Revlon, Inc. (NYSE:REV) Q3 2018 Earnings Conference Call November 9, 2018 8:30 AM ET
Eric Warren - VP, Treasurer and Head, IR
Debra Perelman - President and CEO
Victoria Dolan - CFO
William Reuter - Bank of America Merrill Lynch
Grant Jordan - Wells Fargo Securities
Hale Holden - Barclays
Mary Gilbert - Imperial Capital
Carla Casella - JPMorgan
Hello, and welcome to Revlon's Q3 Quarter 2018 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Friday, November 9.
I would now like to turn the conference over to your host, Eric Warren, Vice President, Treasurer and Head of Investor Relations. Please go ahead.
Thank you, Courtney. Good morning, everyone, and thank you for joining the call. Earlier today, the company released its financial results for the quarter ended September 30, 2018. If you have not already received a copy of the earnings release, a copy can be obtained on the company's website at revloninc.com.
On the call this morning are Debbie Perelman, our President and Chief Executive Officer and Victoria Dolan, our Chief Financial Officer. The discussion today might include forward-looking statements that are based on current expectations and are provided pursuant to the Private Securities Litigation Reform Act of 1995.
Information on factors that could affect actual results and cause them to differ materially from such forward-looking statements is set forth in the company's SEC filings, including its Q3 2018 Form 10-Q. The company undertakes no obligation to publicly update any forward-looking statements, except for the company's obligation under the U.S. Federal Securities Laws.
Remarks today will include a discussion of certain GAAP and non-GAAP results. Consistent with past reporting practices, non-GAAP results excludes certain non-operating items that are not directly attributable to the company's underlying operating performance. These adjusted measures are defined in the earnings release and are also reconciled in the financial tables at the end of the release.
Please also note that certain amounts provided throughout this call have been rounded. The call today should not be copied or recorded.
And with that, we'll turn the call over to Debbie.
Thank you, Eric. Good morning, everyone, and thank you for joining us. We are all keenly aware that the pace of change in our world is ever increasing and the beauty industry is not immune to these forces. As I highlighted back in August, we are excited about the changing business landscape and view this as an opportunity for our company to drive the future of beauty and reclaim our leadership position via sustainable long-term growth. We remain focused on our 3 key strategic pillars that will drive our future success and growth.
First, strengthening our iconic brand through innovation and relevant product portfolios; second, building our capabilities to better communicate and connect with our consumers through media channels where they spend the most time, and third, ensuring availability of our product where the consumers shop both in-store and, increasingly, online.
Turning now to this morning's earnings release, we are very pleased with our third quarter business results and believe that our performance is reflective of the strength of our strategy. We continue to stabilize our business, see growth in key areas and drive improved efficiency in all aspects of our operations.
Our key business highlights for this third quarter include higher third quarter net sales on a constant-currency basis versus the prior year quarter. Adjusted EBITDA on a constant-currency basis increased 38%, representing the largest quarter-over-quarter adjusted EBITDA growth since the Elizabeth Arden acquisition in 2016.
Our biggest brands, Revlon and Elizabeth Arden, showed net sales growth in the quarter on a constant-currency basis. In North America, for example, Elizabeth Arden net sales grew 10%, while Revlon net sales grew at 6%. Continuing the trend from last quarter, we saw strong growth in segments and channels of strategic focus.
On an as-reported basis, our China business net sales were up 49% in the quarter, while net sales in our Travel Retail operation grew 25%, driven by strong Elizabeth Arden skin care demand. We are making strong progress against our digital strategy.
Our internal agency, Red House, is up and running; we have launched ElizabethArden.com in the UK and two direct-to-consumer sites in the U.S., Juicy Judy and American Crew. In the quarter, our e-commerce sales grew a strong 23% on an as-reported basis.
One of the critical capabilities that we continue to strengthen is our ability to deliver, on a sustained basis, a compelling innovation pipeline to seed our product portfolio within Revlon color cosmetics, with continued support of our ColorStay franchise with the launch of ColorStay full coverage foundation as well as adding to our lip portfolio with Kiss Cushion tint. Under our Elizabeth Arden brand, we continue to expand our Ceramide offering with the introduction of Ceramide retinal capsules.
