Fortune Brands Innovations, Inc.

Good afternoon. My name is Camilla, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Third 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 Avsek, Vice President of Investor Relations and Corporate Affairs. You may begin the conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Innovations third quarter 2023 earnings call. Hopefully, everyone has had a chance to review our earnings release and supplemental financials. The earnings release and the audio replay of this call can be found in the investor 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. 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 in today's call will focus on our results on a before charges and gains basis, unless otherwise specified. Please visit our website for a reconciliation. With me today on the call are Nick Fink, our Chief Executive Officer, and Dave Barry, our Chief Financial Officer. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick. Nick?

Thank you, Lee, and thank you to everyone for joining us today. On this call, I will walk through the highlights of our third quarter performance and offer some thoughts on the macro environment. I will also give an update on our ongoing evolution into a tightly aligned company focused on brands, innovation, and channel. I will then turn the call over to Dave for discussion of our financial results, our updates to our guidance for the remainder of 2023, as well as some thoughts on our emerging expectations for 2024. Turning to our third quarter performance, our teams executed well and delivered solid top and bottom line results in a macro environment that remains challenging. Our net sales growth outperformed the market for our products, and our margin results sequentially improved over the second quarter of 2023. We delivered above market POS results across most of our businesses. Our recently acquired assets are performing better than we expected, and our balance sheet remains very healthy as we continue to generate strong operating and free cash flow. Our results this quarter demonstrate the potential and power of our aligned organizational structure and our Fortune brand's advantage capabilities, as well as 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, and our digital transformation. The actions we took over the past year to better leverage the strength of our organization and sharpen our focus on our leading brands, meaningful innovation, and our advantage channel relationships helped drive our results and give me confidence in our strong future. Our Fortune Brands Advantage capabilities will continue to advance our growth and margin journey by reducing cost, informing our strategic pricing strategies, in enabling our high-growth focus areas like connected products. Finally, I'm pleased to report that our integration of the EmTech, Schaub, and Yale in August assets is going extremely well, and we are even more optimistic about the growth potential that these businesses have, both regarding their standalone performance as well as the potential they have to accelerate our transformation into a digital, disruptive company and a luxury goods powerhouse. Net sales were 1.3 billion in the quarter versus 1.2 billion the prior year, up 5%. Organic net sales were down 4% versus the prior year. Our operating margin was 17.4%, up 40 basis points versus the second quarter of 2023. Our sales and margin performance, together with exceptional cash generation, resulted in earnings per share of $1.19, a 3% increase over the third quarter of 2022, and gives us confidence in delivering our revised EPS range of $3.80 to $3.90. As we discussed in our last earnings call, we continue to expect some headwinds from lower point of sale performance as consumer softness continues and as we further digest the impact from the slowdown in the new construction market through the first half of 2023. It has been widely reported While single family new construction permits and starts continue to improve off of cycle lows, based on where our products are installed in the production of a home, we do not expect to see the benefit until the end of 2023 and into 2024. The repair and remodel market remained soft, although the pro was relatively stronger than pure DIY categories, and our strength with the pros worked to our advantage. We will remain proactive in our response to any short-term external headwinds while continuing to focus on outgrowing the market, preserving margins, generating cash, and prioritizing strategic investments in the key growth priorities that we expect to pay outsized dividends when the market rebounds. Now turning to some thoughts on the current U.S. housing market and the market for our products. The need for housing remains incredibly strong, although it is being constrained by current affordability challenges. In fact, we believe the recent slowdown has only added to the pent-up need for housing. A recent third-party survey indicated that over a third of respondents reported plans to purchase a residential property within the next 12 months. This remains well above the pre-pandemic average and the longer-term average dating back to 2014 of 29%, demonstrating significant supply and demand imbalance in the larger housing space. While we cannot predict when the Fed will signal the end of the current cycle of rate increases and quantitative tightening, once it does so, we would expect interest rates to return to more normal levels and a corresponding significant return to growth in the housing market. We continue to believe this fundamental 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 single-family new construction market continued to improve versus what was initially anticipated at the beginning of 2023, despite higher than expected interest rates. Builders, particularly the large production home builders with whom Fortune Brands enjoys strong relationships, continue to respond to affordability challenges in a dynamic marketplace. As we have previously stated, While the positive impact on our business will not be immediately apparent due to the timing of when our products are installed in a newly constructed home, this should be a growth tailwind in 2024. Turning to R&R. The R&R market remains dynamic, and there are many variables that are impacting the repair and remodel space, including consumer savings and confidence, employment levels, existing home turnover, and home equity levels. We believe that we are well prepared for any external headwinds and remain confident that our products are increasingly well positioned to outperform in any market. First, as mortgage rates rise to the highest levels in many years, homeowners are increasingly viewing their current homes as a longer-term investment and are interested in improving them to match their tastes and needs. We continue to believe our products are relatively more insulated than other R&R items because they are smaller ticket, are less disruptive to install, and because they offer immediate aesthetic improvement or meaningful innovation and functionality to a home. A recent study indicated that for building products, performance, trusted brand name, and aesthetics were by far the most important factors consumers considered during their purchase journey, more so than price. Our brands perfectly align with those criteria. As we continue to evolve our portfolio and focus on supercharged categories, which are categories that we have identified with high growth potential due to the exposure to secular tailwinds separate from the housing market. And as we continue to build upon our already strong brands and introduce meaningful innovations, we expect that our products will further distinguish themselves. Consumers continue to have high confidence in their homes as an asset. This has resulted in an environment where the home space is still viewed positively, and consumers are willing to invest in making their spaces reflect their lifestyles and needs. That said, we are watching macroeconomic trends closely, including consumer confidence levels, consumer spending habits, and employment levels, all of which impact repair and remodel trends. While we are confident in the mid- to long-term trends for our products, we are anticipating an environment that continues to be challenging and uncertain. As we have in times before, we will respond quickly and decisively in any environment. As Dave will detail more completely in his section, we are actively scenario planning for a variety of outcomes in 2024. Turning now to an update on our organizational transformation. As we approach the