Prestige Consumer Healthcare Inc. (PBH) Earnings Call Transcript & Summary

Good morning, everyone. I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. I'm very pleased to welcome Prestige Consumer Healthcare to Morgan Stanley's Global Consumer and Retail Conference. Before we begin, disclosures are listed on Morgan Stanley's research website at www.morganstanley.com/researchdisclosures, and you can reach out to your Morgan Stanley sales representative if you have questions. We're pleased to welcome Ron Lombardi, Prestige's CEO; and Christine Sacco, Prestige's CFO; as well as Phil Terpolilli, Investor Relations. Thanks so much for being here, guys.

Thank you for having us.

So the format today will be Q&A for myself, and we'll just get right into it. So first, maybe we can start with the 2% to 3% long-term revenue growth target. Can you discuss the key drivers behind that growth as you look out going forward? Maybe the key buckets in order of magnitude, the sustainability of those drivers. And your level of visibility in top line growth as you look going forward now that we've cycled COVID.

Sure. Thanks, Dara. Thanks for having us, and good morning to everybody, and thanks for joining us today. So our long-term organic growth outlook is 2% to 3%. As you kind of mentioned at the end of your question there, we've been through some really interesting periods here in the last 1.5 years where last year, our business held up very well during the first year of the COVID impact. And then this year, we've seen significant growth year-over-year as people have rushed back to travel and back to some of their pre-COVID kind of activities. But long term, it's 2% to 3%. And the way that we think about growing our business long term, always starts with getting consumer insights and talking to the consumer. And understanding what they're looking for: innovation, new products, bringing new technology to the marketplace to grow the categories that we compete in is an important part of that formula for us. And if -- I'll use Dramamine as an example. We've owned that brand for about 10 or 11 years now. And we've meaningfully grown that business by expanding products that are offered. So when we first acquired the brand, there was no kids product out there. We introduced a chewable great flavor, so it was easier to give to kids and get them to take. We introduced Non-Drowsy. And more recently, we've expanded into the nausea category. So we've had significant growth with that brand by not only expanding the products but reminding the consumer what they're trying to treat for and providing them the best product to do so.

Great. That's helpful. And how does the pandemic influence your thinking about your long-term objectives, maybe talk about the various pieces of the business that have been impacted. And any changes in consumer trends you think are longer lasting coming out of this, that will have a significant impact on your business?

Yes. What we've realized during this COVID-impacted period really has reinforced what we've thought all along, which is consumers are very much focused on taking care of their health, really no matter what the backdrop is, whether there's economic disruption, whether the economy is booming, whether people have rushed home and are hiding because they're afraid to get COVID or get exposed. So this period really has reinforced what we thought all along about how consumers think about taking care of themselves. During this last 1.5 years to 2 years, we've seen some interesting changes in consumer habits. Early on, we saw a very dramatic increase in our online sales. During the first quarter of COVID, our online sales went from 4% to 5% of our total revenue to north of 10% in 1 single quarter. We had been investing in preparing for continued high levels of growth in online sales, but we didn't expect that it would double in 1 quarter, but we were ready, and able to support sales into that channel when it happened, is one thing. The next thing is that as consumers have thought more about treating at home and self-care, they've reached to the trusted brands that have differentiated products. So women have maybe skipped going to the OB/GYN office and have looked to Monistat to treat at home because it's a trusted brand. Debrox, which is a brand we don't really talk much about for earwax. Again, consumers have maybe stayed away from visiting the doctor to get their ears cleaned out or maybe wearing earbuds more and being on more video conferences has caused them to develop more earwax, which needs to get treated. But Again, they've turned to that leading Debrox brand that is efficacious in treating your wax buildup. So we've just seen that playbook repeat itself time and time again over the last couple of years is that consumers even more are reaching for those trusted brands, those trusted differentiated products, whether they're going to Amazon, or whether they're back in the drug channel as they wait to get their COVID test or their COVID shot or their COVID booster. So again, our products are broadly distributed, so they're available where the consumer chooses to purchase them. So lots of different nuances. It seems like every couple of months, something new pops up. It's Omicron variant these days that has everybody spooked. So we'll see where that goes in terms of impacting consumer behavior. But what we've seen over the last couple of years is that our business, and business model, and the attributes has us well positioned to do well no matter what seems to happen here.

