Newell Brands Inc. Q2 FY2023 Earnings Call

Good morning, and welcome to Newell Brands' Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After a brief discussion by management, we will open the call for your questions. As a reminder, today's conference call is being recorded. A live webcast of this call is available at ir.newellbrands.com. I will now turn the call over to Sofya Tsinis, Vice President of Investor Relations. Ms. Tsinis, you may begin.

Thank you. Good morning, everyone. Welcome to Newell Brands' second quarter earnings call. On the call with me today are Chris Peterson, our President and CEO; and Mark Erceg, our CFO. Before we begin, I'd like to inform you that during the course of today's call, we will be making forward-looking statements, which involve risks and uncertainties. Actual results and outcomes may differ materially, and we undertake no obligation to update forward-looking statements. I refer you to the cautionary language and risk factors available in our earnings release, our Form 10-K, Form 10-Q and other SEC filings available on our Investor Relations website for a further discussion of the factors affecting forward-looking statements. Please also recognize that today's remarks will refer to certain non-GAAP financial measures, including those referred to as normalized measures. We believe these non-GAAP measures are useful to investors, although they should not be considered superior to the measures presented in accordance with GAAP. Explanations of these non-GAAP measures and available reconciliations between GAAP and non-GAAP measures can be found in today's earnings release and tables that were furnished to the SEC. Thank you. And now, I'll turn the call over to Chris.

