This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk06: Good morning, everyone, and welcome to the Parago third quarter 2023 financial results conference call. All participants will be in a listen-only mode. Should you need assistance, please see a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Bradley Joseph, VP of Investor Relations.
spk02: Sir, please go ahead. Good morning and welcome to Parago's third quarter 2023 earnings conference call. I hope you all had a chance to review our release issued this morning. A copy of the release and presentation for today's discussion are available within the Investor Relations section of the Parago.com website. Joining today's call are President and CEO Patrick Lockwood-Taylor and CFO Eduardo Bezerra. I would like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information for shareholders and investors and safe harbor language regarding these statements in our release issued earlier this morning. A few quick items before we start. First, unless stated, all financial results discussed and presented are on a continuing operations basis. They do not include any contributions from the divested RX business, which was accounted for as discontinued operations prior to its sale. Second, organic growth excludes acquisitions, divestitures, exited product lines, and currency in both comparable periods. All comments related to constant currency remove the impact of currency translation versus the prior year by applying the exchange rates used in the comparable measurement in the prior year's financial statements. And third, Patrick's discussion will focus solely on non-GAAP results, except as otherwise noted. See the appendix for additional details and for reconciliations of all non-GAAP financial measures presented. As for today's agenda, Patrick will cover our solid quarterly financial results and strong business fundamentals. He will then discuss the evolving dynamics in the infant formula industry, followed by our excitement for the anticipated launch of Ophil. He will then round out his comments with reflections after four months as CEO, provide an update on our strategy to build a sustainable and value accretive growth engine, and end with area of focus to close 2023. Eduardo will then walk through the financials, including our updated guidance. And with that, I'd now like to turn the call over to Patrick.
spk00: Thank you, Brad, and good morning, everyone. We delivered another quarter of solid financial results, highlighted by gross margin, and operating margin expansion. Net sales grew 2.2% compared to the prior year. Organic net sales declined 1.2%, including an unfavorable impact of 2.8 percentage points from discontinued lower margin SKUs and HRA distributed transitions, both designed to expand margins. Year-over-year gross margin expanded 300 basis points. including a 70 basis point benefit from our supply chain reinvention program to 39.5%. Operating margin expanded 130 basis points to 13.4%. For the fifth consecutive quarter, Perigo has delivered double-digit growth in gross profit, operating income, and earnings per share. This performance puts us in the top quartile of our peers. Digging a little deeper into quarter three, net sales of our global cough, cold, and pain products increased 7% compared to the prior year, excluding portfolio optimization efforts, driven by seasonal sell-in, which was particularly strong in Europe. Within CSCI, organic net sales grew 6.2% as we held market share in growing markets and categories. In addition to cough, cold, and pain, growth was broad-based, including skincare offerings and high single-digit growth in our UK store brand business. In CSCA, organic net sales declined 5.1% as favorable pricing. The acquisition of Gateway and new products was more than offset by legacy infant formula 3.6 percentage points from the discontinuation of low-margin SKUs, normalizing consumer consumption, and a comparison to the strong and an early cough cold season last year. Importantly, store brand OTC dollar volume and value share grew during the last 13 weeks as consumer-seek high-quality products had a good value. Turning to infant formula, For background, and for over two decades, Perigo has successfully and consistently produced high-quality, safe, and effective infant formula as the leading player in store brands. We have proven we can deliver the most advanced and innovative infant formula on par with the national brands while delivering value for consumers. No one else does this, but it's tougher now than ever before. we're extremely proud to play an important role in this essential category. In response to the updated FDA guidelines issued in March and subsequent warning letters to multiple facilities in the industry, we have shortened production campaigns to perform more frequent major cleanings of our facilities, leading to more downtime between campaigns. In addition, we implemented enhanced product testing and quality procedures leading to longer inventory holds before product is released to customers. Due to these factors, we have been unable to replenish safety stock, leading to low customer in-stocks, intermittent SKU availability, and lost sales. With these changes now implemented and production improving each week, we are focused on rebuilding safety stock for our highest