Fortune Brands Innovations, Inc. Q2 FY2023 Earnings Call

Hello. My name is Shamali, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Second Quarter 2023 Earnings Conference Call. I would like to turn the call over to Leigh Avsec, Vice President of Investor Relations and Corporate Affairs. You may begin the conference call.

Good afternoon, everyone, and welcome to the Fortune Brands Innovations Second Quarter Earnings Call. Hopefully, everyone has had a chance to review the earnings release and our web posting for additional information on our most recent acquisition as well as our supplemental financials. The earnings release and our audio replay of this call can be found in the Investors section of our fbin.com website. I want to remind everyone that our forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, except as may be required by law. Any references to operating profit or margin, earnings per share or free cash flow in today's call will focus on our results on a before charges and gains basis unless otherwise specified. Please visit our website for our reconciliations. With me on the call today are Nick Fink, our Chief Executive Officer; and Dave Barry, our Chief Financial Officer. Following our prepared remarks, we have allowed time to address some questions. I will now turn the call over to Nick. Nick?

Thank you, Leigh, and thank you to everyone for joining us today. On this call, I will walk through the highlights of our second quarter performance and offer some thoughts on the macro environment. I will also discuss our recent acquisition and how we expect these leading brands to accelerate key strategic initiatives and contribute meaningfully to our performance. I'll then turn the call over to Dave for a discussion of our financial results and how we are thinking about the remainder of 2023, including the upward revisions to our market forecasts, and increase to our full year 2023 sales and EPS guidance. Turning to our second quarter performance. Our results and the actions we took this quarter demonstrate the resilience and strength of Fortune Brands Innovations. Our teams delivered solid sales and strong margin results amidst an external environment that remains dynamic. Our leading brands are focused on meaningful innovation and our advantaged channel relationships positioned us well in the current environment and drove our results. I want to thank all of our associates for your dedication and pursuit of excellence, and again, welcome our newest associates to Fortune Brands Innovations. Together, we are going to continue to build an exceptional company. Net sales of $1.2 billion in the quarter were down 7% versus the prior year, and our operating margin was 17%. Our top line results were 50 basis points above our estimates for our market. These results demonstrate our ability to grow above the market, protect margins and invest in key strategic growth initiatives, even in the challenging environment. Our sales and margin performance generated earnings per share of $1.07. As we discussed on our last earnings call, heading into the second quarter, we knew that we were coming up against uniquely challenging year-over-year comparisons. As we expected, we saw sequential point-of-sale dollar growth versus the first quarter of 2023. It was not at the same exceptional levels of ramp-up that we experienced in 2022. As a reminder, the slowdown in the market for our products and major inventory destocking began in the second half of 2022. In fact, our second quarter 2023 organic sales results were 19% higher than in the second quarter of 2019, demonstrating that consumers continue to be interested in investing in their homes. Our results this quarter reflect our unwavering focus on outgrowing the market, preserving margins and generating cash, all while continuing to prioritize key investments, including brand building, thoughtful capacity additions, meaningful innovation and our digital transformation. I believe that we are very well positioned as we head into the second half of 2023. Turning now to some thoughts on the current U.S. housing market and the market for our products. As we have consistently stated, demand outstrips supply in the U.S. for housing, which creates a market opportunity for our products in both new construction and repair and remodel. There is significant pent-up housing demand driven by several factors that I'll touch on shortly. This demand, together with our strong and optimally positioned brands will result in medium- to long-term tailwinds for our business in both new construction and repair and remodel. Starting with new construction. As has been widely reported, the new home construction market has fared better than anticipated despite higher interest rates. Existing home inventories remain near historic lows, as U.S. housing remains severely underbuilt. Builders, particularly the large production builders with whom Fortune Brands enjoys strong relationships, have been responding to affordability challenges in a dynamic marketplace by building spec inventory and providing sales incentives, including rate buydowns. Sales of new homes have been increasing throughout the year and starts are again outpacing completions. The backlog of new homes is also increasing, albeit at a much more manageable rate. With that as a backdrop, we have revised our single-family new construction outlook upward for the remainder of the year, while continuing to monitor for economic volatility and the potential for a full recession. Turning to R&R. Within the broader repair and remodel space, we remain confident that our products are uniquely and optimally positioned to outperform. Several factors are converging to result in a unique opportunity for growth. First, the current lack of existing inventory, combined with the fact that over 80% of mortgages are under 5%, means that people are more inclined to stay