Fortune Brands Innovations, Inc. Q1 FY2024 Earnings Call

Good afternoon. My name is Marianne. I'll be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands First Quarter 2024 Earnings Conference Call. After the speakers' remarks, there will be a question-and-answer session. I would now 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 First Quarter Earnings Call. Hopefully, everyone has had a chance to review the earnings release. The earnings release and the audio replay of this call can be found on the Investors section of our fbin.com website. I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, except as may be required by law. Any references to operating profit or margin, earnings per share or free cash flow on today's call will focus on our results on a before charges and gains basis unless otherwise specified. Please visit our website for reconciliations. With me on the call today are Nick Fink, our Chief Executive Officer; and Dave Barry, our Chief Financial Officer. Following our prepared remarks, we have a lot of time to address some questions. I will now turn the call over to Nick. Nick?

Thank you, Leigh, and thank you to everyone for joining us today. On this call, I will walk through the highlights of our first quarter performance, give some color on the drivers of this performance, including progress on our strategic initiatives, and offer some thoughts on the macro environment. I will then turn the call over to Dave for a discussion of our financial results, including how we are thinking about the remainder of 2024. Our teams delivered strong first quarter results by executing on our priorities, including delivering above-market growth and operating margin improvements. We saw powerful proof points of our compelling investment thesis this past quarter and are increasingly seeing the benefit of the transformative actions we took over the past few years. These actions all support our strategy as a growth-focused company powered by secular tailwinds, underpinned by leading brands, innovation and channel management and fueled by our Fortune Brands Advantage capabilities in our newly aligned structure. Turning to our first quarter performance. Our teams delivered strong top and bottom line results, driving both sales and margins as they executed on our priorities. Through our strategy of growing the core and accelerating digital products, we were able to focus on those opportunities with the highest potential for returns, including in our leading brands, digital and connected capabilities and products and our meaningful innovation while also optimizing and aligning our operations. Looking forward to the remainder of the year, we continue to expect to achieve the full-year guidance we initially outlined during our fourth quarter call. Net sales of $1.1 billion were up 7%, while organic sales were down 3% versus the prior year's first quarter. We estimate that our POS performance outperformed the larger market for our products by over 100 basis points, reflecting our commitment to focus on the highest growth opportunities. Operating income increased 22%, and our operating margin was 200 basis points higher than the first quarter of 2023. Our results are a great testament to the ability of our newly aligned organization to unlock value. Our sales and margin performance generated earnings per share of $0.83 in the first quarter, a 20% increase over the first quarter of 2023. As we have previously highlighted, the Fortune Brands operating model is designed to accelerate our leadership in brand and innovation while also creating value for our channel partners. We are now designed to operate more efficiently and are focused on investing those efficiencies and opportunities with the highest potential for returns. Most importantly, our new structure is a catalyst for accelerated growth. This past quarter, we had some compelling proof points of the power of our new structure as we further sharpened our focus on brands, innovation, and channel leadership. We saw a particular acceleration in our Smart Water Network and are achieving many of our milestones well ahead of schedule. In pursuit of our whole home water management strategy, we announced our acquisition of SpringWell, which provides residential whole home water filtration and water softening solutions via direct-to-consumer channels. The addition of SpringWell paves the way for Fortune Brands to invest and capture opportunities in the approximately $4 billion U.S. residential water filtration and water quality market. We expect this acquisition to increase Fortune Brands' exposure to recurring revenue streams. SpringWell, with digital and direct marketing expertise, augments Fortune Brands' existing digital capabilities. It is proving to be highly synergistic with our Flo leak detection system with a double-digit attachment rate since Flo has been available on the SpringWell site. Consistent with our M&A priorities, the strategic discipline deal will not only augment our product portfolio but has the potential to accelerate our capabilities as we look to integrate their expertise across our businesses. Our brands and products are increasingly being recognized for their innovation, aesthetics, and ability to make the world a better place. In March, Moen was named Fast Company's 2024 list of Most Innovative Companies. This impressive honor recognizes our leadership as a pioneer in whole home water management, including our leading smart water network. Within our security business, our connected residential locks continue to receive critical acclaim, with our recent Yale Assure Lock 2 Touch being named by Forbes Magazine as the best fingerprint in key code smart lock. The innovative features of this exciting product are clearly resonating. Finally, our Fiberon Wildwood composite cladding was recognized by Green Builder Media as a sustainable product of the year. Whether it's saving water, protecting people or incorporating recycled inputs, our brands are highlighting how our company can have success and benefit people, communities, and the planet. Our brands and teams are working together to delight consumers with our innovative and beautiful products, and our increasingly cohesive and integrated portfolio was on display at the recent industry shows in Las Vegas in February. Our House of Rohl