Fortune Brands Innovations, Inc.

Hello, 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 speaker's remarks, there will be a question and answer session. I would like to turn the call over to Lee Abseck, Vice President of Investor Relations and Corporate Affairs. You may begin the conference call.

Good afternoon, everyone. and welcome to the Fortune Brands Innovations second quarter earnings call. Hopefully, everyone has had a chance to review the earnings release and our web posting for additional information on our most recent acquisition, as well as our supplemental financials. The earnings release and our audio replay of this call can be found in the investor section of our fbin.com website. I want to remind everyone that our 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. The company does not undertake any obligation to update, or revise any forward-looking statements, except as may be required by law. Any references to operating profit or margin, earnings per share, or free cash flow in today's call will focus on our results on a before charges and gains basis, unless otherwise specified. Please visit our website for our reconciliations. With me on the call today are Nick Fink, our Chief Executive Officer, and Dave Barry, our Chief Financial Officer. Following our prepared remarks, we have a lot of time to address some questions. I will now turn the call over to Nick. Nick?

Thank you, Leigh, and thank you to everyone for joining us today. On this call, I will walk through the highlights of our second quarter performance and offer some thoughts on the macro environment. I will also discuss our recent acquisition and how we expect these leading brands to accelerate key strategic initiatives and contribute meaningfully to our performance. I'll then turn the call over to Dave for discussion of our financial results and how we are thinking about the remainder of 2023, including the upward revisions to our market forecasts and increase to our full year 2023 sales and EPS guidance. Turning to our second quarter performance, our results and the actions we took this quarter demonstrate the resilience and strength of Fortune Brands innovations. Our teams delivered solid sales and strong margin results amidst an external environment that remains dynamic. Our leading brands, our focus on meaningful innovation, and our advantage channel relationships positioned us well in the current environment and drove our results. I want to thank all of our associates for your dedication and pursuit of excellence, and again welcome our newest associates to Fortune Brands Innovations. Together, we are going to continue to build an exceptional company. Net sales of $1.2 billion in the quarter were down 7% versus the prior year, and our operating margin was 17%. Our top-line results were 50 basis points above our estimates for our market. These results demonstrate our ability to grow above the market, protect margins, and invest in key strategic growth initiatives, even in a challenging environment. Our sales and margin performance generated earnings per share of $1.07. As we discussed in our last earnings call, heading into the second quarter, we knew that we were coming up against uniquely challenging year-over-year comparisons. As we expected, we saw sequential point-of-sale dollar growth versus the first quarter of 2023. 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 and major inventory destocking began in the second half of 2022. In fact, our second quarter 2023 organic sales results were 19% higher than in the second quarter of 2019, demonstrating that consumers continue to be interested in investing in their homes. Our results this quarter reflect our unwavering focus on outgrowing the market, preserving margins, and generating cash, all while continuing to prioritize key investments, including brand building, thoughtful capacity additions, meaningful innovation, and our digital transformation. I believe that we are very well positioned as we head into the second half of 2023. Turning now to some thoughts on the current U.S. housing market and the market for our products. As we have consistently stated, demand outstrips supply in the U.S. for housing, which creates a market opportunity for our products in both new construction and repair and remodel. There is significant pent-up housing demand driven by several factors that I'll touch on shortly. This demand, together with our strong and optimally positioned brands, will result in medium to long-term tailwinds for our business in both new construction and repair and remodel. Starting with new construction, as has been widely reported, the new home construction market has fared better than anticipated, despite higher interest rates. Existing home inventories remain near historic lows as U.S. housing remains severely underbuilt. Builders, particularly the large production builders with whom Fortune Brands enjoys strong relationships, have been responding to affordability challenges in a dynamic marketplace by building spec inventory and providing sales incentives, including rate buy-downs. Sales of new homes have been increasing throughout the year and starts are again outpacing completions. The backlog of new homes is also increasing, albeit at a much more manageable rate. With that as a backdrop, we have revised our single-family new construction outlook upward for the remainder of the year while continuing to monitor for economic volatility and the potential for a full recession. Turning to R&R, within the broader repair in the model space, we remain confident that our products are uniquely and