DuPont de Nemours, Inc. (NYSE:DD) Q3 2023 Earnings Call Transcript

DuPont de Nemours, Inc. (NYSE:DD) Q3 2023 Earnings Call Transcript November 1, 2023

DuPont de Nemours, Inc. misses on earnings expectations. Reported EPS is $0.792 EPS, expectations were $0.84.

Operator: Good day, and welcome to the DuPont Specialty Products USA LLC Third Quarter 2023 Earnings Conference Call. [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. I’d now like to welcome Chris Mecray to begin the conference. Chris, over to you.

Chris Mecray: Good morning, and thank you for joining us for DuPont’s third quarter 2023 financial results conference call. Joining me today are Ed Breen, Chief Executive Officer; and Lori Koch, Chief Financial Officer. We have prepared slides to supplement our remarks, which are posted on DuPont’s website under the Investor Relations tab and through the webcast link. Please read the forward-looking statement disclaimer contained in the slides. During this call, we will make forward-looking statements regarding our expectations or predictions about the future. Because these statements are based on current assumptions and factors that involve risks and uncertainties, our actual performance and results may differ materially from our forward-looking statements.

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Our Form 10-K, as updated by our current and periodic reports, includes detailed discussion of principal risks and uncertainties which may cause such differences. Unless otherwise specified, all historical financial measures presented today are on a continuing operations basis and exclude significant items we will also refer to other non-GAAP measures. A reconciliation to the most directly comparable GAAP financial measure is included in our press release and presentation materials and have been posted to DuPont’s Investor Relations website. I’ll now turn the call over to Ed.

Ed Breen: Good morning, and thank you for joining our third quarter 2023 financial review. This morning, we announced third quarter results, and delivered solid earnings accomplished through strong operating execution by our teams despite ongoing volume headwinds, including channel inventory destocking and continued weak demand in China. We reported sequential operating EBITDA growth of 5% and margin improvement of 140 basis points in the third quarter. We also produced strong cash flow during the quarter, with adjusted free cash flow almost 50% higher than the year ago period, highlighting our efforts to prioritize working capital improvement in a challenging global business environment and normalizing after last year’s global supply chain difficulties, compared to third quarter of 2022 organic revenue declined 10% due primarily to the impact of incremental channel inventory destocking, along with lower volumes from semiconductor and construction end markets.

Within our electronics portfolio, our Interconnect Solutions business recorded a second straight quarter of sequential sales lift as underlying demand improvement and normal seasonality contributed to an 8% sales increase. We also saw signs of stabilization with the semiconductor markets and expect some sequential sales improvement from semiconductor technologies in the fourth quarter. Third quarter volume was lower than expected, primarily due to incremental channel inventory destocking, including with our distributor customers, which was evident in the Water Solutions and Safety Solutions lines of business. In this environment, we remain focused on controlling discretionary spending and are also planning additional restructuring actions to continue to ensure we can drive sound operational and financial performance, targeting at least $150 million in annualized run rate cost savings, which we expected we would see later in the first quarter of 2024.

It’s always difficult to precisely time market inflections, but current industry forecast within electronic submarkets going to recovery by 2024. This includes forecast for PC shipments to grow mid-single-digits, driven by replacement demand, smartphone shipment growth in the mid-single-digits, also driven by replacement demand, and new product launches, and for server demand to gradually improve next year. This growth is supported by the rapid surge in demand for AI servers as well as replacement for traditional servers. In general, demand for high-performance and high-density memory chips is accelerating, supported by AI growth, as well as overall growth for new mobile product launches. This directly correlates with DuPont’s product strengths within the semiconductor and consumer electronics markets.

Despite the near-term headwinds we are experiencing, we are confident that our key end markets are well-positioned for long-term growth, and we expect these structurally attractive markets will provide the foundation for DuPont’s value creation looking ahead. Turning to Slide 4. We significantly advanced our strategic and capital allocation priorities during the quarter to drive shareholder value. First, we closed the acquisition of Spectrum on August 1, which fits nicely alongside our Liveo health care-related product line within our Industrial Solutions line of business with E&I. We are pleased with Spectrum’s operating results to-date, which are aligned with our modeled estimates. We are excited to welcome the Spectrum team, which is currently focused on executing new revenue growth opportunities stemming from significant customer wins earlier in the year.

Second, I am pleased to announce that we are in the process of closing today the previously announced sale of our roughly 80% ownership interest in the Delrin business, the remaining piece of the former M&M segment held for sale to the private equity firm, TJC, and a transaction value in the business at $1.8 billion. This deal was structured to maximize value for our shareholders. It provides significant upfront cash proceeds with minimal expected tax impact, which can then be deployed in line with our strategic priorities. It also provides an opportunity for us to participate in future upside returns upon the exit of our retained interest in Delrin. TJC has an excellent track record of creating value, and we look forward to leveraging their talent and focus to continue to grow the high-quality Delrin business.

