Clorox Company (The)

Good day, ladies and gentlemen, and welcome to the Clorox Company second quarter fiscal year 2024 earnings release conference call. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question and answer session. If you would like to ask a question, you may press star 1 on your touchtone pad at any time. If anyone should require assistance during the conference, please press the star 0. on your touch-tone pad at any time. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference call, Ms. Lisa Burhan, Vice President of Investor Relations for the Clorox Company. Ms. Burhan, you may begin your conference.

Thank you, Jen. Good afternoon, and thank you for joining us. On the call with me today are Linda Rendell, our Chair and CEO, and Kevin Jacobson, our CFO. I hope everyone has had a chance to review our earnings release and prepared remarks, both of which are available on our website. In just a moment, Linda will share a few opening comments, and then we'll take your questions. During this call, we may make forward-looking statements, including about our fiscal 2024 outlook. These statements are based on management's current expectations, but may differ from actual results or outcomes. In addition, we may refer to certain non-GAAP financial measures. please refer to the forward-looking statement section, which identifies various factors that could affect such forward-looking statements, which have been filed with the SEC. In addition, please refer to the non-GAAP financial information section of our earnings release and the supplemental financial schedules in the investor relations section of our website for reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures. Now, I'll turn it over to Linda.

Hello everyone, and thank you for joining us today. We delivered financial results above our expectations in the second quarter, thanks to very strong progress on a recovery from the August cyber attack, continued advancement of our strategies to drive top line growth and rebuild margin, as well as the swift and effective management of currency headwinds in Argentina. We are rebuilding retailer inventories ahead of schedule, enabling us to return to merchandising and restore distribution. As a result, we made great strides rebuilding market shares. Importantly, throughout our out-of-stock period and recovery, we've maintained our strong brand superiority results as measured by our consumer value metric. This speaks to the power of our advantaged portfolio, the superior value of our brands, and their role in consumers' daily lives. While there's still more work to do, we're on the right path to return our business to the trajectory it was on before the cyber attack. Looking ahead, we expect the operating environment to remain challenging as consumers remain under pressure and their value-seeking behaviors continue. Nevertheless, we remain committed to growing the top line and rebuilding margins and expect volume to play a stronger role in our top line performance as we lap pricing. We're well positioned to make further progress in rebuilding distribution and market shares, as well as drive volume and household penetration growth over time through strong demand creation plans. Given the progress we made in the second quarter, we are also updating our full year 2024 outlook. We have a strong, diverse portfolio of trusted brands. We plan essential categories, and we're making the right investments guided by our Ignite strategy to create long-term value for stakeholders. I'm confident that we're taking the appropriate actions to build a stronger, more resilient company that is positioned to win in the marketplace and deliver consistent, profitable growth over time. With that, Kevin and I will take your questions.

Thank you, Ms. Rindle. Ladies and gentlemen, if you have a question, please press star 1 on your touchtone telephone. And our first question today will come from Andrea Teixeira with JPMorgan Chase.

Thank you. Good afternoon there. Linda and Kevin, I just wanted to go back. Obviously, an amazing performance. You caught up with, I think, with the second quarter fiscal. You caught up with kind of, according to my math, a minus 2%. be much first half against first half of the prior year. And then what are you implying given there's some time periods of depreciation is underlying better as you put it in prepared remarks and you commented on this just now, but then you have a greater effect headwind. But when you go and flow through everything and according to the new guidance, the plus 200 basis points improvement, the gross margin, It implies that your gross margin in the back end declines vis-a-vis what you had in the back end of last year. And so I was just trying to reconcile because your numbers kind of imply profitability going the other way. I understand the transactional effects, but it seems a bit high. If you can kind of walk us through why would that happen, given the beats, the magnitude of the beats. Mm-hmm.

