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

Ladies and gentlemen, thank you for standing by, and welcome to Reynolds Consumer Products Fourth Quarter 2022 Earnings Call. [Operator Instructions] Please be advised that today's call is being recorded. I would now like to hand the conference over to your speaker today, Mark Swartzberg. Thank you. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us on Reynolds Consumer Products Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. Please note that this call is being simultaneously webcast on the Investor Relations section of the company's corporate website at reynoldsconsumerproducts.com. Our earnings press release and accompanying presentation slides are also available on the website. With me on the call today are Lance Mitchell, our President and Chief Executive Officer; and Michael Graham, our Chief Financial Officer. For our agenda this morning, Lance will focus his remarks on fourth quarter performance and the Reynolds' Cooking & Baking recovery plan as well as discussion of our performance drivers, while Michael will review our fourth quarter and full year financials as well as our 2023 outlook. Following prepared remarks, we will open the call for questions. Before we begin, I would like to provide a few reminders. First, this morning's discussion may contain forward-looking statements based on current expectations and beliefs. These statements are subject to risks, uncertainties and changes in circumstances that could cause actual results and outcomes to differ materially from those described today. Please refer to our Risk Factors section in our SEC filings, including our annual report on Form 10-K and our quarterly report on Form 10-Q. Please note, the company does not intend to update or alter these forward-looking statements to reflect events or circumstances arising after the call. Second, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these GAAP to non-GAAP financial measures are available in our earnings press release, investor presentation deck and Form 10-K, copies of which can be found on the Investor Relations section of our website. Now I'd like to turn the call over to Lance Mitchell.

