Q3 2022 Whirlpool Corp Earnings Call
Good morning, and welcome to Whirlpool Corporation third quarter 2022 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.
Thank you and welcome to our third quarter Conference call.
With me today are Marc Bitzer, our chairman and Chief Executive Officer.
Jim Peters, our Chief Financial Officer, and Joe <unk>, our Chief operating officer.
Our remarks today track with a presentation available on the investors section of our website.
<unk> Dot 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 future expectations.
Our actual results could differ materially from these statements due to many factors discussed in our latest 10-K 10-Q and other periodic reports.
I want to remind you that today's presentation includes non-GAAP measures.
We believe these measures are important indicators of our operations.
Food 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.
They 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.
We have also provided additional information related to inventory demand and fixed costs that will not be regularly provided our updated in future quarterly earnings materials.
At this time all participants are in a listen only mode.
In your prepared remarks, the call will be opened for analysts' questions. As a reminder, we ask that participants ask no more than two questions.
I'll turn the call over to Mark.
Thanks, Corey and welcome everyone to our third quarter earnings call.
As you can see from our agenda on slide four we plan to discuss today more than <unk>, our third quarter results.
We are operating in unprecedented times and we do feel it is necessary and helpful for investors to broaden the time horizon is called beyond Q3.
Take a step back to reinforce our long term strategy as well as our perspective on favorable mid and long term consumer demand trend.
The first agenda item, we will discuss the Q3 results in detail you will see that short term consumer sentiment and consumer demand are clearly reflective of a recessionary environment.
While at the same time input costs mix.
Would expect to come down in a recessionary environment are still elevated.
Needless to say that this combination impacts our Q3 negatively.
And the second agenda item, we will show you that will put has a strong track record of successfully managing through the cycles.
We're laser focused on ensuring we have the strongest business irrespective of a rapid changes in the macro environment.
We have and we will continue to take action early and decisively and we have done so again this quarter.
Beyond the current recessionary challenges, we strongly believe in with favorable mid and long term demand tailwind in particular in North America.
And our business is very well positioned to win and it's attractive post recession setup.
I'll cover this in the third agenda item and finally, the full for Dan.
I will provide an update on our portfolio transformation, which.
Which is well underway as we continue to move towards a high growth high margin business.
But first I'll turn it over to Joe to review, our third quarter results in more detail.
Thanks, Mike turning to slide five our performance this quarter was impacted by significant industry declines and elevated cost inflation that is now leveling off in key countries across the globe. We saw double digit demand declines in response, we aggressively reduced our inventories by $300 million.
Compared to the second quarter with a 35% reduction in global production.
Needless to say that this volume deleveraging impacted our Q3 results negatively.
We do consider our inventories to now be very well balanced.
We delivered ongoing EPS of $4 49.
And ongoing EBIT margin of five 5%.
With approximately 10% EBIT margins in North America. While these results are below our expectations, we remain confident and we have the right strategy and actions in place.
We're well positioned to deliver strong performance and shareholder returns.
Now turning to slide six I will give more context on the magnitude of the industry decline by country across our key marketplaces, we faced market contractions of 10% to 29% during the quarter.
<unk> similar declines in most countries as we move through the fourth quarter.
In the U S and throughout the world consumer sentiment has been impacted by inflation and increasing interest rates in.
In the ongoing war in Ukraine, and weakening currencies have further weighed on demand.
Turning to slide seven you will see the impact of proactive steps taken to reduce inventories, we lowered our inventory by $300 million from.
From Q2 levels, despite the significantly reduced shipment volumes within the quarter.
In total we reduced production volumes, 35% in the quarter to put this in context. This is pretty much the same level of production as Q2 2020, when we were faced with global Covid shutdown.
Even though painful within the quarter, we are now much better positioned to manage near term demand fluctuations.
Turning to slide eight in addition to managing our inventories in response to industry decline, we're also experiencing elevated and persistent levels of inflation over.
Over the last two years, we've absorbed $2 $7 billion of inflation across our entire value chain.
Thus, increasing our cost of goods sold by well over 10%.
We experienced increases in raw materials freight and logistics costs and more recently energy costs.
Aligning inventories with softer market demand was also a factor contributing to our performance.
As expected inflation peaked in the quarter and will remain elevated we do expect cost inflation to persist throughout the first half of 2023 and costs moderating in the second half of 2023.
Despite historically high inflation and market headwinds across the globe, all pool remains well positioned to capitalize when the macroeconomic environment normalizes.
Turning to slide nine we show the drivers of our third quarter EBIT margin.
