The audience who may have known an earlier Newell, what would you say has changed?
Almost everything is what I would say.
Of course.
But when we got started two and a half years ago on this journey, we started, to your point, with the capability assessment, assessing the 11 core capabilities that are required to win in consumer products, and really trying to do a database deep dive of where did we stand from a capability standpoint versus best-in-class competition. At that point in time, on about half of those capabilities, we were red, meaning we were worst in class, generally on the things that drive top-line growth. We were yellow and green on a lot of the supply chain and back-office functions. That led to a new strategy, which we put in place in June of 2023, with a very clear set of where to play and how to win choices. That then led to the kickoff of a capability improvement project list, as well as a new operating model.
That new operating model was very much focused on establishing global segments that ran the P&L for the brands, establishing brand management, and then ruthlessly scaling our go-to-market, supply chain, and back-office as a one Newell organization structure. Underpinning all of that, we've upgraded talent, changed the company's culture to a high-performing, innovative, and inclusive culture, and established a new set of values across the company. It's been a pretty soup-to-nuts reassessment and rebuild of the company. What we're excited about as we sit here today is we've seen the results of that. Our rate of core sales growth has improved significantly today versus where we were two and a half years ago. Although we're still negative this year, we are less negative this year than we have been in the last couple, and we are on our way to get back to core sales growth.
We've taken our gross margin up almost 600 basis points in two years, which is a remarkable achievement. We've reduced our net leverage ratio. We've improved our balance sheet. We've driven strong cash flow. So we think we're on the right track. Although we're not satisfied with where we are, there's still more work ahead of us to go.
Okay, great. I want to dig into a lot of that further as we go, but maybe first we can talk about your outlook for category growth this year. Earlier in the year, you've been talking about a 1%-2% decline for categories, and then in August, you revised that to low single digits. So subtle change, but a change. So what drove that change in expectations? Any change over the past month? And you also, in that conversation, discussed confidence in improving category growth in 2026. Maybe you can kind of unpack some of that for us.
Yeah, sure. So exactly right. In the August earnings call, we said effectively we're going to be down about where we expect our category growth rate in the categories we compete to be down, call it about 2% this year. That's about what we saw in the first half of the year. One of the things that's important to note is that we were pretty close to that category growth number in the first half of the year from a core sales growth standpoint. And so what that means is that our market share is improving as we're bringing the front-line capabilities on. As we looked at the outlook for the balance of the year, we didn't see a catalyst for the category growth rate in the back half of the year to be better than the first half of the year.
And so we reset our guidance to include the impact of tariffs, but also to include the assumption that the minus two was going to sort of sustain throughout this year. In the last month, we haven't really seen anything from a consumer standpoint that would change that dynamic or change that outlook. That being said, what we are seeing from a consumer standpoint is that the lower-income consumer remains under pressure. The middle-income consumer also is increasingly under pressure. And what that's resulting in is consumers looking for more value. The good news is our portfolio, we've been working on developing products and innovation that deliver strong value behind our leading brands. And we're seeing that on some of our businesses, which I'm sure we'll get into. The high-income consumer remains very, very strong. Equity values have gone up, home values have gone up.
We see a very different dynamic for high-income consumers versus middle and lower-income consumers. As we go to next year, I think there's reasons for optimism that category growth can improve next year in discretionary product categories. I'm not an economist, but the uncertainty from a consumer standpoint that we've endured this year is seemingly lessening as we go forward. I think we're headed to an environment where interest rates are likely to come down as we go into next year. That helps directly on household formation, which directly impacts some of our categories. I think some of the most recent statistics on GDP growth above 3% are encouraging. We're not guiding yet for next year, but I'm cautiously optimistic when I look at the macro environment that the category growth rate can improve next year versus this year.
Okay, great. Before we go further, I wanted to just set the scene on tariffs. So let's just start with what you're facing, where are they the most pronounced, and how you're mitigating and/or benefiting from this new environment.
Sounds good. So tariffs have been a dynamic environment, to say the least, with the number of changes. What I would say on tariffs is a couple of things. First, we've created a trade expertise center across Newell, which we did before tariffs got started, but that we think is a competitive advantage. So we have an organization that in real time gets tariff announcements from all governments, from all countries around the world in which we do business, can run it through our system, and can give us a financial impact, usually within a couple of days. So we have very strong visibility to the impact on Newell from tariffs. We also have created a lot of flexibility in our supply chain. Recall that several years ago, 35% of our business was sourced in China headed to the U.S.
