Apple Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 28, 2022

There are 17 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Church and Dwight Third Quarter 2022 Earnings Conference Call. Before we begin, I have been asked to remind you that on today's call, the company's management may make forward looking statements regarding, among other things, the company's financial objectives and forecast. These statements are subject to risks and uncertainties and other factors that are described in the details in the company's SEC filings. I would now like to introduce your host for today's call, Mr. Matt Farrell, Chief Executive Officer of Church and Dwight, please go ahead, sir.

Speaker 1

Okay. Thank you, operator. Good morning, everyone. Thanks for joining us today. Now we've got lots to talk about.

Speaker 1

I'm going to begin with a review of Q3 results. Then I'll turn the call over to Rick Durker, our CFO. And when Rick's done, we'll open the call for questions. First off, I'll say we revised our full year revenue outlook in early September and we're tracking to hit 3%, which was the midpoint of our 2% to 4% range at that time. In Q3, reported revenue was up 0.4% and that exceeded our expectation of minus 1%.

Speaker 1

As you read in the release, while the majority of our brands are performing well, we have 3 businesses that are coloring our results this year, those are Waterpik, our Vitamin Business and FLAWLESS. And those businesses account for accounted for a 6% sales headwind in Q3. Adjusted EPS was $0.76 Now this was $0.11 higher and our EPS outlook driven by higher international sales, lower SG and A and timing of marketing spend. The U. S.

Speaker 1

Portfolio grew consumption in 11 of 17 categories. The trade down to value laundry detergent continued has ARM and HAMMER liquid detergent achieved an all time high market share of 14.3%. ARM and HAMMER clumping litter, BATISSE Dry Shampoo and Therabreath mouthwash also achieved all time high market shares. Trojan Condoms returned to share growth End OxiClean Stain Fighters and Arm and Hammer Baking Soda delivered double digit consumption growth. The strong performance of these businesses is offsetting the impact of the discretionary businesses and vitamins on reported sales.

Speaker 1

In Q3, our most discretionary brands, Waterpik and Fallas, which account for approximately 10% of our global sales, we're impacted by lower consumer spending. Similarly, the gummy vitamin category in which our VitaFusion brand competes was impacted by a decline in consumption as fewer households purchased vitamins and supplements and we were also lapping the COVID delta variant in the prior year quarter. In Q3, online sales as a percentage of total sales was 15%, and we continue to expect online sales for the full year to be above 15%. Now I'm going to comment on each business. First up is the U.

Speaker 1

S. U. S. Consumer, which had 1.7% organic sales decline, looking at market share, 7 of our 14 power brands held or gained share. Looking ahead, we expect even further improvement in our market share positions in Q4, as we expect our highest fill rates of the year and our highest quarterly promotional and marketing spend.

Speaker 1

I want to look at a few of the important categories in U. S, I want to start with laundry. The trade down to value detergent, which began in Q2, continued in Q3. During Q3, the liquid laundry category grew 3.1%. Now if we break that down, value laundry detergent grew 9%, while premium laundry declined 3%, ARM and HAMMER unit dose also benefited from the trade down.

Speaker 1

Our ARM and HAMMER pods grew consumption by 25 percent in the quarter compared to unit dose category growth of 4.5%. With more consumers migrating to ARM and HAMMER, we have a long term benefit to the ARM and HAMMER brand similar to the last recession. In litter, the category grew 11 While ARM and HAMMER litter grew 14%, so we gained share in the quarter, both our black box, which is premium, and our yellow box, which value had double digit consumption growth in Q3. In the same fighters, OxiClean gained share as consumption was up 10%, while the category grew 7%, the dry shampoo category was up 18% in Q3, driven by BATISTE consumption, which was up 37% and we now enjoy a 46% market share in dry shampoo. The condom category was up 3.5% in Q3, while Trojan consumption was up 4.5%, so again we gained 60 basis points of market share, thanks to our new Trojan bearskin raw condom and the success of more targeted marketing.

Speaker 1

Our most recent acquisitions are performing well. TheraBreath, which we acquired in December of 2021, had a great quarter with 46% consumption growth. TheraBreath grew share 4.3 points to 17.8 percent of the alcohol free mouthwash category. Thorough breath is the number 2 non alcohol mouthwash and the clear number 4 brand in total mouthwash. Thorough breath is we expect it to be a long term grower for Trich and Dwight in the future.

Speaker 1

Zicam also delivered strong results this quarter. You may recall, we acquired Zicam in December of 2020, Zicam is the number one brand in the cold shortening segment with a 76% share in Q3. Now looking ahead to Q4, the regular flu season in the U. S. Is projected to be far more severe than recent years.

Speaker 1

And as a reminder, approximately 40% Xican consumption happens in Q4. We closed on our latest acquisition, HERO, in mid October. While we did that own hero in Q3, the brand performed extremely well, growing consumption 56% and gaining 3.6 share points to achieve a 14% market share in the total acne treatments category. There's a great deal of excitement here about this business as we look ahead to 2023 and longer term. All right.

Speaker 1

Next up is international. Our international business delivered organic growth of 3.2% in Q3, primarily driven by the international subsidiaries, which posted strong growth in the quarter. On the other hand, our Global Markets Group has been impacted by weakening demand in China due to lockdowns, and we expect this to continue in Q4. Finally, Specialty Products. Our Specialty Products business delivered 1% organic growth in the quarter, but keep in mind that the 1% organic growth is on top of 18.5 percent organic growth in Q3 2021.

Speaker 1

Now I want to spend a couple of minutes discussing our 2 discretionary brands, Waterpik and FLAWLESS, which have longer purchase cycles. And after that, I'll talk about the Vitamin business. First, Waterpik. So, WATERPIK is the number one brand in water flushes. We continue to see lower dollar consumption for water flossers in the U.

Speaker 1

S. However, WATERPIK unit volumes are actually positive both in Q3 year to date as consumers trade down to lower priced cordless models. If we look back at 2021 2020, the consumer was healthier and a good portion of our growth came from our super premium products like Sonic Fusion. In 2022, the decline in our flosser sales is driven by trade down and inventory reductions by retailers. Shipments for full year 2022 are expected to decline approximately 20% as retailers reset their inventories and product mix.

