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.

And thank you. And as a reminder, ladies and gentlemen, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, just press the pound or hash key. Our first question comes from Olivia Tong with Bank of America. Please go ahead.

Hi, Olivia.

Hi, can you hear me?

Yeah, I hear you now.

Okay, great. Good morning. First, I want to talk a little bit about some of the expenditures. First, on marketing, can you just talk a little bit about the key buckets of spending and whether, is it more about frequency, depth of brands being advertised, more mediums, you know, and the e-commerce investment that you're making as well? Thanks.

Yeah, about 70% of our advertising right now is digital, and that's been moving up year after year, and it was accelerated more this year because of consumers moving online. As far as where to invest, we have a couple of big launches right now. We have Arm & Hammer Clean & Simple, which I described in the opening comments and also in the script. It's a New platform for us. It's got six ingredients plus water compared to many ingredients for the typical laundry detergent, and we think that's going to be a platform we can build on in the future, so we've been spending behind it. And the second is Arm & Hammer Clump & Seal AbsorbX. So it's a new cat litter. You know, we haven't had a strong cat litter in the category. There's been a lot of growth there over the years. So we came up with a brand-new cat litter that has a different substrate, and it's 55% lighter cat litter. than our existing cat litter. So we're getting behind that in the second half. The third would be Flawless. Flawless is obviously a new brand that we acquired last year. It's an at-home solution. A lot of people are turning to devices instead of going to salons and spas that are generally closed and have lower volume. So I've been putting my money behind Flawless as well. And, again, the other money would be going to just brand building, which we've typically done in the past when we have the ability to spend.

Yeah, and I would just add, Olivia, to that, right? The brand building comment is maybe a quarter ago we did have some out-of-stocks as such, but five of our brands were growing share as of last quarter, seven this quarter, and we think it's going to be even stronger than that as we exit the year.

Can I just follow up, too, on this strength in organic sales? Obviously very strong, but I'm a bit surprised in how little leverage you seem to be getting off of that in the SG&A, because it does seem that peers are growing maybe not 10%, but close to it on the top line, and they're seeing a lot better margin flow through. So can you just talk a little bit about the SG&A? Thank you.

Yeah, sure. No, you're right. We're getting phenomenal growth on the top line. SG&A, we're not getting the leverage maybe you might think because we're also making investments. When we talked about investments last quarter, that transpired across the P&L. So we're talking about marketing investments step up. We're talking about supply chain investments. We're talking about SG&A investments. And so as we look at analytics or we look at IT or cybersecurity or things that we can do to just bulletproof the company for many years to come, SG&A is one factor.

Yeah, hey, Olivia, you know we run church and church. Dwight's a very lean shop, so there's no shortage of good things in which we can invest across the company. So, you know, as Rick said, we've got automation projects, not just in the plants, but the office environment. You know, new product initiatives where we do a lot of test and learns, IT projects, R&D. These are all SG&A items. I love you, Soler.

Does that answer your question? Thank you.

Okay.

Our next question is from Kevin Grundy with Jefferies. Please go ahead.

Great. Thanks. Good morning, guys, and congrats on the strong quarter. Matt, a question for you just on longer-term guidance. I mean, this is clearly an exceptional year for the company, probably the strongest in the company's history from a top-line perspective. and you're planning on 9% organic growth this year, you're clearly investing capacity. So there is recognition here that demand is going to be sustainably higher in some of your key categories, expanding relationships with co-manufacturers, et cetera. So I don't expect you to guide for next year at this point. You'll do that in February. But should investors expect the company to revisit the longer-term algorithm as well? I mean, clearly it would seem like 3% is not the appropriate number, nor do I think that's what's discounted in the stock or in sell-side numbers. So maybe you could just comment on that and then have a follow-up for Rick on margins.

Well, my comment was it's safe to say that we'll hit our number for next year, but we typically don't give the details or the numbers right now, as you know. But we have a lot of tailwinds going into next year, the biggest being in wellness, health and wellness, but also cleaning, you know, at-home grooming and at-home cooking. All of those things are tailwinds for us and We also expect an improvement in consumer mobility next year, and that's going to help the PC brands have an up year for those brands that are down this year.

Yeah, I want to make sure you heard that, Kevin. I know we have 12 pages of material that we read through during the call, but Matt did say that we have a high degree of confidence on hitting our evergreen model next year.

