Earnings Call Transcript - FBIN Q3 2025

Operator, Operator

Good afternoon, everyone. My name is Stacy, and I will be your conference operator today. Welcome to the Fortune Brands Third Quarter 2025 Earnings Conference Call. At this time, I'll turn the call over to Curt Worthington, VP of Finance and Investor Relations. Curt, please go ahead.

Curt Worthington, VP of Finance and Investor Relations

Good afternoon, everyone, and welcome to the Fortune Brands Innovations Third 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 required by law. Any references to operating profit or margin, earnings per share or free cash flow on today's call will focus on our results on a before charges and gains basis unless otherwise specified. Please visit our website for our reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. With me on the call today are Nick Fink, our Chief Executive Officer; and Jon Baksht, 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.

Nicholas Fink, CEO

Thanks, Curt, and good afternoon to everyone. Thank you for joining our call. In the third quarter, Fortune Brands Innovations had solid sales performance and outperformed our end market, demonstrating the power of our brands and our people. Our sales in the third quarter were roughly flat versus the same quarter of 2024. And when excluding China, increased 1%. From a point-of-sale perspective, excluding China, we estimate that we outperformed the market by almost 200 basis points, with a low single-digit point-of-sale growth. While consumer sentiment and housing activity are still facing near-term pressures, our team is focused on execution and advanced several key strategic initiatives. Our balance sheet remains very healthy as we continue to generate strong free cash flow and continue investing behind our core growth initiatives. We remain focused on our strategies while leveraging our Fortune Brands advantage capabilities to continue to position the company for sustained above-market growth. We believe we are well positioned to continue outperforming our end market for the remainder of 2025 and into 2026. On today's call, I will start by sharing an update on our transformation and provide some examples of how it is advancing our strategy and delivering results. Next, I will provide a perspective on the macroeconomic environment and why I believe our portfolio balances stability with exceptional growth opportunities. I will then close with an overview of our performance before turning the call over to Jon for a detailed discussion of our financial results, updates to our guidance for the remainder of 2025 and some thoughts on our emerging expectations for 2026. The third quarter marked a major milestone in our company's evolution. We welcomed more than 500 associates into our new campus headquarters in the Chicago land area and achieved our hiring commitments 2 years earlier than planned. The quality of our new hires has been exceptional. They have joined numerous top-performing associates from within the organization who are either local or elected to relocate, creating a powerhouse team. This combination provides an optimal mix of continuity and new perspectives. While our headquarters consolidation is first and foremost about accelerated growth, it has also allowed us to take a very critical look at our capabilities, talent and investments to drive increased efficiency across the organization. Our state-of-the-art campus is perfectly suited for our business unit-led organizational design, which is supported by dedicated centers of excellence. Our footprint now mirrors our strategy, and we're already seeing increased collaboration and elevated execution, which is starting to show in our results. As I've said previously, this was the third of three phases of our transformation into a tightly aligned operating company. With most of this transition successfully behind us, I'm excited to see how we continue to accelerate performance in 2026 and beyond. Throughout this transformation, we've maintained a consistent overarching strategy. Our brand strength, focus on innovation and expertise in channel management create a compelling value proposition and drive our performance. Our execution of this strategy leverages Fortune Brands Advantage capabilities, which are category management, business simplification, global supply chain excellence and digital transformation. These strengths enable us to rapidly adapt to shifting markets, increase market share and deliver innovation at scale. Our alignment into an execution-focused operating company is allowing us to better leverage strengths across our organization with tangible results this quarter. Using advanced analytics, data science and deep insights into customers and consumers, we are able to implement precise strategies for pricing, promotions and product assortment. This precision allows us to maintain a careful balance between margin protection, price stability and demand responsiveness and facilitates sustainable share growth over the long term, even amidst a dynamic external environment. We continue to expect to fully offset the anticipated in-year dollar impact of tariffs in 2025 and the anticipated annualized dollar impact in 2026 through a combination of supply chain actions, cost-out opportunities, and strategic pricing actions. Fortune Brands has consistently acted as the price leader in our categories and our high integrity, transparent and collaborative approach to tariff pricing was consistent with that history of leadership. As a result, our tariff-related pricing was relatively modest, and absent any new significant tariffs, is now largely in the market. While some of our competitors are still taking significant additional tariff pricing, our work for 2025 tariff pricing is essentially complete and has been for some time. That positions us well to focus on execution, strengthen channel relationships and preserve pricing integrity while allowing us to capture additional share. We intend to opportunistically look for areas to now promote and drive volume. Now turning to the external environment. The macro environment remains uneven, with consumer sentiment cautious and housing activity showing mixed signals. However, our demand profile is stable, and we see green shoots heading into 2026. As we enter the final