Thank you, Sofya. Good morning, everyone, and welcome to our second quarter call. Second quarter results were in line with or ahead of our projections on all key metrics. As expected, top line results were pressured by normalizing category trends, constrained consumer spending on discretionary products and retailer inventory destocking. Operating margins, earnings per share and cash flow were all well ahead of expectations as we made meaningful progress on productivity initiatives and working capital reduction. While our results met or exceeded our expectations for the quarter, on an absolute basis, we aspire for significant improvement going forward. That is why we recently created and deployed a new corporate strategy based on a comprehensive companywide capability assessment with an integrated set of where to play and how to win choices. We're very excited about the clarity this work is bringing to the business and the value creation opportunity ahead of us. But we also recognize that the path forward will not be a straight line. During our first quarter earnings call, we laid out five key priorities for fiscal 2023 which are all progressing nicely. Let me say just a few words regarding each of them. First, starting with an operating cash flow. Year-to-date, we have driven a year-over-year improvement of over $700 million, largely by right sizing our inventory levels through improved forecasting and supply planning processes. Second, gross margin performance improved sequentially behind our ongoing fuel productivity program and Project Ovid, which you will recall completely transformed Newell's domestic go-to-market operations. We are on track for a record high year on productivity savings across the supply chain. Third, Project Phoenix is simplifying and strengthening the organization by leveraging scale, reducing complexity, streamlining the operating model and driving operational efficiencies. The program is pacing well and is on track to deliver $220 million to $250 million in pre-tax savings upon its full implementation. Fourth, our SKU count, which was over 100,000 as recently as five years ago, is expected to be down to less than 25,000 by the end of the year, with numerous other complexity reduction actions also underway. Finally, we have successfully transitioned to and are operating in a new operating model with three segments, centralized manufacturing and supply chain and one Newell approach with our top four customers and across most geographies. It is from this much improved operational and organizational foundation that we made an important where to play choice to focus on and drive a disproportionate amount of our organizational and financial resources to our top 25 brands and our top 10 countries, which each represent about 90% of sales and profits. Once that decision was made, we turned our attention to our how to win choices, which were fully informed by the capability assessment we have just completed. That assessment clearly demonstrated the need for us to significantly improve our abilities in consumer and customer understanding, innovation, brand building, brand communication and retail execution. That's why when we revealed our new strategy in Paris last month we said we are making a major pivot in our frontend consumer facing capabilities to properly support leading brands in top countries. Since these how to win choices are cornerstone elements of the new integrated strategy, we have started to fill talent gaps across key areas and have established clear action plans and KPIs for each capability improvement project. For example, we are upgrading the company's ability to understand consumer and customer wants and needs. This should enable actionable insights around superior product development, leading to stronger claims in a more impactful and focused innovation pipeline as we concentrate on fewer, bigger and longer lasting innovations. In addition, we recently revamped Newell's innovation process, which will be underpinned by proprietary consumer insights. As part of this work, we designed and instituted a project tiering system and implemented an enterprise-wide biannual innovation process to sharpen the company's innovation plans, drive alignment on the funnel, and determine prioritization and resource allocation as we identify bigger bets. We also put in place a centralized tracking system for all new initiatives to enable multiyear technology platforms and ensure appropriate financial rigor to drive accretive margins. Relative to brand building and brand communication, we're building out a comprehensive brand management function, which was not in place previously. Going forward, Newell's brand managers and the multifunctional teams who support them will be responsible for profitably growing our top 25 brands in our top 10 countries alongside a newly redesigned brand communications governance process. Finally, as it relates to retail execution, our sales teams are leveraging the portfolio of Newell's leading brands and scale to actively pursue new distribution opportunities, which they've identified across every business, while also dramatically improving our sales fundamentals in existing accounts. Although it's still early days, I'm encouraged by the progress we are making in bringing the integrated set of where to play and how to win strategies to life. Importantly, these are not just corporate plans. They've been formally cascaded throughout the organization, informing the segment, functional and regional strategies where work is ongoing. Key members of the leadership team and I have visited six of our top 10 countries across Europe and Latin America in the last two months to ensure we are driving the strategy into execution. Now, before turning the call over to Mark, who will discuss our financial results and outlook in detail, I want to address the revisions we have made to our top line estimates for the second half of the year. First, we are incrementally more cautious on the consumption of discretionary products, largely due to the resumption of student loan payments in October. As payments restart after a multiyear moratorium, many consumers will undoubtedly have to manage their budgets even tighter given persistently high core inflation, which has lowered real consumer income. Second, several of our major retail customers recently revised their shipping terms on our business, moving from what is known as direct import to domestic fulfillment. While we welcome this move, because we expect this change to be a positive for Newell longer term, it does put additional one-time pressure on back half shipments as their weeks of inventory coverage comes down further as a result of the transition. Lastly, we are now planning the baby business more conservatively in the back half of the year due to the bankruptcy of Buybuy Baby. Up until now we assumed in our financial modeling that a buyer would emerge for most of their stores. Since that is no longer likely, we have adjusted our sales forecast accordingly. Revising our top line outlook and related demand plan now allows us to continue the strong progress we have made on inventory reduction, which is why we are maintaining our operating cash flow guidance for the year. Additionally, we are taking bold actions to drive stronger productivity in the supply chain, which were made possible by a recent decision to consolidate our supply chain into a centralized organization structure. Specifically, after benchmarking indirect overhead at each of Newell's key facilities, we are taking a series of discrete site specific actions to right size the company's manufacturing labor force. These decisions are never easy, but we are committed to building a one Newell optimized global manufacturing network that minimizes total landed cost, optimizes asset utilization and leverages Newell's global scale. Moving forward, we are assessing how to optimize the company's entire plant network as we look to transition to more regionalized multi-source plants with upgraded automation and digitization capabilities, where appropriate. We will, of course, share more of the relevant details as plans are finalized. These top line revisions notwithstanding, we remain optimistic on the back-to-school season, which kicks into full gear in the coming weeks. And we continue to expect much stronger performance for the company in the back half relative to the first half of the year. The pace of change has accelerated across the company and we are moving with speed and agility to unlock the full potential of the enterprise. On a personal note, I would like to thank Newell's employees for welcoming me as their new CEO and for their strong endorsement of the new company strategy. At its core, our new strategy focuses on improving the company's consumer-facing capabilities while distorting investment to the most attractive value pools and simultaneously building upon the strengthened operational and organizational foundation we have built over the past several years. Their unwavering commitment to our purpose of delighting consumers by lighting up everyday moments inspires me every day. We have plenty of work ahead, but I sincerely believe we are off to a great start. While we continue to navigate through a challenging macroeconomic backdrop in the near term, I remain confident in our ability to accelerate the company's financial performance over the long term. I will now hand the call over to Mark.

