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

Good day, and thank you for standing by. Welcome to the Prestige Consumer Healthcare Acquisition of Breathe Right 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 first speaker today, Phil Terpolilli. Please go ahead.

Thanks, operator, and thank you to everyone who has joined today. On the call with me are Ron Lombardi, our Chairman, President and CEO; and Christine Sacco, our CFO and COO. We're excited to announce the acquisition of a portfolio of brands headlined by Breathe Right this morning. It's an opportunity that fits squarely into our strategic M&A criteria. Ron will review the strategic rationale. Chris will review the financial impact, and then we'll open up the call for some Q&A. A slide presentation accompanies today's call can be accessed by visiting prestigeconsumerhealthcare.com, clicking on the Investors link and then on today's webcast and presentation. On today's call, management will make forward-looking statements around risks and uncertainties. They are detailed in a complete safe harbor disclosure on Page 2 of the slide presentation that accompanies the call. Additional information concerning risk factors and cautionary statements are available in our most recent SEC filings and our most recent company 10-Q and 10-K. I'll now hand it over to our CEO, Ron Lombardi. Ron?

Thanks, Phil, and good morning, everyone. As detailed in our press release, we have entered into a definitive agreement to acquire a portfolio of brands from Foundation Consumer Healthcare. This acquisition represents a compelling strategic opportunity that aligns squarely with our disciplined M&A framework and fits well with our long-term growth objectives. First, the portfolio is headlined by Breathe Right, which defines its category within the attractive better breathing space. It is a scale brand with over $125 million in revenue that we believe is set up for long-term success by growing its category and further expanding its international presence over time. Second, the business is well aligned with ours. It uses outsourced manufacturing and has largely overlapping customers, which will allow us to focus on driving sales growth from day 1. Finally, the business operates with a strong financial profile that is accretive to Prestige, and we anticipate strong returns on invested capital early on. This profile will also support our proven history of rapid deleveraging. Chris will discuss the transaction details later, but let's first review the portfolio beginning on Slide 7. Approximately 2/3 of revenues are generated from Breathe Right, a brand synonymous with better breathing. As the market leader, we see a clear path for long-term growth, and I'll outline the brand's proposition on the next couple of pages. The second largest brand in the portfolio at about 10% of sales is Dimetapp. With a 50-plus year heritage with consumers, it is a trusted children's cold relief brand in a category we are very familiar with. The third is Anbesol, an oral pain relief brand that also has long-standing heritage with consumers. The remainder of the portfolio contains a number of well-established brands. Similar to our loyalty portfolio, we'll manage the brands over time to generate cash flow and earnings that can be used to reinvest in our strategic brand portfolio. Finally, in totality, the portfolio is also highly attractive financially. It generated approximately $200 million in annual revenue last year, which translates into strong profitability, including an estimated gross margin of approximately 70% and EBITDA margins above our company average. In addition, the business operates with a low CapEx model, so we anticipate strong free cash flow conversion similar to our own business. Now let's turn to Slide 8 to discuss Breathe Right. With heritage dating to the 1990s, Breathe Right is an iconic category-defining brand with strong consumer awareness. It has a broad assortment of strip offerings shown on the left side of the page. These are each designed to help consumers breathe better, both throughout the day and at night. With highly efficacious strips that immediately increase nasal airflow by up to 30%, consumers today use the product for a wide range of reasons, including improving sleep quality, snoring, athletic performance, allergies, congestions and more. It's a drug-free product that doesn't cause side effects and the brand also receives wonderful consumer reviews due to its superior user experience. So in summary, the consumer proposition is clear. It works, it's cost-effective solution to improving nasal airflow, and it solves a range of needs. Our objective with the brand will be to lean into these attributes and continue to increase household penetration, which stands at approximately 3% today. Let's turn to Slide 9 to review the brand's reach. As mentioned earlier, the brand is a market leader with 60% market share and over 90% aided awareness. Consumers in the U.S. know and trust the Breathe Right brand. Additionally, the brand is sold internationally, mainly concentrated in Europe, where we will more than double our presence. It also has a nice presence in Australia that will fit well with our current Care Pharma business. We see an opportunity to drive strong growth for the brand consistent with our long-term international segment expectations of 5% growth or more. The brand will be our largest at over $125 million in revenue with attractive profitability. We'd expect the brand to grow ahead of our company's long-term 2% to 3% outlook by utilizing our proven brand-building playbook. The brand has grown steadily in the last couple of years, driven by the proposition I outlined on the prior page. Now let me turn it over to Chris to review the financial details of the transaction.

