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

Good day, and thank you for standing by. Welcome to the Q3 2023 Prestige Consumer Healthcare, Inc. Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Phil Terpolilli. Sir, you may begin.

Thanks, operator, and thank you to everyone who's joined today. On the call with me are Ron Lombardi, our Chairman, President and CEO; and Christine Sacco, our CFO. On today's call, we'll review our third quarter fiscal '23 results, discuss our full year outlook and then take questions from analysts. A slide presentation that accompanies today's call can be accessed by visiting prestigeconsumerhealthcare.com, clicking on the Investors link, and then on today's webcast and presentation. Remember some of the information contained in the presentation today includes non-GAAP financial measures. Reconciliations to the nearest GAAP financial measure are included in the earnings release and our slide presentation. On today's call, management will make forward-looking statements around risks and uncertainties, which are detailed in a complete safe harbor disclosure on Page 2 of the slide presentation that accompanies the call. These are important to review and contemplate. Business environment uncertainty remains heightened due to supply chain constraints, high inflation and various geopolitical factors, which have numerous potential impacts. This means results could change at any time, and the forecasted impact of risk considerations is the best estimate based on the information available as of today's date. Further information concerning risk factors and cautionary statements are available in our most recent SEC filings and most recent company 10-K. I'll now hand it over to our CEO, Ron Lombardi. Ron?

Thanks, Phil. Let's begin on Slide 5. We are pleased with our third quarter results, which built on our first half momentum in what continues to be a dynamic supply chain and retail environment. Revenues of $276 million in Q3, grew about 2% organically versus the prior year, thanks to our diverse portfolio of trusted brands. Q3 revenues were driven by a continued rebound in cough/cold, which I'll discuss in greater detail on the next page, the GI segment's Dramamine brand, as well as a strong International segment performance. Solid revenue continues to translate into strong profitability, generating $1.04 in diluted EPS and over $50 million in free cash flow in Q3, even with almost $20 million in inventory investment in the quarter to support service levels and future growth. Our consistent cash flow profile continues to enable our disciplined capital deployment strategy. These efforts resulted in a Q3 leverage ratio of 3.5x, our lowest level of leverage in over a decade. We continue to anticipate gradually lower levels of leverage over time, which further enables future capital allocation optionality. Now let's turn to Page 6 and discuss the Cough & Cold category, which is experiencing extraordinary demand this fiscal year. Our Cough & Cold portfolio is comprised largely of 2 iconic brands, Chloraseptic and Luden's, each with their own distinct heritage for sore throat treatment. Chloraseptic has a heritage in efficacious sore throat sprays and lozenges that began in the '50s. Luden's goes back even further with the brand created in the late 1800s. Today, consumers continue to associate the product with its iconic great-tasting cherry-flavored throat drop. This long-standing history with consumers has allowed us to benefit from the extraordinary demand that's driven the category this fiscal year. Year-to-date, the category has grown well beyond our start-of-the-year expectations due to illnesses throughout the year, consumers being more proactive around health treatments, and a low level of inventory at stores due to the supply chain environment. The combination of these factors has enabled strong growth for both Luden's and Chloraseptic beyond what we typically expect. As shown on the right of the page, each brand has grown over 20% year-to-date with the potential for additional growth hindered by supply chain limitations that have cast upside for us and others in the category. We have a clear opportunity to sell additional volume, and we've taken strategic actions like adding new suppliers to keep up with this demand and refill retailers' depleted stocks. Looking forward, although the category is small as a percent of total company sales, we anticipate its strong demand to continue through the balance of the year and these strategic actions helping to position these brands for long-term growth. With that, I'll pass it to Chris to walk through the financials.