Got it. Very clear. Rick, quick one for you, and then I'll pass it along. A couple areas that are getting increasing attention from investors are would be the normalization or return of trade spending as well as higher freight costs. With respect to promotion, we're starting to see that a little bit in the Nielsen data. You guys appear to be spending behind laundry and litter and households. Can you just talk a little bit about your intentions, what you're seeing competitively, and then, Rick, with respect to freight costs as well, maybe talk a little bit about that and maybe even broadly expectations from a planning perspective, and I'll pass it on. Thank you.

Yeah, in thinking about the promotional environment, you have to go to household. Household is laundry and litter. So if you go back to Q2, Kevin, and you look at sold-on deal for laundry and litter, if you look year over year, Q2 2020, Q2 2019, litter was down like 800 basis points sold-on deal, and laundry was down 1,700 basis points. So the numbers were In Q2, laundry was sold on deal 19% and litter 12%. If you go to Q3 and you look at laundry and litter sold on deal, you're going to see litter at 15% and laundry at 30%. So they've stepped up a bit in laundry and litter, but if you still look at year over year, there's still a huge gap. So 2019 Q3 sold on deal for laundry was 38%. It's 30% in Q3. So it's still an 800-point gap. And then if you look at litter, it's also similar. Last year, Q3, 23% sold on deal. This year, 15% sold on deal. So an 800-point gap, both in laundry and litter. So as the in-stock levels have improved, promotional activity has slowly returned to normal, but it's still well below normal.

Yeah, and I would just add to what the gross margin impact of that is, right? The first half of the year, if you look at price volume mix, because this is where that would show up, price volume mix for us was on average for the first half a good guy of 180 basis points, 170 basis points or so. And remember, we pulled back a ton on trade and couponing because we just didn't want to exacerbate out of stocks. In the second half of the year, that number was closer to up positive 80 basis points as promotional levels have started to return to normal and we're supporting our new products so while still positive just a deceleration as a

a contributor maybe on margin. Your second question was distribution. ...percent of all spot loads wouldn't be picked up or rejected.

Said another way. And now that's up to about 25% of all spot loads in the industry are being rejected. For us, the good thing is we do have a big, large, significant part that is dedicated lanes. We have some customers that pick up, and so it's more on their supply or distribution network. But I would just tell you it's tight. Costs are increasing. Brokerage costs are increasing. But At the end of the day, we've done a good job managing that, and it's not as impactful for us because of our dedicated lines.

Thanks for the call, guys. Good luck. Okay. Thanks, Kevin.

Thank you. Our next question is from Andrea Teixeira with J.P. Morgan.

Hi. Yes. Hi. Good morning. Thank you. Just following up on the commentary on the gross margin that you just gave now, is it fair to assume that given the tariffs that were, I believe, started more in the back half of the year, right, that you had been hit by some of the tariffs, the Chinese tariffs, especially in the water flossing? Is that fair to assume that you're going to have lingering gross margin pressures at least until the first half of the year, especially as you mentioned now some of the puts and takes, or we should be seeing some mitigating or pricing as you go into 2021?

Yeah, it's a fair question, Andrea. Of course, if the tariffs come in the back half, then there'll be more pressure in the first half of next year. But, you know, I'll just put you back to Matt's comment is we kind of tried to give kind of an outlook and said that in 2021, we believe that we're going to hit the evergreen model. And so that does mean margin expansion as an example, because it's our job to mitigate things like that, whether it's where we manufacture from, how we can increase productivity. You know, our supply chain has done a fantastic job. We hit an all-time high this year in terms of productivity, our good-to-great program. And that trend, we think, is going to continue.

Yeah, the other thing, Andrew, to keep in mind, you know, it's always – we always tend to focus on, you know, what can hurt you. But you say, yeah, there's going to be some pressure on because of tariffs initially. But you've got to remember COVID. is also going the other way. So that won't be as high, those COVID costs in 21 versus 20. So, you know, there's always offsets.

Yeah, and let me give you an example, because you might say, well, what happens if COVID, you know, spikes back up in 2021? Well, a big part of incremental COVID costs for us early on was just trying to ship as much product as we could to customers. And so we were shipping out, you know, less than full trucks, Now that we've built inventory, now that we're building capacity, we have more flexibility to make sure that we don't run into that same issue again.

And then on the distribution centers, which obviously it's the right thing to do. You're trying to get in third parties and all of that. And you're also investing a lot more money on your own capacity. When would you think on that end you're going to be having the capacity coming through from a production standpoint and also the distribution? When do you think you're going to hit those targets and alleviate those pressures that you said you called out as non-recurring?

