Revlon, Inc.
Q3 2014 Earnings Call Transcript

Published: 29 Oct 2014

[Operator:]

Good morning ladies and gentlemen and welcome to Revlon’s Third Quarter 2014 Earnings conference call. At the request of Revlon, today’s conference call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Ms. Jessica Graziano, Revlon’s Chief Accounting Officer and Treasurer. You may begin, Ms. Graziano.

[Jessica Graziano:]

Thank you, Joe. Good morning everyone and thanks for joining today’s call. Earlier today, we released our financial results for the third quarter ended September 30, 2014. If you have not already received a copy of the earnings release, you can obtain one on our website at Revloninc.com. On the call with me this morning are Lorenzo Delpani, Revlon’s President and Chief Executive Officer; and Roberto Simon, Executive Vice President and Chief Financial Officer. Before I turn the call over to Lorenzo, I would like to remind everyone of a few things. First, our discussion this morning might include forward-looking statements that are based on our current expectations. Information on factors that could affect our actual results and cause them to differ materially from such forward-looking statements is set forth in our SEC filings, including our 2013 Form 10-K and our 2014 third quarter 10-Q, which we filed earlier this morning. We undertake no obligation to publicly update any forward-looking statements except for the company’s ongoing obligations under U.S. federal securities laws. Next, our remarks today will include a discussion of certain GAAP, non-GAAP and pro forma measures to enhance the comparability of our results in light of the Colomer Group acquisition that occurred in October 2013. These measures are defined in our earnings release and are also reconciled in the financial tables at the end of the release. Just a note that pro forma results are not necessarily indicative of the operating results that would have occurred if the Colomer acquisition had been completed for the period presented. Also, the unaudited pro forma results do not purport to project the future consolidated operating results of the combined company. In addition, the results of operations have been adjusted to reflect the company’s exit of its business operations in China as a discontinued operation for all periods presented. As a reminder, the company’s results of operations of its brands sold in retail channels, include retail brands acquired in the Colomer acquisition, are included in the consumer segment, and the results of operations of the brands sold in professional channels or acquired as part of the Colomer acquisition are included in the professional segment. Finally, our discussion this morning should not be copied or recorded. With that, I will turn the call over to Lorenzo.

[Lorenzo Delpani:]

Thank you, Jessica. Good morning to all of you, and thank you for joining our call today. Overall, I would characterize this quarter as essentially flat with some ups and downs in net sales across the consumer and professional division. The consumer division on an XFX basis is up 2%, essentially in a category that is showing more single-digit declines. Revlon color cosmetics had positive momentum in the United States, but this has been offset by declines in the distributor markets outside of the United States. Almay had a soft quarter, yet we remain focused on the preparation of its turnaround. SinfulColor has declined slightly due to category decline and fewer promotions this quarter versus last year. On a brighter note, Mitchum is growing behind its brand re-launch and increased focus and brand (indiscernible). On an XFX basis, the professional business is also up 2% for the quarter. While the professional division has posted close to double-digit growth on a year-to-date basis, the growth in the third quarter was modest as higher net sales of American Crew, Revlon Professional and Crème of Nature were partially offset by lower net sales of CND nail products that in this quarter are compared against a very strong 2013 new product pipeline and the timing of certain promotions. However, the customer data we have seen on CND nails (indiscernible) remain positive. As I’ve mentioned in previous calls, we continue to spend more in marketing than last year, mainly for our consumer division and brands. Year-to-date, we have spent approximately $24 million more than the prior year period. This spending has been largely financed by net sales growth, cost reductions, and integration synergies. Speaking of synergies, the integration of the Colomer business remains a priority for us, and we continue to be focused on the integration program which is on track to deliver annualized cost reductions of $30 million to $35 million by the end of 2015. As a final point, as far as adjusted EBITDA is concerned, year-to-date we are up 6.7% on a pro forma XFX basis, outpacing the incremental investment in the business this year. Before turning the call over to Roberto Simon, Revlon’s new CFO, I wanted to note that I am very pleased to again work directly with him. As you may know, Roberto was the CFO of the Colomer Group and in his three years in that role, he contributed to the successful implementation of our strategy of value creation. Roberto has significant hands-on international experience in managing the financial aspects of the consumer and professional businesses, having developed his career across a variety of financial roles in multiple countries, including serving in local, regional and global roles. Since 11 October 2013 acquisition of the Colomer Group, Roberto has served as Revlon’s SVP for Global Finance, which included responsibility for the strategic financial support of both the commercial business and supply chain in the consumer and professional segment. His position also included responsibility for the oversight of the SAP implementation. Now as we look to strengthen market performance, grow our business profitably, and manage effectively our financial drivers, I’m confident Roberto’s experience, leadership and hands-on style will be a critical contribution to Revlon value creation moving forward. With that, I will turn the call over to Roberto.

