Earnings Call Transcript - EPC Q3 2020

Operator, Operator

Good morning and welcome to the Edgewell conference call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to the speakers. Please go ahead.

Chris Gough, VP of Investor Relations

Good morning, everyone. This is Chris Gough, VP of Investor Relations. Thank you for joining us this morning as we discuss Edgewell's Third Quarter 2020 Earnings and the CREMO acquisition. With me this morning are Rod Little, our President and Chief Executive Officer; and Dan Sullivan, our Chief Financial Officer. Rod will kick off the call and he will hand it over to Dan to discuss our results, and we will then transition to Q&A. This call is being recorded and will be available for replay via our website. In addition to the comments we're making on this call, we have posted several supplementary slides to our website that provide additional information on our quarterly results and the acquisition of CREMO. During the call, we may make statements about our expectations for future plans and performance. This might include future sales, earnings, advertising and promotional spending, product launches, savings and costs related to restructurings, changes to our working capital metrics, currency fluctuations, commodity costs, category value, future plans for return of capital to shareholders and more. Any such statements are forward-looking statements, which reflect our current views with respect to future events. These statements are based on assumptions and are subject to various risks and uncertainties, including those described under caption Risk Factors in our annual report on Form 10-K. These risks may cause our actual results to be materially different from those expressed or implied by our forward-looking statements. We do not assume any obligation to update or revise any of these forward-looking statements to reflect new events or circumstances, except as required by law. During this call, we will refer to certain non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures are shown in our press release issued earlier today, which is available at the Investor Relations section of our website. Management believes these non-GAAP measures provide investors with valuable information on the underlying trends of our business. With that, I'd like to turn the call over to Rod.

