Edgewell Personal Care Company - Q2 2023

Transcript

Operator (participant)

Good morning, and welcome to the Edgewell Personal Care Q2 2023 Earnings Conference Call. All participants will be in the listen-only mode. Should you need assistance, please signal 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 then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Chris Gough, Vice President of Investor Relations. Please go ahead.

Chris Gough (VP of Investor Relations)

Good morning, everyone, and thank you for joining us this morning for Edgewell's Q2 fiscal year 2023 earnings call. 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, then hand it over to Dan to discuss our results and update to the full year 2023 outlook before we transition to Q&A. This call is being recorded and will be available for replay via our website, www.edgewell.com. 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, acquisitions and integrations, changes to our working capital metrics, currency fluctuations, commodity costs, category value, future plans of return of capital to shareholders, and more.

Any such statements are forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to future events, plans, or prospects. These statements are based on assumptions and are subject to various risks and uncertainties, including those described under the caption Risk Factors in our annual report on Form 10-K for the year ended September 30th, 2022, as may be amended in our quarterly reports on Form 10-Q, which is on file with the SEC. 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 is shown in our press release issued earlier today, which is available at the Investor relations sections of our website. This non-GAAP information is provided as a supplement to, not as a substitute for, or as superior to, measures of financial performance prepared in accordance with GAAP. However, 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 (President and CEO)

Thank you, Chris. Good morning, everyone, and thanks for joining us on our Q2 earnings call. This was a very strong quarter as organic net sales increased over 11%. Our growth was broad-based, coming from all major geographic regions and all segments of the business. Growth was also balanced, coming in equal parts from higher volumes and price execution, enabled by better brand resonance and stronger presence on shelf. Our operational execution also improved, enabling us to deliver better in-stock positions and meet accelerated retailer demand in the quarter. We delivered against our productivity and efficiency initiatives, which, coupled with price execution, served to mostly offset significant inflationary headwinds. We continued to realize the benefits from our ongoing efforts to strengthen our commercial teams and capabilities, most notably in our international markets. This strong top-line performance translated to the bottom line as well.

In what continues to be a challenging operating environment, adjusted earnings per share increased 12%, despite facing a $0.16 headwind from currency and over 500 basis points of gross inflationary headwinds in cost of goods. On a constant currency basis, adjusted earnings per share increased over 40%. Looking to the drivers of our performance this quarter, we saw further evidence of meaningful progress in our transformation, demonstrated by fundamental improvements across our brands, which reinforces our confidence going forward. This structural improvement is most evident in our ability to generate consistent top-line growth as we delivered our eighth straight quarter of year-over-year organic sales gains. Our ability to consistently, sustainably grow the top line is fueled by the strides we have made across brand building, product innovation, and retail execution. There's probably no better example of this than in our fem care business.

It doesn't get as much attention as some other segments, the turnaround in fem care has been instrumental to our success. With a focus on better innovation, consistent investment, and better shelf outcomes, we've seen meaningfully better sales and share results, and our position in the category in the U.S. has strengthened. In the quarter, both North America and international markets delivered double-digit organic net sales growth, driven in equal parts by volume and price. While healthier categories and favorable phasing of demand were contributors, the fundamental change in our business trajectory is a result of better execution on shelf. Our retail relationships are stronger, our commercial execution and on-shelf positioning is better, and our innovation is more centered on the consumer. As I mentioned last quarter, our brands are healthier and better represented on shelf than at any point since we began as an independent company.

Our focus on consumer-centric innovation and new product development is playing a vital role in our strengthened portfolio, with the acquired disruptive brand-building capabilities of the Cremo and Billie teams now benefiting our broader portfolio. Importantly, growth this quarter was also underpinned by better supply chain execution. We improved stock levels in fem care, particularly in tampons. In sun care, we were able to meet increased retailer demand across the United States, Australia, and Mexico, largely due to our strategic decision to build product early in the cycle in anticipation of another strong season. Market share performance across the total portfolio was solid, supported again by meaningful share gains in key markets for our leading women's shave portfolio. The Billie brand has now expanded across the retail landscape here in the United States, and early results are very positive.

While our efforts to improve service levels are critical, equally important is the work our teams are doing to simplify our business and to deliver meaningful gross cost reduction across both cost of goods and overheads. This quarter, we delivered $18 million in gross savings, providing a significant offset to the inflationary headwinds we faced in the quarter. This work is not only important to help deliver on our earnings commitment, but also strengthens our business over the longer term. We continue to operate in a challenging and uncertain marketplace. Inflationary and foreign exchange pressures, though easing, remain significant headwinds to our business. The labor market remains tight, and perhaps most importantly, we are closely monitoring the market for signs of weakening consumer sentiment in the face of likely economic challenges ahead.

We therefore remain cautious as we consider the balance of the year, act with urgency, and continue to focus on controlling the controllables. This being said, we are increasingly confident in the underlying fundamentals of our business. With the benefit of a strong Q2, we are increasing our full-year outlook for organic net sales growth to the high end of our range or 5%. Importantly, we still see our fiscal Q3, the April to June period, as being an inflection point for gross margin accretion. Through the realization of price actions, the ongoing execution of our productivity initiatives, and some moderation in inflation, we continue to expect gross margin accretion for the full fiscal year. I'm confident that we are taking the right actions to deliver a sustained value creation over the long term.