quarter of 2025, the U.S. housing market continues to show signs of stabilization following a period of elevated mortgage rates and constrained affordability. While overall home sales remain subdued, recent rate cuts by the Federal Reserve have helped ease borrowing costs with a 30-year fixed mortgage rate dipping to its lowest level in a year and almost a full point below where they were at the start of 2025. This has sparked renewed buyer interest and a surge of refinancing activity, suggesting that pent-up demand may begin to unlock as affordability improves. Home inventory levels are also rising, particularly in the South and West, giving buyers more options and helping shift the market toward a more balanced state. Prior business, which is primarily focused on repair and remodel, the mid- to longer-term outlook remains encouraging. In the near term, R&R is below trend even when normalizing for the post-COVID period. However, we believe R&R is poised to rebound in the not-too-distant future, driven by aging housing stock and deferred maintenance projects as well as a consumer base, which is increasingly interested in renovating their homes. For example, a recent survey indicated that 84% of homeowners plan to renovate a part of their home in the next 12 months. Record levels of tappable homeowner equity, together with lower rates means that homeowners are in a strong position to finance improvements through equity extraction tools like HELOCs and cash-out refinancing. Recent data shows that homeowners are utilizing home equity lending methods at the highest rates since 2022 with momentum building. Across our channels and segments, we compete in smaller ticket categories where consumers look to trusted brands and innovation to deliver value. Even in the trade-down environment, our brands were made the preferred choice by pros and consumers because they combine quality, style, innovation and reliability at accessible price points. Our single-family new construction, which comprises roughly 1/4 of our total sales has faced headwinds from elevated rates and cautious builder sentiment; however, it remains a long-term driver of growth supported by a shortage of existing homes. As interest rates continue to trend downward and consumer confidence stabilizes, we anticipate a recovery in single-family activity, which we expect will provide additional growth across our portfolio. Our products are well positioned to benefit from the torque of new construction growth with manageable downside risk. Our products are not affected by homebuilders reducing square footage for affordability since efficient design changes do not significantly change the number of faucets, valves or entry doors within a home. In fact, many of our products can contribute to improved housing affordability because they are easy to install, durable, and can even help save money through reduced insurance premiums and utility costs. It is also important to note that the vast majority of our products are installed later in the construction process, which results in lower variability since completions serve as a moderating factor compared to the more volatile starts. Finally, our relationships with builders position us as the incumbent brand preferred by both professionals and homeowners when these homes eventually engage in repair and remodel activity. Overall, we believe our balanced portfolio provides stability while also offering attractive growth potential, which comes with new construction. With our advantaged footprint and brand strength, we are confident in our ability to continue outperforming our end market and are poised for accelerated growth. Turning to our third quarter performance. Sales were roughly flat at $1.1 billion, and excluding the impact of China, we're up 1%. Our margins were 17.9% and earnings per share were $1.09. Turning to our segment highlights. Our Water segment delivered another quarter of market outperformance. Sales were $619 million, down 3% versus third quarter of 2024. Excluding China, net sales were roughly flat. Importantly, our point-of-sale results, excluding China, were up low single digits versus a market, which we estimate was slightly down. In Moen, we executed the strategic and targeted promotional activity that we called out during our second quarter call, driving momentum and strong sell-through with key partners. We increased our share with all three of our largest retail partners during the quarter, and Moen continues to be recognized as the most trusted brand of faucets. Our brand strength with both consumers and the pro is increasingly evident. Our innovative products continue to win external accolades including Moen's recent inclusion on Time Magazine's Best Inventions of 2025 list. In wholesale, demand remained resilient. Importantly, our relationships with key builders remain very strong, as we not only resigned a number of our key national builders but also converted others to the Moen brand, resulting in further share gains. We are well positioned with builders due to Moen's exceptionally strong value proposition and our superior service capabilities, and we expect to continue to take additional share in this category. The House of Rohl portfolio saw significant sales growth over the third quarter of 2024, and delivered low double-digit point-of-sale growth, significantly outpacing the broader market. Our luxury consumer remains strong and continues to prioritize craftsmanship and design. Our brands are strategically positioned to capitalize on sustained demand and the work we have done to build our luxury brands portfolio is yielding positive results. We expect this to continue to serve as a growth platform through the rest of 2025 and beyond. Turning to e-commerce. This channel has rebounded since our reset earlier in the year. We are seeing the benefits of our updated go-to-market approach, coupled with the refreshed talent and expertise in our team. We generated sequential improvement within e-commerce sales in the third quarter. There is still room for further improvement, and we see upside momentum heading into the fourth quarter of 2025 and into 2026. In digital water, Flow continues to exhibit very strong growth. We recently launched the initial trial of the leak protection service, our new recurring revenue model