand driven by several factors that I'll touch on shortly. Call. This demand together with our strong and optimally positioned brands will result in medium to long term tailwinds for our business call. Starting with new construction.

Speaker 2

As has been widely reported, call. The new home construction market has fared better than anticipated despite higher interest rates. Existing home inventories remain near historic lows call. As U. S.

Speaker 2

Housing remains severely under bolt, builders, particularly the large production builders with whom Fortune Brands enjoy strong relationships, call. Have been responding to affordability challenges in the dynamic marketplace by building spec inventory and providing sales incentives including rate buy downs. Call. Sales of new homes have been increasing throughout the year and starts are again outpacing completions. The backlog of new homes is also increasing, call, albeit at a much more manageable rate.

Speaker 2

With that as a backdrop, we have revised our single family new construction outlook upward call for the remainder of the year, while continuing to monitor for economic volatility and the potential for a full recession. Call. Turning to R and call. Our products are uniquely and optimally positioned to outperform. Several factors are converging to result in a unique opportunity for growth.

Speaker 2

Call. First, the current lack of existing inventory combined with the fact that over 80% of mortgages are under 5%, call. It means that people are more inclined to stay in place and make the home they have into the home they want. Next, call. Consumers continue to have high confidence in their homes as an asset given the extremely high levels of home equity and personal real estate investments, call.

Speaker 2

Finally, the average home is over 40 years old call. And homes built during the early 2000s boom are coming into prime R and R age. Additionally, the baby boomer generation continues to prefer aging in place call. And investing in their homes, while millennials and other first time homebuyers are purchasing homes in need of upgrades due to limited available inventory call. These demographic trends are all supportive of repair and remodel.

Speaker 2

Call. Our data shows that our products are less tied to existing home sales and instead are more dependent on factors like consumer confidence, age of the house call. We believe our products are relatively more insulated than other R and R items call because they are smaller ticket items, are less disruptive to install and because they offer immediate aesthetic improvement or meaningful innovation and functionality call. In short, people buy our products because they want to enjoy them. That said, call.

Speaker 2

We are aware of the uncertainty inherent in the broader macro environment and we are watching market conditions closely and we will respond quickly if warranted. Call. Turning now to our most recent acquisition. I'm extremely excited about the recent acquisition of 2 world class businesses from ASSA ABLOY, call. And the U.

Speaker 2

S. And Canadian Yale and August residential smart lock business. Call. Dave will provide more color into the numbers, but at a high level, we expect second half twenty twenty three sales for these businesses call to be approximately $190,000,000 to $210,000,000 and for this deal to be accretive to our P and L in 2023 call. With $0.04 to $0.06 of EPS, even after factoring in $0.08 of purchase price amortization.

Speaker 2

Call. This acquisition is a great example of our disciplined approach to M and A. Emtek and Schaub call. The market leading brands in the luxury hardware space and will be a fantastic complement to our House of Roll business. The margins for these brands are exceptional call.

Speaker 2

And we look forward to leveraging the team's demonstrated skill at driving phenomenal customer service and highly designed products, call. We are also maintaining high margins across the entire Fortune Brands portfolio. Clearing on Tekken Sharp, our luxury platform call. We'll now be over $500,000,000 in annual sales and the potential synergies are meaningful. This acquisition will allow us to expand our presence in luxury showrooms, call.

Speaker 2

Further penetrate the luxury hospitality market and become an authentic global luxury design house offering cohesive product offerings call. Our consumer remains strong and is increasingly interested in products with storied brands call. And we believe our growing luxury portfolio speaks to the secular demand trend. Call. The Yale and August residential smart security businesses consist of innovative brands with a strong IP portfolio call.

Speaker 2

As part of the acquisition, we've added roughly 100 new engineers supporting in house software and hardware platforms, call. We will leverage across our portfolio of brands over time. In addition, this acquisition call. We will now allow us to expand our retail and omni channel and wholesale door lock business, broaden our residential connected security ecosystem call. And accelerate innovation across our brands, including the potentially transformative development of a fully integrated smart entry door system.

Speaker 2

Call. Here again, the potential for synergies is significant. Call. This acquisition will be a key accelerant to our growth strategy. It allows us to expand in existing channels and categories, call, as well as in new high growth spaces with secular tailwinds.

Speaker 2

Importantly, through the addition of Yale in August, call. This acquisition is a key step in our transformation into a digital innovative disruptor. Further, call. With the addition of Emtek and Schaub, we will materially accelerate our strategy to build the house of Roll into a global luxury powerhouse for the entire home. Call.

Speaker 2

Combined with our existing Fortune Brands business, we now have the knowledge base, the growth platforms and the brands call. To bring new and disruptive products and services to the market that will be the first of their kind. Call. Overall, Fortune Brands Innovations is well positioned for both the near term and the long term. Call.

Speaker 2

Our branding power, meaningful and value add innovation and strength in the multi step distribution channel are powerful motes in uncertain times call. Our recent acquisition of the leading Emtek, Schaub, August and Yale brands call. We'll provide growth opportunities and nicely complement our strategic focus on branding, innovation and channel. Call. Our brands are uniquely positioned to outperform the market in all environments and our newly aligned structure together with our Fortune Brands advantage capabilities call.

Speaker 2

We'll enable this outperformance as our results demonstrated this past quarter. As we announced in the release this afternoon, call. We are raising our full year sales and free cash flow guidance and again raising our full year EPS guidance. Dave will give more details, but this increase call. Before I turn to the individual businesses performance, I would like to remind everyone call.