Right. Okay. That's helpful. And traditionally, you've highlighted a few key areas in terms of driving demand, brand building, innovation, the broad retail distribution you have and being able to move certain products, marketing. Maybe can you just give us a bit of detail on the strategy in each of these areas, a bit of update on sort of where we stand as you look at these core long-term growth drivers and how that ties into your long-term growth trajectory?

Sure. I think the most important attribute of our business and our organization has been our nimbleness over the last couple of years. So yes, we focus on marketing and brand building and all that, that entails balancing between digital and traditional [indiscernible]. But the single most important thing over the last couple of years has been our ability to understand what's going on in the market and quickly change so that our communication and connections with the consumers fits what's going on. I just previously mentioned how consumers have looked to treat at home or self-treat. Early on in this, we pivoted our messaging around Monistat and Summer's Eve and Clear Eyes as 3 examples to better emphasize the products, and connect with consumers as they thought about treating at home. Or in the case of Clear Eyes, having lighter and brighter eyes as they sit on their computer screen across from their coworkers or others. So it really first starts with being nimble and not having some cast-in-stone playbook that we roll out to every one of our brands. So each brand has been nimble to figure out what's the best way to market and brand build. Not only during this highly dynamic environment, but previously during a more static environment or into the future as things continue to change and hopefully, at a slower pace.

Right. Okay. And then maybe short term, can you talk a little bit about how a more normalized flu season this year -- I'm struggling with the cold right now. There's a bunch of sickness that's going through town that aren't COVID, which is good news. But some other sicknesses seem to be coming back this year. So how does that impact your business either directly or just indirectly through store traffic? And how do you think about that short term?

Yes. So directly, about 8% or so of our revenue is tied directly to cough/cold, flu, sore throat kind of activity with Chloraseptic, Luden's, Sucrets. And then indirectly a little bit with our BC, Goody's, which are pain relievers, so maybe you have a headache or a fever related to a cold, you might reach out on the margin for BC or Goody's. So it doesn't really move the needle meaningfully for us. If we have a slow season, it doesn't impact us negatively too much. If it's a booming season, it's not going to move the needle. This year is a little bit odd in that consumers had built up some inventory of product at home. There was slow sell-through. So the retailers had different levels of inventory last year. So this year is kind of an oddity where we have to see, first of all, what level of cough/cold incident level there is. How much consumers have to actually go to the store to buy product because they ran out of it. And then what level the retailers have for inventory before they actually trigger a rebuy. So there's a lot of dynamics this year before a high cough/cold incident level might actually trigger our sales into the retail channel. But at the end of the day, it's really a relatively small part of our portfolio.

Okay. And then maybe we can switch to the margin side, and Christine, maybe you want to jump in here. First of all, on the A&M side, maybe you could talk a little bit about how your marketing strategy has evolved over the years, and particularly the digital strategy. And the 15% A&M level as a percent of sales separately. Is that a normalized base to work off of for future years as we think about the level for this year? Should it move up over time? Might you be able to leverage it as a percent of sales with sales growth? How do you think about A&M from here as a percent of sales? And then maybe more broadly, strategically, talk about how the strategy has changed in marketing in the last few years and how digital plays into that.

Sure. Maybe I'll start, Ron, you can chime in as well. So 15% you mentioned as our A&M spend as a percent of sales is pretty normalized for us, 14% to 16%, I'd say we usually fluctuate around. And that's really, as Ron said, we're a very nimble company in our marketing strategies and plans. And that -- those plans build up from the ground up for each brand. So the way we market. We'd like to use the example of Efferdent, right, where we may send out coupons because those consumers are still clipping coupons, so to speak, is very different than how we would market a Dramamine, right? Where you may be online booking your travel and a Dramamine ad will pop up. So our marketers have autonomy with their brands to think about more -- what's the best platform that works for them. And so over time, I'd say 14% to 6% feels like our range. We've had some periods where 1 brand is getting a little more attention than another. And so I think our nimbleness really helps us in terms of our ability to go to the consumer in different ways. And it's helped showing through the pandemic, right, whether it was the pandemic beginning where the consumer was staying at home and we run a lot more digital or it's as folks -- as Ron mentioned, by returning to the drug channel, to get vaccinated.