subscription service. While it is too early to share any results, interest in a Flow subscription is very strong, and we expect this to be a meaningful unlock in both the consumer and insurance channels. We believe Connected Water will serve as a growth engine for years to come, given its differentiated value proposition and potential to significantly decrease one of the largest drivers around housing affordability, insurance costs. In outdoors, we continue to execute well in the softer market environment. Sales were $345 million, roughly flat versus third quarter of 2024. We estimate that our segment point-of-sale outperformed our end market by over 300 basis points, with market outperformance across our brands. In LARSON, the rollout of our retail aisle reset helped drive double-digit sales growth in the third quarter. Our new approach to innovating and marketing storm doors drove a strong consumer response including point of sale, which was up high single digits versus a roughly flat market. This initiative also received external recognition. Earlier this month, Lowe's named LARSON its 2025 Vendor Partner of the Year for the Lowe's Millwork division. This is a significant honor and a proof point of the underlying investment thesis in LARSON and the ability of Fortune Brands to drive value through its disciplined and returns-focused capital allocation strategy. Therma-Tru strongly outperformed its category with point-of-sale share gains in both wholesale and retail. Although net sales decreased in the third quarter, this was primarily due to the absence of the usual fall inventory build. However, strong customer orders in early October suggest that this decline has not continued into the fourth quarter. In Q3, a significant milestone was reached in the American fiberglass door coalitions case against Chinese fiberglass door panel imports. The court has put in place preliminary countervailing subsidy duties ranging from 50% to 900% on Chinese fiberglass door panel imports. The U.S. government continues its investigation and a final decision is expected in Q1 of 2026. We expect to see the benefit of this government action in addition to tariffs as Chinese inventory in the market is consumed. Fiberon performed well in the third quarter. In September, we recorded the highest monthly sellout for the year. Fiberon saw sales growth in the third quarter versus last year in both retail and wholesale, with strong point-of-sale outperformance in wholesale. Our outdoor brands benefit from their vertically integrated U.S. manufacturing presence, giving them an advantage over import reliant competitors. We expect to see the benefits of our North American footprint to become more apparent in 2026. Turning now to security. Our security segment also made progress in the third quarter. Sales were $186 million, up 5%, building off of many of the initiatives we have highlighted last quarter with further momentum expected in the coming quarters. The Master Lock and SentrySafe brand campaigns continue to build upon our industry-leading awareness and drive consumer engagement. During the quarter, we secured several new retail placements in a variety of outlets, and across multiple price points as competitive products are proving to be inferior alternatives to our iconic and trusted brands. We expect to see the benefit of these retail wins in the fourth quarter and into 2026. Finally, the recent Prime Day exceeded our expectations, and we have gained share in the growing e-commerce channel throughout 2025. As we look toward the end of the year and 2026, we are confident that we will see growth due to our focus on strategic execution. Digital security solutions are also gaining traction and we see a robust pipeline of opportunities for both residential and commercial applications. Recently, our Yale Assure Lock 2 received accolades, including being named Best Smart Lock by CNET and the Spruce. The launch of the Yale Smart Lock with Matter designed for Google Home is also delivering encouraging early results. Turning now to our full digital portfolio. Our digital portfolio continues to scale, and we're making strong progress. We now have over 5 million registered users across our digital platforms with strong momentum in new device activations. For digital overall, we have full conviction in the strength of our product portfolio and its ability to deliver differentiated, sustained growth over the long term. With respect to Flow, we continue to add and expand partnerships with insurance companies, and the data shared regarding the product's effectiveness for both homeowners and insurers continues to affirm its significant impact. For Yale, we won several new retail placements and have a significant number of partnerships, which we are starting to scale more broadly. Across our digital businesses, we are increasingly leveraging our well-established advantaged channel relationships with builders, retailers and wholesalers to drive new opportunities. The fundamentals of our digital strategy are sound, and we remain confident in the potential of this growth platform. We are on track to approach $300 million in annualized sales by the end of 2025 with continued growth into 2026. To recap, the third quarter was another strong demonstration of Fortune Brands' ability to execute with discipline, respond with agility and deliver above-market performance. Our teams are advancing our transformation, strengthening our brands and investing in platforms that create new avenues for growth. Looking forward to the fourth quarter of 2025, we expect to deliver year-over-year sales growth and market outperformance and expect to see the continued benefits of the initiatives that we have detailed in the call. Throughout the recent periods of external uncertainty and market disruption, we have remained focused on what we can control, driving our most strategic investments continuing to support our leading brands and strategically reshaping our business to be leaner, stronger and more agile. These moments of challenge have been opportunities for us to optimize our structure, sharpen our priorities and position ourselves for accelerated growth when conditions improve. Today, we stand not only resilient but designed for performance and built for the future. I will now turn the call over to Jon.

