Whirlpool Corp /De/ Q3 FY2022 Earnings Call

Thank you, and welcome to our third quarter conference call. Joining me today are Marc Bitzer, our Chairman and Chief Executive Officer; Jim Peters, our Chief Financial Officer; and Joe Liotine, our Chief Operating Officer. Our remarks today track with a presentation available on the Investors section of our website at whirlpoolcorp.com. Before we begin, I want to remind you that as we conduct this call, we'll be making forward-looking statements to assist you in better understanding Whirlpool Corporation's future expectations. Our actual results could differ materially from these statements due to many factors discussed in our latest 10-K, 10-Q and other periodic reports. We also want to remind you that today's presentation includes non-GAAP measures. We believe these measures are important indicators of our operations as they exclude items that may not be indicative of results from our ongoing business operations. We also think the adjusted measures will provide you with a better baseline for analyzing trends in our ongoing business operations. Listeners are directed to the supplemental information package posted on the Investor Relations section of our website for the reconciliation of non-GAAP items to the most directly comparable GAAP measures. We have also provided additional information related to inventory, demand and fixed costs that will not be regularly provided or updated in future quarterly earnings materials. At this time, all participants are in a listen-only mode. Following our prepared remarks, the call will be open for analyst questions. As a reminder, we ask that participants to ask no more than two questions. And with that, I'll turn the call over to Marc.

Thanks, Korey, and welcome, everyone, to our third quarter earnings call. As you can see from our agenda on Slide 4, we plan to discuss today more than just our third quarter results. We are operating in unprecedented times, and we do feel it is necessary and helpful for investors to broaden the time horizon of today's call beyond Q3 and take a step back to reinforce our long-term strategy as well as our perspective on favorable mid- and long-term consumer demand trends. In the first agenda item, we will discuss the Q3 results in detail. You will see that short-term consumer sentiment and consumer demand are clearly reflective of a recessionary environment. While at the same time, input costs which you would expect to come down in a recessionary environment are still elevated. Needless to say, that this combination impacted our Q3 negatively. In the second agenda item, we will show you that Whirlpool has a strong track record of successfully managing through cycles. We're laser-focused on ensuring we have the strongest business irrespective of rapid changes in the macro environment. We have, and we will continue to take action early and decisively, and we have done so again this quarter. Beyond the current recessionary challenges, we strongly believe in the favorable mid- and long-term demand tailwinds in particular in North America. And our business is very well positioned to win in this attractive post-recession setup. We will cover this in the third agenda item. And finally, in the fourth agenda item, I will provide an update on our portfolio transformation, which is well underway as we continue to move towards a high-growth, high-margin business. But first, I'll turn it over to Joe to review our third quarter results in more detail.

