Newell Brands Inc. Q3 FY2023 Earnings Call

Good morning, and welcome to Newell Brands Third 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 up the call for your questions. 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 third 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 we refer 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 third quarter call. We had mixed results in the third quarter. We made significant progress delivering against the five major priorities we established at the start of the year as well as deploying and actioning the new integrated corporate strategy. At the same time, we were disappointed core sales declined 9.2% during the quarter. Let me take these each in turn, starting with the five priorities we laid out at the start of the year. First, year-to-date, we delivered excellent results on operating cash flow, which improved more than $1.2 billion versus last year, largely due to significant progress on inventory reduction. The stronger than anticipated performance thus far has given us confidence to raise our outlook on cash flow for the full year. Second, during the third quarter, gross margin reached an inflection point, expanding 170 basis points year-over-year with the fuel productivity program along with pricing serving as the driving force. We continue to expect record productivity savings in 2023 with year-over-year gross margin improvement continuing into the fourth quarter. Third, we’ve completed the Project Phoenix organization design changes with all markets moving to the One Newell approach. We are on track to realize $140 million to $160 million of pre-tax savings this year and $220 million to $250 million on an annualized basis. Fourth, we are moving at pace with the simplification and SKU count reduction work across the organization and are on track to end the year with less than 25,000 SKUs, down from about 28,000 last year and over 100,000 at the end of 2018. Finally, the new operating model with three segments, a centralized manufacturing and supply chain and a One Newell approach with our top four customers and across the geographies is now fully in place and starting to pay dividends. The most concrete example of how we are already creating and leveraging scale under our One Newell approach is the difficult but necessary actions taken during the third quarter to right-size the manufacturing labor force across selected sites. Those actions, which would have not been possible previously, due to the way Newell was organized, are expected to yield about $50 million in annualized cost savings. The challenging macroeconomic background continued to weigh on Newell’s top line during the third quarter, reflecting soft demand for discretionary and durable products amidst persistent inflation on everyday goods, normalization in category trends post-COVID, tight inventory management by retailers as well as the unfavorable impact from the bankruptcy of Bed Bath & Beyond. We estimate that about 80% of the sales decline was driven by category declines and retailer inventory actions. However, there was a meaningful portion of our sales compression that traces back to the gaps in our front-end consumer-facing capabilities or was the direct result of the July 1st pricing actions we took to proactively address situations where our structural economics were untenable. That is why since my appointment in May, we have placed so much emphasis on developing a robust set of corporate, business unit, functional and brand-specific strategies, all of which were fully informed by our brutally honest capability assessment to guide our approach in the years ahead. At its core, our new strategy focuses on improving the Company’s consumer-facing capabilities, while distorting investment to our top 25 brands in the top 10 markets and building on the strengthened operational and organizational foundation we have built over the past several years. Following the deployment of our new strategy in June, we’ve taken decisive actions to bring the new strategy to life in several ways. First, to put consumer understanding and insights at the center of everything we do, we’ve reinvented the consumer insight function and overhauled Newell’s innovation process around the biannual review process. This new process has been established to identify strong consumer-driven propositions on our top 25 brands with a focus on creating fewer, bigger and longer lasting innovations that are gross margin accretive as part of a comprehensive tiered product launch system designed to get consumer-relevant innovation into the market faster. Consistent with this and to ensure we are being selective in driving the strategy into execution, we are taking swift action relative to the exit of smaller non-core brands. We are moving at pace and expect to finish the year with a tighter, more focused brand portfolio comprised of about 60 master brands versus 80 at the start of this year. Second, to dramatically improve brand building and brand communication and as we strive to build brand management into a foundational capability, we replaced close to half of Newell’s brand managers over the past several months and put exceptional performance standards in place, which set clear KPI-driven expectations for all brand managers going forward. In addition, we recently implemented important changes to the process and structure of our marketing and digital organizations to unlock quicker decision-making, drive accountability and improve our ability to drive stronger purchase intent across our top 25 brands. Third, key members of Newell’s sales team have been tasked with leading new business