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Good morning, ladies and gentlemen, and welcome to the Prestige Brands Holdings Second Quarter 2019 Earnings Conference call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Phil Terpolilli, Director of Investor Relations. Sir, you may begin.
Thank you, operator, and good morning to everyone on the phone. Joining me on the call today are Ron Lombardi, our Chairman, President and CEO; Christine Sacco, our CFO. On today's call, we will cover the highlights of our fiscal 2019 second quarter, review the financial results and our fiscal '19 outlook and then take questions from analysts. There is a slide presentation, which accompanies today's call. You can access it by visiting prestigebrands.com, clicking on the Investors link and then on today's webcast and presentation. Please remember some of the information contained in the presentation today include non-GAAP financial measures. The reconciliations between adjusted and reported financial measures are included in today's earnings release and slide presentation. During today's call, management will make forward-looking statements around risks and uncertainties, which we detail in a complete safe harbor disclosure on Page 2 of the slide presentation accompanying the call. Additional information concerning risk factors and cautionary statements are available in our most recent SEC filings and the most recent Prestige Consumer Healthcare 10-K. I'll now hand it over to our CEO Ron Lombardi to walk through the highlights of our second quarter performance. Ron?
Thanks, Phil, and good morning, everyone. Let's begin on Page 5. Q2 was a continuation of the solid first quarter performance we discussed back in August. Our organic top line performance and consumption trends for our portfolio remain favorable, and we continue to expect 2% to 3% consumption growth for the full year. We continued to experience gross margin improvements in line with our expectations and were further improved by the divestiture of the Household Cleaning business. Adjusted EPS grew 7% versus the prior year, driven by our strong financial profile and resulting leverage capabilities. We continued to generate strong free cash flow. And in combination with the proceeds from our July 2 divestiture of Household Cleaning, we paid down $100 million in debt during the quarter. Lastly, during Q2, we also changed our corporate name to Prestige Consumer Healthcare to reflect our evolution as a company. It's an important shift to remind ourselves, investors and customers what our business strategy focuses on every day. Now let's turn to Slide 6 for more detail on our Q2 results. Our net sales were approximately $239 million for the quarter, up 1.6% versus the prior year after adjusting for the household divestiture. This was supported by strong consumption trends in the quarter, which aligned with our 2% to 3% expectation for the year. Our consumption trends remain healthy in North America, with sales growth led by the GI and ear and eye care categories. Our International segment experienced strong double-digit top line growth in Q2, led by our business in Australia and Asia Pacific. Similar to Q1, a strong consumption performance was partially offset by shipment timing associated with the new BC & Goody's packaging launch as well as the change in accounting policies around revenue recognition timing and the timing of related expenses. These headwinds in the first half of the fiscal year will gradually begin to reverse in the second half. I will add additional detail when we cover second half guidance.
Total company gross margin in Q2 came in at 57.4%, up 200 basis points sequentially from Q1. We've made solid progress against the higher freight and warehouse costs we discussed last year and have approached normalized level for both. Adjusted free cash flow was $44.1 million in the quarter and continues to benefit from our industry-leading EBITDA margins, minimal capital spending needs and the low cash tax rate. Our cash flow expectation for the full year remains unchanged. Last, we paid down $100 million of debt in Q2 with our ongoing cash generation and the net proceeds from the July 2 divestiture of the Household Cleaning business. So let's summarize our first half highlights on Slide 7. We feel good about our solid fiscal year-to-date performance with revenue growth as expected. Our consumption performance also continued the long-term trend of outgrowing categories in our core portfolio, outperforming both category growth and private label during the period. Freight and warehousing costs continue to improve, and we continue to use our strong financial profile to leverage revenue growth into strong EPS growth. Based on these factors, we are pleased with our business results and expect our full year performance to be a continuation of the momentum we have from the first half of the year. The core of our success comes from being a brand-building organization, with leading sales, marketing and new product development efforts behind our leading brands, with #1 market share brands representing over 