Thanks, Marc. Turning to Slide 5. Our performance this quarter was impacted by significant industry declines and elevated cost inflation that is now leveling off. In key countries across the globe, we saw double-digit demand declines. In response, we aggressively reduced our inventories by $300 million compared to the second quarter with a 35% reduction in global production. Needless to say that this volume deleveraging impacted our Q3 results negatively. We do consider our inventories to now be very well balanced. We delivered ongoing EPS of $4.49 and ongoing EBIT margin of 5.5%, with approximately 10% EBIT margins in North America. While these results are below our expectations, we remain confident that we have the right strategy and actions in place and are well positioned to deliver strong performance and shareholder returns. Now turning to Slide 6. I will give more context on the magnitude of the industry decline by country. Across our key marketplaces, we faced market contractions of 10% to 25% during the quarter and expect similar declines in most countries as we move through the fourth quarter. In the U.S. and throughout the world, consumer sentiment has been impacted by inflation and increasing interest rates, and the ongoing war in Ukraine and weakening currencies have further weighed on demand. Turning to Slide 7. You will see the impact of proactive steps taken to reduce inventories. We lowered our inventory by $300 million from Q2 levels despite the significantly reduced shipment volumes within the quarter. In total, we reduced production volumes 35% in the quarter. To put this in context, this is pretty much the same level of production as Q2 2020 when we were faced with global COVID shutdowns. Even though painful within the quarter, we are now much better positioned to manage near-term demand fluctuations. Turning to Slide 8. In addition to managing our inventories, in response to industry decline, we are also experiencing elevated and persistent levels of inflation. Over the last two years, we've absorbed $2.7 billion of inflation across our entire value chain, thus increasing our cost of goods sold by well over 10%. We experienced increases in raw materials, freight and logistics costs and more recently, energy costs. Aligning inventories with softer market demand was also a factor contributing to our performance. As expected, inflation peaked in the quarter and will remain elevated. We do expect cost inflation to persist throughout the first half of 2023, with costs moderating in the second half of 2023. Despite historically high inflation and market headwinds across the globe, Whirlpool remains well positioned to capitalize when the macroeconomic environment normalizes. Turning to Slide 9. We show the drivers of our third quarter EBIT margin. We continue to deliver a strong price/mix of 550 basis points with previously announced cost-based price increases and slightly increased promotional activities that will continue into the fourth quarter. We responded to accelerated industry declines, and we are prepared for the upcoming holiday season. While we successfully reduced inventory, the associated volume deleveraging alongside continued elevated logistics and energy costs drove a 325 basis point impact in net cost. Raw material inflation was as expected and negatively impacted margins by 750 basis points, and we begin to see cost actions gaining traction with reduced marketing and technology spending, which was more than offset by the impact of foreign currency as the U.S. dollar strengthened during the quarter. Overall, we delivered an ongoing EBIT margin of 5.5%. Turning to Slide 10. I'll review results for our North American region. As we continue to optimize our supply network, improving availability, we saw slight sequential share gains in the quarter. However, our revenues were down 8%, driven by weaker demand. We did aggressively reduce production levels to rebalance our inventory levels. This temporary volume deleveraging and related operating inefficiencies, in addition to continued inflationary pressures negatively impacted our margins for the quarter. Even with these challenges, the region delivered approximately 10% margins. Looking forward, we are excited about the unique opportunity to add InSinkErator to our portfolio of leading brands and expect the transaction to close on October 31. This acquisition is a clear accelerator of our ongoing portfolio transformation and delivering on our commitment to investing in high-growth, high-margin businesses. We continue to remain confident in the strength of our North American business. Turning to Slide 11. I'll review results for our Europe, Middle East and Africa region. As part of our portfolio transformation, we completed the sale of our Whirlpool Russia business on August 31. Revenue was negatively impacted by 11 points of foreign currency. Excluding Russia and the impact of foreign currency, revenue was down approximately 8%. The region's cost-based pricing actions were more than offset by lower volumes and cost inflation as consumer sentiment continues to be impacted by the war in Ukraine and inflation, resulting in a negative EBIT margin of 3.1%. Marc will provide an update on the strategic review of our EMEA business later in the call. Turning to Slide 12, I'll review results for our Latin America region. The region saw significant demand declines and continued inflation more than offsetting our cost-based pricing and cost actions. Despite these negative impacts, the region delivered more than 5% EBIT. Turning to Slide 13, I'll review results for our Asia region. Excluding the impact of currency, revenue declined 1%. Cost-based pricing actions were more than offset by inflation, ultimately leading to an EBIT margin of slightly below 5%. Now, I'll turn it over to Jim to discuss our full year 2022 guidance.

Thanks, Joe. Now turning to Slide 14, I'll review our updated guidance for 2022. We expect to deliver fourth quarter EBIT similar to Q3. As a result, we have revised our full year ongoing EPS guidance to approximately $19. We have reduced industry expectations for all regions, except Asia, reflecting the continuation of trends we experienced during the quarter. We now expect a revenue contraction of approximately 9% and ongoing EBIT margin of approximately 7.25% for the year, with North America margins of 12% plus for the full year. We expect to generate free cash flow of approximately $950 million or around 4.75% of net sales. While we have revised our guidance to reflect the current macro environment and expect many of these trends to continue through mid-2023, we remain committed to our long-term goals to drive profitable growth of 5% to 6%, ongoing EBIT margin expansion of 11% to 12% and cash conversion of 7% to 8% free cash flow. Turning to Slide 15, we will discuss the drivers of our 2022 free cash flow. We now expect to generate free cash flow of approximately $950 million compared to our previous guidance of $1.25 billion. With cash earnings of approximately $1.6 billion, we expect to continue to invest in our products and fund organic growth by unlocking capacity constraints and launching innovative products. These investments are in line with our target for capital expenditures of approximately 3% of net sales. Additionally, we lowered our working capital expectations, reflecting the previously discussed inventory reduction actions. Lastly, our expectation remains unchanged as we anticipate minimal cash outlays related to restructuring as these actions have been largely completed. Now, I'll turn it over to Marc to provide our perspective beyond 2022.