Booth displayed our comprehensive suite of luxury fixtures and provided clear intangible evidence of how seamlessly our existing House of Rohl brands integrate with our newly acquired Emtek and Schaub brands. Our message of curated luxury clearly resonated and House of Rohl was awarded the Best Booth Large Booth of KBIS. And for the first time, Therma-Tru, LARSON, Fiberon, Fypon, and Solar Innovations were all on display together in a cohesive booth that showcased our material science expertise and product innovations working together. Turning to our digital portfolio. We saw over 200,000 device activations in the first quarter, and the overall digital business continues to accelerate. Our connected water business was particularly strong. In the first quarter alone, we added 15,000 users of Flo, and our POS performance exceeded our expectations. And in the quarter, our retail and e-commerce POS performance for Flo grew by 85% versus the first quarter of 2023. As you may recall, last fall, we formed a new connected products group by combining the original Fortune Brands team with the Yale and August team into a single powerhouse organization under aligned leadership. This group of about 200 engineers is performing very well and delivering milestones ahead of schedule as we leverage our combined insights and talent across the entire portfolio with increasing speed and efficiency. Our results this quarter and some of the exciting developments we are seeing give me full confidence in Fortune Brands Innovations' ability to deliver long-term growth and sustained value creation through the cycle, and we remain committed to achieving our long-term goals. Turning now to some additional thoughts on the current housing market and the market for our products. Looking at the overall market and consistent with what we anticipated in our fourth quarter call, we saw continued softness in the R&R market, while we also saw encouraging POS growth in our products, which serve the single-family new construction channel, including Moen and Therma-Tru. The need and desire for homes remain incredibly strong, and our products are optimally positioned in the context of the larger macro environment. Earlier this quarter, and with a more stable interest rate environment, we saw an uptick of buyers in the market, although activity slowed as interest rates increased in the face of persistent inflation. As the progress of the quarter demonstrated, consumers remain sensitive to rate fluctuations, but the need for interest in housing remains strong. The U.S. continues to be massively underbuilt. Housing prices and home equity levels continue to remain high. Demographic factors and high personal income levels continue to support housing demand, while housing stock remains extremely constrained. At the same time, the stock of existing homes that are currently available for sale remains far below pre-pandemic norms, and home values increased faster in March of 2024 versus March of 2023. Turning to new construction, single-family new construction permit activity in starts was strong in the first quarter of 2024, where completions continue to lag. Over the last few months, mortgage applications increased in response to stabilized mortgage rates and the expectation of interest rate cuts. While it appears interest rates will remain higher for slightly longer, the market continues to remain massively underbuilt and pent-up demand is only being exacerbated. In addition, large production builders remain optimally positioned to continue to be able to address the need for housing. And we are a trusted partner to a very significant number of these large home builders. Importantly, because our products are incorporated closer to completion than starts, our products are experiencing the tailwinds from the uptick in housing that began in the second half of 2023, and we expect this tailwind to remain robust. Turning to R&R. We expect the R&R market to remain dynamic throughout 2024, and there are many variables that are impacting the repair and remodel space, including consumer savings and confidence, employment levels, home equity levels, and existing home turnover. We continue to expect R&R market for our products to be down 2% to 4% in 2024. However, the combination of high home equity levels, the low supply of homes and aging housing stock, and the fact that many homeowners are living in homes that they purchased with no mortgage or with low interest rates is causing many people to rethink their existing space. Google Search shows that search terms around home renovations are up versus a year ago. While a recent third-party study of homeowners indicated 82% of respondents were planning on engaging in home renovations in the next 6 months. The same survey indicated that the most compelling attributes of products are product quality, trusted brands, and attractive features. Our portfolio is optimally positioned with our leading brands, innovative features, and beautifully designed products, all resonating with the needs of our core customers. Finally, in China, the market continues to transition away from speculative new construction to R&R, and we have confidence in our team's ability to successfully navigate the disruption and remain focused on creating long-term value in China, including in the emerging and high-potential R&R space. We continue to believe that our China business will serve as an innovation engine for the larger business and that it offers attractive optionality for future opportunities. Fortune Brands is very well positioned. Our branding power, meaningful and value-added innovation, and channel strength are powerful catalysts for accelerated growth in the most attractive categories. We are focused on driving outperformance in categories driven by secular growth tailwinds, our connected products, material conversion, luxury, and products with sustainability and safety benefits. Our consumers continue to reward us with growing market share, and our customers continue to view us as valued partners with unique insights, category management expertise, and best-in-class supply chain performance. We believe our products and brands are uniquely positioned to outperform, as our results demonstrated this past quarter. Turning now to our individual business results. Starting with Water Innovations, this