optimally positioned to outperform. Several factors are converging to result in a unique opportunity for growth. First, the current lack of existing inventory combined with the fact that over 80% of mortgages are under 5% means that people are more inclined to stay in place and make the home they have into the home they want. Next, 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 which have offered financial stability and strong rates of return. Finally, the average home is over 40 years old, and homes built during the early 2000s boom are coming into prime R&R age. Additionally, the baby boomer generation continues to prefer aging in place and investing in their homes, while millennials and other first-time homebuyers are purchasing homes in need of upgrades due to limited available inventory and affordability concerns. These demographic trends are all supportive of repair and remodel. 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, and home equity and employment levels. We believe our products are relatively more insulated than other R&R items because they are smaller ticket items, are less disruptive to install, and because they offer immediate aesthetic improvement or meaningful innovation and functionality to a home. In short, people buy our products because they want to enjoy them. That said, 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. Turning now to our most recent acquisitions, I'm extremely excited about the recent acquisition of two world-class businesses from Assa Abloy, the Emtek and Schaub premium and luxury door and hardware business, and the U.S. and Canadian Yale and August residential smart lock business. Dave will provide more color into the numbers, but at a high level, we expect second half 2023 sales for these businesses to be approximately $190 to $210 million, and for this deal to be accretive to our P&L in 2023, with $0.04 to $0.06 of EPS, even after factoring in $0.08 of purchase price amortization. This acquisition is a great example of a disciplined approach to M&A. Emtek and Schaub are 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, and we look forward to leveraging the team's demonstrated skill at driving phenomenal customer service and highly designed products, while also maintaining high margins across the entire Fortune Brands portfolio. Clearing on Tech & Sharp, our luxury platform will now be over half a billion dollars in annual sales, and the potential synergies are meaningful. This acquisition will allow us to expand our presence in luxury showrooms, further penetrate the luxury hospitality market, and become an authentic global luxury design house, offering cohesive product offerings and finishes throughout the home. Our consumer remains strong and is increasingly interested in products with storied brands and distinctive quality, and we believe our growing luxury portfolio speaks to the secular demand trend. The Yale and August residential smart security businesses consist of innovative brands with a strong IP portfolio and exceptional digital talent. As part of the acquisition, we have added roughly 100 new engineers supporting in-house software and hardware platforms, who we will leverage across our portfolio of brands over time. In addition, this acquisition will allow us to expand our retail and omnichannel and wholesale door lock business, broaden our residential connected security ecosystem, and accelerate innovation across our brands, including the potentially transformative development of a fully integrated smart entry door system. Here again, the potential for synergies is significant. This acquisition will be a key accelerant to our growth strategy. It allows us to expand in existing channels and categories, as well as in new, high-growth spaces with secular tailwinds. Importantly, through the addition of Yale in August, This acquisition is a key step in our transformation into a digital, innovative disruptor. Further, with the addition of EmTech and Schaub, we will materially accelerate our strategy to build the House of Roll into a global luxury powerhouse for the entire home. Combined with our existing Fortune Brands business, we now have the knowledge base, the growth platforms, and the brands to bring new and disruptive products and services to the market that will be the first of their kind. Overall, Fortune Brands Innovations is well positioned for both the near term and the long term. Our branding power, meaningful and value-add innovation, and strength in the multi-step distribution channel are powerful moats in uncertain times and accelerants in times of broader economic growth. Our recent acquisition of the leading Emtek, Schaub, August, and Yale brands will provide growth opportunities and nicely complement our strategic focus on branding, innovation, and channel. Our brands are uniquely positioned to outperform the market in all environments, and our newly aligned structure, together with our Fortune Brands Advantage capabilities, will enable this outperformance, as our results demonstrated this past quarter. As we announced in the release this afternoon, 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 reflects our confidence in the Fortune Brands business. Before I turn to the individual businesses' performance, I would like to remind everyone that our second quarter 2023 results reflect both the impact of challenging prior year comparisons plus the impact of the single-family new construction market which slowed abruptly in the second half of 2022. That slowdown is now being digested through our business. In the second quarter, water innovation sales declined 5% compared to the prior year quarter due to market-driven volume declines across the segment, partially offset by price. Our margins for the segment were 23.2%. The Moen U.S. business has strong long-standing relationships with the top U.S. production builders, and our strategic decision to invest in our relationships with these key customers yielded tangible results. In retail, we saw more general market softness as the DIY consumer market slowed. Our House of Roll brand's total sales were up low teens for the quarter, including Aqualisa, and down high single digits organically, reflecting the impact of high second quarter 2022 comps and a softer market. 