Prestige Brands Holdings' (PBH) CEO Ron Lombardi on Q3 2016 Results - Earnings Call Transcript

| About: Prestige Brands (PBH)

Prestige Brands Holdings, Inc. (NYSE:PBH)

Q3 2016 Results Earnings Conference Call

February 04, 2016, 08:30 AM ET

Executives

Dean Siegal - Director of Investor Relations

Ron Lombardi - Chief Executive Officer

David Marberger - Chief Financial Officer

Analysts

Frank Camma - Sidoti

Linda Bolton Weiser - B. Riley

Carla Casella - JPMorgan

Operator

Good day ladies and gentlemen and welcome to the Prestige Brands Holdings' Q3 Fiscal 2016 Earnings Conference Call. At this time, all participants are on a listen only mode, later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Mr. Dean Siegal, Director of Investor Relations. Sir, please begin.

Dean Siegal

Good morning and welcome. As a reminder, there's a slide presentation which accompanies this call. It can be accessed by visiting prestigebrands.com, clicking on the Investor link and then on today's webcast and presentation.

I am required to remind you that during this call Management may make forward-looking statements regarding their beliefs and expectations as to the company's future business prospects and results. All forward-looking statements involve risks and uncertainties which in many cases are beyond the control of the company and may cause actual results to differ materially from Management's expectations. You are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date of this conference call. A complete Safe Harbor disclosure appears on page two of the presentation accompanying this call.

Additional information concerning the factors that might cause actual results to differ from Management's expectations is contained in the company's annual and quarterly reports, which is filed with the U.S. Securities and Exchange Commission. Also as a reminder, some of the information contained in this presentation includes adjusted projections which exclude acquisition related and other items. A reconciliation between adjusted results and reported results is included in today's earnings release.

Now, I would like to introduce Ron Lombardi, CEO.

Ron Lombardi

Thanks, Dean and good morning, everyone. Today's agenda and presentation will cover our third quarter and nine months performance, give an update on the expected closing of the DenTek acquisition and reconfirm our outlook for the remainder of the year.

So with that's let's turn to page five and get started. We are very pleased with our solid results for the quarter and first nine months of the year. The third quarter continued to benefit from strong performance across a number of fronts including strong consumption gains in our Invest for Growth brand and our international business.

Sales were in line with our expectations for the quarter coming in at $200 million an increase approximately 3% excluding the FX impact and increased 1.3% with it. Our core OTC business continued its strong consumption in sales trends during the quarter and I'll cover more of this on slide seven and eight.

Our nine months year-to-date sales growth came in at plus 14.1% and was in line with the previous outlook for the full year. FX impacted organic growth by approximately 2 points in Q3 and 2.5 points for the nine months year-to-date. Our core OTC brands continue to benefit from our long-term brand building focus with consumption growth of 4.7% in Q3 and year-to-date growth of over 5%.

Our gross margin came in at 58.3% for the quarter and improved 1 point versus last year's level of 57.2%. It was also in line with Q2's level of 58.2%. EPS came in at a solid $0.53 for the quarter which was 10.4% above last year's level. Free cash flow came in at a solid $45 million in Q3 and allowed us to continue to rapidly delever ahead of the DenTek acquisition with our Q3 leverage ratio decreasing to approximately 4.8 times. We also now expect the DenTek acquisition to close in early February and possibly as soon as the next few days.

In summary, we're very pleased with our solid performance during the quarter and the first nine months of the year.

Turning to slide six, we have an update on the outlook for the remainder of the year. In terms of our full year outlook, we continue track to deliver a full year FY '16 outlook and strong financial results for the year. Our outlook for revenue reflects current FX rates and we continue to expect full year revenues to be at the midpoint of the plus 10% to plus 11% range with Q4 revenue expected to be in the $190 million to $192 million range.

Regarding our full-year EPS outlook, we expect to be at the high-end of the range of $2.05 to $2.10 or slightly above that. In addition, our outlook for free cash flow continues at $175 million or more with year-end debt-to-EBITDA expected to be approximately 4.6 times before the DenTek acquisition. As a reminder, this outlook excludes any impact that DenTek will have on Q4 results.