in place and make the home they have into the home they want. Next, consumers continue to have high confidence in their homes as an asset, given the extremely high levels of home equity and personal real estate investments, which have offered financial stability and strong rates of return. Finally, the average home is over 40 years old, and homes built during the early 2000's boom are coming into prime R&R age. Additionally, the baby boomer generation continues to prefer aging in place and investing in their homes, while millennials and other first-time homebuyers are purchasing homes in need of upgrades due to limited available inventory and affordability concerns. These demographic trends are all supportive of repair and remodel. Our data shows that our products are less tied to existing home sales and instead, are more dependent on factors like consumer confidence, age of the house and home equity and employment levels. We believe our products are relatively more insulated than other R&R items because they are smaller ticket items, are less disruptive to install and because they offer immediate aesthetic improvement or meaningful innovation and functionality to a home. In short, people buy our products because they want to enjoy them. That said, we are aware of the uncertainty inherent in the broader macro environment, and we are watching market conditions closely, and we will respond quickly if warranted. Turning now to our most recent acquisition. I'm extremely excited about the recent acquisition of two world-class businesses from ASSA ABLOY, the Emtek and Schaub premium and luxury door and hardware business and the U.S. and Canadian Yale and August residential smart lock business. Dave will provide more color into the numbers, but at a high level, we expect second half 2023 sales for these businesses to be approximately $190 million to $210 million, and for this deal to be accretive to our P&L in 2023, with $0.04 to $0.06 of EPS even after factoring in $0.08 of purchase price amortization. This acquisition is a great example of our disciplined approach to M&A. Emtek and Schaub are the market-leading brands in the luxury hardware space and will be a fantastic complement to our House of Rohl business. The margins for these brands are exceptional, and we look forward to leveraging the team's demonstrated skill at driving phenomenal customer service in highly designed products while also maintaining high margins across the entire Fortune Brands portfolio. Including Emtek and Schaub, our luxury platform will now be over $0.5 billion in annual sales, and the potential synergies are meaningful. This acquisition will allow us to expand our presence in luxury showrooms, further penetrate the luxury hospitality market and become an authentic global luxury design house, offering cohesive product offerings in finishes throughout the home. Our consumer remains strong and is increasingly interested in products with storied brands and distinctive quality, and we believe our growing luxury portfolio speaks to the secular demand trend. The Yale and August residential smart security businesses consist of innovative brands with a strong IP portfolio and exceptional digital talent. As part of the acquisition, we've added roughly 100 new engineers supporting in-house software and hardware platforms who we will leverage across our portfolio of brands over time. In addition, this acquisition will allow us to expand our retail and omnichannel and wholesale door lock business, broaden our residential connected security ecosystem and accelerate innovation across our brands, including the potentially transformative development of a fully integrated smart entry door system. Here again, the potential for synergies is significant. This acquisition will be a key accelerant to our growth strategy. It allows us to expand in existing channels and categories as well as in new high-growth spaces with secular tailwinds. Importantly, through the addition of Yale and August, this acquisition is a key step in our transformation into a digital innovative disruptor. Further, with the addition of Emtek and Schuab, we will materially accelerate our strategy to build the House of Rohl into a global luxury powerhouse for the entire home. Combined with our existing Fortune Brands business, we now have the knowledge base, the growth platforms and the brands to bring new and disruptive products and services to the market that will be the first of their kind. Overall, Fortune Brands Innovations is well positioned for both the near term and the long term. Our branding power, meaningful and value-add innovation and strength in the multistep distribution channel are powerful moats in uncertain times and accelerants in times of broader economic growth. Our recent acquisition of the leading Emtek, Schuab, August and Yale brands will provide growth opportunities and nicely complement our strategic focus on branding, innovation and channel. Our brands are uniquely positioned to outperform the market in all environments and our newly aligned structure together with our Fortune Brands' capabilities will enable this outperformance as our results demonstrated this past quarter. As we announced in the release this afternoon, we are raising our full year sales and free cash flow guidance and again, raising our full year EPS guidance. Dave will give more details, but this increase reflects our confidence in the Fortune Brands business. Before I turn to the individual businesses' performance, I would like to remind everyone that our second quarter 2023 results reflect both the impact of challenging prior year comparisons plus the impact of the single-family new construction market, which slowed abruptly in the second half of 2022. That slowdown is now being digested through our business. In the second quarter, Water Innovations sales declined 5% compared to the prior year quarter due