Rod Little, CEO

Thanks, Chris, and hello, everyone. I hope everyone is doing well and staying safe and healthy as we work our way through this pandemic. Today, I'll begin my remarks by providing an update on the current environment and its impact on our results. I'll then discuss our third quarter performance and the progress we continue to make on our strategic initiatives before finishing with the announcement we made earlier this morning about our intent to acquire CREMO. Dan will then review our financial results in more detail, provide further details on the planned CREMO acquisition, and share some thoughts on how we are approaching the final quarter of our fiscal year. Since we last spoke, the pandemic has spread across the globe with far-reaching impact in the categories in which we compete, and therefore on our business, as you saw in our results posted earlier this morning. COVID-19 had a considerable impact on our sales in our core categories in the quarter. The difficult conditions we saw in April worsened in the month of May with some moderation in June. Within this challenging environment, characterized by significant declines across all of our categories, I'm encouraged by many elements of our relative performance. In the U.S., we saw strong market share gains in our Sun Care and preps businesses and stabilization in branded wet shave. Wet Ones saw another quarter of accelerated growth and market share gains. Internationally, we drove gains in our Wet Shave business in Japan, which is our second largest market, as well as improving share performance in Europe. We remain focused during this challenging period on three key priorities: first, the health and safety of our colleagues; second, ensuring the continuity of our business operations and providing the best possible service to our customers; and third, managing the business in a disciplined and balanced manner while ensuring we continue to invest in the long-term success of the company. We've made progress on all of these priorities. With the health and safety of our associates being our number one priority, the protocols we put in place as far back as December of last year have helped ensure the ongoing safety and well-being of our colleagues. The steps taken to ensure safe operations at our manufacturing plants maintain the continuity of production and availability of essential products to consumers. Therefore, all of our global manufacturing plants and distribution centers remain open and fully operational. We are also slowly beginning the process of bringing our teams back to offices around the world on a voluntary basis. The significant impact of COVID-19 was evident in our organic net sales decline of 14.7% in the quarter. However, we estimate that excluding COVID-19 impacts, the business continued on a flat to slightly down top-line trend. Organic sales in the quarter were most negatively impacted in Sun Care, as store traffic, holiday travel, resort business, and outdoor activities were significantly curtailed by COVID-19. Sun Care, which represents approximately 20% of total company sales, accounted for nearly half of the year-over-year decline. Leading into the Sun Care season, I was pleased with our preparation and execution, highlighted by strong innovation, robust shelf-positioning across the channels, solid off-aisle placements, and strong initial in-stock positions, while successfully implementing a 5% increase in price across the U.S. mass and drug channels. Though COVID-19 has now meaningfully impacted the overall category, the 370 basis points of share gains we realized in the U.S. in the third quarter offer some validation of our strong execution and position us well as the category returns to more normal conditions over time. Wet Shave was also impacted by COVID-19 and the resultant stay-at-home trends that are headwinds to shaving regimens, with organic net sales declining 14% in the quarter. Rounding out the Sun and Skin Care segment, we had strong organic sales growth in Wet Ones, increasing 52% over the prior year and 6% over the prior quarter, while remaining on track to add additional capacity in the coming weeks. Feminine Care saw a reversal of last quarter's pantry load as well as the impact of expected distribution losses. From a market share perspective, we are in a more stable position than we were a year ago. During the most recent 12-week period, we've seen market share growth in razors and blades in Asia; fairly stable and improving trends in Europe; and although the U.S. branded business is still declining, share losses have stabilized and are in line with the 52-week trend despite lost distribution in Sam's Club and further competitive rollouts. As we reflect on the quarter, we are cautiously optimistic that April and May will prove to be the most severely impacted months of the fiscal year, given slowing rates of top-line decline in June as well as quarter-to-date in our fiscal fourth quarter. However, there remains a great deal of uncertainty and volatility that we are carefully monitoring and will need to continue to navigate. To effectively operate in this environment, we continue to manage the business in a highly disciplined and balanced way, making choices and focusing on key priorities that are most relevant in the near-term, while continuing to advance the strategic priorities that will drive our long-term success. We tightly managed discretionary spend as the quarter evolved, reassessed trade investment, and prioritized investments where we believed impact and return would be the strongest. With respect to our growth investments, we continue to invest in e-commerce and R&D, adding critical capabilities across both organizations. We are operating from a position of strength in terms of liquidity with a healthy balance sheet and over $100 million in operating cash flow generation in this COVID-impacted fiscal third quarter. During quarter 3, we also successfully refinanced our 2021 notes with a high-yield upsized offering, reflecting continued confidence in our business. In 2020, our commitment and performance were recognized as Newsweek ranked Edgewell as one of America's most responsible companies. In the third quarter, we unveiled our Sustainable Care 2030 strategy, establishing ten bold ambitions for the next decade and reinforcing our role in creating a sustainable future. Importantly, I have finalized the reshaping of my management team, a process that began upon my appointment 15 months ago. We recently announced Eric O'Toole as our new President of North America. His extensive experience and digital expertise will be instrumental as we continue to innovate and reshape our portfolio. We also appointed Nick Powell as our new President of International, providing tremendous global experience and a proven track record for delivering results. We are thrilled to announce our intent to acquire CREMO, a brand that represents a great strategic fit as we expand our business in the fast-growing U.S. men's grooming category. CREMO is one of the strongest and fastest-growing masstige brands in personal grooming, offering a complete line of products across the personal grooming category. This brand will reinforce our broader insurgent playbook, offering us unique portfolio options to meet a variety of consumer needs. Dan will talk more about the strategic fit and opportunity in a few moments. In summary, though the environment remains uncertain, we continue to manage the business with strong discipline, and we are pleased to be driving trend improvement in our market share position across our key categories. Over the last 12 months, we have seen an underlying stabilization of our top-line and gross margin profiles, the current COVID environment notwithstanding. This has always been an important first step in reshaping our business. And I’m pleased with our progress to date, recognizing that work remains. Importantly, we have been diligently working to develop and refine the go-forward stand-alone strategy for Edgewell. This work is progressing well, and we plan to discuss it in more detail in calendar Q4. Before turning the call over to Dan, I want to thank our teams across the company for their focus and effort. Together, we are excited to push forward and execute on the next chapter of growth for Edgewell. And now I’d like to ask Dan to take you through our fiscal third quarter results and discuss CREMO in more detail.