We continued to deliver strong price mix of 550 basis points with previously announced cost based price increases and slightly increased promotional activities that will continue into the fourth quarter.
We responded to accelerated industry declines and we are prepared for the upcoming holiday season.
While we successfully reduced inventory the associated volume deleveraging alongside continued elevated logistics and energy costs drove a 325 basis point impact in net cost.
Raw material inflation was as expected and negatively impacted margins by 750 basis points.
It will begin LLC cost actions, gaining traction with reduced marketing and technology spending.
Which was more than offset by the impact of foreign currency as the U S dollar strengthened during the quarter.
Overall, we delivered an ongoing EBIT margin of five 5%.
Turning to slide 10, I'll review results for our North American region.
As we continue to optimize our supply network improving availability, we saw a slight sequential share gains in the quarter. However, our revenues were down 8% driven by weaker demand we.
We did aggressively reduced production levels to rebalance our inventory levels.
This temporary volume deleveraging and related operating inefficiencies. In addition to continued inflationary pressures negatively impacted our margins for the quarter.
Even with these challenges the region delivered approximately 10% margins.
Looking forward, we are excited about the unique opportunity to add <unk> to our portfolio of leading brands and expect the transaction to close on October 31.
And this acquisition is a clear accelerator of our ongoing portfolio transformation and delivering on our commitment of investing in high growth high margin businesses. We continue to remain confident in the strength of our North American business.
Turning to slide 11, I will review results for our Europe , Middle East and Africa region.
As part of our portfolio transformation, we completed the sale of a whirlpool, Russia business on August 31 Rep.
Revenue was negatively impacted by 11 points of foreign currency excluding.
Excluding Russia and the impact of foreign currency revenue was down approximately 8%.
The region's cost based pricing actions were more than offset by lower volumes and cost inflation as consumer sentiment continues to be impacted by the war in Ukraine and inflation, resulting in a negative EBIT margin of three 1%.
Mark will provide update on the strategic review of our EMEA business later in the call.
Turning to slide 12, I will review results for our Latin America region.
The region saw significant demand declines and continued inflation more than offsetting our cost based pricing and cost actions.
Despite these negative impacts the region delivered more than 5% EBIT.
Turning to slide 13, I'll review the results for our Asia region excluding.
Excluding the impact of currency revenue declined 1% and cost based pricing actions were more than offset by inflation.
Ultimately leading to an EBIT margin of slightly below 5%.
Now I'll turn it over to Jim to discuss our full year 2022 guidance.
Thanks, Joe now turning to slide 14, I'll review, our updated guidance for 2022.
We expect to deliver fourth quarter EBIT similar to Q3.
And as a result, we have revised our full year ongoing EPS guidance to approximately $19.
We have reduced industry expectations for all regions, except Asia.
Afflicting the continuation of trends, we experienced during the quarter.
We now expect a revenue contraction of approximately 9%.
And ongoing EBIT margin of approximately seven 5% for the year with North America margins of 12% plus for the full year.
And we expect to generate free cash flow of approximately $950 million or around 475% of net sales.
While we have revised our guidance to reflect the current macro environment and expect many of these trends to continue through mid 2023, we remain committed to our long term goals to drive profitable growth of 5% to 6% ongoing.
Ongoing EBIT margin expansion of 11% to 12%.
And cash conversion of 7% to 8% free cash flow.
Turning to slide 15, we will discuss the drivers of our 2022 free cash flow.
We now expect to generate free cash flow of approximately $950 million compared to our previous guidance of $1 25 billion.
With cash earnings of approximately $1 6 billion.
We expect to continue to invest in our products and fund organic growth by unlocking capacity constraints and launching innovative products. These.
These investments are in line with our target for capital expenditures of approximately 3% of net sales. Additionally.
Additionally, we lowered our working capital expectations, reflecting the previously discussed inventory reduction actions.
Lastly, our expectation remains unchanged as we anticipate minimal cash outlays related to restructuring as these actions had been largely completed.
Now I'll turn it over to Mark to provide our perspective beyond 2022.
Thanks, Jim I wanted to spend a bit of time to demonstrate our strong track record of successfully operating for various economic cycles.
Turning to slide 17, you see that when faced with inflation across the board from materials logistics and energy. We have responded early and decisively with cost based pricing actions.
Our strong execution of certain cost based pricing actions that smart value, creating promotion activity.
The positive price mix in nearly every quarter since 2019.
With broad based cost based pricing actions across the globe in nearly every product category and channel we've delivered a cumulative price mix impact with 13%.
Turning to slide 18, I will discuss our significantly reduced fixed cost base.