development, where they will leverage Newell’s scale and extensive portfolio of leading brands to identify and pursue incremental distribution opportunities within new accounts, while the bulk of our selling resources will continue to maintain their focus on strengthening our partnerships and increasing distribution with existing customers. Finally, to properly cascade Newell’s integrated set of corporate where to play and how to win choices, along with the new segment function and top 25 brand strategies, key members of the leadership team and I have now visited 8 of Newell’s top 10 countries across North America, Europe and Latin America. Based in part on those interactions, we have decided to bring in new, strong talent to fill crucial roles across several of Newell’s businesses and geographies. For example, we recently hired new leaders for the home fragrance and kitchen businesses as well as new heads of Europe and France. Before turning the call over to Mark, I’d like to provide a little perspective on the back-to-school season since that’s always an area of interest. While predictions for the back-to-school season varied widely across the industry, in aggregate, the categories where Newell competes declined modestly with stronger market performance from retailers that put their support behind leading brands versus those that focused on private label offerings. Against this backdrop, several of our major brands such as Sharpie and EXPO grew market share, which we were excited to see. That said, gaining share in a down market is not a prescription for long-term success. That’s why we are already incorporating the learnings from this season, the most important of which is the role our leading brands can play in driving category growth into next year’s back-to-school plans with leading retailers. While there are parts of Newell’s portfolio where we are gaining share, that’s not the case broadly. This highlights why we needed to make a major pivot in the Company’s front-end strategy. While we are dissatisfied with our current sales performance, we did say at the Deutsche Bank conference in June that we expected our top line performance to be below our evergreen target of low single digits for the next 4 to 6 quarters. Beyond that and as the bulk of our new capabilities ramp up, we remain fully committed to returning the Company to top line growth. Back in June and during our last earnings call, we also reiterated that our top financial priorities for 2023 were strengthening cash flow and improving gross margin, and very good progress is being made on both of those fronts. So, while there is certainly much more work to do ahead of us, the strategy is starting to take shape. That’s why we are confident that this year, free cash flow productivity will exceed our evergreen target of about 90%. And the business will continue to improve sequentially next year as measured by gross margin expansion and the number of top 25 brands growing market share. As we operationalize and execute our new strategy to significantly improve our financial performance, we have been laser-focused on implementing the organizational, operational and cultural changes required to strengthen the Company’s front-end consumer-facing capabilities while harnessing the scale and power of One Newell. While the path forward will not be a straight line, we remain confident Newell’s financial performance will improve and significant value will be created over time for our stakeholders. I would like to thank our leaders and employees for their hard work, perseverance and dedication amidst significant organization changes and for their unwavering commitment to our purpose of delighting consumers by lighting up everyday moments. I’ll now hand the call over to Mark.

Thanks, Chris. Good morning, everyone. In the third quarter, both net sales and core sales dropped around 9%, primarily due to ongoing macroeconomic challenges we've faced since last year's third quarter. On a brighter note, we made notable strides in enhancing the structural economics of the business during Q3, with Newell's normalized gross margin increasing by 170 basis points compared to last year and 140 basis points sequentially to 31.3%. A contribution of 500 basis points from fuel productivity savings and substantial pricing actions implemented across about 30% of our U.S. operations, mainly in the home and commercial sectors, more than compensated for the tough headwinds caused by inflation and fixed cost absorption. Despite the team's impressive productivity efforts and strong savings from Project Phoenix of $49 million this quarter, normalized operating margin decreased by 220 basis points from last year to 8.2%. The main reason for the reduction in the third quarter's normalized operating margin was higher incentive compensation charges. As you may recall, incentive compensation was significantly lowered during Q3 last year, complicating comparisons for the current period. In the third quarter, net interest expense rose by $12 million from last year to $69 million solely due to increased interest rates, as net debt decreased by nearly $500 million year-over-year and by almost $400 million year-to-date. We captured the discrete tax benefit originally expected in the fourth quarter during the third quarter, resulting in a normalized tax benefit of $73 million, which, combined with the other elements discussed, led to normalized diluted earnings per share of $0.39 and a notable upside in normalized earnings per share compared to the previous outlook of $0.20 to $0.24. Now, regarding operating cash flow, effective inventory management enabled us to generate $679 million of positive operating cash flow year-to-date through the third quarter. This shows a considerable improvement from a $567 million cash outflow during the same timeframe last year. Thus, through the first nine months of 2023, operating cash flow increased by over $1.2 billion, an impressive feat for which Chris and I thank Newell's dedicated planning, sourcing, and production teams. As anticipated, the Company's leverage peaked at 6.3 times at the end of Q2 before improving sequentially, ending the third quarter at 6.1 times. We are surpassing our cash flow expectations and reducing debt, expecting further enhancement in the leverage ratio in Q4. Looking ahead, we are committed to achieving investment-grade status and targeting a leverage ratio of about 2.5 times. For the fourth quarter, we anticipate net sales between $1.96 billion and $2.03 billion, with both net sales and core sales projected to decline by 14% to 11% from last year. Gross margin is expected to be significantly higher than last year's fourth quarter due to our targeted efforts to enhance the business's structural economics. In terms of SG&A expenses, we expect a decrease in dollar terms compared to last year due to Project Phoenix savings and control of discretionary spending, although SG&A as a percentage of sales will likely increase because of lower sales and, to a lesser extent, our investments in consumer and customer understanding, revenue growth management, data analytics, and retail execution, among others. Consequently, the fourth quarter's normalized operating margin is forecasted to be between 7.8% and 8.8%, reflecting a 290 to 390 basis-point improvement from last year. Therefore, Q4 is anticipated to represent a significant turning point in the Company's operating profit, with the midpoint of the forecasted range indicating nearly 50% growth compared to last year. Lastly, for Q4, we predict interest expenses to rise year-over-year, a tax rate in the high teens, and normalized earnings per share between $0.15 and $0.20. For the entire year, we estimate net sales in the range of $8.02 billion to $8.09 billion, primarily due to a core sales decline of about 13%. We expect normalized operating margin to be 7% to 7.3%, considering the negative top-line flow-through and earlier discussed capability investments. Interest expenses are expected to increase significantly compared to last year, with a normalized tax benefit in the teens, reflecting the sizable tax advantage realized in Q3. Normalized diluted earnings per share are now projected to be in the $0.72 to $0.77 range. At the year's beginning, we established cash generation as our top priority. We are pleased to raise our cash flow outlook for the year based on our strong performance year-to-date, despite tempered top-line expectations and earnings per share estimates. We now expect to generate operating cash flow between $800 million and $900 million, including $95 million to $120 million in cash payments related to Project Phoenix, which is on track for $140 million to $160 million in pretax savings this year. At the midpoint of our projection, operating cash flow has improved by over $1.1 billion year-over-year, with free cash flow productivity projected to exceed 100%. While next year’s planning process is still very early, we wanted to share some high-level thoughts. Meaningful improvement in top-line run rate is anticipated on a sequential basis, although 2024 core sales are still expected to decline due to continuing macroeconomic challenges and rebuilding front-end capabilities. This preliminary sales outlook aligns with comments made at the Deutsche Bank conference in June, where we indicated that core sales growth would fall below our evergreen target of low single-digit growth over the next 12 to 18 months. Currency fluctuations, driven by current exchange rates and planned brand exits, may further reduce net sales by 2 to 3 points. Notably, we expect substantial gross margin improvement next year, supported by productivity savings, carryover pricing benefits, fewer excess and obsolete charges, and an improved product mix. This should enable operating margin growth beyond the 50 basis-point evergreen target while we continue investing in front-end capabilities. Interest expenses are expected to increase slightly in 2024, and we are currently planning for a normalized effective tax rate of around 17%, which would pose a significant headwind to earnings per share year-over-year. Regarding cash, we will share more details as we progress in our planning process, but for now, we affirm that cash will remain a key focus for us. In conclusion, there are two main takeaways from today’s call. First, we are making solid progress on implementing our integrated corporate, business unit, functional, and brand strategies, informed by a thorough company-wide capability assessment. We now have clear decisions on where to focus our efforts and how to succeed, allowing us to effectively pursue our major pivot in consumer-facing capabilities. Second, Newell is meeting its two key financial priorities, gross margin and cash flow, established for 2023, despite greater-than-expected macro-driven pressures. Specifically, we are strengthening the underlying structural economics of the business, with gross margin improving both sequentially and year-over-year, along with further improvements expected in Q4 and next year. Furthermore, we have intensified our focus on controllable actions, resulting in over $1.2 billion improvement in operating cash flow year-to-date.

Thank you. 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. Have a great day.