Daniel Sullivan, CFO

Thank you, Rod, and good morning, everyone. As Rod discussed, within this highly uncertain environment, we continue to manage the business with discipline, focused on our core priorities: execution against our commercial and operational opportunities, strengthening the balance sheet, maximizing our brand-building investments, and executing on Project Fuel. While the results for the quarter reflect the unique circumstances of this COVID-19 environment, we continue to make solid progress against these core priorities. Our top-line performance was largely the result of COVID-related systemic category declines. We are cautiously optimistic that April and May will prove to be the most significantly impacted months of the fiscal year. Organic net sales in April decreased 15%, followed by a 19% decline in May and an 11% decline in June. July trends have further improved with net sales running down in the mid-single-digits year-over-year. While we continue to see strong performance in both Wet Ones and Men's Grooming, the expected distribution losses in Wet Shave and Fem Care continue to be headwinds to our Q3 sales results. Our gross margins were significantly impacted by COVID-19, both in the direct one-time costs incurred as well as in the negative mix effect caused by the significant shift in category performance. Adjusted operating income, excluding the impact from the Infant and Pet Care divestiture, decreased significantly. Project Fuel efforts continue to drive cost savings and increase operational efficiency across all areas of our business. Our balance sheet and free cash flow remain strong, with nearly $118 million in cash from operations year-to-date, which reflects improved working capital performance. Organic net sales in the quarter decreased 14.7%, largely driven by the ongoing COVID-19 impact on consumer demand, particularly in our Wet Shave and Sun Care categories. Excluding these effects, we estimate that the underlying organic top-line run rate for the business in the quarter was flat to slightly down. Looking at our performance by segment, Wet Shave organic net sales decreased 14% in the quarter, largely driven by significant COVID-19 related category declines globally. By region, North America organic net sales decreased 16%, while international markets decreased 13%. For the 12-week period, our market share in razors and blades declined 190 basis points, reflecting recent loss distribution at Sam's Club, heightened competitive pressures, and negative channel switching. However, we were pleased with the launch of our new Hydro Silk and Intuition campaigns. Our market share performance improved in Japan and Europe amidst competitive pressure. Sun and Skin Care organic sales decreased nearly 19%, inclusive of a 30% organic net sales decline in Sun as global demand was significantly impacted by COVID-19 in the quarter. Men's Grooming increased 5%, driven by Bulldog, which benefited from strong e-commerce sales and new distribution. Rounding out the segment, Wet Ones organic net sales increased 52%, and we anticipate that this brand will approach $100 million in sales for fiscal 2020 or approximately 65% year-over-year growth. Our gross margin rate decreased 200 basis points year-over-year, while advertising-related costs were flat as a percentage of net sales. SG&A was approximately 2 million below the same period last year, driven primarily by lower travel and discretionary spends. The increase in income during the third quarter was largely related to favorable revaluation of balance sheet exposures, driven by currency recoveries. Our net cash from operating activities was $101 million for the quarter, with a strong free cash flow profile. We've continued to take the necessary steps to ensure that we maintain our strong financial position, and we are very well positioned to continue to weather near-term challenges while also investing in growth. The Men's Grooming category and the soft goods market represent a strategic focus for us. Our confidence in the business's future and the CREMO acquisition demonstrates our commitment to this growth area. This all-cash transaction is expected to close by the end of our fiscal Q1 2021 and is subject to customary closing conditions. As we look ahead, the environment remains highly uncertain, and we are not providing a financial outlook at this time. However, we saw sequential top-line improvement in this business across Q3, signaling a positive trend as we move forward.

