Good morning, ladies and gentlemen, and welcome to the Church & 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 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. Thank you, operator. Good morning, everyone. Thanks for joining us today. We've got lots to talk about. I'm going to begin with a review of Q3 results. Then I'll turn the call over to Rick Dierker, our CFO. And when Rick is 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%. 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. And 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 than our EPS outlook, driven by higher international sales, lower SG&A and timing of marketing spend.

The U.S. portfolio grew consumption in 11 of 17 categories. The trade down to value laundry detergent continued as ARM & HAMMER liquid detergent achieved an all-time high market share of 14.3%. The ARM & HAMMER clumping litter, BATISTE dry shampoo and THERABREATH mouthwash also achieved all-time high market shares.

TROJAN condoms returned to share growth and OXICLEAN stain fighters and ARM & 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.

In Q3, our most discretionary brands, WATERPIK and FLAWLESS, which account for approximately 10% of our global sales were impacted by lower customer 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.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. I want to look at a few of the important categories in the U.S., and 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%, premium declined 3%. ARM & HAMMER unit dose also benefited from the trade down.

Our ARM & HAMMER pods grew consumption by 25% in the quarter compared to unit dose category growth of 4.5%. With more consumers migrating to ARM & HAMMER, the long-term benefit to the ARM & HAMMER brand similar to the last recession. In litter, the category grew 11%, while ARM & HAMMER litter grew 14%, so we gained share in the quarter.

Both our black box, which is premium, and our yellow box, which is value, had double-digit consumption growth in Q3. In stain 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 BARESKIN RAW condom and the success of more targeted marketing. 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 of 4.3 points to 17.8% of the alcohol-free mouthwash category. THERABREATH is the #2 nonalcohol mouthwash and the clear #4 brand in total mouthwash. THERABREATH is expected to be a long-term grower for Church & Dwight in the future. ZICAM also delivered strong results this quarter.

You may recall, we acquired ZICAM in December of 2020. ZICAM is the #1 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. And as a reminder, approximately 40% of ZICAM consumption happens in Q4.

We closed on our latest acquisition, Hero, in mid-October. Now 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. 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% organic growth in Q3 2021.

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 #1 brand in water flossers. We continue to see lower dollar consumption for water flossers in the U.S.

However, WATERPIK unit volumes are actually positive both in Q3 and year-to-date as consumers trade down to lower-priced cordless models. If we look back at 2021 and 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.

We continue to invest in demand-driving activities for WATERPIK, such as Lunch & Learns with dentists and hygienists to drive household penetration of flossers. And in 2023, next year, we expect to return to pre-pandemic levels for Lunch & Learns.

Now remember, WATERPIK is the Kleenex of water flossers and 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.S. population flosses every day.

Now looking back, WATERPIK 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 #1 brand in women's health hair removal.

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 Pedi.

And 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. Now finally, over in VMS, we have the #1 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. For the last 3 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 plus 33% increase in the category in Q3 2021. And there is some good news here. In the first 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 long-term appeal of the gummy category.

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

Thank you, Matt, and good morning, everybody. We'll start with EPS. Third 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&A expense and timing of marketing spend. Reported revenue was up 0.4%, including a 1% drag from currency.

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 third quarter gross margin was 41.7%, a 250 basis point decrease from a year ago.

Let me walk you through the Q3 bridge. 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 million year-over-year, although this was a significant increase of $40 million sequentially from our first half 2022 levels of 8% of sales, as our fill rates have improved. Fill 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.

We expect continued increase in marketing spend in Q4 to approximately 13% of net sales. For SG&A, Q3 adjusted SG&A decreased 30 basis points year-over-year. Other expense all-in was $19.4 million, a $7.3 million 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% a year ago. And now to cash. For the first 9 months of 2022, cash from operating activities decreased $119.5 million to $534 million 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 million. Looking ahead to Q4, we expect reported sales growth of approximately 2%, organic sales decline of approximately 1% and gross margin contraction.

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 a 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. 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 million.

And our full year CapEx plan is now approximately $170 million 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 fill levels continue to improve.

And with that, Matt and I would be happy to take any questions..

[Operator Instructions]. Our first question comes from the line of Dara Mohsenian of Morgan Stanley..

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

Yes. Dara, it's Rick. I'll take the margin mix, and Matt will take the vitamin question. So really, the change in the outlook is pretty straightforward. It is -- we didn't change the 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.

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..