Thank you, Mark. Thanks to our people, our integrated brand and store brand business model and our unwavering commitment to category leadership. We made strong progress on our key initiatives in 2022. We entered 2023 with increased market share in our largest categories, service returned to pre-pandemic levels and profitability restored in 3 of our 4 business segments. However, as you can see from our fourth quarter results, the Reynolds Cooking & Baking business segment performance fell short of our expectations. On our earnings call in November, we reported that the Reynolds Cooking & Baking business segment entered the fourth quarter having experienced periods of unplanned equipment downtime, resulting in additional manufacturing costs and impacting our ability to adequately supply customers. Equipment reliability remained challenging in the fourth quarter, driving inefficiencies and manufacturing costs higher than expected while also driving continued higher aluminum costs. These factors drove the EBITDA shortfall versus the expectations we shared with you in November. In addition, while we were successful driving Reynolds Wrap share to the highest quarterly level for the year, household foil consumption was weaker than expected, also contributing to lower-than-anticipated net revenues for the quarter. Now let's turn to our plan to return Reynolds Cooking & Baking to historical levels of profitability. And as I do so, I want you to know that we entered 2023 with a thorough understanding of what has been impeding Reynolds Cooking & Baking margin recovery as well as the team and resources in place working to correct the issues impacting that business segment. Key actions underpinning the Reynolds' recovery plan include following: management changes, including several key operational leadership roles; redesign of equipment reliability processes and practices; incorporating benchmarks and input from experts in operational excellence; return to pre-pandemic preventive maintenance disciplines and new initiatives focused on improving operational excellence, including implementation of condition-based monitoring and predictive maintenance, cross-functional teams focused on critical asset efficiencies, investments aimed at improving equipment reliability and performance and increased technical expertise alongside key production assets. We believe that these and all the improvements we are making to the Reynolds Cooking & Baking operations will not only drive a major improvement in manufacturing efficiencies, but also a decline in our use of the higher-cost supplemental purchases of milled aluminum that I mentioned previously. Mike will speak more to our expectations for phasing the Reynolds Cooking & Baking business segment earnings recovery. Now let's review key drivers of our performance overall: pricing, consumer demand, innovation and manufacturing and supply chain capabilities. First, pricing. We continue to selectively increase trade promotions, which are expected to be up in 2023 versus 2022 levels. We also remain watchful of commodity trends and the cost of aluminum and resin is up versus end of December levels. On balance, I would describe the pricing environment as far more stable than it was either last year or in 2021. Second, consumer demand. Our categories have settled into a new normal. And in 2023, we expect a return to household formation is our main driver of growth offset by inflation's continued impact on consumption and lapping of elevated demand in the first several months of 2022. We also entered 2023 in a position of strong category leadership. Consumption in many of our categories is up 5% or more since 2019, and we have built market share in our largest categories and in multiple adjacencies over this period. We've also gained additional share in these categories in 2022. Reynolds Wrap's market share gains accelerated in the second half of 2022, driven by promotions to key price points, nearing price gaps to private label and consumers' appreciation of Reynolds Wrap performance advantages by comparison to private label foil. In Waste bags, Hefty's household penetration increased in 2022. Hefty Waste bag brand increased buyers in almost every generational group, especially among millennials. And in disposable tableware, Hefty again gained share in 2022, driven by disposable plates, including our rapidly growing Hefty ECOSAVE line. Our third performance driver is innovation. Innovation remained a major source of volume in 2022. In 2023, we plan to continue leaning into the success by expanding distribution across a number of high-velocity products while also introducing multiple major new products and increasing our emphasis on sustainable solutions. In Reynolds Cooking & Baking, we plan to increase distribution of Reynolds Wrap Pitmaster Foil and Reynolds Kitchens Air Fryer Liners among others, while also introducing Reynolds Kitchen stay flat parchment and other products designed to meet the increase in cooking and baking among young adults and other major segments of the population. In Waste & Storage, we plan further distribution gains for our portfolio of Hefty Fabuloso products, including new Hefty 4 & 8 gallon drawstring trash bags and we're excited to announce that Hefty Trash Bags is launching a new Fabuloso Refreshing Lemon scent in the first quarter. In dollar sales, Refreshing Lemon is the #2 scent of Fabuloso multiple purpose cleaners and Lemon citrus scented waste bags are growing at 2x the rate of the larger waste bag category. We're also doing a lot in the area of sustainable solutions. Reynolds Kitchens Butcher Paper and wax paper are now compostable. Hefty ECOSAVE continues to grow rapidly with additional strong growth expected, driven by SKU expansion, further distribution gains and continuing strong consumer demand. Early results for the Hefty Compostable Printed Paper Plates also gives us confidence in our expansion plans for this new solution. And in Waste & Storage, a wide range of sustainable products are lined up for commercialization. For example, our recently launched private label food bag made from 20% renewable plant and ocean materials is off to a strong start. Manufacturing and supply chain is our fourth driver of performance. Our entire organization is focused on the execution of the Reynolds Cooking & Baking business segment recovery plan. In addition, we've expanded the scope of Reyvolution cost savings, giving us confidence in another year of at least 200 basis points of incremental margin as a source of funds for reinvestment and margin expansion. Legacy Reyvolution programs still have considerable runway, and we are undertaking new procurement and operations-related programs in 2023 as well. Before I turn the call over to Michael on your questions, I'd like to leave you with the following. Our people have responded to the many opportunities and challenges in the last 3 years with exceptional resilience and resolve to serve our customers, combat inflation and leverage our integrated brand and store brand business model to help consumers simplify their daily lives and make our business stronger. Our market share, our category consumption levels and full recovery of pre-pandemic profitability in 3 of our 4 business segments are proof points of our success. Looking forward, the Reynolds Recovery Plan is in place, and I have the utmost confidence in our plan, our ability to deliver a strong recovery of that segment's profitability. I'm extremely proud of the entire RCP team, and we look forward to earnings growth in 2023 and the years to come. With that, over to you, Michael.

