Akzo Nobel Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2023

There are 11 speakers on the call.

Operator

Good morning, and welcome to Whirlpool Corporation's Third Quarter 2023 Earnings Release Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Senior Director of Investor Relations, Corey Thomas.

Speaker 1

Thank you, and welcome to our earnings conference call. Joining me today are Mark Pitzer, our Chairman and Chief Executive Officer and Jim Peters, our Chief Financial Officer. Our remarks today track with a presentation available on the Investors section of our website at whirlpoolcorp.com. Before we begin, I want to remind you that as we conduct this call, we'll be making forward looking statements to assist you in better understanding Whirlpool Corporation's Our actual results could differ materially from these statements due to many factors discussed in our latest 10 ks, Thank you and other periodic reports. We also want to remind you that today's presentation includes the non GAAP measures outlined in further detail at the beginning of our earnings presentation.

Speaker 1

We believe these measures are important indicators of our operations as we exclude items that may not be indicative of results from our ongoing business operations. We also think the adjusted measures will provide you with a better baseline For analyzing trends in our ongoing business operations. Listeners are directed to the supplemental information package posted on the Investor Relations section of our website for the reconciliation of non GAAP items to the most directly comparable GAAP measures. At this time, all participants are in a listen only mode. Following our prepared remarks, the call will be open for analyst questions.

Speaker 1

With that, I'll turn the call over to Mark.

Speaker 2

Thanks, Corey, and good morning, everyone. Before we discuss our Q3 results in more detail, I want to acknowledge the great news that we received earlier this week. On Tuesday, the European Commission announced their unconditional approval of our European transaction with Arschlik. With this decision In earlier clearances from Austria, Germany and China, we passed a major regulatory hurdle and are now fully focused And obtaining Phase 2 approval from the UK's CMA. While a transaction closure within this year is unlikely, We are confident that we can close by April next year.

Speaker 2

The transaction closure will unlock significant value for us, largely coming from an improved free cash flow of $250,000,000 per year. Later during this call, we will give you more detail about the expected regulatory process And the value creation of this transaction. Looking more short term at our Q3 results, we are pleased with our operational progress and our top line growth In what is still a very challenging environment, the bottom line showed solid progress over last year, but is essentially flat from prior quarters. Our operational progress during the entire year has been sustained and even accelerated during Q3. We improved our supply chain execution.

Speaker 2

We accelerated our cost takeout actions and are fully on track towards our full year cost targets, and we launched several innovative products across multiple categories. As a result, we were able to gain market share in almost all of our major businesses. As I mentioned earlier, the market environment is still challenging. Market demand in the Americas has been solid, but this is entirely driven by a very strong replacement demand related to increased appliance usage at home, A trend which we expected and which we expect to continue. The other side of demand discretionary purchases have been even softer than anticipated as a result of increased mortgage rates and low consumer confidence.

Speaker 2

The low discretionary demand sparked a more intensive promotional environment, in particular, North America. Essentially, we're back to a pre COVID promotional environment. Being back to a pre COVID promotion environment is not surprising. However, we expected this to occur 1 or 2 quarters later. Looking into the Q4, we do not anticipate this environment to fundamentally change, and we do expect our business to perform on a similar level as Q3.

Speaker 2

As a result, we're updating our full year guidance. We now expect full year EBIT margins of 6.25% to 6.5%. At the same time, we're able to achieve additional tax benefits. Putting both together allows us to remain at the lower end of our original of approximately $16 but with a lower free cash flow of $500,000,000 Turning to Slide 6, I will provide an overview of our solid Q3. We delivered 3% of top line growth, both year over year and sequentially.

Speaker 2

Promotions, which were normalizing sooner than expected, were more than offset by over point of share gains in North America, strong and growing replacement demand, Our builder channel benefiting from a shortage of existing homes and the in sinkerator acquisition. We realized $300,000,000 Cost takeout benefit in the quarter and are fully on track to deliver over $800,000,000 of cost takeout in 2023. Our actions drove 100 basis point margin expansion year over year with solid EBIT margin of 6.5% And ongoing earnings per share of $5.45 Now turning to Slide 7, I will share more details on our 100 basis points margin expansion. Sequentially price mix negatively impacted margins by 150 basis points and 3.75 basis points year over year, driven from a normalization of promotions, which was Largely absent in recent years and reemerged in the Q3 of 2022. The promotional environment is now reflecting return to historical levels Faster than previously expected and normal seasonal patterns, which are weighted more towards the second half of each year.

Speaker 2

In addition, mix was negatively impacted in the quarter due to over indexed share gains in Laundry, as our Laundry share was disproportionately impacted by supply chain disruptions During the pandemic, our strong cost actions delivered both sequential and year over year benefit of 10625 basis points, respectively. Both year over year and sequentially, we invested more in Marketing and Technology. Ultimately, we delivered ongoing EBIT margin of 6.5%. Turning to Slide 8, you will see operational priorities are fully on track. Our resilient and adaptive supply chain has delivered share gains throughout the Americas.