In support of our Fragrance business, we launched Elizabeth Arden My 5th Avenue; we, by Juicy Couture; JV x NJ, a collaboration between John Varvatos and Nick Jonas; My Prerogative by Britney Spears; and Violet Noir by Christina Aguilera. Under our American Crew brand, we launched ACUMEN, our first prestige product assortment for men, which will be sold in department stores globally.
Additionally, we have demonstrated our ability to quickly identify consumer trends and deliver speed to market. For example, in collaboration with Refinery29, we were able to bring a limited-edition lip kit product to market in 14 weeks. This was one aspect of a broader partnership that will impact our ability to build the Revlon brand equity.
Next, let me provide you with an update on our Oxford plant. As mentioned on our second quarter call, our plan is back to producing a pre-SAP level, and we continue to fill customer pipelines internationally. The Oxford impact to our third quarter results was significantly lower than the second quarter, and we expect continued improvement going forward.
We remain focused on transforming and enhancing the way we do business. We are streamlining our operations, cutting costs and overhead, reducing duplication and eliminating wastes. This effort will not only improve our financial efficiency in the short- and long-term, but it will significantly speed up our operations and cusp our responsiveness.
This morning, we announced a business Optimization Program, through which we will build a stronger global business operation that will be our foundation for achieving profitable sales growth and cost efficiency. At its core, this program is focused on 3 key areas. First, optimizing our global supply chain; second, enhancing end market commercial execution; and third, reducing overhead costs and streamlining all of our operations.
I'll now hand the call over to Victoria, who will show details on the Optimization Program as well as our third quarter results before we begin Q&A.
Thank you, Debbie, and good morning to everyone on the call. Before I speak in detail about the newly announced 2018 Optimization Program, let me highlight our third quarter results. As Debbie mentioned earlier, on a constant-currency basis, net sales were up versus prior year quarter.
On an as-reported basis, net sales for the third quarter of 2018 were $655 million, a decline of 2% versus prior year quarter. We experienced as-reported double-digit net sales growth in our Elizabeth Arden segment, offset by net sales declines in our Revlon Portfolio and Fragrances businesses.
In addition to unfavorable foreign exchange, our international net sales were impacted in part by the SAP-related disruptions in the Oxford plant, which we estimate to have driven a loss of approximately $12 million in net sales during the quarter, due to long lead times associated with filling some international geographies.
Next, our selling, general and administrative expenses were down in the quarter, driven in part by lower brand support due to a re-phasing of certain marketing initiatives. The lower marketing expenses were offset by increased distribution costs associated with our continued growth in Asia.
Despite lower SG&A, we continue to invest heavily in the business via new permanent wall displays as we remain focused on improving the in-store consumer experience. We have also invested heavily in our digital capabilities, including the staffing of Red House and the formation of our dedicated e-commerce teams in various key markets.
As-reported operating income for the quarter was $2 million, compared to an operating loss in the prior year quarter of $5 million. On an adjusted basis, our operating income was $26 million for the quarter, compared to operating income of $14 million in the prior year period, driven by the lower selling, general and administrative expenses previously discussed, offset by lower gross profit margin impacted by higher commodity costs and unfavorable foreign exchange.
As-reported net loss for the quarter was $11 million as compared to our as-reported net loss in the prior year quarter of $32 million. In addition to the other drivers discussed previously, the lower net loss is attributable to a larger tax benefit due to the impact of the U.S. Tax act, partially offset by increased interest expense.
Finally, adjusted EBITDA was $72 million for the current quarter compared to $54 million in the prior year quarter. Next, I would like to turn to our segment results. Our Revlon segment net sales in the third quarter of 2018 were $250 million, which represents a 2% decline on an as-reported basis.