This chart shows the total of our SG&A factory and logistic costs over past six years.
Despite the inflation, which we also experienced in parts of our fixed costs such as logistics of salaries.
Due to a fixed cost by approximately $700 million.
All around 3% net reduction every year.
In response to the current macroeconomic challenges, we have initiated a number of $500 million cost takeout program at the server reduce our fixed and variable costs in 2023.
As a result of these actions with drastically reduced our breakeven point, which will benefit us once industry volumes recover from the current temporary weakness.
This is an important step and structure improving our long term margins.
As mentioned before <unk> has a history of proactively responding to challenges we are facing in particular during these past years.
And we've been used as successful in managing through the headwinds of the past years as evidenced by our financial results as shown in slide 19.
Our multi year financial performance shows our structure improved business is expanding EBIT margins significant EPS growth and strong ROIC.
Our ongoing EBIT margin has improved with a compound annual growth rate over 4% and our ongoing earnings per share with a compound annual growth rate of approximately 13%.
Alongside strong returns on invested capital with a six point improvement since 2010.
Now turning to slide 21, I want to address how we are well positioned to benefit from long term demand takeaways.
While we are experiencing short term demand softness where at the same time very optimistic about the mid and long term demand trends in particular in North America.
Let me start by giving you a more detailed perspective on the U S appliance demand.
As discussed in previous earnings calls it has two fundamental components replacement demand, which currently represent 65% of our total market and the discretionary demand.
This is a trough of a tool H 'twenty 11 replacement cycle now behind US replacement demand has been very stable and even growing.
And we do expect further momentum on the replacement side of demand due to significantly increased appliance usage over the past years.
As evidenced in the data, which we see from our connected appliances.
While it is still not fully recovered from the great recession to aid it.
Discretionary demand side, which ultimately is driven by the housing market.
Moving to slide 22, you can clearly see the strong connection between existing home sales and overall appliance demand.
Existing home sales for slowly recovering from a great recession, but still haven't reached pre recession levels are.
The same time over a ninth demand. It's also slowly recovering to essentially pre recession levels.
Turning to slide 23, we show the same data in a bit of a more granular view as well as our prediction of over the next two years.
Obviously existing home sales declined sharply in 2022, reflecting the mortgage rate shock.
Both new buyers away from our market as well as keeping prospective sellers from selling due to existing fixed mortgage rates, which are significant lower than current mortgage rates.
However that doesn't change with fact that various compounded pent up demand for millennials as they reach prime home buying years.
We do expect home price appreciation for slow down housing inventory to slowly improve to more historic levels and ultimately existing homes. It return back to historical averages of above 6 million units per year.
Now turning to slide 24, I'll share my perspective on new housing EMEA us and its impact on the <unk> <unk>.
Housing contributes approximately 15% of our clients' demand and U S.
New housing construction has significantly lagged historical averages for more than a decade.
For perspective.
<unk> from 1968 to $2 eight a 40 year span.
There was only one year in which fueled by $1 2 million new housing inventory build.
But much of our peer between two <unk> and 2017 was below this level, leading to OLED U S housing stock in the country's history.
In total we estimate an under supply of housing of approximately three to 4 million units, while we do not expect housing to reach what we call. It steady state supply of one 7% to $1 9 million units in 2000.
Turning to our 2023, we do expect 2024 to show meaningful progress towards this level.
Turning to slide 25, I will share some perspective of our major clients business outside of the U S.
We expect to win the Americas and accelerate our growth in India, India in particular had a very long runway for growth due to favorable demographics and is still very low client penetration rates.
We also fully expect to capture replacement demand with our strong share positions in Canada, Brazil and Mexico.
And in India, We recently expanded our offering with a majority stake in antique of India in 'twenty, one and.
And we've just started the production frontload losses in India, and we want to continue to invest in this business.
Combined with the best portfolio of brands, including console and breath stampede, each generating $1 billion in sales in Brazil, we are well positioned to outside the U S.
Let me now move onto our last agenda item and discuss our progress on our portfolio transformation towards a higher margin and higher growth business. As you can see on slide 27. These efforts have been underway for some time since 2018 with executed multiple steps to streamline and optimize our portfolio.
And are excited to add the integrator business to our portfolio.
On slide 28, I will remind you of a free strong pillars that will accelerate our portfolio transformation towards a higher margin and high growth business.
Our global small appliance business and our commercial lines business, both deliver strong margins over 15%.
<unk> edition of the integrator, we have taken yet another significant step in strengthening our major crimes business, specifically in North America.
