Fortune Brands Innovations Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 6, 2024

There are 12 speakers on the call.

Operator

Good day, ladies and gentlemen. My name is Morgan, and I will be your conference operator today. I'd like to welcome you to the Fortune Brands Third Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Following the speakers' remarks, we will open the call for a question and answer session.

Operator

At this time, I'd like to turn the call over to Leigh Avsak, Vice President of Investor Relations and Corporate Affairs. Lee, please go ahead.

Speaker 1

Good afternoon, everyone, and welcome to the Fortune Brands Innovations' Q3 2024 earnings call. Hopefully, everyone has had a chance to review the earnings release and our supplemental financials. The earnings release and the audio replay of this call can be found in the Investors section of our website. I want to remind everyone that the forward looking statements we make on the call today, either in our prepared remarks or in the associated question and answer session, are based on current expectations and market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC.

Speaker 1

The company does not undertake any obligation to update or revise any forward looking statements except as required by law. Any references to operating profit or margin, earnings per share or free cash flow on today's call will focus on our results on a before charges and gains basis unless otherwise specified. Please visit our website for reconciliations. With me on the call today are Nick Fink, our Chief Executive Officer and Dave Barry, our Chief Financial Officer. Following the prepared remarks, we have allowed time to address some questions.

Speaker 1

I will now turn the call over to Nick. Nick?

Speaker 2

Thank you, Lee, and thanks to everyone for joining us today. On this call, I will walk through the highlights of our Q3 performance, give some color on the drivers of this performance, including progress on our digital strategy and offer some thoughts on the macro environment. I'll then turn the call over to Dave for a more detailed discussion of our financial results, our updates to our guidance for the remainder of 2024 as well as some thoughts on our emerging expectations for 2025. Before turning to our Q3 performance, I would like to provide some context around our market. While we are increasingly excited about the long term opportunities in our space and for our company, we continue to operate in a choppy environment with continuous year over year U.

Speaker 2

S. Repair and remodel declines and unprecedented market disruption in China. Our seasoned team is managing our business tightly, while continuing to prioritize investments in our strategic growth priorities, including our digital transformation. We have purposely moved away from less profitable categories to focus our resources on our supercharged higher margin opportunities. We continue to streamline our operating model, which has allowed us to operate more efficiently, reduce SG and A and fuel growth.

Speaker 2

While our short term results remain pressured in a demand challenged environment, we are already seeing tangible results from the strategic actions and investments undertaken to advance our longer term growth opportunities. As in Q2, we saw areas of sales strength in our core North American Moen and Thermatory businesses. Our digital products portfolio once again saw some very exciting wins this past quarter and the organization continues to ramp our sales pipeline. Finally, as we approach the 2 year anniversary of our new operating model, we're working as a more aligned and efficient organization, including developing new marketing campaigns, launching new products faster and building a new company purpose. This new purpose, which better captures the ambition of Fortune Brands innovations will help unify and motivate all 11,000 associates across the globe behind our unique opportunity.

Speaker 2

Net sales were $1,200,000,000 in the quarter, down 8%. Excluding China, which was again impacted by lower sales as the Chinese consumer remained very cautious, our organic sales were down 5% in the quarter. Importantly, point of sale excluding China was down low single digits. We have now annualized the sales of MTech, Yale and August into our organic results. 1 year following this transaction, we remain very pleased with their performance as well as how they have helped accelerate our transformation into a digital disruptive company and luxury goods powerhouse.

Speaker 2

We are fortunate for the exceptional talent that we acquired along with these brands. In the Q3, we continued our trend of delivering strong margin results. Our operating margin in the quarter was 18.7%, up 130 basis points versus the Q3 of 2023. Our strong margin performance resulted from continuous improvement initiatives, targeted cost reduction activities, as well as our continued focus on growing more profitable categories. These initiatives enabled us to continue to make key investments in the quarter.

Speaker 2

Our 3rd quarter earnings per share were $1.16 and our operating income was $216,000,000 Turning first to our digital portfolio. We have made excellent progress with our flow strategy. We have now signed 7 insurance These agreements feed our opportunity pipeline creating leads, which we then convert into sales. In the Q3 alone, we added around 20,000 users of our Flow Smartwater monitor and shutoff and retail and e commerce POS performance was up 80% versus the Q3 of 2023, exceeding our expectations as consumers increasingly gain awareness of the incredible value of our Flow device. We expect our Flow business to grow nicely in the Q4 of 2024 and expect this growth to accelerate into 2025.

Speaker 2

We currently have agreements in place covering approximately 8,000,000 policyholders and are in active discussions with homeowner insurance companies representing around 60,000,000 homeowners. We are also having continued conversations with municipalities and water utility companies across the country, including our recently announced partnership with Miami Dade County. To give a sense of the amount of sales we have coming down the pipeline at a conservative 5% sales conversion assumption of the insurance agreements that we currently have under contract, the potential sales pipeline we currently have for flow is over $160,000,000 While the timing of this backlog is hard to predict, we reasonably expect to see these sales soon. Significant progress we've made in just a few short months to expand the reach of our smart leak detection is truly impressive. This past quarter, we again had some key wins in our digital product space and saw over 225,000 new device activations in the Q3 between both water and security and now have approximately 4,500,000 users across our digital platforms.

Speaker 2

This continued acceleration gives us confidence in the strong future of Fortune Brands as a digital leader. In addition to the several large insurance partnerships with Flow, our Yale and August businesses made progress with some key customers, including integrations with ADT, ecobee and Airbnb. In addition, we are excited that our new Monster Lock Connected Lockout Tagout solution is now in beta testing at several facilities. More to come on this, which we believe will be the next big breakout opportunity. While our digital product journey is well on its way, we have much more runway ahead as we are still learning the best and most efficient ways to get our products to our customers and partners.

