Kenvue Inc. (NYSE:KVUE) Q4 2023 Earnings Call Transcript

Kenvue Inc. (NYSE:KVUE) Q4 2023 Earnings Call Transcript February 8, 2024

Kenvue Inc. beats earnings expectations. Reported EPS is $0.31, expectations were $0.28. KVUE isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello. And welcome to the Kenvue Fourth Quarter and Full-Year 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tina Romani, Head of Investor Relations for Kenvue.

Tina Romani: Good morning, everyone. I’m pleased to be joined today by Thibaut Mongon, Chief Executive Officer, and Paul Ruh, Chief Financial Officer. Before we get started, I’d like to remind you that today’s call includes forward-looking statements regarding, among other things, our operating and financial performance, market opportunities and growth. These statements represent our current beliefs or expectations about future events and are subject to various risks, uncertainties, and assumptions that could cause our actual results to differ materially. For information regarding these risks and uncertainties, please refer to our earnings materials related to this call posted on our website and our filings with the SEC. During this call, we’ll also reference certain non-GAAP financial information.

The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a subject for financial information presented in accordance with US GAAP. These non-GAAP financial measures should be viewed in conjunction with the most comparable GAAP financial measure. A reconciliation of these items to the nearest US GAAP measure can be found in this morning’s press release and our presentation available on the IR website. With that, I’ll turn it over to Thibaut.

Thibaut Mongon: Thank you, Tina. And thank you to everyone for joining us today. 2023 was a year of transformational change for our company and for 22,000 Kenvuers around the world. Our teams accomplished a tremendous amount, successfully standing up Kenvue as an independent public company, while continuing to drive profitable growth. While we accomplished a lot in 2023, we know we have areas where we need to increase our focus and improve. So as we enter 2024, we have identified three key priorities that will enable our continued transition as an independent company, while continuing to grow the business. This year, we will reach more consumers, with a stronger focus on our 15 priority brands, free up resources to invest behind our brands and foster a culture that rewards performance and impact.

In 2023, we delivered on our long-term value creation algorithm centered around profitable growth, durable cash flow generation and disciplined capital allocation. Our 5% organic growth was broad-based across all three segments, all four regions, and all eight product categories. Self Care delivered another banner year of 8.4% organic growth, sustaining the momentum we have built over the past several years, resulting, once again, in strong revenue growth and share gain. Essential Health grew ahead of our long-term expectations, with 3.6% organic growth, while continuing to execute our strategy to drive gross margin enhancement through successful value realization and premiumization initiatives. And in Skin Health and Beauty, organic growth was 1.8%, less than we expected, mostly due to specific missteps around in-store execution in the US, which we are actively addressing, and I’ll give you more details about that in just a moment.

We continued our successful multiyear program to expand gross margins in 2023 with 30 basis points of expansion through thoughtful revenue management initiatives and relentless supply chain optimization. This further demonstrates that we have the capabilities and the strategies in place to drive profitable growth even in a dynamic and uncertain macro backdrop. And finally, we utilized our strong free cash flow to initiate our dividend program, delivering on our commitment of returning cash to shareholders. Pivoting to Q4 specifically, let’s now have a look at the performance of each one of our segments, and I’ll start with Skin Health and Beauty as our disappointing fourth quarter’s performance on top line clearly fell short of expectations, both yours and ours.

Looking by region, it is evident where we have strength to leverage and where we need to improve. EMEA and Latin America ended the year strong. In EMEA, organic growth improved sequentially quarter-over-quarter on positive consumer response to innovation launched earlier in the year. In Germany, for example, Neutrogena Hydro Boost has fueled growth ahead of the category. In Latin America, where we continued to grow double digits, Neutrogena faced doubled sales in the quarter, supported by the successful launch of Hydro Boost refills. In China, weaker consumer demand continued to pressure the overall category in our skin care brands. However, it is our performance in the US that did not meet our expectations. As we have talked with you about, we had ambitious fourth-quarter recovery plan for the US, but, frankly, the execution of this plan was disappointing.