Thanks, Chris. Good morning, everyone. As Chris indicated earlier, our Q2 results continue to reflect the significant macro-driven top line pressures we have been contending with since the third quarter of last year, namely soft consumer demand as inflation continued to put pressure on discretionary spending and subcategories continue to normalize, along with trade inventory destocking and the bankruptcy of a major retailer. Thus, while the 13% contraction in net sales of $2.2 billion and the 11.9% decline in core sales might on the surface be discouraging, we believe a more thorough examination shows the interventions we have made to improve the underlying structural economics of the business and strengthen operating cash flow are working as intended. For example, normalized gross margin and operating margin both improved sequentially due to enhanced productivity efforts and Project Phoenix savings, which were critical in helping mitigate the significant 400 basis point headwind during the quarter from inflation. Nonetheless, Newell's normalized operating margin contracted 490 basis points versus last year to 9.1% as normalized gross margin declined 320 basis points versus last year to 29.9%. And top line softness resulted in 160 basis point increase in the normalized SG&A sales ratio. In addition, during the second quarter, net interest expense did increase $21 million to $76 million, reflecting overall higher debt and interest rates versus year ago, but the decision to rightsize the dividend in a nearly $700 million year-over-year reduction in inventory allowed us to lower debt levels versus last quarter by nearly $300 million. Our effective normalized tax rate of 13.7% was slightly below a year ago, which when combined with the other elements we just reviewed, brought normalized diluted earnings per share in at $0.24, which was considerably better than the $0.10 to $0.18 outlook we had previously provided. Turning to operating cash flow, the planning team did a great job managing inventory levels down while increasing fill rates, which in North America improved to 94% year-to-date from 82% last year. This allowed us to generate $277 million of positive operating cash flow year-to-date through the second quarter. Importantly, this stands in stark contrast to a $450 million use of cash during the same period last year. Therefore, through the first six months of 2023, operating cash flow improved by more than $700 million and encouragingly in transit inventory as of June 30 was approximately $275 million below year-ago levels, so we are confident inventory levels will be even lower throughout the balance of the year. The company's leverage increased to 6.3x at the end of Q2, which was nearly one full turn better than anticipated. We believe leverage has peaked and expect it to drop to approximately 5x by the end of the year. Our long-term goal was to reach leverage at 2.5x. As we look towards the balance of the year, Chris laid out the incremental top line pressures we are facing, so I will not reiterate them. However, it does bear mentioning that this additional sales compression, coupled with our decision to lower inventory balances even further, does create a short-term fixed cost absorption challenge. Although we are aggressively optimizing the company's manufacturing labor force within the confines of our existing planned network, fixed costs deleveraging will still weigh on our second half gross and operating margins. Second half operating margin will also be impacted by our decision to invest in capability building and brand support to implement and accelerate critical aspects of our new corporate strategy. Given that context, we've assumed the following for the third quarter. Net sales of $2.11 billion to $2.16 billion with core sales down 7% to 5%. Traditionally, we do not respectively comment on gross margin. But in this instance, we think it's important to point out third quarter normalized gross margin is expected to represent an inflection point as strong productivity gains inclusive of our simplification efforts and July 1 pricing activity across roughly 30% of our U.S. business, primarily in the home and commercial solutions segment, are only partially offset by inflation and fixed cost absorption. We expect SG&A to be higher on a year-over-year basis in both dollar terms and as a percentage of sales as we increase brand support and invest in frontend capabilities such as consumer and customer understanding, revenue growth management, data analytics and retail execution, among others. Parenthetically, last year's third quarter SG&A was favorably impacted by a meaningful drop in management compensation accruals. Third quarter normalized operating margin is expected to be in the range of 8.5% to 9.4%. While this is admittedly down versus last year, the rate of decline is expected to ease relative to both Q2 and the first half as the structural economics of the business should continue to improve. We forecast interest expense to be substantially higher year-over-year and expect a mid-teens tax rate. All-in, we're guiding to normalize third quarter earnings per share in the range of $0.20 to $0.24. For the full year, we expect net sales of $8.2 billion to $8.34 billion, driven by core sales decline of 12% to 10%. Normalized operating margin is expected to be 7.8% to 8.2% as we reflect the negative top line flow through and incremental capability investments discussed earlier. Interest expense is forecast to be up slightly versus year ago and the tax team has done some terrific planning work, which should create a sizable tax benefit in the fourth quarter. Assuming that benefit is realized, the full year normalized effective tax rate is expected to be close to zero. Normalized diluted earnings per share are now expected to be $0.80 to $0.90. Relative to cash, which was our number one priority this year, we continue to anticipate $700 million to $900 million of operating cash flow, inclusive of $95 million to $120 million of cash payments related to Project Phoenix, which remains on track to realize $140 million to $160 million of pre-tax savings this year. The midpoint of our operating cash flow range implies operating cash flow will improve by more than $1 billion year-over-year with free cash flow productivity comfortably above 100%. So with all that said, let's summarize the key takeaways from today's call. First, top line pressures are expected to persist throughout the balance of the year. But as core inflation moderates, trade destocking slows and we cycle against easier comps, we anticipate that our top line results will improve on a relative basis. Second, we believe the underlying structural economics of the business will improve in the back half behind significant interventions across all facets of the business. In fact, at the midpoint of our guidance range, we expect second half normalized operating margin to expand over 200 basis points versus last year, and more than 350 basis points versus the first half of this year. Frankly, this would be a good outcome. Since again, using the midpoint of our range, full year net sales are expected to be down approximately $1.2 billion versus last year. Moreover, since we expect inventory to drop by approximately 25% year-over-year and the July 1 price increase that negatively impacted unit volume, one could reasonably assume production volumes will be down this year by 20% to 25%. Thus, the amount of cost takeout required to hold Newell's gross margin flat, let alone expanded, against this backdrop is not inconsequential and should provide significant positive financial leverage once the macroeconomic environment stabilizes and we begin to see the benefits of the major pivot we are making in our frontend consumer-facing capabilities. Third, the year-over-year increase in operating cash flow is expected to be at least $1 billion, which speaks for itself. Finally, we now have a unified corporate strategy based on a comprehensive companywide capability assessment with very clear where to play and how to win choices. We believe strongly in the strategy and are investing behind it as we move with deliberate speed to unlock the full potential of Newell's portfolio of leading brands. Operator, if you could, please open the call to questions.

