WDFC Earningcall Transcript Of Q2 of 2024

Sara Hyzer -- Vice President, Chief Financial Officer

Thanks, Steve. I have several updates for you today, including some additional thoughts around
the sale of the homecare and cleaning business. But before I begin, I would like to provide an
update on our ERP implementation, which has been a significant investment under our strategic
enabler number four, which is to drive productivity via enhanced systems. In the second quarter,
we went live with the first phase of our ERP system, which is now in place over a substantial
portion of our business, including the U.S., Latin America, and Asia regional distributor
businesses.

Each month that goes by, we experience fewer and fewer issues. And although we did
experience some minor disruptions in the third quarter, I am pleased to share that most of the
critical issues have subsided by the end of the quarter. We are currently facing some of our
functional teams out of hyper care, which is an indication of the stability of the system. This is a
very positive sign and a significant milestone for our ERP team.

We know there is still work to do and have several enhancements that are already being worked
on, which is not unexpected at this phase of the project. Most importantly, we have gained
numerous learning moments from this implementation, allowing us to make process
improvements and become more proactive. I want to acknowledge and thank our employees for
their ongoing diligence in managing through this implementation. Our strategic enabler number
four is much more than an ERP system.

We are making foundational investments in systems and data that will allow us to grow faster.
For example, we have rolled out Salesforce in the U.S. and will be expanding that further in the
near term, driving sales efficiencies and effectiveness and helping us reduce operating costs.
We also know that use of data analytics and automated tools leveraging data is increasing and
can be a real enabler for the business.

The foundational work we are doing now around data governance, centralizing our data
architecture, and data quality management will allow our people to leverage our data quicker
and drive better decision-making. We are making progress on the sale of our U.S. and U.K.
homecare and cleaning product brands.

As a reminder, this business represents only approximately 4% of our total sales. Post
divestiture, WD-40 Company will be a more focused company with a higher sales growth and
gross margin profile. We have engaged an investment bank, and they are currently in
discussions with potential suitors on our behalf. While there are no certainties on identifying a
buyer when going to the market, our expectation is that we will likely complete the divestiture of
these brands during fiscal year 2025.

We will provide further updates on the divestiture process as appropriate. And now, for an
update on our business model. Our asset-light and dynamic business model has helped the

company maintain a healthy financial position and generate strong returns for our stockholders
for many years, and it continues to be our guiding light. Our 55-30-25 business model is a
long-term beacon that we will move toward and align with over time.

In the short and midterm, we think about each critical component of the model in a range. Let's
start with our third quarter gross margin performance. We target a range of 50% to 55% for
gross margin, and we have made significant progress to perform well within this range. In the
third quarter, our gross margin was 53.1% compared to 50.6% last year.

This represents an improvement of 250 basis points, which was driven by a few factors. Gross
margin benefited 160 basis points from favorable sales mix and other miscellaneous mix. Lower
costs associated with specialty chemicals also positively impacted gross margin by 110 basis
points. We are pleased to see that, for now, the inflationary environment has stabilized.

Gross margin was also positively impacted by 70 basis points from lower warehousing,
distribution, and freight costs, primarily in the Americas segment. We have continued to reduce
our inventory levels in the U.S., which is having a positive impact to our gross margin. Gross
margin improved over prior year across all trade blocs. Within the Americas, gross margin
improved 240 basis points over prior year to 50.6%.

EIMEA continues to expand gross margin, improving 280 basis points over prior year to 54.8%.
And Asia-Pacific again turned in a strong gross margin performance, improving 130 basis points
over the prior year to 57.6%, I am very pleased with how gross margin has held up through the
duration of fiscal year 2024. And at this point, with less than one quarter to go, we do believe we
will come in closer to the high end of the guidance range for gross margin. Based on the current
trajectory, cost environment and macro environment, we are targeting to achieve gross margin
of 55% by the end of fiscal year 2026.

Now, turning to our cost of doing business, which we define as total operating expenses less
adjustments for certain noncash expenses, and is primarily comprised of investments in our
employees, investments in our brand, and freight expense. As we continue to grow our top line,
we also remain focused on operating efficiently and is sustaining the WD-40 Company economy.
As we get more operational leverage, we expect the cost of doing business to perform within
our targeted range of 30% to 35% over time. For the third quarter, our cost of doing business
was 34% as compared to 32% in the prior year.

The increase was primarily driven by increases in employee related costs due to higher accrued
incentive compensation, annual compensation increases, and higher headcount. We also
experienced increase in professional services, including costs associated with our ERP
implementation and the acquisition of our Brazilian distributor. Investments in advertising and
promotional activities, or A&P, increased over the prior-year quarter, as we continue to invest in

brand building activities and make investments that support long-term profitable growth. As a
percentage of sales, A&P investments was 6% compared to 5.4% in the prior year.

