Kenvue Inc. (NYSE:KVUE) Q2 2023 Earnings Call Transcript

Kenvue Inc. (NYSE:KVUE) Q2 2023 Earnings Call Transcript July 20, 2023

Kenvue Inc. beats earnings expectations. Reported EPS is $0.32, expectations were $0.29.

Operator: Greetings and welcome to the Kenvue Second Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tina Romani, Head of Investor Relations for Kenvue. Thank you. Tina, you may begin.

Tina Romani: Good morning, everyone. Joining me on the call today is our Chief Executive Officer, Thibaut Mongon; and our Chief Financial Officer, Paul Ruh. Please note that today’s call will include forward-looking statements regarding, among other things, our operating and financial performance, market opportunities and our growth. These statements represent our current beliefs or expectations about future events and are subject to various risks, uncertainties and assumptions that could cause our actual results to differ materially. For information regarding these risks and uncertainties, please refer to our earnings materials related to this call posted on our website and our filings with the SEC. During this call, we will also reference certain non-GAAP financial information.

The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP. A reconciliation of these items to the nearest U.S. GAAP measure can be found in this morning’s press release and our presentation available on our IR website. With that, it’s my pleasure to turn the call over to Thibaut.

Thibaut Mongon: Thank you, Tina. Good morning and thank you for joining our second quarter earnings call and our very first as a public company. Our recent IPO marked an important and exciting milestone in Kenvue’s history. Over the last 135 years, we have established ourselves as the world’s largest pure-play consumer health company. And now as a standalone company, we are looking forward to building on our strong heritage and continuing to deliver on our purpose to realize the extraordinary power of everyday care. Before we begin, as you may have seen this morning, Johnson & Johnson announced their intended next step in the separation of Kenvue. At this point, we are very limited on what information we can provide other than what has been made public, and as a result, we will not be able to discuss any further details at this time.

What I can tell you is that we are ready to take on the next phase in our journey to becoming a fully independent company. For today’s call, I will begin with an overview of our second quarter results, Paul will then take you through a more detailed view of our Q2 financials and 2023 outlook, and then Paul and I will be happy to answer any questions you may have. But first, let me begin with our strong results this quarter. With over $4 billion in net sales, Q2 was one of the strongest quarters in our 135-year history and certainly is the strongest since the beginning of our business transformation in 2019. Organic sales grew 7.7%, bringing our first half organic growth to a very strong 9.4%. Similar to Q1, our growth was broad-based across all segments of our portfolio and across all geographic regions.

So this quarter was yet another proof point showcasing the power of our portfolio. Our three segments did well. We saw double-digit growth in Self Care, continued recovery in Skin Health and Beauty and growth ahead of our long-term expectations in Essential Health. Further, we delivered balanced growth across all geographic regions, with North America contributing about half of the growth with all other regions representing the remainder. There were several portfolio highlights in the quarter, but let me focus your attention on a few standouts. In Pain and in Cough and Cold Care, we saw higher incidence rates drive continued demand for our leading brands such as Tylenol, Motrin and our other brands in these need states. Across our Self Care portfolio, we see innovation, premiumization and health care professional recommendations, all fueling market share growth for many of our brands.

In Skin Health and Beauty, our performance in Sun Care showed the power of our brands as we see continued recovery after a period of disruption. Innovation, improved supply and strong commercial execution contributed to sustained market share growth for Neutrogena Sun this season. In Essential Health, our Listerine mouthwash superiority claim of dental floss is being deployed around the world, and our Listerine gum therapy product in the U.S. is ranked number one new code in the mouthwash category this quarter, and we continue to see the power of Band-Aid, where consumer-led innovation and strong customer partnerships delivered another strong quarter. Band-Aid was also recognized in the quarter as America’s most trusted brands for 2023 by Morning Consult, and this is the second year in a row that Band-Aid has earned the top spot.

With the macro environment continuing to be challenging, consumers are increasingly more choiceful with their purchase decisions. In the consumer health space, though, they turn to brands and products they know and trust and we have many of those brands in our portfolio. We see this playing out in the value-volume dynamics of Kenvue this quarter. While value represented 9.4 points of growth, volumes only declined 1.7 points and excluding the impact of our own intentional decisions like portfolio rationalization or suspension of our Personal Care business in Russia, volumes were about flat this quarter. Important to note that we delivered this exceptionally strong first half of the year, in part thanks to the investment we have made in our supply chain, building capacity and resiliency.