Okay. And then maybe, Ron, do you want to touch on how marketing has evolved in the last couple of years here, and how digital plays into that, your strategy there?

Yes. Over the long term, really, digital has grown and expanded in terms of the role it plays in the marketing playbook here that we have. And clearly, it's an important part. Each brand has their own mix, if you will. But clearly, digital has ended up being a major component of our -- of all of our biggest brands. And I would expect it to continue to evolve over time in terms of -- we talk about digital, but the way that you connect with consumers digitally or online has evolved over time as well. At one time, it might have been through Facebook, for example. And we're evolving more now to working with Amazon as a way to connect as consumers go out there and look for information, whether it's product reviews or details on it over time, or any of the dot-com arms of our retail partners. And I would expect that will continue to evolve over time.

Great. And inflation hasn't been too burdensome for you guys, given your business model, relative to other CPG companies that are experiencing some really outsized pressures. You've talked about $10 million to $15 million of pressure in this full year. Can you discuss what the potential risk factors would be in terms of cost from here? And also your ability to take price to manage through this cost inflation? And then on the $10 million of pricing you've outlined, maybe you could talk a little bit about what percent of the portfolio that represents, what the magnitude is there and the potential areas for additional pricing. So cost risk from here, pricing offset and then give us a little bit of detail on what's actually happened from a pricing standpoint so far in your portfolio?

Sure. First, let me start by addressing the pricing, the selling price side of it, and then I'll let Chris pick up the inflationary side of things. But first of all, we're seeing many of the same inflationary headwinds that you hear many other CPG companies talk about. But as you mentioned, we're getting hit with a 5-ounce hammer, and many other CPG folks out there are getting hit with 5-pound hammers over the head here. So as you said, we're dealing with a $15-ish million, $20 million, $10 million headwind. You hear other companies talk about $200 million headwind. So I wake up every day feeling fairly lucky that the hill that we're climbing up here isn't as big as many others. So again, that's a function of our business model, largely sourcing from North America, meaningful gross margins need to have a smaller input cost pool to be impacted over time. So again, our business model has lots of benefits, and this clearly is one of them. One of the other benefits from our business model is with our focus on leading brands, #1 brands that, in many cases, have share or more. In some cases, like in BC, Goody's, it's 100% of that powdered analgesic market. It's not that it's easy, but we're better positioned to push through price increases as we get inflationary impact on them. So rather than competing in a crowded market where the retailer can position you against others, say if there's 2 or 3 players that each have third share. It's a very different pricing environment. You have a very different discussion than when you sit down with a buyer and you're 50% to 60% share, and you talk about the inflationary impact and the selling price increases that need to happen. And this is nothing new. We've talked about this attribute for a long time. So it's a bit easier, I think, to manage price increases with our portfolio than maybe in other categories. So Chris, do you want to comment on inflation?

Sure. So for us, macro trends, right? We're talking about transportation, labor and some raw material inflationary pressures. And we took some actions just a couple of years ago to change our logistics provider and location, which really positioned us well just ahead of the pandemic just from -- whether it's transportation, where more lanes are available at the newer location. We automated a great deal of what's going on in that facility, which has helped us a lot as the labor market got tight. So I think we've taken some good actions. As Ron mentioned, about 85% of our portfolio is sourced from North America. That also has helped to insulate us a bit. And just a reminder that as we think about revenues and we talk about our diverse portfolio, that helps us on the cost component side as well. So I think we're managing it well. As Ron said, the pricing power that we believe we have should help to largely offset most of it. And over time, no reason press we wouldn't be able to protect our margin structure.

Okay. And is there a percent of the portfolio you've taken price increases? Can you give us a sense of magnitude? It doesn't sound like inflation is -- that owner is a factor from a P&L perspective based on what you've outlined. So I assume it's a pretty selective strategy. So maybe talk a little bit strategically about the pricing strategy.