At the beginning of this year, we had reduced that number proactively down to 15%, and by the end of this year, we'll be less than 10% China to the U.S. dependent on our business. We're still very much on track for that. We've also created free trade zones in the U.S., which give us the ability to navigate this environment. When the tariffs came into the current state of play, we've guided that we expect the cash impact on tariffs for Newell this year to be about $155 million incrementally. The P&L impact of that is about $0.21 a share. We have done a couple of things. One, we've gotten more aggressive on overhead cost management, and we've gotten more aggressive on full productivity programs. We've also, to partially offset the impact of tariffs, we've also taken three rounds of pricing.
The first round we put in place effectively around May 1st, then June 1st, and then the last round was August 1st. So we have, at this point, fully priced for tariffs. The retail pricing has not fully reflected our pricing yet, but our pricing is now fully in place. The other thing I would point out is about 55% of our U.S. business we manufacture ourselves. We have 15 U.S. manufacturing plants, and we have two plants in Mexico that are USMCA compliant that are not subject to tariffs, and on those categories, we're advantaged because we're not facing really any tariff exposure on that part of the business.
Okay. Categories where you're advantaged, maybe mention a couple of them. And then also, are there any categories where you're actually disadvantaged as a result of tariffs? And if so, how are you going to address those?
Yeah. So I would say we're advantaged in significantly more categories that represent a greater percent of the business than where we're disadvantaged. There's 19 categories that we are advantaged. And one of the things we've done since tariffs have gone on is we've gone on a proactive selling pitch to retailers to effectively delist the competitive set that's coming from overseas that's going to have tariff exposure and change out to our brands. On the last earnings call, we said we expected about $30 million of wins already in the back half of this year from that. We've actually secured more wins at this point, so we're up to 35. So we've gotten another $5 million since we last reported in additional wins this year.
That number, for what it's worth, I think is going to be bigger as we go into next year because we'll have a full year impact of that. We're on our front foot pitching where we have cost-advantaged categories. Those categories would include things like eight of our top 10 brands are made in the U.S. It would include things like the writing business, which is made in Maryville, Tennessee. The food storage business behind the Rubbermaid brand. We have a big Rubbermaid Commercial Products business that's made in Virginia. We've got part of our Outdoor & Rec business that's made in Kansas, to name a few, and several others. There's then a set of categories where we're kind of neutral. The biggest category where we're subject to tariffs that we're kind of neutral with the industry is the baby category with Graco.
On that category, it's interesting because that's where we've taken the most aggressive pricing. And about half of the pricing that we've taken has been reflected at this point by retailers. The interesting thing on that business is we're gaining market share right now despite the pricing. And we're gaining significant market share behind great innovation. We've launched the EasyTurn convertible car seat. We've launched the SmartSense bassinet and swing that is driving market share growth. The other thing we're seeing is consumers are trading down from the super premium segment to Graco. So we're seeing Nuna, UPPAbaby, and Maxi-Cosi, which are at the super premium, all losing market share. And Graco, which is positioned at the high end of MPP, is the beneficiary of that because consumers are deciding, "I don't need to buy a $1,400 car seat when I can buy a $500 car seat.
That's very good." So that's one that we feel good about our trajectory. And then the couple of categories that I would mention where we're disadvantaged would be things like we have a metal trash can business in Rubbermaid consumer products that's sourced from outside the U.S. that some competitors have U.S. manufacturing: toaster ovens. But they tend to be small categories that represent a small percentage of the Newell business.
Okay. I'm not sure I knew you made toaster ovens.
Yes. Exactly.
Okay. Let's go a bit into these distribution wins because you just said, "Well, now $35 million in incremental sales as a result of these tariffs advantage categories." Should we take that $30-$35 million and kind of run rate it into 2026? Or you mentioned it can grow. Does it grow as retailers reset shelves? I just understand a little bit of that flow through.
Yeah. So if I take that $35 million that we've just updated five minutes ago externally from $30 million and say, "Well, how does that go to next year?" There's a part of the $35 million that is a line review reset where the retailers are resetting and giving us more shelf space. That should be sustaining. And there's a part of it that are merchandise wins for promotional events that are sort of more, "You win it this year, and then you hope you win it next year, but you don't know that you're going to win it next year." And so part of it sustains, part of it doesn't. The way I would think about it is the $35 million will be in the base as we head into the back half of next year.