As we move beyond this period of significant inflation and foreign exchange headwinds, as well as other supply chain challenges, I believe we will realize the full potential of our fundamentally improved business model, driven by top-line growth, gross margin expansion, and free cash flow generation. Now I'd like to ask Dan to take you through our Q2 results and also to provide additional details on our outlook for fiscal 2023. Dan?

Dan Sullivan (CFO)

Thank you, Rod. Good morning, everyone. As you just heard, this was a strong quarter top to bottom. Commercial and operational execution across all segments and key geographies, accompanied by a backdrop of healthier categories, led to a quarter that exceeded our expectations. Despite the ongoing macroeconomic challenges, strong operational and commercial efforts in the quarter drove double-digit organic net sales growth and double-digit adjusted EPS growth, giving us increased confidence in our ability to meet our full-year outlook. Before getting into the details of the quarter, I would like to discuss three main tenets of our success thus far. First is the importance of winning on shelf, with greater quantity and higher quality shelf presence serving as a key catalyst for the eight consecutive quarters of organic net sales growth we've delivered and our increased full-year outlook for organic sales.

Second, we remain on a path to return to year-over-year gross margin expansion in 3Q. As in the Q1, in Q2, we again essentially fully offset the headwinds from gross inflation with a balanced combination of further productivity delivery and ramping benefits from price increases. Finally, we are committed to incrementally investing in our brands through a thoughtful combination of above-the-line and below-the-line investments. Through half 1, we've been both strategic and intentional in the support of our brands, prioritizing those investments that offer the highest return. We will maintain this return on investment discipline as we meaningfully increase A&P spending in the second half of the year. Let me give you some further insight into what we saw across our business in the quarter. In North America, the consumer environment remained robust, and we saw underlying category growth across all segments.

Pricing continued to contribute to organic growth, and elasticities remained below historical norms. In our international markets, categories are strengthening in most geographies, especially in key sun care markets within Southern Europe, Oceania, and Latin America, as travel and leisure activity remain robust. Shave categories across Asia remain soft and below pre-pandemic levels. Let me turn to the detailed results for the quarter. As mentioned, organic net sales increased 11.4%, with price and volume gains contributing equally to our growth. International organic net sales increased over 13%, while in North America, organic net sales increased just over 10%, with both International and North America growth achieved through nearly even price and volume gains.

As we previewed last quarter, we also benefited from the phasing in sales from 3Q to the Q2, delivering an estimated 3 points of growth, largely due to timing of global sun care shipments. Even after adjusting for this phasing tailwind, underlying organic growth was a robust 8% in Q2. Wet shave organic net sales increased 4.6%, with North America organic net sales increasing 5%, driven largely by price as volumes were essentially flat. Growth in men's systems, including the launch of a new Cremo razor in Costco, disposables and shave preps, were partly offset by declines in women's systems. Billie organic sales declined in the quarter, as expected, reflecting the churn associated with the year two planogram resets at Walmart as we cycled the launch a year ago.

The year-over-year impact of consumers transitioning from starter kits to blade refills and the still building expansion across retail channels. Importantly, consumption results for the brand are strong, and we're very pleased with initial performance on shelf. The brand has reached the number four position at Target in its first four weeks, despite a crowded set, with similarly strong performance across grocery and drug. Organic net sales in international markets increased just over 4%, mainly driven by realized price increases in all key regions. Men's and women's systems and disposables all grew mid-single digits, driven by European strength in branded and custom brands. Importantly, we will take steps in Japan in the Q4 to simplify ongoing operations and reduce business volatility across our wholesale partners.

The result is a structural reduction in wholesaler inventory levels, which will be executed in Q4 and will provide improved operational and commercial execution in our second biggest market. These actions were not previously reflected in our outlook, and I will discuss the expected impact for fiscal 23 shortly. In U.S. razors and blades, consumption increased 3% in the quarter, while our market share in aggregate declined 30 basis points as gains across our women's systems portfolio, led by Billie and Hydro Silk, were offset by modest declines in men's systems and disposables. Sun and skincare organic net sales increased 15%, driven by strong global sun care and grooming performance. Results exceeded our outlook and come on top of double-digit growth a year ago.

North American growth was led by better distribution outcomes, both in quantity and quality, innovation through Banana Boat Protection + Vitamins and Hawaiian Tropic line extensions, and incremental price. As expected, Q2 benefited from favorable phasing of some replenishment orders as retailers focused on stronger in-stock positions into and out of spring break and the Easter holiday. International sun care sales increased nearly 60%, driven by both price and volumes and some tailwinds from similar shipment phasing. International sun care saw strong underlying growth in Southern Europe, LatAm, and Oceania as a return to travel and leisure activity drove demand recovery. In the U.S., the sun care category remains healthy, growing nearly 12% for the quarter. As competitive products returned to shelf following last year's recalls, our sun care brands predictably lost approximately 190 basis points market share in the quarter.

Grooming organic net sales increased just over 12%, led by Bulldog growth internationally and Cremo growth in North America. Fem care organic net sales increased 35%, driven by a healthy category, incremental pricing, and lapping prior to your supply chain challenges. Fem care's two-year stacked organic growth was over 9%. Growth was delivered across Playtex Sport, Carefree, and Stayfree brands. Category consumption increased 7%, and our share was effectively flat in both the Q2 and the latest 52-week period. Now, moving down the P&L. Gross margin on an adjusted basis decreased 170 basis points or 75 basis points constant currency.