Yeah, and maybe let me take a stab at answering some of those questions and let me know if we've missed anything. But as it relates, maybe I'll just start with Argentina might be a good place to start. Because you've heard from many of our peers, that's an incredibly difficult environment right now. I think if you just step back and think about our business in Argentina, we've been in there for a very long time. We have very capable leaders managing very strong brands. While there are some negative impacts in Argentina flowing through our outlook we provided today, both on the top line in terms of higher FX, as well as higher inflation and FX exposure and margin, what you should know is based on the actions we've taken in Argentina, including incremental pricing, we think we've fully covered the negative impacts of Argentina within this outlook, with the one exception of the remeasurement loss, and I'm happy to talk about that. But setting that remeasurement loss aside, we think we've fully covered contain the Argentina impact in this P&L. As it relates to the back half, you were asking about gross margin. And as you saw, we deliver about 41.5% gross margin in the front half. And if you look at the back half based on outlook, it suggests we'll be fairly similar, 41.5% as well. And so we're looking at sequentially fairly consistent trends. If I think about what's changing from the front half to the back half, there's a few items I'd point out. In terms of increased headwinds, We continue to expect higher trade spending in the back half of the year as we get to a more normalized environment. We also now have lapped all our U.S. pricing. We lapped the last round of pricing in December. So you'll see less benefit from pricing in the U.S. And then we're expecting more inflation and more FX headwinds coming out of Argentina. We are offsetting that with incremental pricing we're executing in Argentina. So you'll see international price mix benefits in the back half of the year to a greater degree than the front half of the year. as well as we're projecting improving volume trends. And so collectively, that's offsetting those headwinds. And we're getting to a margin fairly consistent front half versus back half. And that puts us in a position to improve margins about 200 basis points on a full year basis. Now, I think maybe the last question you talked about versus prior year, I think you have to be a little careful looking at the comps. If you look at our gross margins in the back half of last year, I think they're up almost 600 basis points. And so we're relatively flat, but on a very strong performance in the prior year. But let me stop there, Andrea. Let me know if that answers your question.

Yeah, that did, Kevin. Thank you. And I think one of the kind of like a fine point on that commentary, when you say, and prepare remarks, I think Linda had mentioned you're confident to regain shelf space and you're looking obviously regained service levels. It sounds to, and even in our meeting recently in New York, you kind of alluded to initially that guidance, and I think we all in this call appreciated there was a lot of moving pieces and you were conservative. It seems like you're embedding some potential risk at that point of not being able to recover the service levels. Now you did recover. So I'm more in the side of like thinking of the strength of what you achieved in six months. So I'm thinking more why not expecting that momentum to continue now that you potentially could recover some of the shelf space losses that you had, especially now coming up on the spring reset.

Sure, I'll take that. And maybe I'll just start with your first important point. which was our expectations in Q2 and what drove the significant over-delivery. If you recall, you got it exactly right. At the point where we provided an outlook for Q2, we were at a point where we had just turned back to automated order processing and we knew there would be a transition time going from manual to automated and that that would take us a bit of time to ramp up. We were also heading into key holiday time for retailers, which is a challenging time to ensure that we get the ability to have appointments and ensure that we could deliver what we needed to in order to deliver what we ended up doing for the quarter, which was every single day shipping significantly above an average day that we would normally ship. And we, I think, were appropriately cautious given all of those potential headwinds on what we could accomplish. And again, the goal was to restore inventories by the end, the majority by the end of Q2, knowing some of that would flow into Q3 and Q4. So what happened in Q2, we were able to get all of that ramp up and we really leaned into our operating model. We designated a general manager who was in charge of solely getting inventories rebuilt in retailers. And she had a multifunctional team around her to do that. And we were able to quickly ramp up from manual to automated and ship nearly every single day significantly above an average shipping day pre-cyber event. And our retailers were extraordinary. So we were able to get in, we were able to get appointments. And the result of that, if you look at distribution, we were down over 30% of our TDPs, if you look at average weekly TDPs, down over 30% at the height of our auto stocks. We've gotten back to mid-single digits. Some businesses slightly better than that, some slightly worse, and I can cover that. Market shares at the height of this, we were down over five points. If you look at the four or five-week ending December, we were down a point. Look at the latest four or five weeks ending January 21st, down 0.7. So all that flowed in the right direction, which gives us confidence. But that speaks to the work we have remaining, and we talked about this last quarter. We spoke about the fact that a lot of this was under our control, and we were going to maximize that, and I felt good about what we did in Q2. But we are also dealing with the fact that in order to fully restore distribution, we need to have retailer resets, and those happen mainly in the spring, and they vary through the back half of our year. and we intend to finish the job then. And in addition to that, we have to fully restore merchandising. So as we get our business up to the service levels we expect, and to be clear, our service levels are still depressed. They're significantly better, but we need to fully restore those. We'll return to merchandising in the back half and full as well. And with that, we feel good about our plans. We feel like we have the right investment levels. Our brands have maintained their superior value, as I said in my opening comments, so feel good about it. But I just want to be clear, we didn't, you know, the job's not done in Q2. Tremendous progress, but we have more work to do in the back half.