Speaker 2

Expect more from us as we continue to evolve this growth engine. As we stated last quarter, we see a path for well over $1,000,000,000 in digital sales by 2,030. Turning now to some thoughts on the current U. S. Housing market and the market for our products.

Speaker 2

The external macro environment continues to be uneven and challenging. While the Fed lowered interest rates earlier this quarter, mortgage rates remain elevated above 6% and many homebuyers and homeowners remain on the sidelines. Repair and remodel data has generally stabilized relative to larger declines over the prior 12 months, albeit at a lower than historical rate consumers remain cautious. Notwithstanding the recent market softness, we continue to be very excited about our future, including in 2025. Housing fundamentals remain positive with the need for housing remaining strong, home prices holding steady and equity levels exceeding $35,000,000,000,000 As we continue to evolve our portfolio and focus on our supercharged categories and as we continue to build upon our already strong brands and introduce meaningful innovations, we expect that our products will further distinguish themselves.

Speaker 2

With regards to the single family new construction market, large builders continue to remain resilient as they use their balance sheets to lower mortgage rates and to help get people into new homes. We expect that large homebuilders will continue to gain share and we have the added torque of the exposure to their growth. While starts were down this summer, the homebuilder market is continuing to grow. In September, the single family NAHB housing market index for sales expectations for the next 6 months were up 8% versus prior year, while builder sentiment was also improving. Turning to repair and remodel.

Speaker 2

R and R is driven by several factors, including consumer confidence, employment levels, home equity levels and access to credit. Our R and R has been down over the last 2 years. We believe this has created unprecedented levels of pent up demand with one recent estimate putting it at $30,000,000,000 As we previously mentioned, Americans have more than $35,000,000,000,000 in home equity, up 81% from the end of 2019. However, the usage of equity extraction vehicles like home equity loans and cash out refinancing has fallen as rates remain high. In fact, the percentage of extracted home equity fall by more than half since the Q4 of 2019.

Speaker 2

It is now estimated that over 14% of homeowners have mortgages above 6%, finally making refinancing a sensible option. In addition, as the federal prime rate comes down next year, HELOCs and credit card rates and we would expect more people to utilize them to finance their R and R projects. As interest rates decline and as mortgage lock in effect subsides, we believe people will increasingly tap into their home equity for renovation projects through a variety of vehicles, including refinancing HELOCs, key loans and home equity agreements. Finally, we expect that there will be a short term negative impact from the recent hurricanes on our Q4 sales as we have seen this in our point of sale data. Our thoughts are with those impacted and we have been providing products and assistance to those in need.

Speaker 2

We expect that there will be opportunities as communities rebuild in 2025 and our teams are working actively to capture this. Additionally, these tragedies have put additional pressures on insurance companies to find innovative solutions to offset the losses that they can control through devices like Flow. As Dave will detail more completely in his section, we are actively scenario planning for a variety of outcomes in 2025. We believe the demand environment in the U. S.

Speaker 2

Will inflect positively with the recovery more weighted to the second half of the year. Additionally, as we complete our pivot from lower growth, less profitable categories to supercharged categories, our mix will help accelerate growth regardless of the external conditions. We will focus on growing our core and accelerating our digital products and we'll continue to invest behind our long term growth priorities. As we head toward the end of 2024 and set our sights on 2025, we are focused on execution and delivering on our commitment to above market sales growth and margin performance. Turning now to an update on a key part of our transformation.

Speaker 2

As we approach the 2 year anniversary of the Cabinets spin off and the reorganization of our business from a decentralized mechanical only business into a digital innovator, I wanted to highlight a key milestone. Over the past 9 months, we leveraged associate feedback and senior leader conversations to develop a new purpose statement with supporting strategic drivers and behaviors. This new purpose captures the unique opportunities Fortune Brands Innovations has to positively impact lives and communities. Our purpose is to elevate every life by transforming spaces into havens. This represents a bold multi decade vision for the company where through our products, we can impact the lives of our customers, our associates and our communities.

Speaker 2

We will bring our purpose to life by executing upon a specific set of behaviors and strategic drivers. Grounding our business in an authentic, clearly articulated purpose, unique set of strategic drivers and expected behaviors will help unlock higher levels of innovation, increased employee engagement and retention and transformative growth. Teams across the globe made a unified effort to ensure that every one of our 11,000 associates had an opportunity to discuss our purpose, behaviors and drivers, helping to underscore each associates connection to how they can make an impact. As the market improves, the work that we have done to enhance our already strong culture will accelerate our opportunities for growth. We've continued to refine the organization, including recently reducing inefficiencies, while continuing to invest in key strategic priorities.

Speaker 2

Our more efficient structure has allowed us to make strategic decisions faster and with more precision and deploy our Fortune Brands advantage capabilities across the portfolio. As we have often noted, this is a multiyear journey, but one which is already showing concrete results. Turning now to segment results. Starting with Water Innovations, sales declined 8%, while operating margin improved 40 basis points versus last year. Excluding China, organic sales were down 2%.

Speaker 2

We're managing the business tightly, while continuing to make key investments in our most critical priorities like brand, innovation and digital. Our Moen North American business delivered organic sales down low single digits. Our brand metrics remain strong with Moen being number 1 for unaided brand awareness and the most trusted brand. Our whole home water performance showed significant share gains. As I mentioned earlier, Flow continues to gain traction with insurance companies, municipalities and consumers as the leader in this emerging space.

Speaker 2

We are finding new use cases every day for this ecosystem of products. While the new insurance and municipality partnerships are continuing to ramp up, our retail and e commerce point of sale accelerated 80% in the 3rd quarter, highlighting the continued adoption by consumers. We expect sales of our digital water business to accelerate through 2024 and throughout 2025. Turning to our luxury business. Organic sales were down low single digits in House of Roll, which now includes Emtek.