Thanks, Jim. I want to spend a bit of time to demonstrate our strong track record of successfully operating for various economic cycles. Turning to Slide 17. You see that when faced with inflation across the board from materials to logistics and energy, we have responded early and decisively with cost-based pricing actions. Our strong execution of seven cost-based pricing actions and smart value-creating promotional activity has driven positive price/mix in nearly every quarter since 2019. Turning to Slide 18, I will discuss our significantly reduced fixed cost base. This chart shows the total of our SG&A factory and logistics costs over the past six years. Despite the inflation, which we also experienced in parts of our fixed costs, such as logistics or salaries, we've been able to reduce the fixed cost by approximately $700 million or around 3% net reduction every year. In response to the current macroeconomic challenges, we have initiated over a $500 million cost takeout program that will further reduce our fixed and variable costs in 2023. As a result of these actions, we have drastically reduced our breakeven point, which will benefit us once industry volumes recover from current temporary weakness. It is an important step in structure improving our long-term margins. And as mentioned before, Whirlpool has a history of proactively responding to challenges we are facing, particularly during these past years. We've usually been successful in managing through the headwinds over the past years as evidenced by the financial results as shown on Slide 19. Our multiyear financial performance shows our structure improved business with expanding EBIT margins, significant EPS growth and strong ROIC. Our ongoing EBIT margin has improved with a compound annual growth rate over 4% and our ongoing earnings per share with a compound annual growth rate of approximately 13%, alongside strong returns on invested capital with a six-point improvement since 2010. Now turning to Slide 21. I want to address how we are well positioned to benefit from long-term demand tailwinds. While we are experiencing short-term demand softness, we're at the same time, very optimistic about the mid- and long-term demand trends, particularly in North America. Let me start by giving you a more detailed perspective on the U.S. appliance demand. As discussed in previous earnings calls, it has two fundamental components: replacement demand, which currently represents 55% of our total market; and discretionary demand. With the trough of a 2008 to 2011 replacement cycle now behind us, replacement demand has been very stable and even growing. We do expect further momentum on the replacement side of the demand due to a significantly increased appliance usage over past years as evidenced in the data from our connected appliances. What has still not fully recovered from the great recession in 2008 is the discretionary demand side, which ultimately is driven by the housing market. Moving to Slide 22, you can clearly see a strong connection between existing home sales and overall appliance demand. Existing home sales were slowly recovering from the great recession, but still haven't reached prerecession levels. At the same time, overall appliance demand is also slowly recovering to essentially prerecession levels. Turning to Slide 23, we show the same data in a bit of a more granular view as well as our prediction over the next two years. Obviously, existing home sales declined sharply in 2022, reflecting the mortgage rate shock, keeping both new buyers away from the market as well as keeping prospective sellers from selling due to existing fixed mortgage rates, which are significantly lower than current mortgage rates. However, that doesn't change the fact that there's compounded pent-up demand for millennials as they reach prime homebuying years. We do expect home price appreciation to slow down and housing inventory to slowly improve to more historic levels. Ultimately, existing home sales are expected to return to historical averages of above 6 million units per year. Now turning to Slide 24. I will share my perspective on new housing in the U.S. and its impact on Whirlpool. New housing contributes approximately 15% of appliance demand in the U.S. New housing construction has significantly lagged historical averages for more than a decade. For perspective, consider this: from 1968 to 2008, a 40-year span, there was only one year in which fewer than 1.2 million new housing inventory was built. However, much of the period between 2010 and 2017 saw levels below this, leading to the oldest U.S. housing stock in the country's history. In total, we estimate an undersupply of housing of approximately 3 million to 4 million units. While we do not expect new housing to reach what we call steady-state supply of 1.7 million to 1.9 million units in 2022 or 2023, we do expect 2024 to show meaningful progress towards this level. Turning to Slide 25. I will share some perspective of our major appliance business outside of the U.S. We expect to win in the Americas and accelerate our growth in India. India, in particular, has a very long runway for growth due to favorable demographics and a still very low client penetration rate. We also fully expect to capture replacement demand with our strong share positions in Canada, Brazil, and Mexico. In India, we recently expanded our offering with a majority stake in Elica of India in '21, and we just started the production of frontload washers in India, and we intend to continue investing in this business. Combined with the best portfolio of brands, including Consul and Brastemp, each generating $1 billion in sales in Brazil, we are well-positioned outside the U.S. Let me now move on to our last item and discuss our progress on our portfolio transformation towards a higher margin and higher growth business. As you can see on Slide 27, these efforts have been underway for some time. Since 2018, we have executed multiple steps to streamline and optimize our portfolio and are excited to add the InSinkErator business to our portfolio. On Slide 28, I will remind you of the three strong pillars that will accelerate our portfolio transformation towards a higher margin and higher growth business. Our global small appliance business and our commercial appliance business both delivered strong margins of over 15%. The addition of the InSinkErator has taken yet another significant step to strengthen our major appliance business, specifically in North America, bringing the iconic brand to Whirlpool. InSinkErator is the largest manufacturer of food waste disposals and instant hot water dispensers with more than 70% of the U.S. industry, adding approximately $1.25 EPS accretion in '23. As Joe mentioned, we expect the acquisition to close on October 31. We expect to continue to invest in building Whirlpool as a higher growth and higher margin business while delivering significant shareholder returns. Now turning to Slide 29. I will provide an update on the strategic review of our EMEA business. We have been assessing a number of options for our business to maximize long-term value. We have two guiding principles as we navigate this review: one, what creates the most value for Whirlpool Corporation; two, what is required for future success in Europe. We received significant interest from a number of parties and narrowed the discussions to the final negotiations with two strategic investors. Given the confidential nature of these discussions, we are unable to share further details but will provide an update no later than our fourth quarter earnings call. Again, our focus is to ensure we have the strongest business for our shareholders and employees further supporting our portfolio transformation towards a high-growth and high-margin business. In parallel with reviewing external options, we also revisited our internal continuation plan. We have completed a pressure test of all our business segments and evaluated strategic alternatives. Additionally, we have worked diligently to develop a sustainable and attractive business case for our region. Ultimately, this will serve as a comparison and alternative path to any external option. Now let me close with a few remarks and turn to Slide 30. We have a proven track record of successfully operating through cycles. Despite the significant industry headwinds we're facing, we still expect 2022 to be the second best year in our 111-year history. We have the right strategy and actions in place to navigate the current environment. We've largely offset raw material inflation with decisive pricing actions. We have initiated cost actions which will deliver $500 million of benefit in 2023 and adjusted inventories to reflect the current demand. We are reiterating our long-term growth outlook, and based on the initiatives we are taking, we believe that Whirlpool will exit the current and temporary industry low and high operating margin. At the same time, we continue to advance our portfolio transformation, leaving us well positioned to continue to deliver strong shareholder value. Now, we will end our formal remarks and open it up for questions.

