Church & Dwight Company, Inc.

Good morning, ladies and gentlemen, and welcome to the Church and Dwight Third Quarter 2021 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 filings. I would now like to introduce your host for today's call, Mr. Matt Farrell, Chief Executive Officer of Church & Dwight. Please go ahead, sir.

Okay, thanks. Good morning, everyone. Thanks for joining us today. I'll begin with a review of the Q3 results, and then I'll turn the call over to Rick Durker, our CFO. And when Rick is done, we'll open up the call for questions. But before we begin, we would like to recognize all Church & Dwight employees around the world for their continued dedication to keeping our company going, especially our supply chain, and R&D teams, as during this quarter the company faced the complexities of widespread raw material and labor shortages at our suppliers and at our third-party manufacturers. Now let's talk about the results. Q3 was a solid quarter. Reported sales growth was 5.7%. Organic sales growth grew 3.7% and exceeded our 1.5% Q3 outlook. The 3.7% organic growth rate in the quarter is impressive, considering the prior year Q3 2020 organic sales growth was 9.9%. So that's growth on top of growth. The adjusted EPS was $0.80, and that's $0.10 better than our outlook. We grew consumption in 12 of the 16 categories in which we compete, and in some cases on top of big consumption gains last year. Regarding brand performance, five of our brands saw a double-digit consumption growth, and I'll name them for you. Vitamins, Arm & Hammer Cat Litter, Scent Boosters, Batiste, and Zycam. And although many of our brands experienced double-digit consumption growth, it's not all reflected in our 3.7% organic sales growth as shipments were constrained by supply issues. In Q3, online sales as a percentage of total sales was 14.3%. Our online sales increased by 2% year over year. Now, keep in mind, this is on top of 100% growth in e-commerce that we experienced in Q3 2020 versus 2019. And we continue to expect online sales for the full year to be about 15% as a percentage of total sales. Now, as described in the release, Hurricane Ida's impact was substantial. which resulted in limited availability of raw materials and caused our fill levels to continue to be below normal. Labor shortages at suppliers and third-party manufacturers have constrained their ability to produce. Transportation challenges have further contributed to supply problems. Now, the good news is that over the past 18 months, we have made our supply chain more resilient by qualifying dozens of new suppliers and co-packers which provides, of course, both short-term and long-term benefits. And in a few minutes, Rick will tell you about our plans to expand capacity in 2022 with a significant increase in CapEx next year to support our growth plans. Now, due to a lower than normal case fill rate, we pulled back on Q3 marketing compared to the prior year, and we expect the supply issues to begin to abate in the first half of 2022. Our biggest issue is widespread demand. Inflation. We're dealing with significant inflation of raw and packaging materials, labor, transportation, and component costs, which is compressing our gross margin. These conditions are expected to continue well into 2022, and Rick will cover gross margin in his remarks in a few minutes. On past earnings calls, we described how we expected categories to perform in 2021. Overall, our full-year thinking is generally consistent. Just to name a few categories, demand for vitamins, laundry additives, and cat litter has remained elevated in 2021. The condoms, dry shampoo, and water flosser categories have recovered and are experiencing year-over-year growth as society opens up and consumers have greater mobility. Baking soda and oral analgesics have declined from COVID highs as expected. So now I'm going to talk about each business. First up is consumer domestic. So the consumer domestic business grew organic sales 2.8%, and this is on top of 10.7% organic growth in Q3 2020. Looking at market shares in Q3, six of our 13 power brands gained share, and our share results are clearly impacted by our supply issues. I'll comment on a few of the brands right now. VitaFusion gummy vitamins saw huge consumption growth in Q3, up 24%. Consumers have made health and wellness a priority. it appears that the new consumers that came into the category are staying. Because if we look at the last year, VitaFusion household penetration is up almost 10%. Batiste dry shampoo grew consumption 36% in the quarter and grew share to over 40%, first time that's happened. Dry shampoo is recovering as stores have reopened and consumers are becoming more mobile. Next up is Waterpik. Waterpik consumption declined in the quarter, due to the year-over-year timing of a major online retailer sales event. But the good news is that Waterpik continues to have strong consumption year-to-date and continues to benefit from the heightened consumer focus on health and wellness. In household products, Arm & Hammer Liquid Laundry held share despite leading with price. Arm & Hammer Scent Boosters continued to gain share. Going the other way was unit dose share, which declined due to supply issues. The good news in unit dose is that we are now self-reliant with reliable in-house production. And also in household products, Arm & Hammer cat litter grew consumption 11% while gaining 50 basis points of market share. Next up is international. Despite disruptions due to COVID, our international business came through with 2.3% organic growth, primarily driven by strong growth in the global markets group. Asia continues to be a strong growth engine for us, Sterimar, FemFresh, VitaFusion, and Little Critters led the growth for the international business. Now the next one is Specialty Products. Our Specialty Products business delivered a very strong quarter with 18.5% organic growth, but this was on an easy comp. The prior year quarterly organic growth for Specialty Products was actually down 3.4%, so 18.5% is a really nice rebound. And this was driven by both higher pricing and volume. Milk prices remain stable and demand is high for our nutritional supplements. Now let's talk about pricing. In response to the rising costs, we have already taken pricing actions in 50% of our portfolio, effective July 1 and October 1. The volume elasticities have been slightly better than expected since the July price increases. We will be announcing pricing actions effective Q1 2022 and on an additional 30% of the portfolio. That means that as of Q1 2022, we expect to have raised price on approximately 80% of our global portfolio of brands. Due to our expectation of incremental cost increases, we continue to analyze additional pricing actions that can be put in place next year in 2022. Now let's turn to the outlook. Significant inflation of material and component costs and co-packer costs impacted our gross margin in Q3. Looking forward, we expect input costs and transportation costs to remain elevated in Q4, and we expect significant incremental cost increases in 2022. Our EPS expectations are unchanged. We expect adjusted EPS growth of 6% this year. It's important to remember that we are comping 15% EPS growth in 2020. We expect full-year reported sales growth of 5.5% with 4% full-year organic sales growth. It's also important to call out that we are committed to maintaining the long-term health of our brands by ensuring a healthy level of marketing investment in Q4 and in 2022. As many of you know, we typically target 11% to 12% marketing spend. Q3 was 12.3%, and we expect Q4 to be approximately 13%. Just to wrap things up, October consumption continues to be strong. We're navigating through significant supply challenges and cost inflation. We expect our portfolio brands to do well both in good and bad times and in uncertain economic times such as now. We have a strong balance sheet, and we continue to hunt for TSR accretive businesses. And next up is Rick to give you more details on Q3.

