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Revlon, Inc. (NYSE:REV)

Q3 2013 Earnings Conference Call

October 24, 2013 09:30 a.m. ET

Executives

Elise A. Garofalo – SVP, Treasurer and Investor Relations

David L. Kennedy Vice Chairman of the Board and Interim CEO

Chris Elshaw – COO & EVP

Jessica Graziano – Corporate Controller and Chief Accounting Officer

Analysts

Grant Jordan – Wells Fargo

Connie Maneaty – BMO Capital Markets

Operator

Good morning ladies and gentlemen, and welcome to Revlon’s Third Quarter 2013 Earnings Conference Call. At the request of Revlon, today’s conference is being recorded. If you have any objections, you may disconnect at this time. (Operator instructions) And now at this time I like to turn the call over to Ms. Elise Garofalo, Revlon’s Senior Vice President, Treasurer and Investor Relations. You may begin Ms. Garofalo.

Elise A. Garofalo

Thank you, Alan. Good morning, everyone, and thanks for joining today’s call. Earlier today, we released our results for the third quarter ended September 30, 2013. If you have not already received a copy of the earnings release, you can obtain one on our website at revloninc.com.

On the call with me this morning are David Kennedy, Revlon’s Vice Chairman and Interim Chief Executive Officer; Chris Elshaw, Chief Operating Officer; and Jessica Graziano, Corporate Controller and Chief Accounting Officer.

Before I turn the call over to David, I’d like to remind everyone of a few things. First, our discussion this morning may include forward-looking statements that are based on our current expectations. Information on factors that could affect our actual results from time-to-time and cause them to differ materially from such forward-looking statements is set forth in our SEC filings, including our 2012 Form 10-K and our 2013 third quarter Form 10-Q, which we filed earlier this morning. We undertake no obligation to publicly update forward-looking statements.

Next, our remarks today may include a discussion of adjusted EBITDA and free cash flow, both of which are non-GAAP measures. These non-GAAP measures are defined in the footnotes to our release and are also reconciled to their most directly comparable GAAP measures in the financial tables at the end of our release. And finally, as a reminder, our discussion this morning should not be copied or recorded.

With that, I’ll turn the call over to David.

David L. Kennedy

Thank you, Elise, and good morning, everyone. Before I turn the call over to Chris to discuss our performance in the quarter, let me comment on our recent acquisition. As you are aware, we purchased The Colomer Group for $665 million on October 9. This acquisition represents a significant, strategic step forward for Revlon.

The combined company will have pro forma annual net sales of approximately $2 billion. We also expect the acquisition to provide cost synergies and to be accretive to cash flow and earnings in the first year. The Colomer Group primarily markets and sells professional products to salons and other professional channels complementing Revlon’s primarily mass channel business. The combination provides us with a strong platform to generate profitable growth.

It will also allow us to leverage the enhanced product, innovation and strategic brand marketing capabilities of the combined company, while expanding our brand channel in geographic scale and scope. We have developed and will be executing a detailed integration plan over the coming months, and we will remain -- maintain a strong focus on performance and effectively operating the combined business during this period of change.

Our objective will be to ensure the success of the combined business as we continue to build our brands through innovative, high-quality new products, effective brand communication, advertising and promotion, and superb execution in all aspects of our business.

So with that I will hand it over to Chris who will talk about our marketplace performance.

Chris Elshaw

Thank you David and good morning everyone. Total company net sales in the third quarter were $339.4 million, an increase of 1.1%, excluding the impact of foreign currency fluctuations as compared to last year. This increase was primarily driven by higher net sales of Revlon color cosmetics, despite lower year-over-year new product net sales, particularly in the US, as well as higher net sales of Revlon ColorSilk hair color and Revlon beauty tools.

These increases were partially offset by lower net sales in Venezuela and lower net sales of other beauty care products in the quarter. In addition, Almay continues to perform below expectations.

From a profitability standpoint, we sustained competitive operating income margin this quarter, which in part benefited from successful execution of our 2012 restructuring plans.

