Fortune Brands Innovations, Inc.

Good day, ladies and gentlemen. My name is Morgan, and I will be your conference operator today. I'd like to welcome you to the Fortune Brands third quarter 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. Following the speaker's remarks, we will open the call for a question and answer session. At this time, I'd like to turn the call over to Lee Avsek, Vice President of Investor Relations and Corporate Affairs. Lee, please go ahead.

Good afternoon, everyone, and welcome to the Fortune Brands Innovation's third quarter 2024 earnings call. Hopefully, everyone has had a chance to review the earnings release and our supplemental financials. The earnings release and the audio replay of this call can be found in the 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 risk 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 on 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 the prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick. Nick?

Thank you, Leigh, and thanks to everyone for joining us today. On this call, I will walk through the highlights of our third quarter performance, give some color on the drivers of this performance, including progress on our digital strategy and offer some thoughts on the macro environment. I'll then turn the call over to Dave for a more detailed discussion of our financial results, our updates to our guidance for the remainder of 2024, as well as some thoughts on our emerging expectations for 2025. Before turning to our third quarter performance, I would like to provide some context around our market. While we are increasingly excited about the long-term opportunities in our space and for our company, We continue to operate in a choppy environment with continuous year-over-year U.S. repair and remodel declines and unprecedented market disruption in China. Our seasoned team is managing our business tightly while continuing to prioritize investments in our strategic growth priorities, including our digital transformation. We have purposely moved away from less profitable categories to focus our resources on our supercharged, higher margin opportunities. We continue to streamline our operating model, which has allowed us to operate more efficiently, reduce SG&A, and fuel growth. While our short-term results remain pressured in a demand-challenged environment, we are already seeing tangible results from the strategic actions and investments undertaken to advance our longer-term growth opportunities. As in Q2, we saw areas of sales strength in our core North American Moen and ThermaTru businesses, Our digital products portfolio once again saw some very exciting wins this past quarter, and the organization continues to ramp our sales pipeline. Finally, as we approach the two-year anniversary of our new operating model, we're working as a more aligned and efficient organization, including developing new marketing campaigns, launching new products foster, and building a new company purpose. This new purpose, which better captures the ambition of Fortune Brands Innovations, will help unify and motivate all 11,000 associates across the globe behind our unique opportunity. Net sales were $1.2 billion in the quarter, down 8%. Excluding China, which was again impacted by lower sales as the Chinese consumer remained very cautious, our organic sales were down 5% in the quarter. Importantly, point of sale, excluding China, was down low single digits. We have now annualized the sales of EmTech, Yale, and August into our organic results. One year following this transaction, we remain very pleased with their performance, as well as how they have helped accelerate our transformation into a digital, disruptive company and luxury goods powerhouse. We are fortunate for the exceptional talent that we acquired along with these brands. In the third quarter, we continued our trend of delivering strong margin results Our operating margin in the quarter was 18.7%, up 130 basis points versus the third quarter of 2023. Our strong margin performance resulted from continuous improvement initiatives, targeted cost reduction activities, as well as our continued focus on growing more profitable categories. These initiatives enabled us to continue to make key investments in the quarter. Our third quarter earnings per share were $1.16, and our operating income was $216 million. Turning first to our digital portfolio, we have made excellent progress with our flow strategy. We have now signed seven insurance contracts. These agreements feed our opportunity pipeline, creating leads, which we then convert into sales. In the third quarter alone, we added around 20,000 users of our flow smart water monitor and shutoff And retail and e-commerce POS performance was up 80% versus the third quarter of 2023, exceeding our expectations as consumers increasingly gain awareness of the incredible value of our Flow device. We expect our Flow business to grow nicely in the fourth quarter of 2024 and expect this growth to accelerate into 2025. We currently have agreements in place covering approximately 8 million policyholders and are in active discussions with homeowner insurance companies representing around 60 million homeowners. We are also having continued conversations with municipalities and water utility companies across the country, including our recently announced partnership with Miami-Dade County. To give a sense of the amount of sales we have coming down the pipeline and a conservative 5 percent sales conversion assumption of the insurance agreements that we currently have under contract, The potential sales pipeline we currently have for Flow is over $160 million. While the timing of this backlog is hard to predict, we reasonably expect to see these sales soon. The significant progress we've made in just a few short months to expand the reach of our smart leak detection is truly impressive. This past quarter, we again had some key wins in our digital product space and saw over 225,000 new device activations in the third quarter between both water and security, and now have approximately 4.5 million users across our digital platforms. This continued acceleration gives us confidence in the strong future of Fortune Brands as a digital leader. In addition to the several large insurance partnerships with Flow, our Yale and August businesses made progress with some key customers, including integrations with ADT, Ecobee, and Airbnb. In addition, we are excited that our new MonsterLock connected lockout tagout solution is now in beta testing at several facilities. More to come on this, which we believe will be the next big breakout opportunity. While our digital product journey is well on its way, we have much more runway ahead, as we are still learning the best and most efficient ways to get our products to our customers and partners. Expect