Restoring Neutrogena to the level of growth we know the brand is capable of is a priority for me and for the team. So over the past several months, I spent significant time with our team in the US and engaged with our customers as the diagnosis is clear. We know our brand equities are healthy and our products resonate with consumers in the category. However, we must improve our in-store execution capabilities to drive stronger demand for our brands, better communicate our value proposition to consumers, launch innovation successfully, and finally, support our brands with a robust level of marketing investments. In early December, we shared that Jan Meurer, previously our Chief Growth Officer, will assume the position of Head of North America.

With Jan’s deep knowledge of our portfolio and our growth strategy, he has already outlined with his team the focused road map that they are executing to strengthen their capabilities and stabilize the business. Specifically, the recently redesigned North America Skin Health and Beauty leadership team is taking action in three areas. First, we are strengthening in-store presence and prominence through better planning with customers, enhanced packaging that clearly articulate dermatological benefits and more prominent in-store brand activation. Second, we are enhancing consumer engagements through distinct and consistent brand experiences delivered with the appropriate level of reach and frequency and supported by a revamped marketing effort.

And third, we are amplifying innovation through bolstered demand-generation activities with consumers and healthcare professionals. So, this will not be an overnight shift. It will take time for these actions to generate impact on our results, which we expect to occur in the second half of the year, but we are confident we have correctly diagnosed our weaknesses and are making the necessary changes. Additionally, we believe our strong partnerships with retailers, coupled with increased investment and a higher level of precision in our execution, will enable us to stabilize the business in the US and deliver stronger growth in 2024. So now turning to the rest of the portfolio. In Self Care, our largest segment, it’s a very different picture.

We ended the year in line with our expectations, delivering organic growth of 8.4% in 2023 on top of 10.9% growth in 2022. We continued to demonstrate our leadership in the fourth quarter, reading the season accurately and activating our brands with precision. Adult Tylenol continued to gain share in the US, with 78 consecutive weeks of share growth even as category volumes declined as expected with roughly 15% lower incidence levels this cold and flu season compared to 2022. And again, this quarter, we strengthened our leadership positions with relevant innovation, premiumization and leading healthcare professional endorsement. So looking to 2024, we intend to continue to deploy this winning formula around the world. And finally, in Essential Health, performance was led by oral care and women’s health, while baby care shipments were less robust this quarter.

Oral care grew 8%, with organic growth in all regions, including the US, where Listerine, despite being around five times bigger than our next competitor, remains the most productive brand in the category and has now delivered 21 weeks of double-digit consumption growth. The launch of Listerine gum therapy has done extremely well as the largest innovation in the US mouthwash category in 2023, reaching 1 point of share in 12 months just for this code. And we have more great innovation planned in 2024. Which brings me to our priorities for this year. 2024 will be our first full year as an independent company. And you will see us starting to operate differently than what we have in the past, which will enable us to unleash the full potential of our portfolio.

As I shared earlier, we have three priorities: First, we are going to reach more consumers, with a strong focus on our 15 priority brands. We are strengthening our plans to build attractive, consistent brand experiences for our 15 priority brands, which represent two-thirds of our growth. With strong retailer partnership, we will bring to market relevant innovation across the segments, driving mental availability, but also ensuring physical availability where and when our consumers need us. We are also raising our bar in terms of activation excellence in our focus markets, starting with the US. So you are going to see our top brands with a higher level of activation in 2024 as we fuel growth. In Self Care, we have strong plans to bring forward science-based, category-leading innovations to meet the needs of consumers, maintain category-leading healthcare professional recommendation, and ultimately, drive continued share gains.