Speaker 2

Our Q2 2023 results reflect both the impact of challenging prior year comparisons, plus the impact of the single family new construction market, call, which slowed abruptly in the second half of twenty twenty two. That slowdown is now being digested through our business. Call. In the Q2, Water Innovation sales declined 5% compared to the prior year quarter call. Due to market driven volume declines across the segment, partially offset by price, our margins for the segment were 23.2%.

Speaker 2

Call. The Moen U. S. Business has strong longstanding relationships with the top U. S.

Speaker 2

Production builders and our strategic decision call. To invest in our relationships with these key customers yielded tangible results. In retail, we saw more general market softness call. Our House of Rolled Brands total sales were up low teens for the quarter, including Aqualisa call. And down high single digits organically reflecting the impact of high second quarter 2022 comps and a softer market.

Speaker 2

Call. For the full year, we expect our organic sales to be flat as our story of craftsmanship and unique designs continues to resonate with the luxury consumer call. We recently announced the building of a new facility in the UK, call, which will help meet global capacity needs of the business as we continue to expect our brands to perform well. Call. In China, sales were up over 30% year over year.

Speaker 2

This reflects the impact of lapping the Q2 of 2022, call, which was marked by the Shanghai COVID shutdown. We also saw higher than expected project completions, although the overall market remains soft call. And the Chinese consumer remains cautious. However, we continue to capitalize on our leadership positions and are well positioned within the Chinese housing market, call, where we are increasingly focused on the emerging Chinese R and R market. For the full year, we now expect China sales call to be down high single digits.

Speaker 2

In outdoors, sales declined 14%, reflecting expected market softness, call, which was partially offset by price. We saw sales improvement sequentially throughout the quarter and are encouraged by July results so far. Call. We're pleased with our operating margin of 16.4%, which is 80 basis points higher than our Q2 2022 results call. And as a proof point of the success of our newly aligned operating model.

Speaker 2

We are well positioned across our outdoors brands call. To respond to any changes in demand patterns and are making investments to continue to best serve all of our customers and channel partners, call, while also focusing on the innovations, which we believe will further differentiate our products. In decking, call. POS trends indicate continued strong consumer interest in this category and the recent reacceleration of sales call. As the value proposition is increasingly understood by consumers and pros alike.

Speaker 2

Wholesale sellout improved throughout call. And we exited June up high single digits. In the quarter, sales were down high teens versus the same quarter of 2022. However, call. When comparing to Q1 of 2023, we saw sequential sales increase by more than 50%.

Speaker 2

Our channel partners were conservative with inventory buys in the beginning of the quarter, call. In June and into July, we've been accelerating their inventory purchases and our POS data shows that we are growing above the market. Call. Endoors, sales declined low teens as the slowdown from the 2022 single family new construction market impacted ThermoTrue. Call.

Speaker 2

We are confident in the long term opportunity as well as the strength of our product offerings and our long standing advantage relationships with our key customers and channel call. As we look to maintain and grow market share in the most attractive parts of the market, including in the single family new construction market. Call. Lastly, in security, sales increased 2% over the prior year quarter. Call.

Speaker 2

These results were driven by price and continued growth in commercial and international markets. As we have previously mentioned, our Security and Water businesses call. Thank you, everyone. Thank you, everyone. Thank you, everyone.

Speaker 2

Thank you, everyone. Thank you, everyone. Thank you, everyone. Thank you, everyone. Thank you, everyone.

Speaker 2

Thank you, everyone. Thank you, everyone. Thank you. Thank you, call. The Security business continues to implement the Fortune Brands Advantage playbook call that we first used to transform our water business 8 years ago and the results are becoming apparent.

Speaker 2

Going forward, call. The team will work to continue to evolve this business into a higher growth, higher margin business focused on driving the power of our brands and developing call. Before I turn the call to Dave, let me share a few final thoughts. Call. We took meaningful steps this past quarter to prepare Fortune Brands for continued growth.

Speaker 2

Our reorganization into a more efficient call. A centralized company focusing on brands, innovation and channel has progressed more quickly than we anticipated, call. Thanks to the strong engagement from our teams and the impact was apparent in our results. We made important changes to our supply chain call. To align with our growth areas and margin progression targets, we continue to invest in our key strategic priorities, including our iconic brands, call.

Speaker 2

And finally, we closed on an exciting potentially transformative acquisition call that we expect to drive growth and accelerate our larger strategy. As we highlighted last year, call. The actions we took in 2022 were designed to transform Fortune Brands into a growth focused, highly innovative company. Call. 6 months following our separation, I am encouraged by all that we've accomplished and excited about what we will achieve next.

Speaker 2

Call. As reflected in our revised full year guidance, we see some positive indicators of a healthy consumer, while also being mindful of potential call. We're constantly monitoring and are well prepared to respond to uncertain end markets in the short term, call. While we position ourselves for accelerating longer term outperformance in the market supported by fundamental growth characteristics. Call.

Speaker 2

As we head into the second half of twenty twenty three, we are focused on execution and delivering on our commitment call to above market sales growth and margins. With that, I'll turn the call over to Dave.

Speaker 3

Call. Thanks, Nick. As a reminder, my comments will focus on income before charges and gains to best reflect ongoing business performance. Call. Additionally, comparisons will be made against the same period last year unless otherwise noted.