[Roberto Simon:]

Thank you, Lorenzo, and good morning everyone. Here are the financial results for the quarter. On a GAAP result basis, third quarter 2014 net sales were $472.3 million versus $333.1 million in the comparable period last year. I want to remind you that our reported results through quarter three 2014 reflect the inclusion of the net sales of the brands acquired from TCG with no comparable results in the prior period. Income from continuing operations net of taxes, which includes the impact of certain non-recurring items in both periods, was $14.2 million or $0.27 of earnings per diluted share compared to $11 million or $0.21 of earnings per diluted share. As Jessica mentioned, my commentary on the results for the third quarter 2014 compared to Q3 2013 will be on a pro forma basis adjusted for certain non-recurring and non-operating items. These pro forma results reflect the financials of both company and the Colomer Group as if they were a combined company for all of 2013. The details of these non-recurring and non-operating items and reconciliations of GAAP results to adjusted and pro forma adjusted results can be found in this morning’s earnings release. Total company net sales during the quarter were $472.3 million. On an XFX basis, net sales increased 2% compared to third quarter of 2013. Moving now on to the segments, in the third quarter of 2014 consumer segment net sales decreased 0.9% to $348.2 million as compared to same period last year; however on an XFX basis, consumer segment net sales increased 2%. This increase was primarily driven by $8.8 million of favorable returns reserve adjustment in the U.S. as a result of lower expected discontinued products in the future. These adjustments were partially offset by increased return expense for current year returns that were based on innovation previously launched. Finally, these net sales costs include lower net sales of Almay and SinfulColor partially offset by higher net sales of Mitchum. The consumer segment profit decreased 2.9% to $78.1 million which on an XFX basis increased 1.6%. The increase was largely due to higher gross profit as a result of the return adjustment I just mentioned offset by $3.8 million of higher marketing support for the company’s consumer brands. Moving on to the professional segment, third quarter 2014 net sales were $124.1 million, which increased 1.2% on an as-reported basis or 2% on an XFX basis versus quarter three 2013. As Lorenzo mentioned, this increase includes higher net sales of American Crew, Revlon Professional, and Crème of Nature partially offset by lower net sales of CND nail products. Professional segment profit was $25.2 million, which on an XFX basis was essentially flat. Turning to sales by geography, in this quarter net sales in the U.S. were $243.8 million, 3.8% higher than same quarter last year. Within the consumer segment, U.S. net sales increased mainly due to the impact of the returns adjustment I spoke about earlier. In addition, there were higher net sales of Revlon color cosmetics and Mitchum products, partially offset by lower net sales of Almay and SinfulColor. The professional segment delivered higher U.S. net sales of Crème of Nature, which was more than offset by lower net sales of CND nail products (indiscernible). Outside the U.S., net sales of $228.5 million were essentially flat on an XFX basis versus Q3 2013. In the consumer segment, net sales decreased mostly due to lower net sales of Revlon color cosmetics in certain distributor markets partially offset by higher net sales of Revlon color cosmetics in Venezuela, Japan, and South Africa. Within the professional segment, the company had higher international net sales of American Crew and Revlon Professional. Moving to adjusted operating income and adjusted EBITDA, the company adjusted operating income for the period decreased 13.8% (indiscernible). Pro forma adjusted EBITDA decreased 5.3% to $85 million in the same comparative period. Both adjusted operating income and adjusted EBITDA were largely offset by higher market support of the company consumer brands, higher incentive compensation expense that was driven by a lower accrual in Q3 2013, and unfavorable foreign currency fluctuations of approximately $4 million. Finally, taking a look at our liquidity as of September 30, 2014, our unutilized borrowing capacity and cash on hand was $338.5 million. It was made up of available cash of $172.5 million and available borrowings of $166 million on our revolver. Now I will turn the call back to Jessica.