one-year anniversary of the Cabinet spinoff and reorganization of our business, I wanted to reflect on the many transformational activities we undertook over the past year. These activities are driving our future as an exceptional company focused on growing our core while also accelerating our emerging connected products business. As we noted at the time, the separation represented the chance for Fortune brands to evolve into an entirely new company, one marked by excellence in brands, innovation, and channel. And while we are proud of the amount of value creation the separation has generated for our shareholders, we're even more excited about the growth potential that we unlocked. We've now had nearly a year operating as a more fully aligned company with an organization that is designed around accelerating growth. While it would take more time to realize the full impact of our new structure, we are already seeing tangible results. A more efficient structure has allowed us to remove unnecessary duplication, make strategic decisions faster and with more precision, and deploy our Fortune Brands Advantage capabilities across the portfolio. By removing those activities that do not create value, we create space for those that do. This is a multi-year journey that has already begun to pay dividends. Our new structure has allowed us to invest additional capital and talent in those projects with the greatest opportunity to drive growth, including our digital transformation and connected product. which we believe have the potential to transform our entire space. We now also have a dedicated transformation and integration office reporting directly to me, which is responsible for driving progress on the key growth initiatives across the company. And we are now able to deploy our best talent and our Fortune Brands Advantage capabilities across the entire enterprise in a much more rapid, efficient, and holistic fashion. There has been an enormous amount of change across the organization, but our 12,000 associates across the globe have leaned into the change and embraced our transformation in a way that is nothing short of exceptional. I am so proud of our team. Fortune Brands Innovations is stronger, more agile, and more aligned than it has ever been. One of the key areas that we have identified as a growth catalyst is connected products. Today, I want to help put this business in its proper context. Our leading brands, advantage route to market, and technology backbone makes us uniquely positioned to capture growth in the connected product space. A recently aligned organization is helping us fully unlock our potential across the full company. The addition of Yale in August enhances our capabilities and product set, giving us the scale and talent to lead in connected products. Now with our strengths combined, we are further on the path to becoming a digital innovative disruptor. From 2020 to 2022, Fortune Brands connected product sales nearly tripled. And this was during a chip constrained environment that limited us from reaching our full sales potential. Including our recent acquisitions, our annualized run rate of connected product sales approaches $250 million. Today, we have 4.5 million activations of our connected products, and we expect those numbers to grow exponentially as we continue to transform and disrupt the market. Our connected product portfolio offers real solutions to real needs, from making life easier and more secure for the individual to addressing some of the world's most pressing sustainability and safety issues. Businesses are using our monster-like connected access solutions to help them work more efficiently and Individuals with Yale and August smart residential locks have peace of mind and have been freed from using keys. Homeowners with products from the Moen Smart Water Network, including our AI-enabled Flow smart water monitor and shutoff, can better protect against damaging and costly leaks in their homes. I cannot overstate the potential positive impact our smart water products can have on homeowners, insurance companies, and on the environment. as we look to save billions of dollars in preventable water damage claims and trillions of gallons of water. While our connected product journey is well on its way, we have much more runway ahead, including our ability to deliver first of its kind connected products and ecosystems. We will continue to innovate to make our homes, communities, and the planet smarter, safer, and more sustainable. Expect much more from us as we continue to evolve this growth engine for our business. Before I turn to the individual businesses' performance, I would like to put our results in their proper context. We were well prepared for the challenges that we are currently facing and took meaningful action in anticipation of the environment. As a result of these actions, we were able to deliver solid top and bottom line results. As the external market remains soft due to affordability concerns and macro uncertainty, we will continue to protect our business while prioritizing investment in a tight set of key strategic priorities, such as those just discussed, in order to win for the long term. In the third quarter, water innovation sales were $688 million, an increase of 8% compared to the prior year quarter. Our margins for the segment were 24.2%, On an organic basis and excluding FX, sales decreased 3% due to market-driven volume declines, partially offset by price. Our Moen North America's business was down low single digits versus last year's third quarter due to lower volumes as a result of market softness, particularly in retail. However, our POS data showed that we gained share in the market driven by our strong outperformance in the key wholesale channels. Retail promotional activity increased in the quarter we've been highly strategic about our promotional activity to ensure our promos are targeted and tailored to drive the best results. Organic House of Roll sales were down low single digits in the quarter, the US luxury consumer continues to remain relatively resilient and high quality artisanal crafted products resonate. I recently acquired and tech business performed above our expectations in the quarter. We are extremely pleased by the progress of the integration of EmTech. The more I learn about this business and their commitment to the consumer and the customer, the more impressed I am. I look forward to a bright future as we bring all of the brands together under the House of Roll platform, which is now a uniquely positioned global luxury powerhouse with exceptional growth potential. In China, sales are down low teens year over year, or mid-single digits excluding FX. While we saw higher-than-expected project completions as the government is increasingly incentivizing developers to deliver finished projects, the overall market remains soft and the Chinese consumer remains cautious. However, our non-developer channels that focus on the emerging R&R market, which include showroom, home decorator, and e-commerce, all saw growth, and our business is well-positioned to capture the market evolution away from new construction. Turning to our outdoors segment, Sales declined 9% in the quarter, reflecting market softness, particularly in the doors business. Our margins were 14.8%. In decking, third quarter sales were up mid-single digits versus prior year as we gained share in the key wholesale channel. Looking forward, we are focused on driving meaningful innovation in this space and have the resources and talent to innovate for the future in this growth category. Indoors, sales declined low double digits as the slowdown from the 2022 single-family new construction market continues to impact ThermaTru, and general market softness remains in the space. Looking forward, as the impact of the recent improvement in the single-family new construction market begins to flow through in late 2023 and early 2024, we expect to see improving results from my door brands. Lastly, in security, Third quarter sales increased 32% year over year and grew 6% organically. Operating margins for the segment were 16.8%. Our organic results were driven by price and continued growth in commercial and international markets. Importantly, improvement in our operating margin is a true testament to the power of the new organizational structure and our Fortune brand's advantage capabilities. We expect we will continue to see even more impressive margin results in security as we continue to deploy these capabilities. As we integrate Yale and August, we continue to be extremely impressed by their