volume SKUs. I anticipate our operations to normalize by the middle of next year. This improved production, continued strong demand for store brand formula, and the annualization of price actions implemented in 2023 positions us well to recapture most, if not all, of the $0.35 EPS impact against our original 2023 expectations. Turning now to Opel, which will be the most unique product launch in the history of Perigo, forming an entirely new US OTC category. This launch requires an innovative approach to accelerate brand awareness and consumer conversion. We will build one-to-one consumer relationships, leveraging CRM data that will self-learn and get smarter throughout a consumer's journey to maximize the Opel brand experience and its conversion. To accomplish this, we are partnering with leading technology organizations to build a marketing technology stack that will drive engagement through all touchpoints of consumer conversions. from awareness to purchase. As we ramp up pre-launch activity, timing the Opel sell-in to retail customers is now expected in quarter 1-24 to ensure customer inventory levels meet the build-up of consumer demand. To maximize long-term potential in this category, we will look to extend investment beyond the Opel brand with a franchise of women's health products. Now, I'd like to reflect on my first four months as CEO. I've immersed myself in all facets of our global organization and met with many key stakeholders, including many of you, our shareholders. Coming out of these conversations, I remain confident in our strategy and I'm increasingly excited about the opportunity ahead. Our business is highly unique, marked by significant scale, multiple points of consumer access and value, and is attractively diversified. Let me briefly explain each of these. With an addressable market of $400 billion, the global self-care segment has cemented itself as an independent industry within consumer products. Our scale is unmatched, evidenced by the fact that every second of every day, 2,200 doses of our product are consumed around the world. and we're the only company that can produce most major products across entire categories. We're a leading provider of value and access through a distinct model across brand, value brand, and store brand. Not only do our offerings drive savings for consumers through value pricing, but also by bypassing doctor visits for their health needs and providing very significant savings for healthcare systems as well. Lastly, Our horizontal category breadth and vertical pricing is a unique advantage. Our offerings extend through nine major OTC product categories with our blended branded portfolio, providing consumers access across the value spectrum wherever their point of purchase. Our portfolio is also well diversified for economic environment shift across geographies and across SKUs. with no one product representing more than 3% of total revenue. This better insulates us from economic slowdowns and seasonal factors in individual categories. My interactions with all key stakeholders have clarified the next evolution of strategic thinking at Perigo. Throughout these learnings, four key pillars have emerged, culminating in a blueprint designed to deliver the one Perigo model, a model in which our portfolio, operating systems, structure, and behaviors will be simplified, standardized, and scaled. This will position us to win in self-care through the creation of a sustainable and value-accretive growth engine that will drive Perigo financial performance for the long term. First, we will consumerize and digitize the company. Second, drive category growth in partnership with our customers. Third, leverage our global supply chain. And fourth, optimize into one global operating model. To provide a bit more detail on each of these, first, we will deliver consumer-preferred brands through innovation by consumerizing and digitizing Perigo. The consumerization of Perigo will focus on bringing consumer-preferred innovation and brands to market in more value-accretive offerings. This will be enabled through the digitization of Perigo, powering our marketing strategies with digital insights, AI that will offer real-time actionable insights, and end-to-end visibility of the consumer journey. This is a transformation in how we're going to bring products to consumers. OPA was a great example of this, where we have a stack of marketing and digital tools to enhance the consumer journey and accelerate conversion. Next, we will leverage these consumer preferred offerings and our strong customer partnerships to drive growth in the OTC categories where we participate by delivering differentiated solutions benefiting all members of the value chain. All of this will be powered by our global supply chain, allowing for increased manufacturing of higher margin products. Our supply chain reinvention program is already delivering significant benefits, including the reduction of 750 of the 1,000 SKUs planned for this year. Finally, we will evolve to a uniform operating model that will drive consistent focus across our organization on the most value accretive opportunities. We will simplify, standardize, automate, and globalize our structure to optimize our organization. This will provide tremendous opportunity to reinvest in our business and enhance financial