Church & Dwight Company, Inc.

Good morning, ladies and gentlemen, and welcome to the Church and Dwight Third Quarter 2020 Earnings Conference Call. Before we begin, I have 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 risks and uncertainties and other factors that are described in detail in the company's SEC filing. I would now like to introduce your host for today's call, Mr. Matt Farrell, Chief Executive Officer of Church and White. Please go ahead, sir.

Good morning, everyone. Thanks for joining us today. I'll begin with a review of the Q3 results, and I'll turn the call over to Rick, our CFO, and when Rick is done, we'll open up the call for questions. The pandemic has given us an opportunity to display our agility as a company. We increased our communications with retailers. We changed our marketing messages. We've shifted investments to categories that are most important to consumers. And we've set new production records for VitaFusion, Arm & Hammer Laundry, and Arm & Hammer Baking Soda. And we've moved people to focus on the online class of trade. So we've been proactive in seizing the opportunities presented by the Crisis Center, increasing manufacturing capacity in our plants and externally with new co-packers. I want to thank all of our employees for their hard work. Their efforts are paying off. The agility and resilience of the Church & Dwight team is showing 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 keeping safe, which has contributed to our ability to operate our supply chain. Our office employees continue to work remotely and are doing a super job running the company. So now let's talk about the results. Q3 was another exceptional quarter. Reported sales growth was 13.9%, and adjusted EPS was $0.70. Revenue, earnings, and operating cash flow were all significantly higher in Q3 than last year, driven by the significant increase in demand for many of our products. Organic sales grew 9.9%, driven by higher consumption. Regarding e-commerce, we were already strong pre-COVID and well-positioned online. In Q3, our online sales increased by 77% as all retailer.coms have grown. One example would be Gummy Vitamins. In 2019, 8% of our full-year sales were online. This year, we expect full-year to be about 14% online. Recall we began the year targeting 9% online sales. That's a percentage of global consumer sales. In Q1, it was 10% online. Q2, 13%, and Q3, also 13%. So we expect the full year to be actually close to 13% as well. We continue to conduct research on the purchasing habits of U.S. consumers. There's no surprises here, actually. There is continued consumer concern that stores will run out of stock and websites will face delivery issues. Consumers report that they are consolidating shopping trips and continue to stockpile to ensure that they have enough product. or a couple of weeks at a time. If we look at year-to-date shipment and consumption patterns, our brands remain generally in balance in the 15 categories in which we compete. With respect to our brands, we had broad-based consumption growth in Q3. We saw double-digit consumption growth in VitaFusion and Little Critters gummy vitamins, Arm & Hammer baking soda, OxyClean, Flawless, Origel, Nair, first response pregnancy kits, and cleaners. In household, our laundry business consumption was up 4%, and Arm & Hammer cat litter was up 8%. Water flossers is another bright spot, as consumption turned slightly positive in Q3. Although our lunch and learn activity continues to be significantly curtailed, we intend to continue to address this with incremental advertising. In addition to VitaFusion and Little Critters, Water flossers is another brand we expect to benefit from the heightened consumer focus on health and wellness. Batiste dry shampoo remains impacted by social distancing, with consumption down 10%, but improved sequentially compared to Q2 when consumption was down 22%. Trojan consumption was down 6% in Q3, but also improved sequentially when we were down 15% in Q2. There's no doubt that consumers have made health and wellness a priority. VitaFusion and Little Critters gummy vitamins saw the greatest consumption growth of any of our categories in Q3, up 49%. The category consumption was even higher. Our expectation is that consumer demand for gummy vitamins will remain high, and we have new third-party capacity coming online in late Q4 to take advantage of this trend. Consumers are focusing on health and wellness, but also cleaning, home cooking, and new grooming routines. At a recent investor conference, you may have heard me cite consumer research that suggests it takes 66 days to form a new habit. The only time we'll tell if all of these new behaviors will translate into permanently higher levels of consumption. But if they do endure over time, we believe we are well positioned. Now a few words about private label. As you know, our exposure to private label is limited to five categories. Private label shares have remained generally unchanged for the first, second, and third quarters of this year. I'm now international. Our international business came through with double-digit organic growth in the quarter, driven by strong growth in our GMG business, that's our global markets group, and Canada. In