But I expect that the wins next year from what we see will be a bigger number than $35 million incrementally versus this year. So in other words, I expect not only will we lap the $35 million, but we'll add on more than that based on the full year impact next year. And that incremental next year will probably be more significant in the front half of next year because we're not lapping anything versus the back half when we're lapping the $35 million.
Okay. And then I believe there's other distribution wins beyond things that are kind of directly related or influenced by the scope of tariffs. So is that right? And maybe you can quantify or talk a little bit about what that looks like.
Yeah. So one of the things we've been working on is improving the company's new product innovation pipeline. So when we started on the strategy refresh, we did an assessment of our innovation pipeline and concluded that we were terrible. And so we completely reset the innovation process and pipeline. For perspective, we put in a tiering system of Tier 1, Tier 2, Tier 3, and Tier 4 innovations. Tier 1 and Tier 2 innovations, I think we had one or two in all of 2023 as a company. Last year, we had eight. This year, we've got kind of a mid-teens number. So we have significantly ramped up impactful, high-quality consumer-based innovation. And as we're doing that, we're gaining distribution when we bring those initiatives to market.
And so as an example, I mentioned in the baby category that the EasyTurn convertible car seat, the SmartSense bassinet and swing, that's allowing us to go to retailers with a category growth story that says, "We're the ones that can turn the category growth around." But in order to do that, you've got to support our innovation that we're bringing to market. And we're starting to get stronger and stronger traction from retailers and starting to win an ever-increasing set of distribution. So if you look in the U.S., for example, we put in one of the other things we weren't doing historically was tracking distribution. We've now, as of about a year and a half ago, put a sophisticated tracking system in place. But we were losing distribution pretty consistently up until about the middle of this year.
We now, as we go into the back half of this year, are turning net positive on distribution for the first time since we've put the new strategy in place. And so as we go forward, we can see that distribution should go from what was a headwind on revenue to being a tailwind.
Okay. Great. Let's keep going on innovation. So pipeline's stronger. You gave us examples of Tier 1 and T ier 2. So it's quality and quantity. But from the outside, I guess it can be difficult to know if innovation will matter. A lot of times, things seem like, "That's a great idea." We don't know if it ended up mattering. So I guess how should an outside investor judge the quality of innovation? And also, how do you think about launching innovation against this subdued macro backdrop?
Yeah. It's interesting, so we went back and looked at because we've launched a meaningful number of these sort of, call it 15 Tier 1 and Tier 2 innovations this year. So let's say we've launched 10 of them already in the first half or something like that, or maybe something like that. Some of them launched at different periods of time, but from what we've seen so far, in total, we're actually doing better than we thought in terms of revenue, incremental revenue, margins, and net present value on that innovation portfolio. We've got some that are doing dramatically better than we thought, and we've got some that are doing worse than we thought, and that's okay because we're not going to get it right all the time, but as a portfolio in total, we're actually doing better than what we projected.
So that's the first thing that gives me confidence that we're on the right track. On the ones that we're doing better than we thought, we're asking ourselves, "How can we double down and invest more behind the winners?" This year, we'll have the largest A&P budget as a percent of sales and as an absolute dollar amount and we've used the gross margin improvement to effectively fund higher A&P spend, which is effectively going against these leading innovations has been the model that our playbook and we're seeing consumers resonate even in this environment to that so consumers are responding when we come out with innovation because the innovation is compelling from a value perspective.
And the price points generally that we're asking consumers to pay on a good part of our business is not high enough that it's going to make the difference in their lifestyle. And the products are representing a good value. So I'm pretty optimistic that innovation still matters and will continue to matter as we go forward.
Okay. Let's take (I'm just looking at my questions quickly) a closer look at your assumptions for the back half. So I wanted to just check in on how back to school has gone at earnings. Selling was constructive. We now have another month of data. I still haven't taken my kids back to school, so that's this weekend. But curious what you can tell us about consumption.