segment delivered 5% sales growth versus the prior year, with organic sales down 7% while generating 100 basis points of operating margin improvement. Sales in the U.S. largely rebounded following the inclement weather to start the year, and our Moen POS was around 100 basis points higher than our market estimate. We are also seeing single-family new construction volume coming through. The Emtek brand continues to perform extremely well, and our reputation for delivering market-leading products is being rewarded with continued share gains, including low single-digit positive POS versus a market we estimate was down mid-single digits. Finally, our work toward integrating our brands into one comprehensive and complementary luxury portfolio is progressing very well, including our work to update existing showrooms with our combined suite of luxury products and integrating our Emtek products into our luxury outdoor offerings. As I mentioned earlier, our Flo connected leak detection product continues to gain traction with insurance companies, municipalities, and consumers. We recently launched a new Flo site on our Moen website and deployed an exciting branding campaign designed to raise awareness of how our products can help solve the critical issue of residential water leaks. According to the Environmental Protection Agency, the average American family is wasting 9,400 gallons of water annually from preventable household leaks. And the resulting damage costs U.S. insurers and homeowners many billions of dollars every year. At a time in which insurance costs are rising and water scarcity is becoming even more serious, the need for a product like our Flo Smart Water Monitor and Shutoff is becoming more acute. In addition to the billions of dollars, we believe our products can save insurance companies and homeowners every year. We're working to help homeowners, builders, and municipalities achieve their water-saving and carbon reduction goals. Our innovative connected sprinkler system recently achieved EPA WaterSense certification, which significantly expands the number of rebates available to consumers across the country. Additionally, we are finalizing our partnership that we expect will greatly facilitate the number and availability of rebates for our smart water products for residents of municipalities across California, which should help further drive adoption of our products. We expect this program will officially launch this summer, and we are excited for how it can help raise awareness and adoption of home smart leak detection solutions in a location where it is greatly needed. Looking to the remainder of 2024, we expect our Water segment to continue to execute on our commitment to deliver above-market sales performance by focusing on those parts of the market with the greatest potential for growth. We plan to continue to make thoughtful investments in our key priorities, including branding and marketing, digital and capacity. We expect our pricing actions to hold up as we continue to innovate as the benefits of our products resonate with our customers and consumers, and the promotional environment remains stable. We are on track to open 2 new facilities in the second quarter of 2024, including a new highly efficient West Coast distribution center for Moen and a state-of-the-art U.K. production facility for the House of Rohl. These targeted investments will help drive our strategy to grow the core and accelerate digital and connected products. We continue to be very excited about our water business, particularly the opportunities we see to capture growth in connected luxury and water filtration. Turning to Outdoors. We had a strong first quarter with an impressive 9% sales growth and operating margins that increased 680 basis points versus last year. Our performance is a direct result of the hard and strategic work of the team, and I thank them for their dedication. We are laser-focused on leveraging our expertise and investing behind our core categories and in those products which we expect will offer the most attractive growth opportunities. Outdoor brands delivered low double-digit sales growth as tailwinds from new construction and recent product launches drove growth. Therma-Tru is seeing the benefit of the increase in starts and completions, which began last year. As we previewed this past quarter at the International Builder Show, Larson is introducing some innovative and on-trend new products at key price points. Additionally, we will continue to roll out synergistic product offerings between Outdoor brands and our larger portfolio, including Emtek hardware in the Yale and August connected locks, which we expect will drive incremental future growth. Once again, our Fiberon business is a great proof point of the power of our strong channel relationships. We saw over 20% growth for Fiberon in the profitable wholesale channel. And our POS data indicates that our Fiberon wholesale sell-through significantly outpaced the market. Finally, our Security segment grew sales 9% in the quarter but it was down high single digits on an organic basis, primarily due to destocking activities at select customers ahead of general consumer weakness. However, this segment also saw 170 basis points of operating margin improvement, inclusive of the investments in Yale and August smart lock residential brands as the work we did around continuous improvement and optimizing our footprint continues to pay off. We expect our Security segment will continue to benefit from the transformational work that we have done over the past 2 years. We've evolved our legacy brands from mechanical-only products into innovative and growth-oriented businesses with a much more strategic portfolio. We will reinvest the efficiencies gained from our recent optimization of the business to take advantage of strong secular trends like connected products and safety. The Yale and August brands have proven to be a strong fit. In addition to being great assets, the Yale and August team is excellent, and their capabilities have made significant contributions to our connected group across the product portfolio. To recap, in the first quarter, we executed our priorities of focusing on the core and accelerating digital products and delivered above-market performance. For the remainder of 2024, we will continue this focus of driving above-market growth by pursuing incremental growth opportunities and by building on the foundational work established by our transformation into a brand, innovation and channel leader. We will proactively manage any dynamic periods while actively positioning Fortune Brands Innovations for the future. We continue to have full confidence in our ability to meet the targets we outlined in our full-year guidance on our fourth quarter call. 