Speaker 3

Let me start with our 2nd quarter results. Call. As Nick highlighted, our teams executed well this quarter amid challenging comparables and the impact of last year's abrupt slowdown in single family new construction. Call. Our results reflected their dedication.

Speaker 3

Sales were $1,200,000,000 down 7% and consolidated operating income was call. $198,000,000 down 11%. Total company operating margin was 17% and earnings per share were 1.07 call. Our sales in the 2nd quarter largely tracked our POS. Volume was down high single digits, which was partially offset call.

Speaker 3

Changes in channel inventories did not impact consolidated results. Call. As we discussed previously, we expected operating margin in the first half of twenty twenty three to be heavily impacted by production inefficiencies call. And stranded fixed costs related to our inventory reduction efforts. We continue to make excellent progress against our near term inventory reduction target call.

Speaker 3

And our organic 2nd quarter inventory finished at $845,000,000 down roughly $240,000,000 from our Q3 2022 peak. Call. Our 2nd quarter operating margin of 17% included a roughly $20,000,000 impact from these efforts, call. Bringing the total P and L impact in the first half to more than $50,000,000 Going forward, healthier supply chains call. And our more aligned organizational structure should improve our ability to accurately forecast with continued focus call.

Speaker 3

While we are pleased with our 2nd quarter results, our teams remain focused on driving outperformance, call, including above market growth, preserving and enhancing margins and generating cash. Our continued focus on these performance metrics call. As I will detail later, our balance sheet remains strong call. And we have the flexibility to manage through various economic outcomes while deploying additional capital to drive shareholder value. Call.

Speaker 3

Now let me provide more color on our segment results. Beginning with Water Innovations, sales were $617,000,000 call, down 5% and down 6% excluding the impact of the Aqualisa acquisition and FX. The net sales results reflect the impact of lower volumes, call, partially offset by price. Water Innovations operating income was $143,000,000 and operating margin was 23.2%, call, reflecting lower volumes, partially offset by price and continuous improvement initiatives. Our point of sale performance for Moen call.

Speaker 3

Was down low double digits and in line with our expectations given the challenging comparable period and prior year slowdown in single family new construction. Call. House of Roll total sales were up low teens, while organic sales, excluding our Aqualisa acquisition, were down high single digits, call, primarily due to strong prior year comparables and market softness, which was most pronounced outside the United States. Call. China sales grew more than 30%, primarily due to an easy comparable following the prior year's COVID shutdown that acutely impacted the Shanghai region.

Speaker 3

Call. The Chinese market remains soft and though the completion of delayed projects is accelerating, new home sales and starts

Speaker 2

call. We are moderating as the

Speaker 3

Chinese consumer remains cautious. That said, we continue to see growth in the emerging R and R channels call and are positioned for market outperformance due to the strength of our brands and expertise of our in country leadership. Call. Turning to outdoors, sales were $376,000,000 down 14%. Segment operating income was call.

Speaker 3

$61,600,000 down 10%. Importantly, our margins improved both versus the prior year call. We are now seeing a sequential decline in our sales and marketing strategy. We are now seeing a significant increase in our sales and marketing strategy.

Speaker 2

We are seeing a significant

Speaker 3

increase in our sales and marketing spend in the quarter. Call. As expected, sales were impacted by lower volumes from the single family new construction slowdown in 2022 and the challenging POS comparables. Call. However, our wholesale business is performing above market and the business should be positively impacted by the improved new construction outlook.

Speaker 3

Call. In decking, as Nick mentioned, we saw POS accelerate through the quarter and continue to expect full year sales to be roughly flat to prior year. Call. Finally, in Security, sales increased 2%, reflecting increased distribution, price and continued call. Security segment operating income was $27,000,000 up 6% versus 2022.

Speaker 3

Call. Segment operating margin was 15.6%, up 70 basis points. Our team continues to work to transform our call. Security business into a higher growth, higher margin business focused on attractive categories, where our brands and innovations can drive consumer and customer share gains call over time. This strategy will be accelerated by the integration of the Yale and August assets.

Speaker 3

Call. Turning to the balance sheet and our cash flow performance. Our balance sheet remains strong with cash of 682,000,000 call. Net debt of $2,600,000,000 and net debt to EBITDA leverage at 2.9 times. This leverage ratio reflects the impact of our recent acquisition, call, and we expect to reduce our net leverage ratio over time as the business continues to generate strong cash flow.

Speaker 3

We generated free cash call. We have a flow of $358,000,000 in the quarter, bringing our first half free cash generation to $391,000,000 call. Our working capital reduction efforts continue to shrink our balance sheet and generate cash. To summarize the quarter, call. We delivered solid sales and strong margin results in a fluid environment, while overcoming the most challenging period of prior year comparables call.

Speaker 3

And the impact of the slowdown in single family new construction market in 2022. With that call. If you don't mind, I'll now provide an update to our 2023 guidance, inclusive of the acquisition of the ASSA ABLOY assets. Call. As indicated in our release and in our supplemental presentation, for the second half of twenty twenty three, call.

Speaker 3

The acquisition is expected to generate net sales of $190,000,000 to $210,000,000 and earnings per share of $0.04 to 0 point 06 dollars call. This includes the unfavorable impact of approximately $0.08 from purchase price amortization. Based on our revised market assumptions, call, which include an improved outlook for U. S. Single family new construction, plus the impact of the ASSA acquisition, call.

