Reynolds Consumer Products Inc. (REYN) Earnings Call Transcript & Summary

Okay. So next up this afternoon, we're pleased to welcome Reynolds Consumer Products to our conference for the first time following the company's IPO at the start of the year. With this in mind, investors still have plenty to learn about the company. So we're lucky to be doing this in the form of a Q&A session with the company's CEO, Lance Mitchell; and CFO, Michael Graham. Before we jump into it, I'm going to turn it over to Mark to go through the safe harbor statement, and then I'll go into the Q&A.

Great. Thanks, Lauren. I'd like to note that our remarks will include forward-looking statements and non-GAAP financial measures. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties and other limitations of forward-looking statements. With respect to non-GAAP financial measures, reconciliations of those measures to the most directly comparable GAAP financial measures to the extent they are available are included within the press release we issued yesterday, which is posted under the Investor Relations heading at reynoldsconsumerproducts.com.

Great. Thanks. So I'll jump right in. And so starting out with the near term, I think maybe we'll start with Lance. How are you thinking about the third quarter from a top line perspective? Your press release from yesterday calls for high single-digit revenue growth, which is a significant sequential acceleration from the second quarter. What's different? And could you also, in this context, maybe help us clarify a bit how much of your sales are captured by the Nielsen or IRI scanner data? Just to help us get better oriented on how we can use publicly available data sources to kind of gauge progress in a given period of time.

Well, first, thank you for the invitation to be here, Lauren. I hope you and your family are safe and cooking a lot and using a lot of Reynolds products in your home. In front of today's conference, as you mentioned, we issued a press release with revenue guidance for Q3. We estimate high single-digit increase in the quarter. That was built into our earnings guide on August 5, and it reflects another quarter of strong demand. Within that, foodservice trends are improving versus the second quarter. And the lapping of low-margin private label exits is a smaller headwind than it was in the second quarter. Our estimate, of course, includes our September expectations, and that includes a softer back-to-school than a year ago, as you would expect. On the scanner data that you asked about, we've decided to give you an estimate on the quarter's revenue increase after the quarter is underway because a large portion of our business is not captured by scanner data. Nearly 40% of our sales are of brands sold in track channels. You can take that 40%, and it could be lifted to as high as 70% or so if you use IRI data and make assumptions about our private label business and tracked channels. However, 70% is still a good distance from 100%. So that's the reason for our decision to provide revenue guidance going forward. Your conference is giving us an opportunity to give an estimate with 2 months behind us. Typically, what we'll do is provide an estimate of the current quarter's revenue hand-in-hand with the release of our prior quarter results. I'd also like to point out that we intend to provide a revenue guide in addition to our other metrics when we guide for 2021 performance, followed by, of course, our quarterly updates.

Okay. That's great. I think that's going to be very helpful, and not just because of the scanner data piece of it, but you've been -- you and Michael both have been so great at giving us a lot of detail on the sort of intricacies of things moving in and moving out in the trends, and it's sometimes difficult to put it back together in terms of how big are a put versus a take, and so I think that's a great decision and great to hear. Let's also maybe talk a bit about margins in the quarter. Yesterday, also in the pre-announcement, you talked about 23% EBITDA margin. So if you could sort of unpack that a little bit for us and give us some of the key drivers to profitability in the quarter.

Sure. Since we're now 2 months into the quarter, it also gave us an opportunity to give a solid window into our adjusted EBITDA margin. Approximately 23% is how we're looking at the quarter. And that's the same as when we reported Q2 earnings. In terms of how we get there, we expect another quarter with fixed cost leverage from higher production volumes, which benefit our gross margin. We're also keeping up spending on COVID-related safety measures and continuing to see increases in supply chain-related costs.

Okay. That's great. And an interesting contrast, I think, to some companies in the food space, where there's a conversation about new sales start to slow or ease, we'll call it, while those COVID costs remain. And for you, and it's actually the trend seem to be maybe a bit stickier. If we just move a little bit higher level, right, a lot happened since the IPO in January, probably feels like a lifetime ago. So maybe anything about how your broader outlook may or may not have changed since that time?

