Earnings Call Transcript - WDFC Q3 2021

Operator, Operator

Good day, and welcome to the WD-40 Company Third Quarter Fiscal Year 2021 Earnings Conference Call. Today’s call is being recorded. All participants are in a listen-only mode. At the end of the prepared remarks, we will have a question-and-answer session. I would now like to turn the presentation over to the host for today’s call, Ms. Wendy Kelley, Director of Investor Relations and Corporate Communications. Please proceed.

Wendy Kelley, Director of Investor Relations and Corporate Communications

Thank you. Good afternoon and thanks to everyone for joining us today. On our call today are WD-40 Company’s Chairman and Chief Executive Officer, Garry Ridge; Vice President and Chief Financial Officer, Jay Rembolt; and President and Chief Operating Officer, Steve Brass. In addition to the financial information presented on today’s call, we encourage investors to review our earnings presentation, earnings press release and Form 10-Q for the period ending May 31, 2021. These documents are available on our Investor Relations website at investor.wd40company.com. A replay and transcript of today’s call will also be made available at that location shortly after this call. On today’s call, we will discuss certain non-GAAP measures. The descriptions and reconciliations of these non-GAAP measures are available in our SEC filings, as well as our earnings presentation. As a reminder today’s call includes forward-looking statements about our expectations for the company’s future performance. Of course, actual results could differ materially. The company’s expectations, beliefs and projections are expressed in good faith, but there can be no assurance that they will be achieved or accomplished. Please refer to the risk factors detailed in our SEC filings for further discussion. Finally, for anyone listening to a webcast replay or reviewing a written transcript of this call, please note that all information presented is current only as of today’s date, July 7, 2021. The company disclaims any duty or obligation to update any forward-looking information whether as a result of new information, future events or otherwise. With that, I’d now like to turn the call over to Garry.