2/3 of our sales, and oftentimes representing the branded category, we are advantaged in being able to focus on driving long-term category growth and winning with consumers. On Slide 8, let's review one such brand from this portfolio, Debrox. The Debrox brand was acquired in 2014 as part of our GSK portfolio acquisition and fit well with our acquisition criteria, which focuses on leading brands. Today, it's one of a dozen brands that make up what we call our core portfolio, which represents about 30% of our sales. It's another excellent example of the long-term success of our brand-building strategy. Debrox earwax remover represents over 60% of the earwax removal category, a small category, but one with a loyal consumer base. With the leading share and strong consumer heritage, it allows us to focus on long-term investments. Key ways we've invested are shown on the right side of slide. We've used focused marketing to educate professionals on the distinct advantages of Debrox to clean ears. Debrox is also part of our digital marketing strategy, and we've invested in brand placement and content to remind consumers of the brand. And last, we've utilized ongoing consumer insight work to drive new product development like our recently launched formula with more microfoam action that helps Debrox consumers know that the product is working. As a result of our team's efforts, Debrox has grown on average over 6% annually since fiscal 2014, which is well in excess of the earwax removal category. Now let's turn to Slide 9 for an update on our BC & Goody's packaging change. As we've discussed since May, a key objective in fiscal 2019 is the successful launch of our new easier-to-use packaging for both the BC & Goody's brands. The launch is an example of our ongoing commitment to broad-based brand-building efforts where we utilize consumer insights and feedback to continually improve product offerings across our portfolio. I'm pleased to report that the launch activity to date continues on plan, and we continue to transition to the new packaging at retail. As of October 1, nearly all of our major customers are now converted and ordering the new product. Late in October, we began to activate key marketing initiatives designed to enhance brand equity and awareness around the new packaging and its benefits. In the second half of fiscal 2019, we anticipate shipment conversion for nearly all of our remaining customers. We should gradually see both revenue and margin headwinds from the transition abate as we move forward. The ongoing success of Debrox and BC & Goody's are perfect example of the impact of leveraging brand heritage, innovation and channel development. And our efforts behind each of these areas continues to show in the results across our brand portfolio. Moving to Slide 10, let's discuss a timely example around channel development. The emerging e-commerce channel is a great example of our ability to adapt and serve customers whatever they research and shop for their health care products. Our online business continues to grow rapidly, and we believe we maintain a market share equal to or better than traditional retail. As a result, we continue to view online as a long-term opportunity rather than a threat. Our strategy is relatively simple. First, be available in the channel when a consumer goes to shop for their trusted brand. Although many of our products are needs based and often have an unpredictable purchase pattern, over time we still expect consumers to gradually show up in increasing numbers to shop online. Our portfolio brands can each benefit from this in different ways with a few examples shown on the left side of the slide. A brand may be challenging for a loyal consumer to find in a physical store, so they seek it out online like the case with NasalCrom or they may be uncomfortable learning about the product in the presence of others like Monistat. Finally, in the case of DenTek floss picks, a consumer can buy with predictable frequency and is well suited for e-commerce delivery. These are all very different examples but are all unique opportunities for us to win with online over time. The second piece is channel investments, which runs in parallel with availability. Over the last several years, we've made smarter investments around online and more specifically content. We make sure that our brand pages are informative and that content on retail or websites gives consumers the ability to identify and understand the value of our trusted products quickly and easily. And the third critical component is profitability. With online sales, we make sure the profitability structure is similar to our brick-and-mortar partners, with our high ring, low rate products providing an excellent starting point versus other categories.
Our performance versus the competition and ongoing success in e-commerce can be attributable both to our strong core brand portfolio and strategy. This provides a sound underpinning for continued sales growth, as shown on the right side of the slide. With that, I'll turn it over to Chris to walk through Q2 financials in greater detail.