more from us as we continue to evolve this growth engine. As we stated last quarter, we see a path for well over a billion dollars in digital sales by 2030. Turning now to some thoughts on the current U.S. housing market and the market for our products. The external macro environment continues to be uneven and challenging. While the Fed lowered interest rates earlier this quarter, mortgage rates remain elevated above 6%, and many homebuyers and homeowners remain on the sidelines. Repair and remodel data has generally stabilized relative to larger declines over the prior 12 months, albeit at a lower than historical rate as consumers remain cautious. Notwithstanding the recent market softness, we continue to be very excited about our future, including in 2025. Housing fundamentals remain positive, with the need for housing remaining strong, home prices holding steady, and equity levels exceeding $35 trillion. As we continue to evolve our portfolio and focus on our supercharged categories, and as we continue to build upon our already strong brands and introduce meaningful innovations, we expect that our products will further distinguish themselves. With regards to the single-family new construction market, large builders continue to remain resilient as they use their balance sheets to lower mortgage rates and to help get people into new homes. We expect that large homebuilders will continue to gain share, and we have the added torque of the exposure to their growth. While starts were down this summer, the homebuilder market is continuing to grow. In September, the single-family NAHB housing market index for sales expectations for the next six months were up 8% versus prior year, while builder sentiment was also improving. Turning to repair and remodel. R&R is driven by several factors, including consumer confidence, employment levels, home equity levels, and access to credit. While R&R has been down over the last two years, we believe this has created unprecedented levels of pent-up demand, with one recent estimate putting it at $30 billion. As we previously mentioned, Americans have more than $35 trillion in home equity, up 81% from the end of 2019. However, the usage of equity extraction vehicles like home equity loans and cash-out refinancing, has fallen as rates remain high. In fact, the percentage of extracted home equity fell by more than half since the fourth quarter of 2019. It is now estimated that over 14 percent of homeowners have mortgages above 6 percent, finally making refinancing a sensible option. In addition, as the federal prime rate comes down next year, HELOCs and credit card rates should be more attractive. and we would expect more people to utilize them to finance their R&R projects. As interest rates decline and as mortgage lock-in effect subsides, we believe people will increasingly tap into their home equity for renovation projects through a variety of vehicles, including refinancing, HELOCs, key loans, and home equity agreements. Finally, we expect that there will be a short-term negative impact from the recent hurricanes on our fourth quarter sales, as we have seen this in our point of sale data. Our thoughts are with those impacted, and we have been providing products and assistance to those in need. We expect that there will be opportunities as communities rebuild in 2025, and our teams are working actively to capture this. Additionally, these tragedies have put additional pressures on insurance companies to find innovative solutions to offset the losses that they can control through devices like Flow. As Dave will detail more completely in his section, we are actively scenario planning for a variety of outcomes in 2025. We believe the demand environment in the U.S. will reflect positively with the recovery more weighted to the second half of the year. Additionally, as we complete our pivot from lower growth, less profitable categories to supercharged categories, our mix will help accelerate growth regardless of the external conditions. We will focus on growing our core and accelerating our digital products and will continue to invest behind our long-term growth priorities. As we head toward the end of 2024 and set our sights on 2025, we are focused on execution and delivering on our commitment to above-market sales growth and margin performance. Turning now to an update on a key part of our transformation. As we approach the two-year anniversary of the Cabinet's spinoff and the reorganization of our business from a decentralized, mechanical-only business into a digital innovator, I wanted to highlight a key milestone. Over the past nine months, we leveraged associate feedback and senior leader conversations to develop a new purpose statement with supporting strategic drivers and behaviors. This new purpose captures the unique opportunities Fortune Brands Innovations has to positively impact lives and communities. Our purpose is to elevate every life by transforming spaces into havens. This represents a bold, multi-decade vision for the company where, through our products, we can impact the lives of our customers, our associates, and our communities. We will bring our purpose to life by executing upon a specific set of behaviors and strategic drivers. Grounding our business in authentic, clearly articulated purpose, unique set of strategic drivers, and expected behaviors will help unlock higher levels of innovation, increased employee engagement and retention, and transformative growth. Teams across the globe made a unified effort to ensure that every one of our 11,000 associates had an opportunity to discuss our purpose, behaviors, and drivers. helping to underscore each associate's connection to how they can make an impact. As the market improves, the work that we have done to enhance our already strong culture will accelerate our opportunities for growth. We've continued to refine the organization, including recently reducing inefficiencies, while continuing to invest in key strategic priorities. A more efficient structure has allowed us to make strategic decisions faster and with more precision and deploy our Fortune Brands Advantage capabilities across the portfolio. As we have often noted, this is a multi-year journey, but one which is already showing concrete results. Turning now to segment results. Starting with water innovations, sales declined 8% while operating margin improved 40 basis points versus last year. Excluding China, organic sales were down 2%. We're managing the business tightly while continuing to make key investments in our most critical priorities like brand, innovation, and digital. Our Moen North American business delivered organic sales down low single digits. Our brand metrics remain strong, with Moen being number one for unaided brand awareness and the most trusted brand. Our whole home water performance showed