Thanks, Ron. Let me first walk everyone through the highlights. We're acquiring a portfolio of brands headlined by Breathe Right. The purchase price is $1.045 billion or $900 million net of anticipated tax benefits. Trailing 12-month EBITDA through December 31, 2025, was estimated to be approximately $95 million, which equates to a purchase price of approximately 9.5x EBITDA net of tax benefit. We'd expect the business to be immediately accretive to the company's margin profile, EPS and free cash flow. Ron discussed much of the strategic rationale, but to reiterate, we are pleased to add an attractive and growing market-leading brand to our portfolio. It also provides long-term international sales opportunities, aligned with our business model and reinforces our long-term financial algorithm for sales and earnings. For financing, we're expecting to finance the transaction primarily with the new term loan facility with an emphasis on deleveraging post close that I'll discuss in detail shortly. Last, we expect the acquisition to close during our fiscal Q2 ended September. Let's turn to Slide 12. Shown on the page is some additional detail regarding financial impacts. First, the transaction will add nearly 20% to our revenue base and add Breathe Right to our stable of scaled strategic brands. We'd anticipate the aggregate portfolio growing approximately 2% to 3%, consistent with our own organic growth outlook with the Breathe Right franchise growing at a faster rate. It's a highly profitable portfolio, leading to a company EBITDA margin approaching 35% on a pro forma basis. For EPS, we'd estimate approximately $0.25 of EPS accretion on an annual basis, reflecting the impact of incremental interest and estimated intangible amortization. Now let's turn to Slide 13. We anticipate funding the transaction with a combination of cash on hand and a new term loan facility. On a pro forma basis, we anticipate bank-defined net leverage of approximately 4x at closing. We believe this is an effective use of our balance sheet that generates strong returns for shareholders. As we've done in the past, such as in fiscal '22 following the acquisition of TheraTears, we intend to use the company's strong and consistent free cash flow to return to our long-term leverage target of less than 3x in fiscal '28. Now let's turn to Slide 15, and Ron will review our company strategy.

Thanks, Chris. Shown on this slide is a reminder that we have a proven value creation strategy. Utilizing these 3 pillars resulted in a resilient business model that continues to deliver value over the long term by, first, using our brand-building tactics to grow our sales in the long term; second, to maintain and leverage our superior financial profile to enable robust free cash flow; and finally, deploying this capital optimally to further amplify shareholder returns. The result of this execution is clear in our financial performance with 5-year compound growth rates for organic revenue and adjusted EPS largely aligned to our long-term targets of 2% to 3% sales growth and 6% to 8% EPS growth, respectively. Now let's turn to Slide 16. We believe this growth profile can be supplemented over time by incremental M&A that can both expand our portfolio as well as offer incremental business capabilities. This page highlights the many successful transactions that have done just that. Whether it's acquiring Care Pharmaceuticals, which added geographic capabilities for us in Australia or the acquisition of C.B. Fleet, which enabled us to acquire 2 leading brands alongside strategic manufacturing capabilities, we will continue to seek out future M&A in the fragmented consumer health space. Today's announced acquisition of Breathe Right is the latest example. Now let's turn to Slide 17 and wrap up. So to recap, we have a diversified portfolio of leading consumer health care brands, strong financial profile and an advantaged position to continue scaling strategically. We will execute disciplined strategic M&A over time, and today's announcement is just the latest example in driving long-term value creation. Now let's open it up for questions. Operator?

[Operator Instructions] And our first question will come from the line of Rupesh Parikh of Oppenheimer.

Congrats on the acquisition. Just a couple of questions for me. So first, on the synergy front, just curious your thinking on potential cost synergies and revenue synergies down the road.

Rupesh, so from a synergy, not really a synergy play. They're very limited in this transaction. This model was run pretty lean by a PE firm, largely outsourced. That being said, again, not a synergy play, but already immediately accretive to our gross margin and our EBITDA margin. So that was the play here for top line opportunity for long-term growth of the Breathe Right brand.

And then just, I guess, just diving deeper into some of the sales opportunities. Just curious how you guys feel about opportunities on the distribution front domestically and internationally? And then just from an innovation perspective, just overall, how is the pipeline?

Yes, up. So let me start by talking about our expectations for total growth for the portfolio that we're acquiring. So over time, we expect it to grow in line with the company's average, following really the model that we have for the existing business, which is in the U.S., we would expect Breathe Right to grow above the company average. Internationally, we would expect Breathe Right to grow at 5% or more, again, similar to what we've been experiencing with our international business. And then we would manage the investment in their heritage and tail brands that we would expect them to decline, their role being to generate earnings and cash flow that we'd invest behind the big brands. So you put all that together, we'd expect it to reinforce total company organic growth of 2% to 3%.