So let me start by discussing net sales performance by brand. As a reminder, I will review net sales performance excluding the impact of changes in foreign currencies. In Revlon color cosmetics, total company net sales increased as compared to the prior year. With respect to new product innovation, this year we have had mixed results. Products that have performed well for us [indiscernible] where Revlon plays an important role as the color authority.

Examples of our success in lip include ColorStay Ultimate Suede Lipstick, which continues to be exceptionally well-received in the marketplace along with our Super Lustrous color franchise, we are pleased with the recent introduction and renovation of Super Lustrous Shine lipstick, and Super Lustrous lip gloss.

We have also had success in nail this year, where we have had positive performance with our new products namely our Revlon Nail Art, as well as our Revlon Brilliant Strength nail enamel in the US. You may recall last year we relaunched our two biggest nail franchises, ColorStay Nail and Revlon Color Nail as part of our renovation of existing color franchises. While we have continued to introduce on trend nail offerings in 2013, the scale of these launches has not matched the performance of our two biggest franchises last year and in addition, we have seen a trend of slowing growth in nail.

Let me take a moment for a few comments on the nail category’s performance in the US, which has been in the news. The category has slowed progressively throughout this year. However, to put that in context this is compared to significant double-digit growth rates in 2012 on top of significant double-digit growth rates in 2011 based on Nielsen data. While I cannot predict how the category will fare in the coming months, what is clear is that today the nail category is significantly bigger than it was in the past. In fact it is as big as the lip category year-to-date, and we have multiple successful franchises with a continued strong pipeline of innovation.

Moving on to face, last year we introduced several new innovations in face throughout the year. In 2013 however, our primary innovation was in Nearly Naked franchise, which we introduced at the beginning of the year. As we mentioned last quarter, this franchise continues to perform below our expectations, which we believe is in part due to the strength of the emerging BB Cream trend. In fact, consistent with this trend, our PhotoReady BB Cream continues to perform well. That said, overall because of the performance of Nearly Naked, we haven’t been able to cycle last year’s new product sales in place during the quarter. Note that the underperformance of this franchise was one of the primary drivers of lower net sales in the US.

And finally with respect to our Revlon brand and innovation, we recently received a number of Best of Beauty awards from Allure Magazine, including PhotoReady Kajal Intense Eye Liner, PhotoReady Color Correcting Primer, Photoready Sculpting Blush Palette, and Colorstay 16 Hour Eye Shadow Quad.

Turning now to Almay. Net sales decreased year-over-year primarily due to its performance in the US. As we discussed in previous quarters, we have taken and continue to take actions on our renovation plan for Almay. This year we have added Smart Shade CC Cream and expanded our highly successful eye make up removal range to satisfy more consumer needs, and re-enter the lip category with an exciting new product Almay Color and Care Liquid Lip Balm, which is a new form of liquid lip balm.

As this demonstrates, we continue to focus on breakthrough innovation across our portfolio. In addition, as I mentioned last quarter our renovation work on Almay graphics, packaging and merchandising is underway.

In women’s hair color, net sales of Revlon ColorSilk increased year-over-year. ColorSilk continues to perform well despite softer demand in the US category overall. In Revlon beauty tools net sales increased year-over-year consistent with our comments year-to-date, the beauty tools category remains soft. However, we continue to maintain our strong leadership position in the US and Canada, and in 2013, our new products are performing very well in the marketplace.

Now moving onto performance by region. In the United States, net sales decreased $6.2 million or 3.2% primarily driven by lower net sales of Revlon and Almay color cosmetics, partially offset by higher net sales of Revlon ColorSilk hair color. As I mentioned earlier, lower net sales of new products on a year-over-year basis impacted the Revlon brand performance in the US.

In Asia Pacific, net sales increased $2.9 million or 4.8% primarily due to higher net sales of Revlon color cosmetics throughout most of the region, partially offset by lower net sales of other beauty care products in Hong Kong.

Moving onto Europe, Middle East and Africa, net sales increased $6.1 million or 13.9%. Net sales in the third quarter of 2012 included the negative impact of a returns accrual of $1.6 million associated with our 2012 restructuring action, which benefited the quarter comparison in 2013. In addition, the region benefited from higher net sales of Revlon color cosmetics in the UK and in certain distributor territories, as well as higher net sales of fragrances in both Italy and South Africa.