Bringing iconic brand to Wolfgang <unk>.
<unk> is the largest manufacturer of food waste disposal and instant gottwald expenses more than 70% for U S industry.
Adding approximately $1, 25% EPS accretion in 'twenty three.
Joe mentioned, we expect the acquisition to close in October 31.
We expect to continue to invest in building whirlpool has a higher growth and higher margin business as we continued to deliver significant shareholder returns.
Now turning to slide 29, I will provide an update on the strategic review of our EMEA business.
And we have been assessing a number of options for our business.
All of maximizing long term value.
With two guiding principles as we navigate this review one will create the most value for vocal Corporation.
What is required for future success in Europe .
We received significant interest from a number of parties and narrowed with discussions to the final negotiations with two strategic investors.
Given the confidential nature of these discussions we're unable to share further details, but we will provide an update no later than our fourth quarter earnings call.
Again, our focus is to ensure we have a strong business for our shareholders and employees further supporting our portfolio transformation towards a high growth and high margin business.
In parallel with reviewing external options, we also revisited our internal concentration plan.
We have completed a pressure test of all our business segments and evaluated strategic alternatives.
Additionally, we have worked diligently to develop a sustainable and attractive business case overreaching.
Ultimately this will serve as a comparison and definitive path to any external option.
Now, let me close with a few remarks and turn to slide 30.
We have a proven track record of successfully operating Precycle.
And despite the significant payments through headwinds, we're facing we still expect 2022 to be the second best year in our 111 year history.
We have the right strategy and the actions in place to navigate the current environment.
But largely offset raw material inflation with decisive pricing actions, we have initiated cost actions, which will deliver $500 million of benefit in 2023, and adjusted inventories to reflect the current demand.
We are reiterating our long term growth outlook and based on the initiatives. We're taking we believe a vocal exit the current and temporary industry now at high operating margin.
At the same time, we continued to advance our portfolio transformation, leaving us well positioned to continue to deliver strong shareholder value.
Now we will end, our formal remarks and open it up for questions.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
And your first question comes from the line of Sam Dark cash from Raymond James Your line is open.
Good morning, Marc Jim Joe how are you.
Good morning, Sam Good morning.
Good morning. Thank you I have a couple of questions. The first around raws and the second around production.
I guess I was originally going to ask you why the spread.
<unk>.
Possible raw material inflation in the fourth quarter was so wide.
I'm guessing that's mostly a function of youre not entirely sure yet what what demand and production.
Look like and so I'm really more interested in your 23 thoughts.
I think in your prepared remarks, you mentioned that the first half of 'twenty three you might see raw material inflation year on year and im confused as to why that might be given the steel contract resets and what have you. So could you give some some more quantification or clarification in terms of what youre expecting.
For Raws next year.
Sam It's Marc let me maybe first talk about the raw materials, and then I would have Joe com demand production reduction and how we feel about the inventories.
So first of all on the raw material you. Obviously saw that was still quite a bit of an element in Q3 of seven 5% impact on the EBIT margin, obviously macaques them more and that has as we indicated we expect that that is pretty much peaks in Q3, However, Q4, not being materially better.
So let me first talk about Q4.
Hardware reason is and there's two reasons why some materially better one as spot prices have not come down a whole lot yet.
I emphasize yet.
Second part is keeping mind big.
Big parts of our raw materials are under hedging contracts with similar contracts in particular steel and plastics, so even though with spot prices start moving in the right direction. The impact you see on the contractual terms are not.
Yet fully visible, but they will at one point, so to really clarify and I'm glad you're raising in the first half we're not seeing it's increasingly say it starts to ease. So we do expect raw materials to come down and starting coming down throughout the first half, but I don't think you would see a dramatic change.
Kind of year over year, and I think you'll see much more favorable comparisons in the back half, but we do absolutely see an easing of raw material in the first happened.
We will give you much more detail, but in our January earnings call around raw material.
Production. Thanks, Mark this is Joe.
Related to production and we did see the industry a little bit softer than we anticipated. So we made very.
Very decisive actions to right size, our production and ultimately our inventory to ensure we were in sync with what where we saw the market developing we expect that kind of continue into Q4, and so we took those actions in a sharp manner to make sure that we were right sized.
And then ready for upcoming Q4 holiday promotions and the demand that we saw ahead of US those actions were very pronounced 35% reduction in production globally. So.
As indicated in the prepared remarks that is a level that we've not seen historically.
Other parallel would be early on in Covid, we took a similar amount of production out just given all the things happening so very pronounced very decisive but it got it.
Balanced position and we think going forward that it responds to where we're going to be with the market.