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 who is increasingly seeking differentiated goods and values, timeless quality. We recently announced the building of a new facility in the UK, which will help meet global capacity needs of the business as we continue to expect our brands to perform well. In China, sales were up over 30% year over year. This reflects the impact of lapping the second quarter of 2022, which was marked by the Shanghai COVID shutdown. We also saw higher-than-expected project completions, although the overall market remained soft and the Chinese consumer remains cautious. However, we continue to capitalize on our leadership positions and are well positioned within the Chinese housing market, where we are increasingly focused on the emerging Chinese R&R market. For the full year, we now expect China sales to be down high single digits. In outdoors, sales declined 14%, reflecting expected market softness, which was partially offset by price. We saw sales improvements sequentially throughout the quarter and are encouraged by July results so far. We are pleased with our operating margin of 16.4%, which is 80 basis points higher than our second quarter 2022 results and is a proof point of the success of our newly aligned operating model. We are well positioned across our outdoors brands to respond to any changes in demand patterns and are making investments to continue to best serve all of our customers and channel partners. while also focusing on the innovations which we believe will further differentiate our products. In decking, POS trends indicate continued strong consumer interest in this category and the recent re-acceleration of sales as the value proposition is increasingly understood by consumers and pros alike. Wholesale sellout improved throughout the quarter and we exited June up high single digits. In the quarter, Sales were down high teens versus the same quarter of 2022. However, when comparing to Q1 of 2023, we saw sequential sales increased by more than 50%. Our channel partners were conservative with inventory buys in the beginning of the quarter, but in June and into July have been accelerating their inventory purchases, and our POS data shows that we are growing above the market. Indoors, sales declined low teens as the slowdown from the 2022 single-family new construction market impacted ThermaTru. 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 partners 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. Lastly, in security, sales increased 2% over the prior year quarter. These results were driven by price and continued growth in commercial and international markets. As we have previously mentioned, our security and water businesses share many key similarities, including the importance of their iconic brands with consumers and trade partners, a strategic focus on connected products, and the structure of their operations and supply chains. The security business continues to implement the Fortune Brands Advantage Playbook that we first used to transform our water business eight years ago, and the results are becoming apparent. Going forward, the team will work to continue to evolve this business into a higher growth, higher margin business focused on driving the power of our brains and developing meaningful innovation. Before I turn the call to Dave, let me share a few final thoughts. We took meaningful steps this past quarter to prepare Fortune brands for continued growth. Our reorganization into a more efficient, centralized company focusing on brands, innovation, and channel has progressed more quickly than we anticipated thanks to the strong engagement from our teams and the impact was apparent in our results. We made important changes to our supply chain to align with our growth areas and margin progression targets. We continue to invest in our key strategic priorities, including our iconic brands, digital transformation, and meaningful innovation. And finally, we closed on an exciting, potentially transformative acquisition that we expect to drive growth and accelerate our larger strategy. As we highlighted last year, the actions we took in 2022 were designed to transform Fortune brands into a growth-focused, highly innovative company. Six months following our separation, I am encouraged by all that we've accomplished and excited about what we will achieve next. As reflected in our revised full-year guidance, we see some positive indicators of a healthy consumer while also being mindful of potential short-term disruptions. We're constantly monitoring and are well-prepared to respond to uncertain end markets in the short term while we position ourselves for accelerating longer-term outperformance in a market supported by fundamental growth characteristics. As we head into the second half of 2023, we are focused on execution and delivering on our commitment to above-market sales growth and margins. With that, I'll turn the call over to Dave.