Speaker 2

We have addressed recent supply challenges, significantly reducing the risk of supplier driven disruptions by Expanding dual sourcing and reducing parts complexity by more than 50% since 2021. We're fully on track to deliver over $800,000,000 of cost reductions in 2023, even with some raw material cost benefits coming slightly later than originally expected. And while we're not providing guidance for 2024, we're increasingly confident about sustained cost progress well into 2024 due to a number of factors. A significant cost takeout during the second half of twenty twenty three will obviously create sizable carryover benefits. The recent trends in raw materials, in particular steel and trade rates, which have been favorable throughout the year, are likely to continue to create tailwinds.

Speaker 2

Now, I will turn it over to Jim to review our regional results.

Speaker 3

Thanks, Mark. Good morning, everyone. Turning to slide 10, I'll review results for our North America business. The region saw mid single digit revenue growth, both sequentially and year over year, With improved supply chain execution and new product introductions delivering over a point of year over year share gains, Coupled with resilient replacement and builder demand, the addition of In Syncorator and strong cost actions, partially offset by normalized promotions negatively impacting price mix. Overall, the region delivered double digit margins of 10%.

Speaker 3

Turning to Slide 11, I will discuss how North America is well positioned to grow and expand margins. We continue to invest in product innovation with a 25% increase in new product introductions this year compared to 2022, Leading to premium product share gains, our strong portfolio of brands targets over 90% of consumers With 3 of those brands delivering well over $1,000,000,000 of North America sales annually, we are the number one choice for U. S. National homebuilders And our strong direct to consumer business has been growing at 20% annual compounded growth rate in the U. S.

Speaker 3

Since 2018. Additionally, we have a relentless focus on delivering the best cost position and reducing complexity. With an industry demand of over 56,000,000 annual units between the United States and Canada and approximately 75,000,000 100,000 replacement units are purchased every day and an undersupply of houses continues to exist in the U. S. Our brand and product leadership coupled with our operational priorities has North America business well positioned to deliver margin expansion in From our top load laundry innovation for pet lovers and the industry's only 2 in-one agitator washing machine To our latest premium KitchenAid French door refrigerator with superior craftsmanship and purposeful innovation like the industry's largest 3rd rack dishwasher Or the 1st in the industry flush mount microwave hood combo.

Speaker 3

These innovative new products demonstrate our Commitment to being the best kitchen and laundry company, improving life at home for our consumers and strengthen our leading position in North America. As we look forward to 2024, we have an even stronger lineup of new product introductions that we expect will positively impact Price mix and market share. Turning to slide 13, I'll review results for our Europe, Middle East and Africa region. The region saw continued demand weakness as the inflationary environment and geopolitical tensions continue to weigh on consumer sentiment. Revenue was down 2% year over year excluding the Russia business, which was divested in Q3 of last year.

Speaker 3

The region delivered margin expansion year over year from cost takeout actions and held for sale accounting benefits due to reduced depreciation. Later in the call, Mark will provide additional insights on the Europe transaction as it continues to progress through the regulatory process. Turning to slide 14, I'll review the results for our Latin America region. The region saw strong share gains and industry recovery in both and Brazil, with a double digit net sales increase year over year of 14% and sequential growth of 5%. Strong cost takeout actions and higher volumes drove 100 basis point expansion in EBIT margins year over year.

Speaker 3

Turning to Slide 15, I'll review results for our Asia region. Excluding the impact of currency, revenue declined approximately 8%, driven by continued consumer demand weakness. The region delivered EBIT margins of 2.2% with our cost takeout More than offset by negative price mix. Turning to Slide 16, I will discuss our full year 2023 guidance. Our net sales guidance of $19,400,000,000 is unchanged.

Speaker 3

We are revising our full year ongoing earnings per share to approximately $16 and free cash flow guidance to approximately $500,000,000 As previously discussed, we continue to expect to deliver over $800,000,000 of However, as promotions have normalized to historical levels sooner than expected and the macro environment weighs on discretionary demand, which continues to be depressed. We now expect to deliver EBIT margins of 6.25% to 6.5% with 4th quarter operational results expected to be in line with our Q3 performance. Our guidance also includes updated expectations for our Effective tax rate, now between 0% to negative 5% for 2023, reflecting European legal entity restructuring benefits. I would like to remind you as the European transaction progresses, the close timing may have a material impact on our guidance. We also expect our 2024 adjusted effective tax rate and cash tax rate to be impacted by the closing of the Europe transactions and to be below historical norms.

Speaker 3

We currently estimate that it will be at or below 15%. We also continue to expect to repay approximately $500,000,000 of debt associated with the In Syncarator acquisition during the Q4, in line with our commitment to maintaining our investment grade credit rating. Turning to Slide 17, I will review our regional expectations for 2023. Globally, we now expect a flat industry with industry demand up 1% to 2% in North America Due to stronger than expected replacement volumes, trade customer inventory replenishment and resilient builder demand. We expect these demand trends to continue and to see low single digit industry growth in 2024.