Yes. With respect to vitamins, as you heard in my opening remarks, we've lost some share due to fill rates. So we had lost some consumers to brands earlier in the year. So we got to win them back. And there's definitely fewer households purchasing.

Your question is, , is can we call the bottom? And do we know that all the consumers who are leaving the category have left? Obviously, not knowable. I will say that the coming flu season actually should bolster the VMS category, just beyond COVID because we haven't had a weaker flu season for a few years.

But we -- 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 fourth quarter that, at least early in the fourth quarter, 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..

Our next question comes from the line of Chris Carey of Wells Fargo..

I'm trying to determine how much of WATERPIK, FLAWLESS, Vitamin pressure impacted your consumer domestic versus your international segment. You've previously given some perspective on geographic mix of these businesses. I wonder if you can update us on the U.S. versus non-U.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 frequencies were neutral growth. Obviously, you gave the 6% headwind, which is quite helpful. I'm wondering how that looks out between your reporting regions..

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.S., is even more -- FLAWLESS 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. versus international and more skewed towards the U.S. for FLAWLESS..

Yes. And I would only add to that, that 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 3 businesses were about a 6% headwind. And as Matt said, our divisions are usually 80-20 split, but WATERPIK is probably more 50-50.

But I don't think we'll get any more granularity, but we had a 6% headwind in the quarter..

Yes. And Chris, the reason we called that out in 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 a weakening consumer, weakening economy..

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 what the growth started to come off? And then can you just confirm whether you're seeing any sequential worsening or you expect stabilization and this is really just about getting beyond tough comps..

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 FLAWLESS 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, et cetera. But we think after that, things are going to even out. ..

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 about the color we'd give you..

Our next question comes from the line of Kaumil Gajrawala of Credit Suisse..

Can you maybe talk a little bit about -- and you alluded to some of this, but how are you balancing between how much to advertise versus how much CapEx to put it on the vitamin side versus this uncertainty of demand? Because 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?.

I'll start with CapEx and then maybe Matt can end up on the consumer. So -- and I'll talk about demand a little bit, too. So on CapEx, for example, we had said for 2023, we're going to have about $300 million of CapEx, a step-up, and that was laundries, 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 million and $270 million. We'll finalize that when we give our full 2023 outlook. So that's on the CapEx side..

Yes. 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. And that amped up in Q3 where it's 10.7%.

And you can -- you 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 fill rates become more normal, the marketing spend will also return to a normal rate..

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. So on a stacked basis, it's up 25%.

So it's not like the category is cratering, I think it's just coming back in line with a super high growth relative to the pre-COVID levels..

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

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?.

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 it in liquid laundry detergent. We're seeing it 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 the value, and I'm sure your comment about supply does not extend to all liquid laundry, pods, Scent Boosters every aspect of laundry, so we're seeing it in so many subcategories within laundry.

It's weak concluded. It's real and it will continue..

Our next question comes from the line of Stephen Powers of Deutsche Bank..

I guess there's -- as I listened to you, in the third quarter, you had both like demand degradation for sure in FLAWLESS and WATERPIK and Vitamins as well as 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?.

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. 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..

Yes. As far as inventory in the channel, Steve, it's -- that's more -- the focus here is more on WATERPIK and FLAWLESS. And that's why we think for the next, say, 6 to 8 months, I think it's going to be choppier for those 2 brands. But we don't have worries about ship to consumption with respect to the rest of the business..

Okay. Okay. And then you talked about marketing into next year.

Could you give us an update on whether or not you've layered on any coverage on the cost side of things into '23 at this point? And if so, how much? And I guess just in broad brush strokes, do you want -- also walking away from this call thinking that Evergreen is a table for next year? Or is that too ambitious?.

We have a range for Q4. You're asking us for a commentary on 2023. So there are pluses and minuses when you think about the 2023. So the majority of our business is doing well. 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 really for the next 90 days where 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. So obviously, we expect that to continue for the next 12 months.

Going the other way, we all -- everybody is dealing with higher interest rates and FX, so that's a drag. And then obviously, if we're going to reinflate our marketing spend in 2023, so -- there may be a couple of other pluses or minuses.

Rick, anything else you want to throw in there?.

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 a lot of puts and takes. We're not ready to call 2023 yet. We'll do that in 3 more months.

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

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

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?.

That's a good question. So usually, 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.

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

Yes. 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 call 2023..

Our next question comes from Nik Modi of RBC..

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 XTRA 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. And then I had a question on FLAWLESS..