Thanks, Ron, and good morning, everyone. Let's turn to Slide 8 and review our third quarter fiscal '23 financial results. As a reminder, the information in today's presentation includes certain non-GAAP information that is reconciled to the closest GAAP measure in our earnings release. Q3 revenue of $275.5 million increased 40 basis points versus the prior year, and increased 1.8% excluding the effects of foreign currency. North America revenues were down approximately 1% versus prior year, excluding currency, with sharp increases in the cough and cold and gastrointestinal categories, offset by declines in the Women’s Health and Eye & Ear Care categories. Our International segment revenues of $38.6 million were up over 25% in Q3 excluding FX. The performance included broad-based strength across regions and product categories. EBITDA and EPS were up 4% and 5% in Q3, respectively, from the prior year with inflationary pressures and higher interest costs more than offset by higher revenues and lower marketing spend. Let's turn to Slide 9 for more detail around year-to-date consolidated results. For the first 9 months, fiscal '23 revenues increased 2% versus the prior year on an organic basis. The performance drivers were largely similar to what we experienced in Q3, with the largest benefits coming from our International segment performance, strength of Dramamine and robust Cough & Cold category growth. We also continued to experience solid year-over-year growth in the e-commerce channel, continuing the long-term trend of higher online purchasing. Total company gross margin of 56% in the first 9 months, declined 170 basis points versus last year's adjusted gross margin of 57.7%. The gross margin change was anticipated and attributable to cost increases, partially offset by pricing actions across our portfolio, which offset the dollar amount of inflationary cost headwinds. For Q4, we anticipate a gross margin of approximately 54.5%. Advertising and marketing came in at 13.6% for the first 9 months, down versus 14.7% in the prior year as a percentage of revenue. As a reminder, we anticipate spend for the year of about 13% of revenue, owing primarily to the timing of initiatives and reduced spending around certain categories due to strong consumer demand. G&A expenses were 9.5% of revenue for the first 9 months. We still anticipate full year G&A dollars to approximate prior year at around 9% of revenue. Finally, diluted EPS of $3.14 compared to $3.15 in the prior year, as higher revenues were more than offset by the gross margin compression just discussed. Our year-to-date tax rate of 23% was slightly favorable to prior periods due to the timing of certain discrete tax items. We still anticipate a Q4 and long-term normalized tax rate of approximately 24%. Now let's turn to Slide 10 and discuss cash flow. In the first 9 months, we generated $165.5 million in free cash flow, down versus the prior year. Although, quarterly variations can be affected by the timing of working capital, beyond this, we have strategically invested behind inventory in light of the current supply chain environment, finding opportunities where we can increase inventory to better support targeted service levels. This is the primary driver to our updated free cash flow guidance for the year of $220 million. Our stable EBITDA margins enable consistent and strong free cash flow generation. And as a result, we have the ability to invest behind our brands to support increased levels of customer service through working capital investments, without derailing deleveraging efforts and targets. We anticipate Q4 free cash flow of about $55 million and year-end leverage below 3.5x, reflecting our disciplined capital deployment strategy that includes debt pay down. Looking beyond this inventory step-up and related cash flow timing, we anticipate a more normalized free cash flow profile in fiscal '24, and we'll provide a full outlook in May. At December 31, our net debt was approximately $1.4 billion, and we maintained a covenant-defined leverage ratio of 3.5x. We now anticipate interest expense of $69 million for the year, owing to the timing of debt pay down. With that, I'll turn it back to Ron.

Thanks, Chris. Let's turn to Slide 12 to wrap up. With just 1 quarter to go in the year, we are refining our outlook. Our proven business strategy and leading consumer health care portfolio are enabling us to grow within our original outlook range for the year even in the current supply chain and inflationary environment we and others are facing. For fiscal '23, we anticipate revenue growth of approximately 3% on both a reported and organic basis, consistent with our long-term target. Q4 revenues are anticipated to be approximately $278 million to $280 million, translating into growth of mid-single digits versus the prior year. We anticipate EPS of $4.18 for fiscal '23, which implies Q4 EPS of $1.04. Our disciplined pricing actions and cost management are helping to offset inflationary headwinds, while the benefits of our strong free cash flow continues to help offset the impact of higher interest rates. Lastly, we now anticipate free cash flow of $220 million or more, reflecting the strategic increases in inventory investments that Chris just discussed. So in summary, our business strategy is working. With 1 quarter to go, we anticipate solid fiscal '23 growth with record revenue and earnings that builds on our strong fiscal '22, despite a dynamic market backdrop. We also expect this momentum to result in continued growth in fiscal '24, which we'll provide a full outlook on in May. We remain confident in our business attributes and that our strategy is set up to reward our stakeholders over the long-term. With that, I'll open it up for questions. Operator?

[Operator Instructions] And our first question will come from Susan Anderson of Canaccord Genuity.

Nice job on the quarter. I was wondering if you -- just a follow-up on the supply chain. Obviously, there were some really strong sell-throughs in Cough & Cold. I'm curious, are you guys seeing still supply-demand imbalances in the store? Do you guys feel like, I guess, maybe if you could talk about by category too that the in-stocks are getting better and the out-of-stocks fewer as we kind of look forward through the rest of the year?