Speaker 3

Industry expectations in EMEA of down 6% to 8% reflect an increasingly challenging macroeconomic and geopolitical environment. Latin America has seen significant demand recovery and we now expect industry to be flat to up to 2%. Finally, Asia demand continues to be impacted by softer consumer sentiment and we now expect industry to be down 2% to 3%. We have adjusted EBIT margins to reflect the normalized promotional environment negatively impacting price mix. We expect solid full year North America margins of approximately 10%.

Speaker 3

With industry demand weakness in EMEA continuing, We now expect EBIT margins to be approximately 1%, and we now expect Latin America and Asia to deliver EBIT margins of approximately 6% and approximately 3%, respectively. Now, I will turn the call over to Mark.

Speaker 2

Thanks, Jim. Turning to Slide 19, let me provide an update on our portfolio transformation. We have and are continuing to take the right actions In the last 5 years, we have significantly streamlined our business Divestitures of Embraco and Vopu China along with other transactions to transform a company based on 3 strong pillars: Small Appliances, Major Appliances and Commercial Appliances. We also acquired Elika India and In Syncorator as part of our portfolio transformation. In 2022, we announced a strategic review of our Europe business, which we concluded in January.

Speaker 2

We agreed to contribute our European major domestic appliance business into a newly formed entity with Arschlik. Our portfolio transformation efforts, In addition to delivering on our operating priorities, we're open on track to being a higher growth, higher margin business. Turning to Slide 20, I will provide an update on the Europe transaction. As I mentioned before, we passed major regulatory milestones with the European Commission Unconditionally clearing the transaction in addition to approvals from Germany, Austria and China. The U.

Speaker 2

K. Competition and Market Authority is conducting a Phase 2 review of the transaction. We look forward to continuing the dialogue with the CMA about the newly formed entity that will benefit consumers with All product and service offerings, bringing together the best of the best in innovation, brands and sustainable manufacturing. We believe the European Commission's decision along with the other approval supports the view that consumers will benefit from this transaction. We will continue to work diligently with all parties to close the transaction.

Speaker 2

And as mentioned before, we are confident that the transaction will close by April 2024. Until then, we will continue to focus on Europe delivering the best products and consumer preferred brands. And we continue to be excited about the significant value creation this transaction will deliver. Turning to Slide 21, Let me remind you of the benefits of a transaction. We will own approximately 25% of a newly formed European appliance company.

Speaker 2

As part of this agreement, we have a potential to unlock long term value creation for our ability to monetize our minority interest. Coupled with a 40 year Whirlpool brand licensing agreement, we expect approximately $750,000,000 net present value of future cash flows. Additionally, post closing, we expect the transaction to improve our value creation metrics annually by $250,000,000 of incremental free cash flows And 150 basis points improvement in ongoing EBIT margin. In anticipation of the closing of the Europe transaction, We expect to have a new financial reporting segment structure starting January 2024, including segmenting our attractive small domestic appliance business. You can expect to receive more details on our new financial segments in our Q4 earnings release in January.

Speaker 2

Turning to Slide 22, let me close with your remarks. We delivered a solid third quarter performance in a challenging macro environment. Our operational priorities delivered 100 basis points improvement of margin expansion, improved supply chain execution, Share gains in North America and $300,000,000 of cost takeout actions. We are on track to deliver over $800,000,000 of cost takeout actions in 2023. As we look to next year, we're confident that Vopul is well positioned to deliver growth and margin expansion.

Speaker 2

We expect Positive cost takeout to continue into 2024 from both our net cost actions and recent favorable commodity trends. Combined with resilient replacement and builder demand, our leading position as U. S. Builders' number one choice with over $2,000,000,000 in annual sales in this channel And our continued product innovation, we're well positioned to deliver long term shareholder value. Additionally, our portfolio transformation will continue to unlock The Europe transaction alone is expected to deliver approximately 150 basis points of margin expansion And approximately $250,000,000 of annual incremental free cash flow.

Speaker 2

We're confident in the trajectory of our business and our portfolio transformation

Speaker 4

Should we think about the mix component in there and perhaps how that's also Speeding into that price mix headwind that you're facing.

Speaker 2

Susan, good morning. It's Mark. By the way, first of all, some of you may have heard some acoustic interference on the earlier part of the call. I apologize for that. Believe me, it's not a new form of entertainment, which we're trying to add to the earnings call.

Speaker 2

It's just a technical glitch. So I apologize for that. So let me, Susan, come back to your question around Demand, share gains and mix and promotion. And I guess given that it's probably, it's a question which was On the mind of most analysts on the call, let me just give you a little bit more expansive answer. So let's first talk about the demand.