Speaker 1

We continue to invest in demand driving activities for Waterpik, such as lunch and learns with dentists and hygienists to drive household penetration of flossers. And in 2023, so next year, we expect to return to pre pandemic levels for lunch and learns. Now remember, WATERPIK is the Kleenex of water flossers 9 out of 10 dentists recommend the product by its brand name. This is extremely important as 60% of consumer purchases are driven by a recommendation from a dental professional. It's fair to say that gum health is not going away and still only 16% of the U.

Speaker 1

S. Population flosses every day. Now looking back, Orderpik averaged high single digit top line growth from 2017 when we acquired the business through 2021. So we're taking a big step back in 2022, but we're confident that the long term growth prospects for WATERPIK are sound. Now the other discretionary brand we have is FLAWLESS, which is the number one brand in women's health hair removal.

Speaker 1

We're experiencing lower consumption in this category, which resulted in higher inventories at retail, our share has been further hurt by the delay in launching new products caused by the China lockdowns at our supplier. After the conclusion of a 30 month earn out period, which ended in 2021, our marketing team took over the front end of the business and has been narrowing the product assortment to the winners. So if you're familiar with the brand, that's Face, Brow, Mani and Teddy. We're also shifting the focus from older consumers to digital targeting of younger consumers in the beauty space. Now we believe these changes will have a positive impact on the long term prospects for the business.

Speaker 1

Now finally, over in VMS, we have the number one adult gummy vitamin. Category consumption is being impacted as temporary consumers who were interested in prevention during COVID times have exited the category. Beyond category dynamics, the VitaFusion brand has also lost some share due to our lower fill rates, particularly earlier in the year. It's clear that fewer households are purchasing vitamins and supplements post COVID and the category is being impacted by the recession. So here are some stats.

Speaker 1

For the last three quarters, the category growth rate has been plus 10% in Q1, plus 5% in Q2, and most recently, minus 8% in Q3. Now the minus 8% compares to a +33% increase in the category in Q3 2021. And there is some good news here. In the 1st few weeks of October, the rate of category decline has moderated to minus 4%. And longer term the transition from pills and capsules to gummy vitamins gives us confidence in the longer long term appeal of the gummy category.

Speaker 1

And I'll conclude with a few takeaways that I'd like to leave you with. The majority of our business is strong. We believe the 3 brands that are coloring our numbers good long term prospects. Case fill is now over 90% and improving. We've ramped up our marketing and trade promotion investment in the second half, especially in Q4, and we have confidence in our Q4 outlook.

Speaker 1

Now I'm going to turn it over to Rick to give you more details on Q3.

Speaker 2

Thank you, Matt, and good morning, everybody. We'll start with EPS. 3rd quarter EPS was $0.76 down 5% to prior year. The $0.76 was better than our $0.65 outlook, primarily due to higher sales, lower SG and A expense and timing of marketing spend. Reported revenue was up 0.4%, including a 1% drag from currency.

Speaker 2

Revenue was higher than our outlook of minus 1%. Organic sales declined 0.7% as volume was down 8.5%, partially offset by positive pricing of 7.8%. Matt reviewed the top line for the segments, so I will go right to gross margin for the company. Our 3rd quarter gross margin was 41.7%, a 2 50 basis point decrease from a year ago. Let me walk you through the Q3 bridge.

Speaker 2

Gross margin was impacted by 580 basis points of higher manufacturing costs, primarily related to commodity inflation, distribution and labor. These costs were offset by a positive 190 basis point impact, largely from pricing, positive 20 basis points from acquisitions and a positive 120 basis points from productivity. Moving to marketing, marketing was down $20,000,000 year over year, although this was a significant increase of $40,000,000 sequentially from our first half twenty twenty two levels of 8% of sales, as our fill rates have improved. Sale rates in Q3 were 91%, and we expect further improvement in Q4. Marketing expense as a percentage of net sales was 10.7% in the quarter.

Speaker 2

We expect a continued increase in marketing spend in Q4 to approximately 13% of net sales.

Speaker 3

For

Speaker 2

SG and A, Q3 adjusted SG and A decreased 30 basis points year over year. Other expense all in was $19,400,000 a $7,300,000 increase resulting from higher average outstanding debt levels and higher interest rates. And for income tax, our effective rate for the quarter was 20.2% compared to 20.4 and net of cash for the 1st 9 months of 2022, cash from operating activities decreased 119,500,000 to $534,000,000 due primarily to higher inventory levels from WATERPIK, FLAWLESS and Vitamin. We expect inventory levels to come down over the next 12 months. And as of September 30, cash on hand was $438,000,000 Looking ahead to Q4, we expect reported sales growth of approximately 2%, organic sales declined of approximately 1% and gross margin contraction.

Speaker 2

Adjusted EPS is expected to be $0.58 to $0.62 per share, a 3% to 9% decrease from last year's adjusted Q4 EPS. This decline is primarily due to significantly higher quarterly tax rate of 25% versus an unusually low tax rate in the prior year of 3.7%, which was largely due to high number of stock option exercises a year ago. Turning to the full year, we expect the full year outlook for reported sales growth to be approximately 3%, the midpoint of our previously 2% to 4% range. We expect organic sales growth to be approximately 1%. The strong consumption across most of our businesses in 2022 has offset the slowdown in discretionary brands as Matt talked about, we now expect full year adjusted EPS to be $2.93 to $2.97 a decline of 2% to 3% compared to 2021.

Speaker 2

The range is influenced by the extent of margin mix within the portfolio. We continue to expect the full year tax rate to be 23%, and we now expect cash from operations for the full year to be approximately $800,000,000 and our full year CapEx plan is now approximately 170,000,000 as we continue to expand manufacturing capacity in anticipation of future growth in laundry and litter. In closing, we continue to perform in a volatile environment. We expect further market share gains in Q4 as we invest in our brands and our supply chain sales levels continue to improve.

