Newell Brands Inc. (NASDAQ:NWL) Q3 2023 Earnings Call Transcript October 27, 2023
Newell Brands Inc. misses on earnings expectations. Reported EPS is $-0.52632 EPS, expectations were $0.23.
Operator: Good morning, and welcome to Newell Brands Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After a brief discussion by management, we will open up the call for your questions. [Operator Instructions] Today’s conference call is being recorded. A live webcast of this call is available at ir.newellbrands.com. I will now turn the call over to Sofya Tsinis, Vice President of Investor Relations. Ms. Tsinis, you may begin.
Sofya Tsinis: Thank you. Good morning, everyone. Welcome to Newell Brands third quarter earnings call. On the call with me today are Chris Peterson, our President and CEO; and Mark Erceg, our CFO. Before we begin, I’d like to inform you that during the course of today’s call, we will be making forward-looking statements, which involve risks and uncertainties. Actual results and outcomes may differ materially, and we undertake no obligation to update forward-looking statements. I refer you to the cautionary language and risk factors available in our earnings release, our Form 10-K, Form 10-Q and other SEC filings available on our Investor Relations website for a further discussion of the factors affecting forward-looking statements.
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Please also recognize that today’s remarks will refer to certain non-GAAP financial measures, including those we refer to as normalized measures. We believe these non-GAAP measures are useful to investors, although they should not be considered superior to the measures presented in accordance with GAAP. Explanations of these non-GAAP measures and available reconciliations between GAAP and non-GAAP measures can be found in today’s earnings release and tables that were furnished to the SEC. Thank you. And now, I’ll turn the call over to Chris.
Chris Peterson: Thank you, Sofya. Good morning, everyone, and welcome to our third quarter call. We had mix results in the third quarter. We made significant progress delivering against the five major priorities we established at the start of the year as well as deploying and actioning the new integrated corporate strategy. At the same time, we were disappointed core sales declined 9.2% during the quarter. Let me take these each in turn, starting with the five priorities we laid out at the start of the year. First, year-to-date, we delivered excellent results on operating cash flow, which improved more than $1.2 billion versus last year, largely due to significant progress on inventory reduction. The stronger than anticipated performance thus far has given us confidence to raise our outlook on cash flow for the full year.
Second, during the third quarter, gross margin reached an inflection point, expanding 170 basis points year-over-year with the fuel productivity program along with pricing serving as the driving force. We continue to expect record productivity savings in 2023 with year-over-year gross margin improvement continuing into the fourth quarter. Third, we’ve completed the Project Phoenix organization design changes with all markets moving to the One Newell approach. We are on track to realize $140 million to $160 million of pre-tax savings this year and $220 million to $250 million on an annualized basis. Fourth, we are moving at pace with the simplification and SKU count reduction work across the organization and are on track to end the year with less than 25,000 SKUs, down from about 28,000 last year and over 100,000 at the end of 2018.
Finally, the new operating model with three segments, a centralized manufacturing and supply chain and a One Newell approach with our top four customers and across the geographies is now fully in place and starting to pay dividends. The most concrete example of how we are already creating and leveraging scale under our One Newell approach is the difficult but necessary actions taken during the third quarter to right size the manufacturing labor force across selected sites. Those actions, which would have not been possible previously, due to the way Newell was organized, are expected to yield about $50 million in annualized cost savings. The challenging macroeconomic background continued to weigh on Newell’s top line during the third quarter, reflecting soft demand for discretionary and durable products amidst persistent inflation on everyday goods, normalization in category trends post COVID, tight inventory management by retailers as well as the unfavorable impact from the bankruptcy of Bed Bath & Beyond.
We estimate that about 80% of the sales decline was driven by category declines and retailer inventory actions. However, there was a meaningful portion of our sales compression that traces back the gaps in our front end consumer facing capabilities or was the direct result of the July 1st pricing actions we took to proactively address situations where our structural economics were untenable. That is why since my appointment in May, we have placed so much emphasis on developing a robust set of corporate, business unit, functional and brand-specific strategies, all of which were fully informed by our brutally honest capability assessment to guide our approach in the years ahead. At its core, our new strategy focuses on improving the Company’s consumer-facing capabilities, while distorting investment to our top 25 brands in top 10 markets and building on the strengthened operational and organizational foundation we have built over the past several years.