Speaker 3

We now expect full year consolidated Fortune Brands sales to be flat to down 2% or down 4% to 6% on an organic basis. Call. We now expect full year operating margins between 16% 16.5%, reflecting the impact of purchase price amortization from the acquisition. Call. On an organic basis, we continue to expect operating margin to be around 16.5%.

Speaker 3

Call. As today's press release and our supplemental web posting indicated, we are increasing the midpoint of our EPS guidance by $0.08 call. And narrowing the overall range to $3.75 to $3.90 reflecting the acquisition call and our organic businesses performance in an improving market. As a reminder, we previously raised our EPS guidance call during our Q1 2023 earnings call, reflecting our operational outperformance. So in total, our updated EPS guidance reflects call.

Speaker 3

It's a $0.13 increase over the midpoint of our initial guidance. In closing, as we head into the second half of twenty twenty three, call. We remain ahead of or tracking to the guidance targets we put forth at the beginning of this year. We have delivered solid sales results, call. We've successfully managed our margins and made significant improvements in cash generation.

Speaker 3

Our teams have done a fantastic job navigating the uncertainty of the past few years. Call. And as we come into the back half of twenty twenty three, we remain confident about the future of the business. I will now pass the call back to Leigh to open the call for questions. Call.

Speaker 3

Please?

Speaker 1

Thanks, Dave. That concludes our prepared remarks. We will now begin taking a limited number of questions. Call. Call.

Speaker 1

I will now turn the call back over to the operator to begin the question and answer session. Operator, can you open the line for questions? Thank you.

Operator

Call. There may be a number of you who would like to ask a question. I ask that you limit your initial questions to 2 and then reenter the queue to ask additional questions. Call. Our first question comes from the line of Phil Ng with Jefferies.

Operator

Please proceed with your question.

Speaker 4

Call. Hey, guys. Appreciate the great investor deck. It's got some good insights on the asset deal. Looks like you're anticipating pretty strong growth call.

Speaker 4

With sales stepping up from $400,000,000 to $525,000,000 in 20.26. Can you provide some color on the growth drivers? Call. And Nick, I think you don't typically bake too much cross selling in past deals. What's giving you the confidence on call.

Speaker 4

The cross selling synergies you're calling out, I think it's about $65,000,000 to $85,000,000 How do you see that kind of wrapping up and what are some of the big opportunities?

Speaker 2

Call. Thanks for the question. Happy to elaborate a little bit. And we obviously seen call. Variety of deals and done a variety of deals over the time.

Speaker 2

This one really sits at a wonderful crossroads of being fantastic call. Brands backed by an excellent team, a great price pay through some really call. Disciplined approach to the asset itself. But then thirdly, the third part of the intersection is really the opportunity to come and unlock call. Growth by putting these things together in our portfolio.

Speaker 2

And we try to be really disciplined around value, but then also really disciplined call. On the other two items, which is looking for great brands and teams, but asking where we can add value with the Fortune Brands call. And I'd say this is one of the more exceptional deals that we've seen. And so I'll give you a couple kind of call. Key foundational pillars and then happy to elaborate if it's helpful.

Speaker 2

But one, I'll just start actually with the Emtek business. Call. So Emtek and Schaub, leader in the luxury hardware category, very design led, call. A lot of colors and choices for designers, incredible supply chain and service, really concierge approach call. And doing that at really, really fantastic margins, not something that you see very often bringing all of those things together.

Speaker 2

And we look at the House of Roll platform, which you can see in the call. The results here continues to take share and outperform the market and is really, really resonating with consumers and designers. By putting those two things together over time, call. We'll now have a platform that's north of $500,000,000 outgrowing the market and has global reach, call. Right.

Speaker 2

And the elements really work together, whether it be in the channel where we have overlap in types of distribution channels, but not necessarily Overlapping all of our distribution, but then even things like being able to unlock collections for an entire room, call. Do color matching, do design work together and really provide a solution where a designer or consumer gets to put something together the way they want it, call. But in a way that works with our backing as a company. And so that's an example. And then I think you go over to the other side, Yale in August, call.

Speaker 2

Really driving tech first and connected product first and the August platform itself as we're getting in there and learning call. More about it, we think is a very, very powerful platform. That is something that we can bring in the business, by the way, learn from what call. They've done and be really thoughtful about how we integrate it, but we see it as a huge unlock and potentially a transformational unlock call. In our Connected Products business generally, right, the ability to bring that many engineers, that skill set, that kind of agile and fast call.

Speaker 2

Way of working, into the investments we've already made, which we're really happy with, but we think it could be exponentially greater when When you bring those two things together and one of the things that we called out in the deck, for example, is Smart Entry, right? We're going to have one of the leading entry call. Lock businesses and brands with some of the best, if not the best technology and you marry that with the leading Call. Fiberglass Entry Door brand already kind of a leader in its space, right? And think about all the innovation that went into that.

Speaker 2

Call. And you actually make that thing work not as a just a bolt on to an existing system, but a total system solution for consumers. Call. That's just an example of the kinds of things we're thinking about. And so the team has been getting off to this one really enthusiastically.

Speaker 2

Call. The number of deals, I'm not sure I've ever seen a business team sort of jump on synergies, the way this team's jumped on them and with the level of call. And really kind of pushing it beyond our initial case, which we thought was pretty good to begin with. And so you bring all those things together, we just think It's really exciting to have this quality of brands, this team coming into our portfolio with this potential transformational unlock and to have been able to do it

Speaker 4

call. That's super. That's great color. Nick, glad to see you're really excited about this transaction. Call.