As in approximately 500 basis points of combined strong price gains and productivity savings were more than offset by 550 basis point headwind from inflationary pressures and a 30 basis point impact from negative category and market mix. A&P expense was 10.5% of net sales. Excluding the favorable impact of currency translation, A&P decreased about $6 million compared to the prior year quarter, primarily due to timing of brand investments and marketing campaigns versus a year ago. Adjusted SG&A decreased 110 basis points versus last year as the benefits of leverage, operational efficiency programs, and favorable currency movements more than offset the impact of higher people costs. Adjusted operating income was $62.5 million compared to $46.7 million last year, an increase of nearly 34% or a 50% constant currency increase.

GAAP diluted net earnings per share were $0.37 compared to $0.43 in the Q2 of fiscal 2022. Adjusted earnings per share were $0.56 compared to $0.50 in the prior year period, including an estimated $0.16 negative impact from currency and $0.02 favorable impact from share repurchases. Adjusted EBITDA was $83 million compared to $73.7 million in the prior year, inclusive of an estimated $10.3 million unfavorable impact from currency. Net cash from operating activities was $1.9 million for the first six months, compared to an outflow of $39.9 million in the same period last year.

We ended the quarter with $155 million in cash on hand, access to the $243 million undrawn portion of our credit facility, and a net debt leverage ratio of about 3.8 times. In the quarter, share repurchases totaled over $15 million. In addition, we continued our quarterly dividend payout and declared another cash dividend of $0.15 per share for the second quarter. In total, we returned nearly $23 million to shareholders during the quarter and $46 million over the first half of the year. Turning to our outlook for fiscal 2023.

As we've discussed, the commercial and operational fundamentals of our business are strong, and we are increasingly confident that we're on track to deliver another year of mid-single digit top line growth, coupled with a return to gross margin accretion in the second half of this fiscal year. However, it is important to note that we continue to operate in a challenging environment. Inflationary and currency pressures remain elevated. The labor market continues to be highly constrained. Covid reopening in APAC remains choppy, and there are meaningful unknowns with respect to the future state and overall sentiment of the consumer. For the fiscal year, net sales are now expected to be at the high end of our previous 2%-4% range, inclusive of slightly less currency headwinds than our prior outlook.

Reflective of the stronger unit performance across most segments, we now anticipate organic net sales growth to be at the high end of the 3%-5% range and inclusive of an estimated 50 basis points full-year headwind related to our intentional steps to structurally reduce wholesaler inventory levels in Japan in the Q4, which was not previously contemplated in our outlook. Our outlook for gross margin is unchanged as we continue to anticipate about 30 basis points of year-over-year rate accretion, and there is no material change to our view on inflation headwinds and pricing and productivity offsets for the year. We continue to anticipate adjusted operating profit margin accretion on a full year basis, mostly as a result of gross margin rate gains.

The impact of currency on operating profit is now expected to be an approximate $24 million headwind, a $2 million improvement over our prior outlook. Adjusted EBITDA is expected to be at the high end of the $320 million-$335 million range. The tax rate is now expected to be approximately 25% compared to 24% in the prior outlook. Adjusted EPS is still anticipated to be in the range of $2.30-$2.50, though now slightly above the midpoint, inclusive of approximately $0.43 per share of currency headwinds. This upward revision to our outlook reflects our expectation for stronger sales and slightly lower currency headwinds, partially offset by the higher tax rate.

In terms of phasing, we now expect 3% organic sales growth in half two of the fiscal year, with the overall rate of growth reflecting the shift in sun care shipments from 3Q into 2Q and the structural reduction of wholesaler inventories in Japan in the Q4. Given both of these dynamics, our half two organic growth is expected to occur entirely in two to three, with the Q4 organic sales expected to be flat to last year. For more information related to our fiscal 2023 outlook, I would refer you to the press release that we issued earlier this morning. I'd like to return the call to the operator for the Q&A session.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To ask a question, you may press Star, then one on a telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press Star then two. At this time, we will pause momentarily to assemble our roster. Our first question is from the line of Chris Carey with Wells Fargo Securities. Please go ahead.

Chris Carey (Senior Equity Analyst)

If you can hear me. I just wanted to understand, you know, how the quarter came in relative to your expectations. I hear you on low single digit organic sales growth in the back half of the year. You know, how much of that would you chalk up to, hey, this is, you know, an uncertain macro and you're kind of unwilling to flow through some of the momentum you're seeing right now relative to, that's just the size of the shift that we've seen in sun care and I guess the 2-point hit from, you know, inventory work down in Japan in Q4? Just quick perspective on that, and then a follow-up.

Dan Sullivan (CFO)

Hey, Chris, good morning. It's Dan. Yeah, thanks for the question. I think the quarter was largely in line with our expectations at the core level in terms of growth, margin profile and overall profit flow. I think what we called out in the quarter as phasing, and we profiled it a bit last quarter, was sun care shipments globally, not just in the U.S., which we would say was probably worth about three points in the quarter. We did see some A&P spend shift into the back half of the year, mostly in international markets, but that was a bit of a small adjustment. I think largely in line with expectations at core level, and again, quite pleased obviously with the balance of growth from both price and units.