And your first question comes from Sam Darkatsh from Raymond James. Your line is open.

I have a couple of questions. The first concerns raw materials, and the second is about production. I was initially going to ask why the range of possible raw material inflation for the fourth quarter is so broad, but I assume it's mainly because you're not entirely certain what demand and production will look like. I'm more interested in your thoughts for 2023. In your prepared remarks, you mentioned that in the first half of 2023, you might see year-on-year inflation in raw materials. I'm confused about this, considering the steel contract resets and other factors. Could you provide more details or clarification regarding your expectations for raw materials next year?

So Sam, it's Marc. Let me start by addressing the raw materials, and then I'll have Joe discuss the production reductions and our thoughts on inventories. Regarding raw materials, you saw that in Q3, there was a significant impact of 7.5% on the EBIT margin. We believe that this impact has peaked in Q3, but Q4 is not expected to show notable improvement. There are two main reasons for this. First, spot prices haven't significantly decreased yet, although I want to stress the word "yet." Second, a large portion of our raw materials is covered by hedging contracts, especially for steel and plastics. So even if spot prices start to decline, the effects of those contractual terms won't be fully apparent immediately, but they will be in due time. To clarify, we're not saying raw material costs will increase; rather, we expect them to start easing. We anticipate a decrease in raw materials throughout the first half of the year, but the year-on-year change won’t be drastic. However, there will be more favorable comparisons in the latter half. We definitely expect a reduction in raw material costs in the first half, and we will provide more detailed information in our January earnings call regarding this topic.