[Jessica Graziano:]

Thank you, Roberto. This concludes our prepared remarks, and we would now like to open up the call for your questions. Joe, if you would please prompt the participants for questions.

[Operator:]

[Operator instructions] We do have a question from Connie Maneaty from BMO Capital Markets.

[Connie Maneaty:]

Good morning, everybody. I have a couple of questions. First of all, the $8.8 million in the favorable returns adjustment, is this a one-time adjustment for 2014 or will we see these adjustments quarter by quarter, and do you imagine as you get your more impactful new products on the market that the size of the adjustments will decrease?

[Lorenzo Delpani:]

Okay, I’ll take this response. The adjustment that we made, if you remember in the first quarter we made one for Almay of 6.3, and now made one, it is a combined one for Revlon and Almay in total for 8.8, which is in this case primarily Revlon. It’s an adjustment of reserve that takes into account future returns. This calculation is quite complex and takes into consideration the future expected returns stemming from our future expected SKU discontinuation. So we don’t give future guidance, so I can’t give you exact details of what’s driving it, but you can expect by what I just said that we are expecting lower discontinuation, and this is somewhat the side effect of our strategy of fewer, bigger, better innovations. Now it’s not the objective of our strategy of fewer, bigger, better innovations. The objective of our strategy of fewer, bigger, better innovations is to deliver market share growth and subsequently net sales growth, things that—and KPI that have not been achieved, if you want, for the past 10 years. One of the reasons that this management team believes that that’s the key reason is that we have (indiscernible) innovated and innovated in quantity as opposed to quality. The change that is taking place, and what sometimes people that are not part of this process don’t fully appreciate, it takes time for this change to take place because we have two resets per year, so we can effectively make changes twice a year only, and a new product can take between, best scenario, one year to up to three, depending on the complexity to develop. So this strategy of fewer, bigger, better innovations is going to take us one and a half to two and a half years to start to be deployed in the short term, and what we have been doing this year, let’s say the strategy is essentially we do fewer and we aim to do better, and by doing so we will be able to focus on what’s left in a better way and therefore it will become bigger and deliver sustainable growth. So with this logic, we are executing for next year by now mainly the fewer, and we are working on developing the better. The collateral effect of doing this fewer is that we have to adapt for returns, because in accounting for fewer innovation next year, we are looking at lower returns. Now at a certain point in time in the future, which is over the next—I can’t predict exactly, but over the next couple of years, two, three years, something like that, which is I give you just a conceptual range because much will depend on our speed of execution of the strategy, we’ll probably reach our desired new rate of innovation in terms of quantity and quality, and at that point our ongoing level of returns will adjust to a new level that is different from our historical level. From now to that moment, we can expect possibly a series of adjustments—no, series is inaccurate, let’s say some adjustments like the one we’ve been experiencing this year. I am not in a condition right now, lacking the quantitative details, to give you an estimate or an accurate forecast, and especially I wouldn’t want to do that because it’s also very much guidance for the future. But in a nutshell, it’s reasonable to expect another couple of adjustments like this one going forward until we reach the ongoing level.

[Connie Maneaty:]

Okay, that’s helpful. Could you explain what the non-operating foreign exchange was in the quarter? Was that a hedging loss? Below the line, I forget the number – it looked like $9.3 million. What was that?

[Roberto Simon:]

This adjustment was due to a balance sheet devaluation of our euro intercompany loans.