Speaker 2

The demand on and I'm particularly referring to North America and the other regions obviously follow different dynamics. North America showed solid volume growth in Q3, and on full year, we now guide to respond to 2%. As you know, the demand, if you simplify it falls into 2 components, 1 is the replacement side of a business and the other one is the discretionary side. The replacement side of business has been the one which has been very strong. And to put that in perspective, historically, when we look at the North America split between replacement and discretionary.

Speaker 2

You would see a replacement demand being kind of 53%, 54%. That part hovers now around 60%. So it is very high. On absolute terms, what it means, it has been growing. That part actually is not surprising.

Speaker 2

It's actually something which we talked about repeatedly that post COVID, we See significant increased appliance usage at home, which in term drives fast replacement cycles. So replacement side has been strong. The downside of a replacement type being strong, replacement business typically comes with a slightly lower mix than discretionary demand. Somebody who replaces a broken down refrigerator in a kitchen typically doesn't go for the same mix as a home remodel in an entire new kitchen. So it's good volume, slightly no mix, but that has been basically the growth driver in the industry.

Speaker 2

The other side is the discretionary demand side, which as you know typically is driven or is highly correlated with consumer confidence and existing home sales. As you all know, existing home sales pretty much dropped to slightly below $4,000,000 which is now all the way back to 2010 post financial crisis And consumer sentiment is very soft. So the discretionary side of the demand has been very soft throughout Q3, but it could almost say throughout the entire year. That side to become with higher mix. And so because of that shift towards replacement, the entire business comes with slightly lower mix.

Speaker 2

And the Eversight, the lower discretionary demand, that's why now being chased by a lot of players in the industry and that probably blow for promotion environment. And just to be clear of the promotional environment and we're very mindful in 2 words, it has normalized. It is not normalizing. What we mean with that, it has basically gotten back to pre COVID level, but we also mean we expect a stabilization going forward. It is not higher than pre COVID.

Speaker 2

It's just earlier back to when we originally expected, which is entirely driven by the drop of discretionary demand And in turn, kind of a more intense promotional environment. So that is right now, that has been kind of our change with the original expectation, but it just happened earlier and when expected. Now, we know how to operate in that environment. As we demonstrated for many years, it's kind of It is a normal promotional environment. We participate in promotions and value trading, and I think we have a pretty good knowledge base and algorithms in terms of how to drive maximum promotion So Susan, so there was a long answer to your question, and I hope I clarified a little bit.

Speaker 4

Yes. No, that was very helpful color. Thank you for all of that. And maybe turning to the margins a bit, I know that you mentioned Expecting some of those continued raw material tailwinds into 2024. But I guess as we think about that $300,000,000 to $400,000,000 range that you've talked about, Any sense of where we're falling today within that and any additional color you can provide as you're thinking about the cost environment for next year?

Speaker 2

Yes. Susan, let me take first and then maybe Jim may also add something on the cost environment. Again, stepping back and Beginning of the year, we guided towards an $800,000,000 cost takeout and we're right now looking at $800,000,000 plus something for the full year. So we're pretty much fully on track. Also in terms of the split of where this is coming from, it's pretty close to where we had in mind.

Speaker 2

So roughly less than half of that is raw materials and the other ones are really Through cost take, albeit in logistic cost or in product and reengineering, etcetera. So we feel pretty good about where we are. As you can also see from our numbers, the momentum in taking office cost has picked up as the year has been progressing. So as you saw on the chart, I think it's on Page 8 or so, you see we had very little cost takeout in Q1, Little bit more on Q2. Q3, we had some $300,000,000 in Q4.

Speaker 2

We see already even more. So we certainly do like the momentum, which we see Cost takeout and what that means also because I know you're all curious about 2024. First of all, you will because How it's skewed in the year, you will have carryover office cost takeout into next year. But frankly, we also like some of the underlying Dynamics and what we see right now on the cost side, we also do expect some additional tailwinds on the raw material side, in particular,

Speaker 3

on steel as we head into I mean, I'd just emphasize what Mark said is I think the trends are very positive. We do believe there'll be A good amount of carryover in the range of 25% as we head into next year. And the momentum we have right Now is in line with what we expected in a very positive trend from a cost perspective heading into next year.

Operator

Your next question comes from the line of Sam Darkatsh from Raymond James. Your line is open.

Speaker 5

Good morning, Mark. Good morning, Jim. How are you?

Speaker 3

Good morning, Sam. Good morning, Sam.

Speaker 5

Two questions. The first Has to do with your you were citing expectations next year for margin expansion. I was hoping you could Help quantify or at least give us a sense of a reasonable ballpark for 'twenty four North American margins. Obviously, price cost is coming in more profound headwind than you thought. I think your North American margin guide for the 4th quarter alone is like down 300 basis points, 400 basis points versus where it was before.

Speaker 5

But then you're also citing the Expectations for unit growth next year and the raw tailwinds and the cost takeout rollover. So if you could help bracket What margin expansion expectations should be right now for North American segment margins next year, that would be really helpful?