innovative focus and startup mentality. There's clearly deep talent and passion, and I look forward to seeing their knowledge and insights contribute to the entire Fortune Brands Connected product portfolio. Importantly, Yale and August exceeded our expectations as they recover from the impact of chip shortages and are working to develop new customers and channels. As with EmTech, the more I learn about these incredible brands and the teams who support them, the more enthusiastic I am. Before I turn the call to Dave, let me share a few final thoughts. Our reorganization into a more efficient, centralized company focusing on brands, innovation, and channel has progressed faster than we anticipated. thanks to the strong engagement and trust from our teams. We continue to invest in our key strategic priorities, including our iconic brands, digital transformation, and meaningful innovation. We are growing our connected products portfolio. And finally, we made meaningful progress in the integration of our transformative acquisition. We are transforming Fortune Brands into an even more growth-focused, highly innovative company in spite of continued external and macro headwinds. I am encouraged by all that we have accomplished and excited about what we will achieve next. We are constantly monitoring and are well prepared to respond to uncertain end markets in the short term, while we position ourselves for accelerating long-term outperformance in the markets supported by fundamental growth characteristics. As we head into the last part of 2023, And as we set our sights on 2024, we are focused on execution and delivering on our commitment to above-market sales growth and margin performance. With that, I'll turn it 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 third quarter results. As Nick highlighted, our teams executed well and delivered solid sales, margin, and free cash flow performance. Sales were 1.3 billion, up 5%, and consolidated operating income was 220 million, up 2%. Total company operating margin improved sequentially to 17.4%, and earnings per share were $1.19, up 3%. Free cash flow in the quarter was 269 million, which brings our year-to-date free cash flow generation to $660 million. Turning to sales, on an organic basis, net sales were down 4%, driven by volume declines. Overall, volume was down mid-single digits, driven by high single-digit POS volume declines, partially offset by low single-digit favorable channel inventory comparables. Price contributed a low single-digit benefit in the quarter. Through the quarter, our POS volume softened sequentially in line with normal seasonal trends, and DIY channels continue to remain softer than pro channels. Our operating margin of 17.4% reflects our team's continued ability to drive continuous improvement savings and fund key strategic priorities while remaining agile in the face of challenging end markets. Our teams remain focused on driving above-market growth preserving and enhancing margins, and generating cash. 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 $688 million, up 8%. Organic sales were down 4%, or down 3%, excluding the impact of FX. The organic net sales results reflect the impact of lower volumes, partially offset by price. Water Innovation's operating income was $166 million, and operating margin remained strong at 24.2%, reflecting lower volumes, partially offset by continuous improvement initiatives. U.S. Moen point of sale was down mid-single digits, while U.S. House of Roll point of sale was down low single digits. The luxury consumer continues to outperform the broader market. China sales declined low teens or down mid-single digits when adjusting for the impact of FX. The Chinese market remains soft, and though the completion of delayed projects accelerated as a result of government programs, 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, including at brick and mortar locations and online. As we have stated, our performance in the face of challenging external conditions has been nothing short of remarkable, and we are confident we will lead as that market continues to evolve. Turning to outdoors, sales were $366 million down 9%. POS for the segment was down low double digits, which was partially offset by mid-single-digit favorable channel inventory benefit from the prior year comparable. Segment operating income was 54.3 million, down 18%. Operating margins for the third quarter were 14.8%, driven by reduced volumes. Door sales were down low double digits. As expected, sales were impacted by lower volumes from single-family new construction and market softness. However, these brands should be positively impacted by the recently improved new construction environment as we look toward 2024. In decking, we saw sales increase mid-single digits in the quarter driven by mid-single digit POS growth in the wholesale channel. Finally, in security, sales increased 32% to $207 million, or 6% on an organic basis, reflecting the impact of the acquisition, increased distribution, price, and continued strength in Master Lock's commercial and international channels. Total security segment operating income was $35 million, up 46%, and operating margin was 16.8%, an increase of 170 basis points. Utilizing the playbook first deployed in our water innovations business, 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 continued integration of Yale in August. Turning to the balance sheet and our cash flow performance. Our balance sheet remains strong with cash of $453 million, net debt of $2.4 billion, and net debt to EBITDA leverage at 2.6 times. Our working capital reduction efforts continue to shrink our balance sheet and generate cash. We continue to make excellent progress against our near-term inventory reduction targets, and our organic third-quarter inventory finished at $829 million, down roughly $260 million from our peak in 2022. Our impressive free cash flow of $269 million in the quarter allowed us to make significant progress in deleveraging following our recent acquisition. In addition, our cash generation enabled us to opportunistically repurchase $30 million of shares in the quarter. And as of today, our total 2023 share repurchases are $150 million. To summarize the quarter, we delivered solid sales and margin results in a soft environment while further reducing inventory levels and generating significant cash flow. With that in mind, I'll now provide an update to our 2023 guidance. As today's press release indicates, we are updating our full year 2023 guidance to reflect our current expectations and market conditions. Due to our continued strong execution and agility in this dynamic environment, we are increasing the midpoint of our EPS guidance by two cents and narrowing the overall range to $3.80 to $3.90. In total, our updated EPS guidance reflects a 15-cent increase over the midpoint of our initial guidance earlier this year. As a reminder, our fourth quarter EPS will be unfavorably impacted by five cents as a result of a non-recurring extra fiscal week in the fourth quarter of last year. We are also updating our sales and margin guidance to reflect current market conditions, including a softer than anticipated second half R&R market which is predominantly impacting sales in our outdoor segment. The full details of our updated guidance can be found in our press release. As we head into 2024, we are actively planning for a variety of scenarios. While it would not be prudent for us to provide a full set of guidance assumptions for 2024 at this point, we are able to share some initial thoughts. Our base planning assumptions currently include a low single-digit market decline, with U.S. R&R also down low single digits. Our U.S. single-family new construction market is up low single digits based on the impact of second-half 2023 starts growth and a 2024 starts and completion forecast of up 3% to 5% and roughly flat, respectively. We expect China and Canada markets to be more challenged than the U.S., both down high single digits. We would expect our organic sales to beat this market estimate, and given the work we continue to do to replatform the business and drive efficiencies, we see a path to operating margin improvement and earnings growth if the market is down low single digits or better. Our teams have done a fantastic job navigating the uncertainty of the past few years, and as we approach the end of 2023, we remain confident about the future of the business and our team's ability to create value regardless of the macro environment. I will now pass the call back to Leigh for question and answer. Leigh?