Yeah. So when we talk about back to school, we talk about a 12-week period that basically goes from around July 1st to around September 30th. We're eight weeks into the 12-week period at this point in terms of data that we see that's not public because we get data in advance of what becomes public. Based on that eight-week data, you're right. Our selling was terrific. The back to school season, I think I said, got off to a little bit of a slow start, but then started to accelerate. And that trend has continued. And so as we sit here today through the first eight weeks, we're seeing on the writing business, which is our primary back to school business, category growth is about flat this year versus last year is the first thing I would say.
And so that we think is positive and about in line with what we had expected. The second thing I would say about back to school is that we haven't seen prices move up in the writing category really at all. Not just by, we don't need to raise prices because we're manufacturing in the U.S., but much of the private label and the competitive brands are coming from outside the U.S. and are subject to tariffs. They have not raised prices, so they've protected prices during back to school. We think that's because many of these companies brought their back to school inventory in before the tariffs took effect. The thing that we're now going to be into in the month of September, which is always the largest month of the quarter for us in Q3, is the replenishment orders because July and August is more about the setup.
September is more about the replenishment orders. And the thing that we're watching is we think that some of these competitors are going to have to replenish now at the higher cost base. And so we're watching the pricing dynamic carefully as we go forward.
Is there a chance that that manifests differently, that they don't price what they pull back on marketing? Is that another scenario this year anyway?
It's possible. And we've got our strongest marketing plan, our strongest marketing spend, strong innovation, and a cost now an increasingly cost-advantaged position because of our U.S. manufacturing footprint. So I'm optimistic about where we're headed on this business as we go forward. We also have (I think I shared at one of our previous discussions) we've done a big shelf aisle reinvention with one of the leading retailers. And that aisle reinvention, which disproportionately benefits our brands, gets reset in October of this year. And so we should see distribution gains start to ramp up on the writing business in Q4 as well.
Okay. Great. Speaking of Q4, so one area of focus for investors has been core sales in general and the timeline to inflection to growth. At the midpoint of the fourth quarter guidance, or implied fourth quarter guidance, I should say, it would have core sales flat. So what dictates that? What, if anything, could drive upside? And let's also talk frankly about risk to the downside in this questionable consumer environment and the notion that inflation will start to show up more now in store.
Yeah. I think there's a couple of things. One of the questions we've gotten to your point is, "Boy, if your Q3 guidance was - 2 to - 4 and the implied is relatively flat in Q4, why is there an improvement in Q4 versus Q3?" And I think there's three things that are in our, that we would say are positives as we think about Q4 versus Q3. The first one is we have stronger innovation hitting. The Yankee Candle Restage, which is our biggest innovation of the year, really comes into play in full force in Q4. And we're optimistic that that's going to drive a meaningful growth on that business that's disproportionate in Q4.
Second thing is in Q3, we did have some retailers that shifted how they buy products from us from direct import, where they take possession of the product in Asia to buying from us in the U.S. from our distribution centers. And when that happens, it causes a retailer inventory reduction because they transfer basically the 30 days of inventory on the ocean from them owning the inventory to us owning the inventory. That has about a point of negative impact in Q3 that we think is one time and is not going to repeat in Q4. And then the third thing is this tariff-advantaged selling that we've talked about is really more pronounced in Q4 than it is in Q3 just because of the timing of when it's going to present itself.
We think we've got a plot to have Q4 be significantly better than Q3 from a core sales perspective.
Okay. And then those sound like almost mechanical effects, not to be too flippant. But what about the consumer? Right? I mean.
Yeah. The consumer remains under pressure, as I said, particularly the low-income consumer and the mid-income consumer. And we know that the consumer is focused on value. And so we are focused on value. And many of our brands are not positioned as HPP brands. Many of our brands are positioned as leading brands in the MPP. And we still have some exposure to OPP, the higher end of OPP. So we think if we do our job right on consumer insights, innovation, brand communication, and particularly focusing on value, we think we can navigate this environment well and we're well positioned to do that. We cannot outrun the category to a great degree.
If I were to say, "Boy, if you're firing on all cylinders from things you can control, we should be able to ultimately grow maybe a couple points faster than the category if we're doing our job well." So if the category is -2, we should be able to do a couple points better than that. But as I said, we are laser-focused on getting back to top-line growth. I think we've proven that we can improve the structural economics from a gross margin standpoint. We've proven that we can drive cash and improve the balance sheet. We know that the next thing is for us to get to top-line growth. We think that the market is actually, the consensus is we're not going to be able to do it, by the way, I think, if you look at where we're trading.