Yeah, well, the great news is we just did our first shipment from the new 3PL this past week. And so we believe we'll be up and running almost full blast. in Q1 of next year, which is fantastic. So that's distribution. That's a meaningful difference in terms of our shipping capacity overall for the network. For manufacturing, right, if you do something in-house, it always takes about 18 months. But the good news, as we said, for vitamins specifically as an example, that we're going to go outside, and that's going to be outside for some small quantities already in Q4 and then ramped up really quickly in the beginning of 2021.

Okay, great. Thank you so much, Ocasio-Cortez.

Thank you. Our next question is from Rupesh Parikh with Oppenheimer. Your line is open.

Good morning. Thanks for taking my question. Also, congrats on a nice quarter. Hey, Matt. So I guess just starting out the M&A, curious what you're seeing right now on the M&A front. And does anything change in terms of what you guys are looking at from an M&A perspective, just given the pandemic and maybe some of the new opportunities you see going forward?

Well, we've had the same criteria for many years as Rupesh, so I don't expect that to change. At one point, we thought that there may be more properties come to market in the back half of the year as the election was looming. I guess that's still possible between next week and the end of the year. We did have We did do a deal once upon a time that started in mid-November and we closed it by the end of December, so we know that's possible. But I would say with respect to our criteria, you know, it hasn't changed.

Okay, great. And then you guys also mentioned that you may resume share buybacks. So is it fair to assume that you may prioritize share buybacks over debt paydown near term?

Well, I mean, you've got to keep in mind, Rupesh, that our net debt to EBITDA levels are still 1.1 times by the end of the year. So in my mind, we can do both, no problem.

Okay, great. And then maybe just one last question. So there's been some questions just around thinking about gross margins going forward. So clearly you have some headwinds this year. We also have PL1s from a lower promotional environment. How do you think about the base level of gross margins as we look to next year? Like, is a flat, I guess, is a modestly, I guess, a 20 basis point decline in gross margins, is that the right way to think about the new base level? Or could there be more, I don't know, more headwinds this year that are artificially depressing that base level of gross margins?

Well, I mean, you heard Matt, and we talked about the COVID costs as an example that we think are extraordinarily high this year that won't be as high next year. But Again, in January or February, when we go through our outlook, we'll go through it in detail. Today, we just want to leave you guys with that we're confident in achieving our Evergreen model, and that means gross margin expansion. Okay, great. Thank you. All right. Thanks for your question.

Thank you. Our next question is from Lauren Lieberman with Barclays.

Great. Thanks. Good morning. I wanted to talk a little bit about the vitamin business. I know you guys have expressed, you know, a high degree of confidence in both it being, you know, taking vitamins and health and wellness concerns being a sticky habit. And I think assuming that you can, you know, lap the performance this year with growth in 21 has to be a key part of the outlook. Because as I look at it, at least using the Nielsen, not knowing, you know, I don't have the full look of all channels. vitamins is growing, is contributing maybe 50% of the top-line growth in consumer domestic right now. So, I mean, historically, VMS has been a fairly cyclical business overall for the industry. So can you just maybe talk a little bit about why you think this time is different, why you think that, you know, taking vitamins is going to be something that really persists as, you know, people's degree of belief that immunity comes from vitamins, I think that would be a really helpful perspective because it feels pretty critical to the outlook. Thanks.

Yeah, I think you're a little bit high on your 50% estimate.

Okay. It's just using Nielsen. That's why I tried to clarify.

You're a bit over the line there. I think you have to remember that when we bought this business, gummies were 3% of BMS, and obviously that's grown over time. And I think a lot of people have discovered gummy vitamins as a result of of the pandemic. So you have a lot more consumers oriented towards gummy vitamins than they were in the past. So that's number one. Number two is we're not growing as fast as the category. Q2 and Q3, the category, on average, grew 55%. We grew 40%. We grew 35% in Q2, and this is consumption, Lauren, and 49% in Q3. So, you know, Consumers are looking for product. We're the number one brand, and we're sold out. We're capacity constrained. So we're going to take the governor off the business as soon as we get this third-party capacity online. And we expect to get our fair share, which we're missing out on right now. And like I said in my remarks, it does take a while for a new habit to stick. But I don't expect the current levels to return back to 2019 levels. If anybody's thinking that's a possibility, I would dispel that worry.