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 second quarter results. 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. Our results reflected their dedication. Sales were $1.2 billion, down 7%, and consolidated operating income was $198 million, down 11%. Total company operating margin was 17%, and earnings per share were $1.07. Our sales in the second quarter largely tracked our POS. Volume was down high single digits, which was partially offset by low single-digit price. Changes in channel inventories did not impact consolidated results. As we discussed previously, we expected operating margin in the first half of 2023 to be heavily impacted by production inefficiencies and stranded fixed costs related to our inventory reduction efforts. We continued to make excellent progress against our near-term inventory reduction target, and our organic second quarter inventory finished at $845 million, down roughly $240 million from our third quarter 2022 peak. Our second quarter operating margin of 17% included a roughly $20 million impact from these efforts, bringing the total P&L impact in the first half to more than $50 million. Going forward, healthier supply chains and our more aligned organizational structure should improve our ability to accurately forecast with continued focus on service levels and inventory mix. While we are pleased with our second quarter results, our teams remain focused on driving out performance including above-market growth, preserving and enhancing margins, and generating cash. Our continued focus on these performance metrics has enabled the team to drive both key strategic growth investments and strong cash flow. As I will detail later, our balance sheet remains strong, and we have the flexibility to manage through 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 $617 million, down 5%, and down 6%, excluding the impact of the Aqualisa acquisition and FX. The net sales results reflect the impact of lower volumes, partially offset by price. Water Innovations operating income was $143 million, and operating margin was 23.2%, reflecting lower volumes, partially offset by price, and continuous improvement initiatives. Our point-of-sale performance for Moen 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. House of Roll total sales were up low teens, while organic sales, excluding our Aqualisa acquisition, were down high single digits, primarily due to strong prior-year comparables and market softness, which was most pronounced outside the United States. 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. The Chinese market remains soft, and though the completion of delayed projects is accelerating, new home sales and starts are moderating as the Chinese consumer remains cautious. That said, we continue to see growth in the emerging R&R channels and our position for market outperformance due to the strength of our brand and expertise of our in-country leadership. Turning to outdoors, sales were $376 million, down 14%. Segment operating income was $61.6 million, down 10%. Importantly, our margins improved both versus the prior year and sequentially to 16.4%, driven by volume leverage, price, and plant productivity. Door sales were down low teens, As expected, sales were impacted by lower volumes from the single family new construction slowdown in 2022 and the challenging POS comparables. However, our wholesale business is performing above market and the business should be positively impacted by the improved new construction outlook. 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. Finally, in security, Sales increased 2%, reflecting increased distribution, price, and continued strength in commercial and international security. Security segment operating income was $27 million, up 6% versus 2022. Segment operating margin was 15.6%, up 70 basis points. Our team continues to work to transform our 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 over time. This strategy will be accelerated by the integration of the Yale and August assets. Turning to the balance sheet and our cash flow performance. Our balance sheet remains strong with cash of 682 million, net debt of 2.6 billion, and net debt to EBITDA leverage at 2.9 times. This leverage ratio reflects the impact of our recent acquisition and we expect to reduce our net leverage ratio over time as the business continues to generate strong cash flow. We generated free cash flow of $358 million in the quarter, bringing our first half free cash generation to $391 million. Our working capital reduction efforts continue to shrink our balance sheet and generate cash. To summarize the quarter, we delivered solid sales and strong margin results in a fluid environment while overcoming the most challenging period of prior-year comparables and the impact of the slowdown in single-family new construction market in 2022. With that in mind, I'll now provide an update to our 2023 guidance, inclusive of the acquisition of the YASA ABLOY assets. As indicated in our release and in our supplemental presentation, for the second half of 2023, the acquisition is expected to generate net sales of $190 to $210 million and earnings per share of $0.04 to $0.06. This includes the unfavorable impact of approximately $0.08 from purchase price amortization. Based on our revised market assumptions, which include an improved outlook for U.S. single-family new construction, plus the impact of the AASA acquisition, we now expect full-year consolidated Fortune brand sales to be flat to down 2% or down 4% to 6% on an organic basis. We now expect full-year operating margins between 16% and 16.5%, reflecting the impact of purchase price amortization from the acquisition. On an organic basis, we continue to expect operating margin to be around 16.5%. As today's press release and our supplemental web posting indicated, we are increasing the midpoint of our EPS guidance by 8 cents and narrowing the overall range to $3.75 to $3.90, reflecting the acquisition and our organic businesses' performance in an improving market. As a reminder, we previously raised our EPS guidance during our first quarter 2023 earnings call, reflecting our operational outperformance. So in total, our updated EPS guidance reflects a 13-cent increase over the midpoint of our initial guidance. In closing, as we head into the second half of 2023, 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, managed our margins, and made significant improvements in cash generation. Our teams have done a fantastic job navigating the uncertainty of the past few years And as we come into the back half of 2023, we remain confident about the future of the business. I will now pass the call back to Lee to open the call for questions. 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 would like to ask a question, I will ask that you limit your initial questions to two and then re-enter the queue to ask additional questions. 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.