Yes. So no matter how you analyze research data reports that we've invested in, the fact is more people are spending more time at home than any of us thought a year ago when we went public. That means a higher estimated demand in 2021 than we expected at the time of the IPO. And that's supported by category analysis we do with partners like IRI and Harris, including category forecasts for 2021, above the start of 2020 estimates. But remember that our laps are particularly tough in March and April, and the social mobility is likely to increase year-over-year. Now looking at costs as we go into 2021, we feel really good about our ability to neutralize commodity increases between our capabilities of scale buying, some cost-savings programs we already have in motion and pricing levers. And we're always going to invest in safety. So our bias is for protecting our employees and their families, and that prompted a sizable spend from the start of the pandemic. Now reopening implies the need to keep the spending high, and although we're certainly looking for opportunities to be able to dial that back. Unit logistics costs could also moderate with a generally better year in terms of distribution efficiencies, although there's other factors in play like fuel costs. And of course, our Reyvolution initiatives, they provide us the capability to help offset some of these higher costs. From a capacity standpoint, we're adding more than we’d intended at the start of the year, supporting demand, supporting our innovation investments and further cost improvements with an emphasis on automation. Turning on new capacity is certainly not like turning on a light switch, but it's going well. And I like what it means for additional in stock performance.

Okay. And what is the risk, I guess, if we go out, let's say, 2 years or 3 years, whatever the time may be, and consumption patterns at home change a bit with having too much capacity. What's the ability to kind of put the other way? Yes. Just thinking about that as companies add capacity at time kind of elevated demand.

Well, I look at it in 2 ways. One, we're not high-intensity capital investments in capacity. It's not like we're adding new roofs. These are not significant capital investments. And secondly, some of it is decommissioning mothballed assets. So it's just a question of flexing labor in those particular facilities. And the ones where we are adding equipment, that equipment is lower cost, more automated. And I think regardless of how you look at the future, labor is going to continue to be a challenge, and that capacity will provide us a payback because of the automation, albeit on a longer-term basis than from just selling the capacity, but nevertheless, a good investment.

Okay. That's great. That's very helpful. And then what about 2020, maybe some of the opportunities and watchouts as you head into the balance of the year?

I don't call this a watchout, but I think one of our -- our biggest priority is service, behind safety, and we've made a lot of progress here, and I expect to report more progress each quarter. And as we've said previously, these service challenges can cause supply chain inefficiencies and, therefore, higher costs. But as I look at opportunities, I know a favorite question inside Reynolds is the turkey question. And my kids love this question, too. The question, will there be more turkeys consumed during this year's holidays? We know a lot of families will not be going over the river and through the woods to grandmother's house for Q4 holiday gatherings. So Q4 use occasions for our products versus a more traditional Q4 could possibly be a benefit versus our expectations. But it's really a challenge to predict. I also want to point out, we don't anticipate typical holiday-related spend on trade promotions because of the favorable environment for demand. And as we mentioned with Q2 results, we do intend to redirect some of those savings to advertising because we suspended a lot of advertising in Q2. So it's a shift in timing versus a total year increase in advertising investment. October is an important month for us. It'll tell us a lot about the holiday-related shipments.

Okay. Great. Trying to go back to supply chain. You've talked about the increase in capacity. But one thing in particular was just in some of the categories like trash bags, obviously, to cooking and baking. But just thinking about how the monthly build on capacity will mean in terms of throughput and kind of working through out of stocks? When do we kind of get back to a shipments equating to demand situation?