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 to the operator to begin the question and answer session. Operator? Thank you.

If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tell will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please while we pull for questions. Thank you. Our first question comes from the line of Matthew Bully with Barclays. Please proceed with your question.

Hey, good evening, everyone. Thanks for taking the questions. Maybe just start off on the guide and kind of how you're looking at the fourth quarter here. Clearly, a lot of cross currents in the market. I think you just mentioned some deceleration on the DIY side. Sort of looking at the guide, it looks like you're implying some sequential uh, deceleration in the top line. So, so just, you know, I know we can kind of back into what you gave given the, with the full year guide, but just sort of any puts and takes, um, you know, upside downside to how you're thinking about the fourth quarter. Thank you.

Yeah, Matt, why don't I give you, um, some kind of high level, uh, thoughts on that. And then, you know, Dave can take you through some of the puts and takes, uh, but you know, a couple of things, I mean, certainly just from perspective, as we said in the prepared remarks, you know, the, Market has been more or less as we've expected, I think, with some of the point of sale, DIY, maybe some of the retail stuff being a bit softer, single-family new construction being a bit stronger. And as we see how it plays through the year, the top-line performance of every quarter has been improving. And so as we look to the fourth quarter, You know, on an organic basis, never that 53rd week, we'd expect that to be flat, which is a sequential improvement. And so, you know, good to see the business kind of coming back to flat, in particular with the market outperformance. And then as I look at some of the, you know, the actual dollar point of sale that we get, which is more retail-based, it's actually held remarkably steady for the last, call it 10 to 12 weeks on a dollar basis. So obviously comparables move around in terms of percentages versus last year. But just, you know, what are consumers doing when they go into stores? What are the dollars they're spending? That's been very steady. So, you know, while we'd like it to be higher, the predictability of seeing that kind of steady line sort of feeds into our degree of confidence around the fourth quarter.

Matt, I'm happy to provide a bit more color. I think, you know, starting with sales, if you look, And our organic performance throughout the year each quarter, as Nick mentioned, we've gotten better versus prior year. So started down 10 in the first quarter, then down 8, now down 5. And we'd expect the fourth quarter to be flat, excluding that extra fiscal week comp or likely down 3% to 4% reported organically when you factor in that comp. So nice, say, sequential improvement versus the prior year on the sales line. And then on margin, you know, we still see the second half operating margin around 16.5% or better, which would imply kind of a fourth quarter of 15.5% or better, which is, you know, I think expected in the fourth quarter to see a bit of a sequential increase. pullback from the third quarter, just given volumes are down, but still well ahead of where we were in the first quarter, which is our other low-volume quarter. So feel good about, you know, how the business is managing, I think, both the top line and the margin opportunity. And then if you think about just EPS, you know, I remind people that our prior year had two favorable impacts that won't repeat, one being the flow-through from that extra fiscal week and the other being some favorable tax outcomes as we spun cabinets that were one time in nature. So, as we look at EPS in the quarter, we see something normalized that's down low single digits or better versus the prior year. So, you know, I know our teams are still working hard to capitalize on opportunities, you know, in the quarter, but still feel like we're managing the business well given the environment.