Thank you. Again, we will now be taking a limited number of questions. And since there may be a number of you who would like to ask a question, I ask that you limit your initial questions to two and then re-enter the queue to ask additional questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. The confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Again, that's star one to register a question at this time. Our first question comes from the line of Phil NG with Jefferies. Please proceed with your question.

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 with sales stepping up from $400 million to $525 million in 2026. Can you provide some color on the growth drivers? And, Nick, I think you don't typically bake in much cross-selling in past deals. What's giving you the confidence on the cross-selling synergies you're calling out? I think it's about $65 to $85 million. How do you see that kind of wrapping up and what are some of the big opportunities?

Thanks for the question. Happy to elaborate a little bit. We've obviously seen a variety of deals and done a variety of deals over time. This one really sits at a wonderful crossroads of being fantastic brands backed by an excellent team. a great price pay, you know, through some really disciplined approach to the asset itself. But then thirdly, you know, the third part of the intersection is really the opportunity to come and unlock growth by putting these things together in our portfolio. And, you know, we try to be, really disciplined around value, but then also really disciplined around the other two items, which is, you know, looking for great brands and teams, but asking where we can add value with the Fortune Brands portfolio. And I'd say this is one of the more exceptional deals that we've seen. And so, you know, I'll give you a couple kind of key, you know, foundational pillars, and then, you know, happy to elaborate if it's helpful. But, you know, one, you know, I just start actually with the EmTech business. You know, so EmTech, And Shaw, leader in the luxury hardware category, very design-led, a lot of colors and choices for designers. incredible supply chain and service, you know, really, you know, a concierge approach. And doing that at really, really fantastic margins. Not something that you see very often, bringing all of those things together. And we look at the House of Roll platform, which you can see in the organic 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, you know, we'll now have a platform that's north of, half a billion dollars outgrowing the market and has global reach, right? And the elements really work together, whether it be in the channel where we have overlap in types of distribution channels, but not necessarily overlap in all of our distribution. But then even things like being able to unlock, you know, collections for an entire room, do color matching, do design work together, you know, and really provide a solution where a designer or consumer gets to put something together the way they want it, but in a way that works with our backing as a company. And so, you know, that's an example. And then I think you go over to, you know, the other side, Yale and August, you know, really driving tech first and connected product first. And, you know, the August platform itself, as we're getting in there and learning more about it, we think is a very, very powerful platform. That is something that we can bring in a business, by the way, learn from what 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 in our connected products business generally. The ability to bring that many engineers, that skill set, that kind of agile and fast 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 you bring those two things together. And, you know, one of the things that we call that in the deck, for example, is smart entry, right? We're going to have one of the leading entry lock businesses and brands with some of the best, if not the best technology, and you marry that with the leading fiberglass entry door brand, already a leader in its space, and think about all the innovation that went into that, and you actually make that thing work, not as just a bolt onto an existing system, but a total system solution for consumers, 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. I've done a 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 a level of excitement 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, you know, 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 at this valuation.

That's super. That's great color, Nick. Glad to see you're really excited about this transaction. You bumped your organic sales guide. Give us some color on any inter-color transactions Interquarter trends you saw early into July. You've expressed a more upbeat outlook on new construction. How do you see that inflection in the orders the builders have called out in your business, particularly plumbing and doors? Thank you.

Yeah, I'll start and then I'll hand it over to Dave and he can give a bit more detail about it. But I'd say at the highest level, if you think about it, it's actually been fairly consistent thematically with what we saw in the second quarter. And so, you know, what did you see? You saw relative strength in both Boulder, I think relative to expectations, in their order books and what was being reported. Now, obviously, in Q2 of 23, we're digesting the slowdown from last summer, right? And so the uptick is yet to come through the P&L. And then on our side, I'd say relative strength in everything that was more project or pro-related and relative weakness in things that were more kind of DIY or, you know, weekend warrior related. And as you then look into July, I'd say thematically that continues to be true, you know, and we're going to see more uptick around the large production builders. We're seeing their value chains, supply chains start to strengthen as people prepare for those orders to come through. We've seen continued strength in our pro-related channels where I think projects continue to be strong. And it's more around the very discretionary 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's some encouraging signs of certain product groups where you're seeing at retail a little bit more life than we've seen in, you know, that DIY stuff. So, Dave, I don't know if you want to add to that.

Yeah, so I'd add some color around just the second half sales cadence. And so if our prior organic guidance was down 3% to 5%, I'd remind people that includes the extra non-repeating fiscal week from last year, that for the second half is roughly two percentage points, you know, all in the fourth quarter. or four percentage points overall. So that organic guidance, then call it, you know, down two percentage points, excluding that comp. We're moving it, you know, the midpoint of our current guidance now to flat in the second half of the year. And I think simply You think about it, it's POS down, low single digits, offset by a favorable inventory comp of low single digits. That gets you roughly to the flat. And then the non-repeating fiscal week is a two percentage point headwind. That gets you to the midpoint of the guidance. So the next point, here at the end of July, we look at our POS data. We see it trending in the right direction to support this forecast. And then if you layer on top of that the single family new construction data, improvement that will really start to benefit us in the fourth quarter that gives us confidence to believe in our second half outlook.