Thank you, Matt, and good morning, everybody. We'll start with EPS. Third quarter adjusted EPS, which excludes the positive earn-out adjustments, was $0.80, up 14.3% the prior year. We don't expect any further adjustments to the earn-out. The $0.80 was better than our $0.70 outlook, primarily due to continued strong consumer demand and higher than expected sales, as well as lower incentive comp and lower marketing spend as supply chain shortages were impacting customer fill rates. We also overcame a higher tax rate year over year. Reported revenue was up 5.7%, and organic sales were up 3.7%. Matt covered the details of the top line. I'll jump right into gross margin. Our third quarter gross margin was 44.2%. A 130 basis point decrease from a year ago. This was below our previous outlook of expansion as we faced incremental pressure from the effect of Hurricane Ida on material costs and distribution. Gross margin was impacted by 500 basis points of higher manufacturing costs, primarily related to commodities distribution and labor. Tariff costs negatively impacted gross margin by an additional 40 basis points. These costs were partially offset by a positive 250 basis point impact from price volume mix and a positive 120 basis point impact from productivity. Moving to marketing. Marketing was down $10 million year over year as we lowered spend to reduce demand until fill rates could recover. Marketing expense, that's percentage of net sales, was healthy at 12.3%. For SG&A, Q3 adjusted SG&A decreased 180 basis points year over year with lower legal costs and lower incentive comp. Other expense all in was $12.1 million, a slight decline due to lower interest expense from lower interest rates. And for income tax, our effective rate for the quarter was 20.4% compared to 17.3% in 2020, an increase of 310 basis points primarily driven by lower stock option exercises. We continue to expect the full year rate to be 23%. And now to cash. For the first nine months of 2021, cash from operating activities decreased 18% to $653 million due to higher cash earnings being offset by an increase in working capital. We continue to expect cash from operations to be approximately $950 million for the full year. As of September 30th, cash on hand was $180 million. Our full-year CapEx plan is now $120 million, down from the original $180 million in the outlook due to project timing. This CapEx moves out a year, and we now expect CapEx in 2022 to exceed $200 million. The future is bright as we continue to expand manufacturing and distribution capacity, primarily focused on laundry, litter, and vitamins. On October 28th, the Board of Directors authorized a new stock repurchase program up to $1 billion. As you read in the release, this is a sign of our confidence in the company's future performance and the expectations of our robust cash flow generation. Our number one priority for capital allocation remains acquisitions, and given our low leverage ratios, we have confidence to do both. Through October, we purchased approximately $130 million worth of shares, and in Q4, we will likely get ahead of our 2022 planned purchases as well. And now for the full year outlook. We now expect the full year 2021 reported sales growth to be approximately 5.5%, and organic sales growth to be approximately 4%. Our consumption is strong and outpacing shipments. We expect our customer fill levels to improve throughout Q4. Turning to gross margin, we now expect full-year gross margin to be down 170 basis points, previously down 75 basis points. This represents an incremental impact from our last guidance due to broad-based inflation on RAS and transportation costs that was exacerbated by Hurricane Ida. In our prior outlook, we had discussed $125 million of higher costs versus our plan, That number today is 170 million, and the majority of that increase in the last 90 days relates to transportation, labor, and other increases. As a reminder, we priced to protect gross profit dollars, not necessarily margin. The $45 million movement versus our previous outlook is primarily non-commodity related. Commodity spot pricing today is elevated compared to spot pricing just three months ago, and now for the full year. We expect adjusted EPS to be 6%. Our brands continue to go from strength to strength as strong consumption and organic sales growth lapped almost 10% organic growth a year ago. And while inflation is broad-based, we have taken price and actions to mitigate, which gives us confidence over the long term. For our Q4 outlook, we expect reported sales growth of approximately 3%. We expect organic sales growth of approximately 2% due to the supply chain constraints and our SBD business to return to a more normal growth rate. Adjusted EPS is expected to be 61 cents per share, up 15% from last year's adjusted EPS. And with that, Matt and I would be happy to take any questions.

Ladies and gentlemen, if you have a question at this time, please press the star and the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question comes from the line of Rupesh Parikh with Oppenheimer.

Good morning. Thanks for taking my question. Hey, Rupesh. Hey, Matt. So I guess the first area, just with the supply chain headwinds, is there a way to frame how significant impact it was on your top line in Q3 and Q4, and just any initial thoughts in terms of the magnitude of impacts early next year?

Yeah. Let me direct Rupesh. I'll just take from a – Top line perspective, organic for the domestic division was, I think, 2.8%. If we look at what consumption was, remember our fill levels at retail are pretty good, our in-shelf, in-stock levels are in the mid-90s. We want to be in the high 90s, but they're in the mid-90s. But consumption was closer to 6%. So that just means retailer inventories are depleted to some degree. So you can do the math between the 2.7% and really the 6% consumption.

Okay, great. That's helpful. And then on the cost side, so you guys mentioned that you expect significant or incremental increases next year. Is there any way to quantify, like, you know, if you look at your current spot prices and cost pressures, you know, what significant could mean as of today for next year?