As we look to the back half of the year and your question around flow-through, I think there's 3, you know, 3 core reasons why you don't see the full flow-through, let's say at EPS level, although you do see some as we've taken our guide up. 1 is just the phasing of sales that I talked about earlier doesn't, you know, affects the back half of the year in sun care. I think two is the strategic choice we've made in Japan to strengthen our position with wholesalers and take some inventory out of the system. Then three is that A&P spend, which we shifted out of half 1 that comes back in half 2. You know, obviously we're still operating in a bit of an unknown market, in a bit of a challenging macro environment.

Sun care being so important to us, and we're in the heart of the season right now, feel really good about where we are, but still a lot to learn about the season here in the US. All of that sort of factors into how we thought about the full year guide.

Rod Little (President and CEO)

Chris, I would just add to it. We did take the sales guide up to the 5% number. I think the other thing we look at when we look at EPS is we still don't know what we don't know about the sun care season, right? We've had a very good sell in. The sell out will happen here over the next couple of months, and depending on how weather impacts that, will ultimately determine where we land. We don't wanna get ahead of ourselves on that assumption. The other thing I think we look at is just the overall broader macro environment still remains very uncertain and highly volatile. If we've learned anything over the last couple of years, we can't predict what's coming at us.

I think wanting to keep investment in, we also want to be prudent as we thought about the bottom line.

Dan Sullivan (CFO)

Okay.

Rod Little (President and CEO)

Thank you, Chris.

Chris Carey (Senior Equity Analyst)

Okay. That's helpful. Hey, just one follow-up, if I can. Can you hear me?

Rod Little (President and CEO)

Sure. Sure, bud.

Chris Carey (Senior Equity Analyst)

Yeah. Can you just expand a bit on Billie? I think you mentioned organic sales declined in the quarter, but consumption is strong. Is that just lapping, you know, year ago pipe fill? Maybe just elaborate on, you know, confidence that you're continuing to see what you expect to see out of the offering. Thanks.

Rod Little (President and CEO)

I think on Billie, we remain very optimistic with where the brand can go and very happy with what we've done the last couple of quarters here. We got the team in place. The Billie team that we brought in via the acquisition remains in place. The team has integrated the business, so it's fully integrated into the Edgewell order shipping billing systems. We exceeded expectations with Walmart. If you go back and look at what we thought we would do in year one at Walmart, as well as what Walmart thought it would do. Walmart was incredibly happy, which has led to a great national rollout, which has just begun. There's more to come in terms of that national rollout. Beyond that, the innovation pipeline is working.

There's a new SKU, for example, Billie Body Buffer. It's a pre-shave exfoliating bar. It has already won multiple awards as a new interesting piece of innovation. When you think about the portfolio and where it can go over time into a broader lifestyle brand, not just a shave brand, we also have a very interesting portfolio and long lead discussions going with a few retailers around category adjacencies. I think we're super excited with what we're seeing and where the brand can go. Dan, anything to add?

Dan Sullivan (CFO)

Yeah. Good points, Rod. The only thing I would add, Chris, just to put some finer points on the math. I think you're right. I think there's a little bit of an imbalance between organics and consumption. We know we're cycling a strong Q2 last year for women's brand at about 7%. Part of that is Billie, obviously at Walmart. Part of that is Intuition going into Costco, dermaplaning, getting national pipe fill. There was some things happening last year. When you ladder back, though, and look at the shelf, to Rod's point, we couldn't be more pleased with what we are seeing. The Billie brand has risen to about a four and a half share in the category. It's up over a point versus a year ago. It's performing consistently well across Target, drug, and grocery.

You look at the full portfolio. Hydro Silk is up almost a point in share over the same period, and Intuition is flat. You're seeing incredibly strong shelf performance by Billie, but equally additive for the portfolio of Edgewell. I think there you do point to a little bit of an imbalance between organics and consumption. Thanks, Chris. Operator, next question, please.

Operator (participant)

Thank you. Our next question is from the line of Susan Anderson from Canaccord Genuity. Please go ahead.

Susan Anderson (Managing Director and Equity Research Analyst)

Hi. Good morning. Nice job on the quarter. Thanks for taking my question. I was wondering if you could maybe expand on gross margin. You said return to expansion in Q3. Should we think about that as sequential improvement then from third to fourth? Basically will Q4 see more leverage? Also if you could talk about the drivers there, will we have fully cycled the inflationary pressures and are you expecting those to basically be flattish year-over-year?

Rod Little (President and CEO)

Hey, Susan, can you restate the first part of that question? The line was choppy, and we didn't pick up the first part of that.

Susan Anderson (Managing Director and Equity Research Analyst)

Yeah. Just how should we think about the progression of the gross margin the rest of the year?

Rod Little (President and CEO)

Got it. Dan?

Dan Sullivan (CFO)

Good morning, Susan. Look, I think we are increasingly confident in the way that we have profiled the margins over half one and half two, right? We feel really good about how we thought about the inflationary pressures, largely as we had expected in the first half of the year. A bit higher in Q2, that's mostly due to sun penetration, right? Where you saw exaggerated cost inflation on sun chemicals. Pricing has now in and scaling productivity savings really consistent. We sit here at the halfway mark, having delivered what we thought would be a margin profile, you know, exactly as we've seen in the first half of the year, and really good line of sight to half two. What you're gonna see happen, we believe in half two is the productivity savings consistent.

That's in the 200 basis point range. You're going to see the pricing tailwinds scale up a bit. We expect to be, for the back half of the year, closer to 300 basis points. I think the real unlock is that gross inflation number, which has been about 500 basis points, is likely half that over the back half of the year. You put all of that together and we start to see in Q3 the business turn towards margin accretion, and we expect that that rate accretion will actually even increase in Q4. Increasingly confident back half of the year.