to market-driven volume declines across the segment, partially offset by price. Our margins for the segment were 23.2%. The Moen U.S. business has strong long-standing relationships with the top U.S. production builders and our strategic decision to invest in our relationships with these key customers yielded tangible results. In retail, we saw more general market softness as the DIY consumer market slowed. Our House of Rohl brands total sales were up low teens for the quarter, including Aqualisa and down high single digits organically, reflecting the impact of high second quarter 2022 comps and a softer market. For the full year, we expect our organic sales to be flat as our story of craftsmanship and unique designs continues to resonate with the luxury consumer, who is increasingly seeking differentiated goods and values timeless quality. We recently announced the building of a new facility in the U.K., which will help meet global capacity needs of the business as we continue to expect our brands to perform well. In China, sales were up over 30% year-over-year. This reflects the impact of lapping the second quarter of 2022, which was marked by the Shanghai COVID shutdown. We also saw higher-than-expected project completions although the overall market remains soft and the Chinese consumer remains cautious. However, we continue to capitalize on our leadership positions and are well positioned within the Chinese housing market where we are increasingly focused on the emerging Chinese R&R market. For the full year, we now expect China sales to be down high single digits. In Outdoors, sales declined 14%, reflecting expected market softness, which was partially offset by price. We saw sales improvement sequentially throughout the quarter and are encouraged by July results so far. We are pleased with our operating margin of 16.4%, which is 80 basis points higher than our second quarter 2022 results and is a proof point of the success of our newly aligned operating model. We are well positioned across our Outdoors brands to respond to any changes in demand patterns and are making investments to continue to best serve all of our customers and channel partners, while also focusing on the innovations, which we believe will further differentiate our products. In decking, POS trends indeed continued strong consumer interest in this category and the recent reacceleration of sales as the value proposition is increasingly understood by consumers and professionals alike. Wholesale sellout improved throughout the quarter, and we exited June up high single digits. In the quarter, sales were down high teens versus the same quarter of 2022. However, when comparing to Q1 of 2023, we saw sequential sales increase by more than 50%. Our channel partners were conservative with inventory buys in the beginning of the quarter, but in June and into July, have been accelerating their inventory purchases and our POS data shows that we are growing above the market. In Doors, sales declined low teens as the slowdown from the 2022 single-family new construction market impacted Therma-Tru. We are confident in the long-term opportunity as well as the strength of our product offerings, and our long-standing advantage relationships with our key customers and channel partners as we look to maintain and grow market share in the most attractive parts of the market, including in the single-family new construction market. Lastly, in Security, sales increased 2% over the prior year quarter. These results were driven by price and continued growth in commercial and international markets. As we have previously mentioned, our Security and Water businesses share many key similarities, including the importance of their iconic brands with consumers and trade partners, a strategic focus on connected products and the structure of their operations and supply chains. The Security business continues to implement the Fortune Brands' advantaged playbook that we first used to transform our Water business eight years ago and the results are becoming apparent. Going forward, the team will work to continue to evolve this business into a higher-growth, higher-margin business, focused on driving the power of our brands and developing meaningful innovation. Before I turn the call to Dave, let me share a few final thoughts. We took meaningful steps this past quarter to prepare Fortune Brands for continued growth. Our reorganization into a more efficient centralized company, focusing on brands, innovation and channel has progressed more quickly than we anticipated, thanks to the strong engagement from our teams and the impact was apparent in our results. We made important changes to our supply chain to align with our growth areas and margin progression targets. We continued to invest in our key strategic priorities, including our iconic brands, digital transformation and meaningful innovation. And finally, we've closed on an exciting potentially transformative acquisition that we expect to drive growth and accelerate our larger strategy. As we highlighted last year, the actions we took in 2022 were designed to transform Fortune Brands into a growth-focused, highly innovative company. Six months following our separation, I am encouraged by all that we've accomplished and excited about what we will achieve next. As reflected in our revised full year guidance, we see some positive indicators of a healthy consumer while also being mindful of potential short-term disruptions. We're constantly monitoring and are well prepared to respond to uncertain end markets in the short term, while we position ourselves for accelerating longer-term outperformance in the market supported by fundamental growth characteristics. As we head into the second half of 2023, we are focused on execution and delivering on our commitment to above-market sales growth and margins. With that, I'll turn the call over to Dave.