Yes. Thanks, Marc. This is Joe. Related to production, we did see the industry a little bit softer than we had anticipated. So we made very decisive actions to right-size our production and ultimately our inventory to ensure we were in sync with where we saw the market developing. We expect that to continue into Q4. And so we took those actions in a short manner to make sure that we were right-sized and then ready for upcoming Q4 holiday promotions and the demand that we saw ahead of us. Those actions were pronounced, with a 35% reduction in production globally. So as I indicated in the prepared remarks, that's a level we had not seen historically. The other parallel would be early on in COVID, we took a similar amount of production out, just given all the things happening. So very pronounced, very decisive, but it got us a nice balanced position that we think we can go forward. But it responds to where we're going to be with the market.

Joe, why would you ramp production back up in the fourth quarter, at least I think that's what you're anticipating, based on demand still being weak and the need to retain as much price as you can in '23 once raws come off? I'm confused as to why you just took one big bite out of the apple as opposed to keeping production really modest until you start to see stabilizing trends.

Yes. Maybe that wasn't clear, saying what the intent was we right-sized in the quarter given the environment we're in, which is slightly worse than we anticipated from an industry standpoint, that got us to the right level. So from here on out, we'll essentially be more in sync and managing production with output as is more typical. And so, there isn't an assumption of a big ramp down or a big ramp up. That wasn't the implication. It was more about adjusting and synchronizing in Q3. And then now it's in sync with our expectations for Q4.

It's Marc. In Q3, we produced significantly less than we sold. In Q4, these numbers will be much more aligned. In North America, we will likely sell what we produce, with production slightly higher than in Q3, but we will be cautious not to overproduce. One of the reasons for the significant reduction in Q3 was to manage costs and avoid producing at a higher cost base, which we believe peaked in that quarter. Now that this operational adjustment is behind us, we are in a strong position to navigate the next couple of quarters.

And you want to add, Marc. That's true also globally. So, that phenomenon more of the characteristics are slightly different. Those themes are true globally, which is important given all the things that we've experienced.

Your next question comes from the line of Eric Bosshard from Cleveland Research. Your line is open.

Two things, if I could. First of all, the price/mix realization in the quarter was, I think, 200 basis points different than you expected 90 days ago. What changed to influence that different result?

This is Joe. We did experience improved availability, which allowed us to market our products more effectively than we initially expected. The intensity of our go-to-market strategy was greater than planned, influenced by our better availability and the emerging opportunities in the market. As a result, we found our efforts to be productive. Specifically in North America, we saw a slight increase in market share from Q2 to Q3 due to our availability and marketing strategy.

I understand the availability now. Could you elaborate on the go-to-market strategy? Specifically, I'm trying to determine if this involves more participation in promotions, a less aggressive stance on price increases, retailer pushback on these increases, or consumers opting for lower-priced options. Something has changed. While I appreciate the improved availability in go-to-market strategies, could you provide more details on this?

Yes. I mean there's obviously varied components in there. So there isn't just one answer for all things. But what I would say is there was some promotion involvement that we thought was accretive. So, we participated there. There were also some launches. We had a new dishwasher launch that came out. And so there were some investments behind some new innovations as well. But by and large, those were slightly different than the constrained environment, where we didn't have either of those two assets available to us.

Eric, maybe just adding to this one. First of all, again, that's why we also included the slides about the past price increases. We have now, in North America, but globally seven price increases behind us in a very short time period. So we certainly haven't been shy of passing on costs to the marketplace. What happened in Q3 and more specifically to your questions, yes, the market is slightly more promotional than, for example, a year ago or half a year ago. I also want to point out it's not comparable to pre-COVID periods. So it is more promotional, more promotionally elevated, and that's what we probably expect to see going forward. But you can't compare it to pre-COVID time. So, it's somewhere in between, and that's what we're just dealing with right now. The good news is we start seeing sequential share gains for our North America business.