Yeah, hey, Rupesh, I would imagine it would be a lot of questions on 2022 and want us to quantify that. Here's what I would say. You know, our goal is to offset cost increases dollar for dollar with our price increases. And, you know, the 2022 plan, you know, this time of year is a working process. And we have, we expect to have, like I said, significant incremental cost increases year over year, 22 versus 21. If you look at what's happened so far, you know, in April, we priced up 30%, and that was primarily laundry, and that was high single digits. And in July, did another 20%, which is litter, additives, baking soda, flossers, and showerheads. And that was mid to high single digits. And today, we're saying another 30%, but that's largely personal care. And that will be mid to high single digits as well. But as one of my friends likes to say, is everyone is chasing a ball downhill. And so costs have continued to escalate. Even since the April announcements and the July announcements. So we're going to be revisiting all of our 2021 pricing decisions next year. And, you know, Rick could probably give you a little bit of color on maybe a couple of things that are causing the incremental cost increases. But that's probably as far as we would go on 22. But, Rick, you want to add to that?

Yeah, just to kind of triangulate what we're seeing, I would tell you that in our July outlook, if we looked at our Q4 forecast, for example, and you look at the gross margin bridge or even the dollars, we were seeing that inflation was largely going to be offset by price. Fast forward three months, and the gap is a couple hundred basis points. And so that's why we're As Matt said, revisiting pricing, that's why we're doing more pricing for other parts of the portfolio. We are going to, you know, I think it's a no-brainer at this point in time, we are going to assume spot pricing as we move into 2022 for a large part of it that we're at right now. We're going to assume transportation tightness. You know, the good thing for us, though, is as our fill levels improve, that tightness, the efficiency improves, right? There's still macro tightness, but the efficiency of our trucks improve. And we're going to assume labor is still elevated. But we're going to do as best we can to mitigate as much as that, and we'll give you our outlook in January.

Great. Thank you. I'll pass it along. Okay.

Your next question comes from Nick Modi with RBC Capital Markets.

Hey, Nick. Hey, Matt. How are you? So I wanted to kind of get into, obviously, the supply chain issues are causing fill rates to be pretty weak. Retailers are obviously looking for more efficient assortment. I wanted to get your thoughts around that, especially as it relates to innovation, because you've got, obviously, innovation as such a critical part of your algorithm. So as you think about that now and kind of going forward into 2022, maybe you could just provide some context on kind of how you think that's going to play out.

We always have a robust lineup for new products. We did in 21. We have them ready to go in 22, and we got great ideas for 23. So, as you know, retailers are interested in innovation. It attracts consumers to the store. It increases footfall. So, I think we're in good shape for 2022. You know, the question is, are consumers, we do think that the balance sheet for consumers is healthy right now. So, disposable income is up and, you know, savings rates are up, but Going the other way is inflation, right? So one headline is, you know, $4 for a gallon of gasoline. But, you know, as far as the willingness to, you know, to buy new products and for demand to stay strong, the stimulus has ended. I do think household balance sheets are going to be strong, well, are strong at the moment and likely will sustain strong demand for a although visibility is poor beyond a quarter or two, as we all know. But we got a good lineup for 2021, and we do think, at least in the near term, the consumer seems somewhat flush, and that often influences their buying intent.

And, Matt, if I could just follow up, when it comes to, you know, during the pandemic, consumers were obviously migrating to well-known brands, you know, exploration brands, dropped, people wanted to get in and out of the store quickly for health and safety reasons. Have you seen exploration actually pick back up, you know, consumers looking for some of those newer, niche-y, you know, kind of concept-oriented brands?

No, I wouldn't say yes to that, Nick. No, I still think that the larger brands are still winning. Excellent. Thanks. I'll pass it on. Okay.

Your next question comes from Olivia Tong with Raymond James. Thank you. Good morning.

A few questions on pricing, not surprisingly. First, on the new pricing you're planning to take, do you know whether your competition is also taking similar pricing in personal care? And then just a little bit more color on the price increases you already took. You mentioned price elasticity, that it was better than you had anticipated. Curious if you could give a little bit more color in terms of what you had anticipated and what you're seeing with respect to impact to consumption. Thank you.

Yeah, we are aware in a couple of personal care categories where our competitors have already moved, but we wouldn't call those competitors out on this call, nor would we cite the percentage increase that they had. But there are a couple of categories, and I expect there are going to be more, Olivia, where people are already moving in personal care. You know, we moved early on laundry and largely household products, our first two rounds, the April announcement and also the July announcement, because laundry, litter, additives, baking soda, you remember. So next up is going to be personal care, but that's as far as I can go with respect to competition.

And then on elasticities, I'd say we're really happy where it's at for many of the household products. I think, you know, we moved first in laundry as an example, but competition is starting to move and elasticities are better than we had expected, which is good. And then litter, you know, when I originally told you about the litter price increase, competition, you know, we assume competition did not move when we did all of our math and our forecast, and it's obvious that competition has moved in litter as well.

Great. And then In terms of the marketing spend, you know, kind of getting pulled back a little bit this quarter because of the in-stock levels, are you expecting to reinstate that as time progresses? And then also given pricing plans, you know, fairly decent consumption, obviously hopefully by next year supply chain challenges do get a little bit better. Should we expect fiscal 22 to be a better growth year given all those different factors?

Let me take marketing first. Yeah, so marketing year over year is down, but it's up sequentially, Olivia. So you may remember in the first half of the year, we were like high single digits marketing as percentage of sales. So we dialed it up in Q3. Yeah, it is down less than Q3 2020, but we went from 9% to 12%, 12.3% sequentially from Q2 to Q3. And we expect Q4 to be 13%. So as the in-stock levels in stores have improved, we've dialed up the marketing. And what your second question was?

Just around the fiscal 22, just because if you're taking pricing, the consumption is relatively solid and it's a supply chain challenges that are constricting you. And hopefully those do get a little bit better as time progresses. Just wondering if you think fiscal 22 should be a better growth year given some alleviation of challenges, but also pricing coming through.