Sure. So the $10 million that we discussed on our Q2 earnings call is about 1/3 of the portfolio as we think about where we've taken price. And I mentioned on the call that we were looking at additional pricing actions as we move forward. So again, if there's cost components and inflationary pressures, we're certainly looking into taking additional price.

Okay. Great. So can you discuss also your ability to sustain sales growth in e-commerce here, post-COVID? It's now close to 10% of sales. So -- obviously, we've seen outsized growth in recent periods. How sustainable is growth as you look going forward? Can you talk about your market share also in e-commerce relative to brick-and-mortar and how that may be evolving over time in terms of the share trends in each of those areas?

Sure. In terms of sustainability or the level of growth, online growth, into the future. Ultimately, that will be determined by consumer habits. If consumers stay online, we'll continue to see growth. It'll evolve back closer to probably our total company, long-term growth over the long term. But for now, we continue to see nice growth even off of large gains last year. So it's to be determined based on how consumers shopping habits evolve over time. And then again, I'll go -- we really don't care where the consumer buys our products. We have it widely available. Our gross margins are consistent across channel. We just want our product to be available wherever the consumer may choose to buy it. So that's the first part of it. The second part of it, you asked about our share online. We've seen shares online that are ahead of the shares in general that we have in brick-and-mortar. And part of that is due to really the retailer strategy, right? There's a number of retailers out there who have strategies that may limit the branded offerings that they have in categories. Whether it's the dollar channel or certain retailers within drug, they have their own strategies based on their own objectives. So it ultimately limits brand offering at shelf. When you get to the dot-com of it, there's a bit more of an unlimited shelf, and there's more widely available product. So it's easier for the consumer to find that trusted brand that they're looking for rather than being forced to buy something else because of the immediacy when they're in their retail stores. So we think long term, the consumer finding that trusted brand online will continue to reinforce sales back on brick-and-mortar. So they went to the dot-com, found that trusted brand, if they choose to buy it in store in the future, they're not going to settle because they've been reminded how easy it is to get that trusted brand that they're looking for. So long-term, I think we'll see a lot of the share gains stick that we've had as consumers have rushed to the dot-com.

Right. And can you talk about the relative share gains in the e-commerce channel versus brick-and-mortar? Obviously, the channels versus themselves, how that's changed sequentially over time? Are you seeing share momentum in both sides of the business and any differentiation as you look at the recent share trends and the movement sequentially that we've seen?

Yes. There really isn't any big differences between the growth in share gains in brick-and-mortar versus online, for the most part, right? Again, the last 18 months have been really odd dynamic environment here. But for the most part, where we have invested behind brands from marketing, and have launched differentiated innovative product, we've seen share gains. And I'll use Compound W as a great example. Our share in that work treatment category has grown significantly over the last 5 years as we have launched a steady number of premium products, both in brick-and-mortar and online. And as a result of that, we've seen meaningful share both in brick-and-mortar and online.

Right. Okay. Great. And then can you discuss your capital allocation priorities here? How big a focus is M&A post recent deals? And maybe give us a lens of the strategic and financial criteria that you use in M&A and how you think about your strategy there?

Sure. No, why don't we let Phil address this topic? He is the lead on many of the M&A evaluations. And as VP of IR and Treasury, he's certainly in the thick of things in terms of capital allocation.