Got it. Okay. Thank you for that. Thanks for buttoning that up for us. Second one, a little higher level. Now that you've had the assets on your team for another quarter and been able to dig in and get the integration underway, I'm curious, you had some comments at the top alluding to this, but sort of what have you learned incrementally as you've been able to dig into the assets And specifically, the comments you made around the help with how Yale in August could benefit your connected products portfolio. Curious, number one, do your synergy targets include benefits to the connected products portfolio? And then just number two, more broadly, as you've looked into this further, what areas of upside could you see in those synergy targets? Thank you.

Yeah, I'd be happy to take that question. You know, we were, as you heard in the remarks, we're just delighted with the acquisition. Even putting aside, you know, the fantastic value that it came across that just, you know, the quality of the assets themselves are really phenomenal. The quality of the teams that support those assets have been fantastic. And the performance, you know, since we've owned them, has even exceeded our expectations on the top line. And on the bottom, you'll see that we've actually been able to accelerate some of our investments in the integration just because the integration is going really well. And so, you know, that's kind of the big picture message. Now, you know, it's a great question, sort of, you know, what have we learned? You know, I take them each a bit separately. But certainly, you know, to serve the M-Tech business, I mean, you know, they're just really remarkable, continue to gain share, really, really outperform the market. You know, we were just recently on a market visit, and, you know, one of our customers pointed to you. displays in a relatively small footprint of the store and said, this is 50% of the sales in the category, just from this little area. And I think it just speaks to how powerful the brand is. What we've really learned is what is the formula that supports that and the business model and how does that work as profitably as it does. And so a lot of learning is coming from that that are starting to be integrated into the whole House of Roll strategy. And so just last week we were going over annual operating plans and as those teams are coming together, not just thinking about, you know, how do we offer these as an entire suite of product, which was part of our initial thesis, but really thinking how do we elevate the best of the best in the business models to be an even better solution for customers and designers. And so we think there's a lot of potential and a lot we can learn there. And then on the Yale and August side, look, you know, We're very proud of the Connected Products progress that we've made and the digital initiatives that we've made up to this point. But getting to know those teams, I mean, they really are a mid-cycle, they operate like a mid-cycle startup. And a lot of that team is the original August team, which if you spend some time and speaking to people in that part of the world, some of the most highly respected connected engineers around. And so we're really looking to them to help lead us as we think about how to bring these teams together and how do we take what we've already created, which we're really proud of, the investment that we're already making, which is not insignificant, and then combine it with what we just acquired. And we really think that could be a huge growth unlock. You know, you asked about synergies. I think we went in with a pretty good synergy case of some, I won't call them easy because they take a lot of work, but some lower hanging fruit like, you know, distribution overlaps and those sorts of things. What we're coming away is with some transformational ideas around both the house of role and the connected business that the teams are leaning into, right? It's not me saying, you know, you've got to deliver more. I mean, they sort of took the case and they said, we think we can do far more than this because we really think that this unlocks pretty significant growth for both portfolios. And so those are being refined now, but we're really, really excited. You know, you heard in the comments, I mean, the connected business now, Approximating and approaching 250 million on an annualized basis, but over 4 million activations and compounding at a really, really fast growth rate now feels like a scale connected business and connected platform and having one technological backbone. to which we can continue to refine the products we have, but also add more to the ecosystem over time, is really, really exciting. So I could go on for a while. I'll stop for some sort of other questions, but you can tell we're pretty excited about it.

Great. Well, thanks, Nick. Thanks, Dave. Good luck, guys.

Thank you. Our next question comes from the line of John Lovallo with UBS. Please proceed with your question.

Good evening, guys, and thanks for taking my questions. Nick, I actually did want to follow up on what Matt just asked to some extent on the connected product portfolio. Very interesting opportunity. It goes beyond smart locks, obviously, with smart water. You guys, I think you mentioned you've tripled the sales over the past few years. So the question is, I mean, where do you go from here? What's sort of the expected growth trajectory? And what are the potential product expansion opportunities?

Yeah, well, John, thanks for that question. I mean, we've really taken a big – step forward, I think, through this strapland cycle and really ask ourselves that question that you just laid out. So instead of sort of just thinking about it incrementally, we're really like, what is the addressable market here? And what do we expect that we could gain in terms of ownership of that market? And, you know, you touched on smart water. I mean, when you look at the smart water opportunity from a number of different lenses, it is pretty staggering, right? Just, you know, to start with just the pure how much preventable water damage is there today, we think that's $15 billion of claims a year. It's greater than fire and burglary combined, right? So $15 billion of preventable water damage. I actually believe we're going to grow that addressable market because we're going to come up with more products that can address more types of preventable water damage. We can take that pretty much to zero. I mean, we did a study with LexisNexis. In 10,000 homes, we reduced 96% of the claims to zero, and the other 44% of claims I believe were reduced by over 70%. So pretty much going to zero. there's an ESG lens to it, right? In addition to saving, you take potentially trillions of gallons of water, there's a huge energy component to processing and cleaning water. And so you take Mission Mowen, which is really based on what we have in the market today, our commitment to save a trillion gallons by 2030, that, according to the The math available on the EPA website is the equivalent of us taking a million cars off the road for a year, right? And so you can start to see math from municipalities, right? It has a huge dollar value impact. And so the opportunity is huge. really not thinking of it as a multi-billion dollar opportunity. We're building teams around really addressing not just the core product, making it better and better all the time. We're building an ecosystem around it. So when it connects to your Moen irrigation, smart irrigation system, or your Moen smart faucet, or your Moen smart sump pump monitor, and I could go on and on, it really gets better and better and smarter and smarter because it's able to speak to all these nodes in the home, understand what's going on, and really do things like protect you from freezes because it can, you know, pulse water out of your kitchen faucet or, you know, health protect you if you're on vacation from bacterial bull death and things like that. And so we're really... Now leaning into this, I think, in a much more serious way, and as I just said in response to Matt's question, if you then add on the scale of having the Yale August team come on board and think about what it is to be able to think about cloud as a single team or Wi-Fi as a single team or AI, right? The Smart Water Network is AI-powered. So our AI team becomes sort of a single team with dedicated people to different projects and products. but still functioning as a scale team, we think the opportunity is really, really significant, and we look forward to speaking about it more in the future.