October, our GMG business is off to another strong start, and we continue to see strong POS recovery in Canada and Europe. After three consecutive quarters of growth, Our specialty products business contracted 3.4 percent in Q3, primarily due to the poultry segment. Now turn it to new products. Innovative new products will continue to attract consumers, even in this economy. In 2020, we launched many new products, which are described in our press release. VitaFusion gummy vitamins launched a number of new products, and to capitalize on increased consumer interest in immunity, we launched Power Zinc and Elderberry gummies. We've launched Arm & Hammer Clean & Simple, which has only six ingredients plus water, compared to 15 to 30 ingredients for typical liquid detergents. And in the second half, we've launched Arm & Hammer AbsorbX, clumping cat litter, a new litter which is 55% lighter than a regular litter. Now let's turn to the outlook. We're having an exceptional year. We now expect full-year adjusted EPS growth of 13% to 14%, which is far above our evergreen target. of 8 percent annual APS growth. Given our strong performance, we have raised our full-year outlook for sales growth to be approximately 11 percent and organic sales growth to be approximately 9 percent. As mentioned many times in the past, we take the long view in managing Church & Dwight in order to sustain our evergreen model. In the second half, we took the opportunity to increase our marketing spend behind our new products, and we made incremental investments in the company. As we wind up the year, we are putting together our 2021 plan. It's safe to say that we have a high degree of confidence that we will meet our evergreen model in 21. In February, we'll provide our detailed outlook for next year. Now, in conclusion, I would like to remind everyone of the many 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. And we have a few categories that stand to benefit from the current environment. 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 label. We're coming off some of the best growth quarters we've ever had. And with a strong balance sheet, we continue to be open to acquiring TSR creative businesses. We believe our company is stronger and more agile than ever. And finally, we have the resources, the common sense, and the ambition to to ensure that our brands perform well in the future. Next up is Rick to give you details on the third quarter.

Thank you, Matt, and good morning, everybody. We'll start with EPS. Third quarter adjusted EPS, which excludes an acquisition-related earn-out adjustment, grew 6.1 percent to 70 cents compared to 66 cents in 2019. As we discussed in previous calls, the quarterly earn-out adjustment will continue until the conclusion of the earn-out period Stronger than expected sales performance allowed the company to spend incrementally on marketing. Reported revenue was up 13.9%, reflecting a continued increase in consumer demand for our products. Organic sales was up 9.9%, driven by a volume increase of 10.2%, partially offset by 0.3% of unfavorable product mix and pricing, primarily driven by new product support. Volume growth was driven by higher consumption. Now let's review the segments. First, consumer domestic. Organic sales increased by 10.7 percent, largely due to the higher volume. Overall growth was led by vitifusion and little critters, gummy vitamins, water picks, oral care products, Arm & Hammer liquid laundry detergent, and OxyClean stain fighters. We commonly get asked to bridge the Nielsen reporting to our organic results. This quarter, tract consumption was 7.7 percent for our brands, compared to an organic sales increase of 10.7. In this environment, one might assume that is restocking retail or inventory. That is not the case. We had 400 basis points of help from strong growth and untracked channels, primarily online, and 100 basis points dragged from couponing to support new products. The good news is, as you heard from Matt, consumption and shipments are in balance, both low double digits. Consumer International delivered 11.6 percent organic growth due to higher volume offset by lower price and parts mix. This was a great recovery for our international business from a flat Q2. Growth was primarily driven by the global markets group in Canada. For our SPD business, organic sales decreased 3.4% due to lower volume offset by higher pricing. The lower volume was primarily driven by the non-dairy animal and food production and sodium bicarbonate business. Turning now to gross margin. Our third quarter gross margin was 45.5%, 110 basis point decrease from a year ago. Gross margin was impacted by 110 basis point drag from tariffs and a 90 basis point impact from acquisition accounting. In addition, to round out the Q3, gross margin bridge is a plus 100 basis points from price volume mix, plus 160 basis points from productivity programs, offset by a drag of 80 basis points of higher manufacturing costs, inflation, and higher distribution costs, as well as a drag of 90 basis points for COVID costs. Moving now to marketing, marketing was up 45.7 million year-over-year as we invested behind our brands. Marketing expenses as a percentage of net sales increased 230 basis points to 13.8%. For