Earnings Call Transcript - REYN Q2 2022

Operator, Operator

Greetings and welcome to Reynolds Consumer Products, Inc. Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mark Swartzberg, Investor Relations. Please go ahead, sir.

Mark Swartzberg, Investor Relations

Good morning and thank you for joining us for Reynolds Consumer Products Second Quarter 2022 Earnings Conference Call. On the call today are Lance Mitchell, President and Chief Executive Officer; and Michael Graham, Chief Financial Officer. For our agenda today, Lance will focus on market conditions and our fundamentals, and Michael will review our quarter and outlook. Together, our remarks will be approximately 20 minutes. Then we will open it up for your questions. During the course of this call, management may make forward-looking statements within the meaning of the Federal Securities laws. These statements are based on management's current expectations and involve risks and uncertainties that could cause actual results and outcomes to differ materially from those described in these forward-looking statements. Please refer to Reynolds Consumer Products Annual Report on Form 10-K and other reports filed from time-to-time with the Securities and Exchange Commission and its press release issued this morning for a detailed discussion of the risk that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note management's remarks today will focus on non-GAAP or adjusted financial measures. A reconciliation of GAAP measures to non-GAAP financial measures is available in the earnings release posted under the Investor Relations heading on our website at, reynoldsconsumerproducts.com. The company has also prepared a few presentation slides and additional supplemental financial information, which are posted on Reynolds website under the Investor Relations heading. This call is being webcast and an archive of it will also be available on the website. While we would like to answer all your questions during the question-and-answer session, in the interest of time, we ask that you ask one question and a follow-up, and rejoin the queue if you have additional questions. And now, I'd like to turn the call over to Lance Mitchell.

Lance Mitchell, CEO

Thank you, Mark. We delivered another quarter in line with our earnings expectations and what continues to be a very dynamic environment. First half and second quarter highlights include continued share strength across our business, share gains in branded waste bags, branded disposable tableware, and multiple cooking and baking categories. A return to shipments aligned with consumption. Further narrowing of the price to cost gap across most of our business, including a further improvement in waste bag profitability. Delivery and expansion of Reyvolution savings. A substantial slowdown in foil consumption has been challenging. However, category declines have been moderating since late June. Our branded volume share is growing again and a number of corrective actions are underway to address this issue. In addition, lower cost inventory has a positive impact on foil margins as we head into the holiday season. I will go into our foil plans and other revenue drivers in a moment. But before I do, I want to highlight a few things about the environment and our unique advantages and position within it. Our category advisors are diligently working with our retail partners to support our categories and drive traffic. And as you would expect, consumer behavior during these dynamic times is top of mind. That means we are having numerous discussions about the optimum balance of brands and private label, promotions, pack sizes and features and displays. I also want to point out that our price leadership and the cumulative value of our pricing actions, together with declines in aluminum and polyethylene rates are producing a closer alignment between price and cost, which we have been pursuing since late 2020. This translates into anticipated margin expansion and earnings growth in the fourth quarter and a significant increase in flexibility to invest in trade, advertising and other category drivers as we plan for the holidays in next year. Michael will elaborate on that shortly. Now, let's talk about our main drivers of growth, pricing, consumer demand, innovation and manufacturing and supply chain capabilities. In the area of pricing, we began increasing foil promotions in June, motivated by the historically strong impact of promotions and we are encouraged by the consumer and retail response. We are implementing additional promotional activity over the balance of the year, including a substantial step-up in October in order to drive holiday related demand. We've announced another round of pricing for our tableware products to offset the additional cost increases for polystyrene resin and an additional increase for Hefty brand waste bags. In terms of elasticity, the foil category is demonstrating the largest increase in elasticity prompting many of our actions. Our other categories are also seeing increased elasticity by comparison to what we were seeing earlier in the year and we are watching them all closely. Changes in consumer consumption in our categories has been more dynamic than we have seen historically. We will continue to respond with corrective measures. Turning to consumer demand, as you know our products are in 95% of U.S. households and we have benefited from the changes in habits triggered by the pandemic. We've been meeting these changes in habits and as I said earlier, we are uniquely positioned to respond to new opportunities as economic conditions change. We rely on consumer market research, which allows us to better understand who is driving our categories and their needs. We stepped up at these capabilities during the pandemic and made a number of discoveries. For example, an increased portion of men and younger consumers are more active in the kitchen at home than they were prior to the pandemic. That's a major opportunity in any economic environment. But here are a few examples of how we're responding to it in this environment. In foil, as I said, we're stepping up promotions, allowing us to hit lower retail price points and increase purchase frequency. We're also increasing features and displays to drive usage and targeting advertising to reach younger consumers. In Waste & Storage, we're seeing strong back-to-school demand in branded and private label products and driving the Hefty brand through innovation, larger pack sizes, distribution gains and additional advertising. In disposable tableware, we're driving party cups with a particular emphasis on the club channel. The third driver of our growth is innovation. Our standout innovations continued to be Hefty Fabuloso and Hefty ECOSAVE. Each of which continues to demonstrate high velocity, while also gaining distribution. Other notable contributors in the quarter and year-to-date include new Hefty Fabuloso 4-gallon and 8-gallon waste bags for use in additional rooms of the house and private label waste bags with odor control. Hefty Fabuloso and Hefty ECOSAVE are delivering as major platforms for innovation and we plan to expand them. And in terms of new innovation, we just introduced Hefty Compostable Printed Paper Plates, Reynolds Kitchen Compostable Wax Paper and other Reynolds innovations are in the pipeline and we plan to introduce a wide range of branded and private label products offering sustainable solutions that are wins for consumers, retailers and RCP alike. Our fourth driver is manufacturing and supply chain capabilities. Staffing and supply chain conditions continue to be challenging, but they are stabilizing and much improved versus late 2020 and 2021 levels. Before I pass the call to Michael, I'd like to leave you with the following. We're well-positioned for changing economic conditions and we're responding with promotions, pack sizes, advertising and other pieces of the marketing mix to meet our consumers' increased emphasis on affordability. The gap between our pricing and material manufacturing and logistics cost increases is nearly closed, and we are on course for margin expansion and earnings growth in the fourth quarter and 2023. This means not only a return to earnings growth, but also increased flexibility to invest in our categories and drive future innovation and consumption. We are executing with excellence in our mission to simplify daily life so consumers can enjoy what matters most. I'm extremely proud of the RCP team as we navigate through these dynamic times. We are well-positioned to realize the benefits of the actions we've taken over the last two years. With that, over to you, Michael.