And so that gets us excited because we think when we do it, there's a real opportunity for us to get re-rated.
Yeah. Okay. Let's just pivot to second-half margin expectations. So from a gross margin perspective, tariffs are a drag in 3Q. Can you just talk a bit about the 3Q tariff impact and help us understand why you get back to margin expansion in the fourth quarter?
No. Great question. So since we put the new strategy in place, we've had eight consecutive quarters of meaningful gross margin expansion. That will be put a little bit at risk in Q3, but as you said, it's specifically because of the tariff dynamics that have been at play. We have incurred about $155 million of gross cash impacts on a net basis that hits our P&L. That's more like $105 million, which for us is about $0.21 a share. In our last earnings call, we talked about the fact that that would hit us $0.02 in Q2, $0.11 in Q3, and then about $0.08 in Q4. Of that $0.21 impact, we have found ways to offset $0.16 of it.
And the reason we chose to offset $0.16 instead of the full $0.21 was because there's a nickel that relates to the 125% China tariff that was basically levied against us on shipments that were in transit. That's a nonrecurring item. Right? So we don't want to make any short-term decisions that would take away from the strong A&P plan. We have the second half of the year, the strong capability buildout we have on the overhead side of the house. And so we've chosen to effectively allow that nickel simply to pass through. It will not be recurring next year. And of course, that nickel is about $25 million. And that puts our gross margin trend a little bit at risk in Q3. But when we get to Q4, we fully expect our gross margin to expand once again.
Okay. Great. Let's think a little bit longer term on gross margin expansion beyond this year. Kind of what are the key drivers of continued expansion and how should we think about incremental volume as a driver versus other levers?
Yep. So we have, as I just mentioned, expanded gross margin over the last period of time such that our second quarter print had the two-year stack up 680 basis points. That's a pretty remarkable feat. On a trailing 12-month basis, that comparable number would be 630 basis points of gross margin expansion. We have principally done that by having a world-class supply chain and procurement team that have been driving meaningful savings through the fuel productivity efforts. That are all-encompassing. At any given time, we literally have thousands of projects we're tilting against, and they've been delivering best-in-class performance. Best-in-class performance is typically perceived as being around a 3% COGS takeout per annum. We've been running in the 4%-5% range. And they've done that, importantly, without the benefit of any unit volume.
As we sit here today, because we have put about $2 billion into our automated facilities since the 2017 Jobs Act, we have a network that Chris alluded to of 15 domestic plants, including two on the Mexican border that are 100% USMCA compliant, that are poised to generate really attractive marginal economic unit returns. You think about last year, our gross margin was 34% as a company. We think the next incremental unit coming off our automated facilities is roughly at 50% on a gross margin basis. And even more importantly, because our op margin last year was 8.2%, we think the pass-through rate on that next incremental unit is effectively 45% because 25% of our cost of goods sold is effectively fixed, and our overhead, which is roughly 20% of sales, is largely fixed as well.
These tariff-advantaged wins that Chris was talking about should monetize themselves in very, very short order. And as we think about on a going-forward basis, we're really just at the beginning of our journey as it relates to the PEAK. PEAK is kind of our Lean Six Sigma equivalency. And there's really six stages to that. One is foundations, two is base camp, then you have climbs one, two, and three, and then you attain the summit. For our 44 facilities, we only have one facility that's gotten to climb two. So we're really at the very beginning of our journey. Now, in addition to that, as we continue to bring innovation online, we've made a dictum that all innovation going out the door is at least 500 basis points accretive on the gross margin line, and that's going to continue to build and expand.
We're going to continue to leverage those bigger initiatives into years two and three, which should provide additional ballast. We're doing a much better job with our management reporting systems. Mix management is still a huge opportunity for us as well. We are exceedingly confident that we're going to be able to continue to transform the structural economics of the business. Our near-term goal is to get to a gross margin of 37%-38%. We think the right level of A&P spend for us is somewhere in the 6%-7% range. We expect to finish this year closer to 6%, having started at 4% not that long ago when we put the strategy in place.