Speaker 4

You bumped your organic sales guide. Give us some color on any intra color intra quarter trends you saw early read into July. Call. You've expressed a more upbeat outlook on new construction. How do you see that inflection in the orders the builders have called out call in your business, particularly plumbing and doors?

Speaker 4

Thank you.

Speaker 2

Yes. So I'll start and then I'll hand it over to Dave and he can give a bit more call. I'd say at the highest level, if you think about it, it's actually been fairly consistent thematically with what we saw call. In the Q2. And so what did you see?

Speaker 2

You saw relative strength in both call. Boulder, I think relative to expectations, in their order books and what was being reported. Now, call. Obviously, in Q2 of 2023, we're digesting the slowdown from last summer, right? Call.

Speaker 2

And so the uptick is yet to come through the P and L. And then on the R and R side, I'd say relative strength in everything that was more call. Project or pro related and relative weakness in things that were more kind of call. DIY or weekend warrior related. And I'd say as you've been looking to July, I'd say thematically that continues to be true.

Speaker 2

And we're going to see call. More uptick around the large production builders. We're seeing their value chain, supply chain start to strengthen as people prepare for those orders to call. Come through. We've seen continued strength in our pro related channels where the projects continue to be strong.

Speaker 2

And it's more around the very discretionary call. DIY products that you continue to see some weakness, but as Dave alluded to in his remarks, even there, in the last few weeks, there call. Some encouraging signs of certain product groups where you're seeing, at retail a little bit more life than we've

Speaker 3

call. And so I'd add some color around just the second half sales call. And so if our prior organic guidance was down 3% to 5%, remind people that includes the extra call. Non repeating fiscal week from last year that for the second half is roughly 2 percentage points all in the 4th quarter call. Or 4 percentage points overall.

Speaker 3

So that's organic guidance then call it down 2 percentage points excluding that comp. We're moving it at the mid call. Point of our current guidance now to flat in the second half of the year. And I think simply, if you think about it, it's POS down low single digits call. Offset by a favorable inventory comp of low single digits that gets you roughly to the flat.

Speaker 3

And then the non repeating fiscal week is a 2 percentage point headwind That gets you to the midpoint of the guidance. So the next point, as we here at the end of July, we look at our POS data, call. We see it kind of trending in the right direction to support this forecast. And then the layer on top of that, the single family new construction call. Improvement that will really start to benefit us in the Q4 that gives us confidence to believe in our second half outlook.

Speaker 4

Call. Okay. Really appreciate the color guys.

Speaker 2

Sure. Thank you.

Operator

Our next question comes from the line of call. Stephen Kim with Evercore ISI. Please proceed with your question.

Speaker 5

Yes, thanks very much guys. Appreciate it. Call. Yes, a lot to ask about. Let's start with the acquisition.

Speaker 5

I think that you had indicated that there was going to be a little purchase call. Accounting impact in the back half, any reason why we should expect that to continue into call. And as you look across the sales synergies and cost synergies, call. Do you think we could see some of the cost synergies by the end of the year start to trickle in? Just give us a little color on, I guess, timing call in 3Q, 4Q and maybe a look into 1Q.

Speaker 3

Yes. Steve, this is Dave. I'll talk to that. On the call. Synergy side, I think maybe some of the sales synergies trickle in by the end of the year on the cost side because of their inventory position, call.

Speaker 3

While the teams will be doing the work, we won't see that in our P and L until next year, just given the balance sheet. And then to your question on purchase Just price amortization. So remember, these are trade names that are amortized over a long period of time. So it is call. Roughly $0.08 in the back half of this year, it will be $0.16 full year next year impact.

Speaker 3

And then call. Going forward beyond that, pretty consistent for the next 10 or so years until that trade name is fully amortized and off the balance sheet. So So hopefully that helps to answer your question, Nick, for sending you down.

Speaker 2

Yes,

Speaker 5

absolutely. Call. Okay, great. That's very helpful. Now I know that your guide you mentioned your guide, improvement sort of reflects call.

Speaker 5

To some degree and I think a large degree the enhanced view of single family activity and I'm assuming there's basically the lagged starts effect. Call. Are there any mix or margin implications from the rebound that we've been seeing in housing starts start to emerge as well. If you could talk to that, that would be helpful.

Speaker 2

So the mix impact on us?

Speaker 5

Call. Yes, benefit to you. You talked about the top line, but I'm wondering if there might be margin implications that would come from that. And if you could describe what those might be?

Speaker 2

Call. Yes. So I'll just give you some thoughts around it thematically and Dave can give more color. I would say bottom line is we are and we really work to keep the portfolio call. Margin agnostic, whether it be around product price point I'm sorry, margin percentage, but around product price point or around channel.

Speaker 2

Call. And so if you look, you think about it, we might have if we see a lot more production builder business that may come in at a lower Contribution margin for example, but it takes a lot less to serve that business because they're big customers. You can call on them. It's more standardized than call. Showroom business which you need big sales forces out in the market serving that maybe higher contribution margin, the larger SG and A supporting it.

Speaker 2

And at the end of the day, call. It sort of balances out. And so it moves around the P and L, it's a little P and L geography, but I would think about it as call. We're fairly agnostic no matter kind of the channel or where we sort of set price points in the continuum from premium to ultra luxury in call.