Rod Little, CEO

So, Chris, can you hear me? It sounds like we've lost Dan. I'm going to pick up where he left off and then close out before we go to Q&A. The heightened level of uncertainty in today's environment likely suggests a wider range of potential outcomes than normal. While we expect to continue to see headwinds in gross margin associated with COVID-related costs and negative category mix, we also anticipate tailwinds from further fuel savings, favorable commodity costs, and lower promotional intensity. We will continue to invest behind our key strategic priorities to ensure that we are creating and solidifying our platform to support sustainable growth. We have been working tirelessly to reposition the Edgewell business. We've stabilized the underlying top-line and gross margin profiles, and while the headwinds associated with COVID-19 significantly impacted our reported results in the quarter, our underlying progress has continued. Our global Wet Shave business is on the most solid footing that we've seen in quite some time. It's clear that the focus on personal hygiene continues to benefit our Wet Ones brand. And we are quickly approaching a $100 million brand with plans in place to meet ongoing increased consumer demand. It’s clear that this fundamental shift in consumer behavior is not transitory, and we are well positioned to capture further growth in 2021 and beyond. This profitable brand CREMO will further strengthen our position in the fast-growing soft categories of the Men's Grooming segment. It's difficult to look past these volatile days of COVID-19, but we see a business that is operating more effectively, driven by a more stable top-line and gross margin profile. We're committed to the continued transformation of the business and are convinced that we are on the right path. I’ll turn the call back over to the operator for questions.

Operator, Operator

Thank you. We will now proceed with the Q&A session. Our first question comes from Bill Chappell, SunTrust Securities. You may proceed.

William Chappell, Analyst

Thanks, good morning. Can you hear me?

Rod Little, CEO

Yeah, hey, Bill. Good morning.

William Chappell, Analyst

Sorry, it seems like a couple of the technical difficulties, just checking in. Hey, Rod, I guess, on Wet Shave, and I understand that you're going to unveil broader plans for the strategy in a few months. But can you just help us understand how CREMO kind of fits in? Is this the last piece of multiple acquisitions to kind of fortify the business? Do you need to do more? Are there other more organic plans expected? I'm just trying to understand maybe a little bit of a preview of what you're expecting for Wet Shave kind of long-term strategy?

Rod Little, CEO

Yeah, thanks, Bill. And apologies to you and others on the line with the technical difficulties. We're confident that Wet Shave in particular, and broader grooming, is still a great place to play and a good place to be in business. We think that category will return to normal, which would be a flattish to slightly positive sales line for blades and razors. There's a lot of growth in those grooming categories as more and more men use more products in their daily regimens. This acquisition into that area around grooming is a key piece for us. This is an acquisition into a category where we think we can perform very well. And this is part of the story to regain credibility and confidence with both end consumers and retailers. We are addressing the leaky bucket with urgency and building brands that resonate better with the consumers. So the strategy is going to be focused on doing all of those things, and again, CREMO is a key piece for us.

William Chappell, Analyst

Okay. And then, Dan, if you're on the call, just a follow-up on Sun Care. Did the June quarter - do you have excess inventory that now sits through next year? Did you accrue for returns that will happen this quarter? And just kind of understand if there's any lingering impact for the weak Sun Care season and how that carries over into 2021?

Daniel Sullivan, CFO

Sure, absolutely. No, look, Sun Care is always a difficult category to model. There's always a difficulty in the model, obviously made harder by COVID. But we feel really good about our inventory position. We feel really good about the state of the product at trade. We don't anticipate heightened returns, risk, or accruals. We've been monitoring this obviously quite closely over the course of the last 6 to 8 weeks, in particular, and will continue to do so, so no, we don't anticipate Q4 or looking into 2021 with heightened risk. We've taken the appropriate provisions.

William Chappell, Analyst

Great. Thank you.

Chris Gough, VP of Investor Relations

Operator, next question, please?

Operator, Operator

Our next question comes from Kevin Grundy, Jefferies. You may proceed.

Kevin Grundy, Analyst

Hey, good morning, everyone. Thanks for taking the question. I wanted to start off with the decision not to formally reinstitute guidance this year. But at the same time, given a challenging quarter, a number of HPC companies have reinstituted the practice of providing guidance and instilling some confidence in the shareholder base. Rod, you talked about some recalibration in the Wet Shave strategy, which I think people appreciate. Maybe just talk about the biggest areas of variability and the decision not to formalize guidance here for the remainder of the year?