In Latin America and Canada, net sales increased $1million, or 2%. Net sales were negatively impacted by $2.6 million of lower sales in Venezuela primarily due to the impact of business conditions in the country, including Venezuela’s currency restrictions. Excluding Venezuela, net sales increased primarily due to higher net sales of Revlon color cosmetics in Argentina, Mexico and certain distributor territories, as well as other beauty care products in Argentina and certain distributor territories, that is in [Canada].

Now I will turn it over to Jessica to run you through the rest of our financial results for the quarter.

Jessica Graziano

Thank you, Chris. Since Chris has already discussed our net sales performance, I will begin with gross margin performance for the quarter. Gross margin was essentially unchanged year-over-year at 63.5%. The third quarter 2013 gross margin benefited primarily from higher sales volume and lower manufacturing and freight cost as a result of our restructuring savings and other supply chain cost reduction initiatives. These benefits were offset by the unfavorable impact of foreign currency fluctuations and higher promotional allowances.

SG&A was $175.3 million in the third quarter of 2013 as compared to $179.9 million in the same period last year. Lower SG&A in the third quarter of 2013 was impacted by favorable foreign currency fluctuations of $4.6 million, lower incentive compensation, and a benefit of $4 million due to the combined effect of a $2.2 million litigation loss contingency, recognized in the third quarter of 2012 that did not recur in the third quarter of 2013, and a benefit of $1.8 million of insurance recovery in the third quarter of 2013 for costs related to this litigation. The favorable impact of these items were partially offset by $5.9 million of expenses incurred related to the acquisition of The Colomer Group.

Moving onto restructuring, during the third quarter of 2013 we recorded a net benefit of $1.4 million associated with the September 2012 restructuring program. This consisted of a $2.5 million gain on the sale of our manufacturing facility in France, which was partially offset by $1.1 million of restructuring and related cost. We expect total cost for this program to be approximately $27 million, $26.3 million of which have been recorded to date. We also expect to pay cash of approximately $24 million related to the restructuring, $17.1 million of which has been paid to date. Overall this program is still expected to achieve approximately $10 million of annualized cost savings with $7 million expected to benefit 2013.

Operating income in the third quarter of 2013 was $41.8 million, compared to $19.1 million in the same period last year. Adjusted EBITDA was $59.3 million compared to $36.2 million in the same period a year ago. There were some meaningful currency movements in the third quarter of 2013 compared to the third quarter of 2012. So let me summarize the impact of these for you.

The total unfavorable FX impact on operating income was $4.7 million, which included a $11.4 million negative impact on net sales, a $9.3 million negative impact on gross profit, and a $4.6 million positive impact on SG&A.

Moving onto interest expense, interest expense including dividends on preferred stock decreased $3.6 million to $17.9 million, primarily due to lower interest rates as a result of our February 2013 bank term loan amendment and senior notes refinancing.

With respect to taxes, the provision for income taxes was $12 million, compared to $11.5 million in the same period last year. Cash paid for income taxes net of refunds in the third quarter of 2013 was $2.7 million compared to $2.9 million in the same period last year. And to wrap up our P&L, net income in the third quarter of 2013 was $9.5 million or $0.18 per diluted share, compared to a net loss of $15 million or $0.29 per diluted share in the same period last year. As a reminder, the net loss in the third quarter of 2012 was primarily driven by a $24.1 million of restructuring and related charges.

Moving onto cash flows. Net cash used in operating activities in the third quarter of 2013 was $5.5 million, compared to net cash provided by operating activities of $39.6 million in the same period last year. As compared to 2012, cash flow in the third quarter of 2013 was negatively impacted by the following items, first, we had $9.6 million of higher cash interest payments due to a change in the timing of interest payments as a result of our February 2013 senior notes refinancing. Second, we had $8.9 million in connection with the settlement of litigation related to the company’s 2009 exchange offer, and lastly, the remainder of the change against prior year was primarily due to changes in other working capital accounts.