Thanks, Ron. So Dara, we think about capital allocation really with a disciplined and strategic approach. So we're not doing M&A deals for just financial leverage. It really has to be strategic over time. When we think about our priorities, today, we sit at 4.1x leverage. We anticipate over time, we'll likely to operate at lower degrees of leverage kind of drifting down. But certainly, we'll be opportunistic around. And so debt reduction is kind of first alongside investing in the organic business. And then from there, it's that opportunistic approach around M&A as well as share repurchases over time. So if you look back the last few years, we bought back over $100 million in stock at we think very attractive rates. And we've coupled that alongside M&A deals. So the most recent one and you likely asked about is the TheraTears, Akorn acquisition that we did back in July. So we think about kind of a balanced and disciplined approach. Just in terms of M&A overall, I guess as we sit here and think about kind of the trades for us, we're not just kind of sitting in a quarter off of saying, hey, we'd love to get into baby care. How do we get bigger in that space? We really start with kind of the attributes of the individual portfolio or the brand. Or digging into what the subcategories look like. What's the competitive set. Is there insulation from private label or other competitors? What's the long-term brand building opportunity, and the list kind of goes on and on. From there, the funnel really goes to operational fit. So for us, as Ron and Chris touched on earlier, we're largely an asset-light model, tend to be concentrated in North America. Is it overlapping with kind of our existing customers, et cetera? And then kind of last and not least is we really get to the financial profile once we've sort of checked all of those boxes. So our overriding factor is focusing on return on invested capital. We're looking for that in access of our WACC. And we've paid between, call it, 8 to 12x EBITDA historically for most of the deals we've done. And we think there'll be sort of a consistent pipeline that can check off of these 3 buckets that I just thought through. In terms of deal size, one of the things I think is unique about our company is that we're sort of in this kind of goldilocks zone, call it, where we're large enough to have weight and be able to be competitive on larger transactions. So about 4 years ago, we paid over $800 million for the Summer's Eve and Fleet business. But we can also buy smaller brands and have them be quite additive to our portfolio. A great example here is Dramamine that we touched on at the start of a conversation, where we bought this business from Johnson & Johnson many years ago, and we've more than doubled it in the 7-plus years that we've owned it now. And it was, I think, $15 million in sales at the time. So if we focus on that brand-building criteria and staying disciplined around M&A, we think it can pay dividends over the long term and sort of this balanced approach across all these...

Right. Okay. And can you discuss how the TheraTears acquisition is going so far? How incremental has it proven to your portfolio? Is there some cannibalization of other areas as it grows? And how has it impacted your relationship with retail?

Yes. So still relatively early days here. It hasn't even been 6 months since we closed. I guess it's just about 5 months. We closed back around the beginning of July. 5 months into it, we continue to feel as optimistic about the opportunity as we did during the diligence, which is a great fit with our eye care platform alongside Clear Eyes. Clear Eyes is redness and allergy-focused, and TheraTears has a great positioning in dry eye treatment, and that's where its heritage is. And we think that the 2 brands can work together great side-by-side as we connect with consumers who have multiple eye care conditions that they treat at. It's just not redness or allergy alone. Those sufferers often suffer from dry eyes as well. And then clearly, when we sit down with the retailer and talk about a broader product offering in their eye care section and helping to work with them to better manage what can be a confusing category, that will pay dividends over the long term. And again, not to mention or miss the fact that we've got lots of consumer insight in this space. Clear Eyes is one of the original brands that's been part of the company's portfolio since the very beginning. So long history of understanding what the consumer is looking for in this category. And again, operationally, fits in with the business model and a great financial profile that's consistent with the overall company.

Great. And then maybe I'll slip in one last question here. Can you spend some time talking about your longer-term expansion opportunity internationally? Obviously, the vast majority of your business is coming from North America. But as you think about international expansion over the next few years, is it a focus point? What product categories or maybe geographies might offer the most opportunity? And where does that sort of fit into your strategic framework in terms of prioritization?

Sure. our thoughts on international growth really first start with growing the businesses that we have. We have a nice scale business in Australia. That's anchored around the Care Pharma business we acquired back in 2012, I believe it was. Then we added Hydralyte to it. And then as we've done other acquisitions like the Fleet acquisition, it's grown by adding the businesses that were in that region as a result of the acquisitions. Same thing in the U.K., we started with a nice business but very small, and it's been growing as we added DenTek. They had a presence over there. So it starts by growing that business, which I think has grown 5% plus over the last 5, 6 years kind of thing. And then we've got great management teams in those 2 locations, and we'd love to bolt on additional small brands that fit in with our M&A criteria. So well positioned for long-term growth. Fits with our operating model and then gives us good return on the investment. So not likely that we would write a big check to chase big growth in those regions. But focused on growing the businesses we have and adding on when opportunities present themselves.

Great. Well, I think we'll wrap things up there. I want to thank you guys for joining us. It's was a very informative discussion and great to catch up with you. And thanks again for being here.

Thank you, Dara. And again, thanks to everyone for joining us this morning.