Certainly. And our first question is from Bill Chappell with Truist Securities. Your line is open.

Thanks. Good morning.

Good morning, Bill.

I guess trying to understand the front-facing moves right now and in terms of it's looking more or sounding more with brand managers and focus on core brands, kind of a P&G model. And I guess historically, a lot of the Newell's categories don't have a whole lot of marketing or advertising or promotional support. And so it was kind of deemed as not always that necessary. So I'm just trying to understand going forward, you're going to be stepping up and doing more merchandising, marketing, stuff like that when a lot of your competitors won't. And so I'm just trying to understand how useful this will be. It certainly will help, but how you kind of looked at the categories when applying this model to it?

Yes. Let me try to provide a little bit of perspective. One of the things that we identified when we did the capability assessment was that because we're coming from a place where every business unit and every category was operated sort of independently, we did not have centralized standardized processes and approaches on the frontend capability like we've been driving over the last four years on the supply chain and the backend. And so when you look at the company's performance, you can see pockets of good performance. So if you look at the most recent periods, we're growing market share on brands like Sharpie, on Rubbermaid, on Expo, on Crockpot, but we're not growing market share on a wide swath of other brands. And we believe the reason we're not growing market share broadly across the company is because we don't yet have the capability in place on consumer and customer understanding, innovation, brand building, brand communication and retail execution consistently across all parts of the portfolio. We do believe, because we're starting from leading brands, in our top 25 brands over two thirds of them are leading brands in the categories in which we compete. We do believe that this model applies broadly. We've seen examples based on all of the businesses that we're in. The people that are growing market share are in fact applying this model. And so we think as we begin to drive and standardize and build this capability more broadly across the company and apply the same amount of operational rigor to it that we've done over the last several years on the supply chain and the back office, we think we can have a meaningful inflection point in terms of getting to a more sustainable top line growth algorithm.

Got it. And I can't remember if I'm allowed to follow up, but I'll ask one anyways. Mark, can you just maybe give us a breakdown in terms of the guidance what like Buybuy Baby, what the change in terms with retailers in terms of inventory, just kind of roughly how that's negatively impacting in buckets the guidance for the top line for this year?