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 first quarter results. As Nick highlighted, our teams executed our priorities amid a dynamic macro environment. As I will detail in my section, our financial results have some very compelling examples of how the transformative actions we undertook over the past 1.5 years are generating tangible returns. In the first quarter, sales were $1.1 billion, up 7% and down 3% excluding acquisitions. Consolidated operating income was $167 million, up 22%. Total company operating margin improved 200 basis points to 15.1% and earnings per share were $0.83, a 20% increase versus last year. Our first quarter performance was driven by higher-than-expected sales in our Outdoor and Water segments and resulting margin flow-through. As Nick mentioned, we remain focused on driving outperformance including above-market growth, enhancing margins, and generating cash. Our teams continue to focus on managing our P&L and balance sheet while maintaining key strategic growth investments. Now let me provide more color on our segment results. Beginning with Water Innovations, sales were $625 million, up $31 million or 5% and down 7%, excluding the impact of acquisitions. Our organic results reflect POS down mid-single digits and channel inventory reductions at select customers. China sales declined mid-single digits and were up low single digits, excluding the impact of FX. As Nick indicated, the Chinese consumer remains cautious in the housing space and our team continues to manage the dynamic environment well while finding pockets of growth in the emerging channels and in product category expansion. Water Innovations operating income was $141.5 million, an increase of 10%. Operating margin was 22.6%, an increase of 100 basis points, reflecting the impact of higher volumes. Turning to Outdoors. Outdoors had a strong first quarter. Sales were $315 million, up 9%, driven by strength in Doors and Fiberon wholesale. Door sales increased low double digits. Sales were supported by higher volumes at Therma-Tru, driven by the increase in single-family new construction. Decking sales were roughly flat, driven by strength in wholesale and partially offset by anticipated declines in retail. Our results this quarter reflect our ongoing strategic approach of focusing on those core categories in which we expect to have the best opportunities to achieve long-term above-market growth and profitability. Outdoor segment operating income was $37.9 million, up 150%. Segment operating margin more than doubled to 12%, a 680 basis point improvement. Segment operating income increases were driven by favorable volume leverage in our businesses and productivity and profitability improvements. We believe this segment is on the right track as we focus on those parts of the market that will drive the greatest potential returns and growth and where we have the right to win. In Security, our first quarter sales increased 9%. Organic sales decreased 8%, reflecting soft POS and select channel destocking ahead of soft consumer activity. We continue to see momentum in the categories we have identified as having higher growth potential such as Master Lock commercial and our connected security products. Segment operating income was $27 million, up 22%, and segment operating margin was 15.7%, an increase of 170 basis points versus prior year and was driven by continuous improvement initiatives. As we have discussed previously, we think our Security segment is a great example of the power of our Fortune Brands Advantage capabilities, and we expect great things from this business. Turning to the balance sheet. Our balance sheet remains solid with cash of $360 million, net debt of $2.7 billion and our net debt-to-EBITDA leverage is 2.9x. We remain on track to achieve our target net leverage ratio of 2.25x by year-end. We have $875 million available on our revolver. In the first quarter, we returned $130 million to shareholders via a combination of share repurchases and dividends, including $100 million of share repurchases. Year-to-date, we have repurchased $125 million of shares. Our first quarter free cash flow was negative $136 million, reflecting the typical seasonality of our business and in line with our expectations. To summarize the quarter, we delivered strong sales and margin results and are on the path of delivering on our full-year commitments to grow sales above market, expand our margins, and generate cash. While our first quarter results were certainly encouraging and speak to the strength of our business, we are aware of the dynamic macro environment. For the second quarter, we expect net sales growth of around 10%, with operating margins between 16.5% and 17%. Operating margins will be impacted by inefficiencies related to the startup of our two new water facilities, which we expect will provide long-term capacity for market-beating growth and cost savings for the business. Looking forward to the second half of the year, we continue to expect sales growth of between 2% and 3% and operating margins of around 18%. As a reminder, we closed on our Yale, August, and Emtek acquisition in June of last year, and the performance of those brands will be included in our second half organic results. Finally, we remain confident in our ability to hit our previously communicated full-year 2024 guidance, including full-year net sales up 3.5% to 5.5% with organic net sales down 1% to up 1%, and operating margins between 16.5% and 17.5%, the midpoint of which includes 100 basis points of operating margin improvement. We continue to expect EPS of $4.20 to $4.40, the midpoint of which represents 10% earnings per share growth. Our teams are off to a great start against our full-year targets and will remain focused on the execution of our key priorities. I will now pass the call back to Leigh to open the call for questions.