Your next question comes from the line of Susan Maklari from Goldman Sachs. Your line is open.

Can you talk a little bit about the channel inventories, appreciating that you took drastic steps to align your businesses. But what are you seeing out in the channels?

What we're observing is a fairly balanced perspective across all of our channels. We don't think we're under-supplied or over-supplied. This is largely due to the adjustments we've made throughout 2022. A few quarters ago, we were still in constrained positions and were undersupplied, but that is no longer the situation. We believe we're in a good place across the channels overall, and we are well positioned as we exited Q3 with the adjustments we implemented. It feels like a positive situation to be in.

Okay. And then perhaps taking a bit of a longer-term approach. Can you talk a little bit about how we think of the North American margin being at that 10% this quarter? Relative to that longer-term target that you've set for us in the mid-teens range, what are the steps that we'll need to see in order to get back there? And is that still the right range as you think about where the consumer and where the business is?

Susan, it's Marc. From our perspective, there has been no change regarding the long-term structural margins in North America. When our North American business had margins around 17% to 18%, we believed that was slightly above what the long-term structural margin would be. Conversely, the current 10% margin does not reflect our structural margins due to two main factors. First, we have two significant macroeconomic cycles that are currently misaligned: demand is down while costs are up, which is a typical cost situation given the demand. Historically, such misalignments have occurred a few times over the last 20 years, but they typically do not last long; a situation this extreme is quite unusual and won't persist for much longer. Second, as Joe mentioned, the 35% production cut also applies to North America, leading to a substantial impact from a large fixed-cost business reducing that level of output. Taking these factors into account, we still anticipate returning to the structural run rate margins we previously communicated and firmly believe they remain attainable. In response to your question about what needs to occur, the main requirement is for external raw material costs to decrease and for us to implement further cost reductions internally. These are the key actions we are committed to in the next zero to 12 months.

Your next question comes from the line of Mike Dahl from RBC Capital Markets. Your line is open.

Marc, it's good to hear that InSinkErator is scheduled to close here just in the next couple of weeks. I was wondering if you could give us any insight on how that business is performing against this recent environment that you've seen in your core business? And how should we be thinking about the financial impacts that are embedded in guidance for the fourth quarter related to InSinkErator?

So Mike, let me provide a first answer and then I’ll ask Jim to share more of a financial perspective. First, we have not yet completed the transaction, which is expected to close on October 31. We are very confident that everything is on track. While we cannot fully disclose details, we have heard that the margins remain intact, which is good news. However, we are also observing a decrease in discretionary demand, and the nature of that business has a longer order pipeline. Overall, I would say we are seeing similar trends and taking similar actions, but the positive aspect is that the margins and market share are very strong. While the housing market is affecting everyone, InSinkErator is not exempt from these challenges. Nonetheless, we firmly believe this is a very healthy, strong, and sustainable business, and we are pleased that we expect to close the transaction in 10 days. Jim, feel free to share your thoughts on what we should anticipate for Q4 and beyond.

Yes, Mike, this is Jim. I think last call, we disclosed that we see for 2023, the impact of the InSinkErator business being about $1.25 per share. If you think about that, the two months that we will then be consolidating within the fourth quarter here would imply right around $0.20, but then also you will have some effects related to just how you account for an acquisition at the very beginning and a few things you may have to adjust or so. So that's probably the maximum amount you'd see. So, it's going to be a pretty immaterial impact to the fourth quarter. The bigger impact will be next year on a full year consolidated basis.

Okay, that's helpful. For my follow-up, it's somewhat related to the pressures you're experiencing. You've reduced your free cash flow guidance and increased your leverage for the InSinkErator acquisition. With a lower free cash flow forecast and ongoing market and inflation pressures expected at least through the first half of next year, how should we consider the implications for your deleveraging plans? Specifically, how much net leverage do you anticipate paying down after closing the deal, and what does that mean for your buyback plans? I understand it's currently on hold, but I'd like to hear your thoughts on the timing and your approach to this.