performance by driving brand growth capability and accelerating consumer innovation. Defining key pillars is crucial and the work to operationalize these is happening now. Execution against these pillars will require skillful sequencing to strengthen our long-term foundation and we will provide updates on these initiatives as our work continues. To wrap up, we have mobilized around the four key pillars that will create and advance the sustainable and value-accretive growth engine to drive Perigo for the long term. We must continue to focus on operational excellence and deliver our trusted self-care products. We have begun the sell-in for the cough-cold season and there is an opportunity for us to further build retail stock, particularly in the U.S. Also in the Americas, we expect store brand market share gains to continue while building safety stocks in infant formula. In international, we will continue to leverage our brands that are growing and on trend, notably in women's health and skin care. Now finally, a few brief comments regarding oral phenylephrine-containing products and acetaminophen litigations. As most of you know, an FDA advisory committee recently voted that oral phenylephrine products do not provide efficacy to consumers looking for decongestant relief. Following the vote, the FDA communicated publicly there are no safety concerns with these products, and that if a decision is made to remove or reformulate, the agency will work closely with industry. Recently, a retail pharmacy chain removed single entity phenylephrine products from their shelves. Our sales of this product across all of our customers is de minimis. Sales of phenylephrine-containing products accounts for approximately and only 2% of total perigone net sales, a very low margin in only our U.S. business. We do not currently expect retailers to pull combination products ahead of the cough-cold season, as this could create a shortage. Turning to acetaminophen, we have not been named in litigation, and the FDA reiterated its stance that there is no causality between ADHD and taking these products during pregnancy. Additionally, we have not agreed to indemnify any customers, or indeed, they us. In closing, we delivered another solid quarter of results with double-digit growth in gross profit operating income, and EPS, in addition to meaningful margin expansion. We are single-mindedly focused on improving our cost structure, cash flow, and profitability. And I'd like to thank all of our Perigo colleagues for your commitment to our self-care vision. Now, with that, I will turn over to our CFO, Eduardo, to cover the financials in more detail. Eduardo.
spk03: Thank you, Patrick, and good morning, everyone. Looking at our financials, starting with our gap to non-gap summary, the company reported gap income of $15 million for the third quarter or earnings of 11 cents per diluted share. Adjusted net income was $87 million and adjusted diluted earnings per share was 64 cents per share versus 56 cents per share in the prior quarter. A few adjustments to the third quarter pre-tax non-GAAP P&L totaling $88 million were, first, amortization expense of $68 million, second, restructuring charges of $15 million primarily related to our supply chain reinvention program, and third, unusual litigation expenses of $3 million. Full details can be found in the non-GAAP reconciliation table attached to this morning's press release. From this point forward, all dollar amounts, percentage, and basis point changes are on an adjusted basis unless otherwise noted. Since Patrick covered net sales, I will begin my comments at gross profit. Both gross profit and operating income achieved a strong growth compared to last year, driven by pricing actions and contributions from new products. I will cover margin expansion in a moment. Our adjusted effective tax rate for Q3 was 19.2% versus 21.8% last year due to changes in the jurisdictional mix of earnings and impact of benefits not realized on certain pre-tax losses in 2022. These factors led to double-digit adjusted EPS growth of 14.3% year-over-year. Year-to-date, EPS has expanded 30.3% compared to last year. Looking at margin expansion in more detail, total perigold growth and operating margin increased 300 and 130 basis points respectively versus the prior year. In CSEA, gross margin expansion of 430 basis points was driven by strategic pricing and winning portfolio actions, productivity savings, and the addition of the higher margin gateway acquisition. This led to a 90 basis points improvement in operating margin in the quarter. In CSEI, Gross margin declined 120 basis points as pricing actions offset the impact of inflation in the quarter, but could not fully overcome unfavorable mix driven by top line growth in our relatively lower margin UK store brand business. Operating margin increased 250 base points driven by favorable gross profit flow through and lower advertising and promotional spending. Year to date, Total Perigo delivered an adjusted gross margin of 38.5% ahead of our expectations for the year as we continue to benefit from strategic pricing actions, acquisitions, and our supply chain reinvention program. These benefits more than offset infant formula and unfavorable mix in legacy CSEI. Moving on to the balance sheet, cash on hand at the end of the