Yes, let me help you out with that. So you might get a little bit more than you were anticipating here, but let's be clear on this point. So our prior range was $0.95 to $1.08 and we said we'd be towards the lower end of that range. So let's just take $0.95 as the starting point. From there, Chris enumerated a number of items that are going to lower our sales in the back half. So I won't repeat those here. But that's obviously fairly consequential. Along with that, we have chosen to take our inventory levels even lower in order to ensure that we can maintain our cash flow range for the full year. In addition, we have some capability investments that we are making, which recited some A&P investments that we talked about as well. And then there's a little bit of other items in there that are kind of mixed related. Those items are only partially offset by the meaningful progression in our programs related to costs takeout. This year will be an all-time high. We actually expect to take out about 6% of COGS through the fuel initiative programs that we have in place. And then there'll be a little bit of resin held, a little bit more transportation, a little bit of positive FX in the second half of the year. So taking all those elements together, that will take you from roughly $0.95, let's call it down to $0.30. And then we have a tax benefit that we have contemplated and put in that's worth roughly $0.15. That brings you to $0.85, which is the midpoint of the new range that we provided of $0.80 to $0.90.

And Bill, on the top line, of the three factors I cited, I would say that the student loan repayment and the more conservative stance on discretionary products as the first item, and the direct import to domestic shift are the two biggest of those items. The Buybuy Baby is a little bit smaller relative to the top line guidance change.

Got it. Thanks so much.

Thank you. And our next question coming from the line of Olivia Tong with Raymond James, your line is open.

Great. My first question is on gross margin. You gave a lot of detail on the changes to your sales outlook, but hoping to get some color on gross margin, which continue to show some sequential progress. And assuming you continue to see that sequential progress, should we expect it to turn positive in the second half? Is that a fair assumption? And if so, could you talk about some of the drivers that better underlying that? Thank you.

Thank you. We are very pleased with our current gross margin performance. In our first quarter, the gross margin was approximately 27%, and our recent report shows it has improved to 29.8%, indicating significant progress. We are confident that gross margin in the second half will be several hundred basis points higher than in the first half, likely between 300 and 400 basis points. This improvement is primarily driven by our fuel productivity program, which has been in place for several years and has intensified following the consolidation of our supply chain with the Phoenix organizational changes. We are on track to reduce about 6% of COGS from the gross margin this year, which is crucial as we continue to manage the impacts of inflation. Inflation in the first half is estimated around 400 basis points, but we anticipate less negative impact in the second half, with around 100 basis points of compression. Additionally, we are consolidating our distribution centers, reducing space from approximately 1.9 million square feet to around 1.5 million, and cutting the number of DCs from 30 to about 20. Our recent four-wall cost assessment will deliver annual savings of over $50 million by streamlining overhead and operational costs. Overall, we believe our productivity initiatives are strengthening, contributing positively to our gross margin outlook. Furthermore, the pricing adjustments we implemented will also enhance margins in the second half. We are optimistic about our gross margin trajectory, especially after experiencing compression every year since the Jarden acquisition, and we hope to reverse that trend this year.

Got it. Thanks. And then, given your updated views on resource allocation across brands and categories and geography, can you give us some idea on whether there are brands that are potentially seeing more spend rather than less, and then the level of divergence you're expecting versus where it currently stands on the brands that are going to see less support?

Yes, as part of our plan, we are increasing our spending on advertising and promotion. The budget for the second half of the year is higher compared to last year and significantly larger than the first half of this year, with a focus on our leading brands. We feel optimistic about the back-to-school period that we are entering, as our customer service results have improved significantly, with fill rates rising from the low 80s to the mid to high 90s in the writing business. Despite a decline in core sales for the company in Q2, the writing business experienced growth in core sales. Our share of retailer assets has improved this year compared to the previous year, and we plan to invest more in advertising and promotion this year than last, confident that we are well-positioned for the upcoming season. Although we have not yet seen consumption figures, we believe this is a smart investment. Together with our strategy of focusing on 80 master brands, of which 25 account for 90% of sales and profits, we are deprioritizing spending on the remaining 55 brands, as the return on investment is much greater on the top 25.

Thank you.

Thank you. And our next question coming from the line of Andrea Teixeira with JPMorgan, your line is open.

Thank you. I wanted to revisit your response to Olivia's question about the 55 brands, Chris. This company has undergone a significant transformation in optimizing and selling brands while also managing the deleveraging process. I am curious about any considerations regarding the potential divestment of some of those brands. Additionally, will this selling process be evaluated as you continue through this transformation, or is it something you plan to reassess after this project has had more time to show results? On your earlier comment regarding back-to-school, I understand there hasn't been much observed in consumption yet. Do you think this category is also experiencing the same inventory reductions that retailers are facing, or is it less affected due to the positive impacts of reopening and returning to the office? Thank you.