Thanks, Nick. As a reminder, my comments will focus on income before charges and gains to best reflect ongoing business performance. Additionally, comparisons will be made against the same period last year, unless otherwise noted. Let me start with our second quarter results. As Nick highlighted, our teams executed well this quarter amid challenging comparables and the impact of last year's abrupt slowdown in single-family new construction. Our results reflected their dedication. Sales were $1.2 billion, down 7% and consolidated operating income was $198 million, down 11%. Total company operating margin was 17%, and earnings per share were $1.07. Our sales in the second quarter largely tracked our point-of-sale. Volume was down high single digits, which was partially offset by low single-digit price. Changes in channel inventories did not impact consolidated results. As we discussed previously, we expected operating margin in the first half of 2023 to be heavily impacted by production inefficiencies and stranded fixed costs related to our inventory reduction efforts. We continue to make excellent progress against our near-term inventory reduction target and our organic second quarter inventory finished at $845 million, down roughly $240 million from our third quarter 2022 peak. Our second quarter operating margin of 17% included a roughly $20 million impact from these efforts, bringing the total P&L impact in the first half to more than $50 million. Going forward, healthier supply chains and our more aligned organizational structure should improve our ability to accurately forecast with continued focus on service levels and inventory mix. While we are pleased with our second quarter results, our teams remain focused on driving outperformance, including above-market growth, preserving and enhancing margins and generating cash. Our continued focus on these performance metrics has enabled the team to drive both key strategic growth investments and strong cash flow. As I will detail later, our balance sheet remains strong, and we have the flexibility to manage through various economic outcomes while deploying additional capital to drive shareholder value. Now let me provide more color on our segment results. Beginning with Water Innovations, sales were $617 million, down 5% and down 6%, excluding the impact of the Aqualisa acquisition and FX. The net sales results reflect the impact of lower volumes, partially offset by price. Water Innovations' operating income was $143 million, and operating margin was 23.2%, reflecting lower volumes, partially offset by price and continuous improvement initiatives. Our point-of-sale performance for Moen was down low double digits and in line with our expectations given the challenging comparable period and prior year slowdown in single-family new construction. House of Rohl total sales were up low teens, while organic sales, excluding our Aqualisa acquisition, were down high single digits, primarily due to strong prior year comparables and market softness, which was most pronounced outside the United States. China sales grew more than 30%, primarily due to an easy comparable following the prior year's COVID shutdown that acutely impacted the Shanghai region. The Chinese market remains soft and though the completion of delayed projects is accelerating, new home sales and starts are moderating as the Chinese consumer remains cautious. That said, we continue to see growth in the emerging R&R channels and are positioned for market outperformance due to the strength of our brand and expertise of our in-country leadership. Turning to Outdoors. Sales were $376 million, down 14%. Segment operating income was $61.6 million, down 10%. Importantly, our margins improved both versus the prior year and sequentially to 16.4% driven by volume leverage, price and plant productivity. Door sales were down low teens. As expected, sales were impacted by lower volumes from the single-family new construction slowdown in 2022 and the challenging point-of-sale comparables. However, our wholesale business is performing above market, and the business should be positively impacted by the improved new construction outlook. In decking, as Nick mentioned, we saw point-of-sale accelerate through the quarter and continue to expect full year sales to be roughly flat to prior year. Finally, in Security, sales increased 2%, reflecting increased distribution, price and continued strength in commercial and international security. Security's segment operating income was $27 million, up 6% versus 2022. Segment operating margin was 15.6%, up 70 basis points. Our team continues to work to transform our Security business into a higher growth, higher-margin business focused on attractive categories where our brands and innovations can drive consumer and customer share gains over time. This strategy will be accelerated by the integration of the Yale and August assets. Turning to the balance sheet and our cash flow performance. Our balance sheet remains strong with cash of $682 million, net debt of $2.6 billion and net debt-to-EBITDA leverage at 2.9x. This leverage ratio reflects the impact of our recent acquisition and we expect to reduce our net leverage ratio over time as the business continues to generate strong cash flow. We generated free cash flow of $358 million in the quarter, bringing our first half free cash generation to $391 million. Our working capital reduction efforts continue to shrink our balance sheet and generate cash. To summarize the quarter, we delivered solid sales and strong margin results in a fluid environment while overcoming the most challenging period of prior year comparables and the impact of the slowdown in the single-family new construction market in 2022. With that in mind, I'll now provide an update to our 2023 guidance inclusive of the acquisition of the ASSA ABLOY assets. As indicated in our release and in our supplemental presentation, for the second half of 2023, the acquisition is expected to generate net sales of $190 million to $210 million and earnings per share of $0.04 to $0.06. This includes the unfavorable impact of approximately $0.08 from purchase price amortization. Based on our revised market assumptions, which include an improved outlook for U.S. single-family new construction, plus the impact of the ASSA acquisition, we now expect full year consolidated Fortune Brands' sales to be flat to down 2% or down 4% to 6% on an organic basis. We now expect full year operating margins between 16% and 16.5%, reflecting the impact of purchase price amortization from the acquisition. On an organic basis, we continue to expect operating margin to be around 16.5%. As today's press release and our supplemental web posting indicated, we are increasing the midpoint of our EPS guidance by $0.08 and narrowing the overall range to $3.75 to $3.90, reflecting the acquisition and our organic businesses performance in an improving market. As a reminder, we previously raised our EPS guidance during our first quarter 2023 earnings call, reflecting our operational outperformance. So in total, our updated EPS guidance reflects a $0.13 increase over the midpoint of our initial guidance. In closing, as we head into the second half of 2023, we remain ahead of or tracking to the guidance targets we put forth at the beginning of this year. We have delivered solid sales results, managed our margins and made significant improvements in cash generation. Our teams have done a fantastic job navigating the uncertainty of the past few years, and as we come into the back half of 2023, we remain confident about the future of the business.