quarter was $598 million, an increase of $43 million from the end of the second quarter. Operating cash flow for the quarter was $125 million, a conversion of 143%. Third quarter operating cash flow included outflows of $12 million from restructuring, unusual litigation, and acquisition-related expenses. We also invested $32 million in capital expenditures and returned $39 million to our shareholders through dividends. Looking ahead, we are reaffirming operating cash flow conversion for the full year of approximately 100%. We also continue to make steady progress in reducing our net leverage. We ended the quarter at 4.8 times net debt to adjust to the beta versus 5.5 times at the end of 2022 and continue to expect net leverage around three times by the end of 2025. As it relates to capital allocation, we are reviewing reinvestment plans and mechanisms of shareholder return while keeping our commitment to leveraging our balance sheet. I expect to provide further details next quarter as we finalize our 2024 plans. Now to our full-year 2023 outlook. As Patrick discussed, in infant formula we are working to rebuild safety stock and production is improving, while at the same time continuing to work through the production changes. Given the totality of the dynamics, we now expect fourth quarter total nutrition net sales to be similar to the prior year. We continue to expect a normal cough and cold season in the US and Europe. And as a reminder, last year's season was both early and strong. We are in a better inventory position with liquid cough cold products in the US versus last year, which will allow us to capitalize in the event of a stronger season. We remain extremely excited about the long-term potential for OPO and expected on retail shelves in Q1 next year. The updated time of selling to retailer customers is also included in our expectations. Lastly, we are updating our assumptions for the recent move in foreign exchange rates, which are now expected to have an unfavorable impact in the fourth quarter. Taking all these factors into account, we now expect year-over-year organic net sales growth of 1% to 3% and reported net sales growth of 4% to 6%. Our creative initiatives, including supply chain reinvention program and synergies from acquisitions, are anticipated to expand total perigold gross margin above our original estimate of plus 200 basis points versus prior year. We now expect a full year tax rate of approximately 14% due primarily to the release of tax reserves related to recent audit settlements. While we have updated our expectation for infant formula and currency translation, the strength of our diversified portfolio, greater margin expansion, and a lower expected tax rate allow us to maintain the mid to lower end of our original 2023 earnings per share guidance range. In closing, I'd like to thank our Paragu colleagues for their tremendous effort in the third quarter and working to take advantage of the many opportunities that lie ahead. Now, I will turn the call back to Brad. Brad?
spk02: Thank you, Eduardo. Can we now open the call for questions?
spk06: Ladies and gentlemen, at this time, we'll begin the question and answer session. To ask a question, you may press star and then one on your touch-tone telephones. To withdraw your questions, you may press star and two. If you are using a speakerphone, we do ask that you please pick up your handsets prior to pressing the keys to ensure the best sound quality. Once again, that is star and then one to join the question queue.
spk04: We'll pause momentarily to assemble the roster. Our first question today comes from Chris Schott from JPMorgan.
spk06: Please go ahead with your question.
spk08: Hi, this is Ethan Brown on for Chris Schott. Thanks for taking my question. To start off, you mentioned, I believe, a 33 cent impact to the original 2023 guidance from lower infant formula sales. And just hoping you can talk about the progression through 2024 for that franchise. more color on how you expect to recapture that EPS impact and maybe what normalized sales look like for that franchise going forward. And then I have one more follow-up from there.
spk03: Okay. Hi, Chris. This is Eduardo here. Thank you for a question. So as we highlighted, you know, into our numbers, so we saw this impact that's mainly happening in the third and the fourth quarter. So as we highlighted there, you know, we – Q3 was our first full quarter operating under the new FDA guidelines. So we shortened our production campaigns to perform more frequent, you know, major cleanings, and we implemented enhanced product testing and quality procedures. And because of that, we were unable to replenish our safety stocks. We're now really focusing on rebuilding those safety stocks for our highest volume SKUs, and production is improving week by week. So we anticipate our operations to normalize by the middle of next year, and then we expect to recapture most, if not all, of the $0.35 CPS impact by mid of 2024.
spk08: Okay, great. And then my second question is just now that we're a couple of quarters into the margin recovery, can you talk about the expected gross margin progression from here and how to think about sequential trends for the overall and America's business? And then how do you think about normalized margins longer term for the company?