While service levels will continue to be a focus area for us, we have made significant progress that have allowed us to capitalize on and deliver against the unique demands of the first half of the year. Regarding our margins, they continue to be healthy fundamentally when excluding non-operational impacts such as FX or standard company costs. Inflationary pressures, though moderating, continue to be meaningful. But this quarter, again, we use a combination of strategic value realization, both price and mix, and productivity initiatives in our operations to offset a significant portion of these costs, which Paul will get into in just a moment. So net, a strong quarter showing the power of our world-class portfolio of category-leading brands that includes many of the most recognizable household names across consumer health, which brings me to Kenvue’s greatest source of competitive advantage.

With a sole focus on consumer health, every day, our 22,000 Kenvue’ers are committed to delivering science-based innovative solutions that increased relevancy with consumers and strengthen credibility with health care professionals. These relationships have been cultivated over decades through innovation supported by rigorous science based on our vast clinical research capabilities and meaningful cross-category consumer insights. As a result, brands across our portfolio have a long history of recommendations by health care professionals and are often the number one most recommended brand in their respective categories, which ultimately fosters lifelong loyalty to our brands, loyalty that is passed down from generation to generation. Our first half results exemplifies its loyalty and consumers’ desire for our efficacious products.

While consumers may be trading down in more discretionary and traditional staple categories, we have not seen this dynamic in our portfolio. Consistent with what we have seen historically during times of challenge and uncertainty, private label penetration for our categories remain stable on a global basis this quarter. Our first half results also reflect the unique opportunity we have to expand usage occasions across the spectrum of consumer health. There is no limit for consumers to take care of their own health. And for Kenvue, there is no limit to finding new ways to help consumers take care of their health. The categories in which we operate tend to be underdiagnosed, undertreated and underpenetrated. Using Sun Care, for example, since we are in the middle of the summer season, it’s estimated that 1 in 5 Americans will develop skin cancer in their lifetime.

Yet today, a majority of Americans do not use sunscreen on a regular basis. At Kenvue, we want to understand why that is? What are the barriers to adoption? That’s a tremendous opportunity for us to leverage our extensive capabilities and consumer insights to develop innovative new products to better serve the needs of our consumers. So with this in mind, this year in the U.S., we launched Neutrogena PureScreen Plus Mineral UV in 4 sheds that blends mostly to complement skin tones. Our new products are up to 30% less whitening at the leading mineral sunscreen, which is one of the biggest frustrations consumers have. Innovations like these have fueled share gains through better customer retention, increased consumption and attraction of new consumers to the brand, all driving the strength we saw in the quarter for Neutrogena Sun Care.

That’s what makes this consumer health space very attractive the infinite ability to expand usage occasions and give consumers around the world new opportunities to take care of their health. Now let me take a moment to speak to the strength and agility of our operating model that supported our results. Since 2019, we have made tremendous strides in removing complexity, streamlining our organizational and operational footprint and simplifying our portfolio while investing in digital and omnichannel capabilities that position us well for the future. Today, we have a resilient portfolio with iconic brands well balanced across categories and geographic markets. Our model is designed to drive synergies across our portfolio from shared consumer insights, go-to-market strategies, operation, marketing, innovation and so on.

While we set our strategy and allocate resources at the segment level, all 3 segments are focused on one single and cohesive end market, consumer health. Take products for children as an example. You will see products living in Self Care with children’s Tylenol; in skin health with Neutrogena or Avino Sun for kids; or in Essential Health with Johnson’s Baby or Band-Aid. But it’s 1 consumer, 1 pediatrician, 1 understanding of the interaction between child and parents that allow us to present ourselves as a preferred partner for everything you need for children’s health. And the same applies to the rest of the portfolio. This dynamic is a critical component in understanding the strength of Kenvue. In addition, being a pure-play consumer health business both drives efficiency across areas like R&D and advertising and also afford us agility and flexibility.

We saw this agility in action this quarter with the Kenvue teams delivering strong performance on multiple fronts, including responding to unprecedented demand for Self Care brands. So as you can see, our second quarter results are emblematic of the power of our portfolio. In a dynamic macroeconomic environment, we delivered strong top line with operationally healthy margins and solid earnings per share, all of which supported the initiation of our first quarterly dividend as Kenvue of $0.20 per share. Now looking to the back half of 2023. This year has, for sure, been an incredible journey for Kenvue so far, but we have a lot to look forward to with the full year organic growth expected to be between 5.5% and 6.5%. Paul will take you through the assumptions embedded within our full year outlook, but I wanted to take a moment to acknowledge the consumer landscape.