Okay. Really appreciate the color, guys. Sure. Thank you.

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

Thanks very much, guys. Appreciate it. Yeah, a lot to ask about. Let's start with the acquisition. I think you had indicated that there was going to be a little purchase accounting impact in the back half. Any reason why we should expect that to continue into fiscal 24? And as you look across the sales synergies and cost synergies, 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, you know, in 3Q, 4Q, and maybe a look into 1Q.

Steve, this is Dave. I'll talk to that. On the synergies side, I think, you know, maybe some of the sales synergies trickle in by the end of the year. On the cost side, because of their inventory positions, while the teams will be doing the work, we won't see that in our P&L until next year, just given the balance sheet. And then to your question on purchase price amortization. So, remember, these are, you know, trade names that are amortized over a long period of time. So, it is roughly 8 cents in the back half of this year. It'll be 16 cents in a full year next year impact. And then 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, hopefully that helps to answer your question, you know, Nick, for sending you down. Yep, absolutely.

Okay, great. That's very helpful. Now, I know that your guide, you mentioned your guide, the improvement, sort of reflects to some degree, and I think a large degree, an enhanced view of single-family activity, and I'm assuming there's basically the lagged starts effect. 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.

So the mix impact on us?

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.

Yeah, so I'll just give you some thoughts around it thematically, and then I can give more color. I would say, you know, bottom line is we are, and we really work to keep the portfolio margin agnostic, whether it be around product price point, I'm sorry, margin percentage, but around product price point or around channel. And so if you look, you know, 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 and say, you know, showroom business, which you need big sales forces out in the market serving that maybe higher contribution margin, the larger SG&A supporting it. And at the end of the day, that sort of balances out. And so, you know, it moves around the P&L as a little P&L geography, but I would think about it as 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 our portfolio.

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

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

Our next question comes from the line of Michael Reholt with JPMorgan.

Thanks. Good afternoon, everyone. You know, first I just wanted to dial in a little bit on some of the puts and takes on the updated margin guidance for the year. I guess, you know, on a segment level, you had security nicked 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 accountings. um and you know 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 you know a little bit better top line outlook um organically at least um you know were there any you know additional leverage that you were thinking of and was that offset by anything else and then i just had a follow-up

Mike, this is Dave. And the security question, you are correct. That's predominantly just impact from accounting from the acquisition. The base business is performing well as evidenced by their margin results in the second quarter. And then in the back half, you know, we had said on our initial call this year that we expected back half operating margin to be between 17% and 18%. we still think that's the right range for the back half between 17% and 18%. Now, there are some puts and takes in there. We are making some incremental investment, investing in digital, investing in brand and R&D in the second half. We're controlling that tightly, but we see some areas that we want to accelerate as we head into 2024. And then interestingly, if you look at our first half margin performance of 15.2% and normalized for the inventory reduction overhead of $50 million that we called out, you're right about at 17.5 percent. So, the business is demonstrating, you know, pretty consistent margin performance and trajectory while digesting some of the implications of reducing our balance sheet and the market volatility. But we feel good about the outlook going forward.

And I just add, Mike, if you think back to our investor day in December when we presented that longer-term margin walk and all the activities that we had planned to start to drive those, you know, feeling very good that that is now coming through in both the security and the outdoors business. And notwithstanding the fact that it's a pretty choppy external environment out there, you can see the businesses making the progression that we want them to make. And we're doing that by taking, you know, this newly aligned structure and the Fortune Brands Advantage playbook and applying it. And the teams are, you know, feeling very good about their ability to execute well against that over time.

Right. And I appreciate that. And I guess, secondly, maybe just go back to the slide on the deck around the synergy opportunities on the top line, which, you know, very detailed and obviously very well thought out. You know, I think back to, you know, the acquisition of Fiberon. And, you know, I believe you had, correct me if I'm wrong, I want to say a 50% growth over three years. and a lot of that due to some really nice additions on the distribution side. You were able to, you know, secure new customers, et cetera, you know, added distribution for the Fiberon product. You know, we see a lot of, you know, expansion of channel in both the Yale and August and EmTech and SHOB. 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. But I would have actually thought perhaps there would have been room for slightly higher numbers. And maybe I'm just being a little too aggressive, or maybe you're perhaps being conservative. I just wanted your take on that, particularly over a three-year period. It does seem like there's a lot of cross-selling opportunities, too, to the point on the slide. And just curious, you know, if I'm thinking about things maybe a little too aggressively in terms of even greater upside potential.