Speaker 4

And with that, Matt and

Speaker 2

I would be happy to take any questions.

Operator

Thank again, if you like to ask a question, please press star. One moment please. Our first question comes from the line of Dara Mohan of Morgan Stanley. Your line is open.

Speaker 3

Hey, guys.

Speaker 1

Hey, good morning.

Speaker 3

First, just a detailed question. Can you just be a bit more explicit on what changed in the earnings guidance for this year post the early September update, I know there's year over year tax rate pressure in Q4, But I think that was known. So just curious on what's changed. And then second, just on the Vitamin side, you guys have articulated that the business is suffering from tough comps versus COVID variance last year that makes sense. As you think about the business longer term, some of the people that were brought in during COVID who maybe aren't as loyal to the category, is there sort of risk that this weakness lingers and perhaps they're more susceptible to pullback in consumer spending and won't be as loyal to the category from these sort of on the fence users who were brought in during COVID.

Speaker 3

So just any thoughts on vitamins as you look out more to next year? Thanks.

Speaker 2

Yes. Hey, Derek. It's Rick. I'll take the margin mix and Matt will take the vitamin discussion. So really, the change in the outlook is pretty straightforward.

Speaker 2

It is we didn't change revenue outlook. We're still the midpoint, the 3% number. The mix to get there has been a little bit different though. The businesses like FLAWLESS and WATERPIK and vitamins have come down and the rest of the household portfolio has gone up. And so that's created a mix pressure.

Speaker 2

Matt also talked about how there's a trade down for WATERPIK going from the higher priced units to the lower priced units, that's also caused a mix issue on a profit basis and that's impacted earnings.

Speaker 1

Yes, with respect to vitamins, you heard in my opening remarks, we've lost some share due to fill rates, so we had some lost some consumers to other brands earlier in the year. So we got to win them back and there's definitely fewer households Purchasing. Your question is, Steve, is can we call the bottom? And do we know that all the consumers who are leaving the category have left. Obviously, not knowable.

Speaker 1

I will say that the coming flu season actually Should bolster the VMS category, just beyond COVID because we haven't had a wicked flu season for a few years. But given it's been many quarters now, several quarters since the end of COVID, we do think things are starting to bottom out. As I mentioned, since we saw that in the Q4 that at least early in Q4, the decline year over year is reduced to 4%, where it was 8% in the previous quarter. So it's possible that we could be hitting an inflection point where the category may flatten out and then start to grow.

Speaker 3

Great. Thanks.

Speaker 2

Thanks, Steve. Thanks, Derek.

Operator

Thank you. Our next question comes from the line of Chris Carey of Wells Fargo. Mr. Carey, your line is open.

Speaker 4

Hey, good morning, everyone. I'm trying to determine how much of WATERPIK flawless vitamin pressure impacted your consumer domestic versus your international segment. You previously given some perspective on geographic mix of these businesses, I wonder if you can update us on the U. S. Versus non U.

Speaker 4

S. Exposure today or how things look today for those businesses? And then just connected to that, do you have a sense of what your organic sales growth would have been in your consumer domestic and international businesses, assuming that these three businesses were mutual growth. Obviously, you gave The 6% headwind, which is quite helpful. I'm wondering how that looks out between your reporting regions.

Speaker 1

Yes. I'll just comment that as you know, Waterpik is a global business, so it affects both international and U. S, U. S. Being the lion's share of the business and U.

Speaker 1

S. Is even more FLAW is even more skewed towards the U. S. So if I don't have those numbers for you, but I think it's fair to say that 6% is probably somewhat equally split for WATERPIK as far as U. S.

Speaker 1

Versus international and more skewed towards the U. S. For FLAWLESS.

Speaker 2

Yes. And I would only add to that, that right, we tried to give you a little bit more visibility and granularity into it. But if we were flat for the quarter on net sales, we said Those three businesses were about a 6% headwind. And as Matt said, our divisions are usually eighty-twenty split the Waterpik is probably more fifty-fifty. But I don't think we're getting any more granularity, but we had a 6% headwind in the quarter.

Speaker 2

Yes.

Speaker 1

And Chris, the reason we called that out and the release on the call this morning is because we want to put a ring fence around where our problems are. We got 80% of the business that's really clicking. And we have 3 businesses, we like them on a long term basis, but certainly hurt us in an environment where you have weakening consumer, weakening economy.

Speaker 4

That's really helpful. If I could just follow-up quickly and then get back in the queue. Just as it pertains to when the headwinds came together for these businesses and as such when you could potentially start lapping those headwinds, is it reasonable to just look at your Personal Care business and when the growth started to come off? And can you just confirm whether you're seeing any sequential worsening or you expect stabilization? And this is really just about You're getting beyond tough comps.

Speaker 4

So thanks, Mark.

Speaker 1

Yes, I'm sure a lot of people have questions about 2023, but what we can say about that 10% of the business WATERPIK and FLOS is that next couple of quarters we do expect to be choppy, meaning Q1 and Q2 of next year, just looking at year over year comps, etcetera, but we think after that things are going to even out.

Speaker 2

Yes. And then on the vitamin side, we think that as Matt said in his prepared remarks that we're starting to see the minus 8 to minus 4 just because of the delta variant year over year and we're seeing that start to inflect in a good pattern, so that's all

Speaker 5

the color we'd give you.

Speaker 4

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Kamil Gharawala of Credit Suisse. Your line is open.

Speaker 5

Hey, guys. Good morning. Can you maybe talk a little bit about and you

Speaker 6

alluded to some of this, but how are you balancing between

Speaker 5

how much

Speaker 6

to advertise versus how much CapEx to put in on the Vitamin side versus this uncertainty of demand? It sounds like there's a fill rate problem, but there's a demand problem and there's incremental CapEx and advertising going into it. So how are you managing these pieces?