And in Skin Health, we will stabilize the business in the US with the plan I outlined today. Outside the US, in China, we will monitor consumer sentiment and thoughtfully calibrate our investment accordingly, while in the rest of the world, where we continue to fuel our growth in Europe and Latin America. This requires investment, and we have plans to invest more in brand activation in 2024, both with consumers and with healthcare professionals. Continued margin expansion and efficiencies across the business will fuel this investment. Which brings me to our second priority, which is to free up resources and invest in our brands. We expect gross margins to expand at an accelerated pace compared to 2023, which will fund increased investment in our brands.

You’ve heard me say that, over the past several years, we have been going to the gym on gross margin. And through this work, we will continue to strengthen this muscle, driving efficiencies across our supply chain, managing our mix, and implementing thoughtful revenue management initiatives. In addition, as we exit our transition services agreement with Johnson & Johnson, we are not simply replicating legacy processes, but rather intentionally reinventing our ways of working. And this includes implementing modern systems designed specifically to meet the needs of our new company and enable speed, agility, accuracy, and a lower cost base. For example, we are implementing a new integrated business planning process that will improve our demand forecasting capabilities and service levels through better integrating and automating retailer data and demand sensing.

This plan will be implemented throughout the next six quarters, with the majority occurring this year. And all of this will be enabled by our teams around the world, which leads me to our final priority, fostering a culture that rewards performance and impact. In 2024, we are deploying our new Kenvue performance management plan, with clear goals and a heightened sense of accountability for every Kenvuer. The plan introduces new incentive programs for all leaders, encouraging and rewarding impact on the four drivers of shareholder return – top line growth, margin expansion, earnings growth, and free cash flow. Further, we are streamlining decision-making across the organization, including in my own leadership team. And most importantly, we are creating a culture based on our Kenvue values where everyone has a strong sense of purpose and belonging, an opportunity to grow, and is rewarded for impact.

So in closing, we made significant progress in 2023. And while we still have a lot of work ahead of us, our priorities are clear in 2024 and give me confidence in our ability to deliver our plan for the year. I’m deeply grateful to our talented teams for their energy and passion to work together as one team to build our new company. It is inspiring to see 22,000 Kenvuers rally behind one purpose, helping people realize the extraordinary power of everyday care, and I know they will make us successful this year and into the future. And with that, I’ll turn it over to Paul.

Paul Ruh: Thank you, Thibaut. And good morning, everyone. 2023 was a transformational year, where we delivered strong top line, gross margin expansion, and robust cash generation, even in the face of a dynamic macro backdrop and significant cost headwinds. I will start with an overview of results for the fourth quarter and the year, then close with our outlook for 2024. As you heard from Thibaut, fourth quarter performance did not meet our expectations as in-store execution fell short of plan in the US Skin Health and Beauty business. While we don’t expect recovery overnight, I’m encouraged by what the new leadership team has accomplished in the past couple of months, diagnosing the issue and putting an action plan in place that is already underway.

Now getting to results. Fourth quarter organic sales declined 2.4%. It’s important to consider our fourth quarter performance in the context of 6.2% organic growth last year, where we experienced outsized growth in Self Care, primarily driven by unprecedented demand for our OTC products. In this context, fourth quarter growth was 3.8% on a two-year stack basis. Value realization contributed 5.8 points to fourth quarter growth, offset by a volume decline of 8.2 points. Let me deconstruct the volume decline as there are several unique drivers impacting volume that do not reflect the underlying strength of our brands. First, about 3 points come from lapping an early and strong cold, cough and flu season that drove double-digit organic growth last year.

Further, this year saw a later start to the season, combined with approximately 15% lower incidence levels. As we have shared previously, in parts of our OTC business, volume is characteristically linked to incidence levels, which can go up or down in any given season. For Kenvue, our focus is to be prepared to serve our consumers, while continuing to gain share, regardless of what the season may bring, and that is what you saw from us this quarter. Second, 2022 product discontinuations negatively impacted the quarter by about 1 point. Of note, as of the fourth quarter, we have fully lapped the product discontinuations and do not expect to see any impact next year. Lastly, trade inventory reduction accounted for about 1 point as retailers tightened their inventory levels.