Yeah, so, well, first I'd say, you know, thanks for calling out that Fibron analogy because I think it's really good. And I think what's particularly interesting about that example that you called out is that is still ongoing. Like that, you know, those gains in the higher margin part of that business are and those distribution gains are still unfolding. You know, obviously, the market's been a little bit tougher this year, but as we just track that conversion rate so that, you know, that bounces between 1% to 2%, you see it sort of move back up, you know, you'll see those play through. And during that whole time, though, we're preparing a business to then build on, right, with brand and innovation. And so, you know, very dramatically, I think, somewhat what I'd say specific to, You know, August and Tech and Shop is, you know, we closed June 30th, so we've only had the teams together for a short amount of time. And, you know, they've identified a series of synergies that we've put here, particularly around channel. And what we'll do is we'll be very respectful of what these businesses do better than the legacy Fortune Brands Innovations business. And so they have channel strength in certain areas that is better. And we will look to learn from that and build it into the legacy business. And then conversely, there are, of course, places where, you know, the legacy business has strength that um these businesses don't where we can start to expand um through distribution and and access and our channel strength and relationships and so you know will there be more upside over time for that possibly but i i think the real big unlock comes from really the you know sort of the one plus one equals five strategy which is as you put these things together can we unlock New innovation, new approach, you know, whether it be on the luxury side where we really are going to have a lot more scale to go off to the business, you know, on a global business and on a global basis with that luxury consumer, you know, who cares about brand and cares about the artisanal stories behind it. or on the technology-enabled side where, you know, our connected business is going to be that much bigger. And the infrastructure and backbone on which it now all sits is going to allow us to unlock innovation at a faster pace. And I think that's where, you know, the real upside may exist, but that's going to take us a little time to work through those innovation opportunities and bring them to market.

Our next question comes from the line of Susan McLary with Goldman Sachs.

Beautiful to see you with your question.

Thank you. Good afternoon, and thanks for taking the question.

For sure.

Can you talk a little bit about how you're positioned from an inventory perspective across the different channels and the different segments? It sounds like you've got a nice lift in the quarter. from the volumes that did flow through there. As you think about the back half, what's the ability to capture any further upside to demand and perhaps see those volumes continue to move a bit further?

Yeah, hey, it's Dave. I'd say, you know, looking at water and security relatively balanced from an inventory perspective relative to the rate of sales. We're still a little bit light in outdoors in the channel, you know, primarily around wholesale decking. 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. But I think if the market were to accelerate beyond our expectations in the second half, there would be some inventory upside opportunities as we would expect customers to put some inventory ahead of those sales. But where we sit right now, it's pretty well balanced and we've kind of gotten through a lot of the prior year challenges from inventory builds and depletes that was really noisy on the sales line.

Okay, that's helpful. And then, you know, you talked about security issues. 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 quarter. Can you just talk a bit more about some of those initiatives and how should we be thinking about them flowing through to the business and actually coming through in terms of both the revenue and the margins over time?

Yeah, I would, you know, 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, you know, observe what sort of happened. Let's say starting in, you know, 15, 16 and the playbook that was applied there. It's the same playbook being applied to security. And actually, they're very similar in sort of brand resonance. ability to put innovation behind it, connected product, and even the supply chain has a lot of commonality. And so you can really sort of almost lift and shift a lot of that playbook. So 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. We're really developing a leadership position in some of the safety work that we do in facilities. It's very sticky work. 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. We're able to put the brand and innovation behind it. Eventually, that will be connected as well and will be a much more data-driven thing. And, you know, that's just an example of 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, 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 those sorts of capabilities that, you know, we talk about the Fortune Brands Advantage capabilities, but 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 are able to accelerate some of the connected overlap. 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 pretty much a virtuous 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.

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 performance versus the second quarter of 2019, you know, sales are up 15% or roughly a 4% CAGR, and their operating margin is up 390 basis points. And so, you know, you see the output of what Nick described as really taking that playbook from water, embedding it at security, and getting that flywheel going around growth, you know, reinvestment and margin enhancement.

Yep. Okay, great. Thank you for the call, and good luck.

Well, thank you.

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

Yeah, thanks very much. Good evening, everybody.

Hey, Joe.