[Connie Maneaty:]

Balance sheet devaluation of intercompany loans. Okay. Why did capital spending increase so much year-to-date versus last year?

[Roberto Simon:]

There’s a big component which is the move from the old office to the new office, (indiscernible) of that, plus the investment on the SAP.

[Lorenzo Delpani:]

And to give you a bit more color, let’s say the standard operation on capex is directionally in line with the history, but on top of it we have two extra items that are completely incremental, the most meaningful of which are SAP investment, which is a multi-year investment to create advanced professional integrated systems in the organization that really needs them. We have multiple legacies that are integrated in the company by mammoth processes, and we are in the process of upgrading all of it. This will improve the way our people, process and systems deliver value in the organization. Right now, it’s the moment of investing, and you see the cost. We obviously do this because we believe that in the future, this will generate value. We have the same experience in the previous company and the process of implementation, the combination of people, process and systems delivered more effectiveness and more efficiency, and that’s what we look for for the future. The second is the office move. Hopefully, this is something you do every 15 years, which is exactly the term of our lease. But this year it has been a very expensive exercise because we had to recondition completely our headquarters here in New York, and in addition you have to mention on this topic we have in the quarter a charge—an extraordinary quarter charge of $1.7 million which is related to a double rent for the month that we had to take the move, so we have to pay double rent. So that’s an item that is also unusual in the quarter. Then there are some other capex that are extra, that are somewhat related to the integration of Colomer, but those are minor and are not worth entering in detail right now.

[Connie Maneaty:]

Okay, just let me follow up on SAP and then I’ll let somebody else ask a question. Is the SAP implementation for the Colomer Group, was it already in the Revlon consumer, or is this an upgrade for the total combined entity?

[Roberto Simon:]

So what we are doing is just taking the Colomer template of the acquisition of the company and just implementing it in the consumer division, with obviously some minor adjustments that reflect the difference between the two segments. But 95% is exactly the same as (indiscernible).

[Lorenzo Delpani:]

And in the process, we are moving to the last version, but essentially for the consumer division it’s new.

[Connie Maneaty:]

Okay, great.

[Operator:]

We’ll move along to our next question from Carla Casella with JP Morgan.

[Carla Casella:]

Hi, I had two kind of clarifying questions. One, on the display spend, total lower than what we had expected for the year. Are you still thinking you’ll hit the $50 million target?

[Lorenzo Delpani:]

Yes.

[Carla Casella:]

Okay, so the spending will pick up in the fourth quarter. Then the other question was the $8.8 million difference in the reserve, how long do you normally take reserves out for? Is that something that you’ll know what the actual—whether it’s an accurate number as of the end of fourth quarter, or is that something that could roll into 2015? I guess I’m wondering how far out in the future you take reserves for.

[Jessica Graziano:]

We do it quarter by quarter to assess the reserve.

[Carla Casella:]

Okay, but—

[Lorenzo Delpani:]

We have a consistent methodology that we review quarter by quarter.

[Carla Casella:]

Okay, great, but I guess what I’m wondering is do you have—is it three months of reserves, six months of reserves, and does that vary?

[Lorenzo Delpani:]

It varies. It’s not about months. It’s about estimating the returns we are going to get, so when a return takes place, we decide to take away an SKU, a specific one. That SKU could have been an SKU launched—in theory it can happen, five years ago, four years ago, three years ago, two years ago, one year ago or this year, if we decided to replace it in any given reset. It can even happen that we replace something we launched in the first half of the year, so it’s not really three months of what. This is not an inventory (indiscernible). These are products that are having slow sales on the retailers’ shelves, so it seems like behind your question you are thinking in analogical terms to inventory, but this is not the way this works. This works on our estimating. We have, for example, 10 new SKUs stemming from new innovation, and we need to make space for those; and depending on the amount of SKUs we need to introduce, we decide which ones we take out and a dynamic reserve is created. As the information becomes clearer because the innovation plan becomes clearer, on a quarterly basis there is a specific methodology that we use to make such a determination. As I said before, it’s a bit complex and it’s really not the forum to go in details about this.