Speaker 2

We're now 1 year into our acquisition of Emtek and the work to integrate the brand into our comprehensive and complementary luxury portfolio, including in showrooms, is progressing very well. And the feedback that we have received around our combined portfolio has been very encouraging. We will have installed over 150 Emtek displays in existing House of Royal showrooms by the end of the year, and we expect this expansion effort will continue as we head into 2025. Finally, China sales were down more than 40% this quarter as the Chinese consumer remains cautious and the real estate market remains soft. The government has recently announced policies designed to spur investments in growth, but it is too early to know the magnitude or timing of impact.

Speaker 2

In the meantime, the team continues to tightly manage costs and cash flow through the current conditions. Given the magnitude of the decline in China, the business now presents very little bottom line risk and is a nice option for future growth when the market returns. Looking to the remainder of 2024 and into 2025, our Water segment will focus on those parts of the market with the greatest potential for growth through our leadership and brands, innovation and channel. We continue to expect our relationships with the large national builders to benefit us and we believe new innovative product offerings will further distinguish us from our competition across our channels. And of course, our smart water network, including our ecosystem of leak detection products, should offer us attractive growth opportunities.

Speaker 2

We will continue to make thoughtful investments in our key priorities, including core branding and digital initiatives. We also see future fuel for growth opportunities as we leverage our Fortune Brands Advantage capabilities to optimize our operations and supply chains and leverage our channel pricing expertise. We remain very excited about our water business, particularly the opportunities we see to capture outsized growth. Turning to outdoors. Sales were down 6% with strong results in our doors business offset by destocking in the wholesale decking channel.

Speaker 2

Importantly, our margins were 18%, an impressive 320 basis points above prior year. We continue to focus on leveraging our expertise and investing behind our core categories and in those areas, which we expect will offer the most attractive growth opportunities. Our door sales were flat as tailwinds from new construction and recent retail wins drove sales and we continue to take share in fiberglass. Therma Tru continues to see the benefit of the increase in starts and completions, which began last year and Larson is seeing nice performance driven by recent innovation launches, which we believe will further accelerate. Decking sales were down more than 30% in the quarter due to inventory actions in the wholesale channel and a slower demand market.

Speaker 2

Importantly, our port of sale in the quarter was down mid single digits. We believe the results in our Fiberon business reflect onetime destocking impacts from a decking season, which was softer than expected and which are now behind us. Looking forward to the remainder of 2024 and into 2025, we expect to continue to leverage our strength in our wholesale channel as well as our expertise in innovative materials. We will continue to benefit from our strong relationships with large builders in our ThermoSure business. Additionally, recent product resets should drive accelerated performance in retail.

Speaker 2

We are focused on outgrowing the attractive outdoors market across our brands. Finally, turning to our security business. Sales declined 14% in the quarter and organic sales were down 12%, while our point of sale was down mid single digits. Results were primarily due to market softness, destocking and consumer trade down on the digital shelf as the number of inferior and non compliant private label alternatives has unfortunately proliferated. We are taking definitive action to reverse this trend.

Speaker 2

Our brands are incredibly strong and we are responding by helping consumers understand the value proposition of our trusted brands. For example, we recently launched a compelling new ad campaign, which highlights the fact that our fire safes keep documents protected from natural disasters like wildfires and floods, while many imposter brands failed to do so. We are already seeing positive momentum in our point of sale. Finally, we've increased our promotional cadence to better meet the market. Importantly, this segment also saw 2 50 basis points of operating margin improvement as our continuous improvement activities, supply chain optimizations and cost controls resulted in expanding margins.

Speaker 2

The significant cost work that we have done on these brands over the past few years is allowing us to invest in marketing, innovation and promotions, all while growing our margins. A year into the acquisition of Yale in August, we are utilizing their team's skills and knowledge throughout the business and their expertise is being deployed across our portfolio as we continue to accelerate our digital strategies. Looking to the remainder of 2024 and into 2025, we will continue evolving the Security business by focusing on our strong brands, opportunities for differentiating innovation and by reinvesting some of the efficiencies gained from our recent optimization of the business to strengthen our already iconic core brands and add meaningful innovation to our products, including our exciting digital products. We are proud of how our business is helping people and companies across the world protect the things that matter most. As we finish up 2024 and turn to 2025, our teams continue to navigate near term challenges while executing multiple initiatives to drive our long term success.

Speaker 2

We will continue to strategically manage the business in light of the uneven market backdrop, focusing on those areas where we have the greatest potential for above market growth, continuing to make key investments and also looking to manage our margins. By taking these decisive actions now, I believe we will be best positioned for accelerated growth when the external market conditions improve. I will now turn the call over to Dave.

Speaker 3

Thanks, Nick. As a reminder, my comments will focus on income before charges and gains to best reflect ongoing business performance. Additionally, comparisons will be made against the same period last year unless otherwise noted. Let me start with our Q3 results. As Nick highlighted, our results reflect our focused execution on a tight set of priorities amidst a challenging external market.

Speaker 3

Sales were $1,200,000,000 down 8 percent and excluding the impact of China, organic sales were down 5%. Consolidated operating income was $216,000,000 down 2%. Total company operating margin improved to 18.7 percent and earnings per share were $1.16 down 3%. Free cash flow in the quarter was 176,000,000 dollars which brings our year to date free cash flow generation to $262,000,000 Turning to sales. Net sales results were driven by China softness, low single digit POS declines and inventory reductions in outdoors and security.

Speaker 3

Our operating margin of 18.7%, a 130 basis point improvement reflects our team's focus on a narrower set of priorities and our ability to drive continuous improvement savings offset by our investment in our strategic initiatives, which we are confident will result in growth as the end markets improve. Our team's execution resulted in decremental operating leverage 4% in a sales environment that was softer than expected. As I will detail later, our balance sheet remains strong and we have the flexibility to manage various economic outcomes while deploying additional capital to drive shareholder value. Now let me provide more color on our segment results. Beginning with Water Innovations, sales were $635,000,000 down 8%.