Following the deployment of our new strategy in June, we’ve taken decisive actions to bring the new strategy to life in several ways. First, to put consumer understanding and insights at the center of everything we do, we’ve reinvented the consumer insight function and overhauled Newell’s innovation process around the biannual review process. This new process has been established to identify strong consumer-driven propositions on our top 25 brands with a focus on creating fewer, bigger and longer lasting innovations that are gross margin accretive as part of a comprehensive tiered product launch system designed to get consumer-relevant innovation into market faster. Consistent with this and to ensure we are being choiceful in driving the strategy into execution, we are taking swift action relative to the exit of smaller noncore brands.
We are moving at pace and expect to finish the year with a tighter, more focused brand portfolio comprised of about 60 master brands versus 80 at the start of this year. Second, to dramatically improve brand building and brand communication and as we strive to build brand management into a foundational capability, we replaced close to half of Newell’s brand managers over the past several months and put exceptional performance standards in place, which set clear KPI-driven expectations for all brand managers going forward. In addition, we recently implemented important changes to the process and structure of our marketing and digital organizations to unlock quicker decision-making, drive accountability and improve our ability to drive stronger purchase intent across our top 25 brands.
Third, key members of Newell’s sales team have been tasked with leading new business development, where they will leverage Newell’s scale and extensive portfolio of leading brands to identify and pursue incremental distribution opportunities within new accounts, while the bulk of our selling resources will continue to maintain their focus on strengthening our partnerships and increasing distribution with existing customers. Finally, to properly cascade Newell’s integrated set of corporate where to play and how to win choices, along with the new segment function and top 25 brand strategies, key members of the leadership team and I have now visited 8 of Newell’s top 10 countries across North America, Europe and Latin America. Based in part on those interactions, we have decided to bring in new, strong talent to fill crucial roles across several of Newell’s businesses and geographies.
For example, we recently hired new leaders for the home fragrance and kitchen businesses as well as new heads of Europe and France. Before turning the call over to Mark, I’d like to provide a little perspective on the back-to-school season since that’s always an area of interest. While predictions for the back-to-school season varied widely across the industry, in aggregate, the categories where Newell competes declined modestly with stronger market performance from retailers that put their support behind leading brands versus those that focused on private label offerings. Against this backdrop, several of our major brands such as Sharpie and EXPO grew market share, which we were excited to see. That said, gaining share in a down market is not a prescription for long-term success.
That’s why we are already incorporating the learnings from this season, the most important of which is the role our leading brands can play in driving category growth into next year’s back-to-school plans with leading retailers. While there are parts of Newell’s portfolio where we are gaining share, that’s not the case broadly. This highlights why we needed to make a major pivot in the Company’s front-end strategy. While we are dissatisfied with our current sales performance, we did say at the Deutsche Bank conference in June that we expected our top line performance to be below our evergreen target of low single digits for the next 4 to 6 quarters. Beyond that and as the bulk of our new capabilities ramp up, we remain fully committed to returning the Company to top line growth.
Back in June and during our last earnings call, we also reiterated that our top financial priorities for 2023 were strengthening cash flow and improving gross margin, and very good progress is being made on both of those fronts. So, while there are certainly much more work to do ahead of us, the strategy is starting to take shape. That’s why we are confident that this year, free cash flow productivity will exceed our evergreen target of about 90%. And the business will continue to improve sequentially next year as measured by gross margin expansion and the number of top 25 brands growing market share. As we operationalize and execute our new strategy to significantly improve our financial performance, we have been laser-focused on implementing the organizational, operational and cultural changes required to strengthen the Company’s front-end consumer-facing capabilities while harnessing the scale and power of One Newell.