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 reenter the queue to ask additional questions. I will now turn the call back over to the operator to begin the question-and-answer session.

Our first question comes from Phil Ng with Jefferies.

Appreciate the great investor deck. It's got some good insights on the asset deal. It looks like you're anticipating pretty strong growth with sales stepping up from $400 million to $525 million in 2026. Can you provide some color on the growth drivers? And Nick, I think you don't typically bake in much cross-selling in past deals, what's giving you the confidence on the cross-selling synergies you're calling out? I think it's about $65 million to $85 million. How do you see that kind of ramping up? And what are some of the big opportunities?

Phil, thanks for the question. Happy to elaborate a little bit. We've obviously seen a variety of deals and done a variety of deals over time. This one really sits at a wonderful crossroads of being fantastic brands backed by an excellent team; a great price paid through some really disciplined approach to the asset itself; but then thirdly, the third part of the intersection is really the opportunity to come and unlock growth by putting these things together in our portfolio. And we try to be really disciplined around value, but then also really disciplined around the other two items, which is looking for great brands and teams, but asking where we can add value with the Fortune Brands portfolio. And I'd say this is one of the more exceptional deals that we've seen. And so I'll give you a couple kind of key foundational pillars and then happy to elaborate if it's helpful. But one, I'd just start actually with the Emtek business. So Emtek and Schuab, leaders in the luxury hardware category, very design-led, a lot of colors and choices for designers, incredible supply chain and service, really a concierge approach and doing that at really, really fantastic margins. Not something that you see very often bringing all of those things together. And when we look at the House of Rohl platform, which you can see in the organic results here, continues to take share and outperform the market and is really resonating with consumers and designers. By putting those two things together over time, we'll now have a platform that's north of $0.5 billion, outgrowing the market and has global reach. The elements really work together, whether it be in the channel where we have overlap in types of distribution channels, but not necessarily overlapping all of our distribution, but then even things like being able to unlock collections for an entire route, do color matching, do design work together and really provide a solution where a designer or a consumer gets to put something together the way they want it, but in a way that works with our backing as a company. And so that's an example. And then I think you go over to the other side, Yale and August, really driving tech first and connected product first. And I think the August platform itself, as we're getting in there and learning more about it, we think is a very, very powerful platform. That is something that we can bring in the business, by the way, learn from what they've done and be really thoughtful about how we integrate it. But we see it as a huge unlock and potentially the transformational unlock in our connected products business generally, right? The ability to bring that many engineers, that skill set, that kind of agile and fast way of working into the investments we've already made, which we're really happy with, but we think it could be exponentially greater when you bring those two things together. And one of the things that we called out in the deck, for example, is smart entry, right? We're going to have one of the leading entry lock businesses and brands with some of the best, if not the best technology and you marry that with the leading fiberglass entry door brand, already a leader in its space, right, and think about all the innovation that went into that, and you actually make that thing work not as just a bolt-on to an existing system, but a total system solution for consumers. That's just an example of the kinds of things we're thinking about. And so the team has been getting after this one really enthusiastically. They have done a number of deals. I'm not sure I've ever seen a business team sort of jump on synergies the way this team's jumped on them and with a level of excitement and really kind of pushing it beyond our initial case, which we thought was pretty good to begin with.