Speaker 2

Sam, it's Mark. So as you know, we give a precise guidance of the detailed guidance in January 2024, but let me To use your words, give us some brackets around what margin expectation is. First of all, looking into 2023, and then we can talk about 2024. As you know, if you go back further, the back half of twenty twenty two, we had disappointing margins as a company and in North America, kind of like Single digit margins. And our job number 1 was to quickly reestablish double digit margins.

Speaker 2

As you've seen, we've done that, And we're studying more because we expanded to double digit margins and picked up share. So we achieved both margin expansion and share. But right now, we kind of you call it, we have sustained margins in Q2, Q3, Q4 pretty much around 10%. In all transparency and that's what Jim alluded to earlier, we expect it to be 11% or 11% plus. But we so we're pleased With double digit 10%, but frankly, because of all reasons, which I mentioned before, because of a promotion environment, we're not yet at 11%.

Speaker 2

So as we look in 2024, the key question obviously on everybody's mind is when do you expect North American margins in the tune of 12% plus, Okay. Which I think is a realistic target corridor. The key question is what are the drivers In order to get there. And again, starting from a baseline of 10% roughly margin. But the 2 biggest drivers of free actually is, One is we have to sustain a cost takeout.

Speaker 2

Again, as I heard as I mentioned earlier, I feel good about the momentum that we have, But that earnings only will not be sufficient in 2024 and we got to find additional cost opportunities for 2024 and we're working on a lot of things and I think Once we come up with guidance, you will see, I would say, number sizable element of cost target, which we have for 2024. Second one is we have to continue to re leverage the business from a volume perspective. Our business and the size of business like North America has fixed costs. And if you know look at our volume right now, it is still fairly Quite a bit below pre COVID. So, releveraging that business will have a significant impact also, of course, on the EBIT margin.

Speaker 2

So, there's more volume growth coming from, but ultimately comes back to, yes, we expect a low single digit growth in the market, But we are very confident in our sustained momentum and market share gains and product innovation, which would broaden the business. And in particular, at one point, maybe not in Q1, Q2, 2, the builder business will pick up, and that, of course, as you know, disproportionately benefits us. The reason why I'm saying it's not Q1 and Q2, We all see these great order intakes from builders. But Sam, as you know very well, it takes 8 to 10 months until an order on the build side turns into a blind shipment. So we know we have volume momentum coming into next year, driven by products and channel mix, And that will continue to help us kind of re leverage our business.

Speaker 2

These are the 2 fundamental drivers to get back North America to what I would call Healthy 12% plus margin. Now the exact timing, again, that is something which we will talk about in the guidance.

Speaker 5

Thank you. My second question, you mentioned retailer refill as A dynamic that was occurring also in the quarter. Can you help quantify what sell through versus sell in Was in North America and what the retailer inventory weeks on hand look like versus pre pandemic at this point?

Speaker 2

Yes. Sam, I think if you zooming out beyond Q3, the entire COVID and post COVID Has been, as you all know, almost a roller coaster of up and down of retail demand. I know technically people refer to a bullwhip effect, but Believe me, we felt it. We have been destocking, restocking, and these swings have been more amplified than the actual Consumer demand was over the last 2 or 3 years. I think now particularly end of Q3, things look reasonably balanced.

Speaker 2

What I mean with that, I think in Q3, we still saw some restocking of retailers. So but technically industry growth you saw in Q3 was Head of the actual consumer sellout in our view, and right now consumer sellout, which we experienced, is pretty much in line with what we guided on the full year Industry growth. So, call it, this low single digit 1% to 2%, with some ups and downs, during the promotion period. As you know, there is unfortunately, we know our numbers, but we don't know entire industry sellout numbers. But the Q3 shipments were slightly ahead of consumer demand and again as a result of rebalancing inventories.

Speaker 2

At this point, we do believe The retailers appropriately stopped from an inventory perspective going to the promotion period.

Operator

Your next question comes from the line of David MacGregor from Longbow Research. Your line is open.

Speaker 6

Yes. Good morning, everyone. Mark, I wanted to

Speaker 2

ask you about promotional

Speaker 6

programs. And you've noted As recently as this call that you're prepared to participate in promotions only for value added. So can you help us understand how you define a value added And what exactly is the metrics you use to determine what is value added? And how would you characterize what you're doing now promotionally within the context of that discipline?

Speaker 2

So David, let me we could probably spend 2 hours on promotion effectiveness. I would say Our teams and for years of our experience without being too arrogant or priding ourselves too much, I think we know 1 or 2 things about merchandising. So we have a very, very good understanding about price elasticity and sensitivity by product category, by Try segments by time of the year in between promotions and during promotions. So we have it all starts with We believe we have a good knowledge base of really understanding how consumer demand is actually lift versus A non promotional environment. We also have a very good understanding in our view in terms of what is pure pull forward or cannibalization versus true incremental growth.