This decline was due mainly to lower net sales of Revlon color cosmetics, primarily internationally due to the Oxford, North Carolina service level disruption, offset by higher net sales of the brand in North America, as retailers replenish inventory levels. Revlon segment profit increased to $37 million or a 64% increase over the prior year quarter, driven primarily by lower brand support due to the re-phasing of certain marketing initiatives as we continue to look for improved productivity across all areas of spend.
For Elizabeth Arden, net sales in the third quarter of 2018 were $122 million, representing a 17% increase on an as-reported basis. This improvement was mainly driven by higher net sales of Elizabeth Arden skin care products, principally, in our international territories. Elizabeth Arden segment profit increased to $7 million from $2 million in the prior year period, driven by higher net sales, partially offset by higher distribution costs.
Net sales for our Portfolio segment were $138 million in the third quarter of 2018, a decrease of 6% on an as-reported basis. This decrease was primarily driven by lower net sales of our regional brands, partially offset by higher net sales of Almay color cosmetics as well as higher net sales of CND nail products.
Portfolio segment profit declined to $2 million from $8 million as a result of lower net sales, partially offset by lower brand support. Finally, net sales of our Fragrances segment were $145 million in the third quarter of 2018, representing a 9% decrease on an as-reported basis. This decline was driven by the loss of certain licenses in 2018 and the closure of certain prestige channel retail stores.
However, as a result of cost reductions associated with in-sourcing production capabilities as well as lower brand support due to re-phasing of certain market initiatives, Fragrances segment profit increased by 22% despite the lower net sales.
Turning to liquidity, free cash flow used in the first 9 months of 2018 was $338 million, compared to $344 million in the prior year period. The improvement in free cash flow usage was primarily driven by lower capital expenditures and changes in working capital, partially offset by lower net sales and increases in the purchases of permanent display cabinetry as well as higher interest payments. Year-to-date through Q3 2018, we spent $42 million in capital expenditures and $57 million on permanent displays.
As of September 30, the company had approximately $87 million of available liquidity, consisting of $62 million of unrestricted cash and cash equivalent, $39 million under our 2018 senior line of credit from MacAndrews & Forbes, and $1 million in available borrowing capacity under the Revolving Credit Facility less float of $13 million.
As of October 31, the company had approximately $113 million of available liquidity, consisting of $67 million of unrestricted cash and cash equivalent, $40 million under our 2018 senior line of credit from MacAndrews & Forbes, and $12 million in available borrowing capacity under the Revolving Credit Facility less float of $6 million.
This morning, we also announced the new 2018 Optimization Program, designed to streamline the company's operations, reporting structures and business processes with the objective of maximizing productivity and improving profitability, cash flows and liquidity.
We have identified three major focus areas underlying the 2018 Optimization Program. First, we will look to optimize our global supply chain to drive manufacturing efficiencies and rationalize our global warehouse network and office locations to drive greater efficiency and lower our cost base.
Second, we will enhance in-market execution by optimizing our commercial and organizational structures to create more effective global and regional capability.
Third, we will reduce overhead costs and streamline functions by leveraging technology and shared services and standardizing and simplifying our business processes, leading to greater agility and, more importantly, faster decision-making. We expect that the actions to be implemented under the 2018 Optimization Program will be substantially completed by December 31, 2019. And it is currently projected to result in annualized cost reductions in the range of approximately $125 million to $150 million by the end of 2019.
In connection with implementing the 2018 Optimization Program, we expect to recognize approximately $30 million to $40 million of total pretax restructuring and related charges, consisting of employee-related costs, such as severance, pension and other termination costs, as well as related third-party expenses.
Of the restructuring charges, we anticipate that we will record in the fourth quarter of 2018 an estimated pretax restructuring charge of approximately $8 million to $10 million with the balance to be recognized in 2019. Approximately 85% of the restructuring charges are expected to be paid in cash with approximately $6 million to $8 million expected to be paid in 2018 and $20 million to $26 million in 2019.
Lastly, we also expect to incur approximately $10 million of additional capital expenditures as part of the 2018 Optimization Program.
I'll now hand the call over to Debbie for closing comments before we begin Q&A.