Speaker 3

Excluding the impact of China, organic sales were down 2%. The organic net sales results reflect the impact of lower volumes amid a softer market. Water Innovation's operating income was $156,000,000 and operating margin remained strong at 24.6 percent, reflecting lower volumes, partially offset by continuous improvement initiatives. Both Moen North America and House of Roll POS were down low single digits. China sales declined over 40%.

Speaker 3

The Chinese market remained soft and while encouraging policies were recently announced to bolster the market, it is too early to predict a recovery. That said, the team continues to focus on replatforming the business while preserving growth optionality. Turning to Outdoors, sales were $343,000,000 down 6%. Sales reflect low single digit POS and a mid single digit channel inventory reduction in the wholesale decking channel. Segment operating income was $62,000,000 up 13%.

Speaker 3

Operating margins for the Q3 were 18%, an improvement of 3 20 basis points. Doors sales were flat. Sales were positively impacted by higher volumes from single family new construction offset by continued R and R softness. In decking, we saw sales decrease by over 30% in the quarter driven by channel destocking. Importantly, POS was down mid single digits in

Speaker 4

the

Speaker 3

quarter. Inventory levels remain low and we expect this quarter to be an abnormal result with evidence of improving trends as we begin the Q4. Finally, in Security, sales decreased 14% to $178,000,000 or down 12% on an organic basis because of a softer market and the impact of lower quality import brands. Total Security segment operating income was $34,000,000 down 1%, while operating margin was 19.3%, an increase of 2 50 basis points as actions we took over the past few years continue to benefit our results. Looking forward, we will invest in our brands and in product and software innovation to further position ourselves as the leader in the mechanical and digital security space.

Speaker 3

Turning to the balance sheet and our cash flow performance. Our balance sheet remains strong with cash of $345,000,000 net debt of $2,400,000,000 and net debt to EBITDA leverage at 2.5 times. We repurchased $35,000,000 of shares in the quarter and have repurchased $190,000,000 of shares year to date. We continue to focus on generating cash and we'll remain opportunistic and returns focused around our share repurchase strategy, while also being mindful of our leverage ratio, which are trending as expected. To summarize the quarter, we focused on executing our priorities for long term growth, while delivering strong margin results in a soft environment.

Speaker 3

Our margin results reflect our commitment to productivity as well as the impact of actions we took to further align the organization around our strategic focus areas. With that in mind, I'll now provide an update to our 2024 guidance. As today's press release indicates, we are revising our full year guidance. This change accounts for several variables, including a choppy demand market, short term impacts in hurricane affected regions and lower channel inventory, partially offset by continued strength of digital water. Importantly, it also reflects our commitment to maintaining investments in key priorities that we expect will generate future growth.

Speaker 3

Our revised EPS guidance is now $4.17 to $4.23 We continue to have full confidence in our long term strategy around our core and digital products. Regarding the impact of the hurricanes, we see the impact most acutely in our Moen and Doors businesses with POS in impacted states down more than 25% since the hurricane. We expect that single family new construction will see an outsized impact as labor is redirected towards storm cleanup in the near term. However, we expect these orders to more than recover as operations normalize and communities rebuild. The full details of our updated guidance can be found in our press release.

Speaker 3

As we head into 2025, we are actively planning for a variety of scenarios around the inflection in the demand environment. While it is impossible to predict the exact timing of this inflection, we continue to believe it is a matter of when, not if and when the demand inflects, we will be uniquely positioned for outperformance. While we will not provide guidance assumptions for 2025 at this point, we are able to share some initial thoughts. Our initial planning assumptions include a market with slightly positive growth. We expect this growth will be weighted toward the second half of twenty twenty five and we expect above market performance accelerating from both our core and digital products driven by the initiatives underway.

Speaker 3

We also expect to make meaningful margin progress and deliver strong EPS growth in this scenario. Our teams have done a nice job navigating the uncertainty of the past few years. And as we approach the end of 2024, we remain confident about the future of the business and our team's ability to create value. We are focusing on controlling what we can control and continuing to pursue our long term strategy. I will now pass the call back to Lee for Q and A.

Speaker 1

Lee? Thanks, Dave. That concludes our prepared remarks. We will now begin taking a limited number of questions. Since there may be a number of you who'd like to ask a question, I will ask that you limit your initial questions to 2 and then reenter the queue to ask additional questions.

Speaker 1

I will now turn the call back to the operator to begin the question and answer session. Thank you.

Operator

Our first question comes from John Lovallo with UBS. Your line is open.

Speaker 5

Hey guys, thank you for taking my questions. A lot of information here, so hoping you can help us unpack some of this. So you're starting at the top, you lowered the consolidated sales growth for the full year from positive 2.5% to 4.5% to down or sorry to flat to plus 1% and then lower the organic sales outlook from down 1 to down 3 to down 1.5 to down 3.5 and the downward revisions were across segments. In terms of the Q3, it looks like results were below expectations across segments. It sounds like the operating environment certainly got more challenging.

Speaker 5

But I was hoping you can just kind of help us better unpack some of the moving pieces in the quarter and in the outlook. I mean, how much of the decline is from the Q3 being softer versus expected 4th quarter slowing versus storm impact, things of that nature?

Speaker 6

Sure, John. This is Nick. I'll try to break it down for you as best I can. So if I think about it, you said sales, around 8 reported, we think outlook sort of organic excluding China because that's all other thing was down 5. Within that point of sale, excluding China, it was down low single digits.

Speaker 6

So you start to dial it in a little bit. And certainly, I'd say consumer was weaker in the quarter than we thought they were, particularly in the middle of the summer. July or August was particularly slow. I think we saw that across consumer company, saw some recovery towards the end of the quarter. But if I look at our performance in particular, I really see 3 things at play.