Speaker 2

Now of course, we all recognize that's all driven by competitive forces, etcetera, but it's we have a pretty good knowledge base. Against this knowledge base, we assess technically what we call an investment, that's just the cost of the promotion relative to normalized prices, Against what kind of margin pickup and what we call is contribution margin pickup we get. If that is a positive, that's So, we, in our expectation, make a decision about do we participate or not. I know that sounds overall technically, but it's not a one Single formula is entirely driven by detail, by price point, by segment, by category, by channel in terms of where we make the decision to participate or not.

Speaker 6

Maybe I could follow-up with you offline on that. My second question is around the free cash flow guidance revision, the $300,000,000 reduction. Could you just talk through, I'm guessing that's the reduced income and maybe some working capital impact there as well. But I guess, along the lines of Sam's question, if there's any way you could kind of bracket out how we should think about free cash flow in 2024 at this

Speaker 3

David, this is Jim. And first thing I'd say, your assessment is correct On free cash flow, the change in it was purely about 2 thirds of that is due to lower earnings and the other third is due to that we think will come out of the year Slightly higher working capital. So obviously, we're not giving guidance for next year, but I think you should think about it. If you even look at where this year is, working capital, despite the fact it's $100,000,000 It's not a big build. And I think going into next year, you shouldn't expect us to be building working capital nor taking it down significantly.

Speaker 3

We're probably going to be around That same point now, as we talked about earlier, we haven't given guidance on earnings and margins yet, but with increased margins, we would expect our cash flow from earnings to improve. The biggest probably variable in the free cash flow for 2024, but will be fully reflected in 2025 Once we close the EMEA transaction here, we've talked about that we believe we will on a full year basis, on an ongoing full year basis, Deliver about $250,000,000 additional free cash flow every year. We still would confirm that number. Now the timing of the transaction could close in early next year, so We will have an impact from having EMEA in, but when you get beyond that, we are still very, very confident in that 250,000,000 A positive free cash flow that will come additionally on top of where we are today. And on top of what I talked about that I think earnings will be in a better place and working capital should be a relatively non event in terms of how it It should be a relatively nonevent in terms of how it impacts free cash flow next year.

Speaker 2

David, maybe just one additional comment on the working capital side. Obviously, with 2 big components, inventory, we feel reasonably good. We're down from Q2, Probably $50,000,000 maybe higher than we originally had in mind, but it's we feel good about how we enter from an inventory position entering Q4. The big difference right now is actually receivables, because frankly that comes with growth. You grow the business, you carry slightly higher receivables, And that will be, to some extent, the same thing in Q4.

Speaker 2

We feel good about our growth momentum, but it means not all the sales Collect this cash in the year. So there's also a timing element about when we actually can collect the cash from receivable and that falls into next year.

Operator

Your next question comes from the line of Eric Bissart from Cleveland Research. Your line is open.

Speaker 7

Thanks. First of all, one clarification and then a question. From a clarification standpoint, Jim, you talked about The cost benefit accelerating through this year and then carrying into next year, does this make next year a little bit more front end loaded than normal Because of the progress you've made on cost, I guess is the first point of clarification.

Speaker 3

I would say, listen, from a Cost perspective, I think we will start the year and we will show positive year over year cost just because of that carryover going into next year and the trends that we're seeing. Now the other thing that you've got to take into account is just the natural seasonality of our business. And I think we've seen the business getting back to what is probably True pre COVID type of seasonality where from a volume perspective Q1 still tends to be the lightest and you see the pickup throughout the year. So I do believe cost will be a positive going into next year, but when you're looking at a year over year basis, I think we've normalized into an environment where Q1 will still be one of our lower quarters from a volume perspective.

Speaker 1

Okay. And then the other

Speaker 7

point of clarification that the strategic payback from Europe, I understand and it's certainly compelling. The EPS impact in 2024, Could you just help us clarify how we should be thinking about this? Is this also accretive to EPS next year as well or how does that work?

Speaker 3

It will not be so much accretive to EPS, because if you think about it right now EMEA is close to a breakeven business. So it will improve our overall margins. It does have negative cash flows, it will improve that. But from an absolute earnings It starts to become a net neutral there. Now, as I said, the bigger lift comes is that it's 150 basis point improvement in EBIT margins.

Speaker 3

It's a reduction or an improvement in free cash flow and then it's a reduction in the volatility and the seasonality of our business also. And I The thing I need to point out on the cash flow is within the year, the seasonality of EMEA's cash flow is much greater than the single benefit of $250,000,000 that we're getting. So the biggest benefit that really comes on the free cash flow side.

Operator

Your next question comes from the line of Mike Dahl from RBC Capital Markets. Your line is open.

Speaker 8

Hi. Thanks for taking my questions. The first one just to stick with margins and specifically North America. I think the part that I'm struggling with is your cost tailwinds have accelerated through the year, your margin guide for the Q4 is kind of At or below 10%. If we think full year impact, 2023 versus 2024, Understand that tailwinds have ramped through the year, but full year, full year, your cost out actions probably are Kind of equal between the 2 years, if not still slightly weighted versus 'twenty three.