If you turn to slide seven, we will take a look at our solid consumption track. Slide seven shows our last seven quarters of core OTC consumption in sales trends with consumption spends on the top of the page and sales on the bottom. Over this period we have had strong and steady consumption gains and have outpaced the industry growth rate for most of the categories we compete at.

Consumption for the third quarter was approximately 5% which was in line with the average for the periods. If you look at the bottom of the slide, you can see that our strong consumption levels continue to drive sales as Q3 organic sales increased 6.5% for this group. We especially feel good about these trends given the retail environment and the low level of cough/cold incidents year-to-date. The consumption and sales trends as well as the strong performance in our international business has a slow position for the remainder of the year.

Turning to slide eight, we have an update on our Q3 sales performance for our Invest for Growth and Manage for Cash portfolios. This slide is important as it shows the execution of our overall growth strategy and how we continue to focus on our Invest for Growth brands in order to achieve our overall growth and cash flow objectives.

Our core OTC and international business currently makes up about 78% of our sales and this is where we are investing for growth and what drives overall sales for the company. On the left side of the page we see that our Invest for Growth portfolio grew a solid 5.7% during Q3 while the Manage for Cash portion declined about 2%.

Over time we would expect the growth in these two areas to vary, but over the long-term would expect our Invest for Growth portfolio to grow approximately 4% to 5% or so excluding FX and the Manage for Cash portfolio may decline 5% or more in any given quarter. For Q3 the combination of the two resulted in solid total organic growth of 3.2% excluding the impact of FX.

Prestige's industry-leading free cash flow and financial profile allowed this level of growth to result in meaningful bottom line growth, continued brand investment and value creation over time with Q3 earnings growth of over 10%.

We will talk more about the continuing evolution of our portfolio on a later slide, but now turning to slide nine, we can start with an update on DenTek. As I mentioned earlier, we now expect the DenTek acquisition to close in early February with the FTC recently completing their review. The closing may even be as soon as the next few days.

We often speak of the importance of being strategic and disciplined in evaluating acquisition opportunities. Our criteria centers on the acquisition's ability to respond to brand building, its fit with our business model and its strong financial profile. We believe we've hit a bull's-eye with the DenTek opportunity on all fronts.

DenTek provides us with the opportunity to acquire a growing brand that is well-positioned in the fast-growing specialty oral care segment. It is relevant to both consumers and retailers and adds scale to our oral care platform. Its financial profile is consistent with Prestige's industry-leading EBITDA margins and free cash flow and we expect it to be accretive to ROIC over time.

Consistent with our strong track record of acquisitions, our team had already developed our integration, transition and brand building plans, so we can hit the ground running the first day of ownership with a clear focus on investing for growth. This acquisition will allow us to invest in new product development, build a brand within an already fast growing category and take advantage of our common outsourced manufacturing model, distribution channels and DenTek's growing international footprint.

On page 10 we can see how this acquisition creates another $100 million platform adding a scale brand and providing access to the higher growth specialty oral care category. We use our successful and proven M&A strategy as a brand building tool and our seven acquisitions have been focused on building out the portfolio and categories you see on page 10. Today, as a result of our strategy we have more well-known brands, stronger cash flow and leading brand categories than ever before.

Turning to page 11, you'll see the impact on our growth profile. We've started this strategic focus back in fiscal 2010 when the company sales had a CAGR of negative 3% for the five years through 2010. Our portfolio back in fiscal 2010 was split evenly between Invest for Growth and Manage for Cash which resulted in the decline of 3% over the five previous years.

Over the last six years, through M&A and organic growth and our Invest for Growth portfolio we've been able to shift the balance to 80/20 after we complete the DenTek acquisition. We now believe our portfolio is better positioned for long-term organic growth with our biggest brand as great examples of how we can grow share over time.

On page 12, you can see Prestige will apply the same approach that we have used with our past acquisitions to drive growth in the DenTek brand and integrate the business into the Prestige model rapidly and efficiently. Integration of acquisitions has become a core competency for the company over time.

We expect to realize benefits by using the Prestige sales and distribution network to expand distribution, especially in the food and convenience channels where we are well established. We plan to meaningfully increase the investments in brand building, A&P and new product developments to build the base for continued long-term growth.

We will also look for cost savings and synergy in the supply chain and in the regulatory and quality functions as part of the integration process. We will provide further details on this at the Q4 earnings call.