Speaker 6

1, we've deliberately pivoted away from some of these low margin commoditized business in favor of focusing on our supercharged categories. And while we did that, 2, we were and did exceed our own expectations on the digital side, but we need to convert those contracts to revenue faster. And to do that, we need to ramp capacity even faster than we thought. And that's just a question of throughput. We've signed the deals.

Speaker 6

They're in the pipeline. But it's a space we're learning. And just like mechanical products, you've got to go build the factory in order to produce it. And we realized we need to ramp that capacity faster than we thought. And so those in the pipeline that didn't materialize in the reported results for the quarter.

Speaker 6

And then the third thing I would call out is marketplace dynamic is we are seeing some trade down to knock off imposter brands, not so much sort of regular private label, which you'd expect for brands that are generally important brands that are making false claims about safety and performance that we're going to come back. And as I described, we're already doing some of that. We have some of that in play. We've got more of it in the pipeline. But where we've done it, we're already seeing the point of sale start to reaccelerate as we're doing a better job explaining to our consumers what the difference is and what the brand premium is worth.

Speaker 6

And so that all sort of leaves me confident as I kind of pull it all together that while it was a bit softer, we also had some stuff moving away from us while a lot of good news coming our way, which just needs to be lifted to sales even faster.

Speaker 3

And John, I'd add a couple of things and I'll unpack guidance a little bit. But before I do that, what's also evident is the team's focus on margin and as we replatform the business and stepped away from some of the lower margin categories where brands and innovation don't matter as much, you see that even though sales were soft, we're delivering pretty strong. Margin results, 4% decremental in a quarter that was softer than we anticipated, up 130 basis points on operating margin year over year and 110 year to date. So the margin is still coming through. That was the story we expect to continue.

Speaker 3

And then on the guidance, you're right to point out the consolidated change. I'd say that's roughly 3 percentage points lower for the year at the midpoint, which call it $135,000,000 or so. $80,000,000 of that came through in the Q3, which leaves about $55,000,000 then in the 4th. And of that in the 4th, about half is hurricane related, about half is continued consumer POS softness that we're working to combat. That said, as we look at the Q4, it still leaves us in a spot where sales are down low single digit.

Speaker 3

We have operating margin improvement of 100 basis points, maybe a bit better than that and high single to low double digit EPS and so EPS growth. And so while not as good as we may have thought 30 days ago, still a pretty good quarter, just not as robust from the consumer as we were hoping heading in the back half of the year.

Speaker 5

That's helpful. And then maybe focusing in on some of the margin improvements. I mean in outdoors sales were down 6.5% year over year. Op margins were up I think over 300 basis points. Security was down, I think, 14% for sales and op margins were up 2 50 basis points.

Speaker 5

And even on a sequential basis, sales were down and margins were up. I mean, so what kind of drove the margin strength in those two segments, both sequentially and year over year?

Speaker 6

Yes.

Speaker 3

I'd say in the outdoors, a combination of doors, thermometer door volume being better year over year and I'd say volume even in Larson and Storm Doors being better year over year. And then in decking, some of the work we've done to shed some of the lower profitable business that we had. As we've talked about in the past, we exited a window supply agreement for window components. We've looked hard at our kind of sourcing and manufacturing around PE and PVC decking to make sure we're driving continuous improvement productivity there. And so a lot of internal initiatives to really drive the margin in outdoors plus some volume coming through on the door side.

Speaker 3

And then in security, we talked about the actions we took earlier this year to drive the cost savings by altering our footprint. I mean, that's really coming through now and we'd expect that's altering our footprint. I mean, that's really coming through now and we'd expect that to continue to be a tailwind into 2025. To Nick's point, this is an area where we are investing back in the business. We're investing in innovation that will come to market next year.

Speaker 3

We're investing in marketing campaigns for the first time in a while for these brands that will come to market now and into next year. And it's all really to combat some challenges on the shelf from these import brands.

Speaker 5

Understood. Thank you, guys.

Operator

Your next question comes from Bill Ng with Jefferies. Your line is open.

Speaker 7

Hey, guys. Dave, thanks for giving us a framework for 2025. Fully appreciates that guidance per se. Frankly, I thought the back half of 2024 is not that bad. I mean, if you flush out some of the noise, it sounds like organic sales is down low single digits, 1% or so.

Speaker 7

So when we kind of look out to 2025, you said slight growth in the market and usually grow a little faster than the market by a few points. Are we kind of talking about call it low to mid single digit organic growth and little more mute in the first half and you see better growth? And then help us kind of think through the levers you have at play in terms of the margin side of things for next year as well.

Speaker 3

Yes. It's a great question, Phil. It's tough for us to pinpoint right now. I mean, still a lot of uncertainty When you've seen what happened with bond markets over the past month, that's going to lead to higher mortgage rates on the flip side. We expect the prime rate to continue to come down, which is going to lead to some affordability benefits around refinances and HELOCs and home equity loans and just everyday borrowing.

Speaker 3

So it's tough for us to say. I would say, we see the outperformance really driven in 2 areas. So 1, improving core category POS based on the actions that we're taking now. And then 2, as we talk about conversion of the connected pipeline into sales. And so I would expect our outperformance to accelerate through the year as both of those things come through the P and L, but hard to say kind of what that level is based on the underlying market

Speaker 6

at this stage. Okay. That's helpful. As we get to 25 guidance, I think we'll have another 90 days of converting that connected to existence flow contracts into sales, and we'll have a better sense. I mean, just being very candid, it kind of caught us both by surprise the pace at which we were able to ramp that business.

Speaker 6

We now have, as I said, 8,000,000 policyholders under contract at only a 5% conversion rate. That's $160,000,000 of sales we have in the pipeline. So what we're learning is you got to set up websites, you got to build collateral, you got to get these things activated in market. And I think as we get a better sense how quickly we're able to do that, we'll be able to dimension market outperformance that we expect. The fact that we have another 60,000,000 policyholders under discussion right now, at least a portion of which will convert to contract, we think is going to give us a great pipeline into next year.