Yes, Mike, this is Jim again. I think if you remember when we talked about how we'll finance the transaction, we will use approximately $500 million of the existing cash on hand. Through multiple term loans, we will finance another $2.5 billion, which will put us about next year, let's just say, on a gross debt to leverage perspective around in the neighborhood of 3.5%. As you mentioned, right now, we have suspended our buybacks and we will be holding off on that until we begin to reduce our debt levels down, obviously, and that's what we said is going to be a focus going forward. But when we look at the structural cash flows of our business, which, as Marc alluded to before, haven't changed and are just being impacted right now by a lower level of demand. If that begins to come back, we expect our cash flows to come back to the levels we've seen in recent years that were above $1 billion per year, which will give us the ability to finance all of our different capital allocation priorities. Obviously, continue to fund our business, pay our dividend, and bring our debt levels down. At some point in the future, once we get back to our targeted leverage areas, then obviously, share buyback will become a priority that we will focus more on then. I have to remind folks that if you look at the last two years leading up to this, our return to shareholders was over $2.5 billion when you look at share buybacks and dividends. So, it's obviously been a focus of ours. We will continue to have that as a focus in the future.

Mike, to add to this, we take pride in having a strong balance sheet, which will remain robust after the InSinkErator acquisition. This strong balance sheet provides us with flexibility. To provide some additional insights, when we talk about leverage, we are specifically referring to gross debt leverage, which we anticipate will be above three by year-end. This figure does not account for the nearly $2 billion in cash we currently hold, so that reflects our gross debt leverage. Additionally, over the past few years, our long-term debt has been stable at around $5 billion. What has changed is our approach to refinancing and managing debt, which has been favorable and has resulted in long-term debt instruments. The average interest rate for this $5 billion in debt is 2.9%, which is very advantageous in the current market. Regarding how we plan to finance the InSinkErator acquisition, we decided to use only $500 million of our cash and will utilize short-term loans for the remainder, which we aim to repay quickly. This strategy may not be entirely sequential, but it could also create an opportunity for share buybacks.

Your next question comes from the line of Mike Rehaut from JPMorgan. Your line is open.

I would like some clarification on the third and fourth quarters regarding the impacts and factors involved. You've mentioned a 35% reduction in global production, and I'm curious about how significantly that has affected your margins. Additionally, if that headwind is removed in the fourth quarter, why are the margins expected to remain similar? Is there a possibility that there may be further moderation in price and mix? You mentioned that promotions are beginning to increase again. Can you provide insight into the effects of inventory reductions in the third quarter and why we might not see an improvement in the fourth quarter?

Michael, this is Jim. We experienced a 35% reduction in our production during the quarter, which cost us over $100 million. Considering the leverage in our factories and the fixed costs discussed by Marc and Joe, that cost will be distributed across Q3 and Q4 since some of it will remain in inventory during this period, flowing into both quarters. Furthermore, as mentioned earlier, we expect the peak of raw material costs around Q3. Although we've reduced our inventory levels, the inventory we currently hold is likely at a peak cost. As that inventory is released, it will also affect our margins in Q3 and Q4. Therefore, looking at the remainder of the year, we anticipate relatively flat performance with no significant change in demand during those two quarters. Lastly, there's also the seasonal nature of our business and the way the promotional environment operates, with Q4 typically being our highest spending period on promotions, regardless of the total annual spend. This contributes to the seasonal effects we see in Q4.

Okay, that's a helpful overview. I appreciate that. Secondly, I think you highlighted some key factors to consider for next year, and there have been a couple of questions. I just want to clarify a bit about cost reductions, which can obviously provide a significant margin benefit, as well as raw materials and pricing mix. You mentioned the challenges expected in the first half, but that these should turn into advantages in the second half, particularly regarding raw materials. I was hoping to understand your early expectations for the full year. Do you anticipate raw materials to pose a challenge or become beneficial based on the current market prices for steel, resins, and so on? Regarding the cost reduction program, should we consider that there might be some savings passed on to consumers, despite a generally softer demand environment? And how might that impact the pricing mix, which could potentially be negative?