Joe why would you.
Ramp production back up in the fourth quarter at least I think that's what you're we're anticipating based on demand still being weak and the need to retain as much price as you can in 'twenty three once raws come off I'm confused as to why you just took one big bite out of the Apple.
As opposed to keeping production really modest until you start to see stabilizing trends.
Yes, maybe that wasn't clear, saying what the intent was we.
<unk> in the quarter given the environment, we're in which is slightly worse than we anticipated from an industry standpoint that got us to the right level. So from here on out we will essentially be more in sync in managing production with output as is more typical and so there isn't an assumption of a big ramp down or a big ramp up that wasn't the implication was more about.
Adjusting and synchronized in Q3, and then now it's in sync with our expectations for Q4.
Put a different it's mark <unk>.
In Q3, we produced significantly less than we sold and in Q4 that these numbers will be much more aligned.
In North America, we're pretty much set.
Hello, Bob producer produce what we sell.
And now in absolute terms that may be in North America slightly higher than Q3, but we will be very careful about not getting ahead of ourselves and production.
Frankly be every reason why we decided to take a big step in Q3, and I'm glad it's behind us in mobile P&L impact are not fully behind us but.
We are convinced that the peak cost inflation. Both in Q3, we just felt why would you want to produce full volumes. When you think it's the highest cost base.
So we want to take this step now thats behind us from an operational perspective and that puts us in a very good position to deal with the next couple of quarters, maybe one add mark that's true also globally. So that phenomenon will the characteristics are slightly different.
Those those themes are true globally, which is important given all the things that we've experienced.
Your next question comes from the line of Eric <unk> from Cleveland Research. Your line is open.
Thank you.
Two things if I could first of all.
The price mix realization in the quarter was.
200 basis points different than you expected 90 days ago.
What change to influence that different results.
This is Joe believed the price mix I mean, we did get a better availability position and as a consequence, we were able to go to market in ways that with our productive now that go to market action was slightly.
More intensive or elevated than we anticipated originally and that was a function of a couple of things are speed and better positioned from an availability standpoint and have seen opportunities in the market as a consequence, those were productive and in North America, specifically, we were able to gain shares slightly from Q2 to Q3 as a consequence of both availability and our go to market approach.
<unk>.
Okay.
Okay that makes sense I understand availability can you just can you expand on the go to market approach and I guess, specifically, what I'm trying to figure out.
Is this participating more in promotions is this you being less aggressive on price increases as this retailers pushing back on price increases as consumers buying down in mix like something is different I. Appreciate that the go to market availability was better but can you just expand on that a little bit close.
Yes, I mean, theres, obviously varied components in there. So it isn't just one answer for all things, but what I would say is there was some.
Promotion involvement that we thought was accretive so we participated there. There was also some launches we had a new dishwasher launch that came out and so there were some investments behind us new innovations as well, but by and large those were slightly different than when we were in a constrained environment, where we didn't have either of those two assets available to us.
Eric maybe just adding to this one first of all again and Thats. Why we also include the slides about the past price increases.
We have now in North America, but globally seven price increase behind us in a very short time period. So we.
Certainly havent been shy of passing on costs to the marketplace what happened in Q3 and more specific to your question. Yes. The market is slightly more promotional than for example, a year ago or half a year ago.
I also want to point out it's not comparable to pre COVID-19 periods. So it is more promotional more promotional elevated and thats, what we would probably expect to see also go forward.
But it's it's con compared to pre Covid times, so it's somewhere in between.
And that's what we're just dealing with right now.
The dose, but the good news is we start seeing sequential share gains for our North America business and Thats good.
Your next question comes from the line of Susan Mcclary from Goldman Sachs. Your line is open.
Thank you good morning, everyone.
Good morning.
Good morning could you talk a little bit about the channel inventories and appreciating that you took drastic steps to align your businesses, but what are you seeing out in the channels.
They are by and large this is Joe again by and large what we're seeing is fairly balanced perspective across all of our channels.
We don't believe that were under supplied.
Oversupplied and a lot of that has to do with the adjustments. We've made throughout 2022 I would say.
Quarters back we were still in constrained positions that were under supplied that's no longer the case, we feel like we're right where we need to be.
Holistically across the channels and frankly well positioned.
We exited Q3 with all the adjustments that we made so I think that feels like a.
A really good spot to be in and where we wanted to end.
Okay.
And then perhaps taking a bit of a longer term approach can you talk a little bit about how we think of the north American margin being at that 10% this quarter relative to that longer term target that you've set for us in the mid teens range. What are the steps that will need to see in order to get back there and is that still the right.