While the path forward will not be a straight line, we remain confident Newell’s financial performance will improve and significant value will be created over time for our stakeholders. I would like to thank our leaders and employees for their hard work, perseverance and dedication amidst significant organization changes and for their unwavering commitment to our purpose of delighting consumers by lighting up everyday moments. I’ll now hand the call over to Mark.
Mark Erceg: Thanks, Chris. Good morning, everyone. Third quarter net sales and core sales both declined approximately 9%, largely due to the same macroeconomic headwinds we’ve been wrestling with since the third quarter of last year. However, on a more positive note, we continue to make significant progress improving the structural economics of the business during Q3 with Newell’s normalized gross margin improving 170 basis points versus last year and 140 basis points sequentially to 31.3%. A 500 basis-point contribution from fuel productivity savings and meaningful pricing actions taken across roughly 30% of our U.S. business, primarily in the home and commercial space, more than offset the significant headwinds from inflation and fixed cost absorption.
Despite excellent productivity work by the team as well as strong savings from Project Phoenix, which amounted to $49 million in the quarter, normalized operating margin contracted 220 basis points versus last year to 8.2%. Most of the contraction in third quarter normalized operating margin was driven by higher incentive compensation charges. As you may recall, incentive compensation was revised sharply lower during Q3 last year, making current period comparisons very difficult. During the third quarter, net interest expense increased $12 million versus last year to $69 million due solely to higher interest rates because net debt was down nearly $500 million year-over-year and down nearly $400 million year-to-date. The discrete tax benefit originally expected in the fourth quarter was captured in the third quarter, yielding a normalized tax benefit of $73 million, which in combination with the other elements we just went over, brought normalized diluted earnings per share in at $0.39 and drove a significant upside in normalized earnings per share relative to the $0.20 to $0.24 outlook previously provided.
Turning to operating cash flow. Strong progress on inventory management allowed us to generate $679 million of positive operating cash flow year-to-date through the third quarter. This represents considerable improvement versus a $567 million use of cash during the same period last year. Therefore, through the first nine months of 2023, operating cash flow increased more than $1.2 billion, which is a remarkable achievement that Chris and I want to thank Newell’s extended planning, sourcing and production teams for delivering. As anticipated, the Company’s leverage peaked at 6.3 times at the end of Q2 before improving sequentially and ending the third quarter at 6.1 times. We are exceeding our cash flow projections and paying down debt and expect additional improvement in the leverage ratio in Q4.
Longer term, we remain committed to achieving investment-grade status and continue to target a leverage ratio of about 2.5 times. Looking out over the remainder of the year, we’ve assumed the following for the fourth quarter: Net sales in the range of $1.96 billion to $2.03 billion as net sales and core sales are both expected to decline 14% to 11% versus last year. Gross margin is expected to be demonstrably higher than the fourth quarter of last year due to the targeted interventions we have made to improve the structural economics of the business. SG&A expense relative to last year is expected to be down in dollar terms, driven by Project Phoenix savings and discretionary spend control, but SG&A as a percentage of sales should increase due to lower and, to a much lesser extent, from the capabilities we’ve invested in, in consumer and customer understanding, revenue growth management, data analytics and retail execution, among others.
Putting all this together, fourth quarter normalized operating margin is forecasted to be in the range of 7.8% to 8.8%, which represents a 290 to 390 basis-point improvement versus last year. As such, Q4 is expected to mark an important turning point in the Company’s operating profit, which at the midpoint of the range is forecasted to grow nearly 50% versus last year. Finally, for the fourth quarter, we forecast interest expense to be higher year-over-year, a tax rate in the high-teens and normalized earnings per share in the range of $0.15 to $0.20. For the full year, we expect net sales in the range of $8.02 billion to $8.09 billion, largely driven by a core sales decline of about 13%. Normalized operating margin is expected to be 7% to 7.3% as we reflect the negative top line flow-through and capability investments discussed earlier.