So Michael, it's Marc. So let me try to answer your question. First of all, I would say upfront, even in normal times in the October call, we would be hesitant to give you a lot of perspective on '23. I think we would all agree, we're not exactly in a normal time. Any forecast for '23, obviously, you need to take it for a grain of salt. So let me just run it down for items where we don't want to or can't give you today's specific answers and that you can get a little bit more color and perspective. So the first one, going through P&L. Demand, and I would say pricing, is right now too uncertain to forecast, the global demand driven by consumer sentiment and ultimately relating to what happens to mortgage rates and the war in Ukraine. There are a lot of macro factors that, if we like it or not, will weigh on short-term demand, but that doesn't change our long-term demand or midterm demand outlook. But some macro concerns need to be reduced or eliminated before we see a significant pickup in consumer confidence. So that's probably the demand and correlated related to pricing, the biggest uncertainty, and we will give you our perspective in January. If you want to get my personal perspective for Q3, Q4, and probably Q1, I think we would still see depressed and volatile demand environment and afterwards, we will see. On the cost side, the $500 million net cost reduction I referred to earlier, we can confirm that. If you want to say so, you can include that in your spreadsheet because that's what you will also hear in January. The raw materials side, we have not quantified. But obviously, as you could see here from our comments, we do expect gradual easing of raw material sides. Yes, on a full year basis, we absolutely do expect this to become a positive factor, i.e., no more increase but rather a decrease of raw material, the magnitude of which we will clarify and quantify in January, but we do expect a reduction of raw material costs.

Your next question comes from the line of Ken Zener from KeyBanc Capital Markets. Your line is open.

Jim, could you clarify the curtailment? I'm getting a bit confused. What do you typically discuss regarding unit leverage in your business? I recall it being in that 15% to 20% range. You also mentioned a $100 million headwind in the third quarter due to the curtailment in North America. Is that correct?

That's about 3...

Not in North America, but I mentioned that we see a reduction of a little over $100 million. This will be reflected in our P&L in the third and fourth quarters.

In the third and fourth quarters, you mentioned that there have been some sequential share gains and increased volume related to promotions. Marc pointed out that while the situation isn't quite like pre-COVID, there is still some negative impact. It's understandable that everyone is trying to manage their costs and assess volume levels in the business. If we were to maintain flat performance next year, could margins help us return to our long-term guidance, especially since this year is ending at a much lower rate, with a divergence between the first and second halves? I'm not sure any of us can accurately predict where existing home sales will be next year given current interest rates. Can you discuss how we might isolate those margin pressures related to production and promotional activities? Did the promotions contribute to an increase in volume compared to a more stable run rate? It's concerning to see such a significant reduction in margins as we finish up the year; that’s my main question.

And maybe, Ken, let me kind of start on a few of the points there, and then I'll ask Joe and Marc to. I think if you start to think about next year and the opportunities for cost reduction that will come possibly with at least a demand headwind, as Marc mentioned, in the first quarter or early in the year. As we come out of this year, what we'll start with is a healthy level of inventory which then allows us to run our factories in a very efficient way and allows us to, hopefully, as we look at the demand environment and stay in check with it, and Joe used the word synchronization earlier, that we synchronize our production with the demand environment. It takes that volatility out, which has a cost and has an inefficiency to it. So as we look forward, I think what you saw was such a big reduction here that we talked about because the market and the demand did move very quickly. We've now adjusted to that level, and we believe we can keep our production at that level and then as demand would increase ramp it up appropriately. As you think about next year, you do get efficiencies and cost savings that are part of that broader $500 million that Marc talked about. But that's just one of many components that would be in there.

Thank you, Jim. I think this was the last question, which we had on the call. So let me maybe just quickly wrap up here. As you heard throughout the prepared remarks and also in the Q&A, we are dealing with the headwinds of what you've seen in a recessionary demand environment and we're dealing with that proactively and decisively. We've done so and we will continue to do so. At the same time, we are not yet experiencing the tailwinds which come in a recession in the form of cost reduction. We will at one point, and we have also announced that we'll take on top of the additional cost actions internally and how we bring down fixed and variable costs. Beyond the short-term recession environment, the tricky question is how we're positioned for a post-recession environment. And on that note, as you hopefully heard, we continue to be very upbeat about the mid- and long-term demand trends, with significant opportunities for us. With everything which we've done on reducing and lowering breakeven points and everything we've done on product innovation and branding, I think we're very well positioned for a post-recessionary environment, which at one point will come. So with that in mind, I thank you all for joining us today, and I wish you a wonderful Friday. Thank you.

Ladies and gentlemen, that concludes today's conference call. You may now disconnect.