Yeah, again, I'll jump in, but we're not going to comment really on our outlook for 2022 yet. We'll go through it in detail next quarter. I'd say, yep, there's tailwinds. Matt talked about that shipments have been lagging consumption. We do well in any economic environment, value and premium. Macro economy also matters, right? And when we have a lot of stimulus in 2021, that cannot repeat to that level in 2022. So those are the brief comments on the outlook. But, Olivia, I would say, you know, just to echo what Matt said, you know, we were at almost 14% marketing in Q3 a year ago and almost 15.5% marketing in Q4 a year ago. Those are well in excess what we would normally spend, you in marketing. So those aren't really the right comparable. The right comparable is our evergreen model between 11 and 12 percent.

Great. Thank you. Okay. Your next question comes from Dara Mosinian with Morgan Stanley.

Hey, guys. Hey, Dara. So a couple things. Just one, you mentioned capacity expansion. in the release in 2022 and 2023, and I think you used the word significant. So can you just help give us a sense for the level of spending you're expecting there or what percent of volume you're hoping to unlock? Is that more something that's typical where you're building more capacity each year, or is it really an outsized level of spend versus history? And Is that just capacity, or are there potential other areas of increased investment also as you look out over the next couple years?

Yeah, maybe I'll start, and Matt has something to add. This is new news. At Cagney this year, we kind of alluded to that we had significant capacity investments for laundry, litter, and vitamins. We also said it, I think, at our analyst day. Typically, we are 2% or lower on CapEx spend as a percent of revenue, and I think we had signaled that it would be closer to 4%. for 2022 and 2023. Today, you know, some of those 2021 projects are slipping just because of timeline and, you know, same supply chain challenges we have in providing finished goods also is happening in the CapEx installation market. So, I would say that we're in excess of $200 million. An excess of $200 million is our outlook for 2022, and it will be even higher than that in 2023, and then it would float back down to our normal 2% of sales.

Yeah, and, you know, these are our largest businesses, right, vitamins, litter, and laundry. So, you know, we've got a lot of faith in the brands. We've got tremendous consumption. So we're real excited about adding this capacity because it's going to stand us well for years to come.

Great. That's helpful. And then second, just on shelf space in the U.S., you guys have done a great job gaining share and shelf space over time, but you're taking significant pricing, granted at a time when competitors are also. You're going through supply chain issues here, right? So there's some product limitations. You're cutting marketing versus original guidance, understanding it's still at a robust level. So just curious for any perspective on if that creates any risk from a shelf-safe standpoint, how you think about that. Those are typically not things that retailers like to see. So just how you think about sort of the level of risk given some of the dynamics that are going on in the business here.

Yeah, I don't see the risk, frankly. We're not alone there, as you know, with respect to raising prices, et cetera. So I think it's a level playing field out there right now. And... You know, keep in mind that our growth rate in Q3 was, you know, almost 4% and top of 10% growth last year. So our brands, our consumption is super strong. And the retailers are aware of that. You know, they see the demand for our products. So, you know, we're not worried about, you know, shelf space losses as a result of our actions.

Okay, great. Thanks, guys.

Your next question comes from with Credit Suisse.

Hey, guys. Good morning. First, I'm going to make a quick one on the new buyback plan. Is the intention to continue to buy back about what you've been doing in recent years, or does it maybe signal a bit of an acceleration from where you were before?

Yeah, you know, if you look at our track record, we've done a few hundred million dollars each and every year. And a few years back when cash was built, we did closer to $500 million. So somewhere in that range, you know, between three and five is what I would tell you.

Okay, great, great. And then as it relates to what we're looking at today in terms of general cost or other costs, obviously we know there's a lot of inflation, but to what degree are those numbers maybe increasing at a higher level than they otherwise was because hedges by now have started to roll off, or are you still hedged and then maybe those roll-offs happen at some point in 2022?

Yeah, I'm going to do my best to answer that. Your phone's breaking up significantly. I believe you're asking about the hedging issue. We are about 90% hedged for 2021, and as we enter the year, we were significantly hedged, which was a good thing. And as we enter 2022, about now, we're about 45% hedged. And, of course, there's probably, I don't know, between $10 and $20 million worth of a benefit from 2021 hedging. And so just as we layer on our new hedges versus that, that's a headwind. but that's something that we've known about for a long time and are managing to do. As of right now, hedges are very expensive, so we actually lean towards a lot of the spot market as of right now. The volatility in the market in 2021 has, I think, made the banks less likely to offer up any reasonable hedges for 2022. So that's a quick overview of the hedging.

Got it. Thank you. Sorry about the audio if you didn't get me.

You're good now.

Talk to you guys soon. Okay.

Your next question comes from Andrea Texera with J.P. Morgan. Hello.

Thank you. Good morning. So I think just going back to the point about pricing and price gaps, again, In some of, like, obviously you've done well rolling the pricing and rolling it, and I think Matt, to Matt's point, obviously you're not alone. But for the most price-sensitive categories you compete in and for the areas that you've seen these price increases roll out, any call around the volume elasticity given the widening price gaps most likely? And related to that, as you're – main competitor in this segment is increasing couponing, I believe, like coming back from, you know, a depressed level from last year. How do you feel about closing the gap in pricing as well as the fact that, you know, at some point, you know, the private labels, I think, have been taking the time to take action there, if you can help us kind of reconcile that.

Yeah, well, as Matt said, and I mentioned, too, on elasticities, those elasticities are better than we expected because competition has moved, and so we're really happy with that. I think some competitors, you know, as they do more couponing or whatnot is – or higher trade, you know, in laundry – We have added a little bit of trade back in Q4, but we're well below normal levels, as an example. So I think overall, Andrea, I would say it's gone better than expected from a price gap perspective.

Enrique, that's helpful. But from that roll-off of the hedging, right, the 45%, and now you're going to enter 2022 doing mostly spot. the headwind will be massive, right? And you quoted the 170 million cost pressure. That is, I think, net of hedges, right? So should we think about that number, obviously extrapolate that number into 2022, obviously that's going to be a much bigger impact, I'm assuming. Is that the way to think?