Thanks, Ron. Good morning, everyone. As Ron reviewed in brief earlier, I'd like to walk through our second quarter results in greater detail and offer some updated context around our expectations for fiscal '19 by line item. As a reminder, the information in today's presentation includes adjusted results that are reconciled in our earnings release. On slide 12, you can see our high-level second quarter results, which include an organic revenue increase of 1.6% to $239.4 million and adjusted EPS growth of approximately 7% versus the prior year. As noted previously, we anticipated a roughly flat organic revenue performance in the first half of '19 due to the launch of BC & Goody's new packaging as well as a change in accounting policies around revenue recognition and the timing of related expenses. Regarding this change, I would remind you the timing change we are referring to relates to the timing of certain deductions against gross sales. Adjusted EBITDA declined versus prior year due to the household divestiture, the impacts of BC & Goody's packaging launch and the accounting policy changes I just mentioned. Now let's turn to slide 13, where I'll discuss consolidated results and review fiscal '19 outlook by item. For the second quarter fiscal '19, our net revenues decreased 7% to approximately $239 million, but were up 1.6% on an organic basis, as I just mentioned. In both Q2 and the first half, we were impacted by the BC & Goody's packaging rollout and accounting policy changes. Adjusted gross margin came in at 57.4% for the second quarter, up both sequentially and year-over-year. We benefited from the divestiture of the lower-margin Household Cleaning segment and continued to make progress against freight and warehousing initiatives during the quarter. These benefits were partially offset by expected Q2 impact from the previously mentioned packaging rollout and accounting policy changes around revenue recognition timing. Looking ahead, we continue to expect full year fiscal '19 gross margin of approximately 57%. Regarding A&P, we came in at 15.5% of revenue for Q2, which grew as a percent of sales as we continued to invest behind our core consumer health care brands. For fiscal '19, we still expect A&P of approximately 14.5% of sales with second half slightly below first half due to the timing of marketing initiatives. Over the long term, we will continually look to grow absolute A&P dollars on a year-over-year basis as we actively seek opportunities for long-term brand building to drive top line growth. Our adjusted G&A spending came in at just under 9% of total revenues in the second quarter of fiscal '19, including certain timing-related costs. For the full year, we continue to expect G&A of approximately 8.5% of sales following the divestiture of Household Cleaning. Last, we reported adjusted earnings per share in Q2 of $0.65, representing high single-digit growth versus the prior year as a favorable tax rate more than offset the operating income shifts resulting from the impacts of accounting timing and BC & Goody's, both discussed earlier. Now let's turn to slide 14 to discuss our second quarter '19 cash flow. In Q2, we generated $44.1 million in adjusted free cash flow, which, as expected, was impacted by the BC & Goody's inventory build to support the new packaging rollout. We continue to anticipate $205 million or more of adjusted free cash flow in fiscal '19 following the divestiture of Household Cleaning. In Q2, we paid down $100 million of debt with $50 million from ongoing cash generation and $50 million in net proceeds from the Household Cleaning divestiture. Our net debt at September 30 was $1.9 billion and equates to a net debt-to-EBITDA leverage ratio of 5.2x. We still anticipate leverage of approximately 4.9x by our fiscal year-end. I'd like to now turn it back to Ron for a discussion surrounding our broad fiscal '19 outlook and some closing remarks.
Thanks, Chris. Let's wrap up with some closing remarks on Slide 16. As shown on the slide, our business outlook for 2019 is unchanged. For net sales, we still anticipate fiscal 2019 to be in the range of approximately $985 million to $995 million, with organic revenue growth between 0.5% to 1.5%. For Q3, please remember, we will lap our most difficult dollar comparison of the prior year and often is the hardest quarter to predict given the timing of year-end holidays. As a result, we expect Q3 sales to be largely in line with the prior year on an organic basis. For profitability, we still anticipate EPS to be in the range of $2.84 to $2.92 or plus 10% to plus 13% year-over-year. Regarding cash flow, we still expect full year adjusted free cash flow of $205 million or more. In summary, 6 months in, we continue to feel well positioned to achieve our outlook for the year, underpinned by our strong portfolio and business strategy. Our year-to-date top line performance of the business was in line with our expectations and we continue to grow our brands in excess of category and private label. Our business continues to grow and our strong and consistent free cash flow has enabled rapid deleveraging and an opportunistic share repurchase in the first 6 months with the focus from these actions on enhancing shareholder value for the long term. These successes are enabled by our focus on our simple and effective 3-pillar strategy that positions our business for continued success. With that, I'd like to turn it over to the operator for questions.
[Operator Instructions] Our first question comes from the line of Joe Altobello with Raymond James.
So first question, I wanted to touch on gross margin. You mentioned it was up nicely year-over-year and sequentially. And it seems like all of that and then some was because of the divestiture from the -- of the household business. If you look at the OTC gross margin, I guess, it was down 180 bps year-over-year. North America was down 220. So if you could sort of tease out how much of that is from the revenue recognition accounting change. How much is still from freight and warehousing and how much is maybe from the BC & Goody's packaging launch?
Joe, this is Chris. So as Ron mentioned in his prepared remarks, we made solid progress against our higher freight and warehousing costs, both of which have approached normalized levels during the quarter. During this quarter, rev rec and BC & Goody's transition, to your question, impacted our gross margin by about 1 point. And so as we look forward, we continue to expect our full year gross margin about 57%, and we're feeling well positioned to achieve that.
Okay. That's helpful. And secondly, you did mention that the change of revenue recognition accounting was a drag on the top line, but it looks like at least from the adoption of ASC 606, that was a pretty sizable benefit in the quarter. So how do we square those 2 statements and why isn't that just a straight calculation?