It continues to be uncertain, and we anticipate market volatility will continue, including in the incidence level for the upcoming winter season. In this environment and building on the unique nature of the consumer health space, we, at Kenvue, will continue to stay focused on what we do best, delivering superior science-backed, efficacious health solutions to serve the needs of our 1.2 billion consumers around the world who know and trust our brands. In Self Care, we will deliver a consistent cadence of innovation and marketing programs to drive growth on our priority brands. You may have seen we just launched Tylenol Precise where we leverage in Self Care our extensive skin health expertise to develop a maximum strength topical pain treatment with rapid absorption in an esthetically pleasing next-level experience.

For me, this is another great example of what we mean by the power of the portfolio with synergies across segments delivering innovative health solutions. Within Skin Health and Beauty, while we expect continued progress on distribution point recovery in the U.S. through the third quarter, we are planning to return to a normal cadence of innovation with a strengthened and more resilient supply chain and reactivation of marketing campaigns to continue to build momentum in our brands. And within Essential Health, we expect science-backed claims and innovation launches to drive category essentiality and relevance the effective execution while strengthening brand equity in priority markets. So as you can tell a lot to look forward to in the back half of the year.

So in closing, as the largest pure-play consumer health company in the world and with unparalleled depth and breadth of our portfolio we offer a one-stop solution for retailers, positioning Kenvue as a preferred partner of choice for retailers who want to become the destination for everyday care. This quarter was another strong illustration of the resilience of our categories and the strength of the Kenvue operating model. None of this would be possible without the passion, commitment and owner’s mindset demonstrated by our amazing team of 22,000 Kenvue’ers who work every day to help consumers realize the extraordinary power of everyday care I want to acknowledge and recognize them here as we start our journey as a stand-alone company. To summarize, we feel confident about the future of this business with the strength of our brands, the power of our portfolio and our unique competitive advantages, which we believe will enable us to consistently deliver strong performance over time and drive long-term value for all our stakeholders.

With that, I’ll turn it over to Paul.

Paul Ruh: Thank you, Thibaut, and good morning, everyone. I am pleased to be co-hosting our first earnings call to report on a strong quarter, our first after a successful IPO. I’d like to echo Thibaut’s acknowledgment of the passionate and talented team we have here at Kenvue. The team’s execution on our proven strategies yielded strong broad-based sales growth with healthy underlying margins despite navigating continued significant inflationary pressure and a challenging macro backdrop. I can’t be prouder of what this team has delivered in the first key steps of our journey as a public company. Now getting into the quarter. We had a strong and balanced quarter with every segment and geographic region contributing to our 5.4% reported growth and 7.7% organic growth.

In terms of drivers, value realization, which is comprised of price and mix represented 9.4 points of growth. Approximately 60% of the value realization growth was driven by carryover of actions in the back half of last year, with the remainder driven by incremental actions in the first half of 2023. Notably, even with 9.4 points of value realization, volume remained strong with only a 1.7 point decline, which includes the impact of intentional strategic portfolio rationalization initiatives and the decision to suspend the sale of personal care products in Russia, which we are anniversarying this quarter. If not for these deliberate actions, volume would have been about flat, exemplifying the resilience of our brands. By segment, Self Care had another strong quarter with a segment gaining share globally, driven by increased consumption across all new states and priority brands, driving 14.2% organic growth.

Value and volume were both strong at 10.6 and 3.6 points, respectively. In addition to broad-based strength across the cold, cough and flu categories globally, our new first-to-market vaping cessation indication in the U.K. is driving consumption in Nicorette and Digestive Health grew with strong Imodium consumption globally. On Allergy, we were very pleased with the performance of our largest brand, Cirtec, which continued to gain share in the U.S. this year, though we saw lower incidences this season. Moving to Skin Health and Beauty. Organic growth of 3.4% was comprised of 6.6 points of value realization with 3.2 points of volume decline. It’s important to note that volume includes intentional strategic portfolio rationalization initiatives and the decision to suspend the sale of personal care products in Russia.

Excluding this impact, volume was up low-single digits demonstrating the healthy underlying demand for our skin held brands. We are pleased with the recovery we are seeing in the business and expect gradual improvements to continue as we restore supply, regain points of distribution with retailer floor resets coming this fall and support our healthy brand equities through innovation and premiumization. This quarter’s strength in Sun Care is a great example of our ability to grow and gain share when we have a full portfolio on shelf supported by innovation, premiumization and media support. Next, moving to Essential Health. Organic growth was 3.8%, comprised of 10.7 points of value realization and 6.9 points of volume decline primarily due to competitive micro dynamics, particularly in Asia.