Susan Anderson (Managing Director and Equity Research Analyst)

Okay, great. That's really helpful. Then also, you talked about better execution on shelf driving the gains. Maybe if you could just give some color on kind of what you're doing better now versus historically, what's changed there, is it better merchandising, more space, et cetera?

Rod Little (President and CEO)

I think, Susan, there's a few things going on there. One is just better branding, better innovation. Going all the way back to the very beginning of what's the consumer insight, what's the need, or what's the pain point to be addressed with our innovation, how we then craft that, how we communicate that's just all working better, and the teams are better at that. For example, I'll just give you one example. Schick right now, both men's and women's, the number one brand on TikTok in terms of followership and activation. We've gotten much better on the brand building and the marketing end of this in terms of activating our brands to create real consumer pull and demand.

The second piece of this then, and we've been talking about this for a while, we wanna be great partners, with our retailers and the retail partners of brick-and-mortar as well as the online partners that ultimately sell us through to the end consumer. We've just gotten better at that. Our teams are very seasoned and also very fresh and new with insight they bring to retailers. We're partnering with retailers in a bigger way, not only with what's happening in the set this year, but the longer lead conversations already with where we see the category going for 2024 and 2025. We're now part of those longer lead conversations in a way that we weren't one and two years ago.

It's all of that put together that I think, you know, you have to have both of those happening to ultimately have, you know, the shelf outcomes improve, which we've seen.

Susan Anderson (Managing Director and Equity Research Analyst)

Great. That's helpful. Then just one follow-up on Billie. Did you say how it performed in DTC? I was curious if you're seeing, you know, any impact as you roll it out more broadly to retail or maybe, you know, it's also been helpful as you kinda gain more consumer eyeballs too.

Dan Sullivan (CFO)

Yeah. We've seen some impact as you would expect. I think all brands who start in that digitally native space and move to this level of retail expansion are going to see impact. What we have seen from a sales perspective actually is DTC has been a bit above our expectation. That's a bit of an early read. We're now entering the season for women's shave, and the brand has fully stood up at retail. We'll see. We'll obviously continue to monitor. I think the other thing the Billie team has done an excellent job of is optimizing spend in that space, which at times can be a bit irrational.

You know, all in all, we like how the total portfolio is performing, but obviously a ways to go here in the season to evaluate both retail and DTC.

Susan Anderson (Managing Director and Equity Research Analyst)

Great. Thanks so much. Good luck the rest of the year.

Dan Sullivan (CFO)

Thank you.

Rod Little (President and CEO)

Thanks, Susan.

Operator, next question, please.

Operator (participant)

Thank you. Our next question is from the line of Peter Grom from UBS. Please go ahead.

Peter Grom (Director of Equity Research)

Thanks, operator, and good morning, everyone. I wanted to ask about gross margin, but more from a longer-term perspective. You know, obviously, you know, the guidance embeds some nice improvement in the back half of the year. If I kind of just take the building blocks that were just provided in your response to Susan's question, 300 basis points of pricing, you know, 200 basis points of cost savings, inflation roughly half of the 500, you're kind of exiting the year, you know, at a gross margin rate that's, you know, approaching the mid 40% range. I just would be curious, you know, how should we think about that exit rate and, you know, how we should think about gross margin recapture opportunity as we look ahead longer term, right?

You know, a lot of your peers are really starting to step up margin improvement and, you know, return to pre-pandemic levels. Just you know, any comments on how we should think about the recapture opportunity longer term and when we can kind of get back to pre-pandemic levels of profitability? Thanks.

Rod Little (President and CEO)

Yeah. Peter, first, welcome. Good morning. Thanks for picking up coverage. On the question, I think we very much see line of sight towards getting back to pre-pandemic gross margin levels. That's a focus for us. It's something we're committed to doing, we think we can do. The unknown for us is just where do we go from here on inflation, around input costs, specialty materials, labor, still very much inflationary. If you look at where we are from here, we're seeing continued inflation there. Some of the commodity baskets are moving lower, which is good. We need that to continue, but I can't predict what's gonna happen with that element.

The other piece, I think, that we can't predict and we've been very much impacted by in this year that we're in, is foreign exchange and the relative strength of the dollar as we have big, long exposures, for example, in Japan and frankly, against, you know, a lot of the G8 X euro, where we're a little more balanced. We can't control that either. Those two things aside, and I think they'll normalize over time, I would suspect, we're going to remain aggressive on pricing, where we can take pricing and there's a little more pricing to come in certain select markets, and we'll continue to monitor inflation and price where we can going forward.

There is a new muscle we've been building in the company around revenue management, looking at mix, accretive innovation, how the teams basically build the business out with a better revenue profit mindset. That will be a contributor. We're gonna continue to stay after the cost productivity work. As Dan referenced, that's something we've done very well over the last three years, thank goodness. We'll continue that, and we've got line of sight for that to continue over the next couple of years as well. When you put that all together, you know, in the back half here, we're gonna be in a gross margin, accretive environment. Hard to predict what that will look like in 2024 at this point, mainly around inflation and foreign exchange.

Those two things aside, I think, you know, we've got line of sight to getting back to pre-pandemic margins, not necessarily by 2024, but it's very achievable, we think, over the, let's call it the midterm.