Interest expense is forecasted to be up significantly versus last year with a normalized tax benefit in the teens, reflecting the sizable tax benefit that was realized in the third quarter. Normalized diluted earnings per share are now forecasted in the $0.72 to $0.77 range. At the start of the year, we said cash generation was our number one priority. So, we’re very pleased that based on our strong year-to-date performance, we can confidently raise our cash flow outlook for the year, even as top line expectations and earnings per share estimates have been tempered. We now expect to generate operating cash flow of $800 million to $900 million, inclusive of $95 million to $120 million of cash payments related to Project Phoenix, which, as Chris indicated, is on track for $140 million to $160 million of pretax savings this year.
At the midpoint of our outlook, operating cash flow improved by more than $1.1 billion year-over-year with free cash flow productivity expected to be well north of 100%. With the caveat that next year’s planning process is still in its very early stages, we thought it might be helpful to provide some high-level conceptual thoughts. So with that understanding, meaningful improvement in the top line run rate is expected on a sequential basis. However, 2024 core sales are still expected to be down as macroeconomic challenges persist and front-end capabilities are still being rebuilt. Please note that this preliminary sales commentary is consistent with comments provided at the Deutsche Bank conference in June, where we stated core sales growth is expected to be below the evergreen target of low single-digit growth over the next 12 to 18 months.
Currency — based on current spot rates in combination with planned brand exits may collectively lower net sales by an additional 2 to 3 points. Importantly, we expect strong gross margin improvement next year, fueled by productivity savings, carryover pricing benefits, less excess and obsolete charges and better product mix, which should allow operating margin to expand ahead of the 50 basis-point evergreen target even as we continue to invest behind front-end capabilities. Interest expense should be slightly higher in 2024, and at this point, we are planning for a normalized effective tax rate of about 17%, which would represent a significant year-over-year headwind to earnings per share. As for cash, we’ll provide more context once we’re further along in our planning process, but in the meantime, suffice it to say cash will remain a major focus area for us.
In closing, there are two key takeaways from today’s call. First, we are making strong progress on the deployment of our new integrated set of corporate, business unit, functional and brand strategies, all of which were heavily informed by a comprehensive company-wide capability assessment. We now have, for the first time in a long time, very clear where to play and how to win choices that the major pivot in our front-end consumer-facing capabilities will allow us to successfully pursue. Second, Newell is delivering against the two key financial priorities, gross margin and cash flow that were established for 2023, even though macro-driven pressures are greater than previously anticipated. Specifically, the underlying structural economics of the business are being strengthened with gross margin expanding both sequentially and year-over-year, with additional gross margin improvement expected during Q4 and next year.
And as we’ve doubled down on actions that are within our control, operating cash flow has improved more than $1.2 billion year-to-date. So, while the macroeconomic environment remains challenging, we are undeterred and are moving forward with deliberate speed to unlock and monetize the full potential of Newell’s portfolio of leading brands by building the front-end capabilities and creating and leveraging the scale required to consistently win with consumers and customers in our product categories. Operator, if you could please open the call for questions.
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Q&A Session
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Operator: [Operator Instructions] Our first question comes from the line of Chris Carey with Wells Fargo Securities.
Chris Carey: So I just want to talk maybe high level. Can you just talk about the evolution of how you would expect to manage the business? I think right now is very much a focus on free cash flow and the balance sheet and over time, as sort of these macro headwinds and other kind of competitive dynamics ease, then the focus can perhaps turn a bit more back to the income statement, delivering earnings, right? So, just maybe the tension in the organization between those two things. And I guess the question underlying that is the performance that we’re seeing right now, how much of that is due to you making certain decisions in favor of the balance sheet and cash flow as opposed to again the income statement, given the priorities right now? Thanks.
Chris Peterson: Yes. Thanks for the question. So let me try to provide a little bit of commentary on that. And you’re right, we did, at the beginning of this year, as we said in the prepared remarks, prioritize cash flow and gross margin improvement and structural economic improvement in the business. And we’ve made a series of choices to try to drive that. You’ve seen our inventory is down, I think, around $850 million versus the same time last year, which is a massive improvement, which is driving the operating cash flow to be $1.2 billion better year-to-date this year versus last year. You’ve also seen that we’ve turned the business to now driving gross margin improvement this quarter of 170 basis points, and we expect gross margin in Q4 to be up even more than that versus a year ago.