Speaker 3

Yes. And I would just add and Steve, I'd point you to our full year guidance for operating margins for Water, which prior was call. 23% to 24% and updated is around 23.5%, so at that midpoint, inclusive of the change in single family new construction and call. The headwind from the purchase price amortization from the asset deal that's now rolling into that segment. So pretty consistent from a margin standpoint within water.

Speaker 5

Call. Great. That's very helpful. Thanks guys.

Operator

Our next question comes from the line of Michael call. I'll rehaut with JPMorgan. Please proceed with your question.

Speaker 6

Thanks. Good afternoon, everyone. Call. First, I just wanted to dial in a little bit on some of the puts and takes on the updated margin guidance call. For the year, I guess, on a segment level, you had security call.

Speaker 6

Nick down at the high end of the prior guidance. And just wanted to confirm that that's, I assume, largely just driven by the acquisition accounting. Call. And if there were any other puts and takes into the back half outlook, particularly I'm thinking about to the extent that you have a call. A little bit better top line outlook organically at least.

Speaker 6

Were there any call. Additional leverage that you were thinking of and was that offset by anything else? And then I just had a follow-up.

Speaker 3

Call. Mike, this is Dave. On the security question, you are correct. That's predominantly just call. The impact from accounting from the acquisition and the base business is performing well as evidenced by their margin results in the Q2.

Speaker 3

And then in the back half, call. We had said on our initial call this year that we expected back half operating margin to be between 17% 18%. Call. We still think that's the right range for the back half between 17% 18%. Now there are some puts and takes in there.

Speaker 3

We are making some incremental investment, call. Investing in digital, investing in brand and R and D in the second half, and we're controlling that tightly, but we call. We see some areas that we want to accelerate as we head into 2024. And then interestingly, if you look at our first half Fortune performance of 15.2% and normalized for the inventory reduction overhead of 50,000,000 call. We called out, you're right about at 17.5%.

Speaker 3

So the business is demonstrating pretty consistent margin performance and trajectory, while call. Digesting some of the implications of reducing our balance sheet and the market volatility, but we feel good about the outlook going forward.

Speaker 2

Call. And I'll just add Mike, if you think sort of back to our Investor Day in December when we presented that longer term margin walk and all the activities call. We had planned to start to drive those feeling very good that that is call. Now coming through in both the security and the outdoors business and notwithstanding the fact that it's pretty choppy external environment out there. You can see the business is making the progression call.

Speaker 2

That we want them to make and we're doing that by taking this newly aligned structure and the Fortune Brands' advantage playbook and applying it call. And the teams are feeling very good about their ability to execute well against that over time.

Speaker 6

Call. Right. And I appreciate that. And I guess secondly, maybe just go back to the call. Slide on the deck around the synergy opportunities on the top line, which very detailed and obviously very well thought out.

Speaker 6

Call. I think back to the acquisition of Fiberon and I believe you had, correct me if I'm wrong, I want to say a 50% growth over 3 years. Call. And a lot of that due to some really nice additions on the distribution side, call. You were able to secure new customers, etcetera, added distribution for the Fiberon product.

Speaker 6

Call. We see a lot of expansion of channel in both the Yale and August and MTech and Schaub. Call. And so I guess the question is maybe just to push, obviously these are really good numbers in terms of the synergies on the sales side. Call.

Speaker 6

But I would have actually thought perhaps there would have been room for some slightly higher numbers and maybe I'm just being call. A little too aggressive, but or maybe you're perhaps being conservative. I just wanted your take on that, particularly over a 3 year period. It does seem like there's a lot of call. Cross selling opportunities to the point on the slide.

Speaker 6

And just curious if I'm thinking about things maybe a little too aggressively in terms of call.

Speaker 2

Yes. So, well, firstly, I'd say thanks for calling out that Fiberon analogy because I think It's really good. And I think what's particularly interesting about that, because I believe you called out is that is still ongoing. Like that those gains call. At the higher margin part of that business and those distribution gains are still unfolding.

Speaker 2

Obviously, the markets have been a little bit tougher this year, but call. As we just track that conversion rate, so that bounces between 1% to 2%, you see it sort of move back up, you'll see those call. And during that whole time though, we're preparing the business to then build on, right, with brand and innovation. And call. So very thematically, I think.

Speaker 2

So what I'd say, specific to August, DenTech and Schwab is call. First, I'll just call out here. We closed June 30, so we've only had the teams together, for a short amount of time. Call. And they've identified a series of synergies that we put here, particularly around channel.

Speaker 2

And what we'll do is we'll be very respectful of what call. These businesses do better than the legacy Fortune Brands Innovations business. And so they have channel strength in certain areas that call. It's better and we will look to learn from that and build it into the legacy business. And then conversely, call.

Speaker 2

There are of course places where the legacy business has strength that these businesses don't where we can start to expand through distribution call. And access and our channel strength and relationships. And so, will there be more upside over time for that? Call? Possibly, but I think the real big unlock comes from really sort of the 1 +1 equals call.

Speaker 2

5 strategy, which is as you put these things together, can we unlock new innovation, call. New approach, whether it be on the luxury side where we really are going to have a lot more scale to go off call. On a global business and on a global basis with that luxury consumer, who cares about Call. Brand and cares about the artisanal stories behind it or on the technology enabled side call. Our connected business is going to be that much bigger and the infrastructure and backbone on which it now all sits call.

Speaker 2

This is going to allow us to unlock innovation at a faster pace. And I think that's where the real upside may exist, but that's going to take us a little time to work call through those innovation opportunities and bring them to market.