spk03: Yeah, so as you were able to see, we're pretty proud of you know, the progress that we have been doing. As we highlighted in our investor day, we're expecting about 200 basis points improvement. But as we share today, we're expecting we're going to outpace that, you know, given all the focus we have done, both on the winning portfolio, you know, exiting low margin products, but also you know, really improving the overall margins through strategic pricing and continue to work on the prioritization of our portfolio. So we expect that to go beyond the 200 basis points this year. So as we look into 2024, we continue the same trajectory so that we originally mentioned we would be achieving 40% gross profit margin by 2025, but given the pace that we're seeing today, we're most likely going to be able to outpace that objective.
spk04: Thank you. That's it for me.
spk06: Thank you, Chris. Our next question comes from Susan Anderson from Canaccord Genuity. Please go ahead with your question.
spk01: Hi. Good morning. Thanks for all the details this morning. It's very helpful. I was curious, I had a question on the slide on the store brand versus national brand, the latest 13 weeks, the .7 share gain. Was that, I guess, overall, or was that in your categories? And then, I guess, just looking at the categories that you play in, did you see share gains across all of them, or were there any categories where you saw some losses? And then I'll have a follow-up. Thanks.
spk03: Yeah, so, Susan, These numbers that we shared, you know, are across the categories overall, right? So we're seeing, you know, consistently over the last 13 weeks, you know, 0.7%. They are into volume share gains of store brands. And from a dollar standpoint, as you know, because of national brands have been more aggressive on pricing, you know, as we look into the dollar share, we see slight gains. As we continue to track that into the latest information that we got in October, that continues to trend, and we believe that's very, very positive. So it means that consumers on a volume basis, they're really trading down. We're not seeing that extensively because of the differential on price increases. But the positive thing is, As compared to last year, where you remember we had some challenges on having enough inventories, this year we're in a much stronger position. As the cough and cold season continues to progress now, as we saw a little bit of a slow start, but we're starting to see a pickup on that, we are at the highest level of the last years on liquid cough and cold. So if the strong season, you know, strong cough and cold season confirms, we're very well positioned to capture additional volume and value versus our current estimates.
spk01: Great. And did you guys say how much of an impact to the top line the U.S. nutrition and then the branded OTC products in America has had?
spk03: Well, to Q3... We would say two-thirds infant formula, one-third the delay on the season is what we saw in the third quarter versus the original expectations.
spk01: Okay, great. And then if I could just add one more. So you mentioned the price increases. I was curious, how much did you raise price and was it across all categories or what categories did you see price increases in? And then... Also, I'm curious just how the retailers and then the consumers are responding to those price increases.
spk03: Yeah, so overall we have almost 5% price increase. I would say the significant portion of that is in the infant formula business. Remember, because of the FDA guidelines and the changes in the operations that we had to do, You know, our – we talked with the – with retailers about that, and so we implemented those actions in July, as we talked before, and we haven't seen any pushback. Of course, you know, we would hope to see more of that benefit, but because of the supply chain challenges to adapt to the new FDA guidelines, we haven't been able to fulfill the volumes there. We expect that pricing benefits continue, and also next year we should see the leap effect into the first half of the year.
spk01: Okay, great. Thanks so much. Good luck the rest of the year.
spk04: Thank you.
spk06: Our next question comes from Daniel from Hedgeye. Please go ahead with your question.
spk07: Hi, thank you. I wanted to follow up on the phenylephrine products. I was wondering how long it would take for you to change the production of the combination drugs, like how much of a lead time it would take to hit retail shelves.
spk03: Well, thank you for the question. So the first thing is today our exposure in the overall portfolio is about 2%, you know, the total company net sales. So, so far the impact has been very small to all retailers. And it's only of all single entity phenylephrine products, right? So we do not expect any action of combination of products given the safety and potential for shortage. So we are already working, you know, to reformulate our phenylephrine products with other active ingredients if needed. So we are pretty well on track with our plans for the next season.
spk07: Okay, thank you. And then I was wondering if you could comment on the effort recently in the Senate to have the OTC birth control covered by insurance, how that would even work, and what Parago's thoughts are on that.