Thank you. I'll pass it on.

And our next question will come from Peter Grom with UBS.

Thanks, Operator, and good afternoon, everyone. So I wanted to ask on the organic revenue growth trajectory, can you maybe just help us understand how you are thinking about volume versus price in the back half of the year? When you mentioned you expect volume to be a stronger contributor to performance, does that assume a return to growth or just kind of less of a drag versus what we've seen prior to the disruption? And then just on the pricing as well, particularly as you've now left the U.S. pricing but are taking incremental pricing related to Argentina. Thanks.

Sure. Hi, Peter. As it relates to organic sales growth and transitioning from the front half to the back, everything about what the changes are, As it relates to volume, we expect to see improving volume trends in the back half of the year. That's a combination of both continuing to recover from the cyber event, as well as now that we've lapped pricing, we'd expect to see improving volume. If you look at the front half, our volume was down high single digits. And so we would certainly expect to see those improving volume trends as we go forward. And then in addition to price mix, we've now, as I said, lapped our U.S. pricing in December, the last of the four rounds we took. And so U.S. will be contributing much less, in fact, very little impact to favorable price mix. But we have now leaned into Argentina in November and December. We took double-digit price increases both months. And so you will still continue to see positive price mix in the back half of the year in spite of increased trade spending. So I'd say overall improving volume trends from the front half of the year, price mix being a little lower than the front half because we've lapped U.S. pricing but still fairly strong for us. And that's how we get to an expectation that we'll be growing for the full year, low single digits. And that'd mean the back half would be a bit stronger than where we landed in the front half in terms of organic sales growth.

Got it. That's really helpful. And then I guess just, Kevin, on the 42% exit rate, and I may be reading too much into this, but are you simply just trying to provide some color on the second half phasing? Or are you trying to signal how we should be thinking about the gross margin recapture opportunity looking at the fiscal 25?

Yes, it's more about phasing in the back half. Just want to make sure we're highlighting it, folks. For all that pricing in Argentina to take effect, it'll probably be the fourth quarter before it's fully in market. So I'd expect my fourth quarter growth margin to be a bit stronger than third quarter. But having said that, as you know, Peter, Lynn and I remain committed to rebuilding gross margins back to the level we had before what I describe as the super cycle of inflation. Good progress last year. We intend to make more progress this year, but the work's not done, and I fully expect going into 25 we'll continue to expand margins. But importantly, we'll do that while we continue to invest to grow the top line and continue to advance our strategic initiatives. So we continue to focus on all three. But as it relates to margin, I expect to make solid progress this year, and I expect that to continue as we go into 25. Thanks so much. I'll pass it on. Thanks, Peter.

And we'll move next to Anna Lazul with Bank of America.

Hi, good afternoon. Thanks very much for the question. I wanted to ask on the outlook and the prepared remarks, you mentioned expecting a modest slowdown in category growth rates in the back half of the fiscal year. Are there any particular categories where you expect an outsized impact versus categories that you think are more resilient?

Sure. You know, this assumption on a modest slowdown in categories is one consistent with what we provided as an original outlook to fiscal year 24 as we saw the consumer come under more pressure. And we originally had the assumption of a mild recession, which we are no longer assuming, but still assuming the consumer is going to be under more pressure given all the factors in the macroeconomy. And so that's consistent with that. And if you look at our categories, given they're all mostly household essential categories, we would expect no large difference in those categories. We might see little nuances here and there, but on average, we'd expect all of them to be slightly slower. And that's consistent with what we've seen in the past in times like this. But I wouldn't call out anything in particular that would be a wide variance to that assumption.