So, turning to slide 14, I'll now turn the call over to Dave, who will review the finance section of today's deck.

David Marberger

Thank you, Ron and good morning everyone. As Ron just described and is summarized on page 14, we are very pleased with our third quarter and fiscal year-to-date results for revenue, margins EPS and free cash flow. Our results for the third quarter include strong organic sales growth, EPS growth of over 10% and free cash flow generation of $45 million.

Moving on to slide 15, we report our consolidated third quarter and nine-month period ended December 31, 2015 results. As a reminder, the information in today's presentation includes adjusted results that exclude acquisition related and other items. Reconciliations between adjusted results and reported results are included in today's earnings release.

For the third quarter organic revenues increased 3.2% on a constant currency basis versus the prior year and for the nine months ended December organic revenues increased 2.1% on a constant currency basis or approximately 14% on a reported basis. These results were driven by continued strong multi-outlet and C-store consumption growth in our core OTC portfolio and also reflect the full year-to-date sales impact of the Insight acquisition which closed in early September 2014.

Our third quarter adjusted gross margin of 58.3% was the highest level in over two years and was up from 57.2% in the prior year quarter. This was primarily driven by favorable sales mix from growing the core OTC portfolio, which includes brands with higher gross margins than the overall average.

Advertising and promotion spending was 15% of sales for the third quarter, which was essentially flat compared to the prior year quarter. A&P spending for the nine months ended December was up 13.4% versus the prior year and reflects our continued brand building and product innovation investment. We will continue to invest in brand building and new product development for our core brands moving forward.

Comparisons of G&A expense for both the third quarter and year-to-date third quarter were impacted by the timing of the Insight acquisition in early September 2014. We continue to expect G&A for the company to be in the 8.25 to 8.5 percentage of revenue range over time as our year-to-date G&A is 8.3% of revenue.

Our adjusted EBITDA margin for the third quarter was 34.8% which was in line with the prior year quarter. Adjusted EBITDA for the nine months ended December increased to 17.2% versus prior year and the EBITDA margin increased to approximately 36% of revenues due primarily to the 140 basis point increase in the gross margin percentage during the same period.

Our adjusted EPS grew faster than revenue in the third quarter compared to the prior year as a result of our ability to use our strong free cash flow to delever and reduce interest expense. Third quarter EPS growth was 10.4% on total reported revenue growth of 1.3%. EPS increased 18.7% for the nine months ended December 31 versus the same period a year ago due to the increase in EBITDA.

Moving on to slide 16, you see the reconciliation of reported net income to adjusted free cash flow. As a reminder, our earnings release contains the full set of disclosures about our non-GAAP financials. For the third quarter we continue to deliver strong adjusted free cash flow of $45.8 million in line with free cash flow in the third quarter of the prior year. For the nine months ended December we generated almost $135 million of adjusted free cash flow, which was up 18.6% versus the prior year driven by increased EBITDA and the benefit of deferred taxes reducing the amount of cash taxes we paid.

Over the last five years Prestige has consistently improved free cash flow driven by EBITDA growth, low fixed asset spending due to our asset-light model and meaningful cash tax benefits resulting from our acquisitions.

For the nine months ended December adjusted free cash flow of $135 million was approximately 22.5% of revenue, a testament to the high level of cash flow being generated and reinvested in the business from every dollar of sales generated. As a result of the free cash flow generated in the third quarter, we were able to reduce our debt by approximately $27 million during the quarter to approximately $1.4 billion and we reduced our leverage ratio to approximately 4.8 times.

We also increased the amount of cash on hand during the third quarter to $49 million in order to prepare for the DenTek closing which could happen as soon as the next few days. As mentioned, we expect to generate approximately $175 million or more of adjusted free cash flow for the full fiscal year 2016.

This concludes my comments and I will now turn it back to Ron.

Ron Lombardi

Thanks, Dave. Turning to page 18, we'll wrap up our prepared comments before we open the lines for questions. We continue to feel very good about the business and the consumption trends in our Invest for Growth brands as they head into the last quarter of this fiscal year. However, we do remain cautious related to the retail environment and what we see across the mass drug and dollar channels.

Brand building and NPD will continue to be our long-term focus and continue to deliver results as witnessed by the consumption trends of our largest brands as highlighted on page seven. Finally, we continue to feel confident in our full year outlook and more importantly, in our strategy that is creating shareholder value.