Thank you, Lance, and good morning, everyone. I'll start with a review of our full year 2022 and fourth quarter financial results before turning to our 2023 outlook and the actions we are taking to return to pre-pandemic profitability this year. For the fiscal year 2022, net revenues were a record $3.8 billion, up 7% from $3.6 billion in the prior year. This growth was driven by pricing up 13%, taken in response to increased material, manufacturing and logistics costs and partially offset by lower volume. Volume was lower driven by price elasticity and increased activity outside the home, which was partially offset by share gains in household foil, waste bags, disposable tableware and other categories. Adjusted EBITDA was $546 million, down 9% from $601 million in the prior year due to lower volume and higher advertising costs, partially offset by the timing of pricing actions to recover increased material, manufacturing and logistics costs. Operational inefficiencies in the Reynolds Cooking & Baking segment and continued supplemental purchases of milled aluminum at a premium to our cost drove the EBITDA disappointment versus our previously provided outlook. Lower household foil consumption, together with higher cost aluminum also contributed to the earnings decrease. Adjusted earnings per share for the year was $1.28 versus $1.59 in the prior year. Turning to our fourth quarter results. We delivered a record net revenue of $1.1 billion during the fourth quarter, up 7% from the prior year's Q4 of $1 billion. And in terms of profitability, each of Hefty Waste & Storage, Hefty Tableware and Presto segments fully recovered to pre-pandemic profitability while also reporting record earnings with improvement driving a 10% increase in adjusted EBITDA to $200 million by comparison to $181 million in the prior year. Operational inefficiencies in the Reynolds Cooking & Baking segment and continued supplemental purchases of milled aluminum at a premium to our costs drove the EBITDA disappointment versus our previously provided outlook. Lower household foil consumption together with higher-cost aluminum also contributed to the earnings decrease. Adjusted earnings per share for the quarter increased 4% to $0.53 compared to $0.51 in the prior period unpacking our volume performance, elasticity and increased consumer activity outside of the home drove a 4% volume decline, driven by a 10% decrease in Reynolds Cooking & Baking volume. However, all 4 segments did gain volume share in their largest categories in tracked channels, driven by innovation, strong retail partnership and service. Hefty Tableware and Presto delivered volume increases in the quarter driven by innovation and share gains. Looking ahead, I'll start with the summary of our earnings outlook for the full year 2023, followed by our expectations for the first quarter. I will then turn to the topic we are all keen to discuss in more detail, our key performance drivers, our expectations for Reynolds Cooking & Baking and more information on the first quarter guide and post first quarter expectations. For the full year 2023, we expect continued pressure from elasticities and our net revenues to be flat, plus or minus 1%, with pricing flat to slightly up on net revenues of $3.8 billion in 2022. We expect rates for key commodities to be relatively stable by comparison to the levels that we saw at the end of January. We expect SG&A to increase to approximately $420 million, driven by compensation related comparisons and increased investments in advertising and market research. We expect Reyvolution related cost savings to be a source of approximately 200 basis points of incremental margin for reinvestment and potential contribution to margin expansion. In 2022, Reyvolution growth initiatives were a source of approximately 2 percentage points of revenue, and we expect a similar contribution from Reyvolution growth initiatives in 2023. Adjusted EBITDA