Thanks for that. And just to follow up on the organic sales question earlier, on the lifestyle segment in fiscal Q2, we saw a negative price mix Can you just tell us what is driving that and should we expect to see negative price mix in the back half of the year on this? Thanks.

Sure. As it relates to lifestyle, that was in our Burt's Bees business. We do quite a bit of holiday gift packing and merchandising in the second quarter on that business. And so you have increased promotional activity. And so that was specific to the second quarter. And you may see that occasionally based on merchandising plans as we go forward.

Great. Thank you.

And our next question will come from Dara Mosenian with Morgan Stanley.

Hey, guys.

Just maybe looking beyond fiscal 24, I think the salient question today is probably the earnings outlook as we look out to fiscal 25. I know obviously you won't comment on that directly, but maybe just looking at a couple line items. First, Linda, from a top line standpoint, obviously a lot of moving parts. Are you pretty comfortable now that longer-term retailer relationships have not been impacted from the systems issue? Do you have a line of sight to eventually regaining full distribution? You know, to Andrea's question, understanding the job's not done, but do you think you have that line of sight? And also, maybe just an update on the competitive environment near term. Are there any pricing or promotional concerns that have cropped up from competitors recently, given some of the volatility there? that might linger as we look out over the next year or two and how you think about that?

Sure. Thanks for the question, Dara. So obviously, as you said, we won't provide any perspective on fiscal year 25, but the things that you outline are important as we think about closing out this year and then, of course, the future of our continued commitment to grow top line while rebuilding margins. And, you know, what we see from a top line perspective is very strong brands. And I think I'd highlight again what I called out around Brand superiority, even in the out-of-stock issue that we experienced in cyber, we maintained our brand superiority ratings, which is significantly higher than it was pre-pandemic. So our brands continue to remain strong. And we feel great about the investments we have in the back half, both increasing our advertising and sales promotion levels. And we're going to spend about 11% this year. We continue to expect that. And we do expect trade promotion to increase, as Kevin highlighted earlier. And innovation plans, you know, we've also spoken about the fact that during the cyber incident we walled those resources off, and so our innovation plans remain on track, and we expect innovation across every major brand at Clorox, and we'll continue to invest in those plans. So I feel great about the brand health going into this. From a category perspective, as we said, we expect to see some moderation in category growth. We tend to fare well in times when the consumers stretch because we offer value superiority, and in fact, We're seeing in many cases people still trading into premium segments of our business. We're seeing that in wipes. We're seeing that in premium litter. We're seeing that in our food business and across many others. So I feel really good about where we stand with the consumer, even as they are more challenged. And we're not seeing excessive trading to private label. We did see some during our out-of-stock period, but we're seeing that rebound as we get back on shelf. And then retailers, you know, I'll just take another moment to thank them. And I can't thank them enough. They've been tremendous partners. And I say with confidence, our relationships are stronger coming out of this unfortunate incident than they were heading in. And they were strong heading in. I'm super grateful for their partnership and what they've done. And we're both back focused on category growth and focused on finishing the job on distribution and I have full confidence given the plans that we have that we will restore distribution. It will just be how fast we can do it and on what timing. And again, some of those things are out of our control. But we have the right plans. We have the right relationships and strong brands to get it done.

Okay. Can you just comment on the promotional environment? And if I can slip in one more, Kevin, on the margin front, you talked about leaving the year at 42%. That's still well below peak levels of 45 to 46 if you go back historically. You mentioned in response to Peter's question that there'll be progress in fiscal 25. Just help us understand potentially the slope of that gross margin recovery over time, the key drivers, and how you think about long-term potential relative to that peak historical level. Thanks.