Operator

Call. Our next question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Speaker 7

Call. Thank you. Good afternoon and thanks for taking the questions.

Speaker 2

For sure.

Speaker 7

Call. Can you talk a little bit about how you're positioned from an inventory perspective across the different channels and the different segments? Call. Sounds like you got a nice lift in the quarter from the volumes that did flow through there. As you think about the back half, call.

Speaker 7

What's the ability to capture any further upside to demand and perhaps see those volumes continue to move a bit call further.

Speaker 3

Yes. Hey, it's Dave. I'd say looking at water and security relatively balanced from an inventory call. Perspective relative to the rate of sales. We're still a little bit light in outdoors in the channel, primarily around wholesale decking call.

Speaker 3

At the end of the quarter. And we do expect and really have started to see some of those orders that we expected come through in July for decking. And so we're seeing that inventory fill back up. Call. But I think if the market were to accelerate beyond our expectations in the second half, there would be call.

Speaker 3

Some inventory upside opportunities as we would expect customers to put some inventory ahead of those sales. But where we sit call. Right now, it's pretty well balanced and we've kind of gotten through a lot of the prior year challenges from inventory call. Builds and depletes that was really noisy on the sales line.

Speaker 7

Okay. That's helpful. And then you talked about call. Security and some of the company specific efforts that are going on there to drive results, just sort of above and beyond the acquisitions that closed this call. Can you just talk a bit more about some of those initiatives?

Speaker 7

And how should we be thinking about them flowing through to

Speaker 2

call. Yes. I would call. A very simple way to think about it is if you sort of rewind the clock a little bit on the water business and you just observe what sort of happened, call. Let's start again 2015, 2016 and the playbook that was applied there.

Speaker 2

It's the same playbook being applied to security. And actually they're very similar in call. So the brand resonance, ability to put innovation behind it, connected product and even the call. Supply chain has a lot of commonality. And so you can really sort of almost lift and shift a lot of that playbook.

Speaker 2

So call. Starting from the top line down, far more emphasis on innovation. And so what we're seeing come through, we alluded to strength in commercial. Call. We're really developing a leadership position in some of the safety work that we do in facilities.

Speaker 2

It's very sticky call. We go in and do consultative selling. We help make facilities safer. There's obviously a lot of emphasis on that right now. It's a great strength of ours.

Speaker 2

We're able to put the brand and innovation call. And that's just an example of call. A vector that can drive top line and then you sort of play it through like the supply chain improvements that we made in water, whether it be in sourcing or footprint over time, call. Allowed us to generate a lot of fuel that we then reinvested to drive the top line, some of which came into margin and you saw the margin progress over the years, but a lot of which was invested in the top line. And so it really is call.

Speaker 2

In the top line. And so it really is those source of capabilities that we talked about the Fortune Brands advantage capabilities, call. It's taking that playbook, applying it. And I think over time and then particularly as we bring these assets, these new assets into play and able to accelerate some of the call. Connected overlap.

Speaker 2

We'll not just see the top line accelerate, but we'll see the margins go along with that. And in our philosophy, it's very much a virtuous call. Cycle, because as you develop those margins, you're able to invest in these businesses faster as you invest in them, obviously the top line grows even quicker.

Speaker 3

Call. And Sue, just to put some numbers behind that, because we are starting to see it come through the results. And so if you look at securities call. This performance versus the Q2 of 2019, sales are up 15% or roughly a 4% CAGR and their Operating margin is up 3.90 basis points. And so you see the output of what Nick described is really taking that playbook from water, embedding it at call.

Speaker 3

Security and getting that flywheel going around growth reinvestment and margin enhancement.

Speaker 7

Okay, great. Thank you for the color and good luck.

Speaker 2

Thank you.

Operator

Our next question comes from the line of Joe Allersmaier with Deutsche Bank. Please proceed with your question.

Speaker 8

Yes. Thanks very much. Good evening, everybody.

Speaker 2

Hey, Joe.

Speaker 8

Just want to go into the Yale business a little bit deeper. If you could maybe quantify call. The amount of the business that's currently going through e commerce and any considerations there around call. Key customer partnerships with the change of control, anything to consider there?

Speaker 2

Yes. Call. I'll give you some perspectives broadly and Dave can elaborate, although we usually don't break it down to that level of granularity, call. I'll put some information in the deck here, but I would think that this business has historic strength call. In the integrated channel, we found very interesting.

Speaker 2

And so as people connect the products into homes, call. There's still one at a time, which August was built on, but there's also sort of the multiple and it works on the system with an integrator. And what's call. Really interesting about the Yale infrastructure backbone is how flexible it is on a variety of different systems. And so that's call.

Speaker 2

A real strength of theirs, something that we don't have elsewhere in the business and so we really want to build upon and we could expand our portfolio even in call. Our existing master lock business and portable security business, right? I think there we have we're able to secure things that are portable in a connected way. And so if we can leverage that backbone. Call.

Speaker 2

And then of course, we have a lot of strength in retail and e commerce, which historically has been, I'd say, call. Weaker for Yale. And so we think that that's an opportunity where we can leverage our historic strength to build their business call.

Speaker 3

Yes. And Joe, interestingly, like our connected product business, this business has been chip constrained and they actually prioritize these Call. 3rd party integrators over other channels over the past few years. So the amount of sales flowing through e commerce or even brick and mortar retail are lower than call. The demand would be for this type of products.

Speaker 3

As we get this business integrated back in stock, that will be another growth avenue for us going forward.