As you think about where the consumer where the business is.
Susan it's Marc so maybe I can give a perspective. So nothing has changed in our perspective about boats will be long term structural margins in North America.
And to be a little bit more specific you know when we had the North America business from 17% to 18% margin.
I mean, we felt that it's probably a little bit higher than we see the long term structural margin by the same token we think fee.
Right now, but 10% also not reflective.
I will structure margins for two reasons.
One is just.
If you're in the most simple way to explain it as kind of we have two major macro cycles are out of sync right now he demand is down and cost is up.
That is an unused typically cost photos demand now if you look back the last 20 years that happened a few times, but it's a big it doesn't last very long so to have these macro cycles out.
Out of sync to that extreme is highly unusual and will not last very long and two as Joe alluded to the 35% production cut was also true for North America. So we have a significant impact of but you have a massive fixed cost business basically taking out that kind of volume.
That of course is to fill it.
So you take these factors out of the equation, we're still coming back to these other structural run rate margins, which we communicated in the past and we still absolutely feel they're achievable.
Your question about what needs to happen the biggest step to happen is the combination of external raw material cost coming down and us taking additional steps on our own cost takeout.
The biggest.
Which is zero to 12 months levers, which we have to pull in which we're committed to port.
Our next question comes from the line of Mike Dahl from RBC capital markets. Your line is open.
Good morning, Thanks for taking my questions.
Mark it's good to hear that in security there is scheduled to close here just in the next.
The next couple of weeks I was wondering if you could give us any insight on how is that business performing against this recent environment that you've seen in your.
And your core business and how should we be thinking about the financial impacts that are embedded in guidance for the fourth quarter related to integrator.
So Mike let me maybe try to give you first antibody that would ask Jim to more give you a little bit more financial perspective first of all we.
We have not yet closed the transaction that is expected to happen on October 31st and obviously we are.
Very very very confident.
We'll have more data and everything is on track.
And as such we have we're not get controlling that business and as such we cannot really fully communicated minimum what we hear.
Is the margins are intact, which is good.
But we also see similar.
Demand or discretionary demand slightly coming down of the nature of that business has a little bit longer order pipe.
Pipeline et cetera, So I would say similar trends.
Similar actions, but the encouraging thing is the margins are very strong and keep them very strong and the market share is very strong so.
Where.
Everybody experienced at the same elements of housing and integrators not immune to that but we strongly believe this is extremely healthy strong and sustainable business and we're happy but we are hopefully not hopefully, but we are going to be closing this transaction in 10 days from now.
If you want to make common delivered what people should expect for Q4 and going forward. Yes. Mike. This is Jim I think you know.
Last call, we disclosed that we see for 2023, the impact of the incinerator business being about $1 25 per share and so if you think about that the two months that we will then be consolidating within the fourth quarter here would imply right around 20, but then also you do will have some effects.
That are related to just some of the of how you account for an acquisition at the very beginning and a few things that you may have to adjust for it. So that's probably the maximum amount you would see so it is going to be a pretty immaterial impact to the fourth quarter and the bigger impacts will be next year on a full year consolidated basis.
Okay. That's helpful. Thank you and then my follow up it's somewhat related but just given this.
Given the pressures you are seeing here, you've taken down your free cash flow guidance.
You have.
You are increasing your leverage to.
To take on and sing creator now you've got a lower free cash flow guide it sounds like at least through the first half of next year, you're still expecting some market pressures from inflation pressures so perhaps.
Some further headwinds to free cash how should we think about the implications.
These are the plans for deleveraging.
How much net leverage.
You can kind of pay down post closing of the deal and what that means for your buyback I know, it's on pause, but just any thoughts around.
On kind of timing.
How youre thinking about that.
Yes, Mike. This is this is Jim again, and I think if you remember when we talked about as we look at how we will finance the transaction as we will use approximately $500 million of existing cash on hand, and then through multiple term loans, we will finance another $2 5 billion, which will put us about.
Next year, let's just say on a gross debt to leverage perspective around in the neighborhood of three five.
As you mentioned right now we have suspended our buybacks and we will be.
Holding off on that until we begin to reduce our debt levels down obviously and that's what we said is going to be a focus go forward, but when we look at the structural cash flows of our business, which as mark alluded to before haven't changed.
Just being impacted right now by a lower level of demand, but as that begins to come back we expect our cash flows to come back to the levels. We've seen in recent years that were above a $1 billion per year, which.