Great. And then maybe my final question. Just from a channel mix perspective, is there anything to highlight there? Like is it pretty consistent with PBH's business today? Or is there more exposure to pharmacy? I'm just curious just from a channel mix perspective.

Yes, it's fairly consistent in the U.S. with one exception. They have a bigger presence in Costco than our business does. And this is the kind of product that consumers might look for in the club channel where they're looking to buy bigger quantity because the product is used routinely. There's many heavy users in the Breathe Right franchise that use it on a fairly frequent basis. So if you go to the club, you look they have 144 account size to support that. So that's probably the only other difference. And then internationally, as we said in today's prepared remarks, there's a nice business that's going to be added to what we've got going on in Europe, and it's going to more than double our scale in Europe and give us the opportunity to continue to grow nicely in that region.

And our next question will be coming from the line of Susan Anderson of Canaccord Genuity.

I guess maybe just looking at the EBITDA margin for the portfolio, how are you thinking about that over the long term? Should we think about it as kind of maintaining that EBITDA margin? Or is there opportunity to improve it after integrating it into your own portfolio? Or should we expect kind of more increased investment maybe for it to come down a little bit?

Susan, it's Chris. So as we mentioned on the call and in the presentation, you see they have over 45% EBITDA margins. We always concentrate on that gross margin being able to support the right level of A&M on the -- for the brand and the category they compete in. Obviously, for a brand like Breathe Right, their A&M spend is at a higher percent of sales than ours and their gross margin obviously can warrant that. And so for now, we're going to look to maintain that and continue to invest behind the brand and are expecting the entire company margin to increase to that about 35% as a result of the acquisition. So we think it's well positioned. It's spending at the right levels. And for now, we'll look to maintain that.

Okay. Great. And then I guess for the Breathe Right brand, how should we think about the brand's competition across, I guess, both branded and private label? I guess, for that brand and then maybe the other brands in the portfolio, do you think of them as similar to yours where their exposure to private label is much lower than some of those other big categories out there?

Susan, it's Ron here. So for Breathe Right, it's got a very long history. It's been in the market for over 30 years and has defined the category. The product really does offer a leading and premium proposition. It works well. And it's really differentiated from the products that are out there based on performance. So there is private label in the category. It's been in place for a very long period of time. And just like we see across OTC, when you have a differentiated premium product with a brand that consumers trust and look for, the share for private label and others has been fairly steady. over the long term. So very similar to what we see in our other OTC categories. And then same thing for their heritage brands with Dimetapp and Anbesol and others, they may have leading positions in very small categories, but the opportunities there will be to look for select opportunities to support them over time.

Okay. Great. And then I guess maybe just looking at kind of the big picture, how does this change the capital allocation priority is deleveraging now a top priority as we look forward? I guess, when do you think you'll look at M&A again down the road?

Susan, it's Chris. So obviously, we're very mindful of leverage. And for the near term, we'll be focused on using our free cash flow to return to our long-term target of less than 3x. So in the near term, I wouldn't expect meaningful share repurchase. We mentioned on the call and you look at one of the slides, right, just as we demonstrated with the TheraTears acquisition, again, this acquisition being accretive to our margins has low CapEx requirements because it's asset-light, has cash tax benefits. As I stated in my remarks, we expect to be back to our long-term leverage targets in fiscal '28. So we get through integration, and I think we'll be in a similar position to continue to reprioritize M&A. But in the near term, we'll be looking to prioritize deleveraging with our cash flow.

And our next question will be coming from the line of David Shakno of William Blair.

This is David Shakno on for Jon Anderson. A couple of questions here. First, I just wanted to follow up on a question earlier on -- is the -- is Breathe Right margin agnostic by channel kind of similar to your existing portfolio? And then a second question, Breathe Right has been around for a few decades, as you mentioned, put under, I think, PE ownership for the past 5 or 6 years or so. Can you highlight any changes that have happened with the brand in the past few years? Were there more recent innovation decisions in the past few years? Was this something on the operations side? Just any kind of historical context would be great.

So let me start with your first question there, David. So gross margin by channel is fairly consistent for the Breathe Right brand. And it was one of the areas that we dug into particularly with the club channel being a different focus for Breathe Right versus our existing business. And what we found was much like with Prestige, they've worked very hard to ensure that the product offering and the way it's promoted in each channel results in similar gross margin. So much aligned with our business. And in terms of the Breathe Right ownership, it did come out of one of the big pharma consumer arms and it's been owned by this PE firm for quite a while. And this PE platform company has a very good marketing and brand building group, and they've done a nice job focusing on long-term growth for the brand despite the PE's shorter-term ownership focus than we would have, right? We think about owning these things in perpetuity. So really no differences in how they might think about brand building. Certainly, we'll evaluate the marketing and brand building approach and adjust as we see fit going forward. But very, very good stewardship under foundation.