Speaker 8

Call. Yes. And that was actually my second question was around those constraints you had mentioned earlier, I guess late last year. Call. So maybe for my second question, I'll just ask a clarifying question on the wholesale decking.

Speaker 8

Did you say that sell out improved call. High single digits and was that versus for specific time?

Speaker 3

Call. We said by the end of July, we were going to high single digits versus prior year sellout.

Speaker 8

Call. Like a trailing 4 weeks or something like what's the period?

Speaker 3

Yes, yes. That's how we look at it.

Speaker 2

All right, great.

Speaker 8

Thanks a

Speaker 4

lot guys.

Speaker 3

Call. Yes, for sure. Thank you.

Operator

And our next question comes from the line of John DiVallo with UBS. Please proceed.

Speaker 5

Call. Hey guys, thank

Speaker 9

you for taking my question. I guess first question would be on Quarter volume in the U. S, I mean, can you just help us with what that was down in the second quarter and maybe what the positive impact from pricing was? Call. And then more broadly, where are you seeing potential opportunities for incremental pricing across your broader portfolio as we move into the back half of the year?

Speaker 3

Call. Yes. I'll start and then Nick can comment. I think just to decompose water sales, reported sales down 5%. Strong call.

Speaker 3

Sales growth from China given the prior year comp and the acceleration of some previously started developments. So if you pull that out, call. Organic excluding China will be down about 9%. We see POS down low double digits. And so within that then, John, it's volume call.

Speaker 3

Down low double digits offset by price up low single, which is consistent with what we've been saying all along. We took a low single digit call. Price increase in water at the beginning of the year and that stuck and remains in market. And then there's a small low single digit benefit call. On sales from product load and timing around Amazon Prime Day, which was just different weeks last year versus this year, call.

Speaker 3

And it fell into the Q2. But the cleanest way to think about it is POS down low double digits, volume down low double offset by low single

Speaker 2

call. And then the second part of your question on pricing opportunity, what I'd say is, as part of these Fortune Brands is about just capabilities, I was call. Just talking about one of the things that we've invested in is category management skills and capabilities, particularly call. In water and security and now turning them over to the outdoors business. And what that does is really give us the gives us the call.

Speaker 2

The ability to understand what is happening with the consumer, what is happening with the Pro at the shelf using data and analytics call. And then to work with our customers and wholesale partners to optimize pricing. And so call. We're constantly we try to avoid doing massive or shocking price increases. And obviously, between call.

Speaker 2

2020 and today, there was some of that in certain categories, but we really seek to do smaller, more incremental regular call. Price that the market expects, that our customers are used to, that are easily digestible. And even at the peak in water, I think you never saw us call. Move beyond mid single digits. And if you do that consistently and you do it all the time, you're able to create value for the entire value chain call.

Speaker 2

All of our partners and do it in a way that you bring the consumer along. And I think that's reflected in the fact that we've been able to do it consistently, but still gain share as we do it. Call.

Speaker 9

That's helpful. Thank you. And Nick, one of the comments that you made and it's not unique to your business, but I would love to get your thoughts on it. Call. DIY being a little bit softer than pro in an environment where there's a little bit more challenge from an economic standpoint.

Speaker 9

I mean, intuitively, you would think it could be the opposite where the consumer is trying to save some money by perhaps doing things a little clip more themselves. I mean, why do you what do you think is driving this dynamic where the Pro is holding up better?

Speaker 2

Yes. I'll give you my hypothesis call. For what it's worth, which A, I think you go back to sort of the fundamentals, right? You have a very, very undervalued housing market. And so you're going to see call.

Speaker 2

New construction, you've seen that come through and the production builders have the systems and the processes and they're excellent doing what they're doing. So you've seen them take share. Call. And then you have a very aged housing stock. And so I think you've seen consumers prioritize their homes and call.

Speaker 2

Go after projects where they really need to bring their homes into a more modern era and you've seen that hold up. Call. And I think where you've seen what I'd say is relative weakness is in the huge call. Growth that we saw in kind of retail POS in 2021 2022 that we've called out pretty consistently saying Coming into that spring selling period, you really saw people go out and spend a lot in retail for kind of the call. Spring into early summer months, my belief is a lot of that was stimulus driven.

Speaker 2

They had money and were probably doing projects call that they wouldn't have otherwise done. And as we anticipated, if you now look at the POS data, call. Sequentially, the numbers improved week on week on week as you sort of went through the late winter into call. The spring as we would expect them to with normal seasonality, but they did not comp the huge hill that was built the prior year when people went up call. And interestingly and consistent with that, as we've now gotten into kind of mid summer and you get past call.

Speaker 2

That hump, you can see those POS dollars come back into line and closer to flat, I would say consistent with call. Flat versus last year, consistent with what we would expect a normal season to look like. And so I guess to sum it up, I think call. New construction, bigger projects, modernizing homes or building new homes continues to be driven. I think what we are digesting is a stimulus call.

Speaker 2

Driven a lap that was pretty tough, a surprise actually that we pretty much lapped 2021 and 2022. And then in 2023, I think you call. You did see sequential growth, but it was just too big a lap without the support of those stimulus dollars.

Speaker 3

Got it. Thank you.

Speaker 2

Call.

Operator

And we have reached the end of the Q and A session. And also this does conclude today's conference. Call. We do thank you for joining today's conference call. You may now disconnect.

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Earnings Conference Call
Fortune Brands Innovations Q2 2023
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