[Carla Casella:]

Okay, great. That’s helpful. Thank you.

[Jessica Graziano:]

Joe, we have time for one more question.

[Operator:]

Certainly. We’ll take our final question from Kevin Zytes with Citi.

[Kevin Zytes:]

Hi, good morning. My question is on the increase in advertising spend. I’m curious which brands you targeted with that. I know I’ve seen a lot of the Mitchum commercials, and I’m curious if there are others that you have targeted and how you feel about the success of it.

[Jessica Graziano:]

Kevin, we’re having some problems, some technical problems. You were breaking up throughout your question.

[Kevin Zytes:]

Oh, I’m sorry. Can you hear me now, or no?

[Jessica Graziano:]

Not really, to be honest.

[Kevin Zytes:]

Okay, I’m sorry about that. I’ll try to—

[Lorenzo Delpani:]

Let me clarify and confirm. I think I got your question. Did you say something—did you ask where did we spend our money in our marketing support? Is that the question?

[Kevin Zytes:]

Yes, which brands.

[Lorenzo Delpani:]

Okay.

[Jessica Graziano:]

You want brand details? Is that the question?

[Lorenzo Delpani:]

Normally we don’t provide that detail, and we don’t want to start doing so; but I know it sounds obvious, my response, but we obviously invested to our focus assets, and the consumer division doesn’t have many – there are few. So it’s Revlon color cosmetics being a core fighting category for us, and it’s Almay because we are supporting and hanging in there in preparation of our turnaround. It’s Mitchum, because in this year it’s actually more significantly more resources in the year because we were re-launching it, and it’s actually we are seeing encouraging signs. So those are the key assets. Then we have other brands like Color Silk and Beauty Tools that also received support, but that’s not so much top line. It’s more in the direction of promotional support and other-other. So the top line support is primarily in the ones I mentioned, and it’s difficult to give you because we started these extra investments somewhere in February and we are in October, and it would be absolutely unreasonable to expect a payback in such a short period; also, because we are going to work on improving the assets that we use to support the brand. Having said that, as I mentioned in my introductory notes, I did make reference to the fact that on a year-to-date basis, XFX pro forma EBITDA is up 6.7%, and that outpaced the incremental investment. So all in all, we’re not unhappy about the financial return of the overall model, okay, which is delivering more EBITDA while investing in the business, which is a bit of shift versus the past. We still need to—we need patience and time, and I have patience and time for this, because we do not work as a company for the month or for the quarter. We work for the medium term. We need to see several items fully deployed to see the medium term impact of all our strategies, and I go back to the fewer, bigger, better innovation plot, the improvement of the assets, the repositioning of our brands, and all those things will come together in the next couple of years. Some sooner than others, and they will be visible to you, but we don’t provide future guidance. So initially from a financial standpoint, we are reasonably satisfied that the investment at least is coming around, and in fact as I said, these incremental investments have been—we have at least enough EBITDA coming from sales to offset the incremental investments, then we have other components in the drivers. But you know, it’s a good sign. It’s a good sign.

[Kevin Zytes:]

I appreciate that. My other question is on the returns. Is the—

[Jessica Graziano:]

(Indiscernible)

[Kevin Zytes:]

Okay, I’m sorry. I’ll try back.

[Lorenzo Delpani:]

You need to go on a good phone!

[Jessica Graziano:]

Yeah, sorry Kevin.

[Kevin Zytes:]

No – my fault. Thank you.

[Jessica Graziano:]

Kevin, this is Jessica. You can follow up with me separately after the call, and I can help clarify any other questions you may have.

[Kevin Zytes:]

Thanks.

[Operator:]

That concludes today’s question and answer session. I’d like to turn the call back over to our speakers for any additional or closing remarks.

[Lorenzo Delpani:]

Okay, so thank you very much for joining our call, and we look forward to speaking to you on our year-end 2014 call. Good morning to all of you. Thank you.

[Operator:]

That concludes today’