In sum, a little over 5 points of volume decline is attributed to idiosyncratic elements of the fourth quarter, with the remaining 3 points mainly attributed to continued softness in China and our underperformance in US Skin Health and Beauty we have discussed. For the full year, net sales grew 3.3% to $15.4 billion. Organic growth of 5% reflects the value realization of 7.7% and a volume decrease of 2.7%, of which approximately 2 points is attributed to the 2022 product discontinuations we have discussed all year and the suspension of personal care products in Russia through the first half. When normalizing volume to exclude these two distinct items, volume was slightly down on nearly 8 points of value realization, demonstrating the low elasticity of our brands.

You also see the power of the portfolio in the fact that private label penetration remained relatively flat throughout the year, even as consumers look to be trending down in other categories. These dynamics give us confidence in our ability to improve volume growth as we progress through 2024. Moving to gross margins. Fourth quarter gross margin expanded 220 basis points to 59.5% and full-year adjusted gross margin increased 30 basis points to 58.4%. As we have discussed with you previously, there are some non-recurring items in our results, as we refine our accounting and reporting methodologies to be more comparable with our peers. Impacts from these refinements were a benefit of approximately 50 basis points in the fourth quarter and 10 basis points for the full year.

Inflationary headwinds moderated during the fourth quarter, as positive trends in logistics offset ongoing pressures in energy and wage inflation, while FX continued to pressure gross margin by about 1 point during the quarter and for the full year. Turning to adjusted operating income. Fourth quarter adjusted operating income margin expanded 190 basis points and full-year adjusted operating income margin was flat. Adjusted operating margin benefited from the non-recurring items I just spoke about by about 180 basis points for the quarter and 70 basis points for the year. For taxes, our fourth quarter adjusted effective tax rate was 15.8%. The decrease versus prior year is primarily the result of tax law changes that negatively impacted 2022, the release of tax reserves, mostly due to statute of limitations expiring and benefits from effective tax planning.

The full-year adjusted effective tax rate was 23.4%. The decrease in adjusted effective tax rate versus prior year is primarily due to the release of tax reserves. And finally, adjusted net income was $586 million for the quarter and $2.4 billion for the year. Adjusted diluted earnings per share was $0.31 for the quarter and $1.29 for the year, including an approximate $0.03 benefit from the non-recurring items I spoke about. Now turning to cash and capital allocation. For the year, we generated $2.7 billion in free cash flow. It is worth noting that the free cash flow benefited from separation-related items and the timing of working capital at the end of the year. During the year, we demonstrated our commitment to disciplined capital allocation, as outlined during our IPO.

We strengthened our balance sheet, reduced our leverage, and returned cash to our shareholders. We have executed on our capital allocation priorities, including a 64% dividend payout ratio and reducing our gross leverage from 2.5 times to 2.2. As you model 2024, it will be important to consider the working capital timing benefit in 2023 as well as the fact that we’ll be paying a full year of dividends and have a full year of interest expense, which brings me to the outlook for 2024. First, I want to echo Thibaut’s point that we have strong conviction in our ability to execute our plan for the year. We have a clear strategy in place. And in 2024, we are focused on reaching more consumers, optimizing the way we work, to invest behind our brands, and rewarding performance and impact.

We will drive efficiencies through further investments in supply chain, technology, and a recently implemented integrated business planning process. We will then redeploy the dollars generated from these operating efficiencies into consumer-facing brand support. Volume growth and market share capture will be of particular focus for this incremental investment. And finally, we will accelerate the exits of TSAs, establishing a new operating infrastructure that meets our needs as an independent company. In summary, it will be a year focused on enhanced engagement with consumers, while continuing our transition to a truly stand-alone entity. In 2024, we expect to achieve organic growth in the range of 2% to 4%. We expect quarterly organic sales growth to improve sequentially as we progress through the year and as compares ease and as impacts of the strategic initiatives that Thibaut outlined begin to materialize.