Jonathan Baksht, CFO

Thank you, Nick. Before I begin, I want to thank those who participated in our recent investor perception study. Your insights will inform our Investor Relations practices, and we are actively working to implement improvements. As part of this effort, we are reviewing how we consistently present period comparisons, certain performance indicators and growth narrative, particularly in areas like digital innovation and other key portions of our portfolio. We'll look to incorporate these enhancements beginning next quarter. As a reminder, my comments will focus on results before charges and gains to best reflect ongoing business performance. Additionally, comparisons will be made against the same period last year, unless otherwise noted. In the third quarter, we again delivered solid results against a soft market backdrop. We delivered sales of $1.1 billion, roughly flat year-over-year. Our results reflect lower volumes compared to last year which were partially offset by strategic pricing actions implemented earlier this year. Sales were up 1%, excluding the impact of the China business. Consolidated operating income was $206 million, down 5% compared to last year, largely due to lower volumes and higher cost of goods, partially offset by pricing, lower incentive compensation and disciplined cost management. Operating margin declined 80 basis points to 17.9% due to lower volumes and product mix in outdoors and security. EPS was $1.09. Turning to our segments, beginning with Water. Sales were $619 million, down 3%, reflecting lower volume, partially offset by price. Excluding China, our sales were roughly flat on a year-over-year basis, reflecting low single-digit POS growth offset by lower inventory build compared to prior year and modest inventory destocking in Canada. Water's operating income was $151 million, down $5 million compared to last year. Operating margin was 24.4%, down 20 basis points compared to last year, reflecting our efforts to strategically balance price realizations and operating costs. We continue to expect full year water margins to be in the range of 23% to 24%. Turning to outdoors. Sales were $345 million, roughly flat compared to last year, with pricing offsetting lower volumes. Sales benefited from the momentum from the LARSON perfect aisle reset and continued share gains of Fiberon. Point-of-sale increased low single digits versus a market that was down low single digits. This is partially offset by lower seasonal channel inventory builds in Therma-Tru in the third quarter as wholesale customers reduced orders in response to weaker external data points. We are encouraged that orders have increased entering the fourth quarter and are trending higher year-over-year. Outdoor's operating income was $53 million down $8 million compared to last year, with operating margin of 15.5%, a decrease of 250 basis points from the third quarter of 2024. These results reflect the impact of lower volumes higher material costs and product mix, partially offset by price. We expect to maintain margins at similar levels in the fourth quarter. And for the full year, we expect segment margins in the 13% to 14% range. In Security, sales were $186 million, up 5%, with price offsetting lower volumes with strong growth in e-commerce and the commercial business. Our Master It brand campaign for Master Lock is resonating, driving a double-digit increase in brand engagement and contributing to improved sell-through. Security operating income was $33 million, down $1 million year-over-year. Operating margin was 17.8%, down 150 basis points versus third quarter 2024, largely due to product mix as well as increased investments in product development during the quarter, consistent with our strategy to invest in future growth throughout the cycle. For the full year, we expect margins in the 15.5% to 16.5% range. Turning to the balance sheet. We are managing our capital structure with the objective of balancing our cost of capital, returns and overall flexibility. We ended the quarter with cash of $224 million. Net debt stood at $2.4 billion with net debt-to-EBITDA leverage of 2.7x, consistent with our deleveraging objective. We remain on track to end the year with net debt to EBITDA at the upper end of our previous guidance range of 2.2x to 2.5x. Free cash flow in the quarter was $177 million. We now expect full year free cash flow of $400 million to $420 million, reflecting reduced operating income, higher working capital levels and higher cash restructuring charges compared to last year. Additionally, our headquarters transition continues to progress ahead of our original timetable. As a result, during the quarter, we updated the range for total restructuring costs related to the headquarter transition to $100 million to $120 million. The increase relative to our previous range reflects the faster completion of the transition with higher estimates for severance, accelerated depreciation, lease termination costs and other refinements. We remain opportunistic with our capital allocation, balancing shareholder returns with investments to drive growth and M&A opportunities that align with our strategy. Before turning to our outlook, I'll provide an update on our tariff exposure. As Nick mentioned, we are still on track to fully offset the anticipated impact of tariffs, both in 2025 and on an annualized basis in 2026. Implemented changes in tariff rates and rules since our last call have only had a de minimis impact on our unmitigated tariff exposure, but the overall tariff environment has contributed to a more cautious consumer and margin pressures. As a reminder, we have worked to get our spend from China down significantly and expect to be around 10% of cost of goods sold by the end of the year. Our predominantly North American supply chain remains a differentiated competitive advantage. Turning now to our outlook. We are pleased with our year-to-date performance amidst the dynamic macro environment. As today's press release details, we are narrowing our EPS guidance and anticipate finishing the year near the low end of our prior range reflecting the impact of mix and lower volumes within an uncertain end market. The full details of our updated guidance can be found in our press release. As we look beyond 2025, we are actively planning for a variety of scenarios. While it is impossible to predict the exact timing of a demand inflection, we continue to believe it is a matter of when, not if, and when the demand inflects. We believe we are uniquely positioned for above-market growth. While we will not be providing guidance assumptions for 2026 at this point, we are able to share some initial thoughts. Our base planning assumptions center around a flat market overall. Importantly, we believe we are well positioned for our sales to outperform this market estimate based on the meaningful opportunities for which we have line of sight. Through our transformation, we are continuing to identify efficiencies and continuous improvement opportunities throughout our business and remain confident in our ability to drive value even in a dynamic market environment. In summary, our third quarter results once again demonstrate the resilience of Fortune Brands portfolio, the strength of our brands and the effectiveness of our advantaged capabilities. We are laser-focused on executing our strategy while investing in the innovations and capabilities that will fuel our long-term growth. I'm confident in our ability to continue executing at a high level as we close out 2025 and look ahead to 2026. I will now pass the call back to Curt to open the call for questions.