And our next question will be coming from the line of Mitchell Pinheiro of Sturdivant & Company.

Congrats on the acquisition. So just 3 quick questions. One, is the e-commerce percentage of this business sort of similar to your current business? Number two, could you explain what the tax benefits are and how they flow through? And three, was this a bid process? Or were you the only bidder?

Yes. Mitch, this is Chris. So first question on e-com, yes, in aggregate, the portfolio has a similar profile in terms of e-comm percentage. And as Ron kind of mentioned, we'll be looking to increase that, obviously, with our e-com playbook that we've executed over the years. In terms of tax benefit, so this was an asset purchase. It's how it was structured. And as a result, you get to amortize goodwill and intangibles for tax purposes. So the way to think about that is this is going to essentially reset the tranches we had from some past acquisitions back, I think Insight and GSK back a few years ago. Those tranches from a cash tax perspective, we were going to be scheduled to roll off in the next couple of years here. And with this acquisition, we'll reinforce a cash tax rate in the mid- to high teens versus our corporate effective tax rate at about 24%. So it kind of reload that. And from a process perspective, this was a bid process. We were not the only -- we don't believe we were the only participant in play here. So started several months ago, and we've been on it and work in diligence for some time here.

And our next question will be coming from the line of Anthony Lebiedzinski of Sidoti.

Congrats on the deal as well. So I guess in light of the still current fluid tariff environment, can you comment on the product sourcing locations for Breathe Right and the other brands?

Yes. Anthony, so all of the CMOs that are providing products are in the U.S., Breathe Right as well. So not expecting a big impact from tariffs for this.

Okay. Got you. Got it. Okay. And then as far as seasonality of the acquired business, I know there's a small cough and cold business. So I guess that would skew towards the December, March quarters. But anything to highlight as far as seasonality otherwise?

Yes. Seasonality, there isn't much seasonality, Anthony, given the broad usage occasions that we described in the prepared remarks today. This really isn't an allergy cold kind of product or snoring. It really has a broad set of uses around better breathing and the advantages of breathing better every day.

Okay. Got you. And lastly, as far as the incremental CapEx, how do we think about that?

It won't be material. So we would continue to think in that 1% to 3% of sales as a company.

[Operator Instructions] Our next question will be coming from the line of Doug Lane of Water Tower Research.

Yes. No, this acquisition seems right on point. I guess my question is, after 5 years or so of ownership under Foundation, what can Prestige bring to the party? They seem to have done a pretty good job, as you mentioned, of stewarding the brand.

Yes. Doug, thanks for the question. So maybe this is a good time just to step back and talk about the opportunity here in totality. We talk about our disciplined approach to M&A. And this opportunity, I think, highlights our approach. First is we've been very disciplined over the last 3-plus years around evaluating opportunities. And what that has allowed us to do is be positioned to do a $1 billion acquisition, right? This really moves our needle. It's going to add 20% to the top line and be very accretive to EPS and our cash flow. So I think that's the first place to start, right, is our discipline has given us the opportunity to be able to manage a deal of this size and the leverage that it will bring appropriately. The second thing, and we touched on these in the prepared remarks today, is it lines up clearly with our 3 criteria. The first is long-term brand building opportunity. So Breathe Right, in particular, it's just getting going, right? Even with the 30 years of heritage here, it's still at a 3% or 4% household penetration and just getting going internationally. So we're going to bring continued investment in our approach to brand building and long-term focus, Doug, to keep that going. Second is it fits our business model, right? We know the customers. It's going to allow us to more than double our presence in Europe. It fits with our customer base. We know the suppliers. So integration is going to be quick and low risk. And then finally, we think this is a fantastic use of our shareholders' capital. We think the returns are very good for this investment. So when we think about it on all those fronts, we really think this is a great opportunity for us.

And I'm showing no further questions. I would now like to turn the conference back to Ron for closing remarks.

Okay. Thank you, operator, and thanks to everybody for joining us on short notice this morning. As we said earlier, today is the announcement of signing the agreement. So we've got a little bit of work ahead of us here as we work to get to the closing, and we'll look forward to providing further updates the next being on our May Q4 earnings call. So we look forward to speaking then. Thanks for joining, and have a great day.

And this concludes today's program. Thank you for participating. You may now disconnect.