SG&A, Q3 adjusted SG&A decreased 30 basis points year-over-year, primarily due to leverage from strong sales growth. Other expense all in was 12.3 million, a 3.9 million decline due to lower interest expense from lower interest rates. And for income tax, our effective rate for the quarter was 17.3 percent compared to 21.6 percent in 2019, a decrease of 430 basis points primarily driven by higher tax benefits related to stock option exercises. And now turning to cash. For the first nine months of 2020, cash from operating activities increased 29 percent to 798 million due to significantly higher cash earnings and an improvement in working capital. As of September 30th, cash on hand was 549 million Our full-year CapEx plan continues to be approximately $100 million as we begin to expand manufacturing and distribution capacity, primarily focused on laundry, litter, and vitamins. As I mentioned back at the Barclays Conference in September, we do expect to step up in CapEx over the next couple years to approximately 3.5% of sales for these capacity-related investments. In addition, as you read in the release, due to the strong cash position, the company may resume stock repurchases in the future. For Q4, we expect reported sales growth of approximately 9 percent, organic sales growth of approximately 8 percent, and as Matt mentioned, we have strong consumption across many of our categories. Turning to gross margin, we previously called 150 basis point contraction in the second half. Now we're saying down 190 basis points. The change is primarily due to non-recurring supply chain costs. We also expect significant expense, and we have called flat for the year in terms of a percent of sales. which implies a step up in Q4. We also anticipate a lower tax rate. As a result, we expect Q4 adjusted EPS to be 50 to 52 cents per share, excluding the acquisition earn-out adjustment, as we exit 2020 with momentum. And now for the full-year outlook, we now expect approximately 11 percent for year 2020 sales growth, which is above our previously 9 to 10 percent range. We're also raising our full-year organic sales growth to approximately 9 percent, up from our previous 7 to 8 percent outlook. We raised our cash from operations outlook to $975 million, which is up 13 percent versus a year ago. Turning to gross margin, we expect gross margin to be down 20 basis points for the year, primarily due to the impact of acquisition accounting, COVID costs, incremental manufacturing distribution, capacity investments, and the higher tariffs on Waterpik. As to tariffs, remember back in 2018, we got caught up in Tier 2 tariffs, for which we were granted an extension in 2019. That exemption expired and was not extended as of Q3 2020. We continue to work on mitigating that impact. Another word or two on gross margin. Previously, I had said the first half of the year was plus 150 basis points on gross margin, and the second half was down 150 basis points on gross margin. And so, our outlook as of last quarter was flat for the year. And then also last quarter, you heard me walk through investments we were making in the second half of 2020. Examples here included a new third-party logistics provider, outside storage to handle surge inventories, preliminary engineering on capacity, VMS outsourcing costs, as well as other investments around automation, consumer research, and analytics. So what changed? Now we're calling down 190 basis points for the back half, or down 20 basis points for the year, and that implies down 250 basis points for the quarter. We have some supply chain non-recurring costs. Here are a few examples. First, because of our outsized growth, I mentioned last quarter, we're adding a new 3PL distribution center. Well, in the quarter, we again had stronger sales, and as such, had duplicative outside storage locations and the new 3PL distribution center that wasn't operational. So, for a period of time, we had duplicative costs. We're also in the process of going through make-first-buy decisions, and that will trigger a couple asset write-offs, likely in Q4. We have lean training across the plans. And finally, due to the great results this year, higher incentive comp costs that flow through COGS. So, our full-year tax rate expectations are 19 percent, and we also raised our adjusted EPS growth to 13 to 14 percent. Now that we're through the outlook, I also want to spend a minute on Flawless. As you saw in the release, we had an earn-out benefit of approximately $50 million in the quarter in reported earnings. We exclude any of the earn-out movements in adjusted EPS. Some color on that swing, as a backdrop, we bought that business for $475 million up front and a $425 million earn-out tied to year-end 2021 sales. That sales target represented in excess of 15% CAGR for three years, off of a baseline of $180 million of trailing sales. That revised three-year CAGR for this business is closer to 8%, and as such, the earn-out liability comes down and earnings go up. We're still positive on this business, and the strong consumption growth these past six months is a great indicator for the future. As you heard from Matt, the company is well positioned as we enter 2021. And with that, Matt and I would be happy to take any questions.