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

Yes. Sure. I'll start, and then I'll hand it over to Dave, and he can give a bit more detail about it. But I'd say at the highest level, if you think about it, it's actually been fairly consistent thematically with what we saw in the second quarter. And so what did you see? Saw relative strength in both builder, I think relative to expectations, in their order books and what was being reported. Now obviously, in Q2 of '23, we're digesting the slowdown from last summer, right? And so the uptick is yet to come through the P&L. And then on the R&R side, I'd say relative strength in everything that was more project or pro related and relative weakness in things that were more kind of DIY or weekend warrior related. And so as you then look into July, I'd say thematically that continues to be true. And we're going to see more uptick around the large production builders. We're seeing their value chain and supply chain start to strengthen as people prepare for those orders to come through. We've seen continued strength in our pro-related channels where the projects continue to be strong. And it's more around the very discretionary DIY products that you continue to see some weakness. But as Dave alluded to in his remarks, even there, in the last few weeks, there are some encouraging signs of certain product groups where you're seeing at retail a little bit more life than we've seen in that DIY stuff.

Yes. So I'd add some color around just the second half sales cadence. And so our prior organic guidance was down 3% to 5%. I'd remind people that includes the extra nonrepeating fiscal week from last year, that for the second half is roughly 2 percentage points all in the fourth quarter or 4 percentage points overall. So that organic guidance then, call it, down 2 percentage points, excluding that comp. We're moving it at the midpoint of our current guidance now to flat in the second half of the year. And I think simply, you think about it, it's POS down low single digits, offset by a favorable inventory comp of low single digits. That gets you roughly to flat. And then the nonrepeating fiscal week is a 2 percentage point headwind, and that gets you to the midpoint of the guidance. So to Nick's point, as we, here at the end of July, we look at our POS data, we see it trending in the right direction to support this forecast. And then if you layer on top of that the single-family new construction improvement that will really start to benefit us in the fourth quarter, that gives us confidence to believe in our second half outlook.

Yes, a lot to ask about. Let's start with the acquisition. I think that you had indicated that there was going to be a little purchase accounting impact in the back half. Any reason why we should expect for that to continue into fiscal '24? And as you look across the sales synergies and cost synergies, do you think we could see some of the cost synergies by the end of the year start to trickle in? Just give us a little color on that, I guess, timing in 3Q, 4Q and maybe a look into 1Q?

Steve, this is Dave. I'll talk to that. On the synergies side, I think maybe some of the sales synergies trickle in by the end of the year. On the cost side because of their inventory positions, while the teams will be doing the work, we won't see that in our P&L until next year just given the balance sheet. And then to your question on purchase price amortization. So remember, these are trade names that are amortized over a long period of time. So it is roughly $0.08 in the back half of this year. It will be $0.16 full year next year impact. And then going forward beyond that, pretty consistent for the next 10 or so years until that trade name is fully amortized and off the balance sheet. So hopefully, that helps to answer your question.