significant share gains. As I mentioned earlier, Flo continues to gain traction with insurance companies, municipalities, and consumers as the leader in this emerging space. We are finding new use cases every day for this ecosystem of products. While the new insurance and municipality partnerships are continuing to ramp up, our retail and e-commerce point of sale accelerated 80% in the third quarter, highlighting the continued adoption by consumers. We expect sales of our digital water business to accelerate through 2024 and throughout 2025. Turning to our luxury business, organic sales were down low single digits in House of Roll, which now includes Emtek. We're now one year into our acquisition of Emtek, and the work to integrate the brand into our comprehensive and complementary luxury portfolio, including in showrooms, is progressing very well. and the feedback that we have received around our combined portfolio has been very encouraging. We will have installed over 150 EmTech displays in existing House of Roll showrooms by the end of the year, and we expect this expansion effort will continue as we head into 2025. Finally, China sales were down more than 40% this quarter as the Chinese consumer remains cautious and the real estate market remains soft. The government has recently announced policies designed to spur investments and growth but it is too early to know the magnitude or timing of impact. In the meantime, the team continues to tightly manage costs and cash flow through the current conditions. Given the magnitude of the decline in China, the business now presents very little bottom line risk and is a nice option for future growth when the market returns. Looking to the remainder of 2024 and into 2025, our water segment will focus on those parts of the market with the greatest potential for growth through our leadership in brands, innovation, and channel. We continue to expect our relationships with the large national builders to benefit us, and we believe new innovative product offerings will further distinguish us from our competition across our channels. And of course, our smart water network, including our ecosystem of leak detection products, should offer us attractive growth opportunities. We will continue to make thoughtful investments in our key priorities, including core branding and digital initiatives. We also see future fuel for growth opportunities as we leverage our Fortune brand's advantage capabilities to optimize our operations and supply chains and leverage our channel pricing expertise. We remain very excited about our water business, particularly the opportunities we see to capture outsized growth. Turning to outdoors, sales are down 6%, with strong results in our doors business offset by destocking in the wholesale decking channels. Importantly, our margins were 18%, an impressive 320 basis points above prior year. We continue to focus on leveraging our expertise and investing behind our core categories, and in those areas which we expect will offer the most attractive growth opportunities. Our door sales were flat as tailwinds from new construction and recent retail winds drove sales, and we continue to take share in fiberglass. ThermaTru continues to see the benefit of the increase which began last year, and Larson is seeing nice performance driven by recent innovation launches, which we believe will further accelerate. Decking sales are down more than 30% in the quarter due to inventory actions in the wholesale channel and a slower demand market. Importantly, our point of sale in the quarter was down mid-single digits. We believe the results in our five-run business reflect one-time destocking impacts from a decking season which was softer than expected and which are now behind us. Looking forward to the remainder of 2024 and into 2025, we expect to continue to leverage our strength in our wholesale channel as well as our expertise in innovative materials. We will continue to benefit from our strong relationships with large builders in our ThermaTru business. Additionally, recent product resets should drive accelerated performance in retail. We are focused on outgrowing the attractive outdoors market across our brands. Finally, turning to our security business. Sales declined 14% in the quarter, and organic sales were down 12%, while our point of sale was down mid-single digits. Results were primarily due to market softness, destocking, and consumer trade down on the digital shelf, as the number of inferior and non-compliant private label alternatives has unfortunately proliferated. We are taking definitive action to reverse this trend. Our brains are incredibly strong. and we are responding by helping consumers understand the value proposition of our trusted brands. For example, we recently launched a compelling new ad campaign, which highlights the fact that our fire safes keep documents protected from natural disasters like wildfires and floods, while many imposter brands fail to do so. We are already seeing positive momentum in our point of sale. Finally, we've increased our promotional cadence to better meet the market. Importantly, This segment also saw 250 basis points of operating margin improvement as our continuous improvement activities, supply chain optimizations, and cost controls resulted in expanding margins. The significant cost work that we have done on these brands over the past few years is allowing us to invest in marketing, innovation, and promotions all while growing our margins. A year into the acquisition of Yale in August, We are utilizing their team's skills and knowledge throughout the business, and their expertise is being deployed across our portfolio as we continue to accelerate our digital strategies. Looking to the remainder of 2024 and into 2025, we will continue evolving the security business by focusing on our strong brains, opportunities for differentiating innovation, and by reinvesting some of the efficiencies gained from our recent optimization of the business to strengthen our already iconic core brains and add meaningful innovation to our products, including our exciting digital products. We are proud of how our business is helping people and companies across the world protect the things that matter most. As we finish up 2024 and turn to 2025, our teams continue to navigate near-term challenges while executing multiple initiatives to drive our long-term success. We will continue to strategically manage the business in light of the uneven market backdrop focusing on those areas where we have the greatest potential for above-market growth, continuing to make key investments, and also looking to manage our margins. By taking these decisive actions now, I believe we will be best positioned for accelerated growth when the external market conditions improve. I will now turn the call over to Dave.