Yes, Joe, so 2 things here. As a reminder, the change in accounting policy that we're referring to when we talk about the timing of our net sales is around the timing of certain promotional expenses that are within our gross to net sales that are requiring certain spend now to be recognized when product ships, when it used to be last year in the '18 numbers when the related program runs -- ran. So for our company, that impact is pulling forward certain spends into the first half of this year that in fiscal '18 were recognized in the second half. So that's just the timing thing for fiscal '19 and there's no impact on the full year comparisons. The disclosure to your point in footnote 2 of our 10-Q around revenue recognition is a hypothetical calculation as if we had not changed accounting policy. It doesn't take into consideration the fact that we've changed the way we operate the business in terms of shipment timing to more efficiently operate the business under the new policy and certain other factors. It's a calculation that's performed by our accounting team after the quarter is ended. Like I said, it's for disclosure purposes only. It's completely independent of customer orders or delivery requirements that haven't changed. I'd like to remind people that adopting a new accounting standard didn't do anything to create more customer orders for us. So it's really just a hypothetical calculation.
Okay. And this is the first revenue recognition accounting change that you mentioned that's independent of ASC 606?
No. Both of the policy changes are contained within ASC 606. It's just -- they're just different components and one is a disclosure and the other actually impacts your results.
Our next question is from the line of Jon Andersen with William Blair.
Could you give us any more color around how much the rev rec change impacted you in the first half of the year? And then, the follow-up is also the BC & Goody's transition. How much that impacted growth in the first half of the year?
Yes. So Jon, as I mentioned, if you back yourself into kind of rev rec and BC & Goody's transition impacting our margin by about 1 point, most of that is within gross to net. I don't think we've given any other specific dollars around that. Remember that rev rec -- so if I think of isolating rev rec within the second quarter, it's about 1 point.
So organic growth would have been about 2.5 -- 2.6 points during the Q2 excluding the change in the gross to net timing, Jon.
Okay. And in the BC & Goody's impact, that was heavier in Q2 than Q1?
Yes. So the BC & Goody's impact heaviest in Q2 throughout the year in terms of gross to net costs, right? We think about most of our largest customers transitioning during Q2, things like slotting, things like returns, those are within gross to net. We will continue to see a little bit of that as we transition through the second half because we've got some transition costs within COGS that will remain through the remainder of this year and then should subside as we work our way into fiscal '20.
So Jon, we've got some noise in comparability to last year. I think it's always good to point back to consumption. The business continues to have solid consumption trends. For the second quarter, consumption trends were at the high end of our outlook of 2% to 3%. And we continue to outgrow the categories by as much as almost 100 basis points as well as private label, which continues to drag the categories we compete in by as much as 200 basis points. So we continue to feel good about the outlook for the business for the remainder of the year given that the solid consumption trends that the business is realizing.
So essentially what you're saying is consumption was closer to kind of 3% in the quarter?
Yes.
Okay. Terrific. That's really helpful. And this may be too early for you to really comment on, but you now, I think, are moving out of kind of the execution of the BC & Goody's packaging and into the kind of the marketing demand generation phase. Have you -- any initial kind of insights into consumer response or uptake or is it just too early at this point?
It's really too early, Jon. We don't have it completely at retail yet. So over the next quarter or 2, we'll start to get more feedback on it. But as a reminder, the conversion to the packaging was like a 4-year project that involved very heavy and intense consumer insight work at the very beginning of this to ensure that we have the right product design and we went through a significant number of changes in evolution to make sure that we were spot on with this. So we'll keep our ear to the ground to get -- to make sure we get good feedback. But we did a lot of consumer insight work and a lot of home use tests to make sure we got this right. So we continue to anticipate that it will be very well accepted.
Okay. On the International business, it seems a bit more volatile. Can you talk a little bit about real strong growth rate this quarter, less so last quarter? What's the -- just operationally, why that happens in that business? Is it because of 2-step distribution? And if we should expect that kind of volatility going forward or if you think it should be a little bit smoother?
No. It's kind of the nature of the beast for that part of the business, Jon. A big portion of the International business is through distributors in given markets, and the order patterns from those distributors kind of ebb and flow. So that kind of flexibility will go forward.
Okay. And you specifically called out -- in North America, you called out strength, I think it was in GI and ear and eye care. Can you talk a little bit more about which -- what's driving that and the brands that you're seeing that benefit most within your portfolio?