As a general reminder, with respect to operating cash flow the timing of cash flows from working capital can vary significantly from quarter-to-quarter based on a number of factors. We continue to closely manage our key working capital accounts, including receivables, payables and inventory.

Net cash provided by investing activities in the third quarter of 2013 was $10.3 million, compared to net cash used in investing activities of $71.6 million in the same period last year. The third quarter of 2013 benefited from a $13.1 million of insurance proceeds related to the 2011 fire in Venezuela, as well as $2.7 million received from the sale of the company’s manufacturing facility in France. These gains were partially offset by $5.8 million of capital expenditures. As a reminder, the third quarter of 2012 included the Pure Ice acquisition, which was paid for with cash.

On the liquidity front, our unutilized borrowing capacity and cash on hand as of September 30, 2013, was $262.6 million, comprised of $132.4 million of available cash and $130.2 million available under our revolving credit facility. After the quarter end, on October 8, 2013, we redeemed our outstanding preferred shares utilizing $48.6 million of the cash on hand at September 30. Again this was a fourth quarter event and therefore not reflected on our September 2013 balance sheet.

Further with respect to our capital structure, during the quarter and as previously disclosed, in August 2013 we amended our existing bank term loan and revolving credit facilities to among other things allow for the [incurrence] of $700 million of incremental term loan debt to fund the acquisition of The Colomer Group, which closed on October 9. This acquisition and that related borrowings were fourth quarter events and therefore not reflected on our September 2013 balance sheet.

Now moving onto cash flows for the full year 2013, consistent with our historical practice following a certain 2013 cash flow information, none of which has changed from the guidance we provided during our last call. Capital expenditures are expected to be approximately $25 million. Permanent display expenditures are expected to be approximately $50 million. Pension plan contributions are expected to be approximately $20 million, and cash paid for income taxes is expected to be approximately $15 million.

This concludes our prepared remarks and we would now like to open the call for your questions. Operator, please prompt the participants for questions.

Question-and-Answer Session

Operator

Thank you, ma’am. (Operator instructions) We will first go to Grant Jordan of Wells Fargo.

Grant Jordan - Wells Fargo

Hi, good morning. Thanks for taking the question. First question just kind of big picture as you think about The Colomer set, like which products in their portfolio or your portfolio do you see as maybe being able to cross distribute into the new channel?

David L. Kennedy

Well, Jordan good morning. At this point it is really early days with respect to The Colomer acquisition, and we haven’t got to the point of developing what I would call a consolidated marketing plan. So it is premature I think to comment on that.

Grant Jordan - Wells Fargo

Okay. Is there a timeline for kind of when you think you will be ready on that?

David L. Kennedy

Well, we are kicking off almost immediately a complete, comprehensive integration plan and as we go through that plan over the next 12 months or so it will be focused not only on obtaining the synergies that we targeted, but also on what revenue synergies that we might be able to achieve.

Grant Jordan - Wells Fargo

No problem. Great, okay my second question, when we look at the Nielsen data, I realize that doesn’t capture the international sales or certain customers you have, but, you know, across a lot of your categories you have lost share over the previous months, is that kind of what you were alluding to when you said the new product innovation has not been as successful this year?

David L. Kennedy

Well, as I said, in the US in particular we had a particular issue cycling out innovation on face of prior year, so that resulted in lower sales. And as I said in nail, we took an opportunity last year to relaunch our two largest franchises. The nail category is very hot. We had some great innovation, and so we relaunched our two biggest nail franchises. That obviously was a big bump a year ago.

So yeah, these things [indiscernible] new product innovation is critical for the category, you know, it is 50% to 20% of the annual business and you know, we never launch anything we don’t think it is going to work but some things work better then we expect and some things work less than we expect.

Grant Jordan - Wells Fargo

How would you classify next year in terms of new product launches or innovation?

David L. Kennedy

Well, as always, we approach launches we believe we have got the strongest pipeline that we can have based on all the technological changes we are making and the examination of the trends. So we are positive as always at this time of the year about our innovation for next year.

Grant Jordan - Wells Fargo

Okay. Great, thank you very much.

Operator

And next we go to Connie Maneaty from BMO Capital Markets.