Thanks, Dave. That concludes our prepared remarks. We will now begin taking a limited number of questions. Since there are a number of you who would like to ask a question, I will ask that you limit your initial questions to two and then re-enter the queue to ask additional questions. I will now turn the call back over to the operator to begin the question-and-answer session. Operator, can you open the line for questions? Thank you.

Nick, maybe I'll start high-level sort of where you started. And just looking for any update on the progress of the various Fortune initiatives to align the company more as one company, whether it's connected products, integrated supply chain efforts, the transformation office. I mean where are the biggest opportunities for improvement this year?

John, that's a good question. We're just over a year into our realignment, which began in September 2022. Redesigning our operating model is a significant challenge, and we needed a full operational cycle, which was 2023, to navigate that change. Now we seem to be finding our rhythm. I'm looking for proof points that demonstrate our progress, which we may not have achieved without this alignment. One clear example is the increasing cohesiveness of our portfolio. People at industry shows like KBIS and IBS have noted the impressive display of Emtek and House of Rohl working together, showcasing our ability to roll out products quickly in the market. In the outdoor area, we’re not just displaying products together; we're integrating innovations across various brands, particularly with Emtek. This alignment is helping us derive more value compared to when our operations were more siloed. Another key aspect is our operational leverage. We now have a unified team supporting the entire business, which has shown in the caliber of work they're producing and the speed at which they're achieving results. A recent example is the complete reformatting of our security manufacturing footprint, executed with a level of professionalism that inspired everyone involved, while also driving positive results in security. Our team is now optimizing supplier spend and resilience faster than ever before, increasing capacity at Fiberon beyond our expectations and opening two major water facilities this quarter alone. I wonder if we could have accomplished this in such a short time before this alignment. Lastly, I want to highlight our digital and connected journey, which has become another area of enthusiasm for us. We now have a single unified group of more than 200 engineers, enabling us to operate much like a seasoned digital business. They set milestones for the Flo and smart water network this year and completed them a quarter early. I’m confident we wouldn’t have achieved this without the integrated team and their collective knowledge. These examples illustrate the speed of progress and a clear vision across the business. While we always had ambition, it was challenging to realize it in our previous structure.

Got it. That's really helpful. And then maybe turning just to Outdoors. Revenue was up 9% in the first quarter versus your full year outlook of plus 1% to 3%. Was there some timing benefit here because the remainder of the year implies more modest growth on a year-over-year basis? And then along the same lines within decking, it sounds like retail may have been down meaningfully to offset that 20% increase in wholesale. So can you provide any color on what's going on there?

Yes, I'll give you some perspectives and Dave can round it out on the rest of the year. I mean, obviously, I'm super excited about the Outdoor for the quarter. I think you may have really seen that business coming into its own, and getting much more aligned under its leadership. Great performance out of the doors business. They did some work to align it. And of course, you're seeing new construction finally start to come through as we sort of move towards the end of the year and starting into this year as that ticks back up. So some really good stuff there. On Fiberon, you're absolutely right. I mean, we made some strategic calls to really focus that on the most profitable part of the market, where we can hopefully generate the types of margins we'd like to see in order to be able to fuel future growth and future innovation. I mean, that's really how we think about the margin journey and the whole company is this, that's a real purpose. And so we're seeing really the growth continue to come through the wholesale channel and seeding some in the retail channel. And then very interestingly for us as we start to see some of the work that we've been at Larson for the last couple of years, hit the marketplace. And so Larson kind of go through a total refresh with some of the ideas that we had coming into that acquisition, but with the pandemic and some of the changes we had to make and some of the less profitable business that we walked away from, just took a while to align that organization and now starting to see some really positive POS coming there. So I'd say in whole, really good quarter coming in ahead of where we thought and gives us some good confidence for not just the rest of the year but where we take this business from here.