Yes, so let me start with the back-to-school question. The writing category is a little different. It is not going through the same dynamics on retailer destocking, consumer discretionary, pullback, et cetera. The writing business is much more normalized. We feel very confident that we are set up to gain market share during this back-to-school period, depending on which projection you look at. Some people project the writing category to be slightly down versus last year. Some people project it to be flat and some people to be up slightly. I think we're trying to take a middle of the road view on that. But we're very confident that we're set up very well to gain market share during the period. On the 55 brand question that represents 10% of the company's sales and profits, I would put those 55 brands into three buckets. The largest bucket of the 55 are brands that we are going to continue to sell. But we just are going to support less, so to speak, in terms of innovation resources. We will continue to support them fully in terms of sales resources, but we think our innovation resources, our A&P dollars are better spent on the top 25 than this other category. So consider that sort of a milk type column, if you will, for those brands. There's a second category of brands that we are going to proactively look to discontinue. And these are brands that represent a very small percent of the company's revenues and profits, and frankly are a distraction. And we believe we're better off just delisting them because we don't believe they're saleable. We don't believe they're significant. And we don't think it's worth it to even go through the effort of trying to sell them. So there'll be some brands in that category. And then there's a third category where we're going to look to do something different. And that could be a divestiture or a licensing type opportunity. That'll be a small subset. I don't think you're going to see massive change like we've had in the past from an M&A divestiture standpoint. That is not our strategy. We believe that we have a strong portfolio. We just want to focus our efforts and our resources on the biggest brands that are market leading, which represent 90% of the sales and profit of the company.

And Chris, just a follow up on that. So thinking about the 10% headwind that eventually we're going to see happening, of course we don't know the size of each of the buckets you just described. But assuming that there's like, call it mid single digit potential headwinds if you were to simply delist some of these to your second bucket or potentially sell, like is that something that we should be worried about into 2024 that could be a headwind or you're going to manage these gradually?

Yes, I think we're going to manage it gradually. I don't expect it to be that high. I think, could there be a period in the future where we have a low single-digit headwind from this? Possibly. But I think this is going to be an over-time thing. I don't think it really will rise to a mid single-digit type level in any given year.

Thank you. And our next question coming from the line of Peter Grom with UBS, your line is open.

Thank you, operator. Good morning, everyone. I appreciate the details on the guidance for this year. I would like to gain a better understanding of the anticipated increase in operating margin for the fourth quarter, as the outlook suggests a significant expansion. You seem quite optimistic about gross margin, so could you provide more insight into what's expected in the fourth quarter? Previously in June, you mentioned core sales below algorithm and operating margin expansion on the algorithm for the upcoming year, projected over the next 12 to 18 months. However, the expected exit rate seems to indicate something much sooner than that. Is there anything specific about the fourth quarter that we should be cautious about when considering operating margin expansion for next year? Thank you.

That's a great question. I want to clarify my thoughts on this. Without getting too caught up in quarterly fluctuations, we expect gross margin to continue increasing throughout the year. Specifically, we anticipate that second-half gross margin will be about 400 basis points higher than the first half, due to factors like fuel productivity initiatives, pricing impacts, and typical business seasonality, which usually sees a larger share of our annual sales in the latter half. We believe trade destocking will ease as we progress, and our comparisons will get easier since the first half is stronger than the second. There are many reasons for our confidence in this positive trajectory. With such robust gross margin growth, we also foresee operating income as a percentage of sales improving by roughly 400 basis points as well. It's important to note that while we are making significant capability investments, overhead expenses in the first half will be similar to those in the second half. This is because we are focusing on enhancing talent, managing change, improving processes, and upgrading technology. Additionally, as Chris mentioned earlier, we're planning to increase our advertising and promotion spending by 50% in the second half compared to the first, targeting compelling consumer offers. Regarding our smaller brands potentially slowing growth, that may be somewhat accurate, but we believe that prioritizing our top 25 brands and allocating extra resources to them will more than compensate, leading to growth. As for the commentary we shared at Deutsche Bank concerning the next 12 to 18 months, we didn't provide specific guidance. Instead, we indicated that this period will face various external challenges, including moderate to high inflation and some level of destocking. While we are cautiously optimistic about avoiding a mild recession, which would be beneficial, we will be investing in the capabilities we've discussed and rationalizing our brand portfolio during this time. We expect core sales to fall short of our evergreen target, which we stand by, but we're aiming for free cash flow to meet or exceed 100 million this year, based on strong progress. We also anticipate operating margin expansion to align with our evergreen target of about 50 basis points. This isn't specific guidance for any quarter, but we are confident in the significant progression of operating income percentage from the first half to the second. We will be making strategic choices to balance margin growth with additional advertising investments to support our top brands. We feel very positive about our current position, and every element of our profit and loss statement is aligning with our expectations.