Thank you, Victoria. In closing, we are pleased with our third quarter results and the growth across our key strategic focus areas. With the launch of our new 2018 Optimization Program, we are reallocating and realigning our resources in order to build new capabilities in higher-priority growth areas, improving the productivity of our spend and continuing to drive operational efficiencies, which will ultimately lead to increased long-term profitability, improved cash flow and a stronger liquidity position.
With that, we will now open up the call for questions.
We will now begin a question-and-answer session. [Operator Instructions] Okay. Our first question comes in from the line of Bill Reuter calling from Bank of America Merrill Lynch. Please go ahead.
Good morning. I know you guys have stopped talking about or giving us updates on the old cost savings program or, at least, the integration savings from Elizabeth Arden. But, I guess, is that process now complete? And I assume that this new cost savings program is on top of those previously achieved synergies. Is that right?
Thank you for the question. Yes, the Elizabeth Arden -- all of the activities associated with the Elizabeth Arden integration program have either been completed or are in process. As you noted, we stopped giving guidance on the savings a while ago. We'll see some residual costs come through, through the end of 2020, but they're substantially complete.
As we think about our 2018 Optimization Program, we really are looking at the company as now a combined company and looking for the areas where we can align our resources and optimize our structure as well as the productivity across all of the lines of the P&L. So we have gone back to looking at specific projects that will do that, and so yes, you are correct, this is on top of whatever we were doing with the integration program.
Okay, that's good to hear. And then you've spoke about as G&A being lower and somewhat -- or largely driven by lower marketing costs. I'm wondering whether these will continue to trend lower going forward or whether there were some timing changes so these will actually revert back to higher levels.
So as you know we don't give forward guidance. So I think what we said in Q3 was this was, in large part, about re-phasing the marketing spend to align with activities that were happening in this market as well as when the supply was in market as we recover from Oxford, North Carolina.
Okay. And then just lastly for me when you were talking about Revlon in North America, you talked about retail replenishment, which offset some declines in international regions. Where there -- I guess, was this an issue of timing? When I look at the Nielsen data in North America, it still suggests that sales are down a little bit for the brand. However, obviously, your sales into the channel were up. So, I guess, was it new products? Or if you can speak a little bit about timing issues with shipments.
Absolutely. So it is actually a mix. So there is a piece that is related to the Oxford recovery and supply into the market and pipeline refill, but a portion of it is also just regular business. So if you look at the trends over the past four to five weeks of the Nielsen, you'll see an uptick with regard to consumption.
Great. That's all for me. Thank you.
The next question comes in from the line of Grant Jordan calling from Wells Fargo. Please go ahead.
Good morning. Thanks for taking the questions. First one is a follow-up on the brand support spending. Was that a pullback, mostly, around the Revlon brand in North America?
No, I think it was across the board as we looked at the productivity of our spend as well as promotional activities. It was across the board.
Okay. And then just -- is there -- do you anticipate a change in how you market your brands going forward, like is this kind of a new run rate?
So we are always looking at the effectiveness of how we market, and we're always looking at new ways to optimize how we go-to-market. So I wouldn't say that it is a massive shift in how we're going to market, what I will say is that we are continually looking to optimize.
Okay. And then looking at the gross margin line, obviously, revenue came out a bit better than where it's been trending, but the gross margin was down in the quarter. Were you surprised not to see more of a lift there?
As we think about our gross margin in the quarter on an as-reported basis, it was down, as you saw, the 290 basis points. When we strip out some of the one-time items, it was actually down 90 basis points. And as we alluded to in the call, some of that, is we are seeing some impact from higher commodity costs, we had some negative impact from foreign exchange fluctuation.
We did take the higher obsolescence reserves, but that was offset by the benefits that we had in terms of the Elizabeth Arden in-sourcing as well as some lower sales returns. So our run rate margin we're pretty comfortable with and it was not down as much, certainly, as the headline number.
Okay. All right. And then my last question, you finished the quarter, you gave a liquidity update, but you've kind of -- thinking in the next year in terms of liquidity, you could see some areas where you might have the need for more cash. Is that something you're anticipating right now?