Garry Ridge, CEO

Thank you, Wendy. Good day and thanks for joining us for today’s conference call. We hope that you and your families are staying safe and healthy. Our tribe continues to work together through the challenges and opportunities associated with the COVID-19 pandemic. In the third quarter, we experienced unprecedented demand for our maintenance products, and today, we reported net sales of $136.4 million for the third quarter of fiscal year 2021, up 39% compared to the third quarter of last year and a new all-time record quarter. The pandemic has created both headwinds and tailwinds for our business. In the third quarter of last fiscal year, we experienced a strong headwind and our sales results were negatively impacted by disruptions related to the COVID-19 pandemic. Over the last year, we have experienced a myriad of lockdown measures, various disruptions in our U.S. supply chain and increasingly higher costs. However, these challenges have been more than offset by significant tailwinds. Due to the shift in consumer spending and the isolation renovation trends that we have associated with the pandemic, millions of end users have been introduced to our brands for the very first time. In addition, our robust tribal culture and increased focus on our must-win battles have enabled us to mitigate many of the adverse impacts COVID-19 has had on our business. The tribe’s efforts have enabled us to meet most of the very high demands we experienced for our maintenance products. As a result, we experienced a 45% increase in sales of maintenance products during the third quarter compared to the same period last year. In addition, translation of our foreign subsidiary’s results from their functional currencies to the U.S. dollar had a favorable impact on sales in the third quarter. On a constant currency basis, sales would have been $128.7 million, up 31% compared to the third quarter of last year. Steve will talk to you in a few minutes about the sales trends we experienced in the quarter in each of our trading blocks. But first, I am going to share an update with you on our strategic initiatives. When the pandemic began, like many other companies, we were uncertain what impacts it would have on our business. We knew that we were going to face some challenging times. However, we also knew that we had a strong foundation and we had a famous brand that people trust, which could bring certainty to both our customers and our end users in uncertain times. We had a strategy with supporting tactics also known as our must-win battles, that focused us on driving long-term sustainable growth. We knew that there would be some choppy waters ahead, but we were well-positioned to navigate them. I always say a smooth sea never made a skilled sailor. Our tribe has learned a tremendous amount from operating under this environment. We have been trusting too in the last year-and-a-half. We know that the consumer spending patterns, or what we refer to as isolation renovation, will not last forever. As things get back to normal from the post-pandemic, consumer spending patterns will change and our sales volumes will most likely return to more normal growth patterns. However, we do believe that the shift in consumer spending patterns associated with the pandemic will benefit us over the long-term. We know that new end users have been introduced to our products for the very first time and history tells us that our brand is a sticky brand. This means a high possibility that the buying behaviors we have been experiencing during the pandemic have created permanent users of our maintenance products. Having said all that, we continue to think that our 2025 targets are just as probably wrong and just as roughly right as before we went into the pandemic. However, we will be up against sizable comparable periods in the next few quarters. In addition, the currency tailwinds we are currently experiencing will likely turn into headwinds at some point in the future. Taking those additional factors into consideration, we’re adjusting our 2025 revenue targets today to a range of between $650 million and $700 million. We believe we can successfully bring these targets within reach by the end of fiscal year 2025 and we will strive to do so while following our 55/30/25 business model. Now I’d like to turn to an update on our strategic initiatives. Strategic initiative number one is to grow WD-40 Multi-Use Product. Our goal under this initiative is to make the blue and yellow can with a little red top available to more people in more places who will find more uses more often. In the third quarter, sales of WD-40 Multi-Use Product increased 45% globally to $104.1 million compared to the third quarter of last year. Strategic initiative number two is to grow the WD-40 Specialist product line. Our goal under this initiative is to leverage our most iconic asset, the blue and yellow can with a little red top and grow the WD-40 Specialist product line through continued geographic expansion, as well as by developing new products and product categories. In the third quarter, sales of WD-40 Specialist increased 24% globally to $11.2 million compared to the third quarter of last year. Strategic initiative number three is to broaden product and revenue base. Our goal under this initiative is to leverage the recognized strengths of WD-40 Company, derive revenue from existing brands, as well as from new sources and products. Strategic initiative number three includes well-known brands such as 3-IN-ONE, WD-40 BIKE, GT85, 1001, Spot Shot, Solvol, Lava, and no vac. In the third quarter, sales of products included under this initiative increased 32% globally to $18.6 million compared to the third quarter of last year. Strategic initiative number four is to attract, develop and retain outstanding tribe members. Our goal under this initiative is to attract, develop and retain talented tribe members and to grow our tribe member engagement to greater than 95%. I am often asked why we call our company employees tribe members at WD-40 Company. We define tribe as a community with a shared purpose that helps feed and defend each other. This definition has remained consistently true for us throughout the duration of the pandemic. It is our culture that empowered our tribe to successfully navigate some extremely challenging times. We cultivated a culture at WD-40 Company that has been the cornerstone of our success for decades. In good times, that culture gives us a tribe of family to celebrate with. In not so good times, that tribal culture gives us a global tribal family to fight for and support. And strategic initiative number five is operational excellence. Our goal under this initiative is to strive for continuous improvement by optimizing resources, systems, and processes. Operational excellence also means making sustainable business decisions that create and protect long-term stakeholder value. We consider our stakeholders to be any group without whose support the business would not exist. Our commitment to operational excellence continues to be an enormous asset for us as we navigate the challenges associated with the pandemic. Using our 55/30/25 business model as a framework, we measure ourselves against this operational excellence initiative. I’ll now pass the call to Steve who will share an overview of our sales and an update on our must-win battles.