Our sales outlook remains at the midpoint of the plus 10% to plus 11% range with Q4 sales of $190 million to $192 million anticipated. As Dave just mentioned, our outlook for free cash flow remains at $175 million or more and our adjusted EPS outlook is now at the upper range of the $2.05 to $2.10 range or slightly above that. All of this excludes any impact from DenTek in Q4.

So with that, let me turn the call back over to the operator and they'll open the lines for questions. Thank you.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Frank Camma of Sidoti. Your line is open.

Frank Camma

Good morning, guys.

Ron Lombardi

Good morning, Frank.

David Marberger

Good morning, Frank.

Frank Camma

Congratulations on the quarter. Hey, I didn’t have a chance to go through the whole 10-Q, but I noticed a couple of things. First of all, the cold/cough was down by 5%, but considering the seasonal so and then if you could comment on that, why - it seems like it might have been down more given the incident levels?

Ron Lombardi

Yes, so Frank I think year-to-date incident levels are down about 15% and cough/cold is broken up into a number of subcategories, but if you look into the subcategories, sore throat and cough is down more like 5% or 6% and that's really where our group is concentrated. So we're performing well. One thing I'll point out is our Luden's business is actually up on a year-to-date basis over last year. So our new flavors are allowing us to buck the trend of cough/cold incident levels.

Frank Camma

Okay good, and MONISTAT looks like it is driving some good growth in the woman's health, I was wondering if you could comment about that?

Ron Lombardi

MONISTAT continues to performance well. Our investment in brand building strategy is long-term and is focused not only on the doctor detailing initiatives that we've talked about in the past, but also updating our consumer advertising as well. So we continue to do well with that and expect to do for a long time Frank.

Frank Camma

Great and a last on the categories, what's going on with the dermatological, it was up like 12%, was there anything new in that category that would have driven that?

Ron Lombardi

Yes, so the Compound W brand is really the big driver in that skin care section for us and we've had really good success with the new product Compound W Advanced [ph] that's helped us increase share significantly in that category over the last few quarters.

Frank Camma

Okay, great. And then final question for me is just, if you can comment on the kind of the state of the debt markets as you see them because obviously longer term that’s a good driver for you as you reload up for acquisitions?

Ron Lombardi

Sure, over the last four months or so the debt market has been, I guess fluid is the best way to describe it. It has been choppy, although the market tends to be pretty good and stable for borrowers who the market is comfortable with and certainly we feel Prestige fits into that category. We actually end up with pricing that's usually a couple of notches above where rating agencies may rate us because of our financial profile and our consistent free cash flow.

Frank Camma

Right.

Ron Lombardi

So as we get ready to close on the DenTek acquisition, we think we’re going to be well positioned to be well situated to close on that.

Frank Camma

Great. Thanks guys.

Ron Lombardi

Sure, thank you Frank.

Operator

Thank you. Our next question is from Joe Altobello of Raymond James. Your line is open.

Unidentified Analyst

Good morning it's Christine on for Joe.

Ron Lombardi

Good morning.

Ron Lombardi

Good morning.

Unidentified Analyst

Good morning, just a follow up on Frank’s question, how is the decline in incidences in cough/cold impacting margins?

Ron Lombardi

Because our portfolio is so diversified we’re not overly impacted by any one category. Cough/cold a few years ago was over 20% of revenue and after we close on DenTek it will be closer to 10%. So it's not really impacting the financial profile of the business one way or the other.

Unidentified Analyst

Okay and then just a follow up on the gross margin question, can you talk a little bit more about the drivers this quarter and was there any transactional FX drug from other companies have been reporting ahead from that?

Ron Lombardi

Yes, so the second of those two questions in terms of FX, although we do get an impact on the top line and we’re impacted by the Australian dollar and the Canadian dollar, in terms of gross margin and EPS we're able to mitigate whatever transactional impact we do have. So it's really not impacting the bottom line for us like it is a lot of other companies. What was the first part of the question, Christina?

Unidentified Analyst

Just a little bit more color on the gross margin during the quarter?