Speaker 2

I'll start with CapEx and then maybe Mac can end up on the consumer. So, and I'll talk about demand a little bit too. So on CapEx, for example, we had I said for 2023, we're going to have about $300,000,000 of CapEx to step up and that was laundry, litter and vitamins to recall. We put a pause on the vitamin CapEx and so that new number for 2023 will be probably between $250,000,000 $270,000,000 we'll finalize that when we give our full 2023 outlook. So that's on the CapEx side.

Speaker 2

Yes.

Speaker 1

And you had a question about marketing. If you look back over the last few quarters, just kind of round numbers, Q1 and Q2, we had 8% marketing as a percentage of sales. And why? Because we had lower fill rates. So that was prudent not to be spending at a higher rate.

Speaker 1

And that amped up in Q3, whereas 10.7%. And you can see we're calling 13% In Q4 and then I'd say next year so on a full year basis this year, we're probably around 10%, but we do expect next year to build on that. So that will move to a higher number as we as fill rates become more normal, the marketing spend will also return to a normal rate.

Speaker 2

And on vitamins, I would just add, I think it's really key to understand when we're talking about the category, right? And yes, the category was down 8% in 2022, but it was up 33% in 2021. And that's what Matt had in his comments. On a stacked basis, it's up 25%. So it's not like the category is cratering.

Speaker 2

I think it's just coming back

Speaker 1

in line

Speaker 2

with super high growth relative to pre COVID levels.

Speaker 1

Yes. In fact, if you look at the stack rate for Q2, it'd be similar to Q3.

Speaker 6

Okay, great. And then on laundry, was any of the strength linked to your ability to supply versus the competition, we've obviously heard of some shortages at some of your competitors. I'm just wondering, is it indeed trading down or is it perhaps that you have better supply at the moment than some others.

Speaker 1

No, I don't think supply would be a very big factor here. I think this is entirely driven by the economy and the consumer. And we've seen this before many, many years ago during the Great Recession. So we're seeing in liquid laundry detergent, we're seeing in the pods and one we didn't talk about is scent boosters, where scent boosters, the category was flat, but we were up 3% or 4%. So everywhere where we have a value, and I'm sure your comment about supply does not extend to all liquid laundry pods, scent booster, every aspect of laundry.

Speaker 1

So we're seeing it in so many subcategories And laundry, it's we concluded it's real and it will continue.

Speaker 7

Great. Thank you.

Operator

Thank you. One moment, please. Our next question comes from the line of Stephen Power of Deutsche Bank. Your line is open. Stephen Power of Deutsche Bank.

Operator

Your line is open.

Speaker 5

Sorry, I didn't hear you call my name. Hey guys, thanks. I guess there's as I listen to you, in the Q3, you had both like demand degradation for sure in FLAWLESS and WATERPIK and vitamins as well as you have continued supply constraints across the business and then retailer destocking kind of impacting the total portfolio. As we think about going forward, when are you able to when do you see yourself shipping to consumption, whether in the Core consumables business or in the businesses that have been the biggest drag.

Speaker 2

Yes. Well, that answer is a little bit more complicated, but our fill rates in Q3 were 91%. We expect in Q4 they're going to be closer to 93%, 94%. Remember historical full numbers were 98%. So we're within spitting distance of that.

Speaker 2

There's a few key areas that largely raw materials that are still holding us back in a couple of key categories. In some cases, it's capacity for international that's being addressed as well. So I think, as we exit this year, in most categories, we'll be shipping to consumption.

Speaker 1

Yes. As far as inventory in the channel, Steve, it's that's more the focus here is more on water picking And FLAWLESS, and that's why we think for the next, 6 to 8 months, I think it's going to be choppier for those two brands. But we don't have worries about shift to consumption with respect to the rest of the business.

Speaker 5

Okay. And then you talked about marketing into next year. Could you give us an update on whether or not you layered on any your coverage on the cost side of things into 23 at this point and if so, how much? And I guess just in broad brushstrokes, do you want us to walk away from this call thinking that Evergreen is on the table for next year or is that too ambitious?

Speaker 1

Hey, Hank. We have a range for Q4. You're asking us for commentary on 2023. So, there are pluses and minuses that when you think about the 2023. So the majority of our business is doing well.

Speaker 1

Certainly, there's inflation next year, but early days with respect to RFPs for procurement and input and things like that. We're seeing some things come back, but we won't know for really the next 90 days for all those RFPs turn out. I said, we're going to have a few choppy quarters from Waterpik and FLAWLESS. Laundry is super strong right now. Value is winning.

Speaker 1

So obviously, we expect that continue for the next 12 months. Going the other way, we all everybody's dealing with higher interest rates and FX, so that's a drag. And then obviously, if we're going we inflate our marketing spend in 2023. So there may be a couple of other pluses and minuses. Rick, anything else you want to throw in there?

Speaker 2

Yes, I would just say, as Matt said, higher marketing because we're going to have higher fill rates, so that kind of normalizes normalized incentive comp. We're going to have a gross margin tailwind though is what we expect. So lots of puts and takes. We're not ready to call it 2023 yet. We'll do that in 3 more months.

Speaker 2

I would just say we are having some glimmers of hope on the RFPs on some of the commodities are starting to inflect. But again, we're not getting into that detail. Yes.

Speaker 1

It's just way too early to call it, Steve.

Speaker 5

Okay. And then Rick, has there been any forward buying and coverage as it relates to commodities for next year or are you still in a floating position?

Speaker 2

That's a good question. So usually, and just for context, right, we are usually about 60% to 70% hedged by now. I said last call, we were approximately 0% hedged. I would tell you today, we're about 25%. We did do some diesel before the run up, as an example.

Speaker 2

But mostly, we're still not back to historical levels on the hedging because we believe those costs will continue to come down. Yes.

Speaker 1

So all those factors, Steve, they're all material one way or the other. So the question is, how big are each of them once we get to the end of January when we 2023.

Speaker 5

Understood. All right. Thanks a lot.

Operator

Thank you. One moment please. Our next question comes from Nik Modi of RBC. Your line is open.

Speaker 7

Yes. Thank you. Good morning, everyone.