Yeah, well, let's just take a big step back. $170 million is versus our outlook, our plan. If you add in, let's talk year-over-year. The year-over-year number is about $250 million, or about 9% of COGS. Okay, so that's the year-over-year inflation in 2021. What we're talking about, my comment on the hedging, was between $10 to $20 million, which in the grand scheme of things is a peanut compared to the $250 million that I'm talking about. And so, yeah, that will be a rollover. Some of these latest price movements will be a rollover, but that's what pricing actions that we've talked about in different categories that we feel pretty good about because competition is moving. It's not just one category or even within CPG. It's broad-based within many different categories across many different aisles.

Just to fine-point that, 250 would be 270, all things equal. But is that based on spot prices or is that based on forward curve?

That's 2021 versus 2020.

Actual.

So it's actual. And then spot pricing for the last two months of the year.

And then the last two months of the year would add you around $20 million only on that $250 million or that's more?

No, Andrea. It's $250 million for the full year. forecast 2021 versus 2020. If we didn't have any hedges, you would add another $10 to $20 million.

Correct. And then for 2022, it has to be higher than that because obviously the beginning of the year, the pressures were much lower than we're seeing now, right? So that's what I wanted to Make sure I understood.

We called incremental inflation in 2022. I would not expect to have another year of 9% inflation on top of 9% inflation.

Now I understood. All right. Thank you so much. I'll pass it on.

Your next question comes from Bill Chappell with Truist Securities.

Thanks. Good morning. Morning, Bill. Just following up on Nick's question about innovation, I guess my question is you're seeing supply shortages and pulling back on marketing, but we're about to flip as we go to the first of the year. I mean, typically you roll out a lot of new products in one queue and step up marketing in two queue. And at the same point you've said you're not sure or you don't believe that things will be back to normal in terms of supply chain until 2020. Sometime in the first half. So I guess, does it change? One, what gives you confidence that things improve in the first half? And two, does it change your cadence of kind of rolling out new products and marketing behind those and stuff like that? Or is everything normal at this point?

Yeah, Bill, what we're saying is that we expect the supply issues to abate. Because some of that is in our control. So we do expect, even though our fill rates today are in the low 80s and they're normally 99%, we think that that is going to improve over the next few months. So that's a good thing. Because we're leaving money on the table because we haven't been able to meet customer orders right now. So as far as marketing goes, typically Q1 is our lowest quarter. So you wouldn't expect a pickup in marketing spend in Q1. It's oftentimes around 9%, 10%. But you're right. A lot of new products do start hitting shelves in March, April. So Q2 is often the quarter when we start amping up the marketing. So that would be our plans right now.

So what you're seeing in terms of fill weights are improving kind of month to month where you get, I mean, just trying to get, what gives you confidence that things are better by April?

Well, because we're in touch with all of our suppliers and co-packers.

Yeah, and we're also optimists by nature in that if Hurricane Ida hadn't happened, we would have been on the road to recovery and further along than where we ended up. We kind of ended up at the same spot. but that was largely due to additional hurricane pressures and disruptions.

Yeah, you probably know, Bill, we had seven force majeures. And, you know, those chemicals that are coming from that part of the U.S., it's not just household. All those chemicals affect personal care products as well. So as all of those things get sorted out, and they are improving, just talking to those suppliers down in Louisiana, for example, things are getting better. And as that supply improves, you know, our fill rates are going to go up and we're going to take advantage of the demand.

Got it. Now that helps a lot. And then one last, you know, as you look back at vitamins in particular, is there, you know, work you've done to kind of understand how many of the incremental consumers over the past 18 months are going to kind of stay in the category versus as we come out of this, they kind of go back to their more normal patterns in terms of vitamin consumption?

Yeah. Our work tells us that household penetration is up almost 10% year over year. So what we're seeing is repeats of new people coming into the category, repeat purchases.

Yeah, with a high loyalty rate of around like 80% plus, which is great.

Yeah. So if you just look at the quarters bill, like Q1, Q2, Q3, consumption of VitaFusion year over year, It's up 25%, up 10%, up 24%. Just big numbers, consistent, all three quarters. And, of course, the tailwind is two tailwinds, I guess. One, the wellness trend. Two, the transition from pills and capsules to gummies. That continues. And we have a good new product lineup in 21. Got another good one in 22. And I guess the other thing that is noteworthy is if you look at private label share of gummies, that has declined significantly. in three consecutive quarters. So that's kind of a fun fact, too. Now, we're really optimistic about vitamins, and that's one of the reasons why we're going to be spending a lot of money on CapEx. It's one of the three businesses we're going to be putting some iron in the ground in 22 in anticipation of growth in 23 and beyond.

Perfect. Well, thanks for the color and the fun fact. Talk to you soon. Okay.

Your next question comes from Kevin Grundy with Jefferies.

Hey, Kevin. Hey, good morning, guys. How are you? Good. So, Matt, if I could just pick up on the last one, a point of clarification around the iron you're going to put in the ground or CapEx, as you referred to it. So we're going to have to step up, if I'm not mistaken, about 25% of the business currently goes through co-packers, and you guys have obviously done a tremendous amount of work building out the supplier and co-packers that you use over the past 18 months. The point of clarity is, is there a rethink on the 25 percent? Is that still the right number? How much is that going to change on the other side of the stepped-up CapEx? And then I have an unrelated follow-up.

Yeah, I wouldn't expect that number to go the other way, Kevin, for the simple reason that that is our operating model. and that we are an asset-light company. So we do rely on co-packers. Yeah, COVID illuminated the fact that in some cases we were a little bit too exposed with sole suppliers or sole co-packers or just not enough options, but we've remedied that. So we think we're going to be in great shape coming out of COVID. And keep in mind, with respect to our acquisitions, strategy as well. That's unchanged, too. We still prefer to buy brands and businesses that are co-packed so that we're not wind up with additional plants and additional needs for CapEx. So no change.