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 results reflect our focus execution on a tight set of priorities amidst a challenging external market. Sales were 1.2 billion, down 8%, and excluding the impact of China, organic sales were down 5%. Consolidated operating income was $216 million, down 2%. Total company operating margin improved to 18.7%, and earnings per share were $1.16, down 3%. Free cash flow in the quarter was $176 million, which brings our year-to-date free cash flow generation to $262 million. Turning to sales, net sales results were driven by China softness, low single-digit POS declines, and inventory reductions in outdoors and security. Our operating margin of 18.7%, a 130 basis point improvement, reflects our team's focus on a narrower set of priorities and our ability to drive continuous improvement savings offset by our investment in our strategic initiatives, which we are confident will result in growth as the end markets improve. Our team's execution resulted in decremental operating leverage of 4% in a sales environment that was softer than expected. As I will detail later, our balance sheet remains strong and we have the flexibility to manage various economic outcomes while deploying additional capital to drive shareholder value. Now let me provide more color on our segment results. Beginning with water innovations, sales were 635 million down 8%. Excluding the impact of China, organic sales were down 2%. The organic net sales results reflect the impact of lower volumes amid a softer market. Water Innovation's operating income was $156 million, and operating margin remained strong at 24.6%, reflecting lower volumes partially offset by continuous improvement initiatives. Both Moen North America and House of Roll POS were down low single digits. China sales declined over 40%. The Chinese market remained soft, and while encouraging policies were recently announced to bolster the market, it is too early to predict a recovery. That said, the team continues to focus on replatforming the business while preserving growth optionality. Turning to outdoors, Sales were 343 million, down 6%. Sales reflect low single-digit POS and a mid-single-digit channel inventory reduction in the wholesale decking channel. Segment operating income was 62 million, up 13%. Operating margins for the third quarter were 18%, an improvement of 320 basis points. DOORS sales were flat. Sales were positively impacted by higher volumes from single-family new construction offset by continued R&R softness. In decking, we saw sales decrease by over 30 percent in the quarter, driven by channel destocking. Importantly, POS was down mid-single digits in the quarter. Inventory levels remain low, and we expect this quarter to be an abnormal result, with evidence of improving trends as we begin the fourth quarter. Finally, in security, sales decreased 14% to $178 million or down 12% on an organic basis because of a softer market and the impact of lower quality import brands. Total security segment operating income was $34 million, down 1%, while operating margin was 19.3%, an increase of 250 basis points. as actions we took over the past few years continue to benefit our results. Looking forward, we will invest in our brand and in product and software innovation to further position ourselves as the leader in the mechanical and digital security space. Turning to the balance sheet and our cash flow performance. Our balance sheet remains strong with cash of $345 million, net debt of $2.4 billion, and net debt to EBITDA leverage at 2.5 times. We repurchased $35 million of shares in the quarter and have repurchased $190 million of shares year to date. We continue to focus on generating cash and will remain opportunistic and returns focused around our share repurchase strategy while also being mindful of our leverage ratio, which are trending as expected. To summarize the quarter, We focused on executing our priorities for long-term growth while delivering strong margin results in a soft environment. Our margin results reflect our commitment to productivity as well as the impact of actions we took to further align the organization around our strategic focus areas. With that in mind, I'll now provide an update to our 2024 guidance. As today's press release indicates, we are revising our full-year guidance. This change accounts for several variables, including a choppy demand market, short-term impacts in hurricane-affected regions, and lower channel inventory, partially offset by continued strength of digital water. Importantly, it also reflects our commitment to maintaining investments in key priorities that we expect will generate future growth. Our revised EPS guidance is now $4.17 to $4.23 we continue to have full confidence in our long-term strategy around our core and digital products. Regarding the impact of the hurricanes, we see the impact most acutely in our Moen and DOORS businesses, with POS in impacted states down more than 25 percent since the hurricanes. We expect that single-family new construction will see an outsized impact as labor is redirected towards storm cleanup in the near term. However, we expect these orders to more than recover as operations normalize and communities rebuild. The full details of our updated guidance can be found in our press release. As we head into 2025, we are actively planning for a variety of scenarios around the inflection in the demand environment. While it is impossible to predict the exact timing of this inflection, we continue to believe it is a matter of when, not if, and when the demand inflects, we will be uniquely positioned for outperformance. While we will not provide guidance assumptions for 2025 at this point, we are able to share some initial thoughts. Our initial planning assumptions include a market with slightly positive growth. We expect this growth will be weighted toward the second half of 2025, and we expect above-market performance accelerating from both our core and digital products driven by the initiatives underway. We also expect to make meaningful margin progress and deliver strong EPS growth in this scenario. Our teams have done a nice job navigating the uncertainty of the past few years. And as we approach the end of 2024, we remain confident about the future of the business and our team's ability to create value. We are focusing on controlling what we can control and continuing to pursue our long-term strategy. I will now pass the call back to Lee for Q&A. 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 to the operator to begin the question and answer session. Thank you.