Michael Graham, CFO

Thanks, Lance. And good morning, everyone. I'll briefly review our second quarter results, then I'll turn to our guide and why we are well-positioned for margin expansion in the fourth quarter and 2023. Net revenues in second quarter were $917 million, an increase of 5% over second quarter net revenues of $873 million in 2021, primarily driven by price increases and partially offset by a decline in volume. Adjusted EBITDA for the second quarter was $118 million, down 20% versus last year's second quarter of $148 million, driven by lower volume, primarily due to declines in foil consumption as well as higher materials, manufacturing, logistics and advertising costs. Significant price increases across our entire portfolio offset all material cost increases and a large portion of increases in manufacturing and logistics costs. We expect to close the remaining gap between price and materials manufacturing and logistic cost increases in third quarter and to see an additional margin benefit in the fourth quarter driven by anticipated progressive easing in aluminum cost and implementation of additional pricing. Adjusted earnings per share for the quarter was $0.26. Turning to our segment performance, details are in our press release and 10-Q. So let me give you the highlights. The 5% increase in net revenues was driven by low to mid-teen increases in pricing in each of our business segments, which was partially offset by a 9% volume decline driven by Reynolds Cooking & Baking and to a lesser extent declines in two other segments. Our overall price increase of 14% is consistent with the year-to-date increase of 13% and reflects our effectiveness in recovering on material cost increases and a large portion of increases in our manufacturing and logistics cost in the second quarter. As you know, in May we expected a mid-to-high single-digit volume decline in the second quarter, and as Lance reviewed, slowing foil consumption was a substantial headwind in the quarter. The 19% decline in Reynolds Cooking & Baking volume also reflected a decline in low-margin reroll volume and an additional headwind from timing of retailer replenishment early in the quarter. Whereas volume declined 3% in Hefty Waste & Storage driven by lower waste and food bag usage as consumers are spending less time in their homes and as Lance mentioned, branded waste bag volume and dollar shares are up in the first half. Volume was flat in Hefty Tableware as gains for Hefty disposable plates and private label party cups were offset by declines in other disposable tableware and Presto products volume declined 7%, driven by lower waste in food bag usage. Turning to our outlook for the third quarter of fiscal 2022, we expect net revenues to grow 8% to 12% or $905 million in prior year, driven by price increases and a low to mid single-digit volume decline. Adjusted EBITDA of $110 million to $120 million and adjusted EPS to be in the range of $0.21 to $0.25 per share. For the fourth quarter of fiscal 2022, we expect net revenues to grow 9% to 17% or $1,021 million in the prior year, driven by price increases and flat to slightly down volume. Adjusted EBITDA of $220 million to $240 million and adjusted EPS to be in the range of $0.59 to $0.66 per share. For the fiscal year 2022, we now expect net revenues to be up 8% to 11% on $3,556 million in 2021, driven by price increases and a mid-single-digit volume decline, including the impact from timing of retailer inventory replenishment, primarily in the first quarter of this year. Adjusted EBITDA of $560 million to $590 million, adjusted EPS to be in the range of $1.32 to $1.43 per share and net debt to be $1.9 billion to $2 billion at December 31, 2022 and as a reminder, our capital allocation priorities are unchanged. As Lance said, elasticities have picked up, particularly in our foil business. And so those assumptions are reflected in our guide, we continue to closely monitor elasticities and how they may change in other categories given the inflationary environment.