Yes, absolutely.

So the mix impact on us? Yes. Benefit to you. You talked about the top line, but I'm wondering if there might be margin implications that would come from that. And if you could describe what those might be. Yes. I'll share some thoughts thematically, and Dave can provide additional details. Essentially, we strive to keep our portfolio indifferent to margins, whether regarding product pricing or channels. For instance, if we observe an increase in production builder business, it may yield a lower contribution margin, but servicing that business is less demanding due to their large size and standardization. In contrast, showroom business requires a significant sales force and may generate a higher contribution margin, yet it incurs larger selling, general, and administrative expenses. Ultimately, these factors balance out, affecting the profit and loss statements as necessary. I would emphasize that we remain largely indifferent to the various channels or the pricing spectrum from premium to ultra-luxury within our portfolio.

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

First, I just wanted to dial in a little bit on some of the puts and takes on the updated margin guidance for the year. I guess, on a segment level, you had Security nick down at the high end of the prior guidance. I just wanted to confirm that that's, I assume, largely just driven by the acquisition accounting? And if there are any other puts and takes into the back half outlook, particularly I'm thinking about to the extent that you have a little bit better top line outlook, organically at least. Were there any additional leverage that you were thinking of? And was that offset by anything else? And then I just had a follow-up.

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

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

I appreciate that. I want to revisit the slide in the presentation regarding the synergy opportunities on the top line, which is very detailed and clearly well thought out. Reflecting on the Fiberon acquisition, I believe you mentioned a 50% growth over three years, much of which was driven by significant enhancements in your distribution that allowed you to secure new customers and expand distribution for the Fiberon product. We're seeing substantial growth in both the Yale and August and Emtek and Schuab channels. My question is, while these numbers reflect strong synergies in sales, I might have expected slightly higher figures. Perhaps I am being too aggressive or maybe you are being conservative. I would like your perspective on that. Over a three-year timeframe, it appears there are numerous cross-selling opportunities, as indicated in the slide, and I'm curious if I might be overestimating the potential for even greater upside.

Yes. So well, firstly, thanks for calling out that Fiberon analogy because I think it's really good. And I think what's particularly interesting about that example that you called out is that is still ongoing. Like those gains at the higher margin part of that business and those distribution gains are still unfolding. Obviously, the market's been a little bit tougher this year, as we just track that conversion rate, so that bounces between 1% to 2%, you see it sort of move back up, you'll see those play through. And during that whole time, though, we're preparing that business to then build on, right, with brand and innovation. And so very dramatically I think. Somewhat what I'd say specific to August, Emtek and Schuab is firstly I'd just call out, we closed June 30. So we've only had the teams together for a short amount of time. And they've identified a series of synergies that we put here, particularly around channel. And what we'll do is we'll be very respectful of what these businesses do better than the legacy Fortune Brands Innovations business. And so they have channel strength in certain areas that is better, and we will look to learn from that and build it into the legacy business. And then conversely, there are, of course, places where the legacy business has a strength that these businesses don't, where we construct to expand through distribution and access in our channel, strengthen relationships. And so will there be more upside over time for that? Possibly. But I think the real big unlock comes from really sort of the 1 plus 1 equals 5 strategy, which is as you put these things together, can we unlock new innovation, new approach, whether it be on the luxury side, where we really are going to have a lot more scale to go after the business on a global business and on a global basis with that luxury consumer who cares about brand and cares about the artisanal stories behind it, or on the technology enabled side where just our connected business is going to be that much bigger and the infrastructure and backbone on which it now all sits is going to allow us to unlock innovation at a faster pace. And I think that's where the real upside may exist, but that's going to take us a little time to work through those innovation opportunities and bring them to market.

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

Yes. So it's Dave. I'd say looking at Water and Security, relatively balanced from an inventory perspective, relative to the rate of sales. But I'd say we're still a little bit light in Outdoors in the channel, primarily around wholesale decking at the end of the quarter. We do expect and really have started to see some of those orders that we expected to come through in July for decking. And so we're seeing that inventory fill back up. But I think if the market were to accelerate beyond our expectations in the second half, there would be some inventory upside opportunities as we would expect customers to put some inventory ahead of those sales. But where we sit right now, it's pretty well balanced, and we've kind of gotten through a lot of the prior year challenges from inventory builds and depletes that was really noisy on the sales line.