Peter Grom (Director of Equity Research)

No, that's super helpful. I guess maybe just to follow up on that, you know, just to the extent that this gross margin recovery does begin to play out, I mean, how does the company think about reinvestment versus allowing some of the upside to flow through? It just would seem, you know, as a percentage of sales and particularly given that you're stepping up investing in the back half of the year, that you're pretty well invested, which would potentially allow for more flow through. Just, you know, any thoughts on how, you know, we should be thinking about, you know, the potential bottom line tailwinds that would come from this gross margin recovery?

Rod Little (President and CEO)

It'll be a mix, Peter. I would like to spend more on marketing support for our brands, particularly around working media. As we are getting better with our innovation, as we're getting better with our messaging and communication and just the proposition we're bringing to consumers, it's worth talking about more consumers knowing about. I do think there's an opportunity to invest more on the media end from here as we go forward. Equally, I think we've got a margin opportunity. As we look at it, there's both. I think if we build our plan right for the future, you'll see net incremental investment going into the brand support line, and you'll see a net margin build from here.

Peter Grom (Director of Equity Research)

That's super helpful. Thank you so much. I'll pass it on.

Rod Little (President and CEO)

Thank you.

Chris Gough (VP of Investor Relations)

Thanks, Peter. Operator, next question, please.

Operator (participant)

Thank you. Our next question is from the line of Bill Chappell from Truist Securities. Please go ahead.

Bill Chappell (Managing Director and Senior Equity Research Analyst)

Thanks. Good morning.

Rod Little (President and CEO)

Morning, Bill.

Bill Chappell (Managing Director and Senior Equity Research Analyst)

Just a couple kind of follow-ups. I guess one on the Japan kinda wholesaler wholesale reduction in 4Q. Kinda help us understand. I was under the impression that the Japanese market had been fairly depressed for wet shave now for quite some time, but was starting to recover. Is the thought that you're waiting to kinda see how it recovers until 4Q and then do the reduction from there? I mean, I'm just trying to understand why there's still so much inventory. It seems like it's been depressed for quite some time. Just trying to understand the thought behind that.

Rod Little (President and CEO)

Yeah. Bill, we have new leadership in Japan. As you know, we put new leadership in there last fall. With that new leadership in the market, it's a increasingly capable team who's very plugged in to the market and with the priority of having strong partnerships with wholesalers. I was there in the fall, met with wholesalers, met with our team, and one of the things we talked about was: What does it take to unlock the future growth from here in the market? As you're rightly calling out, the market has not recovered. As recently as last month, it was still in decline for the three consecutive years in the pandemic. We very much expect that to change for the future. Recognizing we remain the share leader in Japan, our share position is strong.

We see great growth coming in the future in that market around market recovery from COVID. We wanted to be in the best possible position to work with our wholesale partners to go after that growth. The one thing getting in the way of that was historical inventory levels with retailers. This is nothing new to what's happening right now. Historically, the wholesaler model there carried 2x the number of days of inventory than where we're going to end this year. As we worked with the wholesale partners to really get behind us in the future and have more effective spending, simplify the execution for the growth in the future, we agreed and needed to take this action now to unlock real growth and have wholesalers with us in the future. We've done that within the guidance range.

It's a fairly significant change. We think it sets us up well for the future. Again, I think it's a positive step as we look at it.

Bill Chappell (Managing Director and Senior Equity Research Analyst)

Got it. Switching to fem care. I mean, certainly, I think it's probably the strongest performance that I can remember in that business. Just trying to understand where that was with your expectations. It's, if you're kind of going back several years, fairly easy comps. Just trying to understand, you know, how much of that is real market, you know, or shelf space gains that are permanent versus just kind of favorable comps and how it splits between kind of the tampons versus pads and liners, as well on the different brands.

Rod Little (President and CEO)

It's a combination, Bill. We've in the quarter just finished, we were lapping a period that was fairly impacted by supply chain disruption in the prior period. From a comp standpoint, I would say it was an easy comp quarter, if you will. However, that said, the results achieved by the team and the absolute growth in that business, ahead of expectation, even better than what we had planned, which was a healthy recovery. Two-thirds of that's volume, a third's price, so it's very healthy in terms of the mix. We're seeing growth across all of the three key strategic brands, Playtex Sport, Carefree, Stayfree. As we mentioned in the remarks, not only is the category healthy, our relative competitiveness in the category is better. Consumption's up on the brand.

Shelf positioning is holding, if not better, almost everywhere. What's behind all that is a team that's laser-focused on the category, has done an amazing job at brand building and connecting with the target consumer on the three brands and has really interesting things ahead of us as we look at the future with more of that to come.

Bill Chappell (Managing Director and Senior Equity Research Analyst)

Great. Thanks for the color.

Rod Little (President and CEO)

Thank you, Bill. Operator, next question, please.

Operator (participant)

Thank you. Our next question is from the line of Kevin Grundy from Jefferies. Please go ahead.

Kevin Grundy (Managing Director and Equity Research Analyst)

Great. Thanks. Good morning, everyone.

Rod Little (President and CEO)

Hey, Kevin.