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

Yeah, I'll give you some perspectives broadly, and Dave can elaborate on that. We usually don't break it down to that level of granularity. We put some information in the deck here. But I would think that, you know, this business has historic strength in the integrator channel, which we found very interesting. And so, you know, as people connect to products and to homes, they're – there's the one at a time, which August was built on, but there's also sort of a multiple and it works on the system with an integrator. And what's really interesting about the Yale infrastructure backbone is how flexible it is on a variety of different systems. And so that's a real strength of theirs, something that we don't have elsewhere in the business. And so we really want to build upon it. We could expand our portfolio, you know, even in our existing, you know, master like 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, but then of course we have a lot of strength in retail and e-commerce, which, you know, historically has been, let's say, weaker for Yale, and so we think that that's an opportunity where we can leverage our historic strength to build their business up.

Yeah, and Joe, I'd say, interestingly, like our connected product business, this business has been chip-constrained, and they actually prioritize these third-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 the demand would be for this type of product. As we get this business integrated back in stock, you know, that'll be another growth avenue for us going forward. Yeah.

And that was actually my second question was around those constraints you had mentioned earlier, I guess, late last year. So maybe for my second question, I'll just ask a clarifying question on the wholesale decking. Did you say that sellout improved high single digits and was that versus for specific times?

Yeah, we said by the end of, at the end of July, we were going to have single digits versus prior year.

Sell out.

Like a trailing four weeks or something? Like what's the period?

Yeah, yeah. That's how we look at it.

All right, great.

Thanks a lot, guys. Yeah, for sure. Thank you. And our next question comes from the line of John Davallo with UBS.

Hey, guys. Thank you for taking my question. I guess first question would be on water 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? 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?

Yeah, I'll start and then Nick can comment. Just a decomposed water sales, reported sales down 5%. Strong sales growth from China, given the prior year comp and the acceleration of some previously started developments. If you pull that out, organic excluding China would be down about 9%. We see POS down low double digits. And so within that, then, John, it's volume down low double digits, offset by price up low single digits. which is consistent with what we've been saying all along. We took a low single-digit 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 on sales from product load-in timing around Amazon Prime Day, which was just different weeks last year versus this year, and it fell into the second quarter. But the cleanest way to think about it is POS down low double digits, volume down low double offset by low single price.

And then the second part of your question on pricing opportunity, you know, what I'd say is part of these Fortune Brands is about these capabilities I was just talking about. You know, one of the things that we've invested in is category management skills and capabilities, particularly in water and security and now, you know, carrying them over to the outdoors business. And what that does is really gives us the ability to understand, you know, what is happening with the consumer, what is happening with the product. at the shelf using data and analytics, and then to work with our customers and wholesale partners to optimize pricing. And so, you know, we're constantly, we try to avoid doing massive, you know, or shocking price increases. Now, obviously, you know, between 2020 and today, there was some of that in certain categories, but we really seek to do smaller, more incremental, regular pricing 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 move, you know, beyond a 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 for 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 were doing it.

That's helpful. Thank you. And, you know, 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. You know, DIY being a little bit softer than pro, you know, in an environment where, you know, there's a little bit more challenge from an economic standpoint. 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 bit more themselves. I mean, why do you what do you think is driving this dynamic where the pro is holding up better?

Yeah, I'll give you my hypothesis for what it's worth, which, A, I think you go back to sort of the fundamentals, right? You have a very, very under-built housing market, and so you're going to see 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. And then you have a very aged housing stock, and so I think you see consumers prioritize their homes and go after, you know, projects where, you know, they really need to bring their homes into a more modern era. And you've seen that hold up. And I think where you've seen what I'd say is relative weakness is in the Huge growth that we saw in kind of retail POS in 2021 and 2022. You know, we've called out pretty consistently saying, you know, coming into that spring selling period, you really saw people go out and spend a lot in retail for kind of the spring into early summer months. My belief is a lot of that was stimulus-driven. You know, they had money and were probably doing projects that they wouldn't have otherwise done. And, you know, as we anticipated, if you now look at the POS data, sequentially the numbers improved week on week on week as you sort of went through, you know, the late winter into 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, you know, people went out and did a lot. And interestingly, you know, and consistent with that, as we've now gotten into kind of midsummer and you get past that, you know, that hump, you can see those POS dollars come back into line and closer to flat, I would say, consistent with flat versus last year, consistent with, you know, what we'd expect on a normal season. And so I guess to sum it up, I think new construction, bigger projects, modernizing homes or building new homes continues to be driven. I think what we are digesting is a stimulus-driven lap that was pretty tough. I was surprised, actually, that we pretty much lapped 21 and 22. And then in 23, I think you did see sequential growth, but it was just too big a lap without the support of those stimulus dollars.

Got it. Thank you.

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