Speaker 1

Hello, Matt.

Speaker 7

Hello, Matt. Just a couple of brand category level questions. Just on laundry, looking at some of the numerator data, it looks like household penetration is down. And I was just curious on your thoughts around that, what do you think is happening there? And then extra in this kind of environment would typically do better than what I'm seeing at least in the scan data, so I just was hoping you could just comment on that.

Speaker 7

And then I had a question on FLAWLESS.

Speaker 1

Yes. Well, as far as households, loosened households, that's not something it's been a topic for discussion here as far as people less people doing washloads, so I can't go any further on that. As far as Extra goes, Yes, we've been prioritizing ARM and HAMMER over Extra for the past 18 to 24 months just because of fill rate issues. That's behind us now. But we are expecting that in 2023, Extra could clearly be a winner as that's our deep value detergent.

Speaker 1

And we did see the same phenomenon back in during the Great Recession. So I think that's ahead of us. And you said you had another one too, Nick, on FLAWLESS.

Speaker 7

Yes, Anshulal, just this kind of euthanizing the brand from the older consumer to the younger consumer. I'm curious, 20 years of covering the space when anytime a company does that, there tends to be a lot of disruption in terms of alienating the older consumer base, right, as you try to make the brand younger. I'm just curious if you guys have looked into that or worried about that, have seen that, and could that kind of prolong the recovery of that brand?

Speaker 1

No, I would say that because the size of the prize is so great with the younger consumers that we don't think that that shift is going to be So dramatic and so noticeable that it's going to alienate the older consumer. So I would say no, that's not a worry.

Speaker 7

Okay, great. And then just one more question, Matt, sorry. Colgate earlier today talked about some inventory destocking and some of their categories at brick and mortar retail, I'm just curious and their fill rates obviously have been recovering. I'm just curious if you've Seeing any of that happening around in the categories you guys operate in?

Speaker 2

Yes. Hey, Nick, it's Rick. I'll take it. Early in the quarter, we talked about that. We gave updated guidance in September and we said part of the reason was actually because of inventory destocking at retail and it wasn't just One category was multiple categories.

Speaker 2

And so that was implicitly already in our minus one outlook. And so we saw that early in the quarter, but After we got through that, we didn't really see it any further.

Speaker 7

Okay. So it's basically over. Okay. That's what I was trying to get at. Excellent.

Speaker 7

Thank you, Rick.

Operator

Thank you. Our next question comes from the line of Kevin Grundy of Jefferies. Your line is open.

Speaker 8

Hey, great. Hey, good morning, guys. Question for both of you on the promotional environment, and just sort of your expectations there near term and then as we sort of look out to next year, with fill rates normalizing, gross margin still under quite a bit of pressure, a lot of commodity inflation in the P and L that should start to subside. We're seeing some of that and pricing has started to catch up. And then of course, I'm asking about the promotional environment and Trade support within the context of some of the earlier discussion around trade down in laundry, there seems to be some difference in opinion, I guess, between some of your commentary and one of your key competitors as to what's driving the share loss, but that's all kind of a big wind up.

Speaker 8

What's your expectation for trade And are you anticipating seeing perhaps considerably more with Procter in a better supply position? Yes,

Speaker 1

I can't comment on competitors, so you can appreciate that. But if I look at take laundry detergent and cat litter, so on the household side of the house, and those are the most promotional areas. So the category our sold on deal for liquid laundry was 32% in Q3. And we were at 26% and obviously we have competitors that are higher than that, but that 32% was actually year over year. So, yes, I still think that the category spend, the promotional environment is still lower than it has been historically.

Speaker 1

And then it's probably worthwhile talking about litter as well. The sold on deal in litter was 10% in Q3, and that's also historically low as well. Now we were at 13% in Q3, but the 10% and the 13% are still lower than historical levels, which are typically in the high teens level. So it's all ahead of us right now, but I wouldn't say that the environment has been super promotional in Q3 and that could change in Q4 and Q1.

Speaker 8

Got it. Thanks, Matt. Quick follow-up, just on M and A, any thoughts, I know the balance sheet is in a good shape, you guys can transact, maybe just comment on the pipeline? And then in general, just with some of the volatility and albeit the large majority of the portfolio is performing well, but some of it's not. And given that volatility and some of the focus that it takes from management and the fact that you're integrating HERO, does it give you any pause to potentially transact on something else even if the balance sheet is in a good place to consummate a deal.

Speaker 8

So your thoughts there would be helpful and then I'll pass it on.

Speaker 1

Yes. Well, it's important to remember when we acquire businesses, so take and go back to Thoroughbreds, for example, we didn't take a whole lot of employees from Thoroughbreds. And we already have an oral care business, Right. So Oracle Business handles toothbrushes, toothpaste, it's Ora Gel. So we're already in the category dealing with the same buyers.

Speaker 1

So that was really a tuck in. And then when you think about Hero, Keep in mind for HERO, we're hanging on to the 3 founders who are sticking with us for the next few years and we want to retain all the employees. So we got an intact high performing team to run that business. So we don't feel like we're in a position where we can't look at another business. And as you said, the balance sheet is pretty strong.

Speaker 1

And as far as the pipeline goes, we are always looking at new deals and have even looked at one since the HERO deal closed. So it's not to say we're going to transact, but we're always looking for strong brands and good categories.

Speaker 2

And Kevin, it's always a measure of how much complexity the organization can handle at one time and that has to do with when and how much we're integrating. And the Therabreath deal, as Matt said, was an easy tuck in. We're fully integrated from a systems perspective already. HERO, we're going to integrate from a systems perspective by middle of the year. So that's a pretty quick process.

Speaker 1

Okay.

Speaker 8

Fair enough. Thank you both guys. Good

Speaker 1

luck. Okay. Thanks, Ken.

Operator

Thank you. Our next question comes from the line of Rupesh Parikh of Oppenheimer and Company. Your line is open.

Speaker 9

Good morning. Thanks for taking my questions. So on the inventory front, so inventories were up 22%. Do you guys see any risk of obsolescence or markdowns with the higher inventory levels?