Sure. For the GI, a big driver for the performance there is Dramamine, which has had a very, very long run of high levels of growth. Recently, we relaunched Dramamine-N for nausea and that continues to be well received by consumers. That's one of the drivers in GI. And then for ear, eye, as I called out in the prepared remarks today, Debrox is growing well and our eye care business has stabilized from where we were a year ago.
Our next question is from Steph Wissink with Jefferies.
I want to just follow up on Jon's question and maybe unpack a bit of what's going on in the women's health business and then also on how you're thinking about the cough, cold and flu season as we kind of get into that period of the year.
Sure. So for the women's health business, during the quarter, that's actually where a bigger portion of the rev rec hit occurred. So we're actually continuing to see solid consumption growth both in Summer's Eve and in Monistat. So we actually had a particularly good quarter there for underlying consumption. It's just that rev rec impact was concentrated there. In terms of cough, cold season, it represents 7.5% or less of our sales now these days. So it doesn't move the needle like it did, but we made our shipments into the retailers in the quarter ended September, and we'll see how the incident level drives take away as we get into the cough, cold season.
And just one more follow-up on BC & Goody's. So as we're out in the convenience trade, what should we be looking for as signals of merchandising placement, strong representations and the effectiveness of marketing? How should we start to kind of monitor and track? What would you recommend that we keep our eyes out for in the channel specifically, just given that's where a lot of your merchandising and marketing efforts are concentrated?
Sure. So the convenience channel is actually the last part of the distribution channel that we're changing over to the new packaging. So that's just getting going at this point. But when it does make it to retail and that can be a bit of a slow move as it goes to the distributor network and makes its way to the local convenience stores, you'll see new in-store displays and merchandising programs around the product when it makes its way to the local stores, Steph. And we will use NASCAR as a vehicle to help support those programs at convenience as well, especially in the Mid-Atlantic and southern part of the country.
Okay. And then on inventory, also just -- Chris, if you can give us a clarification on inventory at quarter-end. What portion of that is the hold kind of in the staging process for BC & Goody's? How should we think about underlying inventory versus planned inventory into the merchandising cadence for those brands?
Yes. I would say in the quarter ended September, probably $3 million to $4 million of inventory of BC & Goody's built. That will start to work its way through the channel in the third and largely be through as we enter the fourth quarter.
[Operator Instructions] Our next question is from Frank Camma with Sidoti.
My question is on the guidance. You gave some color on the G&A and A&P for the rest of the year. But if you look at the high end of your guidance, you've got a pretty nice -- I mean, implies pretty nice improvement in the gross profit margins. So can you talk about your conviction on that and exactly what drives that? I mean, you've talked about a couple of things that weighs on the margin this quarter, but even still I think it's a fairly nice spread on the second half of the year.
Yes. Frank, this is Chris. If I start with really the midpoint of the math, right, with our outlook, we are calling, as you're pointing out, gross margins at 57% for the full year and essentially holding flat to Q2's results. As I mentioned on the call, we feel very good about the progress that we've made on freight and warehousing costs. We feel they've approached normalized levels as we enter the quarter. We did have a little bit of favorable mix in Q2 on product that we don't expect to repeat in the second half. But then again, we are also lapping, if you recall, the revenue recognition in the BC & Goody's impact on margin as we head into the second half. So we'd like to remind people that rev rec will just reverse, right? Nothing has to happen on that. We're not counting on any home runs as we enter the second half. So it's a little bit more of the same. So we feel good about it.
Okay. And second part is, just flipping back on International because -- I mean, technically that was where the growth was for the quarter. Can you just talk about the FX impact specific to the revenue there in the quarter?
Yes. So we haven't called out FX because it wasn't material for us for the year thus far. We'll call it out in the future if it's material, but we're not expecting -- it's baked into our outlook right now.
And we have a follow-up from Jon Andersen with William Blair.
I just wanted to ask about your expectations for any further inventory destocking. It hasn't really been a point of discussion, I guess, in the last quarter or 2. Has that now kind of resolved itself or -- what do you -- how are you thinking about that in the back half and what's baked into your guidance?
So Jon, so far, year-to-date, the destocking at retail has largely been in line with what we expected and our expectation for the full year is between 0.5 point and 1 point of impact, largely driven by the consolidation in the drug channel, which is -- seems to be proceeding as how we thought it would impact us, and then some continued headwinds from other retailers as they continue to reduce inventory. So it continues to be in line with what we expected for the year, Jon.
And I'm not showing any further questions, so I'll now turn the call back over to Ron Lombardi for closing remarks.
Okay. Thank you. I'd like to thank everybody for joining us today, and have a good day. Thank you.
Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.