That's helpful, Culler. Thank you. And then the next question is on water specifically. The sales outlook was raised from, I think, flat to down 2% to now flat to down 1%. U.S. new construction a little better, China a little worse. So I guess, you know, how are you thinking about House of Roll and Moen in this equation, which I think we're both down organically in the quarter, then also what's driving the decrease in margin outlook from, I think, 23.5 to 23 on an improved sales outlook? Thank you.

Hey, John, this is Dave. I'll handle the margin one first. I think it's more around some of the accelerated investments that we're making, as Nick mentioned, some with the EmTech acquisition and then some in the base. And so as we've talked about in the past, our margin – Quarter to quarter stays in that low to mid-20s, and you may see some fluctuations. It was 24-2 in the third quarter, and we'll step back a little bit in the fourth, but more around investment timing than anything else. And then on the sales line, the team really continues to perform well and drive out performance. And so house of roll, as we've mentioned, down low single digit organically in the third quarter, probably at similar levels in the fourth quarter. And then for Mo and America, it's in a similar performance. We see that down low single digits in the fourth quarter, which really implies that our POS run rate stays at mid-single digits or better, and we have some favorable inventory tailwinds from last year that we've discussed. So I think it's more, you know, as we have line of sight to the end of the year, just tightening that range around the performance that we're seeing out of the business.

Thank you, Gus.

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

Yeah, thanks, guys. Appreciate all the color. Wanted to ask a little bit on the U.S. residential side. You, I think, increased the single-family new construction component of your guide. But multifamily has been looking weaker with the increase in rates and so forth. I think the concerns exist about how things might look over the next few months. So I know that you have a fairly constructive view of that given the undersupplied state of the industry. Obviously, I share that view as well. But I was curious if you could talk specifically about the multifamily side of to the degree to which that may be weighing on the overall outlook, because I didn't hear you call that out. And then similar to this, in your outdoors division, your doors business has a lot of starts exposure, I guess. You said it was kind of as expected, the starts effect, but the sales guide came down a bunch. And so I was curious if you could just sort of maybe tie that in there as well.

Sure. Why don't I start and just give you some perspectives, and Dave will add some more color around it. I'll just start more on your question about the starts and multifamily. And multifamily is actually a pretty small part of our business. And so I don't disagree with you. I do think it's challenged. I think it's going to be challenged. But it's a pretty small part of our business. And then within that, the part of multifamily that we serve tends to be the higher end of multifamily. And so I think where a lot of is probably in places where, you know, we don't have a ton of exposure because, you know, we're more, if you think about multifamily for sale, you know, large concept buildings, those are the type of things that we tend to be calling on versus the, you know, I think we're seeing a lot of pressure in the rental market, which tends to, gear more towards the price competitive stuff. So why not pause there? Jay may have some color, and then we can talk about the outdoors piece.

Yeah. Steve, so multifamily in total is about 6%, 7% of the portfolio, so pretty small. And recall, our products go in towards the end. So our multifamily estimate for this year is actually up high single digits. And so we're not feeling much headwind in the macro this year based on when our products are consumed on multifamily. I'd say what's a little bit softer is probably the overall U.S. R&R. If we're still down four to six, I'd say we're at the midpoint of that, maybe a bit below the midpoint, and that's offsetting the single-family new construction benefit in the overall macro.

Yep. Okay. On your outdoors question, you're right, more single-family new construction exposure there. You know, what's been interesting – is we kind of haven't yet seen the benefit of the starts acceleration pull through our products. And we think that's probably just got to do with when our products are installed. And, you know, that varies. I mean, not the point of installation doesn't vary, but the lag between starts and completes tends to vary. And so, you know, it's kind of an inexact science. And so we've not seen it pull through very strongly in the doors or valves, which for us is a great indicator given our exposure to large production builders. We get a great sense given the valve install is fairly early on when that's pulling through. And so we think that's probably most likely to be a end of 23 and into 24 tailwind.

Yeah, and Steve, just some color on that. So our Moen valve POS in the third quarter, so the component of the product that goes behind the wall into construction was still down mid-single digits. And then our doors wholesale POS, which predominantly serves new construction, was down low double digits. So we're not seeing that new construction pull through yet. It's at this point probably late fourth quarter, early 2024. The other piece on the outdoors guide is driving it down a little bit. Channel inventories are still lean across that segment. And we expected really a bit more inventory to come in in the quarter than we saw. And as we exited the quarter, still pretty lean, both on a decking and door side.

Okay, that's helpful. Yeah, I appreciate that. That info on the valves is interesting, because we have seen that pull-through happen in some other segments, another product. So that's interesting that it should come soon.

Given that we're pretty much locked into that portion of the boulders, it's very high. It's a pretty clean room for us.

Yeah, clearly. Okay, the second question relates to just kind of generally if you could talk about the dynamic between price-cost, if there was anything sort of to call out there that we should be thinking about across the various segments.