And John, I'd add with the Outdoor segment, we saw POS up mid-single digits, which was mostly volume driven in the quarter. And then as a reminder, we had a low single-digit benefit from a prior year inventory reduction primarily in Therma-Tru that took place last quarter. So that drove the 9% sales. Going forward, we do think a better quarter than we expected. It gives us confidence in the full year guide. It helped us derisk some of the second-half sales expectations. I think that's true across the business when you look at our first-quarter results. And then with Outdoors specifically, as the volume returns, and we weren't drawing down inventory, you saw significant margin improvement driven by volume and by productivity, and we expect that to continue through the year, a really good start for that business out of the gate.

After a slower start, it looks like your business certainly picked up. Can you provide any insights on how things are looking in early April? We have noticed that some of your customers are still reducing their inventory in the security and water sectors. Which channel is this affecting? Have you seen a slowdown in this trend and possibly a return to restocking?

Yes. As we mentioned in the last call, the year began somewhat slowly, but definitely picked up. It has been a bit uneven towards the end of the quarter, primarily due to increased noise around interest rates. However, we are still observing resilience in areas we highlighted, such as wholesale channels, single-family new construction, and specific regions like Larson. Looking ahead, we will see how things progress as we enter the season. There is considerable consumer interest, as noted in the prepared remarks, with search activity remaining higher compared to last year. Surveys indicate that consumers are planning projects, so we need to manage this situation carefully. Regarding the destocking issue you mentioned, it is particularly noticeable in e-commerce, more than in other areas, as well as in some wholesale segments. This trend isn't confined to a single area; it appears that some customers are holding back on inventory in anticipation of potential consumer weakness. Consequently, these channels currently have low inventory levels.

And then Phil, on your POS trend question. I'll provide some color sequentially. So first quarter POS finished dollar for dollar almost exactly in line with the fourth quarter. Typically, I think we'd see a first quarter that's a little bit softer than the fourth. But we were dollar for dollar almost equal, Q4 '23 to Q1 '24. And as we've moved through April, we've seen our retail and e-commerce POS ramp seasonally as we would expect moving from the first quarter to the second quarter, though still negative over year, that the channel serving single-family new construction continue to show growth, and we've seen nice input trends to start the quarter in those businesses, in those channels.

That's helpful. Could you provide more insight into the margin profile of your Water Innovation business, especially in the second quarter and the latter half of the year, considering the startup costs from new facilities as you ramp up? Additionally, how should we evaluate the margin profile for connected products, water filtration, and Flo in comparison to your core Moen business?

Yes. On the connected side, really strong contribution margins, a little bit ahead of the core, it's still in an investment phase. So we're managing those investments coming through. But product margins are good. And then on the margin side, overall, for the segment, we still feel confident in tracking to that 24% to 24.5% full-year margin target. And actually, we're a little bit ahead of our internal expectations in Q1. I think you'll see sequential improvement Q1 to Q2 and then continued sequential improvement as we move through the back half of the year. We're ramping up new facilities and getting the savings there and as we have some continued price/cost favorability through the P&L.

Could you give some more color on the upcoming smart water partnership in California? It sounds pretty interesting. Just anything else you could add?

Sure, we have several initiatives underway that we are really excited about. We are ahead on some internal milestones, and we are also developing various external partnerships that we believe can greatly enhance our business. These partnerships aim to improve the purchasing experience, increase awareness, and simplify the installation process. Awareness remains crucial in a relatively new category like ours, and we are launching an advertising campaign focused on informing consumers about the likelihood of experiencing events related to our products in their homes. These are significant initiatives and partnerships. I have always believed that it's not a matter of if, but when this category gains traction. Currently, we are witnessing a buildup of momentum and initiatives that we expect will elevate both our brand and the category itself in front of consumers. Additionally, I want to highlight an unexpected 85% increase in point of sale transactions in retail and e-commerce this quarter. This surge has prompted us to bring in more inventory to better support our customers. We anticipate that our internal efforts, enhanced marketing activities, and partnerships with entities like municipalities and insurers will significantly amplify our marketplace presence. We are very enthusiastic about these developments.

Great. And then, Dave, maybe for you, just on input costs for the year, how you think about that and maybe generally price costs as we move through the year?

Yes. We still anticipate being net price positive for the entire year, with no changes in our businesses. Most of our businesses implemented gross price increases in the first quarter successfully. On the cost side, we expect net deflation of about 1% in cost of goods sold. Our base input costs, particularly for base metals, have risen in the second quarter. However, our supply chain structure means we won't see that impact in our profit and loss statement until very late this year or more likely in the first quarter of 2025, as any changes in base metals affect our pricing in the subsequent quarter. This situation gives our team insight into future developments, allowing them to proactively manage pricing and cost strategies. I feel confident about our price and cost estimates for the year that we discussed during the last call.