And we think because of a lot of the AI enablers and other things that are coming down the pike, we can get our overheads as a percent of sales into the 17%-18% range. If we do all of those things and we're confident that we'll be able to do so, that would put our normalized op margin in the 12%-15% range. And you contrast that with 2023 when we were at 6%, 2024 we were at 8%. This year, we should finish closer to 9%. You can see the real value creation opportunity that that suggests.
Okay. Fantastic. Capital allocation. So you've pruned the brand portfolio significantly. When we ask about divestitures further, the answer is no. But we do have a number of investors that look at certain segments like Outdoor & R ec in particular, where there's been this protracted history of challenges and really do question if Newell has a right to win in those categories. So you're still at five and a half times leverage. Think proceeds could help accelerate debt paydown. So just how do you think about the right to win in outdoor and rec, and would it make sense to be open to a divestiture to bring down leverage?
Yeah. So I think a couple of things. One is we're very focused on shareholder value creation. We have looked at sort of divestitures. We don't see a path for divestitures to help from a value creation path for a variety of reasons. Number one, we have a very low tax basis today because we've done 10 big divestitures since the Jarden acquisition. Number two, we've got a highly synergized at this point go-to-market and supply chain and back office. So the dis-synergy impact is actually fairly significant. And number three, most importantly, we think these are businesses we can win in. And so on Outdoor & Rec, to your question, that's the business that we said was the furthest behind when we started the strategy.
So we've been very clear from the beginning that this was going to be the laggard, and the innovation wasn't going to start to hit until 2026. On that business, that business when we started the strategy was based in Chicago. We completely closed the Chicago office and eliminated the vast majority of the organization and moved the business to Atlanta and hired a brand new team. That brand new team is now on the field. They populated the consumer understanding, the insights, the innovation. That innovation, I'm feeling pretty excited about. We haven't announced all of it yet for competitive reasons, but it's coming next year. So I'm very confident that the Outdoor & Rec business is going to be stronger on core sales growth next year versus this year or last year.
And we've got several of those big innovations on Outdoor & R ec that are going to launch starting actually at the beginning of next year, like in January. And we've shared them with leading retailers, and we've gotten a strong positive reaction. So I think we're on the right trajectory there. And I think you're going to see us get back in the game in a strong way.
Okay. Great. I'm just going to flip it. You've increased financial so that leverage, but you've increased financial flexibility redeeming the April '26 bond. So I think some investors have looked at some of your Gen Merch peers and wonder if there are any brands that are better suited under Newell's umbrella than their current owners. So is an acquisition something you'd consider in the near- to midterm?
Yeah. I think in the near term, probably no. We've still got a little bit of work to do to finish the complexity reduction work, which, by the way, we're making incredible progress on in terms of ERP systems, legal entities, brands, all of that, and continue to delever and continue to bring the top-line front-end capabilities online. That being said, in the midterm, I do believe that acquisitions will be a part of our future at some point. Not large acquisitions, but sort of tuck-in medium acquisitions where we can add a tremendous amount of synergy to either top-line and margin. I think that that is a source of value creation for the company over time.
Okay. Very quick wrap-up question because I've got time. But just given the volatile external environment, I think a lot of people kind of lose sight easily of all the changes that have been underway at Newell and embarked upon before tariffs became the number one topic. So if you just step back and think about the longer term when hopefully the tariff dynamics have settled out, what are you most excited about for people outside of Newell to start to recognize?
I'm excited about the opportunity for value creation overall and for a lot of the progress that we've made that is less visible through the financial results, and so the complexity reduction work is remarkable, and it's coming almost to an end, which is exciting because we're now into the new model with the complexity being reduced. We've also, as an example, when we put the capability investment of projects together, one of the ones we took on was artificial intelligence. A lot of people have talked about artificial intelligence. I think we've done a better job than most at getting going on that, and we haven't just done it to take cost out, but we've done it to fundamentally improve capability.
For example, in our digital marketing area, this year in the first half of the year, our digital asset creation is up 500% versus last year for the same cost. We're literally 500% more effective because we've created a series of AI applications that are allowing us to create digital content at a much more compelling, much lower-cost basis than what we've been doing before. I could give you 25 of those examples that I think are geared toward getting the company back to top-line growth, which is sort of the last remaining piece, I think, of what we need to drive to solidify the turnaround.
Okay. Great. Please join me in thanking Newell for being with us, and we will continue in breakouts.
Thank you.