So we're constantly looking at our liquidity position. We are comfortable where we are. You saw that from the end of September to the end of October, our liquidity position went up by $26 million. And Q4 is, traditionally, because of the seasonal nature of our business, the quarter where we generate the most cash. So we are comfortable.
Right. Yes, I was thinking more like Q1, Q2 of next year.
We are comfortable with our liquidity position.
The next question comes in from the line of Hale Holden calling from Barclays. Please go ahead.
Good morning. Thank you for taking the call. I had a question on the cost out 2018 program. So Victoria, I heard you say it was $6 million to $8 million in cash costs in 2018, and $20 million to $26 million in 2019. And it seems like a very low cash burden for, potentially, $150 million in savings by the end of the year. I was wondering if you could just maybe give us some more color on some of the moving pieces there, then I have a follow-up.
So thank you for the question. I think that's a good question. As we look at the projects and the initiatives that make up that $125 million to $150 million, some of them involve cash charges, as I described, and some of them don't. Some of them are more around, for example, just looking at the efficiency of our existing plants and things that we can do within the existing plants that may not have a specific restructuring charges associated with them.
Okay. And then just because you alluded to it in Grant's question, is there anything that would change a typical Q4 working capital build back to the company? I wasn't quite sure if the distribution changes over the summer had changed the flow through that you were expecting this year, if it could be greater or not in the fourth quarter and would be historically seasonal?
So as I said, Q4 is historically the quarter where we have seen the pattern of that's where we generate our cash as well as our inventory levels come down. Q3 inventory levels are the peak for the year, so we don't see anything different from that. That's why -- and that's how we get as comfortable as we are with our liquidity position.
Okay. Thank you very much for the time. I appreciate it.
The next question comes in from the line of Mary Gilbert calling from Imperial Capital. Please go ahead.
Yes. Good morning and good quarter. I had a couple of questions with regard to, one, Almay. You noted that Almay was up. So I wondered how we consider the growth because you doubled your shelf space in Ulta. And then any updates in terms of shelf resets going forward? And then how we read that with the Nielsen data, given that there was a reduction in sales shelf space in Walgreens.
And then also with Revlon, I wondered if there's any update that you can give us in terms of the pace of new innovation? And you noted that, in the later stage, that we're going to see an increase in consumption. So it sounds like we'll continue to see favorable sales there, is that correct? And then, finally, with regard to Portfolio segment and then some of the local brands where you saw some weakness, what kind of opportunities do you see there?
Thank you. Thank you for the question. So why don't we start with Almay. We continue to be encouraged by the results with Almay, particularly around some of the new products that we put into market around the lip category and the eye category, and we feel strongly that the brand resonates with the consumers today.
With regard to Revlon and new innovation, we have, as mentioned on the call, we have seen encouraging -- also encouraging results from our new innovation in the face category as well as the lip category. And as I did note, you'll see an increase, which is reported in Nielsen, in consumption. And with regard to portfolio, there is opportunity with regional brands, and we continue to be focused on how to optimize that.
Okay. And then do we have an update on Flesh and how that's going? And do you see any expansion in terms of the number of doors within Ulta?
So we, obviously, are very excited about Flesh and encouraged by the results that we see today. We're seeing that it is doing what we expected it to do and more with regards to the digital engagement as well as attracting the young millennial consumer as well as being a partner with Ulta on developing a brand. Currently, I'm not going to comment on any expansion within Ulta, but what I will say is we're very pleased with the results, both in-store and online.
Okay. And any commentary around margin profile around that brand? And then also, is there any opportunity, given the costs increases? Sorry.
Sorry, could you repeat the question?
Yes. Are there any opportunities given the cost increases and some of the challenges there that you're experiencing to improve the margin profile going forward?
Well, it's certainly something we look at all the time because, obviously, the margin is pivotal to our P&L and our overall financial success. I think as we think about the 2018 Optimization Program, 75% of those savings are going to impact cost of goods, so it's definitely something that we are looking at and looking at ways of mitigating those increases.