Yeah, and just to give you some color, Loren, on – we usually don't do this, but since you asked the question directly, we'll do it. You know, VMS, and this is out of the 9.9% organic, was about a third. So a third of the growth out of the company's growth. Uh, laundry was about, you know, 10%. Waterpik was about 20. OxyClean was about 10. Litter was about 10. Kaboom and Bacon said it was 10. So it was pretty broad based, uh, in my mind, uh, this quarter.

Okay, great. That, that's super helpful, helpful color. And then just on the cap.

The other thing too, I think that, that with respect to health and wellness, you got to also keep in mind, um, uh, Waterpik water flossers. So, you know, they took a big hit in the second quarter. Um, um, as far as sales being down year over year. So that business is not going to grow year over year in 20 versus 19. But this is a perennial grower. This is a business that's been growing 10% a year since we bought it. So you've got kind of a reset this year for Waterpik, but there's so much growth ahead of us both in the U.S. and internationally. That's just going to get restarted next year. So long term, that's another one that's going to benefit from this focus on health and wellness.

Okay. That's great. And then On the CapEx, and I know you've spoken around it and maybe I've kind of missed the specifics, but the usual run rate is about 2% of sales, and I think you're going up to 3% to 4% over the next couple of years. It sounds, though, like for Vitamin, it's more going to be a third party. So I just wanted to understand a lot of where this extra CapEx is going, because I think laundry was added this year. So, yeah, just some more color. And for how long do you think that higher rate of CapEx continues?

Yeah, and I said in my remarks it's approximately 3.5%, and I said it for the first time at your conference, and I think I did say 3 to 4 then, but it's about 3.5% for about two years, and it's laundry, litter, and vitamins. Laundry, you know, we just had, we just are experiencing three or four years of growth in one year in many of our categories, and laundry is not, there's no exception. We just, I think we talked publicly last quarter about how we were you know, sometimes better to be lucky than good. And we had a line come on in late March, early April, and that's already fully utilized. I mean, really, a brand-new line fully utilized within, you know, four to six months, right? So we have great plans for laundry. That business is doing extremely well. And so we know that we have to add capacity there. Litter, you know, I think you heard from Matt, I think in the quarter, as an example, was up 8% on consumption. We have some great new products. So, again, we need to lay the groundwork for litter. For vitamins, you're right. We said initially you're going to go outside, but you have to go outside if you need volume within, you know, months. Over the long term, of course, that's one of those businesses that we want to have in-house because we have expertise in gummy manufacturing.

Okay. That's great. Thanks for all the time. I appreciate it.

Okay.

Thank you. Our next question is from with Credit Suisse.

Good afternoon. Would you mind giving us a little more on ad spend, your plans on increase in ad spend, maybe percentage of sales into 4Q, and also maybe some context of how much of the ad spend you're maybe pulling forward from 2021 into the back half of this year, given the strength of your P&L year to date?

I wouldn't necessarily think of it as a pull forward. Remember, Rick said on a full year basis, we're going to be comparable to 2019. It's just that in Q2, we pulled way back because we had lots of in-stocks. So we were spending at a 10% level. You know, we're in the 13s, meaning 10% is percentage of sale in Q2. You know, Q3 was obviously higher, you know, 13 and change. And then fourth quarter will be around 14.5%. So we have a lot of spending coming in the fourth quarter. And again, it's behind these big new product launches. We just happen to have two big ones coinciding at the same time. And so we're concentrating our effort in the second half.

Yeah, the only thing I'd add to that is last quarter when I was asked for the full year outlook on marketing, somebody said, hey, 11.5% to 12%, is that the sweet spot? And I said, yeah, it is. And if you did the math based on our gross margin outlook and and everything else, it would have put you at maybe the lower end of that range, and now we're saying we're closer to 11.8 for the full year, which implies kind of a step up from where we thought even three months ago.

Okay, got it. And if I could, I know we talked about gross margins a lot, but just to try to understand a little bit better from some of the information you gave us is Some of the gross margin pressure sounds like it will continue into the first half of next year, but some of it, such as duplicative storage and such, sound like they are more temporary. Can you give us maybe a read on how much of the pressure is temporary, how much might be permanent as it relates to some of the things you're putting in place?