Curt Worthington, VP of Finance and Investor Relations

Thanks, Jon. 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.

Operator, Operator

First question comes from Susan Maklari with Goldman Sachs.

Susan Maklari, Analyst

My first question is on the pricing strategy. Nick, thank you for all the comments on that and the approach that you've taken there this year. I guess given that, can you talk a bit about how the outcomes have come together? Have they been in line with what you have expected as you approach the pricing? And how you're thinking about this going forward?

Nicholas Fink, CEO

Sure, Sue. I'd be happy to. Look, as we said, I think, on our prior calls and you've tracked us for a long time, as you know, from prior inflationary periods, we maintain a very disciplined approach to pricing. And so as we think about it, our goal is, as category leader, to lead where we have to lead but do it in a clear, transparent and incremental way. And if we feel like we do it well and we do it early, then we can do it in small increments. And if you recall, 2021 through that inflationary period, we were also taking kind of single, mid-single-digit pricing because we were doing it early and we were covering our cost. Now I will say before I touch further on pricing, I mean, we do a lot before we get to pricing. We work our supply chain really hard. We've pursued a lot of cost-out initiatives. And then what we're not able to mitigate through that, we turn to pricing. And in the case of 2025 with the tariffs, we did that very early on. And we said consistently since that time that between all of those actions, we will cover off on tariffs. We've covered off on tariffs. And I do. I've read reports that we're 'behind' in our second round. There is no second round. We did it early, as I said, in the beginning of the year, we got it done. It's behind us. And really, what we're doing now is we're focusing our enhanced data capabilities and actually looking at places that we can lean into the market and drive volume. Where are those opportunities to promote, understand the elasticities. If we have further CI, we're going to hunt for more of those opportunities, and we think that's what is driving a lot of the share gain that we're seeing. And so I'd say we've been consistent on it through this tariff period, but we've been consistent on it through '21 and through the inflationary period in '17. And what we find is sometimes it takes a while for others to follow. And that may mean that, that causes a headwind for us for a quarter or two, and that's fine. We're playing a long game, and we're playing to gain share over the long run, and we'll do it in the highest integrity way for ourselves and our customers. And I think that's exactly what's playing out now.

Susan Maklari, Analyst

Okay. That's great color. And maybe building on that, one of the things that Fortune has historically done really well is outperforming the market and gaining share in periods of weakness. And it certainly sounds like from your comments that is coming through again. But I think something that differentiates you today is this investment that you do have in data, right, a lot more information and nuances of understanding things. How is that helping you to better target those share gains and perhaps even better sustain and further grow the business even as things normalize and we eventually return to market growth?

Nicholas Fink, CEO

Yes. Look, it's a great question. It's a very exciting part of our strategy. I'll say, as you know, we've been on this broader digital journey now for a little more than half a decade. And I'd say the greatest thing about that, whether it's product, whether it is digital initiatives that are customer-facing or internally facing, the whole team is digitally fluent at this point. I'm not going to say we're digital natives, but we can get around the table and we can discuss digital innovations and understand them. And that's allowed us to move very quickly, particularly as some of these AI tools have become available. And so I think specific to your question around something like pricing, I mean, I remember several years ago, when we first invested to build our pricing analytics, and I think they were best-in-class at the time. Today, I say that is pretty antiquated compared to what we have today, which is, a, much more precise and, b, much faster moving, where we can really get insights on a SKU-by-SKU level, and some of the new leadership that we have here with our headquarters transformation has brought in just world-class talent. And so we're getting sharper and faster all of the time. That's on the pricing side. We're also able to do things like customer and consumer insights literally in hours, whereas it may have taken us weeks. So once you understand exactly where your customer is, where your consumer is, what their shopping behaviors are, what their switching behaviors are and how to target them, it makes us a much more fierce machine. Now for all of that said, I think we're just at the early innings of doing this. We've got some great people and some great capabilities in place. We're seeing some unbelievable talent as we continue to hire up as part of our transition and transformation to the new headquarters, but I think it's early innings for what you'll see us do with these capabilities.

Operator, Operator

The next question, Michael Rehaut with JPMorgan.

Michael Rehaut, Analyst

I wanted to clarify what led to the 100 basis point decrease in segment margin guidance for Outdoor and Security. As we approach the end of the third quarter, I'm interested in understanding what has changed in the past 90 days that caused this decline. Additionally, did the margins in either segment during the third quarter reflect any of this change in outlook or performance?

Nicholas Fink, CEO

Sure, Mike. I'm happy to try to take it at the highest level, and then Jon can round it out if you'd like some more detail. In Outdoors, a very simple story. By the way, we saw great performance out of that segment, particularly at the point-of-sale level. What we did not see was the usual seasonal inventory build that you see at this time of year in preparation for the next building season. I've seen this happen once before where we don't see that build, and that tends to be pretty margin-rich product relative to the rest of the portfolio. So in Outdoors, it was pretty much just a mix inside of that inventory build, not particularly concerned about it because that inventory will have to be built to serve that market at some point. And I mentioned it will be at some point next year. And in Security, I'd say it's a variation on that theme. We saw a strong commercial performance, but we did see some backing off from our B2B business. And yet, we maintained our R&D investment at a higher level than prior, and we maintained marketing investment at a higher level than prior particularly with our new Master campaign, which is doing really, really well, and notwithstanding a bit of a mix shift there, we did not want to pull back on those investments. Jon, if you want to add anything?

Jonathan Baksht, CFO

To provide some numbers regarding the inventory for Outdoors, Mike, last year we typically experienced low double-digit increases in that channel inventory during Q3. However, this year we saw low double-digit declines instead. To address Nick's point, we will need to reverse this trend, which is somewhat unique to Q3. As we approach Q4, it's uncertain whether this will reverse then or later. Nonetheless, as we mentioned earlier, October has shown some early signs of recovery, and we are encouraged that it appears to be on the upswing.

Michael Rehaut, Analyst

I appreciate that. I may follow up on that later. Secondly, I want to shift the discussion to digital. Nick, you mentioned that you're on track to achieve a $300 million annual run rate by the end of this year. I would like to understand two things: first, how those sales break down between plumbing and security, and second, you've mentioned a sales goal of $1 billion by around 2030, if I'm recalling correctly. I’m eager to grasp how to evaluate the business growth. I'm not asking for specific guidance, but I would like some direction on how to consider growth in 2026 and 2027, assuming you achieve that $300 million run rate. How should we think about that moving forward?

Nicholas Fink, CEO

I’ll start by sharing a few key points and then address some of your questions. First, we are on track to reach an annualized figure close to $300 million, which aligns with our expectations at this point. In our previous call, we mentioned we anticipated finishing this year around $250 million, and we are actually performing ahead of that forecast. I’m very pleased with the ongoing development of that business. We are experiencing substantial growth in the Flow segment, and I’m extremely enthusiastic about the opportunities available there. Recently, we introduced our subscription service, which includes leak protection. We believe this will remove a significant barrier to growth because, while the benefits of Flow are clear to us and to insurers, pricing has been an issue for many consumers. Research indicates that many are willing to pay a monthly subscription, especially if their insurance savings exceed that amount, creating a win for us, for insurers, and for consumers. We are eager to monitor the performance of this new service and will share updates as we gather data. On the security front, we are seeing positive developments. I mentioned progress with Yale earlier, but I see further opportunities as we introduce new products developed with Google and other key partnerships, which will be implemented by 2026. Additionally, for those who participated in our recent feedback survey, thank you; it was very insightful. We know there’s a desire for more comprehensive information. We aim to provide metrics that are verifiable and consistent. We will return early next year with a clear set of metrics for our digital business that we will update regularly, and we appreciate your patience as we gather feedback on what you want to see.