Speaker 2

Yes. Hey Rupesh, it's Rick. Yes, it's a fair question. I'd say 2 things. 1, we expect inventories to get back in line over the next 12 months what I said in my prepared remarks, right?

Speaker 2

We've adjusted production levels for some of those long lead devices we sourced out of China, as an example, like WATERPIK and FLAWLESS. It just takes months to run through that inventory as consumption slowed a bit. But we have taken some inventory reserves both in Q2 and Q3 whenever we have long dated products like that, so we feel like we've already recognized some of that.

Speaker 9

Okay, great. And then Rick, on the gross margin, I know you guys called out the mix That's a new headwind in Q4, but maybe if you can just walk through some of the puts and takes as you look out for the balance of the year.

Speaker 5

Yes, I mean, I kind of went through the bridge a

Speaker 2

little bit in my prepared remarks. I would just probably keep it high level. And I would say, our previously in Q4, we had said that was the quarter that we expected to inflect positively finally For gross margin, we've been saying that all year long. And so now we're saying contraction. I would just say that we think it's going to contract slightly.

Speaker 2

I think it's going to be much improved sequentially, I think we were down 250 in Q3. We're not going to be down, in our opinion, not near that much in Q4. So tailwinds from that perspective and that's partly because of comps on commodities, it's partly because Q4 itself in the prior year, it was a little bit lower baseline. But I mean, those are a couple of puts and takes. Great.

Speaker 9

Thank you. I'll pass

Speaker 10

it along.

Operator

Thank you. Our next question comes from the line of Jason English of Goldman Sachs.

Speaker 1

He's talking me in. Appreciate it. Good morning, Jason. Good

Speaker 10

morning. Good morning. So I guess I want to come back to that question earlier about trying to unpack the impact of the 3 challenged businesses on the U. S. Side of things.

Speaker 10

It looks like it's around $80,000,000 drag. And if we assume 80% of that hit the U. S, which just sounds like that But either way, if we assume 80% of it, then it equates about a 14% drag in your U. S. Personal Care business.

Speaker 10

Your organic sales over there look like they're down around 2016, so even stripping it out, it looks like your organic sales would still be declining in Personal Care despite the robust growth you're talking about with Houston despite the recovering growth you're talking about with Trojan. So can you unpack that a little bit more for us and help us understand underneath the hood of that Personal Care business, what else is weighing on performance right now?

Speaker 1

Yes. We haven't done the math. I mean, you took a swing at the back of the envelope, but we're not prepared to tell you, okay, for international and for the U. S. Business, here we're going to recast what we put in the release by division.

Speaker 2

Yes, I would just add to that. Remember, our order fill is 91% for the quarter, Right, that's a tale of 2 cities. It's probably like 94% for household. It's in the mid-80s for Personal Care. So you're right.

Speaker 2

The bulk of the decline in Personal Care are those 3 businesses. It's FLAWLESS, WATERPIK and vitamins. We still have 4 or 5 key issues on Personal Care that we're trying to solve. And we're not going to go through all that detail, but I'll give you an example, right? The Batiste is growing like crazy, it's doing fantastic.

Speaker 2

We can't meet all the demand. Consumption is up dramatically and there's can shortages out there, right? You hear that in the beer industry as an example. And so aluminum cans, we're trying to add that as quickly as possible to meet that unbelievable demand. Another example would be VMS, not just because the category is down, but our fill level down is lower than we would like because of one key ingredient on one specific SKU.

Speaker 2

So there is some personal care pressure because of fill rates that we expect to largely be behind us as we exit Q4.

Speaker 10

Okay. Okay. And you mentioned the reload of some investment as you go into next year and a normalization or a return to more normal marketing. What does more normal marketing mean? And also incentive comp, is that I imagine it is a headwind as we go into next year.

Speaker 10

Can you give us any context around how incentive comp this year is tracking versus a more normalized level?

Speaker 2

Yes, I would say incentive comp is going to be a headwind next year. We're tracking anywhere between a 30% payout as an example is Probably

Speaker 1

the best ballpark I'd give you.

Speaker 2

And so that will be a headwind next year as we get back up to 1.0 payout would be our expectations. Your first question was on, remind me, Jason.

Speaker 10

Marketing. Matt mentioned that you expect to return to more normal marketing. What does that mean?

Speaker 2

Yes, yes. And I think we'll go to that in February. And we'll be very clear on

Speaker 4

what it is and what

Speaker 2

it means. I think you should expect that it's a stair step over time back to what we think has been our sweet spot in marketing from a historical perspective.

Speaker 10

Got it. Understood. Thanks, guys.

Operator

Thank you. One moment please for our next question. Our next question comes from the line of Andrea Teixeira of JPMorgan. Your line is open.

Speaker 11

Thank you, operator. Good morning, everyone. So So my question is on VMX. Again, I understand this segment, and correct me if I'm wrong, about represents about 10% of sales. And on top of the WATERPIEC and FLAWLESS issues that you discussed, it seems that the issue has been consumption.

Speaker 11

And Obviously, I understand you're comping a very high comparison from last year. But how much of the VMS business is down in the quarter year to date. So and with that, are you worried about if retailers, if there is excise inventory? I know it's a fast moving item, but I was wondering if that can be or if that's embedded in your guidance in the Q4 that there could be some issues with there's stock in there as well, except of course that SKU that is not being served. Thank you.

Speaker 2

Yes. Thanks, Andrea. I think there's 2 core issues with the vitamin portfolio. 1 is the category. That is the overarching and greatest issue.

Speaker 2

And we quoted a little earlier, but 2021 Q3 was 33% growth. And so we're coming off that extreme high. It's coming off a little bit more than we thought, but that's what's been happening these last 13 weeks or so, and we expect that to kind of continue, but inflect a little bit better as we move forward, right, so that's the biggest one. The second one is fill levels and Matt kind of went through that a little bit as well. And we expect that as we exit the year, our fill levels for vitamins will improve.