Kevin Grundy (Managing Director and Equity Research Analyst)

2 questions for me, Rod. First on the promotional environment and expectations there. The second follow-up question will be around sort of the longer term outlook. First on trade promo, looking at the U.S. Nielsen data, it's generally down across the board in your categories. We're seeing increases, albeit more so in households, product categories versus personal care, but I think that seems unlikely to hold. We probably agree on that, particularly as commodities moderate, which is not lost on your retail partners either. Also, as I look at some of your market share trends, they tend to be down in most categories. Probably, you know, as Dan mentioned, the suntan prep dynamics sort of expected. That's all kind of a big wind up.

Like, one, what are expectations here on trade promotion here as commodities moderate, FX less of a drag? Two, what have you included in your outlook? I have a follow-up. Thanks.

Rod Little (President and CEO)

Yeah. Hey, Kevin, it's Dan. Thanks for the question. I think your sight line there is largely how we're seeing it as well, from a promotional intensity standpoint. We haven't seen any level of increase here over the course of this fiscal year. The consumer remains, from our point of view, pretty resilient. The categories remain, you know, structurally healthy from that standpoint. At some point, though, we do believe that this level of inflation that's been put on the consumer does start to play out in different ways. What we've modeled in the back half of the year is an increase in certain categories in promotional intensity and likely in % sold on deal.

We think that'll largely be in North America to a smaller degree in Europe. We have factored that in to our outlook. It is a slight step up from where we've been. We don't see it, though, getting back to what I'll call pre-pandemic levels. We think that there's enough rational in the system and a healthy consumer that while we've modeled a step up, we don't see a material increase that takes us off our margin profile.

Kevin Grundy (Managing Director and Equity Research Analyst)

Got it. That makes sense. Thanks, Dan. Rod, for you, just a quick follow-up here, or maybe it's not quick, but just the longer term algorithm of the 2%-3%, we can all appreciate it's sort of difficult maybe to unpack everything that you contended with the past three years from COVID to supply chain issues, to this historic inflationary environment. As you do that, and you guys are running the company now for the next quarter, of course, but for the longer term, how are you thinking about the outlook now for this company relative to the 2%-3% long-term growth? You've made substantial efforts behind increases advertising and marketing. You made some good additions to the portfolio.

Devin Weinstein (Senior Equity Research Associate)

Fem care, at least for now, I'm not sure out of the woods, but no longer a drag, at least in recent quarters, though you still have the core business in Wet Shave, which is up modestly, right, about 1% or so over the past few quarters, including the first half of this year. When you kind of pull all that together, how are you thinking about the growth rate for this company longer term? Is 2%-3% still the right place to be, or are you feeling more optimistic?

Rod Little (President and CEO)

Kevin, you've done your homework on the company. You understand the pieces very well. When we put our algorithm out, it was November of 2020. We had the investor day where we put the 2%-3% top line growth algorithm out. That was off of a period where we had declined, you know, low to mid single digits for multiple years. I think there was a view that we actually could not achieve the algorithm, that we were being too aggressive in that moment. Frankly, it was required ultimately to be successful and be a player in our categories. We did 4% two years ago organic. We did 4% last year organic. We're guiding to 5% this year.

Rightly, it's something we should be looking at and thinking about for the future. We're not in a position to change our forward-looking algorithm. I think what we put out there holds at 2%-3% in this moment. We are looking at from here, you know, what happens with FX? How does the consumer behave? How do units move versus price? And how do we go forward with all of that? Frankly, it's quite dynamic, it's quite unknown, and I think we wanna be thoughtful if we're gonna revise an algorithm to be very confident that we can do it.

I think what you can take away is people should be confident we can do the algorithm that we've put out there at the top end, even based on what we've demonstrated with an open question of should we revise that? I think that's something we'll look at for the future.

Kevin Grundy (Managing Director and Equity Research Analyst)

Okay. Very good. I appreciate the thoughts. I'll hop back in the queue. Thank you both very much.

Rod Little (President and CEO)

Thank you.

Thanks. Thanks, Kevin. Operator, next question, please.

Operator (participant)

Thank you. Our next question is from the line of Jason English from Goldman Sachs. Please go ahead.

Jason English (Managing Director and Equity Research Analyst)

Good morning, folks. Thanks for slotting me in.

Dan Sullivan (CFO)

Good morning, Jason.

Jason English (Managing Director and Equity Research Analyst)

Okay. This is still quite a few questions out there. Real quick, I guess I'll fire off a few. Cremo, Costco launch, was that national, and how much did it add to the quarter?

Rod Little (President and CEO)

Yes, national. I wouldn't comment on the quarter. It's more of a Q3, Q4 going forward, just launched toward the end of the quarter.

Jason English (Managing Director and Equity Research Analyst)

Okay, you picked up the pipeline tail this quarter.

Dan Sullivan (CFO)

Not entirely.

Rod Little (President and CEO)

Yeah, partial.

Jason English (Managing Director and Equity Research Analyst)

Okay. You mentioned price will be a 300 basis point tailwind to gross margins in the back half. What was it in the front half?

Dan Sullivan (CFO)

I don't have specific front half, but we can probably do the math. you know, in the Q1, we saw 250 basis points. In the Q2, we saw 285. somewhere in the neighborhood of 275 is probably a good proxy.

Jason English (Managing Director and Equity Research Analyst)

Yeah, yeah. Thanks. I'll do the math on that. I appreciate that. Currency's confounding me. You've got about a $25 million revenue headwind for the year, that somehow is amplified to a $29 million EBITDA headwind, so over 100% margin flow through on that. How's that math work? Why is the amplifier so big? We've got currency turning into a tailwind if spot rates hold later this year. Should we expect the same type of gearing when it flips from headwind to tailwind?