Okay, great. Thank you very much.
The next question comes in from the line of Carla Casella calling from JPMorgan. Please go ahead.
Hi. First question is on the facility. It sounds like it's up and running back to normal schedule. But I'm trying to reconcile, you called out in the press release a $4 million sales impact. But in the discussion, you commented on $12 million. What's the difference there and what's the actual add-back for the $4 million?
So the $12 million was specifically for international -- our international markets. The $4 million is net, globally, where we take -- where we offset any impact with pipeline refill we've seen.
Okay. So that is -- so the $4 million, is that sales that you should have gotten back after quarter-end or is that sales that you should get back next year? Is that just orders you weren't able to fill, is that how should we think about it?
No, no, that -- no, no, no. I'm sorry, that $4 million -- so there are two issues here. One is that there are -- that's why I talked about the $12 million that is lost -- we estimate to be lost business in international because of the long lead times to get there.
When we think about the net impact on net sales, relative to pipeline refills, et cetera, it had a very negligible impact for the quarter. However, we did incur $4 million in customer charges associated with some late deliveries. And that -- I think that's what you're alluding. So there are 2 separate impacts of that. One is replenishment and supply, and the other was around customer charges.
Great, that's very helpful. And then you mentioned that you increased brand support -- I'm sorry, decreased brand support this quarter. That was a pretty significant decrease. Is that just a shift? Should we see that going forward or is that just a shift that you're moving out of SG&A and more into displacement?
Well, I think as we talked about, a lot of it was re-phasing, given the timing of activities in-market as well as the supply availability in-market. And I think as Debbie said also, we're looking at the productivity of our spend and our total commercial spend and making decisions around whether it is in the gross to net or whether it's in brand support or whether it's in permanent cabinetry and targeting spend by market by brand that has the highest ROI.
Okay. And then, I think someone asked a question already on liquidity. But more specifically, are you able to raise more debt internationally? I mean, you did this in the international line this quarter, there's a lot of international assets. Do you have more borrowing availability internationally or is that not as easy -- easily said than done?
So we really don't comment on what our plans are relative to what we're going to do in terms of incremental funding. As I said, we're comfortable with our liquidity position as it stands.
Okay. Maybe just one last thing, if you look at Portfolio brand, I know that includes quite a wide range of brands. Can you just give us a sense of what are some of the biggest needle movers in there, I mean, you talked about American Crew and some initiatives and new products there. Is that enough to really move that portfolio or is that portfolio really broadly spread?
So when you look at Portfolio brands, it includes Almay, CND and American Crew as well as the regional brands. But the three that I mentioned first are the ones that, as you call, the needle movers, right? So with regards to American Crew, our partnership with Harley-Davidson as well as the launch of ACUMEN are helping to drive that brand. If you look at CND, we had a launch of Shellac Lux as well as our continued expansion with [indiscernible 34:31], and I discussed Almay.
Great. Thank you.
The next question comes in from the line of Grant Jordan calling from Wells Fargo. Please go ahead.
I just had a follow-up, and I do appreciate all the detail you've given today on the call. On your comment on Nielsen, were you saying that you think it's going to inflect the trend positive or will it actually turn positive?
No, no, I'm looking at the past five weeks, if you look at the past 5 weeks or the past 4 weeks, not looking at projecting forward.
Okay. I guess, we don't have that reported yet because the last data set we had was still negative.
The trend is turning.
Okay. Turning like greater than zero or just turning more -- turning better than what has been trending?
Turning better what has been trending.
Okay. Thank you. That's what I need.
Seeing no additional questions, let me say thank you to all who joined the call today and a special note to our team members around the Revlon world who are listening. Thank you for all the efforts you make every single day, especially your contributions in driving our strong results this quarter.
I am proud of all that we've accomplished together and excited about our future as we strive to build an even stronger global business operation that will be our foundation for achieving long-term profitable growth. Thank you.
This does conclude the conference call for today. Please disconnect your lines, and thank you for participating.