As I said, we're adding more capacity than we intended at the start of the year. It's really not like turning out a light switch. It's coming on gradually. And we expect in-home use to remain well above 2019 levels even after this year, of course, moderated by increases in social mobility. So I know a lot of you would want me to convert that into a guide through 2021, and it's a little too soon to do that. But the 3 ways we're adding capacity is we're accelerating projects we already have planned; we're investing new capacity for high demand products, as I talked about a moment ago; and we're recommissioning mothball assets, which as I said, will give us capability to flex with labor. So the capacity we're adding is in line with the elevated demand we expect to continue, which will provide us the capability to return our service levels to the retailers and consumers' expectations. That's going to happen gradually as we go through the balance of this year.

Okay. And then when I think about innovation, the one thing that surprised me when I first met you guys was just how much innovation there is in the businesses and what you've done thus far. So what are some of the white spaces or line extensions that you say are still kind of available or of particular interest? And to what degree does that have to go on pause because of these capacity conversations and some of the streamlining we've seen across many, many businesses at retail?

It really didn't go on pause because of the capacity additions. It went on pause because a lot of retailers were really focused on supply and therefore, really didn't have the opportunity to take on new products, and that's changing now. They're now back to the table discussing bringing in new products. So with that, our product pipeline was already strong, and we were well prepared to launch those new products. We've now doubled down on market and consumer research for new product development to further strengthen the pipeline. So I'm really excited about the developments we have underway and are ready to launch. And I'll give you a couple of examples. EcoSafe, which are our compostable paper plates and bowls. Food storage containers, all of us know we're using more leftovers, and this gives consumers the opportunity to be able to save those. Reynolds foil grill bags, a perforated plastic wrap. It dispenses like a paper towel, which eliminates the difficulty of cutting it to size and then the film wrapping up on itself. Standing close, Presto close food bags, parchment cooking bags, individually wrapped cutlery. And we have Hefty with a new Fabuloso scent that we're partnering with Colgate-Palmolive. And that's just a few examples of the products we're ready to launch now.

Very cool. My brains are going out like there's foil bag, perforated -- I'm very challenged on the wrap. Okay. And then just one more question on your portfolio composition, which is just how should we think about this 50-50 balance that you have between brands and private label? How does that evolve or not over time?

During the COVID period, we've seen our brands grow share as consumers thought -- they really looked for performance assurance, and they went with what they trusted in these categories. As we discussed at the formation of the IPO and our commitment is really to grow the entire category. And that means we provide a balance of brands and store brands. That ensures consumers have choices that expand the overall category. We've invested significant resources over the years as part of our strategy that differentiates ourselves from our other suppliers. We provide both brands and store brands, and we support that with the best-in-industry category management team. And that distinguishes us with our retail partners. This has been a winning formula since day one when we formed the company almost 10 years ago, and we expect it to continue to be a winning formula going forward. And as we've said on many occasions since the IPO, these categories have been very stable as to the balance of brands and store brands, and there is currently no evidence to expect that to change in the foreseeable future.

Okay. That's great. Michael, I'm going to bring you into the conversation. So you've spoken about increases in commodity costs sequentially versus May, but still managed to put up gross margin expansion of 200 basis points in the second quarter with all the fixed cost absorption that you've had. So how should we think about commodity cost pressures, volumes and cost savings for the balance of this year?

Yes, Lauren, as you pointed out, a large source of the Q2 margin expansion came from stronger fixed absorption. And considering our outlook is to have a continued elevated level in demand, at least some of that we expect to continue to stick going forward. If you think about commodities, however, materials account for about 60% of our overall COGS with 45 of those points coming from commodities, with polyethylene being the largest, followed by aluminum and then polystyrene plastic. We also saw declines in key commodities at the start of the second quarter. However, this was followed by increases in June and July as suppliers indicated the potential for further increases through the back half of the year. So given the lag in commodities going forward, we expect that we will see a pronounced impact in 2020 for the fourth quarter.

Okay. And then in terms of cash flows, you've had really impressive progression-free cash flow, and you've made very quick progress on decreasing leverage. So how should we think about working capital and free cash conversion in the sort of medium to longer term?