Speaker 7

Okay. That's helpful. Actually, that was my that's a perfect segue, Nick. On Connected Products, if I remember correctly, last quarter, you were calling for maybe 2 points of incremental growth in the 4th quarter. How are you kind of shaping up in 3Q, 4Q?

Speaker 7

And then as we look out to 25, it sounds like a high class problem to have, there's really strong demand and you got some natural bottlenecks here. How do you unlock that supply? Are you actually building facilities? Are you going through 3rd party partners? Help size up that opportunity perhaps in 2025 and how that capacity unlock will like shape up next year?

Speaker 6

Yes. I'll start with the second part of your question and then Dan can dimensionalize the sales piece of what we expect. But think about it like you might think about building a factory, but just in the virtual world and that's exactly what we're learning. Like you have there are certainly the ideators, but it's an opportunity, a lot of our teamwork, the Trojan engineers, they're production people, they're helping produce the product or the software, firmware sites, the things that you need to actually make that sale. And that we need to do a great job of ramping even faster than we have now.

Speaker 6

You know the history that started almost at 0 in 2021 and we're now investing Day 4 Dimension S3, if you like, behind additional opportunity. We've done that while delivering this margin expansion. So we're super excited that we've been able to build this engine. It's been a little eye opening to us that we probably have to build it even faster and saw that is we're going to put growing investment where the growth in the business is and really just invest in the people. Yost sort of is an onshoreoffshore, but it's a combination.

Speaker 6

I mean, you really need the leaders and the thinkers and the architects are part of our organization. A lot of those people came across with the August acquisition. They're fabulous. But then we're also going to leverage outside health or offshore parties that might be really steeped in just a particular part of digital piece of the puzzle that you need to deliver. And so we build that web.

Speaker 6

But myself and my executive team have really been focused over the last 90 days on just how do we put the capability and capacity into to ramp this even quicker.

Speaker 3

And on the financials, Phil, I'd say, if we look at the pipeline and POS activity ahead of expectation, if we look at how that's converting into sales, it's a bit behind where we were a quarter ago. And to Nick's point, that's where we're trying to ramp up some targeted investments to unlock those sales. I feel really good about the opportunity is still there and growing since we're working hard to convert to sales. And then we had a little bit of inventory come out of the Yale channel that's the other headwind on just that sales number. But I feel like that's a one time event that will be through by the end of the year and really focus on getting this pipeline through and converting it to sales in 2025.

Speaker 6

Okay.

Speaker 7

Exciting. Really appreciate

Speaker 6

the color, guys. Just to put a little bit more around that, the way to think about today, probably sign an agreement, taking us 2 to 3 months, we want to be in the 2 to 3 week range. That's the goal. Okay. Thank you.

Operator

Your next question comes from Mike Dahl with RBC Capital Markets. Your line is open.

Speaker 8

Hi, thanks for taking my questions. Just starting with that, I want to make sure we're clear with kind of the terminology on flow. When you're talking about the pipeline and you're talking about the 160,000,000 in sales and assuming 5% conversion. Is that the actual agreements you have in place or this is still an estimate that you're using for a conversion rate based on just the number of insurance policies that you have coverage for right now?

Speaker 6

Yes. I'll demonstrate it a bit for you. I'd say broad line is an estimate. There are 3 probably 3 types of agreements we signed. There is type of agreement where the product may be recommended and offered.

Speaker 6

There's the type of agreement where the product is offered with a rebate. And then there's the type of agreement where it's actually mandated, where the insurer will say to the policyholder, unless you put this in, you will get no more insurance from us. Now even in the 3rd bucket where it's mandated, it's not an instant off. I mean, you could imagine what would happen publicly if they just turn policies off. So they give that homeowner some time to comply with the mandate.

Speaker 6

But those are the 3 types of contracts we're currently out and executing in the marketplace. What we did to get to the $160,000,000 was say, well, we took a mere 5% conversion rate. That would be $160,000,000 on the contracts we've already signed. Now, I'll tell you, we expect a far, far higher conversion rate with the mandated contract. Those will go in at it should be 100% minus whatever policyholders choose to walk away.

Speaker 6

Now these are not markets where it's easy to walk away from your insurance because there isn't a whole lot of insurance. Some of the places where it might be recommended, they pay back for itself with a discount and that's a lower conversion rate. We felt 5% is very conservative, but that's how we get to the number of what we've already signed.

Speaker 8

That's really helpful, Nick. And if I could

Speaker 6

just

Speaker 8

point of clarification and then a second question, the point of clarification would be that 5%. Do you work with your partners on, hey, this is kind of when we've done other things for other parts of insurance policies where you're having to lock in, whether it's like alarm monitoring or whatever, like this is kind of the conversion rate we think about or what informs that? But then the second separate question, just in the spirit of this week's events, can you remind us there's been a lot of moving pieces in your portfolio, in your sourcing initiatives. What is your current cost of goods exposure to China? And then what's your total cost of goods exposure that's outside of the U.

Speaker 8

S. But brought onshore at this point?

Speaker 6

So just on your first question, yes, we use very, very precise models with the insurers to understand, A, what the expected savings will be. I will tell you they're pretty eye watering when you do the numbers, multiply the number of policies they have. And then B, from there, we work on an expected conversion rate and appear in the supply chain accordingly. The 5% is quite a bit lower than that. That's our conservative assumption.

Speaker 6

That's not what we are actually gearing the supply chain and these contracts gearing them to do something and access to that. So that's the first part. The second part, I'll just give you a general concept to think about in a day, because I mentioned a little bit the sourcing piece. But I will tell you that we have been in the mode of optimizing the supply chain and managing tariffs really all the way back to fiber tariffs in 2017. The team is extremely experienced in this area.