Got it. Very clear, Matt. Rick, quick follow-up for you, and then I'll pass it on. Just on the fourth quarter guidance, And I guess what I'm trying to better understand, the consumption trends are strong. We see that in the Nielsen data. The fill rates sound like they're getting better, which is encouraging. But the organic sales growth guidance of 2% implies a modest deceleration on a two-year stack or two-year average basis. I think you made the comment, SPD, maybe will lighten up a little bit. I'm trying to reconcile the improving fill rates what we see in the Nielsen data, and then the guide for the quarter. And I also understand you guys are typically conservative, but just maybe help me better understand that. I'm just trying to triangulate the data points. Thanks.

Yeah, sure. No problem, Kevin. It's really two things. One is SBD comes back to normal growth rates. It had a fantastic 18% organic growth quarter in Q3, and part of that was because of the comp a year ago. But Q4 comes down to normal. So I'd say maybe half the deceleration in the company organic growth rate is SPD. And the other half is we're being conservative on the fill rates. You know, as they continue to improve, but we're still assuming they're in the low 80s. And then we said in the first half of 2022, it gets back to normal. So I would just say it's probably conservatism. If great, unbelievable consumption demand continues, like we just saw in Q3 or earlier, then when you have a bigger number times 80% fill rate, then that's when you kind of over-deliver on the quarter, and that's what happened for us in Q3. We out-delivered because they're consumer domestic. So, yep, short story is we still think the fill rates are what impacts it.

Got it. Very good. Thank you both. Good luck. Thanks, Kevin.

Your next question comes from Lauren Lieberman with Barclays. Great. Thank you.

I'm sorry if I missed it, but have you guys specified which categories or products are suffering most supply chain-wise, you know, where you're, quote, leaving the money on the table?

We haven't, Lauren. We said, in general, our fill rates are around 80%. And because of having seven force majeures after Hurricane Ida, and as Matt alluded to, it's household and personal care. So it's pretty broad-based across the spectrum.

Okay. Okay. Because one of the things I was curious about, and it's a little bit tough to ask a question admittedly without knowing which categories are, you know, more or less impacted, and recognizing force majeure, you know, may well be an industry factor, but, you know, what's going on with your competitive set in those categories? You know, are others on the shelf? Is there a private label producer that's kind of stepping in? But just thinking about not denying the strength of your brands, but if we go forward and supply continues to be constrained for a couple of months, you know, are consumers still shopping the categories but going to other brands? And thoughts around risk, you know, as you come back into stock if you've lost some of those households?

Yeah, let me just make one comment, and I'm sure Matt has some color, too. But we need to distinguish between fill rates and in-stock levels, okay? Fill rates are in the low 80s. In-stock levels are in the mid-90s, okay? So... Very rarely is a consumer going to shelf and not being able to buy our product. What's happened is mostly retail inventories have been depleted, like in their warehouses, or our inventories are lower. Hopefully that clears some of it up.

Yeah, and, Lauren, the in-stock levels weren't as good earlier in the year. So we've really seen them improve quite a bit, particularly as we got towards the end of the third quarter. So looking ahead, you know, going into Q4. Q4, we have a lot of our brands back in the low to mid-90s, whereas earlier in the year they were not. So I think the question might probably be more relevant for an earlier quarter.

Yeah, and you might also say, you know, we haven't spent as much on trade spending or couponing because we didn't want to exacerbate, you know, at-shelf fill levels as well.

And if you look at what we did with marketing, you know, marketing was 9% in Q2. It's 12% in Q3. So, obviously, as stock levels started to improve, we started to dial up the marketing.

Okay. That's helpful. I apologize for that misunderstanding. And so, okay, the pullback also in terms of spend, to the degree there is one, is more on the trade spend piece and couponing. And as you said, marketing is already rebuilding. Yes. So when we talk about then leaving money on the table, right, or even the rebuilding shipments to get closer to consumption into next year, it's not like there's a major hole that needs to be filled, right? Because if stock levels are okay and retailers would like to have more inventory, it's not like there's some major catch-up that has to happen when we think about sales growth for the full 22. Yeah, hey, yeah.

The thing you've got to think about is when we talk about in-stock levels, we're talking about on shelf. So now the whole is in the DCs, the distribution centers. So that's where it's, I think it's hand-to-mouth, and that's where the opportunity is to close the gap between consumption and shipments.

And that was my comment to Rupesh earlier. It was really the 3% or so organic in Q3 compared to the 6% consumption in Q3.

Yeah, and, Lauren, the only class of trade that's not true in it is Club, you know, because Club has their inventory at their stores as opposed to, you know, DC's.

Okay. All right, great. And then just my second question was the SG&A was down a lot this quarter. You cited there was, you know, I think it was litigation, but also the incentive comp. But that was a big piece of kind of holding the P&L together this quarter. And I apologize for being so short-term, but that's kind of, that's what happened now. So as we look into 22, you know, knowing pricing continues to build, but in the interim, right, there's, I'm guessing there's less ability to control the SG&A line, if that's fair, right, given what you said. You have lots of flexibility in marketing. You put so much money to work during 2020. You know, there's a lot of flexibility there. But that SG&A line, you run that pretty tightly to begin with. So I was just curious on your perspective on other ways to mitigate some of the cost headwinds as pricing is still ramping.

Yeah. No, it's a fair point. SG&A is down largely because of incentive comp. Why is incentive comp down? It's because gross margin we have in our targets. And very few companies do that, but we do do that. We're very proud that we do that. It's hard. in times like this, but gross margin will likely be a donut. And so that's impactful on the accrual for incentive comp. So rightfully, conclusion that you had, Lauren, SG&A will be higher next year as we get back and hopefully hit a plan with all the levers that we typically do. But we have things that can offset inflation, right? And we have things that can offset SG&A. And the number one far and away next year is going to be pricing, and the number two behind that is going to be productivity discussions.