Which will give us the ability to finance all of our different capital allocation priorities. So obviously continue to fund our business and pay our dividend and bring our debt levels down and then at some point in the future once we get back to our targeted leverage areas, then obviously share buyback will become.
Our priority that we will focus more on then after remind folks that if you look at the last two years, leading up to this or returned to shareholders with over $2 5 billion. When you look at share buybacks and dividends. So it's obviously been a focus of ours.
We will continue to have that as a focus in the future maybe just adding to this one.
We pride ourselves, we have a very strong balance sheets, and we will have a very strong balance sheet after wins and greater acquisition.
And that strong balance sheet gives us optionality just to give you two more additional comments first of all of them.
When we were referring to leverage keep in mind, we reaffirm to gross debt leverage.
By year end expect to be somewhere north of three.
Keep in mind, but excludes were almost $2 billion cash, which we have right now so thats, a gross debt leverage and be a way to look at our financial structure and our debt structure, we basically had over the last couple of years.
Long term debt level of about $5 billion.
Matt is unchanged what has changed is a little bit how we over last five years refinance and dip of that letter, but dead letter. It's very good very long the average cost interest cost of these five minutes two 9% so extremely attractive in today's terms.
But Jim was referring to is how we in the short term finance.
The <unk> acquisition that we made the decision we political one used $5 1 million of our cash and have embraced a short term loan.
Term loan and we intend to pay that down pretty fast.
But then at the same time, maybe not entirely sequential maybe to some extent parallel, but even potentially open the space again for share buybacks.
Your next question comes from the line of Mike Rehaut from Jpmorgan. Your line is open.
Thanks, Good morning, everyone.
Hi, Michael first question.
Just wanted to get a little clarity on <unk> and <unk> and some of the puts and takes.
Obviously, you highlighted the 35% reduction in global production and I was wondering how much that specifically impacted your margins.
If you have the absence of that headwind in <unk>.
Why would you have kind of similar margins I don't know if theres a further moderation in price mix, you kind of mentioned promotion starting to kick up again.
Any clarity around.
The impact of again inventory reductions.
Reductions in <unk>, and why wouldn't it be a little better than <unk>.
And Michael This is Jim and let me kind of start with that and so if you look at the 35% reduction we did in our production in the quarter that cost us over $100 million. When you just think about the leverage you get within your factories and Mark and Joe talked about the the level of fixed costs, we have there.
That cost actually does get spread across Q3, and Q4, because some of that does get hung up in inventory. During this time period and so it flows out.
Both quarters. Additionally, when you think about we talked about earlier the peak of raw materials coming around Q3, which means and Mark mentioned this earlier, while we did reduce our inventory levels and that's still the inventory that we have on hand, right. Now is probably at a peak cost. So as that begins to flow out do you think about how that flows out in Q4.
That also has an impact on the margin in Q3, and Q4 and Thats why as we look at the rest of the year. We do believe there'll be relatively flat, we arent expecting a significant change in demand through those those two quarters and then the last piece is just naturally in the seasonality of our business and how the promotional environment.
Works, even when it's reduced Q4 is your strongest or your highest amount of promotional spend within a year no.
No matter what the absolute amount is for the year. So that's also why you've got that seasonality effect in Q4.
Okay Alright.
A helpful rundown I appreciate that.
Secondly, I think there has been.
You've kind of highlighted some some.
Key variables to think about for next year and there's been a couple of questions. Just wanted to try and clarify a little bit across cost takeout, which is obviously can be a bit more.
Margin benefit.
But also raw materials and price mix.
Yes.
Kind of talking about obviously the headwinds that you expect in the first half, but then.
It should turn to a tailwind in the second half at least in terms of raw materials.
I was hoping.
To get some of your early expectations at this point on a full year net basis.
Would you expect raw materials to be a headwind or a tailwind based on current.
Prices.
In the market today or in steel and resins et cetera.
And with the cost takeout program should we be thinking that perhaps youre going to get some of that back to the consumer amid a still softer demand environment and what does that mean in terms of price mix being even potentially negative.
So Michael it's Marc So let me.
Try to answer your question first of all I would say upfront even in normal times in the October call. We would be hesitant to give you a lot of perspective in 'twenty three.
And definitely we would all agree were not exactly and if economic time. So in any forecast with 23, obviously you need to take with a grain of salt.
So let me let me just run you don't provide them where we do.
<unk> gone through or cant give you specific answers, but you can get a little bit more color perspective.
So the first one going through our P&L.
Demand.
And pricing is right now too uncertain to forecast.
Mobile demand.