Speaker 6

One of the things that I would say has evolved pretty significantly is our ability to flex that supply chain. And so we've moved away almost everywhere from single source. We now have 2 sources and your secondary source may cost you a bit more than your primary source. But if your primary source were to become more expensive because of tariffs, you can dial that down and dial up your secondary source and rebalance it to be the most efficient. Of course, added to that, we still have a very large U.

Speaker 6

S. Manufacturing footprint that becomes part of that total network solution, not just an independent thing. It's the role that it plays in that total network solution. So I'm confident that we are very well positioned to handle increased tariffs. I'll tell you, we don't invite it because it's a lot of hard work, but every time it happens, our share tends to accelerate because of our ability to execute relative to the competition.

Speaker 6

And that's where we really put the emphasis. And on the final thought, before I end it today, is we do have a SWAT team against this that have been working on this for many months in the run up to, I guess, today and today with the expectation that we will see tariffs. I think the PPD may be exactly where you see them and to what degree, but with the network that I've described, we're well prepared.

Speaker 3

And the impact, Mike, I'd say, going back to 2018 and look at these set of assets, we had over 50% of our COGS sourced from China. That's down to less than 25% today. The next point, the team has been working against that for a while. Tariffs are still in place. We're still paying.

Speaker 3

So the more said we can get out of China, the better. Looking broadly at our COGS, I'd say, U. S. Is roughly 40% to 50% of the COGS base. If you remember, outdoors is almost fully U.

Speaker 3

S. Water has a big piece in the U. S. And then security has a piece in the U. S.

Speaker 3

So you take that, add a little bit that's in China, the balance being rest of world and a portion of that rest of world is North American based. So we do have options. We're operating under a base case scenario that tariffs from China, at least are going to increase and the team is working to optimize our network around that and we do view this as an opportunity. That's very helpful.

Speaker 6

Final thoughts, just referring to the session we had around John's question. I'll just hit on that third point. We have seen in the market a bunch of import brands that claim to perform, whether it be in security, in fire safes, in water safety at levels that our own testing demonstrates they do not deliver. That is something that you'll see us increasingly ramp up our communications around. Some of it is directly to people's well-being and health and safety.

Speaker 6

I don't think that increased focus on some of that product that we've seen coming into the marketplace will necessarily get that thing.

Speaker 8

Yes, makes sense. Thank you.

Operator

Your next question comes from Trevor Allison with Wolfe Research. Your line is open.

Speaker 4

Hey, good evening. Thank you for taking my questions. Nick, I wanted to follow-up on what you were just referring to with some of that non compliant product competition. Can you dive into that a bit further, talk about how big of an impact that had on the quarter? Is that something that you expect to linger here going forward?

Speaker 4

I know you talked about some initiatives that you're going through to mitigate some of that. But just any way you can size that for us would be helpful.

Speaker 6

Yes. I'll give you a few examples just to start off. 1st, to kind of start on fire safe. We're payments via fire safe and our waterproof safe and consumers really depend on that, particularly because of the fire zone or our arcade. Zone.

Speaker 6

We see you can go and do your own research to see products in the market that claim similar performance. We put it through our own testing and whereas our sites will withstand a finer. Most of these, import brands burn within 2 minutes. We put collateral out into the marketplace. That was the first one we've tested and we put collateral out into the marketplace and invested behind telling the story and we are seeing our point of sale turnaround and start to gain actually gain share very quickly and really within weeks of activating.

Speaker 6

So it gives us confidence that when we tell the story, the consumer sees the value in it. We've now extended some of that work to things like faucets. We're finding their faucets that leach lead into the waterway. That is not legal. We will tell that story and so on and so forth.

Speaker 6

WWE started on connected security. So there is no doubt an opportunity. I wouldn't say the impact was massive. But unlike regular way private label, where we don't really compete at opening price point and we've done just fine because people see the value paying for the premium for the brands and we strategically position our portfolio like that. These are places where people are advertising in a misleading way that is directly competitive because they're claiming the same benefits as our brands provide at a lower price and they actually are not providing them.

Speaker 6

And so again, we tell the story. It seems to change the trajectory. We're just now making the investments and taking the time to do that, and we'll be doing it more publicly as we move forward.

Speaker 3

And Trevor, you see this both acutely in our organic security results year to date. This is where most of the problem is showing up and where the team is, as Nick discussed, taking action to offset it.

Speaker 4

Okay. Yes, it makes a lot of sense. Appreciate that color. And then the second question is on China. Conditions there are clearly dynamic.

Speaker 4

Nick, I think you used the word unprecedented, so a lot of uncertainty there. You talk about how you're thinking about that market moving forward? Do you think you're nearing a bottom here? I mean, comps are clearly getting a lot easier. Just any color there would be greatly appreciated.

Speaker 4

Thanks.

Speaker 6

Yes. Firstly, your question is highly logical. You would think one is nearing a bottom, just given how long it's gone on, how much less of new construction there has been as well as the fact that the government does seem committed to creating that bottom and stimulating that marketplace. That said, I will say after a couple of years of this, we just feel like the comp bank on that. The team there has done a fabulous job managing that cost structure and that P and L wherever that is still a profitable business for us.

Speaker 6

And so the way we think about it as long as we can keep it isolated and manage it in that way and frankly when I look at the size of the profit pool today, it's really go to 0 and it wouldn't have a noticeable impact on the total company. It really is a market that should give us exposure to growth and growth returns and demographics would tell you growth has to return at some point. And also it's a really nice innovation engine for the business. We have a great team there that sit very, very close to a lot of great innovation and that serves as a pipeline for the whole business. And so that's really with a lot of humility to the team up that they have done a great job, how we're thinking about it and how we're managing it.

Speaker 6

When that bottom actually forms, I would lose money making that prediction. So we'll just manage it tightly in the interim.