Okay. And it sounds like if incentive comp, we hope, goes up next year, gross margin isn't a donut on that scorecard next year, meaning gross margin could be up.

Yeah, we have 5,000 employees that would like to see that happen. Right. Okay.

Okay.

All right. Thanks so much.

Yep.

Your next question comes from Steve Powers with Deutsche Bank.

Hey, thanks. I think we've covered most of what I wanted to talk about, but just, I guess, a final cleanup on some of the near-term supply constraint dynamics. The cadence of relief that you've talked about, it seems sort of, you know, multifaceted and sort of complex, and therefore I'm assuming that it's more of like a gradual change a continued ongoing gradual rebuild into next year as opposed to some kind of cliff or binary point of recovery. So can you just validate that, that it's kind of a more even and bumpy glide path as opposed to some kind of discrete set of milestones that we should be thinking about?

Yeah, well, you're right. I think you asked and answered it, Steve. It's not a light switch. So there's not going to be a spike at any point in time. So what we hope to be able to tell you when we get together at the end of January is to give you a sense for how October, November, December started to build. Our improvement in fill rates, for example, is what we hope to be able to be telling you at the end of January. And then our expectations for the rest of the first half.

Okay. Yeah, okay, perfect. And so then I guess from that shipment recovery standpoint, versus, you know, hopefully sustained strong consumption. Base case is that that happens sort of progressively. It's not like, you know, a light switch, as you say, and all of a sudden, you know, you... Sorry, go ahead.

Yeah, exactly right. It would be gradual over time as different brands recover faster and it's a stair step back up to normalcy.

Perfect. Thank you both. Okay, Steve.

Your next question comes from Chris Carey with Wells Fargo Security.

Hi, good morning. I guess that echoes Steve's comment that so many of the questions have been covered already. Maybe in that regard, I'll keep it a bit more medium, longer term. I guess, you know, there's this dynamic with the Church's White portfolio where there's a a piece that's valued as a piece that's premium. This offers the flexibility to respond to different economic environments. But we're clearly in this period where demand elasticities are basically non-existent. So, I mean, in theory, maybe that means the value of your portfolio offers relative less value than typically it would. I mean, does that give you more credence to close price gaps to get more, um, aggressive on price gaps. I guess I'm thinking about this, um, 80% of your portfolio is going to be pricing in Q1, but you may have to look at more pricing, um, maybe expand pricing. Maybe you raise pricing. I'm not sure, but, um, I guess it's a, it's a bit theoretical because it's, it's almost like how long this demand deal has to see the environment last. I don't know. I don't think anyone does, but maybe just how you see your, um, your relative positioning on, on shelf, but in the context of this value versus, um, versus premium mix in your portfolio?

Yeah, no, we look at that closely, and we continue to look at when you're pricing up 80% of your portfolio, we're doing a lot of work on what the price gaps are in all the categories where we have raised price and intend to raise price. But, you know, part of our operating model long-term has always been this round number of 60-40 split between premium and value And we do think that we do want to preserve that, and we do want to preserve the price gaps. So consequently, we will always have that ability to perform well in good and bad times. So now, to answer your question directly, we'd not be looking to drive these value brands up into, say, mid-tier markets.

Okay, and maybe if I could just sneak in one clarification. I think you said that shortages are everywhere, but I think in the past it said that households, specifically laundry, had seen some shortages around surfactants. Is that happening? Certainly, shares are improving in laundry. I know pricing is a part of that, mix is a part of that. I suppose couponing, less couponing is a part of that. But are you seeing disproportionate shortages there versus the rest of the portfolio, or is it, as you said, it's a bit broad-based? So thanks for that.

Yeah, as you see share recover in most cases, 80% of the cases, I would say it's largely supply chain disruption that had happened. So as you see share recover in certain areas, it's largely because supply chain is improving.

Okay, thanks.

Our next question comes from Peter Guam with UPS.

Hey, good morning, everyone.

Good morning, Peter.

So I know it's kind of early, but I was just kind of hoping to get your early read on the cold and flu season and the impact this may have on Zycam, you know, kind of going forward. And then I guess, you know, just as it moves into organic, like how should we think about the potential lift to your total company organic revenue growth from just like a normal cold and flu season? Thanks.

Okay. Well, as you know, we bought Zycam at the end of 2020. It's a number one brand. In cold shortening then, still is today. Super high share, it's like 70%. And the recent consumer trends are really encouraging. You probably saw some of Reckitt's comments earlier this week. But if you look at our Q3 all-channel consumption for Zycam, we're up about 40% versus 2020. And Q4, that... 40% increase in all-channel consumption in Q3. That's not the key quarter. Q4 is often 40% to 50% of full-year sales, so that's ahead of us. And we did buy the brand back last year because we thought it had a long-term growth opportunity, and we do expect it to be a big contributor to sales and profits in 2022 because it's been so depressed in 2021. But we wouldn't quantify what we think that might be.

Yeah, we would just say it's going to be a good tailwind if it gets back to normal levels of cold and flu season.

Yeah, exactly.

Great.

Thank you. Yeah, we can probably comment a little bit more on that in January when we give our full year outlook for 2022. Okay, great. Thank you.

Yeah, okay.

Your next question comes from Mark Astrakhan with Thiefle.

Yeah, thanks, and good morning, everyone. I wanted to go back to an earlier statement you made about not lapping or about lapping the stimulus and that not recurring next year. So I'm curious how you think about that in the context of the percentage of products sold on promotion as you head into next year. Any sort of high-level thoughts, comments, discussions with retailers in terms of what they may be asking for or kind of how that plays out as we go through, you know, 22. Obviously, we're all sitting here with a lot of moving parts, but any sort of color you can give at this point would be helpful on that.