David Marberger

Yes, Christina this is Dave. As I mentioned in my comments, it's really driven by mix. So, by driving the core OTC sales at that level we tend to have higher margin, gross margin brands in that portfolio. So, we get a real benefit from sales mix by growing the core OTC segment.

Unidentified Analyst

Okay, great. Thank you so much.

Ron Lombardi

Thank you.

Operator

Thank you. Our next question is from Linda Bolton Weiser of B. Riley. Your line is open.

Linda Bolton Weiser

Hi, I was just curious on the A&P ratio, the A&P spending, I think you said it was – the ratio was flat in the quarter and year-to-date, you’ve been catch up down even, so how are you managing to drive consumption growth so effectively even though your A&P is kind of flattish or even down a little bit? Thanks.

Ron Lombardi

Sure. As a percent of sales it is essentially flat year-to-date 14 to 14.2% last year, 14.1% this year. So more importantly went the spending is up $10 million year-over-year, so you're really going to step back and take a look at the dollars on the year-to-date basis. But really the impact we're having on consumption growth is by concentrating our A&P investment, our new product development behind our biggest brands. So that’s what driving the consumption growth there.

And in the past couple of quarters we’ve highlighted the initiatives that we had against BC, Goody's, MONISTAT, Clear Eyes and Luden's for example of where we are focusing our efforts and we’re getting results from that concentration.

Linda Bolton Weiser

Okay and it sounds like just your tone with regards to breaking up the core versus the non-core brands and the growth rates you seem very assertive in stating those growth rates. I’m just wondering is that the result of some strategic planning process you’ve done or are you looking to accelerate innovation or just kind of what is the root of your - maybe I’m wrong, but your tone sounds just more sort of with regard to the core growing 4% to 5%, so can you just comment on that?

Ron Lombardi

Sure, it’s really consistent with the strategy and what we’ve been talking about for this business for a long time, Linda. What we've said all along is that we expect to outgrow the categories that we compete in for our Invest for Growth portion of the business. And we expect the categories to grow 1% to 2% low single digits and we expect to our A&P investments in new products to outgrow that.

And the other thing that I highlighted on the slide showing the impact of DenTek on the portfolio is that we’ve morphed our portfolio from 50% Invest for Growth to about 80% with the target of getting us to 85% over time. So really it’s just the accumulation of M&A's impact on our portfolio and a reminder that we use M&A as a brand building tool. We don’t use M&A to get bigger. We don’t use M&A to influence the financial profile and just to get more cash flow. Those are benefits that we get when we use it for an M&A tool.

Linda Bolton Weiser

Okay, that sounds good and congratulations, thanks.

Ron Lombardi

Thank you, Linda. Have a good day.

Operator

Thank you. Our next question is from Carla Casella of JPMorgan. Your line is open.

Carla Casella

Hi, one question on inventory, you said I like the chart of the consumption versus your sales and I’m just wondering can you talk about inventory levels at retailer are there any categories where you think the retailers are heavy or light on inventory?

Ron Lombardi

Yes, in general we feel pretty good about our inventory levels at retail or something we do track. Clearly the low cost whole incident levels may impact Q4 reorder levels compared to last year where it was much more robust cough/cold season. So retailers may have a little bit of inventory to get through based on current incidence levels. But generally we feel pretty good about our overall inventory levels at retail.

Carla Casella

Okay. And then you talked about growing the Invest for Growth side of the portfolio, are there any on the other side or even in there any non-core brands or categories you may consider exiting to help fund the Invest for Growth side?

Ron Lombardi

Sure, you know what we've said Carla is that we’re open to sell really any of the non-core brands if a buyer would be willing to pay a value that is equal to what our shareholders benefit from today. I think that benefit is not only EPS and cash flow, but it also adds to our M&A capacity over time. So if somebody is willing to pay a value that is equal to that we would consider selling any of the non-core brands.

Carla Casella

Okay, great. And your commentary on the debt markets is correct, you’re trading, well better than your category and rating at this point. So those markets recognize your performance.

Ron Lombardi

Thank you.

Carla Casella

That’s all I have.

Ron Lombardi

Okay, thanks Carla.

Operator

Thank you. At this time, I'd like to turn the call back to Mr. Lombardi for any closing comments.

Ron Lombardi

Thank you. We'll end the call at this point and thanks for joining us today.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your program. You may now disconnect. Everyone have a great day.

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