Speaker 4

Yes, I would too. Appreciate all the color. Thanks.

Operator

Your next question comes from Stephen Kim with Evercore ISI. Your line is open.

Speaker 9

Yes, thanks very much guys. Appreciate all the color so far. I wanted to ask you in security, I think you had mentioned that POS was down mid single digits, but you're guiding to sales down, I think high single digits, if I'm not mistaken in the 4th quarter. Just curious, if you could sort of talk about that?

Speaker 3

Yes. Happy to. The guide implies sales down mid- to high single digits in the 4th quarter. That's right. And I'd say it's continued consumer POS softness.

Speaker 3

I think that we are starting to see some of the trends turn based on the investments we made, but those investments came late Q3 into the beginning of Q4. And so not ready to predict a complete turnaround yet on that POS trend.

Speaker 9

Got it. Okay. But maybe the outlook into 2025 might be better hopefully. And then to sort of follow on these low quality competition the low quality competitive products you're dealing with in digital security, I just wanted to get a sense, is this issue more pronounced in maybe in the online channel? Or is it are you seeing it pretty much across the retail across all retail, including online?

Speaker 9

And can you share with us like what share of your digital products are sold online?

Speaker 6

Why don't I start? And again, just to reiterate, I actually don't have a problem where they're lower quality. Like we are just sort of not competing at that bottom end of the channel. It's where they're making false claims that we are combating and combating with success. And so that's where we saw this issue sort of emerge quickly.

Speaker 6

And yes, you're absolutely right, it's much more prevalent in the online space where you've got the and there's probably less scrutiny around product claims that are put on web pages. In terms of breaking out that percentage, Dave, I don't Yes. I would

Speaker 3

just say, Steve, it definitely over indexes our mechanical channel breakdown. The digital products more apt to be purchased online, but at least today as we build out the other channels.

Speaker 9

Okay. Thanks very much, guys.

Operator

Your next question comes from Adam Baumgarten with Zelman. Your line is open.

Speaker 10

Hey, good evening guys. Just back to the digital, I think you talked about 150 basis points of growth contribution in the back half of twenty twenty four last quarter. Maybe if you could update that number and maybe what it was in the Q3?

Speaker 3

Yes, we talked about that a little bit earlier. So I'd say our POS and our pipeline is exceeding expectations. The sales number coming through is a bit below that just given our conversion rate from the pipeline into sales, and we're investing to try to unlock that. As Nick mentioned, taking that time to revenue from 3 months down to 3 weeks is really the goal. 3rd quarter, similar, I'd say POS very strong, it's up over 80%.

Speaker 3

Signing new agreements, we just have to get into revenue.

Speaker 10

Okay, got it. And then just you mentioned trade down, I think in security or maybe some of the imposter products. Are you seeing trade down across any other areas like outdoors and water?

Speaker 6

No, not across outdoors. And yes, a bit in water and again, it's not so much trade down, just to open price points. I want to be really clear that's always been around. And it's where we've seen false claims that we've seen the impact in water. We've seen a bit and we've got some of those products in testing and they're not just false claims, they're non compliant.

Speaker 6

And so we're confident in the path to work back against that.

Speaker 10

But in the non connected products, you're not seeing any material trade down?

Speaker 6

We're not actually, I'm not talking about connected products at all. That would be very clear. It's not really in mechanical things like fire safes, kitchen faucets, some of them in the padlock space. It's really mechanical products that just coming in, sort of looks the same, makes a whole bunch of claims doesn't perform where they claim. Got it.

Speaker 6

That's helpful.

Operator

Your next question comes from Matt Bouley with Barclays. Your line is open.

Speaker 11

Good afternoon, everyone. Thanks for taking the questions. Think you made a comment in the prepared remarks around 2025 with that slightly positive market growth and that you would outgrow that. But in that scenario, you would see meaningful margin progress, I think I heard you say. And so, given your outgrowth, maybe you're seeing a little bit of volume leverage.

Speaker 11

But I guess, what are the other pieces of the bridge that might get us to meaningful margin progress? And how do you think about incremental margins in the scenario where the market would be slightly positive? Thank you.

Speaker 3

I'll give you a bit of color and context, Matt. I'd say, we see margin next year coming from a few areas, right? So productivity, which we've had a very nice trajectory. SG and A efficiency, as we continue to bring the businesses together, we're finding more SG and A efficiency. And then mix, we expect to be favorable.

Speaker 3

I think price cost will probably be a slight benefit as well. The offset and why we're not being more specific right now is the level of investment back in the business. When we talk to guidance, we'll be clear about where and how we're reinvesting, primarily around unlocking growth and sending itself for future growth opportunities. So that's the big offset lever right now. The teams are still working through and Nick and I look at it, the decision to make how much are we going to invest back in and how quickly can we turn that into growth on the top line.

Speaker 11

Got it. Okay. Thanks for that, Dave. And then secondly on the decking business, I think I heard you say you were seeing some evidence of improving trends to enter the 4th quarter and something around destocking, if you guys were talking about it potentially being one time. Just maybe hit on both of those points.

Speaker 11

Just have you seen the destocking subside or is there any more to come? And what are you seeing around some of these improving trends here? Thank you.

Speaker 3

The destocking, I think the channel loaded up for a season that was disappointing. And so that came out. That was really primarily the driver of the destocking. And the POS side, we're down mid single in the quarter. As we've looked over the past 4 weeks, it has improved from there from a POS standpoint, which gives us confidence that, hey, we're improving out of where we were in Q3.

Speaker 4

Okay. Thanks, Dave. Good luck, guys.

Speaker 6

Thanks.

Operator

Thank you for joining the Future Brands Q3 2024 earnings conference call. You may now disconnect. Have a wonderful rest of your day.

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Earnings Conference Call
Fortune Brands Innovations Q3 2024
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