Yeah, well, look, we did pull back on promotions and couponing, and we did it pretty early on because it didn't make a lot of sense to be promoting to shelves that weren't completely stocked. As I said earlier, the in-stock levels, particularly towards the end of Q3 and looking ahead into Q4, are now approaching the 90s. So consequently, there is an opportunity to start introducing trade promotion back in 2022. And that is our intent as well. But of course, competitive actions are something that we have to watch as well to decide how much or how little of that we introduce back in. But With some of that, it's starting to happen in Q4. Great. Thank you. Okay.

Your next question comes from John Anderson with William Blair.

Good morning. Thanks for squeezing me in. A lot of great questions.

We got time.

Yeah, a lot of great questions. There's not much meat left on the bone, but I will go with this. Kind of a follow-up to Lauren's last comment on gross margin maybe being up next year. And I guess I'm thinking about your pricing. You're pricing to offset the dollar inflation, not recover gross margin rate. And it also sounds like you're bringing on or plan to bring on new capacity that could add incremental manufacturing overhead at least before that capacity is fully utilized. So as we think about kind of the gross margin outlook for the next 12, 24 months, you know, could it be different than what we've seen from church over a longer historical period of time where you've had very good secular gross margin expansion?

Yeah, I appreciate the question. We're going to defer that question to January when we give our outlook of all the details and all the moving pieces. We're still firming up all of our pricing plans that we're talking about for the balance of the 30%, all those other moving pieces. But you are right. We said we're going to price to protect dollars and not margin, and that's, we think, the right approach. But we'll give you more detail on what we think gross margin will do in January.

Okay, thank you.

And our last question comes from the line of Jason English with Goldman Sachs.

Hey, folks. Thanks for sliding in. Hey, Jason. I'm going to close this out here. Real quick, you mentioned in-stock levels are better, but service levels are worse. How can those coexist? For in-stock to improve, shouldn't you have been overshipping to kind of restore those levels?

Now, as orders increase, that drives up your shipments, but you could still have a low fill rate. Do you know what I mean?

If demand is exceptionally high and you fill at 80%, you can still have, in theory, you can still have 99% in-stock levels at shelf.

The hole is in, so we may be shipping more, but it's not staying in the DCs. It's going directly to the stores to maintain the improved in-stock levels. but you still are stuck with the hole in the DCs. And that's the opportunity. That's the potential tailwind.

So if you just graph the dollars in shipments, as an example, Jason, you would see that we have dollars in shipments that are similar to past practice and historical levels. It's just the demand is so strong.

Okay. Well, that's a high-quality problem, I suppose. Looking at the margin lines, lots of questions around gross margin and trajectory, but You are coming in with marketing well below your initial budget plan. I think it's somewhere between 70 to 100 basis points or so below. And I imagine many of us are going to look and say, well, gosh, they're going to have to restore that next year, plus your incentive comp because of the gross margins. You're going to have to restore that too next year. And it's not hard to step back and look and say, gosh, they've got like 150 basis point margin holes to fill next year just on restoration of the SG&A lines. what's the flaw in that thought process?

Yeah, I think the marketing line, we've said many times that it's a range of 11% to 12%. I think, you know, in 2020, if you're jumping off from that baseline, that was an extreme, you know, if we're talking about swimming and diving boards, that's the high dive. And that's pretty elevated, you know, 15%. 15.6% in Q4 of 2020, I think, was our all-time high in the history of the company for marketing spend as a percentage. So, look, we were very flush in the end of 2020, and so we spent incremental marketing more so than we ever had in the past. And I would say our evergreen model is between 11% and 12%, and we think that our 2022 plan will be – back within that range, probably the lower end of that range. So that's partly, I would say, some of the flaw is we're not going to get back up to the high 11s in 2022 as an example.

Okay. I was just asking relative to guidance. I wasn't really referring to the tail end of last year, but I think you did guide 11.5 to 12 just last quarter. So we're looking at a pretty substantial cut relative to what you had expected last quarter. Yeah, double-checked.

Yeah, double-check the transcript. I think our number was approximately 11.5 for the full year last time.

I will. I'll double-check that. And the SG&A level, we can debate percentage of sales all day long, but at the end of the day, SG&A is kind of a bucket of hard spend. And you spent like 620, 619 to be precise, in fiscal 19, obviously heavy out this year. And relative to 20, it's down, but you're still up big versus 21. why the incremental spend versus 19 to 21, and is there reason to believe that that's going to grow again in 22, or can we actually get back to something closer to 19?

Yeah, so is your question why even excluding incident comp is 21 higher than 19?

Substantially higher, yeah. And I know you've always kind of put a rate out there in terms of percentage of spend, but in absolute dollars, it's grown meaningfully. So I'm really looking for opportunity to offset the marketing reload next year. And I'm questioning whether or not SG&A actually needs to grow or could actually be lower next year.

Yeah, well, from 19 to 21, probably the biggest movement is actually probably amortization, right? We typically are very conservative in some of the deals that we do do and we don't. We typically amortize those trade names over 10, 15 years. And so, you know, adding Zycam into the mix as an example is would have had amortization between 19 to 21.

Yeah, we acquired that one in December of 20.

And look, we're a lean company. SG&A is always lean. We're investing heavily for different things like RPA for our back office. And we're looking at centralizing back offices as we go into Asia in a bigger way. But all those things are are nickels and dimes, but for us, that's how we tend to find the way forward. So, look, again, I don't want to get into 2020 too much today. We're happy to go through it in spades in January.

Yeah, got it. That's helpful, though. It's just structurally higher. Thank you for that. I guess I'd say I pass it on, but there's nobody else on. So, thank you very much. Have a good day. Thank you, Jason.

And there are no further questions at this time. I would now like to turn the call back over to Matt Farrell, Chief Executive Officer of Church and Dwight.

Okay. Well, thanks, everybody, for joining, and thanks for your interest and lots of great questions today. And we look forward to updating everybody again at the end of January with our Q4 results and full year 22. So long.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.