Dan Sullivan (CFO)

We've given pretty prescriptive implications for FX for the year, Jason. I'd ask you to look back at the release and the script. We did talk about an easing inflationary environment. We've quantified that at top line, at margin, and at EPS, and we did call out $0.02 of favorability in our outlook now as a result of easing inflation. I think the challenge, and we've talked about it last quarter as well, is the timing effect of when you realize sales headwinds due to FX versus movements in COGS. Sitting on four months of inventory, for example, creates a timing difference of when do you realize the relief from a favorable FX movements.

That's likely what you're seeing happen here in terms of when we realize it in net sales versus when it flows through to the bottom.

Jason English (Managing Director and Equity Research Analyst)

Got it. Yeah, the inventory makes sense. Sorry, I missed all that comments on the inventory in your press release in prior comments. Sorry to have you restate that.

Dan Sullivan (CFO)

No worries.

Jason English (Managing Director and Equity Research Analyst)

That's it for me. I'll pass it on.

Dan Sullivan (CFO)

Thanks, Jason.

Rod Little (President and CEO)

Thanks, Jason. Operator, next question, please.

Operator (participant)

Thank you. Thank you. Our next question is from the line of Olivia Tong with Raymond James. Please go ahead.

Devin Weinstein (Senior Equity Research Associate)

Hi, good morning. This is Devin Weinstein on for Olivia. Appreciate you taking our questions, and congrats on the quarter. First I wanna ask just a little bit of a piggyback on Kevin's question around pricing and promotion. If you can comment specifically on what you saw during the quarter in your sun care and fem business, just given the fact that in sun care, saw a resumption of supply from your competition and healthier supply dynamics in fem care. Maybe if you can comment specifically on the amount of promotion you saw in there and how it evolved versus your expectation, and any thoughts on your ability to price in those categories going forward.

Rod Little (President and CEO)

Morning, Devin. We're the leader in sun with our two primary brands. We took pricing back in the fall ahead of the season. The pricing went in as expected. Competition, I think largely followed the pricing or was in a similar position with pricing. In sun, price realization is stable. The category is off to a very good start as we've talked, not only our position in the category, but the category in whole. As we come into the more occasion-based season here, we expect our brands from a share perspective to start to pick up as we come into the more occasion-based outdoor sun, beach, pool, park type usage. There hasn't been a lot of promo on sun.

Frankly, we've I think the manufacturer base has been struggling to keep up with demand the last couple of years. I don't see a heavy load of promo happening there. Similarly, on fem care, we took price back in October at the beginning of the fiscal. Price has held, and I think we've not seen any net change in that promotional environment. Similar to sun care and fem care, as a manufacturer set, I think we've been working to try to catch up to demand, you know, throughout the year and which, you know, has an implication on promo environment just given that dynamic. I think we see, you know, pricing holding steady in both categories and no significant change in promotional environment.

Devin Weinstein (Senior Equity Research Associate)

Very helpful. Thank you. If I could ask one more, just wanted ask a little bit about your fiscal year EPS guide. You know, nice to see you guys raise on the top line and understood on some of the dynamics of the shift in phasing for sun care from 3Q to 2Q, Japan, higher tax. Could you maybe comment on why you aren't expecting more momentum given that, you know, Q2 was strong, A&P should accelerate, which I think would continue to fuel the top line? Maybe balance some of the momentum you're seeing with increased A&P against just the level of conservatism given the unknowns of 2H. Thank you.

Rod Little (President and CEO)

The combination of those two, Devin, the Japan piece and the sun care profile shift as we look at it, in the range of $25 million-$30 million, right? Japan is more of a one-time event that we'll look at in Q4. Sun care is just a profile shift we've talked about. I don't think we see anything that suggests momentum of our business will decline in the second half. It's just we're in a period where it's a short term and a profiling piece of not only those elements, but what happened in the base. I think from a consumption standpoint, based on what we have line of sight to in an overall share position, I think we feel really good about the back half, equally as good as we did the front half.

It just sets up a little bit differently on some of those drivers. Certainly, you know, you're seeing us have conviction on the sales number in total, taking the guide up to 5%. Dan?

Dan Sullivan (CFO)

Yeah, I think that's the important context. We took the sales number up to 5%. That's inclusive of we estimate 50 basis points of headwinds based on Japan, we have flown through that increased sales through to EPS. You've got easing FX, you've got higher tax, which puts probably $0.02-$0.03 in the EPS line. I think Rod's points are spot on. There's tremendous confidence and conviction in the underlying structural elements of the business. We also have to be fair. We're sitting here on May ninth with the full sun season in front of us. 50% of the sun category in the U.S. happens in this quarter.

Not that we're not confident and not that we don't believe in the brands and the shelf, but there's a lot to go here and weather becomes an increasingly important variable in our business. We're not being conservative. I think we're just trying to be thoughtful.

Devin Weinstein (Senior Equity Research Associate)

understood and appreciated. Thanks so much for your time.

Rod Little (President and CEO)

Thank you.

Chris Gough (VP of Investor Relations)

Thanks. Devin, operator, next question, please.

Operator (participant)

That concludes our question and answer session. I would like to turn the conference back over to Mr. Rod Little, CEO, for closing remarks.

Rod Little (President and CEO)

Thank you, everybody. Have a great day. We'll talk to you in three months.

Operator (participant)

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.