Sure. Thanks, Susan. So the supply chain, we've been talking about that topic, I think, on just about every one of these calls for a good year now. I think the positive thing is we've been able to keep up with record demand for our business through last year and through this year so far. But we are seeing certain categories that are challenged to keep up with demand, and cough/cold is a clear example of that situation for us and, quite frankly, for many other players in the cough/cold category. And you can see that shelf when you go to retail. I think we mentioned in the prepared remarks that we brought on some additional liquid -- the liquid supplier to help with capacity there going forward, but it's clearly a category where we see limitations. The other thing I'll call out during the third quarter was our eye care category was another example where despite good continuity of supply so far through the year, the third quarter actually saw a slowdown and impacted our shipments there, and something we're expecting into the fourth quarter. So I think the important note here on the supply chain is that we continue to operate in a challenged environment. We've been trying to add to inventory for a good year now. We made some progress in Q4 really as a way to add buffer to the categories that are doing well and get ourselves in a good position to support continued growth next year and improve our service levels.

Great. That's really helpful. And then maybe if I could just add one more on International business. So another strong quarter there. Maybe if you could just talk about kind of the trends you're seeing there and particularly Hydralyte, and how you're seeing that to play out the rest of the year?

Susan, this is Chris. So you're right. International had another really strong performance coming off of a record year last year, right? And so helped a little bit with illnesses. But we saw a strong performance across all regions, not just Australia in the third quarter. So we feel good about Hydralyte. It went up to about 10% household penetration on Hydralyte, which is a few points over the last couple of years, which is quite good. But obviously, at 10% household penetration, still plenty of room to go. So we continue to feel good about the growth prospects internationally. And we target, remember, a long-term growth rate of about 5% internationally, and we feel pretty confident about that going forward.

[Operator Instructions] And our next question will come from Rupesh Parikh of Oppenheimer & Co.

So I just want to go back to the full year guidance. If you can just give more color in terms of the sales reduction to now the lower end of the range in terms of what drove that? And then also for EPS, it looked like higher interest expense may have had an impact on the EPS ratio?

Yes. Rupesh, so the guide -- reported guide going from 4% growth to 3% growth is really FX-driven. We've seen some currency headwinds, as a reminder for us that in particular, the Australian and Canadian dollar. There's been a lot of movement, particularly in the third quarter in the Australian dollar in particular. So from an EPS perspective, as we just talked about, right, we narrowed our original sales guide to the lower end of the range. There is some currency headwinds sitting in the P&L. It's an other expense related to the currency headwinds, I just discussed. And then interest got called up just about $1 million for Q4 just given the timing of some of the rate hikes and the pay down. So those are the main drivers of the EPS calling down to the lower end of the range, but still within the targeted range.

Okay. Great. And then just in terms of the categories that you guys called out as weaker, Women's Health and Eye & Ear Care, when do you expect those categories to improve? Is that something in Q4 or next year? Maybe just some thoughts there.

So let's talk about those both individually, starting with eye care, eye and ear. We actually continue to have great momentum in that category. Consumption is good. Sales are good, as I mentioned, in response to Susan's question. The issue in the third quarter for us is really all about supply chain impact, and we expect a bit of that into the fourth quarter as well. And then on Women's Health, we've actually seen a decline in the total category. Again, we continue to see consumer changes, as a result of COVID and everything else that's been going on, in particular, women going back to the doctor's office, impacting the yeast infection category and continued impact on the -- on-the-go portion of the Summer's Eve business. So again, it's easy to forget, but we're really in year 3 of 3 years of disrupted factors on the business. And in some cases, it's comps versus a funny number, last year, in some cases, it's the continuation of a change in consumer habits, or continuing to chase supply to keep up with demand.

Great. And then maybe one -- just one last question. So I know you're not ready to provide FY '24 guidance. But I was just curious, is there any puts and takes you can share at this point? And I am curious just on A&M. I know this year went down to 13% of sales, if you expect that to be a larger percent of sales next year?

Yes. So let me start, I guess, with a comment on overall momentum of the business. I think I said in the prepared remarks today, we continue to feel good about the positioning of the business, the consumption trends behind many of our brands. And we feel that we're positioned for continued growth in fiscal '24 after 2 record year's top and bottom line in a row, and I'll let Chris comment on A&M for next year.