Speaker 8

So the promotional cadence has Normalized and is expected to remain steady. The cost takeouts for now have probably reached their peak run rate. The bridge to margin improvement in 2024 in North America, it is again, it's Cost and volume, but doesn't that mean it's really just volume next year in terms of driving the levers? Or What's the I guess I'm struggling to see that magnitude of uplift to get from kind of 9 to 10 and 4Q up to 11, 12 next year.

Speaker 3

Yes. And Mike, let me start and then I'll let Mark kind of add on to this. I think As you even alluded to in your question there is, right now, we do see actually cost continuing to drive further benefits and we will see Additional cost benefits coming into next year and then also you did highlight that as we've said, we believe the promotional environment is normalized. So that should not be A factor in terms of margin impact year over year as we go into next year, cost should be a positive impact and then picking up Additional share and volume will also have a positive impact both on our margins, just from the incremental Margin that comes from that, in addition to the leverage and benefit we get within our factories and other things, our logistics network from the leverage that We did on that. And you've got to remember today that today if we look at our environment, we still have we don't need to add capacity or anything.

Speaker 3

So each unit that we Adds an incremental amount of margin that's above and beyond our margin that we have today. So those are the levers and

Speaker 2

the drivers. And Mark, if you want Yes, Michael. Just first of all to clarify, because you mentioned, non margins are at or below. We We guided to 10% and we delivered 10%. So we are on a sustained double digit margin level and had best Q2, Q3 and Q4.

Speaker 2

So We feel very good about regaining with double digit in particular compared to 2022. Now on the cost side, there is also another element. Keep in mind what We showed you we see significant progress on the cost side, but as I think most of you know, given how standard costing works, you're basically selling For the cost which you had in Q3, because you have 60 days of inventory. And the same is true for when going to Q1. So the Cost progress, which we see in Q4, technically will only be fully P and L visible in the 1st 2 months of next year.

Speaker 2

So that's just Timing that's normal standard cost accounting. So don't forget that part of the equation. Now to your point about it's only volume. No, we need cost, Volume and product introductions, all three of that. Cost, we feel very good.

Speaker 2

We have our momentum. We know how to get cost out, But it's a highly competitive environment where you just need to remain resilient on the cost takeout. 2, volume is to Jim's point about re leveraging and just because It comes to capacity which you already paid for, so you get the full leverage. And 3, ultimately, you can only get the volume if you have strong products in the market. And I mean, as Jim showed earlier in my presentation, we feel very good about what we launched this year.

Speaker 2

There's a lot of good new product launches in the pipeline. So Again, I just I absolutely would not reduce into volume. We need all 3 components.

Speaker 8

Yes, that's helpful. I appreciate the additional color there. My second question, just shifting gears, and I know this is probably some accounting Technicalities around tax, but it's such a meaningful number to figure out. I'll ask you. I mean, it's unusual to see a net tax benefit being considered Part of ongoing EPS and in this case it's kind of like a north of $3 a share impact versus your prior guide, this shift in Tax expectations, can you just maybe give us a little more detail on what's actually driving this and maybe more importantly as we look out to The 2024 and beyond, has your view changed on what a more normalized Tax rate would be especially post the disposal of EMEA.

Speaker 3

Yes. And here's what I'd say, Michael, and whenever we've looked at a lot of these tax things because they flow through very unevenly from a GAAP perspective, so we normalize them Typically from an ongoing perspective, the first thing is the cash benefits of What we realized within this quarter and we'll realize this year and then what I'm about to talk about next year will come over a multi year period of time. So we will see ongoing cash benefits just from some of these tax benefits that we talked about. I'd say the second thing With that, as you look at next year, listen, we expect our rate to be below 15%. And once we close the EMEA transaction and we're able to realize The benefits of some of the losses we'll have from investments we've made in there, we will see, also in 2024 a significantly lower tax Great, then we historically have.

Speaker 3

Then as I alluded to, over the period of multiple years, we'll continue to realize cash benefits And so right now, we're not going to give a full guide on next year's tax rate because it's very dependent upon when we close the EMEA transaction. But then additionally, as we look forward beyond that, right now, I'd say absent of any changes in the tax environment out there, At some point in time in the much more distant out future, we could see the rate going closer to 20%. But over the next couple of years, We will continue to see benefits from this transaction.

Operator

Your next question comes from the line of Liz Suzuki from Bank of America. Your line is

Speaker 4

open. Great.

Speaker 9

Thank you. Just had a question about the cash flow again and just the lowered Outlook implying that the majority of your free cash flow this year is being paid back out to shareholders in the form of the dividend. So at this point, how are you thinking about addressing the debt and reducing your ongoing interest expense burden?

Speaker 3

Yes. So this is Jim. And I think the first thing, we still intend to pay down $500,000,000 of debt in the back half or in the last 4th quarter here. That will come from cash on our balance sheet. As you pointed out, our free cash flow is funding our dividend, which will be around $400,000,000 that will return to shareholders here.