Regarding share repurchases, in September, we completed the $3.25 billion accelerated share repurchase transaction launched last November. We then launched a new $2 billion ASR, which we expect to complete during the first quarter of 2024. Combined these two ASR transactions, we have repurchased approximately 15% of our outstanding shares when complete, reflecting our continued commitment to returning capital to shareholders as part of our balanced financial policy. Including these ASRs and the proceeds from the Delrin sale, we anticipate finishing the year close to our target net leverage ratio of about 2.1 times. Further, we anticipate using a significant portion of excess cash during 2024 for incremental share repurchases once the ASR is complete.

With that, I’ll turn it over to Lori.

Lori Koch: Thanks, Ed, and good morning. Our teams continue to execute well in a softer volume backdrop driven by broad-based inventory destocking, demonstrating strong financial discipline and focus on operational excellence. I am most pleased with the sequential margin improvement registered by each of our segments in the third quarter as well as our strong cash performance in the period. Given volume headwinds, the delivery of stronger margins and better cash flow are attributed to execution around lowering our input costs, coordination with the operating teams to rightsize our inventory position, as well as overall progress with productivity via operational excellence initiatives. We are very focused on operating discipline and pleased that site level operating execution is positively positioning us for solid margin upside as volumes recover.

We expect to see evidence of this in 2024 given expected recovery in key end markets, including electronics. Turning to our financial highlights on Slide 5. Third quarter net sales of $3.1 billion decreased 8% versus the year ago period, a 10% organic sales decline was slightly offset by a 2% portfolio benefit due primarily to revenue contribution from spectrum acquisition. The organic sales decline reflects a 10% decrease in volume, resulting primarily from semiconductor and construction end markets as well as the impact of channel inventory destocking. E&I and W&P organic sales declined 13% and 8%, respectively, while the retained businesses and corporate reported 1% organic sales growth, including mid-single-digit growth in the adhesives portfolio.

From a regional perspective, consolidated DuPont sales decreased on an organic basis globally versus the year ago period with Asia Pacific, North America and Europe down 12%, 10% and 2%, respectively. China sales were down 16% on an organic basis versus the third quarter of 2022, though E&I sales in China increased sequentially in the quarter and saw smaller year-over-year declines in each of the last three quarters. Third quarter operating EBITDA of $775 million decreased 9% versus the year ago period, driven by lower volumes and the impact of reduced production rates primarily within E&I as we align inventory with demand, partially offset by lower endpoint costs related to raw materials, logistics and energy along with the portfolio benefits from Spectrum.

Operating EBITDA margin during the quarter of 25.3% was down 50 basis points versus the year ago period driven by volume pressure in the high-margin semi business and reduced production rates, primarily within the E&I segment, offset partially by cost equation benefits, which increased somewhat from second quarter levels. On a sequential basis, operating EBITDA was up 5% and operating EBITDA margin improved 140 basis points. Decremental margins for the quarter was 31%, enabled by cost deflation and aggressive actions taken year-to-date to reduce spending. As I mentioned earlier, I am pleased with our cash flow improvement during the quarter. Optimizing working capital performance continues to be a top priority for us. On a continued operations basis, cash flow from operations of $740 million, less capital expenditures of $119 million, resulted in adjusted free cash flow of $621 million in the third quarter, a 47% increase versus the year ago period.

Adjusted free cash flow conversion during the quarter was 151%, an increase versus last year, and much improved compared to the first half of this year. We currently expect to finish the year with conversion around our targeted level of 90%. Turning to Slide 6. Adjusted EPS for the quarter of $0.92 a share increased 12% compared to $0.82 in the year ago period. Below-the-line benefits, including a combined $0.16 benefit related to a lower share count and lower net interest expense more than offset lower segment earnings. Other below-the-line benefits, including a lower tax rate and lower foreign exchange losses, contributed $0.06 to adjusted EPS improvement versus the year ago period. Our tax rate for the quarter was 24.6%, down from 26.2% in the year ago period, driven by the impact of a rate true-up in the year ago period, and lower than our previously communicated modeling guidance as discrete tax headwinds were lower than expected.