That's helpful. You mentioned Security and some specific initiatives the company is implementing to enhance results, in addition to the acquisitions that closed this quarter. Can you elaborate on these initiatives? How should we anticipate their impact on the business, particularly regarding revenue and margins over time?

Yes. A simple way to understand this is by looking back at the Water business and what occurred starting in 2015 and 2016, and the strategy applied there. The same strategy is now being used for Security. Both segments share similarities in brand impact, innovation potential, connected products, and even aspects of the supply chain. Therefore, much of that strategy can be easily transferred. We are focusing more on innovation which is showing strength in our commercial sector. We are establishing a leadership position in safety initiatives within facilities, which is crucial as we engage in consultative selling to enhance safety. This area is becoming increasingly important, and it plays to our strengths. We can leverage our brand and innovation here, and eventually, this will become more data-driven. This is just one example of how we can grow revenue. Additionally, the improvements we've made in the Water supply chain, whether in sourcing or operational efficiency, have provided resources that we reinvest to boost revenue. Some of this has improved margins, as you have seen over the years, but much of it has been reinvested in revenue growth. These capabilities reflect the advantages of Fortune Brands, as we can apply this strategy effectively. Over time, especially as we integrate these new assets, we expect not only to accelerate revenue but also to improve margins. We see this as a virtuous cycle, where enhancing margins allows for faster investment in the businesses, leading to even quicker revenue growth.

Yes. And, Susan, just to put some numbers behind that, because we are starting to see it come through the results. And so if you look at Security's performance versus the second quarter of 2019, sales are up 15% or roughly a 4% CAGR, and their operating margin is up 390 basis points. And so you see the output of what Nick described as really taking that playbook from Water, embedding it at Security and getting that flywheel going around growth, reinvestment and margin enhancement.

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

Yes, I can provide some insights, and Dave can add more details. While we typically don’t delve into specifics at that level, we have included some information in our presentation. Historically, this business has shown strong performance in the integrated channel, which we find quite intriguing. As products are connected to homes, advancements continue from one device at a time—this is where August excels—but there’s also a possibility of integration that utilizes a system with an integrator. The flexibility of the Yale infrastructure is particularly noteworthy, as it can accommodate various systems. This unique adaptability is a significant advantage for us, one that is not present in other areas of our business. We aim to build on this and potentially expand our offerings within the existing Master Lock and portable security segments, where we can provide connected solutions that are budget-friendly. Leveraging that infrastructure is key for us.

Yes. And Joe, I'd say interestingly, like our connected product business, this business has been chip constrained, and they actually prioritized these third-party integrators over other channels over the past few years. So the amount of sales flowing through e-commerce or even brick-and-mortar retail are lower than the demand would be for this type of products. As we get this business integrated back in stock, that will be another growth avenue for us going forward.

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

Yes, we said at the end of July, we were in high single digits versus prior year sellout?

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

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

In response to your question about pricing opportunities, I would like to highlight that one of Fortune Brands' strengths lies in our category management skills, particularly in the Water and Security sectors, which we are now applying to the Outdoors business. This investment allows us to better understand consumer behavior and professional buying patterns using data and analytics. We collaborate with our customers and wholesale partners to optimize pricing. We aim to avoid large price increases; while there were some adjustments since 2020, our approach focuses on smaller, incremental prices that align with market expectations and customer familiarity. For instance, even at the peak in Water, our price adjustments never exceeded mid-single digits. By maintaining this approach consistently, we create value throughout our entire value chain and successfully bring consumers along, which is evident in our ability to gain market share while implementing these strategies.

That's helpful. Nick, I wanted to get your thoughts on a comment you made, which isn't just relevant to your business. DIY seems to be a bit weaker compared to pro in this challenging economic environment. You would think it might be the other way around, with consumers looking to save money by doing things themselves. What do you think is behind this trend where the professional segment is performing better?

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

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