That's very helpful. Chris, I have a question about visibility. This is the second consecutive quarter where things are trending down, especially regarding the core sales outlook, and you've traditionally been quite cautious. Has visibility improved to the extent that you feel you can return to that cautious outlook, ensuring we don't experience another downward revision, or does it still seem a bit unclear?

Yes. I would say that visibility is currently challenging due to the normalization following the unprecedented COVID pandemic, the significant inflation that is beginning to decrease, and the effects this has on consumer spending. Additionally, retailer inventory patterns have been unusual as a result. However, visibility is improving. We were pleased to achieve results right in the middle of our top-line guidance range for Q2 in terms of core sales growth, meeting our Q2 target. It's important to note that the farther we look out, the more difficult it is to project top-line guidance. Our focus is on what we can control, and we are actively investing in capabilities. We have brought in new talent, including a President of Brand Management and Innovation and a new Head of Consumer Insights. Leadership in our outdoor and recreation segment has also changed. We have initiated projects that specifically target improvements in consumer and customer insights, innovation, brand building, communication, and retail execution. We are making progress on these fronts and believe that improvements will materialize over the next 12 to 18 months. While these changes won't happen overnight, we are excited about the prospects that align with a high-performing supply chain and back-office organization that is achieving record cost reductions. We are optimistic about the direction of the business in the coming years.

Thanks so much. I'll pass it on.

Thank you. And our next question coming from the line of Lauren Lieberman with Barclays, your line is open.

Great, thanks. Good morning. I know it might seem crazy to want to look way further out at this point. But I guess I was just curious, you guys have talked about evergreen 50 basis points on average margin expansion. But what about the conversation kind of longer term P&L benchmarking, because I understand unequivocally the opportunity that could be ahead in terms of positive operating leverage with all the structural costs takeout that you're doing, getting to a more stable and stronger and predictable top line. But I'm just kind of not sure how to think about the reinvestment and capabilities as well. And so even like if I look at just playing with my numbers right now, if I look at general expense, like should I be thinking about '24 as kind of reaching a benchmark level of proper investment in the business. And that you're making that step change this year or I guess over a four quarter period probably, or does that keep building? So just anything you can offer on maybe longer term benchmarking on structure of the P&L would be helpful if you're willing to go there. Thanks.

Yes, let me try to provide some clarity. Starting with 2024, we anticipate that this year will have several one-time factors from 2023 that will allow for a recovery in operating margins. For instance, we expect inflation, which was particularly high in the first half of this year due to rolling capitalized variances, to decrease significantly in 2024. As it stands, our forecasts suggest that inflation will have a much lower impact next year compared to this year. Additionally, we anticipate that the effects of fixed cost absorption will be much less significant in 2024, since this year we've been managing both a revenue decline and inventory reduction. This current fixed cost absorption is somewhat of a one-time phenomenon. Our productivity is also increasing, supported by a strong pipeline that we believe will maintain high productivity levels next year. Furthermore, as we reduce inventory this year, we are aggressively addressing excess and obsolete stock, aiming to finish the year with cleaner inventory levels. We expect not to have to undertake such aggressive liquidation as we move into next year. Also, the destocking occurring among retailers is largely a one-time event. All these factors indicate that in 2024, we should experience a significant improvement in margins, which is our objective. However, I do not see 2024 as the endpoint for margin expansion; rather, I believe there is substantial potential to enhance operating margins over the next three to five years. The consumer-facing capabilities we are developing, alongside our efforts to drive top-line growth, will also contribute to margin improvement. By focusing on innovative products that drive categories for our leading brands in the MPP and HPP segments, we expect to initiate gross margin-enhancing projects. As we enhance these capabilities, we anticipate that our innovation pipeline will strengthen, leading to better category growth, market share gains, and gross margin improvements. Therefore, we are confident that the long-term margin potential in our business is significantly greater than our current levels.