Yeah, no, it's a fair question. I would say we kind of – I would just go through a couple of different lines. We talked about COVID, right, and those costs should be rolling back in terms of some of the inefficiencies on how we shipped, especially early on in the front half. The water pick tariffs, that'll be probably a headwind in the first half, right? You know, the flawless accounting, the good news is we're out of that, the acquisition accounting. We've lapped all that noise, and there's going to be no impact next year from acquisition accounting, which has been a 40 basis point drag this year. So that's fairly significant. You know, commodities for us have actually, you know, we've discussed this the last few calls. Resins and ethylene for us has been up the last few quarters, so nothing really new there. That will likely be a bit of a headwind, but then our productivity program, which I just said was kind of hit an all-time record this year, is going to be a tailwind and will offset that. So I'm not going to get into the quarterly cadence. I would just tell you that at this point in time, we're confident of gross margin expansion for next year. And a lot of those investments that you heard me walk through for Q4 specifically are discrete, one-time, non-recurring items.

Okay, got it. Thank you.

Thank you. Our next question is from Joe Altobello with Raymond James.

Thanks. Hey, guys. Good morning. So first question, you guys have been very clear that you're extremely confident in hitting your evergreen targets next year. I know, Matt, you talked about, you know, a lot of permanent changes going on in consumer habits, which are clearly net beneficial to you. So I guess what do you guys need to see to maybe rethink those evergreen targets, at least on the top line?

um heading into 21 and beyond yeah joe you got to give us a few months i mean we typically come out in february with these numbers we just want to give everybody assurance that uh the um you know the evergreen models intact for next year you know as far as how high is high you know we have to we'll we'll come out with that in february well you said 66 days so i figured we're beyond that period but

Just kidding. Secondly, on flawless, in terms of revised outlook, you know, 8% is obviously still a good number, but it's not 15. How much of that delta is COVID-related and how much of that is coming from other factors?

Yeah, I mean, we're not going to get into that, but, I mean, just know that, right, especially retailers were closed for a period of time, right? So that jumping off point, the baseline is, really was depressed. But if you look at consumption right now, and you guys see this, but consumption for that business is just really strong, and it has been strong for the last six months. So it's a good indicator.

Okay. And just one last one, if I could. In terms of online sales, you mentioned it was up, I think, 77% this quarter. I think it was up 75% last quarter. So do you think that takes a step back next year, or do you think this is a new plateau in we continue to increase penetration off of that 13% base going forward.

Yeah, well, look, one of the things that we found is that there are many consumers that rarely used or ordered online and now have discovered it, and more and more people are discovering it. And, you know, I think as we get into the winter months and it sounds like this COVID thing is not going away, there could be a resurgence, you know, more and more people will get used to it. So I do think you may have one more quarter. Q1, where you'll have a big growth year over year, just because Q1 of 20 didn't spike as much as Q2 and Q3. But I do think this March is going to continue, Joe, over time. You know, we went back to 2015. We had 1% of our sales online, just 1%. And this year will be 13%. Now, last year was 9% or 8%. This is 8% going to 13%. So we had a big pop this year, 500 basis points, but we fully expect that this is going to be a significant part of our online sales in the future. So we'll be well over 20 in a few years. Got it. Okay. Thank you, guys.

Thank you. Our next question is from Bill Chappelle with Truist Securities. Please go ahead.

Thanks. Good morning. Hey, Bill. I guess First question on Flawless, just any color around the timing of, I guess, the change of the payout, and is it just COVID-related and they couldn't get to the three-year numbers in part because of that and the weak start, or is there something else on the outlook that you were seeing that you need to make a change now?

Joe just asked a similar question, Bill. I would say that, you know, our original Aeronaut methodology was an extremely aggressive growth number, right? And it was 15% plus. It was in excess of 15%. So as we go through and time gets closer to that end of 2021, we have to right-side those expectations. And, yep, it's been a little bit choppy because of the current economic environment. But like I said to Joe, we've had – some really good consumption. We feel confident in that business. And, you know, an 8% plus CAGR, we had signed up for that business every day of the week.

Sorry, I don't know. It may not be as big an earn as it might have initially been contemplated, but, you know, the prospects for the business are bright, so we think the math is going to work out. This is going to be a real good acquisition for us.

Gotcha. Well, In the same vein of Joe's questioning, how do you figure out on contract manufacturing versus internal expansion for some of the categories like vitamins or other at-home type categories that are spiking now, which maybe they continue to grow in 2022 at this rate, but certainly it would seem like it would come back to earth. Are there areas... where you're thinking, look, contract manufacturing makes sense for the next couple of years until we know more, or are you changing your CapEx budget for next year at this point? We need to step it up even faster.