Lance Mitchell, CEO

In terms of other key assumptions, we assume rates for key commodities are stable-to-easing by comparison to end of July levels and estimate incremental cost pressures of approximately $525 million for the year, which is a $75 million increase by comparison to our expectations, we reported in the first quarter results. We estimate depreciation and amortization of $120 million for the year, interest expense of $70 million and an effective tax rate of 25% and a capital spending of $135 million to $145 million, down from our previous estimate of $150 million to $170 million, driven by extensions and timing of select capacity and other investments. In terms of phasing, our incremental pricing and costs comparisons have us positioned for substantial margin expansion that we expect in the fourth quarter. As I just reviewed, first-half results reflect a narrowing of the gap between pricing and cost increases. We expect that trend to continue in the third quarter and for our implemented pricing to fully offset increases in materials, manufacturing and logistics costs. We also expect SG&A to be up in the third quarter versus prior year, due to increases in variable compensation and advertising costs. As we enter the fourth quarter, we expect to see progressive easing of aluminum costs, driven by existing inventory positions and fourth-quarter gross margin is expected to also benefit from the implementation of recently announced pricing. Now before I hand the call back over to Mark and your questions, I want to leave you with a few thoughts on recovery of pre-pandemic profitability. We anticipate achieving pre-pandemic levels of profitability in 2023. We estimate this to be in the mid-$900 million, when adjusting to current volume levels, compared to pre-pandemic gross profit of $880 million. We expect closing of the gap between pricing and cost increases, as I discussed when reviewing the guide, to be a major catalyst. In addition, as Lance mentioned, the cumulative value of our price increases is significant. Together with our category leadership position and the anticipated easing of commodity costs, we expect this will allow us to increase category investment, while also gaining additional margin. And we are expanding Reyvolution cost savings based on a comprehensive business review, identifying and targeting additional procurement, manufacturing and logistics savings, giving us added scope for investment in margin growth. In closing, we continue to manage through a very challenging environment. I'm encouraged about the actions we've taken as well as the implications for the future results. And with that, I'll hand the call back over to you, Mark.

Mark Swartzberg, Investor Relations

Thanks, Michael. As I turn it over to the operator for your questions. I'd like to remind you that we ask that you ask one question and a follow-up and then rejoin the queue if you have additional questions. Operator?

Operator, Operator

At this time, we will be conducting a question-and-answer session. Our first question comes from Kaumil Gajrawala with Credit Suisse. Please proceed with your question.

Theo Brito, Analyst

Hi, this is Theo Brito for Kaumil. So you're now guiding to volumes to be down mid-single digits this year. Can you maybe just remind us what was your expectation before and more importantly, what gives you confidence in the new volume outlook, please? Thank you.