We expect certain headwinds to continue in the first half of 2024, such as a lower flu season versus last year, softness in China and persistent impact of in-store issues with our Skin Health and Beauty portfolio. However, as we accelerate investment behind our brands, particularly focused on in-store presence and prominence, enhancing consumer engagement and amplifying innovation, we expect to see growth accelerate as these actions begin to have more of an impact in the second half of the year. We also think it’s prudent to acknowledge that 2024 could be another volatile year as economic and geopolitical headlines impact consumer confidence. The lower end of our guidance reflects the potential for a weaker consumer and the possibility for unknowns in our seasonal businesses.

Looking to the first quarter, we expect organic growth to be about flat. While we don’t plan to guide quarterly as part of our normal practice, given the outsized performance in the first quarter of 2023, which benefited from non-recurring retailer inventory rebuilds, combined with a strong cold, cough and flu season, we thought it would be helpful to provide perspective on Q1. Moving down the P&L. We expect to maintain a healthy gross margin profile, with adjusted gross profit margin expected to be closer to 2021 levels. We expect adjusted operating income margin to be slightly below last year. While the operating efficiency we spoke about begin to materialize, partially offsetting the increased investment in our brands that includes an approximately 15% increase in our marketing spend as well as the absorption of a full year of public company costs.

Regarding other guidance items and EPS, at current spot rates, we expect translational foreign currency impact of about 1 point to reported net sales. We expect net interest expense to be approximately $400 million, evenly split across quarters. We expect an adjusted tax rate of 25.5% to 26.5%, which reflects the changes in tax loss, primarily the enactment of Pillar Two legislation adopting the OECD’s global minimum tax. Regarding EPS, assuming a full-year 2024 weighted average share count of 1.92 billion shares, we expect adjusted earnings per share to be in the range of $1.10 to $1.20. This range assumes about a $0.04 foreign exchange headwind based on current rates. To show a comparable view across years, we have included a slide in our presentation that outlines a rebased starting point for 2024.

In other words, a like-for-like view had we been a public company for the entirety of 2023. This rebased view includes a full year of public company costs, a full year of interest expense, and a normalized tax rate and share count. At the midpoint, our earnings per share guidance is about flat when comparing to the rebased 2023 adjusted diluted EPS. In closing, we are proud of what we have achieved in our first year as Kenvue, while also acknowledging challenges in our Skin Health and Beauty business that we have plans in place to improve. As for 2024, our priorities are reaching more consumers, freeing up resources to invest behind our brands, and fostering a culture that rewards performance and impact. Thank you. And with that, we’ll take your questions.

Operator: [Operator Instructions]. Our first question comes from the line of Stephen Powers of Deutsche Bank.

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Q&A Session

Stephen Powers: Maybe to start just on the top line. I think just given the momentum that we have exiting 2023, I think some people could look at the call for flat organic in the first quarter, given the comparisons as ambitious and also the 2% to 4% for the full year as potentially ambitious. So maybe just a little bit more color on your visibility to that organic forecast and some of the building blocks that we should be looking for as we get into the year.

Thibaut Mongon: Regarding your question on the top line and our ambitions for 2024, we continue to see our categories growing 3% to 4% in 2024 and beyond. Our guidance for 2024 reflects a range of scenarios. It does embed a sequential improvement as we move through the year and as we lap the unusual compares of 2023 that we talked about, but also the fact that we expect our increased investment and the plans that I outlined earlier generate impact, especially in the second half of the year. So that’s what makes us confident in our plan for the year. But we also think it’s prudent to acknowledge some of the dynamics at play in 2024, and that’s why our guidance also contemplates certain headwinds that could materialize, such as further softness in China, the time it will take to improve in-store execution in Skin as well as the possibility for unknowns in our seasonal businesses. But I reiterate that we are confident in our plans for the year.