Speaker 3

Obviously, the incremental $100,000,000 goes towards debt pay down, but we also have cash available on our balance sheet that we will use To pay that down and then as we head into next year, we expect to continue to focus on paying down debt and reducing our level of leverage.

Speaker 2

This may be just adding to this one, because again, also going back more in time, As you know, we held quite a bit of cash balance on our balance sheet now for a couple of years. And some of you may have asked why do you take on the debt. We actually our decision a couple of years ago was while the interest rates are very low, we wanted to lock in some long term debt at favorable interest rates. And that's why we kept a fairly significant cash balance. Now we use the cash balance, some of that to pay down some of the floating interest rates, which Which was a temporary loans, which also partly came from In SyncErator.

Speaker 2

So we basically now use that cash balance to pay down the more expensive part of the debt.

Speaker 9

That makes sense. Just kind of thinking about long term, I mean, you did mention that your cash balance has been high for the last couple of years, but historically, it's Yes, somewhere over $1,000,000,000 So, I guess, how comfortable are you at a cash level below that threshold? Or what is your minimum level of A cash that you like to have on the balance sheet?

Speaker 3

Yes. Listen, and this is Jim again. And part of that is driven by, remember, us as a Geographically diverse company, we have cash in multiple jurisdictions. And to certain extents, because some of those businesses are also separate There's restrictions on some of the usage of cash that we can use outside of those areas. And I think as you've alluded to, typically, we've always had a cash balance around $1,000,000,000 or maybe slightly above that.

Speaker 3

And that deals more with our geographic Now as we exit EMEA, obviously, that will not be an area that will be retaining cash. So I would still on an ongoing basis I expect us to be in the neighborhood of $1,000,000,000 but it could be a little higher, a little lower at times depending on what our funding needs are, as well as where we're generating cash and our ability to repatriate that into the U. S. And use for other things. So That's really more the driver.

Speaker 2

It's just that we have such a diverse geographic footprint. So let's maybe just adding to this one and Jim alluded to this one a little bit earlier. Basic question is why do you have to have cash on hand at all? So the simple reason is within the quarter we have cash volatility. That's just the nature of our business when you collect it and when you build inventory, etcetera.

Speaker 2

And that was historically around this CHF 1,000,000,000 A very significant portion of that intra quarter but also intra year volatility was driven by our European business. Once you close the European transaction, you don't have that same kind of volatility in our cash flow streams, both intra quarter And then of course within the year. So what it all means is in a post Europe transaction environment, We do not expect that we will hold $1,000,000,000 of cash because it's just not needed. We can we will quantify coming to next year how much it will be, but it will not be a mid level of 1,000,000,000

Operator

Your next question comes from the line of Mike Rehaut from JPMorgan. Your line is open.

Speaker 10

Hi, guys. Good morning. Doug Wardlaw on for Mike. I just wanted to kind of clarify

Speaker 2

And see

Speaker 10

if there's any type of trade off between share and margins and is it somewhat of a 0 Some gain and if you continue to gain market share, could we see similar margins in North America to what we see now moving forward?

Speaker 2

Yes. So it's Mark. I mean, obviously, I mean, the simple answer is no. As we demonstrated in Q3, we picked up Share and margins year over year. So, it doesn't need to be a trade off.

Speaker 2

And in the case of what we just announced in Q3, We deliver both share and margin expansion, and that is also our objective going forward. The key to have both share And margin expansion ultimately still comes back to having a strong product pipeline. With the products which we launched and which Jim showed earlier, we were able to expand both Share and margin. If you wouldn't have these products, yes, when you're right, when it probably will turn at 1 point into a 0 sum game. And That's why we'll continue to invest.

Speaker 2

That's why you may have seen also in Q3, we both year over year, but also sequentially continue to invest even more in product and brands. And that's really the key to avoiding this trade off.

Speaker 5

Great. Thanks. And then secondly, and

Speaker 10

this is Just another clarification question, because I know you guys have done it throughout the call is, in terms of the raw material and cost savings carryover into 2024, Do you guys have any sense on the size of dollars of what that might look like?

Speaker 3

No, at this time, we're not really giving any precise guidance on that because as we mentioned before, the trends do seem very positive. We go through during our 4th quarter typically the negotiation process with many of our suppliers to help us bring more clarity to that number and then typically we don't give that number until we January. So right now, we would just say we expect it to be positive. And once we get to January, then we'll give a much more specific number.

Speaker 2

Okay. So with that, let me just close the call. First of all, I appreciate all your, attendance today and good questions. I mean, obviously, as you've seen We feel actually good about Q3. We had revenue growth.

Speaker 2

We expand our share. I think we're delivering on our operational priorities. Did we come all the way on the EBIT percentage? No. And we openly talked about it.

Speaker 2

But we feel good about the fundamentals of our both in Q3 and also as we look into Q4 next year. And we look forward to kind of give you a more detailed picture on Q4, but then more importantly about 2024

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Earnings Conference Call
Akzo Nobel Q3 2023
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