Speaker 2

So that will help our share. So those are the 2 biggest things. I probably wouldn't give you much more detail than that in terms of how big that try to give you a little bit more granularity this time that, hey, 10% of the business is the discretionary portfolio, FLAWLESS and WATERPIK, and another 10% is this vitamin number, I think the key take home comment though is really 2 parts of it and it's predominantly more the category than a sale level issue.

Speaker 11

That's fair. And then the 80% of the remaining business is probably growing like a mid single.

Speaker 2

Yes, if you do the math, 80% of the rest of the business is growing 4%, 4.5%, which is fantastic.

Speaker 11

Okay. That's helpful. Thank you so much. I'll pass it on.

Operator

Thank you. Our next question comes from the line of Anna Lizzo of Bank of America. Your line is open.

Speaker 12

Hi, good morning and thanks so much for the question. I just wanted to follow-up a little bit on the topic of promotions. We've been hearing from some of your peers that promotions are essentially not really going to return to the same depth as they were pre COVID. So just wondering if you're comfortable here with your frequency and depth of promotions where you are now versus pre COVID? Thanks.

Speaker 1

Yes. I mean, where we are right now, we're winning. So if Some of the numbers I quoted, the category in liquid laundry is 32%, we're at 26%, and we're gaining share. So you're right, it would appear that there's no need for a heat up, but I can't predict what competitors will do in the next 6 months.

Operator

Our next question comes from the line of Olivia Tong of Raymond James. Your line is open.

Speaker 13

Great, thanks. My question is on pricing and promotion, you obviously saw a 1 point sequential acceleration in price mix in Q3, but obviously some pressures on the higher price portion of your portfolio while pricing on the Everyday Consumables. So can you give a little bit of a color on what impact mix had versus price and then perhaps a little bit on domestic household versus personal care? Thanks.

Speaker 2

Yes. I don't have the domestic household versus personal care, I can help you with the price volume mix kind of across time. In Q1, we had 7.8 percent growth in price mix and then we went to 6.2% in Q2 and we said that was largely because of the WATERPIK mix issue. From Q2 to Q3, we bumped back up to 7.8%. And so that new laundry and litter pricing that was really announced in Q2, we had a full quarter impact of that in Q3.

Speaker 2

So that was over weighing any other drag from water picker or whatnot. So then, yes, so that's kind of the sequence of events on some of the drivers of price mix.

Speaker 13

Got it. And then on vitamins, I'm curious your view on what you think vitamin consumption trends will be longer term. You obviously recognize that flu could be a factor near term, still variant of COVID here and there.

Operator

But where do you

Speaker 13

think consumption ultimately ends? I mean, does it get back to where it was? Does it stay above pre COVID levels or does it end up getting back to where it was pre COVID in your view? What are you planning for?

Speaker 1

Look, we were planning on expanding our capacity, right? We've got to put a pause on that, but we do think so long term we're going to need that capacity. The transition from pills and capsules to the gummies is pretty important factor. So if you look at the percentage today, it's 27% of the total VMS category is gummies. And we expect that's going to continue in the future.

Speaker 1

A lot of people discovered the category as a result of COVID. Yes, certainly some people have exited, but not all. So consequently, we think the future is still bright for the business, but we're going to have a kind of a rough ride here at least for the next couple of quarters.

Operator

Thank you. Thank you. Our next question comes from the line of Lauren Lieberman of Barclays. Your line is open.

Speaker 14

Great. Thanks. Good morning.

Speaker 1

Hey, Lauren.

Speaker 14

Hey, so just a few questions. First thing is just gross margin progression, I know, Rick, you mentioned, it's likely a tailwind overall next year. But when I look at kind of this quarter what's implied for 4Q and that you've talked about continued headwind, at least in the first 1st half of the year more or less with some of the more discretionary businesses. It feels like that gross margin progression is still like getting back you're probably not inflecting to up until we get toward the second half of twenty twenty three. I mean, is that fair, just again given the mix dynamics that you've kind of called out on the discretionary side of the business?

Speaker 2

Yes, I'm not ready to give quarterly or first half second half guidance on 2023 yet. I would just say that we're kind get ahead of ourselves talking about 2023 at all. And so we were just trying to give broad brush strokes. And I would tell you the answer as of right now, our visibility is gross margin expands next year and we'll get into all the details, all the bridges that you guys want to in February.

Speaker 14

Okay. And then I wanted to come back again on fill rates, which is it's a question I've just kind of grappled with a couple of times already this year really going back over the last 12 plus months. But fill rates have been improving, as you've said, and that's been an achievement. I understand categories where ability to supply, you'd of course, it makes sense not push on the string in terms of marketing, but you've also said out of stocks haven't been an issue. So I just still don't really understand why improving fill rates is a true tailwind to the business as we move forward, I mean, nothing that you didn't have to fix it and you did, but I just don't understand the tailwind to sales growth that should come from improving fill rates of out of stocks haven't been a problem.

Speaker 2

Yes, I think it's Matt, I'm sure, has some comments too. But overall fill rates, we think being at 98% means that For 2023 means that we're going to be able to match consumption all year long, that we're not going to be able to have to turn down promotions in certain areas because that has happened this year. We've said as much as we would like to, we can't. And I'm not going to go through the different examples of that, but that exists. So that's kind of in the back of my mind what we're talking about too.

Speaker 1

Yes. And when we say out of stocks are a lot better and less of an issue, it's because we finally cracked the low 90s. But we're still leaving money on the table. The out of stocks at 90% is not something we're proud of. And by the way, we're still at it with retailer fines because of our inability to sell, so that's another drag that we have on our gross profit.

Speaker 1

So we definitely do in certain categories have certain SKUs that are problems for us that are creating a drag On our organic sales, Lauren.

Speaker 14

Okay. And final thing was just the SG and A in the quarter, was down a bunch, not terribly different than Last quarter, just anyway, I'm sorry then a year ago, but just curious on the levels of SG and A spending, if there's like an incentive comp reset we should we'll be thinking about presumably that would come next year, but any color on the SG and A piece would be great too.