Sure. So obviously, more details to come in May, Rupesh, but we always talk about our A&M plans being built up from the bottom with our marketing teams, right? We talked about additional A&M support being pulled a little bit this year, really related to categories where we have strong demand regardless of our investment. And I would couple that with our ability to provide supply in this environment that we're talking about. So more to come next year. A&M spend is always driven by the timing of initiatives and new product launches, and a whole bunch of variables, but we'll give you more details in a few months here.

[Operator Instructions] And our next question will come from Jon Andersen of William Blair.

I guess on the inventory step-up, the strategic investment in inventory, is that really kind of a short-term remedy for some of the supply chain disruptions or constraints, I should say, that you're experiencing juxtaposed against the strong demand for things like cough/cold? Or is there also a longer-term element to it in terms of retailers looking for higher order fill rates, or tighter delivery windows? I'm just trying to understand the -- kind of the reasoning behind it.

Yes. The first driver is to better align ourselves to meet our retail customers' service requirements. So part of it is that. It's really short term in nature, Jon. As I said earlier, we've been looking to try to build inventory to give us a better buffer for the next hiccup in the supply chain. And supply chains out there in general continue to be impacted by COVID impacting workforces, not only at their own facilities, but at their -- at our suppliers' suppliers, whether it's cardboard or in API or whatever it is. All it takes is one missing thing in the supply chain to disrupt finished goods, whether it's a label, a pallet or an API. So we've been focused on trying to give ourselves a better buffer for the next shoe to drop that we don't know about. As we get into fiscal '24, and we begin to learn more about how things are stabilizing, we'll adjust inventory back down over time. But right now, it's all about getting that buffer in and being better positioned not only to meet service requirements, but to take advantage of those growth opportunities. And as I mentioned with the cough/cold, we brought on a second Chloraseptic, Luden's supplier. Actually got the first shipments, I think, the last week or 2 of December. So we're chasing things out there, Jon.

Okay. That's helpful. Gross margin stepped down a little bit sequentially again in the quarter. And I think, Chris, you mentioned, the gross margin you expect for the fourth quarter is kind of similar to what you just experienced in the third quarter. And I understand the math driving this, I think, is the cost increases juxtaposed again against the price increases. But have -- do you think we've kind of leveled off at this point or -- in terms of the gross margin performance? And is there a potential for some recovery as you look to 2024 and 2025? I'm not sure, what would drive that recovery per se. But any thoughts around that would be helpful.

Yes, Jon, I would just say, gross margin is largely coming in, in line with our expectations, right? And you're right, Q4 being consistent with what we saw here in Q3. I think of -- so if I start with about a 56% gross margin as the base, right, we'll continue to look for opportunities to take pricing actions. That can also come in the form of new product development, as it has historically and -- which is a big focus for our company, as you know, in addition to continued multiyear cost-saving projects that we have going on. So we've talked about in this environment going forward, you're looking at things a little bit differently than we've been operating for the last few years in that cost savings will come in many different forms going forward. And it's -- certainly, we've talked about not having a structural issue with our gross margin. So we'll be looking to increase our gross margin over time and reinvest those dollars into A&M to maintain our EBITDA margin, as we always say.

Great. One follow-up. I think, Ron, at the start of this year, I think you talked about the possibility of perhaps shipping a bit ahead of consumption in fiscal '23, as there was still a need to establish better in-stock levels maybe across certain categories coming out of the pandemic. It kind of feels like you might be in that same situation right now, as you kind of look to 2024. Is 2024 a year where net-net, you think it's possible that you might -- there might be a little bit of a benefit from restocking, given where you sit today?

Yes. As we started '23, we were focused on trying to recover and improve some of the out-of-stocks and service levels. And we didn't make the progress that we would have liked to, hence, the focus on continuing to build that inventory buffer. As we head into '24, we think that will likely be the case again where there's more opportunity for inventory recoveries or builds at retail than it going the other way.

Congrats on the quarter.

Sure. Thanks, Jon.

[Operator Instructions] And it looks like our next question will come from Mitchell Pinheiro of Sturdivant & Co.

Just a couple of questions here. Did the out-of-stocks affect you in any of your categories?

Yes, right? Cough/cold and in certain SKUs in the ear and eye category are the big costs for us as well as Gaviscon up in Canada as well.

Okay. And then was it -- I mean, in terms of having an impact on your revenue, was it significant? Was it just a couple of percent or any way to put a number on that?