Yes. Well, as far as households, losing households, that's -- that's not something that's been a topic for discussion here as far as people -- less people doing wash loads. So I can't go any further on that. As far as XTRA goes, yes, we've been prioritizing ARM & HAMMER over XTRA for the past 18 to 24 months just because of the fill rate issues.

That's behind us now. But we are expecting that in 2023, XTRA could clearly be a winner as that's our deep value detergent. 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, Nik, on FLAWLESS..

Yes, FLAWLESS, just this kind of euthanizing the brand from the older consumer to the younger consumer. I'm curious 20 years of covering this space, when any time 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?.

No. I would say that 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..

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 -- their fill rates obviously have been recovering. I'm just curious if you've seen any of that happening around in the categories you guys operate in..

Nik, it's Rick. I'll take it. Early in the quarter, we talked about that. We gave a bit of 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, it was multiple categories. And so that was implicitly already in our minus 1 outlook.

And so we saw that early in the quarter. But after we got through that, we didn't really see it any further..

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

Our next question comes from the line of Kevin Grundy of Jefferies..

Question for both 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 margins still under quite a bit of pressure, a lot of commodity inflation in the P&L, that should start to subside.

We're seeing some of that and pricing is start 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 differences 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.

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

Yes. 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 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 down year-over-year. So I still think that the category spend, the promotional environment, is still lower than it has been historically. 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..

Got it. Quick follow-up, just on M&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? So your thoughts there would be helpful, and then I'll pass it on..

Yes. Well, it's important to remember, when we acquire businesses, go back to THERABREATH, for example. We didn't take a whole lot of employees from THERABREATH. And we already have an oral care business, right? So oral care business handles toothbrushes, toothpaste. It's ORAJEL. So we're already in the category dealing with the same buyers.

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 that 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. 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..

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..

Our next question comes from the line of Rupesh Parikh of Oppenheimer & Co..

So on the inventory front, inventories were up 22%.

Do you guys see any risk of obsolescence or markdowns with higher inventory levels?.

Yes. Rupesh, it's Rick. Yes, it's a fair question. I'd say 2 things. One, we expect inventories to get back in line over the next 12 months is what I said in my prepared remarks, right? We've adjusted production levels for some of those long-lead devices we source 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..

Okay. Great. And then, Rick, on the gross margin, I know you guys called out the mix shift 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?.

Yes. I mean I kind of went through the bridge a 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 it all year long. And so now we're seeing contraction.

I would just say that we think it's going to contract slightly. 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 is a little bit lower baseline. But I mean, there are a couple of puts and takes..

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

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. It looks like it's around $80 million drag. And if we assume 80% of that hit the U.S., which just sounds like that actually may be high given the water back -- WATERPIK [Technical Difficulty].

But either way, if we assume 80% of it, then it equates to about a 14% drag in your U.S. personal care business. Organic sales over there look like they're down around 16%.

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 BATISTE and 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?.

Yes. We're -- we haven't done the math. I mean you took a swing out of 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..

Yes. I would just add to that. Remember, our order fill is 91% for the quarter, right? It'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, 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? BATISTE is growing like -- it's doing fantastic, 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. But 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. So there is some personal care pressure because of fill rates that we expect to largely be behind us as we exit Q4..

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 market you mean? And also, incentive comp, is that -- I imagine it is a headwind as we go into next year.

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

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. It's probably the best ballpark I'd give you. 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..

Marketing, marketing. Matt mentioned that you would expect to return to more normal marketing. My question was what does that mean? ..

Yes, yes. And I think we'll go through that in February. We'll be very clear on what it is and what it means. I think you should expect that it's a stairstep over time back to what we think has been our sweet spot in marketing from a historical perspective..

Our next question comes from the line of Andrea Teixeira of JPMorgan..

So my question is on VMS. Again, I understand this segment, and correct me if I'm wrong, about -- represents about 10% of sales. And on top of the WATERPIK and FLAWLESS issues that you discussed, it seems that the issue has been consumption, and I obviously understand you're comping a very high comparison from last year.

But how much of the VMS business is down in the quarter and year-to-date? So -- and with that, are you worried about if retailers, if there is excess inventory? I know it's a fast-moving item, but I was just wondering if that can be -- or if that's embedded in your guidance in the fourth quarter, that there could be some issues with destocking there as well, except, of course, that SKU that is not being served..

Yes. Thanks, Andrea. I think -- there's 2 core issues with the vitamin portfolio. One is the category, that is the overarching and greatest issue. And we quoted a little earlier about 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 in these last 13 weeks or so. And we expect that to kind of intend you 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, 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 -- we try to give you a little bit more granularity at 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 of the category than a fill level issue..