Similar to skin health, it’s important to note that excluding intentional strategic portfolio rationalization initiatives and the decision to suspend the sale of personal care products in Russia, volume was only down mid single-digits. With a healthier core portfolio, the business is focused on strengthening brand relevance through innovation-driven brand differentiation and premiumization. Overall, our second quarter results are indicative of the leadership positions we hold across the growing consumer health categories in which we operate. The resiliency we’ve seen this quarter and since our transformation efforts began in 2019 give us confidence that the investments we are making in our technology and digital capabilities to modernize our supply chain, product innovation pipeline, R&D and our strategic marketing are working and position Kenvue well to drive sustainable growth over the long-term.

Now turning to gross margins. Excluding amortization, adjusted gross margin was 57.5%. We continue to face significant though moderating inflationary pressures during the quarter. Through value realization and supply chain productivity improvements, we were able to successfully offset the majority of these headwinds. In parallel, gross margin was negatively impacted by transactional foreign currency fluctuations of approximately 100 basis points and other non-operational costs related to building our stand-alone infrastructure. Our teams are focused on identifying and actioning productivity initiatives that will mitigate these headwinds. Moving to adjusted EBITDA margins. Adjusted EBITDA margin was 24.5% and reflects the impact of the ForEx headwinds I just mentioned and incremental cost of being a stand-alone public company.

In Q2, our stand-alone public company costs were approximately $50 million to $60 million, which reflects a front-loading of these costs. Acknowledging the complexities of standing up a company of our size and scale and that there is more work ahead over the coming two quarters, we expect these costs to remain elevated as several investments are concentrated upfront in the process. However, we expect these costs to decrease and be offset by other productivity efforts over time, remaining in line with our initial expectations. Turning to taxes. As can be expected, there are several unique items impacting our second quarter effective tax rate with our IPO in May. On a reported basis, our tax rate is approximately 32.7%; and on an adjusted basis, our Q2 effective tax rate is 30%.

The primary drivers for this higher tax rate versus last year are: first, higher GLT and subpart F taxes, net of foreign tax credits; and second, less favorable discrete benefits in 2023 as compared to 2022 related to share-based compensation, law changes and prior year items; and third, the recording of a valuation allowance on our ability to utilize foreign tax credit assets in Q2 of 2023. And finally, our adjusted net income was $581 million and adjusted diluted earnings per share of $0.32. All in, we are proud of what we delivered in our first quarter as a public company: strong and balanced top line with fundamentally healthy margins. As we look ahead, we remain committed to investing in our business for the long-term with an eye towards delivering attractive total shareholder returns in a balanced way, which brings me to our capital allocation philosophy.

We have a proven track record of generating robust, durable cash flow north of $2 billion per year historically, which gives us the flexibility to pursue our balanced capital allocation strategy. This is comprised of four pillars: number one, responsibly invest resources in our iconic brands to drive profitable growth; two, return cash to shareholders through dividends; three, de-lever, our reliable cash flow gives us the flexibility to prudently de-lever and reduce interest rate expense at the appropriate time; and number four, assess potential inorganic tuck-in growth opportunities that strengthen our position as a leader in consumer health. And we’ve already begun executing on this strategy with this morning’s announcement that our Board of Directors declared a third quarter dividend of $0.20 per share.

The decision by our Board reflects the confidence we have in our ability to deliver profitable growth over the long-term while returning cash to shareholders and their commitment to our balanced capital allocation strategy. Now let’s get into our 2023 outlook. Starting with top line. Reflecting our strong first half, we expect full year net sales growth to be between 4.5% and 5.5% and organic growth to be between 5.5% and 6.5%. At current spot rates, we expect an approximate 1-point negative impact of foreign currency fluctuations for the full year. A few other items to keep in mind as you model the remainder of the year. It’s important to consider a strong performance in the back half of 2022, as we improve service level over that period.

Further, our first half 2023 results benefited from a couple of one-time-in-nature dynamics that we would not expect to continue in the second half. First, our Q1 results were supported by higher-than-normal inventory replenishment, primarily in Self Care and Skin Health and Beauty. This was a result of our retail customers exiting Q4 with lower-than-average inventory levels, generating outsized orders during the quarter as they looked to restock. Second. Globally, there has been an exceptionally strong cold, cough and flu season throughout the first half of the year. While we will be operationally ready for any level of seasonal demand, our outlook contemplates more normal incident rate levels this coming winter. With regards to interest, we expect reported net interest expense to be approximately $270 million and approximately $300 million on an adjusted basis.