And some of those choices are things like the July 1st price increase that we put in the market where as Mark commented on, we priced structurally unattractive businesses. And in some cases, what we’ve seen is retailers have accepted those price increases, consumers have accepted those price increases and the structural profitability of those businesses improved. In some cases, we’ve lost distribution on those businesses, but it was effectively zero margin business that we’ve walked away from. And so, we think that what we’re doing is improving the long-term quality of our portfolio consistent with the strategy that we’ve deployed focused on the top 25 brands, top 10 countries. At the same time, we are very focused on the capability improvement actions that I mentioned around consumer understanding, brand building, innovation which we believe can get the Company back to market share growth more broadly than where we are today.
We are growing market share today on a number of our leading brands, brands like Sharpie and EXPO and Rubbermaid and Crock-Pot and Ball, but we’re not growing market share across a broad enough set of our brands, and we aspire to do that so that when the macro environment turns, we are positioned with leading brands that are growing market share and in a position with a more structurally attractive business. And that’s really the — how we’re thinking about the trajectory going forward.
Chris Carey: And one quick follow-up. Just as you think about this dynamic of over the next 12 to 18 months, that core sales, for example, would remain under pressure, how much of that is a function of category growth, market share performance versus things that you think you need to do in the organization to create a cleaner, maybe smaller, more profitable foundation for the longer term?
Chris Peterson: Yes. I think the majority, as I mentioned in the prepared remarks, this quarter, about 80% of the core sales decline was really driven by market contraction and retailer inventory actions. But there’s 20% that’s related to us not having the front-end capabilities where we want them and walking away from some of these structurally challenged businesses. I think, as we go forward, you’re going to see that 20% bucket improve dramatically as the strategy and the capability investment starts to take shape. And we believe that’s going to turn into a positive rather than a headwind over the next 12 to 24 months. The category growth dynamic is hard to predict, as we’ve said repeatedly. But I do think that the category growth dynamic, from a macro standpoint, some of the dynamics that are driving that are coming to an end.
We believe that retailer inventory destocking is largely behind us at this point, for example. The consumer — underlying consumer pressure that’s causing consumers to prioritize spending on food, essentials, and away from durable and discretionary categories is harder to predict.
Operator: And our next question comes from the line of Andrea Teixeira with JP Morgan.
Andrea Teixeira: So, I wanted to go back to this point about growing share. You mentioned it’s not enough to grow share in a declining category, which I appreciate the honesty. But, could it make sense to perhaps sell some of the businesses? I know you’ve been through a lot of rationalization over the years since the Jarden acquisition. But wondering if some of these other businesses, even though they may have cash flow there that you can sell but perhaps be more, I think, choiceful from what you can keep or what you cannot. And I understand that you just mentioned about 20% of what you saw in the decline of core sales have been from not having capabilities or having made choiceful decisions for distribution on things that are not — they are not so profitable.
So, I wanted to just go back and see if number one, you can, there is space for divestitures or it’s going to be like — it’s not like a full business, and therefore, it’s more you getting out of some of these categories or some of these SKUs. And how far along in this process you believe you are? Because I understood that you’ve been doing this all along from reducing the very massive reduction in SKUs. So, I was wondering why it’s taking so long, or is that something that you realized like you have to continue to do in order to improve profitability?
Chris Peterson: Yes. So, let me try to provide some perspective. So, when we announced the strategy in June, we had — at that point in time, we had 80 brands that we were selling across the Company. The 80 brands that we were selling largely fit within the Company’s portfolio because they are branded products that are sold based on the same capability set of consumer understanding, innovation, brand building, applies to all of the 80 brands. And they’re largely distributed through the same retail channels across the world. And so we feel like we’ve got now a portfolio from the divestitures that have been completed over the last five years that fits together and where there is scale that can be leveraged. We’ve also made important progress on the supply chain and the back office to get things on to one IT system, to get things into one distribution network with the Ovid program, et cetera, so that we believe, in most cases, we are the best owner of those brands.