to be in the range of $605 million to $635 million, which is a low double-digit to mid-teen increase by comparison to results in the prior year and EPS to be in the range of $1.30 to $1.41 per share. Other key assumptions for the year include depreciation and amortization of approximately $120 million, interest expense of approximately $120 million as well and an effective tax rate of approximately 25% and capital spending of approximately $120 million to $130 million. For the first quarter, we expect net revenues to be flat, plus or minus 1%, with pricing up mid-single digit on net revenues of $845 million in the prior year period. Adjusted EBITDA to be in the range of $75 million to $85 million, down by comparison to adjusted EBITDA of $112 million in the prior year period and EPS to be in the range of $0.06 to $0.09 per share. Now let's talk about the performance drivers and phasing, including the first quarter guide. We entered 2023 with margins benefiting from pricing alignment to the current cost environment and expect the significant improvement, which is evident in the fourth quarter results to drive adjusted EBITDA growth and margin expansion on an annual basis as well. In terms of segment performance, we expect 2023 results to be driven by continued solid performance for Hefty Waste & Storage, Hefty Tableware and Presto and improving performance for Reynolds Cooking & Baking as we move through the year. Focusing on the first quarter, while volume comparisons are more challenging in the quarter and expect it to be a drag on year-on-year EBITDA growth, the major driver of the expected decline in year-on-year adjusted EBITDA is Reynolds Cooking & Baking performance. Between Reynolds Cooking & Baking's fourth quarter operational inefficiencies and continued supplemental purchase of milled aluminum at a premium to our costs, we expect limited, if any, EBITDA for Reynolds Cooking & Baking in the quarter. Obviously, our first quarter expectations are far shorter what we normally expect for Reynolds Cooking & Baking profitability. And with that in mind, I thought it would be helpful to elaborate on the factors driving our confidence in earnings growth after the first quarter. Each of our business segments is winning at retail and entered 2023 with increased share in our largest categories. We have the in-store display, promotions and advertising plans in place to reinforce and build category leadership and profitability in all of our business segments. Pre-pandemic profitability is already recovered in 3 business segments and the level of pricing and margin achieved in the fourth quarter translates into margin expansion for these businesses in 2023. After the first quarter, we expect to see a lot less reliance upon supplemental milled aluminum, in turn, resulting in a sizable improvement in average product costs. And our other big headwind in Reynolds Cooking & Baking is operational inefficiencies. We expect operational efficiencies to improve over the course of the first quarter and continued to improve during the second quarter, driving a significant increase in earnings by comparison to the first quarter results and to return to pre-pandemic profitability as we entered the third quarter. Now before I turn the call back over to Mark and your questions, I'd like to leave you with the following few thoughts on cash flow. We remain committed to leading our categories and driving progress towards recovering pre-pandemic profitability across our business leading to stronger cash flows. Our increased emphasis on cash conversion benefited fourth quarter results, and we expect further cash flow gains in 2023 as we grow earnings, further emphasize balance sheet efficiency and maintain capital spending discipline. All of this is expected to drive returns and debt pay-down this year. And finally, our capital allocation priorities are unchanged. With that, I'll hand the call back over to Mark.