Moving to taxes. With regards to the full year, we expect a reported effective tax rate of 34.5% to 35.5%. On an adjusted basis, we expect the range to be between 24.5% and 25.5%. The higher rate versus prior year is primarily driven by jurisdictional mix of earnings and less favorable discrete benefits in 2023 as compared to 2022. On the bottom line, we expect full year adjusted diluted EPS to be in the range of $1.26 to $1.31. This range assumes a full year 2023 weighted average share count of 1.855 billion shares. As we look to the back half, we continue to operate in a challenging environment with ongoing pressures from labor costs, raw materials, packaging and foreign exchange volatility. While our guidance reflects a variety of scenarios, we remain focused on the things that we can control and will utilize the levers within our operating model to mitigate these headwinds.

As we have done over the past several years, I’m confident in our proven ability to navigate on certain operating environments, leveraging the power of the portfolio and the expertise of our teams. Now I’ll turn it back to Thibaut for some closing remarks.

Thibaut Mongon: Thank you, Paul. Again, we are pleased with the strength of our second quarter results and our first quarter as a publicly traded company. This quarter highlighted our unique model as the world’s largest pure-play consumer health company, building on our clear sources of competitive advantage to deliver robust financial performance. And now let’s open up for Q&A.

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Q&A Session

Operator: [Operator Instructions] Our first questions come from the line of Anna Lizzul with Bank of America. Please proceed with your question.

Anna Lizzul: Hi, good morning. And thank you for the questions. You mentioned innovation several times on the call, and you previously shared that Kenvue has launched over a 100 new product innovations each year since 2020 and they have comprised about 10% of net sales each year. Are you on track for product innovations to contribute to a similar amount to net sales this year? And also, what gives you confidence in the coming quarters that consumers are still willing to spend on higher price innovation and consumer health when we have seen some greater trade down within some categories in HPC? Thank you.

Thibaut Mongon: Yes. Good morning, Anna. Thank you for your questions. Yes, as you rightly pointed out, innovation is a big part of our model at Kenvue. That’s what we have been doing historically and that has been our history of 135 years with their many first-to-market innovation. And we definitely intend to continue on this trajectory. I talked in my prepared remarks about a number of examples of innovation we launched this quarter and they have been well received. And we are excited to – about what is in the pipeline and what we are about to launch in the market in the back half of this year across all three segments. I would remind you that for us, innovation means not only new products, but also it can be a new claim or a new clinical data that allows us to give consumers and healthcare professionals another reason to use our brands.

So yes, we are pleased with the health of our innovation pipeline and the impact it has on our business. Regarding your second question regarding the consumer confidence, while you may have seen in, I would say, more traditional staple categories, some downgrading happening in some geographies. At Kenvue, we don’t see this dynamic happening in our portfolio. You saw that excluding our own intentional discontinuations. Our volumes were flat in the second quarter despite strong value realization. You remember that we saw the same thing happening in the full year 2022. So what we see is that even in this more dynamic environment, consumers remain focused on their health and well-being. They want to take control of their own health and they are looking for trusted product, solutions and brands that have been in their household for years, for decades, sometimes for generations.

And as you know, many of these brands are in the Kenvue portfolio. So that’s what makes us confident in the fact that our brands will continue to be the go-to brand for consumers around the world.

Anna Lizzul: Thank you. And just as a follow-up, in terms of distribution, are you happy right now with your distribution with various retailers like Walmart, Target and the drug channel? Do you see any areas where you might be under penetrated or any potential categories where you can expand distribution with certain retailers, either domestically or internationally?

Thibaut Mongon: Yes. I would tell you that domestically and internationally, distribution is always an opportunity for our vast portfolio of brands. It’s something that we continuously work on with our retail partners around the world across the portfolio. Following the period of disruption we had in the past that particularly hit of Skin Health and Beauty segment and some part of our Essential Health segment, we are focused on recovering distribution points. I’m pleased with the progress we have made so far, but I would expect a continued recovery in distribution points in the back half of the year. But beyond this specific event, distribution is something that we always work on with our retail partners, yes.

Anna Lizzul: Great, thank you. I will pass it on.

Operator: Thank you. Our next question is come from the line of Filippo Falorni with Citi. Please proceed with your question.