Rod Little, CEO

Yeah. Dan, go ahead.

Daniel Sullivan, CFO

Yeah, I think it is simply a recognition that the uncertainties that surround COVID far outweigh the knowns and the certainties. The sequential improvement we are seeing gives us some confidence. We also are seeing a bit more stability in the margin profile of the business. There are still headwinds related to COVID, for sure. We anticipate slightly less impact from category shift in the margin profile. We are confident we'll be generating positive tailwinds from our continued cost savings, higher commodity prices, and lower promotional intensity.

Kevin Grundy, Analyst

Okay. I appreciate the color. I'll pick up with Chris off-line. Just while I have you guys on the CREMO deal, how that came about maybe some financial information, EBITDA in that business? You did mention it was profitable growth rate, what you think you can do with this in terms of revenue and cost synergies and where you see sort of the biggest opportunities from a distribution perspective?

Rod Little, CEO

Yeah. Kevin, I'll start, and I'll throw it over to Dan for some of the specifics. How it came about? We had the FTC block our transaction with Harry's, and coming out of that, we were always very interested in increasing our exposure around men's grooming. This transaction will allow us to expand into the soft goods market where we see significant double-digit growth happening across the category. So again, we are confident we can create a lot of value here.

Daniel Sullivan, CFO

Sure. Yes. The top-line of this business is extremely attractive, reaching $58 million in TTM sales in June. The expansion opportunities we have are substantial, and we see quite a bit of opportunity for this brand both in current distribution channels and geography.

Kevin Grundy, Analyst

Okay. I appreciate the color, guys. Good luck.

Rod Little, CEO

Thank you.

Chris Gough, VP of Investor Relations

Operator, next question, please?

Operator, Operator

Next question comes from Mr. Jason English, Goldman Sachs. You may proceed.

Jason English, Analyst

Thank you. So the underlying market share trends are encouraging. Meanwhile, it doesn't appear reflective in your valuation. Can you agree with that kind of conceptual math? And do you think it's possible to scale CREMO to the expected revenues? And what’s the pathway?

Rod Little, CEO

Yeah, good morning, Jason. Fair question. We are looking at capital allocation considering our organic needs, smart, disciplined acquisitions, and potential share repurchases. We are confident we can create a lot of value here, and we spent a lot of time looking at that and going through the assumptions. We feel like this is the right choice for our shareholders.

Jason English, Analyst

Okay. I appreciate that. That’s helpful.

Chris Gough, VP of Investor Relations

Thank you, operator. Next question, please?

Operator, Operator

Our next question comes from Faiza Alwy, Deutsche Bank. You may proceed.

Faiza Alwy, Analyst

Yeah, hi, good morning, everyone. So I wanted to talk a little bit about investment spending and sort of where you are in that process. Can you give us a preview because it seems that a lot of your competitors have been spending significantly behind the category? So it seems like the cost of growth is increasing. And I wonder how you were thinking about it?

Daniel Sullivan, CFO

So on the investment side of the business, we obviously made significant steps to prioritize in the quarter. We feel like we invested at the right level, but importantly, invested behind the right priorities. Yes, the answer to that is yes. We are going to continue to run this business with the same level of focus and effort on productivity and efficiency.

Faiza Alwy, Analyst

Okay. That's helpful. But do you think for longer term, do you think that you need to further increase your A&P spending?

Daniel Sullivan, CFO

We do, and we still maintain a leaning instance when it comes to investments behind the right strategic priorities.

Faiza Alwy, Analyst

Okay. Thank you.

Chris Gough, VP of Investor Relations

Thank you. Operator, next question, please?

Operator, Operator

Our next question comes from Olivia Tong. You may proceed.

Olivia Tong, Analyst

Great. Thanks. First, I want to ask about Wet Shave and just the competitive environment. And then, assuming that the COVID impact turns into recession challenges over time, can you talk about your expectations of your business in terms of branded versus private label performance?

Rod Little, CEO

On Wet Shave, the competitive environment remains high, and we have a lot of respect for the competition. Despite the competition, we are seeing better execution and performance within the space we have. We think our portfolio sets up well in a recessionary environment. Our branding focuses on mid-tier and value segments, so we are confident in our portfolio and price points.

Olivia Tong, Analyst

Got it. Thanks. And then just one follow-up. How much do you think COVID-related costs impacted SG&A in particular?

Daniel Sullivan, CFO

The COVID impact outside of sales hit us most significantly in gross margin. We made conscious choices to pull back on non-discretionary and discretionary spend, while still investing in talent and capabilities that are essential for growth.

Olivia Tong, Analyst

Thank you.

Chris Gough, VP of Investor Relations

Thank you. Operator, next question, please?

Operator, Operator

Next question from Nik Modi, RBC Capital Markets. You may proceed.

Nik Modi, Analyst

Thanks, good morning. I was hoping you can just talk a little bit about the share progress that you've made, helping us understand some of the underlying dynamics here.

Rod Little, CEO

The share position we are seeing has little to do with distribution gains. We've been working hard on our execution and messaging, particularly on our women's portfolio where we are growing share rapidly on platforms like Amazon. We are addressing the leaky bucket urgently, and we're confident that we can hold distribution and build some back as we move forward.

Nik Modi, Analyst

Thank you, very helpful.

Chris Gough, VP of Investor Relations

Operator, next question, please?

Operator, Operator

Next question comes from Jonathan Feeney, Consumer Edge. You may proceed.

Jonathan Feeney, Analyst

Good morning. Thanks very much. I wanted to clarify an earlier comment. When you said your portfolio share was flat, is that flat ex-distribution losses? Like across all of your brands and businesses in the U.S., you're saying your share was flat. Could you clarify that?

Daniel Sullivan, CFO

Yes, that's exactly what it is. So if you take the U.S. portfolio in totality, the categories in which we compete, share was flat.

Jonathan Feeney, Analyst

Got you. And that ties to Rod's comment in the prepared remarks about share gain for Hydro franchise excluding distribution losses, is that right?

Rod Little, CEO

Yes, that’s right. Are we happy about where we are versus plan ex-COVID around share? Yes. Are we happy with much else relative to where we are overall? No, we're very dissatisfied, particularly in Wet Shave. We are very hungry to change that.

Jonathan Feeney, Analyst

Thank you very much.

Rod Little, CEO

Thank you.

Chris Gough, VP of Investor Relations

Thank you, operator. Next question, please?

Operator, Operator

Thank you for holding. We will now proceed with the Q&A session. Our first question comes from Bill Chappell, SunTrust Securities. You may proceed.

William Chappell, Analyst

Thanks, good morning. Can you hear me?

Rod Little, CEO

Yeah, hey, Bill. Good morning.

William Chappell, Analyst

Sorry, it seems like a couple of the technical difficulties, just checking in. Hey, Rod, I guess, on Wet Shave, and I understand that you're going to unveil broader plans for the strategy in a few months. But I mean, can you just help us understand how CREMO kind of fits in? Is this the last piece of multiple acquisitions to kind of fortify the business? Do you need to do more? Are there other more organic plans expected? Or I'm just trying to understand maybe a little bit of a preview of what you're expecting for Wet Shave kind of long-term strategy?

Rod Little, CEO

Yeah, thanks, Bill. And apologies to you and others on the line with the technical difficulties. I was concerned for a moment that Dan wasn't going to be able to rejoin. But we're confident that Wet Shave in particular, and then broader grooming, so the Skin Care regimen and that whole category is still a great place to play. We are seeing the category return to normal in the future. This acquisition into that area around grooming is a key piece of our strategy. So CREMO is a part of our execution around growing share in the grooming segment.