Speaker 5

Yes, I think that's I kind

Speaker 2

of alluded to it last quarter that we expected SG and A favorability and unfortunately it is because of incentive comp. When you have some of these recessionary pressures on discretionary items, it's It's dragging the whole company below some of the key metrics. And so I just answered Jason and said that our payout was tracking around 30%. And so that's a benefit in the quarter per se and for the year, not the one that we would want, and that we'll have to get we're refunded next

Speaker 14

year. Yes.

Speaker 10

And if you recall,

Speaker 1

Lauren, we have 4 targets annually, right, sales, gross margin, EPS and cash and the last 2 we got a 0 on. So that's what's affecting our incentive comp. As you well know, we know where our EPS is and our cash flow.

Speaker 14

Okay. Thanks so much. I appreciate it.

Speaker 1

Okay.

Operator

Thank you. Our next question comes from the line of Bill Chappell of Tuohy. Your line is open.

Speaker 15

Thanks for squeezing me in. Hey, Bill. A couple of just clarifications, I guess on Jason and Lauren's question. So I assume you accrued for variable comp in the 1st two quarters. Was there a reversal that gave A bigger benefit in the Q3 or will it in the Q4 or is that not the way you look at it normally?

Speaker 2

Yes, you always have to accrue kind of on a year to date basis and we were tracking more favorably in Q1 and Q2. And then as some of these pressures like on inventory, for example, on these discretionary categories impacted cash flow, then we have to adjust the accrual and you could like some of the catch up, year to date catch up in the Q3 accrual as an example. So yes, it's true.

Speaker 1

Yes, it's been coming down all year long, Bill.

Speaker 15

Okay. So there wasn't an outsized like benefit this quarter from the reversal of accrual?

Speaker 1

There was a benefit in Q2 and a benefit in

Speaker 2

And a bigger benefit in Q3 as we've as projections for incentive comp have come down.

Speaker 15

Got it. And then second, and just trying to couple the commentary on the vitamin business, I mean, I understand, I think you said it's starting to stabilize and It's really way up versus kind of 2019 levels, which I appreciate. But at the same point, you said you would put a pause on the CapEx expansion, maybe it was you're lowering your CapEx by $100,000,000 maybe that's too aggressive. But just trying to understand how to put those 2 together, if you think it we're just getting back to normal, why would you kind of tape down CapEx expansion that would probably add capacity 2 years from now?

Speaker 2

Yes. That's a fair question. The nuance is when we were doing all of our capital planning and demand forecasting 12 months ago when we we started that project. It was jumping off of a baseline of this new COVID behavior, assuming all this behavior stuck and all this incremental, whatever, 50% increase from 2019 stuck and there's no decline. So now that we're seeing a decline from that behavior, not all of it going back, but a decline from that behavior, we're just readjusting our baseline and growing from there.

Speaker 2

So when we do that, it doesn't mean that we're going to not do the capacity projects. It just means we need to we can easily pause it for 12 to 18 months. The other

Speaker 1

thing too, Bill, is during COVID times, we had to go outside and get a third party supplier. So we have more flex and our ability to supply today. So that gives us a little more flexibility with timing of the CapEx. Got

Speaker 15

it. Thank you.

Operator

Okay. Thank you. Our next question comes from the line of Jonathan Feeney of Consumer Edge. Your line is open.

Speaker 5

Hey, thanks very much. I just wanted to follow-up on the earlier question about M and A. Obviously, congratulations on how you manage the balance sheet, particularly the I think 2.3% coupon plus December, but marginal funding rates have changed Tremendous amount as I guess, would guess valuations have. So how maybe Rick or Matt, how do you think about M and A differently right now, like have hurdle rates changed? How do we quantify that?

Speaker 5

And has it become on margin a better or worse environment for accretive M and A with those 2 valuations down and funding rates up. Thanks.

Speaker 1

Yes. No, it's a great observation. When you look at where the tenure is right now and where it's going And just look at the change in commercial rates, it's more expensive to fund an acquisition. And we're focused And incremental cash earnings and cash earnings is impacted by interest rates and interest expense. So Yes, that would make it a higher hurdle, as far as at least how we look at deals from a cash earnings standpoint.

Speaker 5

Yes, I would just add

Speaker 2

to that. I actually think it's a net net positive though, like, and it doesn't matter if the interest rate is 2%, 4%, 6%, a good business that we want to own and a brand that's going to be around for 50 years typically is going to generate a lot of cash earnings and most of the time accretion as well. But for those people that are bidding against us, especially private equity, they could not handle a 6% or 7% interest rate.

Speaker 1

Right. Makes a

Speaker 5

lot of sense. Thank you.

Speaker 1

Okay.

Operator

Thank you. Our next question comes from the line of, one moment please, Peter Grom of UBS. Your line is open.

Speaker 16

Good morning, guys. This is Brian Adams on for Peter. Thanks for taking the quick question here.

Speaker 1

Hey, Brian.

Speaker 16

Hey, guys. It sounds as though the updated guide doesn't assume things have gotten much worse incrementally in Europe. I know it's a smaller piece of the business, but I know it's fair to say some of that you were probably contemplating back in September, but just wanted to get a mark to market on the business and how it's performing there and if you're seeing anything in terms of weakening on the part of the consumer since September? Thanks.

Speaker 1

Yes, that's an insightful question. We are worried about the European consumer over the next 6 months and just focus on the effect of heating bills. Now, so you've read about the government support to try to cover some of that.

Speaker 2

But just to give

Speaker 1

you an illustration, like our utility bills in our U. K. Plant are up 80% year over year. So it is something to watch. It's something we've built into our Q4 look, but it is a concern.

Speaker 1

So it's Good observation, Brian. Thanks guys. I'm good. Okay.

Operator

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to Matt Farrell for any closing remarks.

Speaker 1

Okay. Hey, thanks everybody for joining us today and we do look

Operator

today's conference. Thank you all for participating. You may now disconnect. Have a great day.

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Apple Q3 2022
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