You mentioned that there was a slight slowdown at the end of the quarter. It seems that in April, there were some signs of improvement in e-commerce and retail point of sale. I don't want to misinterpret your words, but would you say that these conditions were better than what you experienced at the close of the quarter? Additionally, would it be accurate to interpret the strong performance in the first quarter and the decision not to raise the guidance for the year as a sign of caution based on the challenges observed at the end of the quarter?

Yes, I think that's absolutely right. It's still uncertain out there, and we want to observe how it develops. I don't want to become too enthusiastic about the recent improvements, as things are still somewhat inconsistent with consumers. We want to see how it unfolds. Overall, we are pleased with the quarter compared to our expectations, but I believe we need to progress significantly beyond our current position. It will take a few more weeks into spring and summer before we can accurately assess the year.

Yes. Regarding POS, I see it showing a week-over-week improvement, which aligns with the seasonal expectations. However, looking year-over-year, the retail and e-commerce sectors are still experiencing negative trends, but for us, it provides valuable insight into R&R. On the other hand, single-family new construction is still in a growth phase, which should support a healthy number of starts. In the first quarter, single-family starts remained robust, even though completions were down by 6%. As our products approach completion, the negative completion rate will give us clearer visibility into sustained volume throughout the year as builders respond to the increase in starts. Regarding facilities, I would estimate a margin headwind of 25 to 50 basis points this quarter due to ramp-up and production inefficiencies compared to a normal rate. On the topic of China, as we shift away from speculative new construction, which has significantly influenced sales towards repairs and remodeling, we are observing Chinese consumers engaging with different categories. A new home decoration segment has surfaced in the last three years, and our team is gaining a good market share in that area. We are also focusing on enhancing our e-commerce and showroom efforts to capture repair and remodeling opportunities as the market evolves. There is a noticeable transition taking place, although the impact of new construction has been more pronounced than the shift towards repairs and remodeling at this time.

Yes. Interestingly, for much of last year, we actually observed growth in several of the R&R channels that Dave mentioned. Consumers are starting to come in, but we need to see more new construction before we fully recognize that growth. This market is naturally transitioning, with many established players. Additionally, our exposure is primarily to Tier 1 and Tier 2 cities, which account for our highest market share and where most R&R demand is expected to develop. We appreciate the options available in the market. The team has done well managing profitability while we navigate these changes. We value the opportunities this provides for R&R exposure and the innovation it fosters, as our team is highly innovative and is developing new areas for growth.

I'll ask on security. It sounded like it was a little softer in Q1 there, maybe a little bit of destocking as well. It looks like you held the full year guide unchanged. So just any additional elaboration on sort of what happened in Q1 and then the confidence in some improvement to kind of achieve that full year guide?

Sure. On the Master Lock and SentrySafe side of the portfolio, we had a very strong performance last year. However, we noticed a slowdown in consumer demand towards the end of the year, which continued into the first quarter. Interestingly, about 50% of the decline in Q1 can be attributed to destocking. This adjustment brings the point of sale figures closer to mid-single digits. We are putting a lot of effort into transforming this business into a growth-oriented one by focusing on promising areas such as commercial, which now represents a third of our business and is experiencing notable growth. We are also integrating connected technologies with the Yale and August brands, where we see significant growth potential. Additionally, we are refreshing our offerings in both safes and padlocks, which will start appearing on shelves throughout the year. We've dedicated substantial effort over the past few years to reengineer this business, and we are beginning to see it shift towards a much healthier margin profile. This gives us the confidence to invest and continue supporting the direction of the business, and we remain very optimistic about its future.

Secondly, just looking at the balance sheet, it looks like inventory dollars stepped up a bit, presumably the acquisition played into that. But maybe just kind of refresh us on how you're thinking about inventory going forward? Does there need to be any sort of rightsizing of production from here? Or is that really just the acquisition? Any additional color there?