Thank you, Michael. As I turn the call over to the operator for your questions, in the interest of time, we ask that you please ask 1 question and a follow-up and then rejoin the queue if you have additional questions. Operator?

[Operator Instructions] Our first question is from Lauren Lieberman with Barclays.

I guess to start at a kind of high level and appreciating you went through in kind of key bullets on this plan to recover in the Cooking & Baking business. I guess upon first getting to know the company, my assumption was this is going to be a great manufacturing operation, right? Reynolds comes out of packaging background that this is a manufacturing company. And then my positive surprise with how -- what great marketers the company is. But now what we're finding is where there seem to be cracks in the -- what I thought was core, right, the manufacturing. So I just -- knowing you've offered words already on the plan to repair. I just need to go back and understand a little bit better what's going on in terms of "equipment reliability?" Is it a matter of underinvestment in capital? I just -- I'm struggling with kind of what's broken down operationally because last quarter, when you had this downtime, you discussed it as temporary in nature. And so there's something here that wasn't temporary, it was a misunderstanding of the issues that began in the third quarter. So just a little bit more color on all that would really be great.

Lauren, it's a very, very fair question and very accurate. We are a great manufacturing company, and the cause really goes back to the pandemic. Our focus during that period of time, really strong demand from consumers, particularly for Reynolds Wrap, included some swings in production rates that we've never seen historically and compromised our maintenance programs and therefore, our equipment reliability. In addition, we paid heavy attention to restoring the element of production to -- on a preventive maintenance. So the resolution of that is to return to historically effective preventive maintenance disciplines while also implementing multiple new initiatives, including the ones I mentioned in my prepared remarks. I think it's also worth reminding that we have a very strong team. And along with the input of some outside expertise that we brought on board, it gives us a high degree of confidence in the effectiveness of our plan. The key here is the improvement in operational efficiencies as that reduces the manufacturing costs while also decreasing our reliance on supplemental purchases of milled aluminum. And we expect to proceed along the lines that Michael reviewed in his prepared remarks. Our plan is very detailed and has multiple elements to it. I think that, ultimately, the key assumptions are that, one, we have a very firm grasp on the causes of the downtime; two, a prescription match to the causes; and three, a team to apply that prescription. I mentioned the confidence in our team and I'm equally confident in our understanding of the loss of efficiencies in our plan for fully reversing them.

Okay. That's great. And then just in follow-up, in the release, it was specifically that you're not going to offer non-GAAP or adjusted net income and EPS and sticking with EBITDA. So that's fine. EBITDA is cash, it's closer to cash. But any sort of perspective you can offer on some of those non-GAAP adjustments? Or just maybe even why, right? Is it because you don't yet know the cost of restructuring and sort of remedying the plan that you're detailing and you don't want to put a number out there for the cost of the plan? Is that the key reason we're moving away from adjusted EPS?

The reason we're moving away from adjusted EPS, and I'll let Michael elaborate on this is there is no transaction costs anymore. And so we don't expect there to be any adjustments to any of the GAAP measurements 3 years after the IPO. So -- and as a matter of fact, our compensation is based on EBIT and not EBITDA based on the incentive plan. So that comment in the release was primarily just to say there's not going to be adjustments, period.

Okay. Great. That was a misunderstanding. I was reading it and thinking is this about there being restructuring costs that can't be quantified, but it's rather that there's -- that the adjustments post IPO or that's in the past. That's great.

Our next question is from Jason English with Goldman Sachs.

A couple of questions. First, you hinted that the issues you're seeing in first quarter going to bleed into 2Q with comments like lapping elevated consumption through the first half, comments like you're still going to be working through the inefficiencies through the second quarter, et cetera. Can we just put a finer point on that? And can you unpack what really are your expectations through the first half of the year with the implicit second quarter?

Yes. So as I said in my prepared remarks, after Q1, we have significantly less reliance on supplemental milled aluminum, resulting in lower average cost. Operational efficiencies improved over the course of first quarter, improved further in Q2 followed by a return to pre-pandemic profitability in the second half. A bit more color on this, we'll see carryover Q4 as additional purchases for supplemental -- supplemented by milled aluminum into Q1. Also since Q1 is seasonally a smaller quarter, the profit impact will be more pronounced in the second quarter, which is a larger one.

Okay. Okay. So let's switch gears then back to sort of Lauren's angular questioning, and if we go back to your pre-IPO days, and I remember all the hype about your Shake & Bake technique of taking and just starting to kind of form your own stuff, you don't have to go out there in the open market and buy this. And I recall it being kind of new. It sounded like you've been doing this for a decade. It's something that you began to implement really just a few years ago. And it sounds like given that you're now going back out to the market to buy this, it sounds like that's the issue. Like this new approach that's still relatively young isn't working for you. So do you have to kind of revisit that whole model, this whole Shake & Bake approach and milling and why should we have confidence that it's just a couple of tweaks on the preventative measures and you'll be back to bright?

Shake and Bake is about melting aluminum. It's about melting scrap aluminum. It's -- that production process is in Hot Springs, Arkansas, part of our aluminum melting facility, and it's 100% operational. What we're talking about here is the milling operations in [ global ]. That is the area where we have the challenges in that we're addressing. So we're able to melt more aluminum than we can mill. And so we have to buy milled aluminum from a third party. That's the significant issue here that we're addressing. There are 2 different manufacturing processes that you're addressing.

Our next question is from Kaumil Gajrawala with Credit Suisse.