Yes. And Lauren, if I could add just one point to that, it makes relevant. We had gross margin right around 30% in Q2. We talked about the fact that the second half is going to be considerably stronger for the reasons that Chris just reiterated. So our exit rate will be several hundred basis points beyond that. And that's when we're still operating 46 manufacturing sites, with capacity utilization frankly now given where we are probably in the low 30s, 90% of which are single sourced and many of which aren't in the right geographic locations to really optimize the global supply chain. So we think we have tremendous opportunity on the cost takeout side as well as all the innovation that will be brought forward, there'll be more MPP, HPP to push that meaningfully forward which will give us I think the ability to spend more in A&P, also expand our operating margins considerably over time while we get more efficient on the overhead line as the sales revenue starts to come back to us. So we feel very good about the proposition of us monetizing this business over any reasonable period of time.

Okay, thanks so much. It was really comprehensive. I appreciate it.

Thank you. And our next question coming from the line of Stephen Powers with Deutsche Bank, your line is open.

Thanks very much. Okay, so everything you just articulated makes good sense to me and is exciting. I do want to kind of circle back to what Peter was asking about in terms of the commentary a few months ago about the next 12 to 18 months not being a straight line. Everything Chris and Mark you just described about exiting '23 and then the bounce back year in '24 seems to run counter to that next 12 to 18 months being a lot more grounded. So maybe it's just a change in kind of macro assumptions, but just seems like a very different message as to how we think about back half '23 and '24 grounded in June commentary versus grounded in your recent commentary. So if you can just square that circle for me.

Yes. If you take a step back, we are aiming to make substantial improvements in a challenging turnaround situation for the company, which is influenced by an unpredictable macroeconomic environment. Currently, the macro conditions are unfavorable, but we believe they will eventually become favorable or at least stabilize. However, it is tough to predict when this will occur. We feel confident that our strategy, which was implemented six weeks ago, is on the right path. Still, it will take time to achieve these improvements since they involve significant changes to the company's operations. We are transitioning to a new operating model with Project Phoenix, making it difficult to specify when these enhancements will impact our performance. We are optimistic that the financial results will reflect these changes in two to three years, but it is uncertain if they will appear next quarter or in later periods. We want to convey that our progress may not be linear, yet we believe the trajectory is upward over time. While we can't predict the exact pace of this progress, we trust that in a few years, we will see notable and meaningful advancements in the company's performance.

Right. And if I could add one thing. And during that period, when we say core sales growth will be below the evergreen targets, because of obviously all the reasons that we've been discussing today, we were saying that look, cash is going to be our top priority and it's going to be moving forward above our target, and this year we're going to probably be 100% free cash flow productivity or better. And then the operating margin expansion is going to continue in part because the gross margin takeout is so big and so extreme, and we're very confident that it's going to come to pass. So we feel like over the next 12 to 18 months, sales might be a real challenge but margin will progress and cash will be our focus.

Thank you. And our last questioner comes from the line of Filippo Falorni from Citi. Your line is open.

Hi. Good morning, everyone. I know we covered a lot of ground. I just want to add maybe, Chris, you clearly announced a lot of strategic changes is coming on. The more recent changes on the frontend, kind of the restructuring programs, change in capital allocation. Any other areas where you think like there's more focus on your end, like in terms of potential further changes in the organization that we should be thinking about?

I believe we have reached a stage where we have completed our strategic groundwork, thanks to the changes in our operating model, our capability assessment, and the new strategy we have put in place. Our focus is now shifting towards executing this strategy rather than debating it further. We are confident that we have the right approach, but strategies only come to fruition through effective execution. This execution requires time and clear communication with our segments, geographies, and functions, ensuring that the strategy is integrated into each individual's work plan. By doing so, we aim to alter the enterprise's trajectory. Therefore, I do not anticipate any significant changes to our strategy at this time. Instead, you will hear more about our progress in driving this strategy into action.

Great. Thank you. That's helpful.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. A replay of today's call will be available later today on the company's website at ir.newellbrands.com. You may now disconnect. Everyone, have a great day.