Sure. On the merchandising and competitive front, we continue to see merchandising levels below what we saw pre-pandemic, and we expect in the back half for those to continue to ramp up. But what I'd say is, you know, some of that was depressed given the fact that we were out of stock and not had as much merchandising. But we're not seeing anything in any material way where we're seeing, you know, deep discount price merchandising, where we're seeing a fundamental change. But we would expect that level to rise consistent with a more pressured consumer. And I would say there are little pockets here and there in categories. We're seeing some competition in litter. where there's a bit more aggressive merchandising and price promoting going on, but nothing outside of what we have assumed in our outlook from our categories and competition. And again, we continue to expect merchandising to increase both ours and competition in the back half, but we don't expect that to go to levels beyond what we saw pre-pandemic. And we'll see how that plays out.

And then Dara, on gross margin, as I said, I getting to about 42 as our exit in Q4. I expect we'll make more progress in fiscal year 25, and I'm sure you can appreciate. I'll refrain from being too specific. We haven't finished our plan yet for 25. But here's what I expect. We will continue to drive cost savings. And as you know, we target 175 basis points of EBIT margin expansion each year. You know, the last couple of years, we've been doing north of 200. So we'll continue to drive cost savings. If you assume we're going to move into a more normalized cost environment, potentially even some cost deflation, you can see how that 200 basis points can quickly start advancing our gross margins. It's not being absorbed by cost inflation. So that'll be what we expect going forward. We'll have to see where the cost environment is when we get there. Pricing will play a smaller role as we've now lapped U.S. pricing. We're still doing some pricing international, but that'll play a smaller role. But as we mentioned, we can do expect improving volume trends, which will certainly contribute to margin expansion as well. So as I said, we're going to make progress. It's hard to call you know, when we think we'll get back to that initial margin. We talk about 44%. It's hard to call exactly when we'll get there because it's not fully in our control. Some of that's going to be driven on how that cost environment plays out. If we see deflation, it could move more quickly. And if it still continues to inflate, it may take a little bit longer. And then I think once we get back into a more normalized environment, typically our cost savings is more than enough to offset a normal level of cost inflation. And we get to take a little bit to the bottom line And that's how you get that 25 to 50 bps of EBIT margin expansion each year ongoing. So I think job one is to get back to that 44%. We remain committed to doing that. I think over time you get back to a more modest improvement year after year in a more normalized cost environment.

Thank you.

And our next question will come from Filippo Filoni with Citi.

Hey, good afternoon, guys. So, Linda, I wanted to go back to your comment of there's still some job to be done in terms of recovering shelf space. Maybe zooming in a few categories, if I look at the track channel data, there's three big categories where your total distribution points are still below cyber attack levels, particularly trash bags, bleach, and cat litter. Maybe you could give us a color, like what your plans are to get the shelf space back.

Sure, Filippo. You know, just in aggregate so that we're completely clear, we still have fewer distribution points than we did pre-cyber, but we are close to restoring at an aggregate enterprise level. So as I mentioned earlier, we were down well over 30% in average weekly distribution points at the low point of our auto stocks, and now we're mid-single digits on average. But you're right to call out that, in particular, trash and cat litter were actually – More on track to what we originally expected in Q2, and we were able to, in the rest of the categories, accelerate the distribution point recovery. But trash and cat litter were more on the schedule that we had expected them to be in Q2, and there's really two things driving it. The first on cat litter is the ongoing catch-up that we're playing as the category has grown so fast to catch up from a supply perspective to demand. We continue to expect to make progress on that this year, but that's part of the reason why cat litter is slightly behind And then trash, you know, that's a complex category, and we prioritized a certain set of items to ensure that those were on shelf fast. And with that, we have to bring back the full distribution, particularly I'll call it large sizes is one that we have not fully restored yet. We have plans to do that in these upcoming resets. Those are important items in the category, and retailers realize that. And we feel we have the right plans in place to get them back. But those are two categories that will look more like we had thought at the beginning of Q2. But just like the rest of the categories, we believe we have the right plans. We will make progress in Q3 and Q4. And we're not seeing anything abnormal from a consumer perspective that gives us any concern of our ability to do that.

Right. That's super helpful. And then, Kevin, two quick follow-ups on the gross margin. First, on the commodity line, it was neutral this quarter. You talked about maybe a more favorable environment. Are you expecting some deflation in the second half, meaning a benefit? And then on the manufacturing and logistics, maybe you can walk us through the drivers of that line as well.