Steve Brass, President and COO

Thanks, Garry, and good afternoon. When we last spoke, I mentioned that we believed there was a positive trend for us coming out of the COVID-19 pandemic. In reality, the pandemic has brought both challenges and opportunities for our team. Jay will elaborate shortly on the challenges we are facing and the strategies we are implementing to address them, while I will concentrate on the positive trends. Today, we’re reporting a 39% increase in sales compared to the third quarter of last year. We continue to see strong demand for our maintenance products due to changing consumer spending habits related to the pandemic. Although we don't expect to maintain this level of growth long-term, we believe that the changes in consumer behavior during the pandemic have helped us gain millions of new end users globally. As we transition into the post-pandemic era, we are confident that many of these new users will become regular customers of our maintenance products. Looking at our performance in the Americas, net sales were up 20% in the third quarter, reaching $60 million, setting a new record for this region. Sales of maintenance products increased by 28% in the Americas, driven by strong demand for the WD-40 Multi-Use Product, which saw increases of 24%, 138%, and 74% in the U.S., Latin America, and Canada, respectively. The robust sales trends in the U.S. were fueled by the isolation renovation phenomenon, and the prior fiscal year's sales were negatively affected by pandemic-related disruptions. However, reduced sales of WD-40 Specialist, which fell by 33% in the U.S. this quarter, partially offset these gains. The good news is that consumer demand for WD-40 Specialist remains high, with increases of 85% in Canada and 253% in Latin America. U.S. sales of WD-40 Specialist were hindered by ongoing supply chain disruptions, which we discussed with investors last quarter. We continue to face challenges in meeting the high demand for maintenance products, especially for WD-40 Specialist, sourced from third-party manufacturers significantly affected by global supply chain issues. Factors such as the availability and costs of raw materials, labor, and freight are impacting our North American supply chain. However, we are making progress towards resolving these issues and anticipate most of them will be addressed by the first half of 2022. We have learned valuable lessons operating our supply chain amid these challenges, which will help us improve our North American operations in the future. In Latin America, all our maintenance products experienced strong sales in the third quarter, with an impressive 151% increase, primarily due to strong sales in Mexico, our newest direct market. This significant growth comes after the prior year's sales were negatively affected by pandemic disruptions. As conditions improve and restrictions lessen in the region, we see growing demand among end users in Latin America. In Canada, our maintenance products also performed well, seeing an 87% increase, driven by the isolation renovation trend and boosted sales through e-commerce channels. However, our homecare and cleaning products in the Americas have seen a decline of 37%, as demand has returned to more normal levels due to improvements in public health conditions. Moving forward, we consider many of our homecare and cleaning products, aside from our strategic brands, as harvest brands that will contribute to cash flows but will likely represent a smaller percentage of our business over time. Overall, our Americas segment accounted for 44% of our global business in the third quarter, with long-term growth projected at 5% to 8% annually, revised from the previous 2% to 5% estimate thanks to new opportunities we've identified. Shifting attention to EMEA, net sales for this region, which includes Europe, the Middle East, Africa, and India, increased by 80% in the third quarter, reaching $58.6 million. Foreign currency exchange rate fluctuations positively impacted these sales. On a constant currency basis, sales would have grown by 63% compared to last year. Maintenance product sales in EMEA rose by 82% due to strong sales across our direct and distributor markets, with increases of 88% and 70%, respectively. In direct markets, we saw an 81% increase for WD-40 Multi-Use Product and a 95% increase for WD-40 Specialist, attributed to the isolation renovation trend, heightened e-commerce activity, and increased promotional efforts. Sales in our EMEA direct markets accounted for 69% of Regional sales this quarter. In terms of our distributor markets in EMEA, we experienced a 68% rise in WD-40 Multi-Use Product sales and a 151% increase in WD-40 Specialist sales, driven by recoveries in these markets following previous lockdowns. All in all, our EMEA segment made up 43% of our global business in the third quarter, with long-term growth expectations of 8% to 11% annually. In the Asia-Pacific region, which includes Australia, China, and other countries, net sales were up 14% in the third quarter to $17.8 million, also positively influenced by foreign currency exchange rates. On a constant currency basis, sales would have shown a 5% increase compared to last year. In Australia, sales reached $6 million, a 22% rise from last year, although on a constant currency basis, sales remained steady. Maintenance product sales in Australia increased by 9%, largely driven by strong performance of 3-IN-ONE and WD-40 Specialist, which were up 114% and 24%, respectively, due to the isolation renovation trend. That said, sales of our homecare and cleaning products decreased by 9% amid a return to normal demand levels. In our Asia distributor markets, we saw net sales of $7.3 million, which is a 26% increase year over year, led by a 22% rise in WD-40 Multi-Use Product sales in the region. These gains were primarily fueled by eased COVID-19 restrictions and improved economic conditions, particularly in the Philippines, South Korea, and Indonesia. In China, net sales were $4.5 million, down 9% year over year due to the previous year’s spike in sales following the easing of lockdown measures. Nevertheless, we remain optimistic about strong sales growth in China for the full fiscal year. Overall, our Asia-Pacific segment accounted for 13% of our global business, with long-term growth expectations ranging from 10% to 13% annually. As we look ahead beyond the pandemic and aim to meet our 2025 sales targets of between $650 million and $700 million, we remain concentrated on driving revenue growth through our key initiatives. Our primary focus is expanding the reach of WD-40 Multi-Use Product, as there are considerable growth opportunities in this area. Year-to-date, sales of this product have reached $284.7 million, marking a 27% increase compared to last year, reflecting our invested efforts in our top global growth markets, enhanced by over $2 million in marketing investments to connect with end users there. In China, our industrial sampling initiatives have led to a 48% increase in WD-40 Multi-Use Product sales year-to-date. We are also directing resources toward India and Mexico, contributing to significant sales growth in those regions. Our second key priority is the premiumization of WD-40 Multi-Use Product, which opens up avenues for revenue growth and margin expansion. Sales of WD-40 Smart Straw and EZ-Reach combined came in at $135.8 million, nearly 48% of total sales. We aim to increase the global penetration of Smart Straw to over 60% as we continue rolling out the next generation of this product. Next, we focus on growing WD-40 Specialist, which allows us to address new end-user needs while reducing competitor presence in retail spaces. Year-to-date, sales for WD-40 Specialist reached $32 million, a 21% increase from the previous year, with expectations of reaching about $100 million by the end of fiscal year 2025. Lastly, we are prioritizing digital commerce to engage end users broadly and create memorable online experiences that facilitate easy access to our brands. Global e-commerce sales have seen a 25% increase year-to-date, and we believe we are positioned well to benefit from the ongoing shift towards online shopping in a post-pandemic world. Digital commerce is emerging as a significant driver of our future growth. In conclusion, I want to share some perspective on the future. Despite the excellent results this quarter, we will face challenging sales comparisons in the upcoming quarter, so investors should keep that in mind. Current market conditions suggest that for the full fiscal year, net sales will likely range between $475 million and $490 million, indicating year-over-year growth of 16% to 20%, primarily driven by the strong third-quarter results. Over the long term, we foresee that many new users who engaged with our products during the pandemic will become lifelong customers of our maintenance solutions. Post-pandemic, we anticipate consolidated net sales growth in the mid-to-high single digits. I'll now hand the call over to Jay for a financial update on the business.