Matt, I'd say a few things. The acquisition is a piece of it, but also say we're back more to a normal seasonal first quarter where we're building inventory for a couple of reasons: one, to mitigate Chinese New Year supply chain impacts and two, in advance of spring and summer seasons. And so we still expect to deliver free cash flow conversion of around 100% for the year and have positive free cash flow quarters Q2 to Q4, which is consistent with this business. So I don't think there's anything unusual in the results. I think actually last year, first quarter was more unusual as we're pulling inventory down at such a rapid rate. We had positive free cash flow in the first quarter of '23. So I think it's back to normal results. And the team continues to work to optimize inventory, and we'll do so throughout the year more driven by systems enhancements and process enhancements and then the final driver is we brought in a bit of extra inventory to buffer our supply chain against the Suez Canal and Panama Canal disruptions that have taken place. We're probably holding on to that maybe a bit longer than we expected through the year, just given those continued disruptions.

And the other thing I'd add to that is, going back to the first question about the aligned organization. Which simply excites me and you saw a lot of this last year, and I think we'll continue to see this year is there's not kind of one budgeting operations team really owning not just inventory, but thinking about the total balance sheet from a shareholder perspective and working to pull every lever on it. And so they're having conversations with some of our suppliers. We're going to have to put extra inventory on the water to support all of our businesses, what are the impacts of total working capital, how do we think about that? And just having that shareholder lens inside the business, sort of working all the time is part of what's going to drive total working capital improvement beyond just inventory. And I think the big drivers last year, and I think you'll continue to see that improvement in this year.

Thank you. Good afternoon, everyone. My first question is on the acquisition you did of the water filtration operations there, which is an interesting addition to your whole smart water network that you're building out there. Can you talk a bit about that opportunity, how it fits into this where it can go over time, the potential there? And maybe just how to think about the M&A pipeline more broadly and what you're seeing as well?

Sure. I'll start with SpringWell. We've been exploring this area for a while and are careful about finding a high-quality entry point into the business. The market is substantial, currently valued at $4 billion in the U.S. and is on the rise, with increasing concerns about water quality. There will be technological advancements allowing for better monitoring of water quality in and out of systems, making this an exciting entry point. Moreover, SpringWell is a digital native business, having launched in a digital landscape. The team is focused on learning from our expertise while selectively integrating the best practices from our other operations. Their ability to engage with consumers digitally and efficiently execute sales is highly appealing to us, and we aim to incorporate that capability throughout our business. Additionally, there’s a strategic alignment with our smart water network and filtration systems, as both address the same entry point into water management. This creates a logical opportunity for cross-selling, and we’ve seen good results in terms of attachment rates. We are excited about continuing to enhance our presence in the water quality sector smartly, which we believe will be a critical element of the overall smart water network. Regarding M&A, our pipeline remains strong, and we will continue to approach it with discipline. As we develop these capabilities, we plan to be more selective, focusing on opportunities that align with the growing trends in water quality. This sector is likely growing at a double-digit rate, and we aim to maximize value from these investments. Looking ahead, I’m optimistic about the opportunities in the pipeline, which should generate substantial cash flow. We will be thoughtful about how to deploy it for the benefit of our shareholders, with many interesting opportunities to further our business.

Okay. All right. That's encouraging. And then maybe turning a bit to the consumer. You talked a fair amount about new versus R&R activity in the quarter. But anything that you would highlight in terms of consumer behavior or any changes you're seeing in the business across the various price points, luxury versus some of the other offerings that you have? Just anything of note there? And I guess, anything that's changed in the last couple of weeks as well with that.

I don't think much has changed. Reflecting on the trends we discussed in the last call, the consumer has remained somewhat inconsistent. The luxury segment has performed better, likely seeing growth in the mid-single digits at the point of sale. Recently, luxury spending is still nearly double what we're seeing in the core water business. Consumer interest is still present, and we are actively working to ensure we're aligned with where the consumer is headed, as we're making strategic investments in that area. We're continuing to shift towards online sales and are focused on enhancing our online capabilities, which includes not just pricing but managing our entire online presence. I believe SpringWell will support this strategy effectively. Beyond that, not much is new; Dave shared some insights on the sales we’re experiencing through retail and e-commerce. We want to observe how this develops. I think that as interest rates stabilize, it may influence consumer sentiment. While this fluctuation hasn’t greatly affected our product, a shift in confidence could lead to more consumers undertaking the projects they're discussing with us.

I agree with everything Nick mentioned regarding the consumer's involvement with us in housing. One change we've noticed is in security, which likely reflects broader consumer trends. This part of our portfolio is more sensitive to consumer behavior. We observed that the point-of-sale trends were weaker for core consumer products and for some non-core items like TSA locks and bike locks, which were purchased in previous quarters but are not continuing to see the same sales now. This could indicate how the overall consumer sentiment is shifting. While we are monitoring this trend, I believe what Nick said about the consumer suggests that there hasn’t been significant change in those trends.

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