So clearly something didn't go, I guess, according to plan in Cooking & Baking. It sounds like you have a grasp on what occurred. Is there -- are you able to put some -- perhaps some numbers around precisely what it costs? Obviously, your guidance for 1Q EBITDA for the segment gives us a sense. But did it cost $20 million of EBITDA or $40 million? Or can you just give a little bit of a read on what it might have -- what the expense might have been that a little more onetime?

Yes. We missed the guide by, let's call it, $20 million. $10 million of that was volume, approximately $5 million of it was the metal purchases and the other $5 million was the operations disruptions.

Thanks for being so clear. And typically, we don't ask for a guide to buy segment or anything. But I think in this instance, it might be helpful to just get a sense for the full year as Cooking & Baking has made between $200 million and $250 million of EBITDA. As we're thinking about the full year for '23 or if you can at least give us a sense of where you expect it to end up once we get past 1Q?

Yes, you're right. We don't give guidance on individual segments. We did try to be very clear about the cadence of the earnings recovery in the Cooking & Baking segment. And Michael, in his prepared remarks, talked about Q1 being breakeven-type EBITDA and then recovering the full profitability by the second half with good progress in Q2. For the full year, that business segment will be better than it was in 2022. It is back-half loaded. But specific numbers, we're not going to guide specific numbers on segments.

Our next question is from [ Tristan Chao ] with Stifel.

Thanks, and good morning, everyone. This is Tristan on for Mark. I just have 2 questions. First, just on cash flow, just saw that working capital was dragged down by increased inventories. So what gives you confidence that working capital or inventories can improve to get net debt to $1.8 billion to $1.9 billion as forecasted in your guidance? And what's a reasonable expectation for cash flows from operations? And I have a second question after that.

Yes. Big driver is -- obviously, a big part of it is return to profitability within our Cooking & Baking. We also see commodities as being stable. We have a number of Reyvolution initiatives that we've talked about before, and we've had a great track record in terms of driving that and that materializing in bottom line results. Beyond that, we also have a number of working capital initiatives that we continue to push. Inclusive in that, obviously, is just making sure that we manage our CapEx spending but that's going to be supplemented by a very high focus on accounts payables as well as managing inventory levels.

Great. And my second is just you mentioned an increase in A&P spend in '23. And so how does that compare to pre-pandemic levels? Is there a certain threshold where volumes respond?

Yes. This brings us back to historical levels of advertising spending. It will be approximately $20 million higher than it was in 2022.

Our next question is from Andrea Teixeira with JPMorgan.

This is Shovana on for Andrea. You did mention that you are expecting to see improvement of profitability by Q3, end of Q2, progressing and laid out all the foundational, but can you please go over the specific reasons, like is it the timing of the commodities, addressing the inefficiencies and/or promotions? And if you could please give us a sense of the kind of numbers you're allocating to each of these reasons?

Yes. I did say that in my prepared remarks that we do expect that we're going to see increased operational efficiencies throughout the quarter. And obviously, a big part of that is going to be the timing of the actions we've put in place. We do also see commodities. As I mentioned earlier, our commodity is not being as much of a drag on overall business. And we see they lower Cooking & Baking having better performance, as we've mentioned earlier. Those are the key drivers.

And promotions would not play a factor at all or...

Well, it's minor in terms of the overall impact to overall. Yes, I don't think that is a big factor.

Our next question is from Peter Grom with UBS.

So I wanted to ask about the profit outlook, but more just kind of what's embedded in terms of the commodity cost. I think the release states that you're expecting spot rates from the end of January to hold, is that simply just being conservative? Or is there something that you're seeing that would kind of actually drive these spot rates to hold at current levels? And then maybe just a follow-up on that. I mean a lot of news around potential tariffs on Russian aluminum. Any thoughts on how this may or may not impact your profit targets?

Let me answer the last question first. We don't buy metal from Russia. So it will not have any impact to us either way. The first question -- remind me the first question again, it was...