Our expectation of a full year 2023 base tax rate of 24% remains unchanged. Turning to segment results, beginning with E&I on Slide 7. The E&I third quarter net sales of $1.4 billion decreased 9% as organic sales declined 13%, offset partially by a portfolio benefit of 4% from the Spectrum acquisition. The organic sales decline reflected a 12% decrease in volume and a 1% decrease in price. At the line of business level, organic sales for semiconductor technologies were down high teens versus the year ago period, resulting from a continuation of inventory destocking across the channel and, to a lesser extent, ongoing weak end market demand and the impact of China trade restrictions. On a reported basis, semiconductor technology sales were flat sequentially in the third quarter.

Within Interconnect Solutions, organic sales declined 11% year-over-year due to both volume and price declines, driven by the pass-through of lower metal pricing. Volume continued to be impacted by weak smartphone, PC and tablet demand, particularly in China, along with more moderate inventory destocking, which we believe is largely complete. On a sequential basis, the Interconnect business reported a second straight quarter of sales improvement, with sales up 8%, driven by seasonality as well as some underlying demand improvement within PCB markets. Organic sales for Industrial Solutions were down high single-digits versus the year ago period, due primarily to destocking within biopharma applications for our Liveo product line, and continued lower demand in electronics related end markets.

These declines were partially offset by increased demand for OLED display materials. Operating EBITDA for E&I of $383 million was down versus the year ago period, primarily due to volume declines and lower operating rates to better align inventory with demand, slightly offset by a portfolio benefit related to Spectrum. Operating EBITDA margin increased 140 basis points sequentially during the third quarter. Turning to Slide 8. W&P third quarter net sales of $1.4 billion declined 8% versus last year as volume decline of 9% was slightly offset by a 1% increase in price due to the carryover impact of actions taken last year. Within Safety Solutions, organic sales were down high single-digits, due primarily to channel inventory destocking. Shelter Solutions sales were down high single digits on an organic basis, driven by continued demand softness in construction markets and ongoing channel inventory destocking.

On a sequential basis from the second quarter, shelter sales increased slightly, and we expect narrow year-over-year declines in fourth quarter. Organic sales for Water Solutions were down mid-single digits versus the year ago period due primarily to inventory destocking, including key distributor customers and lower industrial project demand in China, mainly impacting reverse osmosis. We expect generally flat sequential volumes in the fourth quarter versus the third quarter. Operating EBITDA for W&P during the third quarter of $362 million decreased versus the year ago period due to lower volume, partially offset by the impact of net pricing benefit. Operating EBITDA margin of 25.6% increased 70 basis points year-over-year and 100 basis points sequentially from the second quarter.

Turning to Slide 9, I will close with a few comments on what we are seeing in the fourth quarter and how that translates to our full year 2023 guidance. Underlying consumer electronics demand in the fourth quarter is expected to be generally similar to the third quarter, with some sequential sales is expected in semiconductor technologies. As mentioned earlier, we saw additional channel inventory destocking and slower industrial demand in China, mainly impacting Water Solutions compared to prior expectations, and we assume these same trends to continue through the end of the year. As a result of this incremental volume softness, we are adjusting our net sales and operating EBITDA guidance and now expect full year net sales to be about $12.17 billion and operating EBITDA to be at about $2.97 billion, which is at the low end of our prior range.

For the fourth quarter, we expect net sales of approximately $3 billion, with a sequential decline versus third quarter, driven predominantly by additional inventory destocking in the Safety Solutions line of business and, to a lesser extent, by the impact of seasonality and incremental currency headwinds. We expect full year 2023 adjusted EPS to be approximately $3.45 per share, which is the midpoint of our prior guidance range. With that, we are pleased to take your questions. And let me turn it back to the operator to open the Q&A.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Jeff Sprague of Vertical Research Partners. Your line is open.

Jeff Sprague: Thank you, good morning, everyone.

Edward Breen: Good morning, Jeff.

Jeff Sprague: Good morning, Ed. A lot going on in these channels, obviously. Do you have any kind of sense or how do you measure kind of your sell-in versus sell-through trying to kind of understand kind of what that incremental headwind is from inventory versus just kind of general demand trends? And maybe just a little bit of color on how much more you might have to do on inventory or production to kind of get things where you need them to be balanced out?

Ed Breen: Yes, Jeff, so we did a pretty detailed analysis of it. And I think a good way to look at it is, what is our distributor customer’s doing versus our direct end customers. So maybe just to give you a couple of numbers on the W&P side of our business, about 50% of our volume goes through distribution and the other 50% we sell direct to customers. And so we did a whole analysis, obviously, because the distributors, you can see quick what’s going on with them and almost across the board, the distributor network is destocking pretty broadly. And it’s, on a percentage basis, down significantly more than our direct customers. So just one because it hit us this quarter, our water business in China, which is mostly reverse osmosis, was down as 36% of it goes through distribution, the rest we sell direct to customers.