Yes, there's nothing material to update really from where we've been in the past few quarters. So still see price as a low single-digit contributor to sales. Started to see some deflation, metals deflation in the P&L in the third quarter as we expected, but I'd say overall deflation still less than 1% of COGS given offsets to labor. Some of the freight lanes have increased and then around indirect spending. Tracking to where we thought we'd be at the beginning of the year and no material update or change.

And I'll just add for some color, talked about this previously, but, you know, one of our key fortune brands advantage capabilities is category management. And so what are, you know, what are the, these are the things that we decided to invest in to get really, really good at. So things like, you know, next generation sourcing capabilities, global supply chain, category management, complexity reduction in digital. And we're finding that that having that capability, which is really, data and analytics driven and understanding of the shelf, the consumer and shopper behaviors, the elasticities, you know, having that tool now has been very powerful because it's allowed us to have very constructive conversations with our trade partners and allows us to be very precise and targeted in how we manage price. And therefore, you know, it continues to be a contributor while keeping us competitive in the marketplace.

Okay, great. Thanks very much, guys.

Thank you. Our next question comes from the line of Michael Rahat with J.P. Morgan. Please proceed with your question.

Great. Thanks very much. Good afternoon, everyone. Just wanted to, for my first question, make sure I'm getting some of the nuances of the change in guidance here. And, you know, I guess just on a basic level, it seems like the slight reduction in Operating margin is predominantly driven by the slight change in sales. So I just want to make sure I'm thinking about that right. It just appears like it's more just a function of the sales leverage. And when you think about, you know, from a top-down perspective, you have a couple of the segments, a slight tick down in the sales guidance. You know, what's really driving that from an end market perspective? And it also appears, if I'm looking at it right, that you were a little better than our outlook on 3Q and a little worse than what we were thinking about for 4Q. So if there's any type of, you know, shift between timing here or if, you know, things are a little better, things are a little worse in the last three months of the year, just wanted to appreciate any of those differences as well.

Okay, Mike, Dave, I'd say your first question, that's accurate. It's really, you know, sales, slight reduction in our sales guidance flowing through to operating margins is based on the volume leverage. But that's really coming in outdoors. I mean, if you look at the segment changes, water segment guidance overall up slightly, so from minus two to flat to minus one to flat, and then security same, you know, up slightly, 13 to 15, up to 14 to 15. So it's really outdoors, as we mentioned earlier on the call. Slightly lower R&R, POS, and then some channel inventories that are leaner. So I think that's the simple way to think about the change in guidance. Third quarter, fourth quarter, there are always some timing benefits across the quarter or challenges across the quarter. As I mentioned earlier, teams are working hard to get the best result out of the fourth quarter that we can, given the market environment.

Right. No, no, I appreciate that. I guess I was focusing a touch more on the organic change. I mean, it brings me really to the second question, which is that you'd mentioned both acquisitions are doing better than you expected. And so, you know, I was hoping to get a sense, number one, of, I know it's just one quarter, perhaps, that's under your belt here, but any kind of updated thoughts about how to think about an annualized revenue run rate for these two businesses. I think, you know, uh, a quarter ago, you're talking about, I believe 240 million, uh, for, um, uh, for, for, uh, M tech shop and one 70 for Yale August. Um, you know, if there's any changes to how we should think about those numbers, um, on an annualized run rate and, um, You know, again, from an end market perspective, if you think about those two different businesses, where is that upside coming from? If it's, you know, again, a certain channel or end market or, you know, if there's even any initial benefits from some of the sales synergies, which I would expect would be more in 24, but just any thoughts in terms of the drivers there?

I'll start with the drivers, and then I'll go to Dave. He can talk you through that. the rest of it. But I'd say the drivers are A, on the, and again, you know, two different, there's EmTech on the short side. I think they, we, I guess now, have just built a fantastic business model and mousetrap that really, really works for the high-end designer consumer. And that continues to take share. And so, you know, it is outperforming film market in a very healthy way. But I think the real opportunity will be to take what's really working in that model and leverage it across the rest of the luxury portfolio. And then, you know, on the Yale and August side, you know, just a really fantastic product set that had been growing really nicely but had been chip constrained for a while. And as that's starting to flow now, and I think also, you know, we're giving the team their sort of the privilege of focus on really working on a number of things that they had on their plates that they wanted to do, but they were also working on other priorities. for their predecessor organization. They told us to give its privilege of focus for a while and let us get some things done next quarter or two. And we're seeing some of that come to fruition. I think it's early days. to say, does that change our view on the run rate? I mean, we've sort of owned it since late June. But what it's allowing us to do is lean into the synergies with a lot of confidence and also invest ahead of plan on bringing some of those synergies to life.

Yeah, I think Nick said it well, Mike. I mean, we'll provide a more detailed view of 2024 on our next call for those businesses. But it's It is going well. It is early days, and the team is capitalizing on a lot of opportunities.

Great. Thank you.

Thank you. Our next question comes from the line of Adam Baumgarten with Zellman. Please proceed with your question.

Hey, guys. Good evening. Just curious on some of the benefits you've been seeing from the leadership reorganization and kind of how that's playing out and I know there's been some savings you've called out, you know, in the past year, in the first year or so, but just kind of had to think about it going forward, and then I'll stop there.