No, that's a good question, Bill. It's a fair question. I'd tell you that for those businesses, those are the keystones of the company. Those are the growth drivers. And we've had capacity plans in place. We have an outlook on three-, four-, five-year capacity and volume forecasts, and it's It's not like it's a new demand. It's just fast-forwarding some of those plans that were already in place.

Okay. So did you change your CapEx budget for next year over the past few months?

Yes. You know, I announced at Barclays, and I reemphasized it today, that for the next two years, we're going to approximate 3.5% of sales as we invest in capacity for laundry, litter, and vitamins, and distribution capacity as well. Okay, great. Thank you.

Thank you. And our next question is from Mark Esther Chan with CISO. Please go ahead.

Thanks, and good morning, everybody. I wanted to ask on promotional activity, just out of curiosity, who's pushing increasing promotions or point of sale or any sort of stuff up there? Is it being done because, as you've talked about, you've got some upside to numbers, want to reinvest? I know not all of that goes into uh, the promotional activity and some of it's in marketing, but you know, is it, is it the CPG companies? Is it the retailers? Is it both? And kind of, how do you think about that looking out to 2021, obviously with a lot of uncertainty, but again, would seem greater than this year, at least in absolute. So anything that could be helpful.

Yeah. Um, I mean, my comments earlier were, were that if you looked at Q2 versus Q3, that sold on deal has, um, has, um, increased sequentially, but it's still down significantly year over year. So the shorthand is both laundry and litter sold on deal is 800 basis points lower in Q3 of 2020 compared to Q3 2019. And the reason for that's recovered a bit is because of in-stock levels. As far as you're trying to figure out what's going to happen in 2021, Look, it's possible that it could stay where it is right now for a period of time, you know, as opposed to keep creeping up, because obviously all the competitors are benefiting from the lower sold-on deal year over year, and it doesn't seem to be affecting consumption. But I think we'll just update everybody with our thinking about 21 sold-on deal or promotion when we get to February. A little bit too soon to speculate on that.

Got it. Okay. And then just quickly back to flawless. So maybe building on the other questions, I guess why now in terms of changing the payout and the CAGR, especially given your commentary last quarter about seeing increasing at-home consumption given salon closings and such. And maybe bigger picture is does this at all change your thinking about which categories you focus on from an M&A standpoint, meaning more kind of the legacy HPC business versus some of the hardware businesses that you've acquired in recent times.

Yeah, maybe I'll take the first part, and then Matt can talk about M&A. But the reason we do it now is the accounting guidance says we need to look at it every quarter. And last quarter, and really the last two quarters, it's tough to go through the haze of... the macro environment when there's a COVID impact or when retailers are closed. And so we were waiting for, as time goes by, you get a little bit more credence on what's actually happening from a consumer trend. And while consumption is positive, it was just going to have to start at a lower baseline because of some of the retailers being closed and some of the consumption and demand trends. I guess my answer would be we look at it every quarter. We didn't make a big adjustment last quarter because we didn't have the visibility into the baseline like we do now.

As far as the category itself, we've made a lot of investments in categories we thought there could be a tailwind. If you go back and we say we bought gummy vitamins in 2012 because we thought there would be a transition from capsules to gummy gummies over time. And that's proved to be true, and we obviously benefited from what's happened this past year. And we bought Waterpik. It was obviously a device. But we believed that gum health was going to become more important to consumers over time. And I think that's proven to be true. So we think there's a lot of opportunity there going forward. When it comes to Flawless, Flawless is hair removal using a device. And historically, there's been a stigma attached to using devices, women using devices to remove facial hair, both face and brows. We thought that was going to pass over time. We think that the COVID has, because spas and salons being closed, has helped the business because people have discovered the at-home solution. So as far as how that's going to work, that's going to work well for both the seller and and the buyer, Church & Dwight, as far as the multiple, ultimately, that we will have paid for it. But our criteria hasn't changed, and all of those investments meet the same criteria. It's got to be a number one brand. It's got to be able to grow. It's got to be a high gross margin asset-like, and it needs to have a competitive advantage. Thank you.

Okay. Thank you. And I'm not showing any further questions in the queue. I would like to turn the call back to Mr. Farrell for his final remarks.

Yeah. Hey, thanks, everybody, for joining us today. And we're looking forward to February when we tell you about our 21 plans. So thank you.

Thank you, ladies and gentlemen, for participating in today's conference. You may now disconnect. Have a wonderful day.