spk00: Yeah, hi, good morning. This is Patrick. We are aware of those efforts. We support those efforts. We're still in discussion to also include the FSA and HSA supports. and I'll describe it at the moment as a work in progress, and hopefully we can give a favorable update soon.
spk07: Okay. And then finally, if I can squeeze one more in, I was just wondering, it's more of an open-ended question, but what has been the response from your customers about the SKU rationalization efforts? What have your learnings to date? Has it been mostly one-off decisions where one decision to not produce a product has not had any sort of impact on anything else, or Have you learned things are interconnected and a little more complicated than it seemed at first? Thank you.
spk00: Yeah, I'll respond first and then Eduardo with a bit more detail. Actually, generally well received. I mean, both in terms of elimination, everybody understands that it's important for mutual value creation. We see movement into other SKUs. And also we've done skew standardization across retailers because we saw changes in pack sizes, lid sizes, labeling, font sizes, all of which was driving tremendous complexity that just wasn't serving the consumer or driving preference. So this basically has allowed us to create more value without really any risk or trade-out. So I think so far the effort has gone extremely well. We continue to be very focused on the U.S. to the question earlier about gross margin expansion, the opportunity for further pricing, and we continue to work that through with our retailers, even looking into 24.
spk03: Yeah, and just to complement to what Patrick mentioned is, as we highlighted, so We achieved already 750 of the 1,000 SKUs planned for this year to be simplified. And so the reaction, you know, hasn't been – has been very positive in that sense. And we continue to – our conversations with them to progress in those areas. So I think that's been very well implemented and very well communicated with the retailers at this stage.
spk04: Thanks, Daniel.
spk06: Once again, if you would like to ask a question, please press star and then one. Our next question comes from Keoni Kim from Morningstar. Please go ahead with your question.
spk05: Hey, guys. Thanks for taking my question here. I wanted to follow up on Oak Hill. I assume the launch of that product will be maybe a little bit diluted for some time through marketing and SG&A spending. But, you know, it'll eventually get to neutral or even accretive. And so I was wondering how big of a headwind should we expect from this launch, if any?
spk03: Well, so the way we were thinking about Opioid, you know, on the launch, so we expected the selling to take place in Q1, mainly because we wanted to make sure there is continuity on the product supply, you know, based on the anticipated customer repair changing levels. But as, you know, it was highlighted, we want to make sure that we invest in the franchise of the whole women's health category. We expect that to be diluted in 2024. But I...
spk00: It's an important question that I think is probably going to come up at some stage. Have we considered that in our balance earning per share growth for 24? Yes, and yes, we have. We still strongly outlook performance in the 290 to 3 range. So even though this will be dilutive, That's standard of any brand launch. The program continues to build well, but it's just part of a sort of balanced set of investments and opportunities as we continue with double-digit earning per share growth.
spk05: Great. That's really helpful. Just one more from me. Can you talk about how much more SKU prioritization is left over, and should we expect any of that for 2024? Thank you.
spk00: I'm sorry. SKU prioritization. We will continue with these efforts of driving gross margin by focusing on more value accretive offerings. So I would expect some effect into 24, but I would expect less revenue impact as we balance that with growth initiatives to a greater extent than we have in 23.
spk03: Yeah, just to complement there, as you remember, in 2024, we have additional benefit from the Supply Chain Reinvention Program. That's mainly because of the other pillars that we have there into our plans.
spk06: And, ladies and gentlemen, at this time, and showing no additional questions, I'd like to turn the floor back over to the management team for any closing remarks.
spk00: Thank you for joining us today. We actually feel very good about the improving structural health of this business. The revenue impacts that we've seen are essentially infant formula disproportionately in the U.S. and a slightly slower start to the cough cold season. This means that the great majority of our programs are on track in line with our expectation, producing upper-caudal performance, and we look to continue that in 24 and 25, and we feel very good about our long-term growth algorithm as well. More of our growth in the future will be branded, both in the U.S. and the international, and we're currently working through those portfolio choices, and we hope to share more with that in the weeks and months ahead. So we feel good about our performance, and we thank you for your support.
spk06: Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.
Disclaimer