Jonathan Baksht, CFO

Yes, absolutely, Mike. To expand on the disclosure for next year, it's more challenging to establish a roadmap for metrics related to 2030. As we develop our reporting framework, we aim to offer something more tangible in the near term for you to consider. Regarding your question about the division between security and outdoors, we currently do not disclose that due to their relative size within our overall portfolio, but both areas are growing rapidly. I can also provide some general guidance that neither category dominates the portfolio; there is a solid balance between security and water in that connected build. We will offer a broader framework in the next quarter that will be easier to guide you through moving forward.

Nicholas Fink, CEO

So just to sum it up, because that was the last part of your question, trending ahead of the $250 million that we gave last quarter, very happy about that. Approaching the $300 million annualized, very happy about that and absolutely convicted about the $1 billion by 2030.

Operator, Operator

The next question, Philip Ng with Jefferies.

Philip Ng, Analyst

It's great to hear about your progress. You've successfully implemented a price increase for plumbing on the water side, correct? It seems like your competitors are slightly lagging behind. Does this position you to take a more proactive approach? Can you share any insights on your performance in different markets and retail channels? Do you have any preliminary thoughts on market placements we should consider for 2026?

Nicholas Fink, CEO

Sure. Let me take the second part first, and then we'll come back to playing offense because it is helpful for just crystal clear. We're very happy with the Water results. I'll just start there. If I look at the opportunities, build there, we're gaining share, very pleased. Retail gained share across all three majors, we're very pleased. As we said on the last call, we saw opportunity to improve our performance in e-commerce. We have a new team in place. We're executing with, I'd say, significantly upgraded capabilities, uncovering a lot of opportunities. Happy with the progress but room to improve. Expect to see that improvement as we come through this year and into next year. As I think about then offense, the answer is, absolutely. As we work hard, very hard, in fact, to continue to mitigate the impact of tariffs. We're still working with supply chain. We're still working on cost efficiencies. We're going to look to redeploy that where we can to meet the consumer where they are and promote as we can. And so it's not signaling anything dramatic. But with a lot of this effort behind us, we see opportunity to then really sharpen the pencil.

Jonathan Baksht, CFO

One piece that Nick didn't mention but brought up in the prepared remarks is House of Rohl, which continues to experience significant growth across the distribution. We are seeing considerable strength with the luxury consumer, and across various metrics such as volume and price, we are noticing very positive indicators in the luxury segment.

Philip Ng, Analyst

Yes. I mean the margin has been stellar. Then Jon, you gave us a little hint that 2026 in terms of the end markets, but you're expecting to outgrow. I want to be great if you could quantify how much, but more importantly, can you flag some of the areas where you think you've had some wins that give you confidence that perhaps you could grow a little faster than the market? And then any directional help how we should think about margins as well?

Jonathan Baksht, CFO

It's still too early to quantify specifics, Phil. We're currently developing the 2026 plan. We do have some visibility into the market environment, and while this year has been slightly down, we expect next year to be largely flat. Although the market hasn't seen a significant shift, we're noticing some positive signs to maintain that flatness. We feel confident in outperforming the market. This quarter's results reflect that, particularly through our largest business unit, where Nick highlighted several wins in the marketplace for Q3 and the early part of Q4, which we anticipate will continue into next year. Each of our business units has specific elements that boost this confidence. In Water, Nick mentioned some positives. In Outdoors, we discussed the success of the LARSON perfect aisle, and Fiberon has shown notable improvements in productivity and efficiency. For Therma-Tru, we addressed the previous lack of seasonal inventory builds and expect a rebound there. The antidumping tariffs affecting that segment should also provide a beneficial boost. In Security, we are investing for next year, with good momentum from our Master It campaign, and the introduction of our connected products and Yale Google Smart locks is expected to be advantageous. Additionally, our connected business is growing, particularly in Flow and our connected products. There's a lot to be optimistic about for driving outperformance next year.

Operator, Operator

The next question, Mike Dahl with RBC Capital Markets.

Michael Dahl, Analyst

I just want to start with kind of a clarifying question around the tariff dynamic. Obviously, still some moving pieces since you last gave your guidance between kind of copper and maybe some refinement around 232's and now the most recent news about reduced China exposure. And Nick, I wasn't sure if your comment referred to the 2025 impacts being de minimis, but maybe can you just clarify that, talk about kind of on an annualized basis as all tariffs as currently announced and maybe inclusive of this reduction in China tariffs, what that gross impact is for you?