Yeah. You know, that... And it was a lot of work, and it's still a lot of work because we're really in the first cycle of the new operating structure, right? So we just saw the first integrated annual plans a week ago. Next month, we'll see the first integrated brand plans, product plans, innovation plans. But in short, it is actually going forward. ahead of schedule and better than we expected. And I say that with a lot of credit to our teams because I think it's really their sort of trust and enthusiasm of leaning into it that's delivering. But, you know, it was designed to unlock growth and productivity. And, you know, Dave can talk a bit to the numbers, but the immediate cost-out benefit is a really nice byproduct of not wasting energy on things that weren't creating value. and allowing the organization to spend their time on things that will. And so we're seeing a lot more of that. We're seeing us be able to move through initiatives a lot quicker. And, you know, a simple example, again, you know, I talked about sort of Fortune Brands' advantage. You know, you have these capabilities, and we were getting much better at deploying them across the organization. But now it's not a question of, you know, is it a good idea, not a good idea, is it a bad idea? You know, those leaders, Sherry Pfeiffer leading our commercial organization, you know, Ron Wilson leading our supply chain organization, if they want to go execute on something across the entire portfolio, they agree with their teams and they go execute. And so we're seeing a much faster execution of our key initiatives. And I think that will be the real unlock over time. And where I expect to show up more than anywhere else is growth. Now, you asked, sir, where are we in that? I think, you know, we've taken out kind of like you know, the bite out of the easy third. Now, again, I caution myself using the word easy because I think our team would say nothing was easy about it, but it's the obvious, you know, lower hanging fruit opportunities. The next two thirds will really come from things like simplifying our systems, being able to work more easily across the business, taking out more duplication as we have more efficient systems in place. And, you know, we see that as a multi-year growth and productivity journey for the company.

And Adam, just to put some financials behind it, as we've mentioned, that first third or so was $55 million of gross SG&A out, and we have invested some back into the business to drive some key priorities. And the teams have been busy working this year on the next phase of that organization in the future. And as we look to design it, it's going to come with process improvement, system simplification, to really get more lean operating environment relative to where we've been.

Okay, great. Yeah. I guess the other switching gears question I would have is just on the decking business, it seems like that's a pretty meaningful positive standout, you guys, your peers, competitors in terms of versus the broader backdrop. I guess maybe if you have any color on what's driving that, how sustainable it is, anything you're seeing there just because of the Because the broader, you know, I think home improvement market is kind of soft at this point.

Yeah, I would start out, you know, a couple things. I mean, firstly, again, you know, as you know really well, just... the underlying value prop of composite and PVC materials continues to really be healthy, particularly when you add in all the other costs of installing a deck. And so that will take share against wood and will continue to do so for a very, very long time. And in our own capacity modeling, you know we we will play with that conversion ratio we think it's somewhere between one and two percent of what so in a really you know hot year it might be a two in a slower year like this year we we think it might be closer to one but it's still happening and so i think that it does continue to drive the top line the the next piece I think is really important that you mentioned was sustainability, right? And we've tried to be very thoughtful and very judicious about how we go to market to do it in a sustainable way for us and all of our route-to-market partners. And so be thoughtful about pricing, be thoughtful about our product offerings, and therefore be thoughtful about where we go across the portfolio. And I think what you see in these latest results is we've been willing to give up a little bit of lower margin business where we think it's not going to be healthy or sustainable to go focus on areas that are and more up the price spectrum. And then that's where we ended up taking share. And I think that's what through these results. We'll continue to pursue that strategy because we think that's the most sustainable way to build this business out for the long term.

Great. Thanks. Best of luck.

Thank you. Our next question comes from the line of Phil Eng with Jefferies. Please proceed with your question.

Hey, guys. Thanks for squeezing me on the call. And, Dave, really appreciate you giving us an early look on 2024 in terms of the market. You're calling for a low single-digit decline in 2024, but you're expecting margin expansion and earnings growth. So can you help us unpack what are the key drivers in terms of growing earnings and any color on ranges because the street certainly modeling a pretty robust earnings growth next year. So maybe we'll have to level set a little bit, but I really appreciate you giving us an early look on 2024. Yeah.

I'm happy to, you know, I think our confidence in, in margin expansion and earnings growth really stems from the work that we talked about on this call. So, you know, replatforming the business, getting after some synergy opportunities and, We've mentioned some changes in the security business that we've made. There's a lot of internal activities that we see coming through the P&L next year. We'll be copying that inventory reduction headwind in the first quarter. Given where production is likely going to be planned, I wouldn't expect to get all of that back because we'll still be producing at a level lower than we were in 2021 and 2022. And then we still see price sauce as a benefit, and our teams are still working through their strategic recommendations to our customers around pricing, but looking to have price contribute again positively to net sales growth next year as we really think about taking price using our category management capabilities and based on the strength of our brands and innovations. in a way that both maximizes our share, but also profit for us and our customers. And we've demonstrated our ability to do that over the past couple of years. So I think it's really those three levers, the internal actions we've taken, you know, some favorable comps on our cost bar, and then some price-cost favorability.

Is there any way to size up those buckets for us so we have a better handle? And should we assume flattish market if you're outpacing the market and you're taking – price again to maybe flat sales, or you could actually get some top line growth?

Yeah, I think so. Our teams are still working through all the details. We've seen enough to be able to give this confidence now. We'll provide more in January. And then, yes, I think depending on where the market settles, you would expect us to beat the market. And typically, organically, we're targeting 150 to 200 basis points above average. And so, you know, that would imply, you know, organic growth in that flat to down low single digits depending on, you know, how the market settles down.

Okay. Appreciate the color.

Thank you. We have reached the end of our question and answer session. And with that, thank you for joining today's conference call. You may now disconnect.