Connie Maneaty - BMO Capital Markets

Good morning. I have a few…

David L. Kennedy

Good morning.

Connie Maneaty - BMO Capital Markets

How are you David? I haven’t talked to you for years.

David L. Kennedy

I am well. I am well, and you?

Connie Maneaty - BMO Capital Markets

The same.

David L. Kennedy

Good.

Connie Maneaty - BMO Capital Markets

[indiscernible] so a question for Chris, could you just refresh us on why fourth quarter 2012 US sales rose 14%? Were the face innovations largely -- it didn’t sound like from your commentary, but were they largely grouped in that quarter, I am just trying -- and how much of that growth was one time versus ongoing?

Chris Elshaw

Well, as you recall, yeah, in the year last in particular the launch timings of all new products launched in the fourth quarter, just as a general comment and we -- we obviously shipped Nearly Naked in the fourth quarter of last year. And as a general view when you look at the categories, the face products are higher priced than say lip and nail products. So sometimes it depends on the make-up of what the new [products] are. So if you have a face launch, then yes, that does tend to produce higher values than the pipeline and promo shipments that you make in the fourth quarter, price of the consumption starting to occur in the first quarter.

Connie Maneaty - BMO Capital Markets

Okay. As you look into 2014, what is the spacing and timing of your new product launches?

David L. Kennedy

It is the same as it has been every year coming, so we started shipping in each quarter the new products for next year. We have had some preview displays out that was -- there was no material change in the spacing or timing of the launches.

Connie Maneaty - BMO Capital Markets

Okay. Could one of you comment on the article in today’s paper about the industry’s efforts -- cosmetic industry’s efforts with the FDA? Are you looking…

David L. Kennedy

I will let Chris comment on that because he is a -- I’m not sure exactly what your title is, but you are part of the PCP Council, right?

Chris Elshaw

Yes. I sit on the board and…

David L. Kennedy

Yeah, and so he is very close to this Connie.

Chris Elshaw

So, let me be very clear, because it wasn’t clear in the article. We are very supportive of the industry’s effort to modernize the regulation with the FDA. We are fully committed to working with the PCPC. I work very closely with the council on this. There is no suggestion from our part that we are not fully committed to working with the FDA on modernizing this legislation.

Connie Maneaty - BMO Capital Markets

And does it mean national standards rather than state standards to you cost, does the cost…

Chris Elshaw

Well that is one -- yeah, I mean there are many parts to this -- to various GMP and things like that, but yes, having national standards is part of the discussion that is occurring. I would point out something Connie. This discussion between the PCPC and the FDA has been going on for years, and so this is not a new discussion. This is not really a new event. It is an ongoing discussion and dialog.

Connie Maneaty - BMO Capital Markets

Okay, and just one final question, as you did your due diligence on The Colomer Group what did you find that you thought would be the most obvious opportunities and what did you find that you think will be the most complicated aspects of the integration?

David L. Kennedy

With respect to the first question, there are a number of opportunities and one of -- and I will speak broadly, you know, there is obviously some synergy opportunities on the cost side, and there is also some real opportunities with the brands that they have, with the capability that they have, with the innovation capability in particular they have been very successful over the past few years of launching some very successful new products.

So we see that capability as a real opportunity for us combined with our capability, which we view as extremely good as well. So, we like very much the opportunity for growth that it presents us and of course, we think that having, now as we say, united the Revlon brand across all channels presents a very broad opportunity for us as well.

With respect to the second part of your question, the -- with these integrations and I have been through a few of them, they are complicated, however, we believe that we have a very good design organization and plan for our integration. We have a reasonable timeline and probably the most complicated part about it is always with the people Connie. As you know, as you go through these integrations and you are looking for cost reductions that make sense, then it causes some organizational change and that is probably the most complicated aspect of an integration.

Connie Maneaty - BMO Capital Markets

Okay. Thank you very much.

Operator

At this time we have no further questions. So I would like to turn it over to Mr. David Kennedy for any additional or closing remarks.

David L. Kennedy

Thank you very much all of you for having this call, and we will talk to you again in January and thank you. Bye.

Operator

And that does conclude today’s call. We thank everyone again for their participation.

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