If you would like to ask a question at this time, please press star then the number one on your telephone keypad. Once again, to ask a question at this time, press star, then the number one on your telephone keypad. Our first question comes from John Lavallo with UBS. Your line is open.

Hey guys, thank you for taking my questions. A lot of information here, so hoping you can help us unpack some of this. So, you know, starting at the top, you lowered the consolidated sales growth for the full year from, you know, positive two and a half to, you know, four and a half to, down, or sorry, to flat to plus one, and then lowered the organic sales outlook from down one to down three to down one and a half to down three and a half. And the downward revisions were across segments. In terms of the third quarter, it looks like results were below expectations across segments. It sounds like the operating environment certainly got more challenging. But I was hoping you could just kind of help us better unpack some of the moving pieces in the quarter and in the outlook. I mean, how much of the decline is from the third quarter being softer versus expected fourth quarter slowing versus storm impact, things of that nature?

Sure, John. This is Nick. I'll try to break it down for you as best I can. So, you know, if I think about it, you said you have sales from eight reported. You know, we then go look for organics. including China, because that's, you know, the whole other thing was down five. Within that point of sale, excluding China, it was down low single digits. So you start to dial it in a little bit. And, you know, and certainly I'd say consumer was weaker in the quarter than we thought they were, particularly in the middle of the summer, July, August. It was particularly slow. I think we saw that across consumer companies. Saw some recovery towards the end of the quarter. But if I look at our performance in particular, I really see three things at play. One, we've deliberately pivoted away from some of these low margin commoditized business in favor of focusing on our supercharged categories. And while we did that, two, we were and did exceed our own expectations on the digital side, but we need to convert those contracts to revenue foster. And to do that, we need to ramp capacity even faster than we thought. And that's just a question of throughput. We've signed the deal. They're in the pipeline. But it's a space we're learning. And just like mechanical products, you've got to go build the factory in order to produce it. And we realized we need to ramp that capacity faster than we thought. And so those in the pipeline that didn't materialize in the reported results for the quarter And then the third thing I would call out that is, you know, a marketplace dynamic is we are seeing some trade down to knock off, you know, imposter brands. Not so much a regular private label, which you'd expect, but brands that are generally import brands that are making false claims about safety and performance that we're going to combat. And, you know, as I described, we're already doing some of that. We have some of that in play. We've got more of it in the pipeline. But where we've done it, we're already seeing the point of sale start to re-accelerate as we're doing a better job explaining to our consumers what the difference is and what the brand premium is worth. And so, you know, that all sort of leads me confident as I kind of pull it all together that, you know, while it was a bit softer and we also had some stuff moving away from us, while a lot of goodness coming our way, we just need to commit that to sales even faster.

And, John, I'd add a couple things, and I'll unpack guidance a little bit. But before I do that, you know, what's also evident is the team's focus on margin. And as we've replatformed the business and stepped away from some of the lower margin categories where brands and innovation don't matter as much, you see that even though sales were softer, we're delivering pretty strong, margin results were 4% decremental in a quarter that was softer than we anticipated. You know, up 130 basis points on operating margin, year-over-year and 110 year-to-date. So the margin is still coming through, and this is a story we expect to continue. And then on the guidance, you're right to point out the contality to change. I'd say, you know, that's roughly three percentage points lower for the year at the midpoint, which call it $135 million or so. Eighty of that came through in the third quarter, which leaves about 55 then in the fourth, and of that in the fourth, About half is hurricane related, about half is continued consumer POS softness that we're working to combat. That said, as we look at the fourth quarter, it still leaves us in a spot where sales are down low single digit. We have operating margin improvement of 100 basis points, maybe a bit better than that, and high single to low double digit EPS, and so EPS growth. not as good as we may have thought 30 days ago, still a pretty good quarter, just not as robust from the consumer as we were hoping heading in the back half of the year.

That's helpful. And then maybe focusing in on some of the margin improvements. I mean, in outdoors, sales were down 6.5% year over year. Op margins were up, I think, over 300 basis points. Security was down, I think, 14% for sales, and op margins were up 250 basis points. And You know, even on a sequential basis, sales were down and margins were up. I mean, so what kind of drove the margin strength in those two segments, you know, both sequentially and year-over-year?

Yeah, I'd say an outdoor combination of doors, temperature door volume being better year-over-year, and I'd say volume even in Larson and Storm doors being better year-over-year. And then in decking, you know, some of the work we've done to shed some of the lower profitable business that we had. We've talked about in the past, we exited a window supply agreement for window components. We've looked hard at our kind of sourcing and manufacturing around PE and PVC decking to make sure we're driving continuous improvement productivity there. And so a lot of internal initiatives to really drive the margin in outdoors, plus some volume coming through on the door side. And then in security, you know, we talked about the actions we took earlier this year to drive the cost savings by altering our footprint. I mean, that's really coming through now, and we'd expect that to continue to be a tailwind into 2025. You know, to Nick's point, this is an area where we are investing back in the business. We're investing in innovation that will come to market next year. We're investing in marketing campaigns for the first time in a while for these brands that will come to market now and into next year, and it's all really to combat some challenges on the shelf for these import brands.

Understood. Thank you, guys.

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

Hey, guys. Dave, thanks for giving us a framework for 25. You know, fully appreciate that guidance per se. Frankly, I thought the back half 24 is not that bad. I mean, if you flush out some of the noise, it sounds like organic sales is down a those single digits, 1% or so. So when we kind of look out to 25, you said slight growth in the market and usually grow a little faster than the market by a few points. Are we kind of talking about low to mid-single digit organic growth and a little more meat in the first half and you see better growth? And then help us kind of think through the leverage you have at play in terms of the margin side of things for next year as well.