Stephen Powers: Maybe this is for Paul on the margin forecast. I guess just some clarifications. The press release talked about the strong gross margin outlook that you talked about just a few minutes ago as well. But it contemplates 50 basis points of FX headwinds. I just wanted to clarify, is that 50 basis points all within SG&A? And maybe you can give some color as to the drivers of that transactional headwind in SG&A, number one? And number two, you talked about year-over-year rates of increase in advertising. I guess I’m a little curious as to where we finished 2023. I’m sure it’s going to be in the K, but maybe just give a little color on where advertising finished as a percentage of sales in 2023 and how you expect that to trend into 2024?

Paul Ruh: In regards to your first part of the question, yes, we are very pleased with our gross margin trajectory. As you know, and Thibaut mentioned, we have developed a muscle in terms of continued sustained gross profit margin enhancement. And the FX that I talked about is embedded in gross margin and also in SG&A, but primarily in gross margin. To your second question, year-over-year rates of advertising, we will disclose advertising in our K. Advertising year over year versus 2022 was slightly down. But I can tell you that we have very strong plans to increase our advertising. I mentioned 15%. We’re approximately $300 million more that will fuel the progressive growth enhancement that Thibault talked about.

Operator: Our next question comes from the line of Anna Lizzul of Bank of America.

Anna Lizzul: I wanted to ask on Q4 Skin Health and Beauty. I know you said the volume weakness was mostly driven by the US. But can you be more specific on how much of the weakness was driven by China on Dr.Ci:Labo? And are you expecting this to recover in Q1 in terms of your guidance? And then also in the US on Skin Health and Beauty, in Q3, you had highlighted some innovation in sun care for Neutrogena, which helped last quarter, but volumes saw a significant deceleration here in Q4. So in terms of the recovery in distribution, where are you at in your conversations with retailers?

Thibaut Mongon: So let me answer your question on Skin Health and where – what do we see in China and the US. So in China, we saw a weak demand for our brands, especially Dr.Ci:Labo due to temporary PR issues that you are familiar with. We believe that these PR issues are dissipating as we speak. But we are going to be thoughtful about continuing to monitor how the categories are doing, how the consumer sentiment is going in China. And while we are going to see gradual recovery in 2024, we are not contemplating in our guidance a strong recovery, especially in the first half of the year in our Skin Care brands in China. I remind you that China is about 7% of our revenue as a total company, but we have our total portfolio represented in China, and Skin Health is not the largest part of our portfolio in China.

Regarding the US, we had an ambitious recovery plan in Q4. And as I said in my prepared remarks, the outcome of this plan was not what we expected. What’s good is that we understand exactly what is going on. Our brands are healthy. Neutrogena, for example, has a very high penetration in the US. Our online sales are doing well. We grew double-digit on Amazon with a brand like Neutrogena, for example. So what we really need to improve is execution, and Jan and his team are laser-focused on improving this execution. And it’s going to be broad-based. It goes beyond just distribution, but it starts with our in-store presence and prominence. And here, I’m talking about better on-shelf execution, increasing displays, increasing fixtures, updating the packaging where needed to make our range easier to shop, making sure that we have the price back architecture everywhere and, ultimately, making it easier for our consumers to shop in-store for their needs.

It’s also about engaging with consumers in a bigger way than what we did in 2023. We have industry-leading ROI on advertising. So, really 2024, it’s about increasing the reach and frequency of our engagement activities – brand activation activities with both consumer and healthcare professionals. We are going to put more products in their hands, think about samples, because we know that once they try our product, they’ll love them. And lastly, we will deploy innovation at a bigger scale, amplifying our 2023 programs, and we are excited about what we have in the plan for 2024 in terms of innovation. And retailers are excited about it as well. So, in a nutshell, it’s a heightened focus, more precision around execution, more presence with consumers, amplified innovation.