But a third of our sales that go through distributors in China, it was down 36%, through distribution was down about 12% direct to the customer base. So, if you do that analysis in our safety business, you get very similar trends going on. So, clearly, the distributors are going through a destock. And I’m sure as we’re approaching year-end, everyone is trying to get their inventories kind of where they want them. Now, by the way, having said that, my take is that the destock obviously goes into the first quarter if we just started to see it in some of these W&P businesses. But I would think the distributors work it down fairly quickly after we’re kind of exiting the first quarter. But that same trend applies almost across the board when you do that analysis.

It’s the distributors are way down vis-à-vis the direct customer channel.

Lori Koch: And on the absorption question, we’re still in the same general ballpark in the second half is where we were in the first half. There’s a little bit of a mix and we’ll be taking a little less absorption headwinds in E&I and a little more in W&P as we see the destock continue as we head into the fourth quarter, but in total, the number is about equal to the first half.

Jeff Sprague: Great. And I was wondering if you could give us a little color on restructuring also, Ed, I think you mentioned $150 million run rate. I wasn’t sure if that was full year 2024. But maybe just give us a sense of how much restructuring tail you have in 2023, the incremental benefit you expect in 2024? And as volumes kind of hopefully improve into 2024, some of that just kind of discretionary temporary stuff that kind of comes back into the P&L?

Ed Breen: Yes. So, on an annual basis, Jeff, we’ll be about $150 million of savings, kind of spread between plant fixed costs and functional costs or mostly G&A expense, not touching R&D at all. And by the way, just to back up on that. Lori and I have been looking at this kind of how we can do some restructuring for over a year. So, we’re not doing it just in response to what’s going on. I think I would have said on other earnings calls, we started looking at it actually a summer ago how could we streamline a little bit more. So, we’re ready with that. We’ll start seeing the benefits on the restructuring in the – towards the tail end of first quarter. We’ll get going on it by the middle of December. So, by time it hits, we get things going, and you’ll start to see the benefit then.

So, you’ll kind of get three quarters of the benefit for a big chunk of that in 2024. A little bit of that would potentially come back on the fixed costs – the plant fixed cost side as volumes pick up, but not all of it. So, you’ll get a little bit of it coming back in as we see the volumes lift, but that’s basically the program.

Jeff Sprague: Great. Thank you.

Ed Breen: Thanks.

Operator: Your next question comes from the line of Scott Davis of Melius Research. Your line is open.

Scott Davis: Hi, good morning everybody, Ed and Lori, Chris.

Ed Breen: Hi Scott.

Lori Koch: Good morning.

Scott Davis: Good morning. A couple of things. I mean, just to follow-up on Jeff’s question because it just seems like it’s so important and topical for you guys. I mean there’s kind of two reasons why people destock inventory, right? I mean one is maybe the lead times come down, and they feel like they can get it fast. And two is they’re really worried about their customers not wanting product. And I’m talking at the distribution level, not your direct. What do you think are the main drivers of this kind of incremental, because we’ve been talking about the inventory destock for several quarters now. And this quarter seem like it almost got a little bit worse, particularly in water and protection.

Ed Breen: Yes. Scott, I’d just give you a ballpark in my thinking. I think two-thirds of it, or 75%, something like that is really that the supply chain healed itself. It’s pretty darn normal for everybody again. So everyone sat on excess inventory. I mean, look, we’re doing the same thing. We had 151% cash conversion. We’re lowering our inventory levels because we have built up more than what normally would during COVID, and every other CEO I talk to is doing the same thing. And by the way, I think as the pressure you’re getting near the end of your year, you’re really trying to get things in line for 2024. So I think a big part of it is that. But there’s certainly as a percent of people just more worried is there a recession coming.

You got an inverted yield curve for 18 months. People start getting nervous. There’s always been a recession. So I can’t say that’s not – if that’s in there. But I think the bigger part of it is we just all build excess inventory. We got what we can get during COVID. And probably I’ll give you one example because we’re seeing some destocking on the metal packaging side. A year ago, I had most of the CEOs of the medical device companies personally call me, pleading that we could ship more Tyvek material for packaging so they could shift their products out. And I remember telling them all, in fact, I sent a letter to the trade industry. I said our shipments to you are up 18% so far this year. I mean, I can’t do much more. And that was everyone scrambling to get it and then they overshot.

And now I probably shouldn’t be surprised we’re seeing some destocking on the medical packaging side. So I think that’s just a great example. That has nothing to do with the recession, that’s just everyone had too much.