No, that's fair. And then the 80% of the remaining business is probably growing like a mid-single..

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

Our next question comes from the line of Anna Lizzul of Bank of America..

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?.

Yes. I mean, where we are right now, we're winning. So 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..

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

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 color on what impact mix had versus price? And then perhaps a little bit on domestic household versus personal care..

Yes. I don't have the domestic household versus personal care in front of me, but I can help you with the price/volume mix kind of across time. In Q1, we had 7.8% 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 year -- full quarter impact of that in Q3. So that was overweighing any other drag from WATERPIK or whatnot. So then -- yes, so that's kind of the sequence of events on some of the drivers of price mix..

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

But where do you 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?.

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 a 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. And 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..

Our next question comes from the line of Lauren Lieberman of Barclays..

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 half -- first half of the year, more or less, in 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 '23.

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..

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 of getting 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..

Okay. And then I wanted to come back again on fill rates, which is -- it's a question of 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, of course it makes sense to 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, not saying that you didn't have to fix it and you did. But I just want to understand the tailwind to sales growth that should come from improving fill rates if out-of-stocks haven't been a problem..

Yes. I think it's -- Matt, I'm sure I have 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 when we're talking about fill..

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 still leave money on the table. The out-of-stocks being at 90% is not something we're proud of. And by the way, we still get it with retailer funds because of our inability to fill.

So that's another drag that we have on our gross profit. 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..

Okay. And final thing was just the SG&A in the quarter. It was down a bunch, not terribly different than last quarter. But just anyway -- I'm sorry, than a year ago. But just curious on the levels of SG&A spending, if there's like an incentive comp reset we should be thinking about, but presumably that would come next year.

But any color on the SG&A piece would be great, too..

Yes, I think that's kind of alluded to at last quarter, that we expected SG&A favorability. And fortunately it is because of incentive comp. When you have some of these recessionary pressures on discretionary items, 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 refunded next year..

If you recall, 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, where our EPS is and our cash flow..

Our next question comes from the line of Bill Chappell of Truist..

A couple of just clarifications, I guess, on Jason's and Lauren's questions. So I assume you accrued for variable comp in the first 2 quarters.

Was there a reversal that give a bigger benefit in the third quarter? Or will it in the fourth quarter? Or is that not the way you look at it normally?.

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 get like some of the catch-up, year-to-date catch-up in the Q3 accrual, as an example. So yes, that's true..

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

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

There was a benefit in Q2 and a benefit in Q3..

And a bigger benefit in Q3 as we -- as projections, for instance, comps have come down..

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 million, and maybe that's too aggressive. But just trying to understand how to put those 2 together.

If you think 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?.

Yes. No, it's a fair question. The nuance is when we were doing all of our capital planning and demand forecasting 12 months ago, when we started that project, it was jumping off of a baseline of this new COVID behavior, assuming all this behavior is stuck and all this incremental, whatever, 50% increase from 2019 stuck, there's no decline.

And 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.

So when we do that, it doesn't mean that we're going to not do the capacity project, it just means we need to -- we can easily pause it for 12 to 18 months, and that's what we plan on doing..

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

Our next question comes from the line of Jonathan Feeney of Consumer Edge..

I just wanted to follow up on earlier question about M&A. Obviously, congratulations on how you managed the balance sheet, particularly the, I think, 2.3% coupon , but marginal funding rates have changed a tremendous amount, as I guess, I would guess valuations have.

So how -- maybe Rick or Matt, how do you think about M&A differently right now? Like have hurdle rates changed? How do we quantify that? And has it become on margin a better or worse environment for accretive M&A with those 2 valuations down and funding rates up?.

No, it's a great observation. We look at where the tenure is right now and where it's going and just to look at the change in commercial rates, it's more expensive to fund an acquisition. And we're focused on 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..

Yes. And I would just add 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 6% or 7% interest rate..

Our next question comes from the line of Peter Grom of UBS..

This is Bryan Adams on for Peter. 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 I 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..

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. I'm sure you've read about the government support to try to cover some of that. But just to give 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. So it's a good observation, Bryan..

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..

Okay. Thanks, everybody, for joining us today, and we do look forward to talking to everybody about 2023. So thanks for joining us..

Thank you. Ladies and gentlemen, that concludes today's conference. Thank you all participating. You may now disconnect. Have a great day..