Some elements driven in terms of consumer sentiment and ultimate you also relating to what happens mortgage rates what happens to be born Ukraine. So theres a lot of macro factors, which if we like it or not will weigh on short term demand doesn't change our long term demand of midterm demand outlook.
But of course, we need to be some macro concerns being reduced or eliminated before we see a significant pickup of consumer confidence. So that's probably the demand and correlated or related to recent pricing is the biggest uncertainty and we will give you a prospect from January .
If you want to give my personal perspective, Q3, Q4, and probably Q1, I think we would still see a depressed and volatile demand environment and afterwards, we got to see.
Then on the <unk>.
Cost side.
The 500 million net cost reduction I was referred to earlier, we can confirm that and if you want today. So you can include that in your spreadsheet because thats what you would obviously here in January .
<unk> materials sites, we have not quantified.
But obviously as you could see a year from our comments, we do expect gradual easing of raw materials side, yes.
Yes on a full year base, we absolutely do expect this to become a positive factor I E. No more increase but rather a decrease of raw materials, the magnitude of which we will clarify and quantify in Denver, but we do expect a reduction of raw material cost.
Your next question comes from the line of Ken Zenner from Keybanc capital markets. Your line is open.
Good morning, everybody.
Good morning, Ken.
Jim I Wonder if you could go back to this curtailment.
Just I think I'm getting confused a little bit.
The obviously cleaned up.
Generally what are you talking about in terms of unit leverage within your business.
Outside of this kind of in that 15% to 20% range and I think you just mentioned there was a $100 million.
<unk>.
Dollar headwinds in third quarter associated with the curtailment in North America was that right.
So thats about $3 well not in North America, but I said there was 10 within we see due to the reduction we did approximately a little bit more than $100 million due.
Due to the that will come through in Q3, and Q4 through our P&L Q3 and Q4 okay.
Right.
And I think Joe you talked about.
And various words.
Gaining some share sequentially productive share gains I E <unk>.
Volume associated with.
Promotions and Marc you said that.
Like pre COVID-19, but still.
A kind of drag.
And I think it's obviously, it's understandable everyone's trying to <unk>.
<unk>.
The cost basis, or where you are in terms of volume in the business. If we were to be let's say.
Next year if.
If the margins would get us back to that.
Longer term guidance just because this year is.
Exiting.
At such a lower rate, it's very bifurcated second half first half and I am not sure.
Is that any of us know exactly where existing homes are going to go next year given where.
Rates are.
Right now.
So is there a way that you can kind of talk about isolate those the margin drag associated with the production and the promotion level.
Is that promotion, obviously help increase your volume versus a more stable run rate.
Okay.
Yes.
Does that makes sense at all gentlemen.
It's such a big cut in the margins as we exit the year is my question.
And maybe Ken let me kind of start on on a few of the points. There and then I'll ask Joe and Mark I think if you start to think about next year and the opportunities for cost reduction that will come possibly with a at least a demand headwind as mark mentioned in the first quarter or early in the year as we come out.
This year, what we will start with a healthy level of inventory, which then allows us to run our factories in a very efficient way and allows us to hopefully as we.
Look at the demand environment and stay in check with it and Joe used the word synchronization earlier that we synchronize our production with the demand environment. It takes that volatility out which has a cost and has an inefficiency to it. So as we look forward I think what you saw was such a big reduction here that we talked about because the market and the demand did move very quickly.
We've now adjusted to that level and we believe we can keep our production at that level and then as demand would increase ramp it up appropriately. So I think as you think about next year, you do get efficiencies and cost savings that are part of that broader $500 million.
<unk> talked about but that's just one of many components that would be in there.
Thank you Jim.
I think this was the last question, which we had in the call. So let me maybe just quickly wrap up here so.
As you heard throughout the prepared remarks northern in Q&A.
We are dealing with the headwinds <unk> seen in recessionary demand environment.
And we're dealing with that proactively and decisively done some will continue to do so at the same time, we're not yet experiencing the tailwind which come with a recession in the form of cost reduction we will have one point.
And we have also non who would take on top of the additional cost actions internally and how we bring down the fixed and variable cost.
Beyond the short term recessionary environment, but cricket questions. How we are positioned to post recession environment.
And then on that note as you hopefully heard us.
To be very upbeat about the mid and long term demand trends, which spells significant opportunities for us with everything which we've done on reducing lowering breakeven points, which everything we've done on product innovation branding I think.
Very well positioned for a post recessionary environment.
Which at one point will come.
With that in mind I. Thank you all for joining us today and wish you a wonderful Friday. Thank you.
Ladies and gentlemen that concludes today's conference call you may now disconnect.
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