Our A&P investments are always impacted by phasing between quarters, and we still expect the
full year to be within our guidance of 5% to 6%. Turning now to adjusted EBITDA margin. While
adjusted EBITDA margin has been under pressure due to the inflationary environment and the
strategic investments we are making, we continue to target an EBITDA margin range of between
20% and 25% over the longer term. For the third quarter, adjusted EBITDA margin was 19%,
which was relatively constant compared to the prior year.

Now, let's discuss net income and EPS. Net income of 19.8 million improved approximately 1
million or 5% from prior year. On a constant currency basis, net income would have increased
4% compared to the prior year. Our net income reflects the provision of income tax rate of
23.2%.

Diluted earnings per common share for the quarter were $1.46 compared to $1.38 in the prior
year. Diluted EPS reflects 13.6 million weighted average shares outstanding this quarter, which
was essentially flat compared to the prior year. Now, we'll discuss a word about our balance
sheet and capital allocation strategy. The company's financial condition and liquidity remained
strong.

And our capital allocation strategy includes a comprehensive approach to balance investing and
long-term growth while providing strong returns to our stockholders. We continue to return
capital to our stockholders through regular dividends and buybacks. Annual dividends will
continue to be our priority and are targeted at greater than 50% of earnings. On June 18th, our
board of directors approved a quarterly cash dividend of $0.88 per share.

During the third quarter, we repurchased 11,250 shares of our stock under our current share
repurchase plan at a total cost of approximately $2.8 million. We will continue to be active in the
market and expect to repurchase at least enough shares to offset shares issued for equity
compensation. We continue to make progress in lowering our inventory levels, which we had
invested in to stabilize our supply chain in prior years. Our inventory levels peaked in the first
quarter of fiscal year 2023.

And since then, we have reduced inventory by nearly $43 million or 36%. Our cash flow from
operations year to date for fiscal year 2024 was approximately $65 million. And we elected to
use approximately 12 million of that cash to pay down a portion of our short-term higher interest
rate borrowings. Our intent is to continue to pay down higher interest rate borrowings under the
current interest rate environment in the near term.

That concludes my discussion on our reported results. Let me now provide an update on our
guidance. We are pleased that the business is performing in line with our expectations. We
continue to believe our current guidance is our best estimate.

And for that reason, we are reiterating our outlook for fiscal year 2024 today. Net sales growth is
projected to be between 6% and 12% with net sales between 570 million and 600 million in
constant currency. Gross margin is expected to be between 51.5% to 53%. However, as I
mentioned earlier, we do believe we will come in closer to the high end of the guidance range.

Advertising and promotion investment is projected to be between 5% and 6% of net sales. The
provision for income tax is expected to be between 23% and 24%. Net income is expected to be
between 67.7 million and 71.8 million. And diluted earnings per share is expected to be between
$5 and $5.30, which is based on an estimated 13.6 million weighted average shares
outstanding.

Also, as a reminder, this guidance assumes no major changes to the current economic
environment. Unanticipated inflationary headwinds and other unforeseen events may affect our
view of fiscal year 2024. That completes the financial overview. Now, I would like to turn the call
back to Steve.

Steven A. Brass -- President and Chief Executive Officer

Thank you, Sara, for that update. I'm pleased with both the top-line and the bottom-line results
we've experienced this quarter. While I'm always happy to see a strong quarter, what's more
important is long-term trends. As a reminder, our long-term growth target is to increase
maintenance product sales within the Americas by 5% to 8%, within EIMEA by 8% to 11%, and
within Asia-Pacific by 10% to 13%.

For full fiscal year 2024, all three of our trade blocs are expected to perform at or above these
levels. In summary, what did you hear from us on this call? You heard that for the third quarter,
we reported consolidated net sales of 155 million, an increase of over 9% over prior year and a
new record for the company. You heard the volumes continue to improve. And in the third
quarter, nearly all our sales growth was driven by volume.

You heard that sales of maintenance products grew over 10% in both the third quarter and year
to date, which is in line with our long-term growth targets. You heard that we're making good
progress on the sale of our U.S. and U.K. homecare and cleaning product brands.

You heard that we continue to execute our must-win battles. Sales of WD-40 multi-use product
and WD-40 Specialist were both up 11% year to date. Premiumization sales grew by 14%. And
year-to-date digital commerce sales grew by 18%.

You heard that our newest direct market in Brazil is off to a strong start and that we believe the
acquisition of the Brazil market was a game-changing opportunity for us. You heard that gross
margin continues to improve and that we believe we'll come in closer to the high end of the
guidance range for gross margin this fiscal year. You heard that we continue to make progress
in lowering our inventory levels and that we have reduced them by nearly 36% since peak levels.
You heard that for the full fiscal year 2024, all three of our trade blocs are expected to perform at
or above our long-term growth targets for maintenance product sales.

And you heard that we're reiterating our guidance for fiscal year 2024. Thank you for joining our
call today. We'd now be pleased to answer your questions.

Questions & Answers: