Church & Dwight Company, Inc.

Good morning, ladies and gentlemen, and welcome to the Church and Dwight Second Quarter 2020 Earnings Conference Call. Before we begin, I've been asked to remind you that on this call, the company's management may make forward-looking statements regarding, among other things, the company's financial objectives and forecasts. These statements are subject to risk and uncertainties and other factors that are described in detail in the company's SEC filings. I would now like to introduce your host for today's call, Mr. Matt Farrell, Chief Executive Officer of Church and Dwight. Please go ahead, sir.

Good morning, everyone. Thanks for joining us today. I'll begin with a discussion of the impact of COVID-19, followed by a review of the Q2 results. Now, I'll turn the call over to Rick Durker, our CFO, and when Rick is finished, we'll open a call up for questions. I'd like to give you a sense of for how Church and Dwight has reacted to the pandemic. The virus disrupted just about everything. Consumer behavior, retailer operations, our supply chain, and how we work. We pivoted every aspect of our business to meet the new challenges. Initially, we had a daily huddle at 8 a.m. seven days a week to address employee safety, production levels, co-packer operations, and shipment patterns. Today we meet five days a week. We increased our communications with retailers and changed our marketing messages. We moved people to focus on the online class of trade to create and upload new content. To speed up our reaction time, we created new data feeds of POS data and retailer in stock levels. We added more co-packers to our supply chain network. We conduct weekly surveys of our consumers. And all of our efforts are paying off. The agility and resilience of the Church & Dwight team shows up in our results. Our priorities continue to be employee safety, meeting the needs of consumers and retailers, helping the communities where we live, and ensuring the strength of our brands. Our plant, warehouse, and laboratory employees have done an exceptional job in keeping safe, which has contributed to our ability to operate a supply chain. The rest of our employees are working remotely and doing a super job running the company. We have been supporting our communities through monetary and product donations, including the contribution of personal protective equipment. In June, we began producing hand sanitizer in our UK plant for both donations and employee usage. With respect to consumers and retailers, we are taking steps to increase both short- and long-term manufacturing capacity. and we continue to work closely with suppliers and retail partners to keep pace with increased demand. A good example is our installation in Q2 of a new liquid laundry line in our York plant, which was quite a feat given the obstacles presented by COVID. And as I mentioned before, we've added more co-packers to ensure steady supply for other categories. Now let's talk about the results. Q2 was an exceptional quarter. Reported sales growth was 10.6 percent, gross margin expanded by 220 basis points, and adjusted earnings per share was 77 cents. Revenue, gross margin, earnings, and operating cash flow were all significantly higher than Q2 last year, driven by the significant increase in demand for many of our products. Organic sales grew 8.4 percent, driven by higher consumption, restocking of retail inventories, and lower couponing. Our exceptional first half is a testament to the diverse set of categories that we compete in and the strength of our brands. Regarding e-commerce, even more consumers have moved online. Our online sales increased by 75% in Q2, as all retailer.coms have grown. We began the year targeting 9% online sales. In Q1, 10% of our sales were online. In Q2, it was 13%, and we expect second half online sales to be equally strong. We continue to conduct research on the purchasing habits of U.S. consumers. Of the categories that we are following, there is continued consumer worry about the ability to leave the house and concern that stores and websites will run out. Consumers report that they are consolidating shopping trips and continue to stockpile them. to ensure that they have enough product for a couple of weeks at a time. Similar to last quarter, I now want to talk about consumption and shipments. Year-to-date shipment and consumption patterns are back in balance for our brands in the 15 categories that we compete. We do have some additional opportunities in gummy vitamins and Arm & Hammer baking soda, as shipments are still well behind consumption. In Q2, we saw double-digit consumption growth in gummy vitamins, women's hair removal, cleaners, and baking soda. On the other hand, restrictions on consumer mobility drove double-digit consumption declines for Waterpik, Trojan condoms, and Batiste dry shampoo. People are just not socializing due to government restrictions on their mobility, which has a big effect on some personal care categories. July consumption for the U.S. business is tracking to be over 10%, led by our gummy vitamin brands, OxyClean additives, and baking soda. One-third of our July consumption growth is attributed to our gummy business. In July, and I think this is important, only two of our 15 brands, that would be Batiste and Trojan, showed negative consumption. In contrast, in the month of May, eight of our 15 key product lines showed negative consumption. So consumption is trending positively. Now, shipments. July shipments for the U.S. business are tracking to be up high single digits. Shipments of gummy vitamins, OxyClean additives, baking soda, and Waterpik are all up double digit in July. Our gummy vitamins have been on fire. Consumption for May, June, and July has been averaging up over 40%. There is an increased consumer focus on wellness, and it is likely that we will reach a permanently higher level of consumption. we are looking at third parties to supplement our existing capacity right now. You may recall that we announced our exit from private label early in Q1, and that turned out to be a timely decision because it helped free up capacity for our brands. Regarding our laundry and litter businesses, consumption is recovering. You will recall that there was massive pantry loading in laundry and litter in the month of March. Laundry pantry loading appears to be absorbed as our consumption improved from being down low single digits in the quarter to up approximately 10% in July year over year. Similarly, Arm & Hammer Litter improved from negative consumption in Q2 to up approximately 5% in July. So our two big categories are recovering nicely. In the water fluster category, Waterpik is starting to recover from the steep decline in April when consumption was down 55%. Q2 consumption was down significantly due to retailer closures, deprioritization of water flossers by some retailers, and closure of dental offices. Remember that dental professionals are an important source of water flosser recommendations, which influences first-time buyers. The most recent surveys indicate that 95% of dental offices are now open, although most are at a reduced capacity. The good news is monthly consumption of water flossers is now positive. Although our lunch and learn activity continues to be significantly curtailed, we intend to address this with incremental advertising in the second half. The Flawless brand has had strong consumption growth in May, June, and July due to reduced consumer access to salons. The launch of our new full-body device, New Razor, was perfectly timed. Flawless is one of our brands that could benefit from the at-home grooming trend, and we intend to strongly support Flawless with advertising in the second half. Now, private label shares is something we track closely. As you know, our exposure to private label is limited to five categories, and private label shares were generally unchanged in Q2, and it was also true in Q1. Because of the virus, consumer trends are emerging which affect our business, including a focus on cleaning, personal wellness, and new grooming routines. These consumer trends may endure over the long term, and if they do, we believe we are well-positioned. Now international. Our international business came through with slightly positive organic growth in the quarter, driven by strong growth in our GMG business. That stands for Global Markets Group. In particular, China and Asia Pacific turned in a remarkably strong performance in the second quarter. And in July, our GMG business is off to a strong start. And we're seeing strong POS recovery in Canada and Europe as well is starting to recover. Our specialty products business has had three straight quarters of organic growth, and we expect continued organic growth from specialty products in the second half. Now turning to new products. Innovative new products will continue to attract consumers, even in this economy. In Q2, we launched a new Arm & Hammer laundry detergent called Clean & Simple, which has only six ingredients plus water, and this compares to 15 to 30 ingredients for the typical liquid detergent. It has a cleaning power comparable to our best-selling consumer favorite, which is Arm & Hammer with OxyClean. However, because of retailer stocking issues in the second quarter, we eliminated advertising, trade, and couponing support that we had planned, and we've pushed it to the second half. We're excited to report today that we have another big product launch this year. The second launch is in the clumping litter category. This month, we began shipping AbsorbX. which is a revolutionary new Arm & Hammer lightweight litter made from desert dry materials. It absorbs wetness in seconds to trap and seal odors fast. AbsorbX is 15% lighter than our existing lightweight, and it's 55% lighter than our regular clumping litter. We have a significant amount of advertising, trade, and couponing planned for the second half to get behind this exciting new launch. And by the way, here's a fun fact. Our friends at Clorax just posted to their website a new litter variant called Ultra Absorb, and we'll take that as a compliment. Imitation is the greatest form of flattery. Now let's turn to the outlook. We had an exceptional first half, and we were running well ahead of our original full-year EPS outlook. We reinstated our EPS outlook with 13% growth, which is far above our evergreen target of 8% annual EPS growth. As in prior years, when we find ourselves in this position, we use the opportunity to invest in our future, which we intend to do in the second half. You may recall that just last year, we had this exact same opportunity to invest, and our EPS was down 4% in Q4 2019 as a result. This year, we just got to a similar point much earlier. Rick will provide some details on those investments when I turn the call over to Rick. It's important to note that we continue to take the long view in running Church & Dwight. Now, in conclusion, there are lots of reasons to have confidence in Church & Dwight. The great thing about our company is we are positioned to do well in both good and bad economic times. The categories in which we play are largely essential to consumers. We have a balance of value and premium products. Our power brands are number one or number two in their categories, and we have low exposure to private labels. We're coming off one of the best first halves we've ever had and are entering this downturn in a position of strength and with a strong balance sheet. And with a strong balance sheet, we continue to be open to acquiring TSR accretive businesses. And finally, we have the resources, the common sense, and the ambition to ensure that our brands perform well in the future. And next up is Rick to give you details on the second quarter.

Thank you, Matt, and good morning, everybody. We'll start with EPS. Second quarter adjusted EPS, which excludes an acquisition-related earn-out adjustment, grew 35% to $0.77 compared to $0.57 in 2019. The EPS increase was largely driven by higher sales due to continued high consumer demand for our products and higher gross margins. As we discussed in previous calls, the quarterly earn-out adjustment will continue until the conclusion of the earn-out period. Reported revenue was up 10.6%, reflecting a significant increase in consumer demand for our products due to COVID. Organic sales were up 8.4%, driven by a volume increase of 4.9%, and positive product mix and pricing of 3.5%. Organic sales growth was driven by higher consumption, lower couponing, and recovery of retailer and stock levels. Now let's review the segments. First, consumer domestic. Organic sales increased by 10.7%, due to higher volume and positive price mix. We typically try to break down their organic growth for you. 6% is consumption growth, reflecting strong, tracked, and untracked in e-commerce growth. 1% from lower couponing. And then approximately 3.5% from improving retail and stock levels. Overall, growth was led by Arm & Hammer liquid laundry detergent, VitaFusion and Little Critters gummy vitamins, Arm & Hammer clumping cat litter and baking soda, and OxyClean stain fighters. Consumer International delivered 0.6% organic growth due to positive price and product mix offset by lower volume. Growth was driven by Batiste dry shampoo, FemFresh feminine hygiene portfolio, and Arm & Hammer liquid laundry detergent in the global markets group business. Partially offset by Europe and Mexico, domestic market declines. Of note, Asia Pacific had strong performance in the quarter. For our SBD business, organic sales increased 3% due to higher volume offset by lower pricing, and demand for our products continues to grow in the poultry industry. Turning now to gross margin, our second quarter gross margin was 46.8%, a 220 basis point increase from a year ago due to a reduction in trade, couponing, and improved productivity. In terms of a gross margin bridge versus a year ago, positive price, volume, and mix contributed 220 basis points. Productivity added 140 basis points, offset by higher manufacturing costs of 110 basis points, which was driven by 110 basis points related to COVID supply chain costs. And then improved commodity costs were offset by higher manufacturing costs. Finally, a drag of 20 basis points from the prior year flawless accounting impact and a 10 basis point drag from FX is how we get to 220 up for the quarter. Moving now to marketing. Marketing was down 6.8 million year-over-year. Marketing expenses of percentage of net sales decreased 180 basis points to 10.2%. Due to retailer out of stocks, marketing spend was significantly reduced and shifted to the back half to support new products. For SG&A, Q2 adjusted SG&A increased 30 basis points year-over-year, primarily due to higher incentive comp and tangible costs related to acquisitions and investments in R&D and IT. And for net operating profit, the adjusted operating margin for the quarter was 21.5%. Other expense all in was $14.7 million, a slight decline due to lower interest expense resulting from lower interest rates. And for income tax, our effective rate for the quarter was 19.6% compared to 18.7% in 2019, an increase of 90 basis points primarily driven by lower stock option exercises. And now turning to cash. For the first six months of 2020, cash from operating activities increased 70% to $599 million due to higher cash earnings and a decrease in working capital. This includes deferring an $81 million income tax payment in line with the CARES Act. Within the quarter, we fully repaid the revolving credit line that was accessed in Q1 during the early days of COVID. As of June 30th, cash on hand was $452 million. Our full-year CapEx plan has gone from $80 million to $100 million as we begin to expand manufacturing and distribution capacity, primarily focused on laundry, litter, and vitamins. And now turning to the outlook. Companies now reinstating the 2020 outlook given we have half the year behind us in strong sales growth in July. However, due to quarterly volatility in retailer orders and consumer consumption, we will only provide a full-year outlook. We now expect approximately 9% to 10% full-year 2020 sales growth, and approximately 7% to 8% organic sales growth. Adjusted EPS growth is expected to be 13% above the high end of our original 7% to 9% outlook. This implies a front-end loaded year and flat EPS in the second half, as the company has shifted promotional and advertising dollars from the first half to the second half in support of new products. Turning to gross margin, the first half gross margin expanded 150 basis points. We expect that second half will contract by a similar amount. Half of it is simply the year-over-year impact of acquisition accounting. The balance reflects incremental COVID costs as well as water pick tariffs, new product support that Matt mentioned, incremental manufacturing and distribution capacity investments. And so net, that means we'll be slightly below our original full-year margin outlook. As you heard from Matt, we intend to make incremental investments in the back half of 2020. Some examples here include a new third-party logistics provider, outside storage to handle surge inventories, preliminary engineering on capacity decisions, VMS outsourcing costs, as well as other investments around automation, consumer research, and analytics. Lastly, consistent with how we've been managing throughout the crisis, our outlook may continue to adapt, and we may continue to defer trade, couponing, and advertising even into next year, depending on consumption, a resurgence of COVID-19, or supply constraints. And with that, Matt and I would be happy to take any questions.