Yeah, it's a great question. It's tough for us to pinpoint right now. There's still a lot of uncertainty there. When you've seen what happened with bond markets over the past month, that's going to lead to higher mortgage rates. On the flip side, we expect the prime rate to continue to come down, which is going to lead to some affordability benefits around refinances and HELOCs and home equity loans and just everyday borrowing. So it's tough for us to say. I would say we see the outperformance really driven in two areas. So one, improving core category POS. based on the actions that we're taking now. And then two, as we talked about, conversion of the connected pipeline into sales. And so I would expect our outperformance to accelerate through the year as both of those things come through the P&L, but hard to say kind of what that level is based on the underlying market.

Okay, that's helpful.

As we get to 25 guidance, I think we'll have another 90 days of converting that connected six-minute flow contract into sales, and we'll have a better sense. I mean, you know, just being very candid, it kind of caught us by surprise the pace at which we were able to ramp that business. We now have, as I said, you know, 8 million policyholders under contract at only a 5% conversion rate. That's $160 million of sales we have in the pipeline. So what we're learning is you've got to set up websites, you've got to build collaborations, that, we'll be able to get that niche and market outperformance that we expect. The fact that we have another 60 million policyholders under discussion right now, at least a portion of which will convert to contract, we think is going to give us a great pipeline next year.

Okay. That's helpful. Actually, that's a perfect segue, Nick. On connected products, if I remember correctly, last quarter you were calling for maybe two points of incremental growth in the fourth quarter. How are you kind of shaping up and 3Q, 4Q, and then as we look out to 25, you know, it sounds like a high-class problem to have. There's really strong demand. You've got some natural bottlenecks here. How do you unlock that supply? Are you actually building facilities? Are you going through third-party partners? You know, help size up that opportunity perhaps in 25 and how that capacity unlock will, like, shape up next year.

Yeah, I'll start with the second part of your question. I mentioned the sales piece, what we expect. But, you know, think about it like you might think about building a factory, but just in the virtual world. And that's exactly what we're learning. Like you have, you know, there are certainly the ideators, but it's an office with a lot of our teamwork. You know, the children engineers, they're production people. They're helping produce the product or the software, firmware, sites, you know, the things that you need to actually make that sale. And that we need to do a great job of ramping up. even foster that we have now, you know, you know, the history that started almost at a zero in 21. And we're now investing very heavily in day four dimensional, if you like, behind our digital opportunity. We've done that while delivering this March expansion. So we're super excited that we've been able to build this, this engine. It's, it's been a little eye-opening to us that we probably have to build it even foster. And so that is, you know, we're going to put, growing investment where the growth in the business is, and really just invest in the people. You know, you ought sort of, is it onshore or offshore? It's a combination. I mean, you know, you really need the leaders and the thinkers and the architects are part of our organization. A lot of those people came across with the August acquisition. They're fabulous. But then we're also going to leverage outside help or offshore parties that might be, you know, really steeped in just a particular part of digital piece of the puzzle that you need to deliver. And so, you know, we build that web. But, you know, myself and my executive team have really been focused over the last 90 days on just how do we put the capability and capacity to ramp this even quicker.

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

Okay, exciting. Really appreciate the color, guys.

Just to put a little bit more on that, you know, the way to think about today, probably, you know, sign an agreement, you know, taking us two to three months. We want to be in the two to three week range. That's the goal.

Okay, thank you. Your next question comes from Mike Dahl with RBC Capital Markets. Your line is open.

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

Yeah. I'll generalize a little bit for you. I'd say, broad line, it's an estimate. There are three, probably three types of agreements we signed. There is a type of agreement where the product may be recommended and offered. There's the type of agreement where the product is offered with a rebate. And then there's the type of agreement where it's actually mandated, where the insurer will say to the policyholder, unless you put this in, you will get no more insurance from us. Now, even in the third bucket where it's mandated, it's not an instant off. I mean, you know, you could imagine what would happen publicly if they just turn policies off. So they give that homeowner some time to comply with the mandate. But those are the three types of contracts we're currently out and executing in the marketplace. What we did to get to $160 million was say, well, if we took a mere 5% conversion rate, that would be $160 million on the contracts we've already signed. Now, I'll tell you, we expect a far, far higher conversion rate with the mandated contract. Those will go in at It should be 100% minus whatever policyholders choose to walk away. Now, these are not markets where you have to walk away from your insurance because there isn't a whole lot of other insurance. Down to places where it might be recommended that they pay back for itself with a discount and that's a lower conversion rate. We felt 5% is very conservative, but that's how we get to the number of what we've already signed.

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

So just on your first question, yeah, we use very, very precise models with insurers to understand A, what the expected savings will be. I will tell you they're pretty eye-watering when you see the numbers, multiply the number of policies they have. And then B, from there, you know, we work on an expected conversion rate in the period of the supply chain accordingly. But 5% is quite a bit lower than that. You know, that's our conservative assumption. That's not what we are actually gearing the supply chain and these contracts. We're gearing them to do something and access to that, so that's the first part. The second part, I'll just give you a general concept to think about, and then Dan can start to dimension a little bit the sourcing piece, but I will tell you that we have been in the mode of optimizing the supply chain and managing tariffs really all the way back to fiber tariffs in 2017. The team is extremely experienced in this area. One of the things that I would say has evolved pretty significantly is our ability to flex that supply chain. And so we've moved away almost everywhere from single source. We now have two sources, and your secondary source may cost you a bit more than your primary source. But if your primary source were to become more expensive because of tariffs, you can dial that down and dial up your secondary source and rebalance it to be the most efficient. Of course, added to that, we still have a very large U.S. manufacturing footprint that becomes part of that total network solution. It's not just an independent thing. It's the role that it plays in that total network solution. So I'm confident that we are very well positioned to handle increased tariffs. I'll tell you, we don't invite it because it's a lot of hard work, but every time it happens, our share tends to accelerate because our ability to execute relative to the competition. And that's where we really put the emphasis. And, you know, the final thought before I end it today is we do have a SWAT team against this that have been working on this for many months and have run up to yesterday and today with the expectation that we will see tariffs. You know, I think the TBD may be exactly where you see them and to what degree, but, you know, with the network that I've described, we're well prepared.

And the impact, like I'd say, going back to 2018 and look at these set of assets, we had over 50% of our COGS sourced from China. That's down to less than 25% today. So to Nick's point, the team has been working against that for a while. Tariffs are still in place. We're still paying. The more spend we can get out of China, the better. Looking broadly at our COGS, I'd say U.S. is roughly 40% to 50% of the COGS base. If you remember, outdoors is almost fully U.S. Water has a big piece in the U.S., and then security has a piece in the U.S. So you take that, add the little visits in China, the balance being rest of world, and a portion of that rest of world is North American-based. So we do have options. You know, we're operating under a base case scenario that tariffs from China at least are going to increase. And the team is working to optimize our network around that. And we do view this as an opportunity.

That's very helpful.

Final thoughts.

Just referring to a discussion we had around John's question. You know, I'll just hit on that third point. You know, we have seen in the market a bunch of import brands that claim to perform, whether it be in security, in fire safes, in water safety, at levels that our own testing demonstrates they do not deliver. That is something that you'll see us increasingly ramp up our communications around. Some of it is directly to people's well-being and health and safety. I don't think that increased focus on some of that product that we've seen coming into the marketplace will necessarily get that thing.

Yeah, makes sense. Thank you. Your next question comes from Trevor Allenson with Wolf Research. Your line is open.

Hey, good evening. Thank you for taking my questions. Nick, I wanted to follow up on what you were just referring to with some of that non-compliant product competition. Keith, dive into that a bit further. Talk about, you know, how big of an impact that had on the quarter. Is that something that you expect to linger here going forward? I know you talked about some initiatives that you're going through to mitigate some of that. Is there any way you can size that for us that would be helpful?

Yeah, I'll give you a few examples to start off. You know, first, it kind of started with fire safety. You know, we're famous for our fire safety. And our waterproof safes, and consumers really depend on that, particularly if you're in a fire zone or a hurricane zone. You can go over and do your own research. You'll see products in the market that claim similar performance. We put it through our own testing. And whereas our safes will withstand a fire, most of these import brands burn within two minutes. We put collateral out into the marketplace. That was the first one we sort of tested. We put collateral out into the marketplace and invested behind telling the story. And we are seeing our point of sale turn around and start to actually gain share very quickly, and really within weeks of activating it. So it gives us confidence that when we tell the story, the consumer sees the value in it. We've now extended some of that work to things like faucets that reach lead into the waterway. You know, that is not legal. We won't tell that story. And so on and so forth. You know, WWE started on unconnected security. So there is no doubt an opportunity. You know, I wouldn't say the impact was massive. But unlike, you know, regular way private label where we don't really compete at opening price point and we've done just fine because people see the value of paying for the premium for the brands, and we strategically position a portfolio. These are places where people are advertising in a misleading way, and these are really competitive because they're claiming the same benefits as our brands provide at a lower price, and they actually are not providing them. And so, you know, again, we tell the story. It seems to change the trajectory. We're just now making the investments and taking the time to do that, and we'll be doing it more publicly as we move forward.

And, Trevor, you see this most acutely in our organic security results here today. You know, this is where most of the problem is showing up and where the team is taking action to offset it.

Okay, yeah, it makes a lot of sense. Appreciate that color. And then the second question is on China. Conditions there are clearly dynamic. Nick, I think you used the word unprecedented, so a lot of uncertainty there. Can you talk about how you're thinking about that market moving forward? Do you think you're nearing a bottom here? I mean, comps are clearly getting a lot easier. Any color there would be greatly appreciated. Thanks.