Nicholas Fink, CEO

Yes. I'll just make a quick comment and turn it to Jon. But I'd just say on the de minimis, we're not processing in that the 10% yet. That's very late-breaking, and we want to do some work on that. So we're talking about all the other changes as we work through it. And then there's some sector-specific challenges, too, that we see. You've referenced some of them that we're going to have to be laser-focused on. I think with respect to the late-breaking news on the 10%, firstly, we want to see it actually get inked and then we will do our work around that to see where there's opportunity. Jon, do you want to give some more color.

Jonathan Baksht, CFO

Yes, I'm happy to provide some insights. During the last call, I mentioned the impact of tariffs, indicating an $80 million effect for 2025 and $260 million annually for 2026. Since then, we've observed significant reductions in reciprocal tariffs across various jurisdictions. Currently, and even with the preliminary 10% reduction on China announced this morning, we believe the $80 million for this year is likely finalized. For next year, we expect the annualized impact to be closer to the low $200 million range. The tariff impact has indeed decreased. Regarding copper, which we discussed since the last earnings call, the overall impact on our business is estimated at around $3 million, so it has not significantly affected us. We're actively working to mitigate these tariffs through various actions, including supply chain strategies and cost-cutting opportunities, as both Nick and I have mentioned. Additionally, strategic pricing actions are part of our approach. All these efforts combined have allowed us to manage the situation effectively, and we feel confident about where we currently stand.

Michael Dahl, Analyst

Yes, that's very helpful and good to hear. And if I just shift gears to a little more near term, you talked about a lot of the dynamics already, but I wanted to drill down on Water margins for 4Q, just given the commentary around now looking to pick your points on promotions and where to lean in on volume. Your guide still implies kind of a wide range of outcomes for the fourth quarter. So can you help us kind of ballpark what that fourth quarter margin impact? And also maybe specifically like within that range of kind of the Water guide, how you're leaning on top line as well when you think about 4Q specifically?

Jonathan Baksht, CFO

Sure. I'm happy to start off. From a margin decline perspective, we have provided guidance for the full year for Water. Our margins and our margin guidance from quarter to quarter have remained consistent. We still expect an operating margin of 23% to 24% in that business unit. This suggests that we anticipate a margin around 23% for the fourth quarter, which would represent a nice or at least modest increase compared to Q4 of last year. Sequentially, if we consider the margin decline, it's primarily due to a mix and spending. We've highlighted some of the spending related to promotional activities, which is one area that could change. Additionally, we are seeing some shifts in the mix of our products and channels.

Operator, Operator

The next question, John Lovallo with UBS.

John Lovallo, Analyst

To follow up on Mike's question, you mentioned the Water margin directionally and indicated that the Outdoor segment is expected to be similar in the fourth quarter to the third quarter. However, with about ten months into the year, the overall ranges still seem quite broad. I'm interested in what might cause fluctuations within this wide range in the coming months. Could you provide additional insights by segment on where you currently stand?

Nicholas Fink, CEO

Yes. John, this is Nick. I'll start with a few conceptual points, and Jon will provide additional details. First, I want to emphasize that we consider margins for the whole year rather than just the quarter. Our focus is on the long-term health of the business, so we won't adjust investments from quarter to quarter just to meet a margin target. We're building for the future. Some of the variability we've experienced this year stems from inventory and channel adjustments. As Jon mentioned, we didn't see a seasonal inventory buildup in a high mix area of the business, which will come later, and this does affect our margins. Regarding margins, I recommend looking at the full year guidance. Concerning tariff pricing, it's crucial to note that our aim is to offset tariffs dollar for dollar, and we will work to restore any margin necessary over time by utilizing our continuous improvement and supply chain initiatives.

Jonathan Baksht, CFO

Yes. To quantify this, if you examine our full year guidance, Q4 is particularly interesting since it's based on just one quarter. You can derive our Q4 margin guidance from that. For both Outdoors and Security, the margin implied in each of these guides is higher than our full year guidance, indicating that we are enhancing our margins in both sectors as we enter the latter half of the year. We have previously discussed various dynamics in Outdoors, particularly related to channel inventory. Additionally, there's a factor that impacts Outdoors, which is related to our product mix. This negatively affected us in Q3, and it appears that this trend will also impact Q4. Similarly, in Security, we are experiencing comparable issues related to the timing of our promotional spending and its effect on sales. Furthermore, as we begin to sell our new technology and hardware, the presence of older hardware being sold at a lower price point may also influence our results in Q4.

Operator, Operator

Thank you for joining today's conference call. You may now disconnect.