Jay Rembolt, CFO

Thanks, Steve. Our record third quarter was driven by robust demand across all maintenance products, coupled with strong operational performance. In the third quarter, we grew consolidated net sales by 39% to $136.4 million. Net income for the third quarter was $21 million compared to $14.5 million last year. Diluted earnings per share for the third quarter was $1.52, compared to $1.06 for the same period last year. Now let’s begin our review of our 55/30/25 business model, the long-term targets we use to guide our business. As you may recall, the 55 represents gross margin, which we target to be at or above 55% of net sales. The 30 represents our cost of doing business, which is our total operating expenses, excluding depreciation and amortization. Our goal is to drive our cost of doing business over time to around 30% of net sales. And finally, the 25 represents our long-term target for EBITDA. First, we’ll look at the 55 or gross margin. In the third quarter, our gross margin was 53.1%, compared to 54% last year. This represents a decline of 90 basis points year-over-year. Gross margin was negatively impacted by 180 basis points due to increases in manufacturing costs, changes in sales mix, and higher miscellaneous costs. These increased manufacturing costs were primarily driven by higher labor and overhead costs at our third-party manufacturers, caused by the global supply chain constraints linked to the pandemic. Also negatively impacting our gross margin was change in foreign currency exchange rates, which adversely affected our gross margin by 50 basis points. This is due to the fluctuations in exchange rates for the euro and U.S. dollar against the pound sterling in our EMEA segment from period to period. This is because in EMEA the majority of our cost of goods are sourced in pound sterling, while approximately 70% of our revenues are generated in currencies other than the pound sterling. Finally, negatively impacting our gross margin were petroleum-based specialty chemical costs, which decreased our gross margin by 10 basis points in the third quarter. Crude oil is one of the primary feedstocks of our petroleum-based specialty chemicals. The price of crude oil has risen significantly over the past several months as compared to the prior year. Our cost of goods sold is now just beginning to see the impact of these increases. There is often a delay of one quarter or more before changes in raw material cost impact our cost of goods sold, due to production and inventory lifecycles. Therefore, the recent increase in these costs are expected to continue to unfavorably impact our cost of goods sold as long as crude oil remains at these higher levels. These negative impacts to gross margin were partially offset by lower aerosol can costs, which positively impacted our gross margin by 80 basis points. In the third quarter, we achieved favorability in the cost of aerosol cans and other components due to higher purchase volume incentives in our EMEA segment. However, we have recently seen costs per aerosol can and other components increase and we expect more cost pressure in the future. Warehousing, distribution, and freight costs positively impacted our gross margin by 30 basis points in the quarter, primarily in our EMEA segment. Gross margin benefited from fixed warehousing costs as these fixed costs had a smaller impact due to higher sales we experienced in the quarter. In addition, the prior year's quarter had higher inbound freight costs associated with the movement of raw materials and finished goods in preparation for Brexit. Finally, positively impacting our gross margin were lower discount charges and price increases, which when combined, positively impacted our gross margin by 40 basis points. Now, let’s talk about our gross margin expectations. Like many other companies, we’re operating in a challenging supply chain and inflationary environment. We’re experiencing rises in raw material, freight, and wage costs, which are all driving higher input costs. We continue to adapt to these dynamic times, however, over the short- to medium-term, we expect to see continued pressure on gross margin. Despite the inflationary pressures we are experiencing, our gross margin target of 55% remains unchanged. In order to combat the economic factors we have been experiencing, we have begun implementing price increases in many of our markets. We continue to be focused and deliberate in managing our business so that we can maintain gross margin at or above our target of 55% over the long-term. Now I’ll address the 30, or our cost of doing business. In the third quarter, our cost of doing business was approximately 32% of net sales, which as a percent of sales was flat compared to last year. As you know, a majority of our cost of business comes from three areas: people costs, or the investments we make in our tribe; the investments we make in marketing, advertising, and promotion; as a percentage of sales our A&P investment was 4.9% in the third quarter; and finally, freight costs, the cost to get our products to our customers. On a dollar basis, our cost of business was up 39% compared to the same period last year. The increase was driven by both higher SG&A and A&P investments period-over-period. SG&A expense increased by $10.2 million compared to the third quarter of last year, primarily due to higher employee-related costs associated with incentive compensation accruals due to the stronger financial results. A&P investment increased by $1.9 million compared to the third quarter of last year, primarily due to a higher level of promotional programs and marketing support in all three trading blocks. This brings us to EBITDA, the last of our 55/30/25 measures. EBITDA was 21% of net sales for the third quarter, unchanged from the comparable period last year. And that will complete our discussion on our business model; now let’s discuss some of the items that fall below the EBITDA line. The provision for income taxes was 21.9% in the third quarter compared to 23.9% last year. The decrease in our effective income tax rate was primarily due to tax benefits, resulting from higher earnings from foreign operations, coupled with a one-time investment tax credit in fiscal 2021. We expect that our effective tax rate will be approximately 18% to 19% for the full year of 2021, compared to an effective tax rate of 19.6% in fiscal year 2020. Now a word about our balance sheet and capital allocation strategy, the company’s financial condition and liquidity remain strong. The capital strategy includes a comprehensive approach to balanced investing in long-term growth while providing strong returns to our shareholders. We continue to return capital to our shareholders through regular dividends. On June 15th, our Board of Directors approved a quarterly cash dividend of $0.72 per share, payable July 30, 2021, to stockholders of record at the close of business on July 16, 2021. So far in fiscal 2021, we have invested approximately $12 million in capital projects, the majority of which have been used to complete the procurement of our proprietary machinery and equipment that we’re using to manufacture our next-generation Smart Straw delivery system. We expect by the end of this fiscal year, we will have invested a total of $16 million in capital projects. This is down from our prior expectations due primarily to $3 million of the next-generation Smart Straw equipment investment being delayed until next year. So with that, let’s turn to fiscal 2021 guidance. Due to the uncertainty regarding the pandemic’s near-term impact on our business, we have not issued comprehensive financial guidance for fiscal year 2021. However, we have provided revenue guidance, and as Steve mentioned earlier, we are increasing our revenue expectations for the full year due to the strong sales results we experienced in the third quarter. Well, that completes the financial overview. Now, I’ll turn it back to Garry.

Garry Ridge, CEO

Thanks, Jay. In summary, what did you hear from us on this call? You heard that consolidated net sales were up 39% in the third quarter to $136.4 million, a new quarterly record for the company. You heard that sales of WD-40 Multi-Use Product were up 45% in the third quarter. You heard that sales of WD-40 Specialist were up 24% in the third quarter. You heard that year-to-date global e-commerce sales grew by over 25%. You heard that we have increased our marketing investment by over $2 million this year with a focus on winning the hearts and minds of end users in some of our top priority markets. You heard the way we are being impacted by inflationary pressure and that in order to combat these rising costs, we have recently begun to implement price increases in many of our markets, because we’re committed to our 55/30/25 business model. You heard that we have increased our revenue expectations for the full fiscal year and believe that net sales will be between $475 million and $490 million and that upward revision is driven by strong sales we experienced in the third quarter. You heard that we are adjusting our 2025 revenue targets today to a range of between $650 million and $700 million, which reflects a compounded annual growth rate in the mid-to-high single digits and we believe we can successfully bring these targets within reach by the end of fiscal year 2025. In closing today, I’d like to share with you a quote from Albert Einstein: in the middle of every difficulty lies opportunity. Thank you for joining us today. We’d now be pleased to take your questions.

Operator, Operator

Your first question is from Linda Bolton Weiser with D.A. Davidson.