Yeah. Firstly, I'd say your question is highly logical. You would think one is nearing a bottom just given how long it's gone on, how much less of – New construction there has been, as well as the fact that, you know, the government does seem committed to creating that bottom and stimulating that marketplace. That said, I will say, after, you know, a couple years of this, we just feel like we can't bank on that. The team there has done a fabulous job managing that cost structure and that P&L, you know, is still a profitable business for us. And so the way we think about it, as long as we can keep it, isolated and manage it in that way. And frankly, you know, when I look at the size of the profit pool today, it's really, you know, could go to zero and wouldn't have a noticeable impact on the total company. It really is a market that should give us exposure to growth and growth returns, and the demographics would tell you growth has to return at some point. And also, it's a really nice innovation engine for the business. You know, we have a great team there that's very, very close to a lot of great innovation and that serves as a pipeline for the whole business. And so that's really, you know, with a lot of humility to the team over there, it's done a great job, you know, how we're thinking about it and how we're managing it. When that bottom actually forms, you know, I would lose money making that prediction. So we'll just manage it tightly in the interim. Yeah, I would too.

I appreciate all the color.

Thanks.

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

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

Yeah, happy to. The guide is implied sales down mid to high single digits in the fourth quarter. That's right. And I'd say it's, you know, continued consumer POS softness. Like I said, we are starting to see some of the trends turn based on the investments we made. But those investments came, you know, late third quarter into the beginning of the fourth quarter. And so not ready to predict, you know, a complete turnaround yet on that POS trend.

Got it. Okay. But maybe the outlook into – 25 might be better, hopefully. And then to sort of follow on this, you know, these low-quality competition, the low-quality competitive products you're dealing with in digital security, I just wanted to get a sense, is this issue more pronounced maybe in the online channel, or are you seeing it pretty much across, you know, the retail, across all retail companies? including online. And can you share with us, like, what share of your digital products are sold online?

Yeah, why don't I start? And, you know, again, I just want to reiterate, I just don't have a problem with their lower quality. Like, you know, we are just sort of not competing at that bottom end of the channel. It's where they're making false claims that we are combating and combating with success. And so that's, you know, that's where we saw this issue sort of emerge. quickly and yes you're absolutely right it's much more prevalent in the online space we've got and there's probably less scrutiny around you know product claims that are put on on web pages in terms of breaking up that percentage day about don't yeah I would just say Steven it definitely over indexes our mechanical channel breakdown the digital products more apt to be purchased online

at least today, as we build out the other channel.

Okay, thanks very much, guys. Your next question comes from Adam Baumgarten with Zellman. Your line is open.

Hey, good evening, guys. Just back to the digital, I think you talked about 150 basis points of growth contribution in the back half of 24 last quarter. Maybe if you could update that number and maybe what it was in the third quarter.

Yeah, we talked about that a little bit earlier, Adam. So I'd say our POS and our pipeline is exceeding expectations. The sales number coming through is a bit below that, just given our conversion rate from the pipeline into sales, and we're investing to try to unlock that. As Nick mentioned, taking that time to revenue from three months down to three weeks is really the goal. You know, third quarter, similar. I'd say POS is very strong. It's up over 80%. signing new agreements, we just have to get them into revenue.

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

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

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

Actually, I'm not talking about connected products at all. I'm going to be very clear. It's not really in the non-connected products. It's really in mechanical things like fire safes, kitchen faucets, some in the padlock space. You know, it's really mechanical products that, you know, just come in and sort of looks the same, makes a whole bunch of claims, doesn't perform where they claim.

Got it. That's helpful. Your next question comes from Matt Bully with Barclays. Your line is open.

Good afternoon, everyone. Thanks for taking the questions. I think you made a comment in the prepared remarks around 2025 with that slightly positive market growth and that you would outgrow that. That in that scenario, you would see meaningful margin progress, I think I heard you say. And so, you know, given your outgrowth, maybe you're seeing a little bit of volume leverage. But I guess, you know, what are the other pieces of the bridge that might get us to meaningful margin progress? And how do you think about incremental margins? in a scenario where the market would be slightly positive. Thank you.

I'll give you a bit of color and context, Matt. I'd say we see margin next year coming from a few areas, right? So productivity, we've had a very nice trajectory. SG&A efficiency, as we continue to bring the businesses together, we're finding more SG&A efficiency. And then mix, we expect to be favorable. I think price-cost will probably be a slight benefit as well. The offset and why we're not being more specific right now is the level of investment back in the business. When we talk to guidance, it will be clear about where and how we're reinvesting, primarily around unlocking growth and setting itself for future growth opportunities. So that's the big offset lever right now. The teams are still working through, and Nick and I look at it as a decision to make how much are we going to invest back in and how quickly can we turn that into growth on the top line.

Got it. Okay. Thanks for that, Dave. And then secondly, on the decking business, I think I heard you say you were seeing some evidence of improving trends to enter the fourth quarter and something around destocking. If you guys were talking about it potentially being one time, just maybe hit on both of those points. Just, you know, have you seen the destocking subside or is there any more to come? And, you know, what are you seeing around some of these improving trends here? Thank you.

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

Thanks, Dave. Good luck, guys.

Thanks.

Thank you for joining the Future Brands Third Quarter 2024 Earnings Conference Call. You may now disconnect. Have a wonderful rest of your day.

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