Lance Mitchell, CEO

So the answer to the first question was down low-single digits. And what gives us confidence in our new volume guide is, this is a very dynamic environment. And as I mentioned in the prepared remarks, elasticities have picked up in much of our business, particularly in foil. But as I also said, in our remarks, our category advisors are actively addressing changing consumer needs with our retail partners and we're seeing an encouraging response to corrective actions in the foil category. Specifically, we have maintained all points of distribution that have historical share position. Our category declines have begun moderating and we're regaining volume share as we've picked up these promotions. The EQ volume for 12 weeks ending June 26 for Q2 essentially, the category was down 12.2% and Reynolds Wrap was down 15.6%. The EQ volume for the four weeks ending July 31, the category is down 5.6% and Reynolds Wrap down 4.4%. We plan to continue increasing foil promotions, features and displays through year-end, including a substantial pickup in October to take advantage of lower foil costs and holiday related demand. And after many months of lagging Reynolds Wrap price increases, we've seen private labels begin taking prices up. And some of the other drivers in our other three business units, we expect our performance in the club channel, which is strong to continue, and that's particularly important for tableware. Hefty Fabuloso continues to gain momentum with new distribution and the introduction of multiple new pack sizes. We are stepping up advertising across our portfolio of Hefty Waste & Storage products and evaluating increases in promotions and we're also introducing new low-price-point packs for above sizes and additional value-pack sizes. The changes in consumer consumption in our categories has been more dynamic than we've seen historically, and we're continuing to watch it very closely and we will continue to respond with corrective measures.

Operator, Operator

Our next question comes from Lauren Lieberman with Barclays. Please proceed with your question.

Lauren Lieberman, Analyst

Great. Thanks. Good morning, everybody. I still just wanted to go back to the reason for the lowered EBITDA and earnings outlook for the year, because the conversation on, yes, the volume declines in foil are worse. But we've talked about this before and that you would turn the promotion on and then you called out the higher cost basket. I'm just curious the sources of that big change, because it just feels like 3Q is a little bit of a shock and I frankly thought there was maybe a little bit more visibility, inherent in the business model. So I'm curious mostly about 3Q? Thanks.

Michael Graham, CFO

Yes. So the main driver of our guide down is lower volume expectations as we are in a more inflationary environment and therefore elasticities have gone up. We estimate approximately 3 points less volume than we previously expected. Those 3 points represent about $40 million of loss contribution margin that's all the $40 million decline in adjusted EBITDA. And when you look at the lower end of our guide of $615 million and the midpoint of our current guide of $575 million. So in terms of the third quarter EBITDA, in terms of volume, as Lance said we're in a dynamic environment. Elasticities have picked up in all of our categories, particularly in foil, but as we look at the commodity curve, the value of the pricing we've implemented and we are expecting a significant increase in earnings in Q4 relative to Q3 as a result. Specific to Q3, in aggregate, the year-over-year benefit of pricing in Reyvolution is fully neutralized, cost increases year-over-year. With the other segment compensating for Reynolds business, where we are still working through some of the higher cost aluminum. So that has to be worked through in subsequent quarters. So this leaves volume in SG&A. We expect volume declines in the range of low to mid single digits, which is a headwind, but there are some offsetting margin benefits from improved innovation. As an example, Hefty waste bags, Fabuloso. We've also have the Reynolds Kitchens have performed very well and we're expecting the same moving forward. So year-on-year the decline really boils down to higher SG&A with most of our total year-over-year increases falling in the back half. The key drivers are increased advertising and market research and higher compensation costs, some of which is timing related.

Lauren Lieberman, Analyst

Okay. To take a step back, the volumes in foil or cooking and baking were worse than expected in the second quarter, which caused a delay in the timeline for moving through some of that higher cost inventory through the profit and loss statement.

Michael Graham, CFO

You got it.

Lauren Lieberman, Analyst

Okay, okay. And then the SG&A piece that you were saying, Michael, I'm sorry. I was still my brain was spinning on the inventory piece. So there's also some higher SG&A that you've built in, because you're investing more than you've maybe previously planned?

Michael Graham, CFO

Yes.

Lauren Lieberman, Analyst

Yes. Okay, great. For the fourth quarter, you will see margin expansion due to the timing returning to the original plan for transitioning to the lower-cost inventory and the additional pricing adjustments.

Michael Graham, CFO

So let's just go back to the SG&A point.

Lauren Lieberman, Analyst

Sure.

Michael Graham, CFO

The year-over-year decline was down to higher SG&A with most of that total year-over-year increase falling in the back half, right? The key drivers are increased advertising and market research and higher compensation costs.

Lauren Lieberman, Analyst

Okay. All right. Great. Okay. I'll leave it there, pass it on. Thank you. I'm fine. We can follow-up offline too, thanks, guys.

Michael Graham, CFO

Okay. Thanks, Lauren.

Operator, Operator

Our next question comes from Robert Ottenstein with Evercore. Please proceed with your question.